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OF  CALIFORNIA 

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Federal  Income  Tax 


INCLUDING  ALSO 

War  Profits,  Excess  Profits,  Stamp,  Capital 
Stock  and  Child  Labor  Taxes 


BY 

GEORGE   E.   HOLMES 

of  the  New  York  Bar 


IBZ2  amnn 


INDIANAPOLIS 

THE  BOBBS-MERRILL  COMPANY 

PUBLISHERS 


Hndsy-P 

97.2 


Copyright, 

1920 

By  George  E. 

Holmes 

15  William  St., 

New  York 

Copyright, 

1921 

By  George  E. 

Holmes 

15  William  St., 

New  York 

Copyright, 

1922 

By  The  Bobbs-Merrill  Company 

Book  waiter  Ball-Greathouse 

Printing  Company 

Indianapolis 


PREFACE 


Much  of  the  criticism  leveled  at  the  Revenue  Act  of  1918  was 
inspired  by  the  high  tax  rates.  The  inequalities  and  shortcom- 
ings of  the  Act  were  brought  into  high  relief  because  of  the  heavy 
tax  burden  resulting  therefrom.  As  compared  with  any  previous 
law,  however,  the  Revenue  Act  of  1918  was  a  clear,  definite,  com- 
prehensive and  equitable  tax  statute.  Credit  should  be  given  for 
the  insight  and  prevision  which  dictated  the  general  scheme  of 
the  law  and  devised  the  remedial  provisions  of  the  Act  which 
have  saved  many  a  taxpayer  from  hardship  and  disaster.  Sev- 
eral of  the  new  provisions  contained  in  the  Revenue  Act  of  1921 
are  a  further  step  in  the  same  direction. 

The  most  violent  criticism  of  the  Revenue  Act  of  1918  was 
directed  against  the  war-profits  and  excess-profits  taxes— neces- 
sary evils  brought  about  by  the  financial  exigencies  of  the  closing 
year  of  the  war.  The  repeal  of  these  taxes  has  been  advocated 
by  many  public  bodies  and  by  two  Secretaries  of  the  Treasury. 
Nevertheless,  Congress  saw  fit  to  continue  the  excess-profits  tax 
for  the  year  1921,  an  action  the  wisdom  or  unwisdom  of  which 
will  be  shown  by  the  statistics  of  revenue  receipts  for  the  past 
year. 

Except  for  the  repeal  of  the  excess-profits  tax  law,  the  Reve- 
nue Act  of  1921  is  in  large  part  a  re-enactment  of  the  1918  Law. 
It  follows  closely  the  structure  and  arrangement  of  that  law,  as 
may  be  seen  from  the  fact  that  in  general  the  section  numbering 
of  the  former  statute  is  preserved  in  the  new  one— a  considerable 
aid  to  those  who  must  become  familiar  with  the  new  law.     Yet 
many  changes  have  been  made  and  many  new  provisions  intro- 
duced.   Some  provisions  are  merely  nominal  amendments,  others 
are   a   statutory   recognition    of   departmental    regulations   and 
practice,  or  are  founded  upon  recent  court  decisions  or  constitu- 
tional doubts  as  to  previous  statutory  provisions  and  regulations. 
Some  modifications  are  directed  against  possible  evasion  of  tax. 
Other  changes,  and  perhaps  the  most  important,  are  remedial 
m  their  nature,  chief  among  which  are  those  which  release  capi- 
tal transactions  from  the  inhibitions  heretofore  imposed  by  un- 
wise taxation.     Many  provisions  recognize  the  disturbed  busi- 
ness conditions  confronting  the  country  in  this  post-war  period. 
The  Avhole  statute  reflects  the  valuable  experience  gained,  both 


111 


iv  PREFACE 

by  the  Treasury  Department  and  taxpayer,  in  dealing  with  prob- 
lems of  taxation  during  the  past  five  years. 

The  new  statute  is  not  a  simple  one,  nor  can  a  simple  statute 
be  devised  to  cover  so  complex  a  subject  as  income  taxation 
applied  to  all  the  varied  activities  of  a  great  nation  like  ours. 
It  is,  however,  another  great  step  forward  in  the  development 
of  our  system  of  income  taxation.  Few  taxpayers  are  aware  of 
the  hard  and  unceasing  work  to  this  end  that  has  been  done  by 
many  able  and  public-spirited  men.  Of  these  Dr.  T.  S.  Adams 
is  a  notable  example.  To  his  untiring  efforts  as  special  adviser 
to  the  Treasury  Department  may  be  ascribed  many  of  the  im- 
provements in  the  law. 

Unfortunately,  every  new  law  creates  new  problems  of  inter- 
pretation and  application.  Years  of  experience  with  the  1918 
Law  were  beginning  to  familiarize  both  government  and  tax- 
payer with  its  more  obscure  provisions ;  the  meaning  of  that  law 
was  becoming  constantly  more  settled  and  certain ;  and  many  of 
its  complexities  were  being  simplified  in  the  daily  round  of  ad- 
ministration. Much  of  the  ambiguity  and  obscurity  of  the  new 
law  can  be  clarified  only  as  concrete  problems  are  presented  in 
the  administration  of  the  law.  Much  of  it  is  apparent  now  and 
will  be  resolved,  it  is  to  be  hoped,  by  a  liberal  interpretative 
attitude  on  the  part  of  the  Treasury  Department,  having  due 
regard,  wherever  possible,  to  the  spirit  as  well  as  the  strict  letter 
of  the  statute. 

It  is  to  be  remembered,  however,  that  the  Treasury  Depart- 
ment is  not  a  judicial  body — the  purpose  of  its  existence  is  to 
collect  revenue.  Its  rulings  may  work  hardship  on  occasion,  but 
frequently  such  rulings  are  inevitable  under  the  statute  from 
which  alone  the  department  derives  authority  to  make  regula- 
tions. The  ultimate  remedy  in  such  cases  is  to  improve  the 
statute  by  amendment — a  matter  to  which  the  taxpayer  gives 
too  little  thoughtful  attention.  Moreover,  the  first  and  gen- 
eral rulings  must  construe  the  law  more  narrowly  than  the 
construction  which  may  be  possible  in  specific  cases.  If  a  broad 
construction  were  indulged  in  generally,  no  taxpayer  would  ever 
call  attention  to  the  cases  in  which  revenue  was  allowed  to  es- 
cape. This  does  not  mean  that  a  taxpayer  is  deprived  of  the 
right  to  protest  when  he  feels  that  the  administration  of  the 
law  operates  unfairly  in  his  particular  case.  The  present  statute 
is  more  explicit  than  any  previous  law  in  making  provision  that 
he  may  do  so.  This  is  perhaps  the  only  practicable  method  by 
which  the  conscientious  taxpayer  may  avoid  being  penalized  by 


PREFACE  V 

rulings,  the  general  purpose  of  which  is  to  prevent  the  evasion 
of  taxes  by  citizens  who  will  not  scruple  to  evade  taxes  by  every 
means  at  their  disposal. 

One  of  the  most  difficult  problems  confronting  us  in  this  criti- 
cal period  of  readjustment  is  presented  by  the  fact  that  the  set- 
tlement of  tax  cases  has  lagged  so  far  behind.    Many  substantial 

1917  taxes  remain  undetermined,  and  taxes  for  1918,  1919  and 
1920  are  in  the  year  1922  an  unknown  quantity  in  thousands  of 
cases.  This  is  said  in  no  critical  spirit;  it  has  been  to  a  large 
extent  unavoidable,  when  the  true  magnitude  of  the  task  im- 
posed on  the  Treasury  Department  is  considered.  Indeed,  the 
confusion  and  uncertainty  might  have  been  far  worse — and  even 
irremediable — but  for  the  skill  with  which  the  1918  Law  was 
drafted  and  the  painstaking  attitude  and  conscientious  manner 
with  which  the  task  of  interpretation  and  administration  has 
been  approached  and  handled.  But  the  fact  remains  that  thou- 
sands of  cases  arising  under  previous  statutes  remain  unsettled, 
and  the  permanent  and  final  readjustment  of  the  business  affairs 
of  the  country  is  hampered  by  delay  in  the  audit  of  returns  under 
these  preceding  laws  and  the  settlement  of  back  taxes. 

The  purpose  of  this  volume  is  to  facilitate  the  early  determina- 
tion of  cases  arising  under  preceding  laws,  as  well  as  to  assist 
to  an  understanding  of  the  statute  which  has  just  been  passed, 
and  pursuant  to  which  returns  for  the  year  1921  must  soon  be 
filed.  No  adequate  understanding  of  this  new  statute  may  be 
had  independently  of  the  statute  it  replaced,  and  even  where  the 
discussion  in  this  volume  is  confined  to  the  provisions  of  the 

1918  or  preceding  laws,  or  the  regulations  issued  thereunder,  it 
is  believed  that  light  will  be  thrown  upon  the  meaning  of  the 
present  law  by  such  a  revelation  of  the  evil  intended  to  be  cor- 
rected by  a  given  provision  of  the  present  law  and  by  the  history, 
development  and  evolution  of  doubtful  provisions. 

Although  this  volume  discusses  many  rulings  issued  under  the 
present  law,  it  does  not  contain  the  new  regulations  (corre- 
sponding to  Regulations  45)  presently  to  be  issued.  This  is  im- 
possible if  the  volume  is  to  be  available  early  in  1922.  The  at- 
tempt is  made,  however,  to  indicate  throughout  the  book  the 
respects  in  which  the  rulings  and  regulations  issued  under  the 
1918  Law  will  necessarily  be  modified,  as  well  as  the  rulings  and 
regulations  issued  under  that  law  which  ought  to  be  substantially 
re-enacted.  Many  references  to  and  quotations  from  Congres- 
sional Committee  reports,  throwing  light  on  the  interpretation 
of  the  new  law,  will  also  be  found.     All  decisions  contained  in 


VI  PREFACE 

the  weekly  Treasury  Bulletins  issued  in  1921  through  number  49 
have  been  included  in  this  volume,  unless  in  the  opinion  of  the 
author  they  contribute  nothing  to  the  solution  of  any  question 
other  than  the  one  involved.  These  Treasury  Bulletins  are  re- 
ferred to  by  the  abbreviation  "T,  B."  References  to  the  Bulle- 
tins also  indicate  the  nature  of  the  decision  cited  by  the  same 
abbreviations  used  in  the  Bulletins,  which  are  as  follows:  "A. 
R.  M."  (Committee  on  Appeals  and  Review  Memorandum), 
"A.  R.  R."  (Committee  on  Appeals  and  Review  Recommenda- 
tion), "Mim."  (Mimeograph  Letter),  "O."  or  "L.  0."  (Solicitor's 
Law  Opinion),  "O.  D."  (Office  Decision),  "Op.  A.  G."  (Opinion 
of  Attorney-General),  "S."  (Solicitor's  Memorandum),  "Sol. 
Op."  (Solicitor's  Opinion),  "T.  B.  M."  (Advisory  Tax  Board 
Memorandum),  "T.  B.  R."  (Advisory  Tax  Board  Recommenda- 
tion) and  "T.  D."  (Treasury  Decision).  The  Income  Tax  Serv- 
ice and  the  War  Tax  Service  issued  by  the  Corporation  Trust 
Company  of  New  York  have  again  been  referred  to  as  sources 
of  information.  Where  possible,  reference  has  been  to  the  latest 
of  such  services.  The  services  are  so  widely  known  and  so  gen- 
erally recognized  that  no  explanation  need  be  given  for  their  use. 
They  are  cited  "L  T.  S."  and  "W.  T.  S.,"  respectively,  in  the 
footnotes. 

The  author  has  had  the  pleasure  of  association  with  many 
officials,  collectors,  and  inspectors  of  the  Treasury  Department, 
and  has  found  them,  with  rare  exceptions,  intelligent,  fair 
minded  and  just  in  their  dealings  with  the  taxpayer.  Differences 
of  opinion  as  to  the  application,  effect  and  interpretation  of  the 
law  have  necessarily  arisen,  and  in  such  cases  the  Treasury 
Department  has  uniformly  stood  ready  to  afford  the  taxpayer 
full  opportunity  to  express  his  views  and  arguments.  Where 
agreement  with  such  views  and  arguments  has  not  been  possible, 
it  has  been  because  such  officials  have  felt  themselves  bound  by 
their  understanding  of  the  law,  even  though  they  might  recog- 
nize the  justice  of  the  taxpayer's  contentions.  In  his  association 
with  such  officials  the  author  has  observed  on  their  part  a  sincere 
interest  in  the  development  and  improvement  of  administrative 
rulings,  which  are  scarcely  less  important  than  the  statute  itself. 
For  this  reason  the  author  has  frequently  commented  upon  vari- 
ous rulings  and  regulations  in  instances  when  his  opinion  differs 
from  that  expressed  in  a  given  ruling  or  regulation.  This  com- 
ment is  intended  as  constructive  criticism,  in  the  hope  that  it 
may  contribute  to  the  difficult  task  of  interpretation  and  admin- 
istration. Criticisms  on  the  shortcomings  of  this  book  and  sug- 
gestions for  its  improvement  will  be  gratefully  received. 


PREFACE  vii 

The  author's  thanks  are  again  extended  to  the  many  friends 
who  have  given  him  helpful  suggestions  and  criticisms,  particu- 
larly to  Mr.  Harrison  B.  Spaulding,  to  Mr.  Randolph  E.  Paul, 
of  the  New  York  and  New  Jersey  bars,  and  to  Mr.  Valentine  B. 
Havens,  of  the  New  York  bar,  for  their  assistance  in  preparing 
the  manuscript.  The  assistance  of  Mr.  John  F.  McCarthy,  of 
the  New  York  Law  Institute,  in  checking  citations  is  also  grate- 
folly  acknowledged. 

George  E.  Holmes. 

New  York,  January  2,  1922. 


CONTENTS 


CHAPTER  1. 

INTRODUCTION, 


Preceding  Federal  Laws — Administration  of  the  Laws — Advisory  Tax 
Board — Committee  on  Appeals  and  Review — Tax  Simplification 
Board — Rulings  and  Regulations — United  States  and  Possessions — 
Porto  Rico  and  the  Philippines — Gross  and  Net  Income — Individ- 
uals— Normal  Tax — Surtax — Corporation  Tax — Personal  Service 
Corporations — Partnerships — Collection  at  Source— Information  at 
Source — Payment  of  Tax — Abatement  and  Refund 1 

CHAPTER  2. 

THE   INCOME   TAX    RATES. 

Normal  Tax — Surtax — Limitations — Comparative  Statements  of  Rates 
—Surtax  on  Stockholders  in  Respect  of  Undistributed  Profits  of 
Corporations — Unreasonable  Accumulation  of  Profits 20 

CHAPTER  3. 

INDIVIDUALS  TO  WHOM  THE  LAW  IS  APPLICABLE. 

Persons  Exempt  from  Tax — Citizens  of  the  United  States— Aliens  Re- 
siding in  the  United  States — Nonresident  Aliens — Possessions  of  the 
United  States — Husband  and  Wife — Community  Property — Minors 
— Incompetents — Agents — Fiduciaries — Persons  Dying  During  Year       35 

CHAPTER  4. 

NONRESIDENT    ALIENS. 

Who  Is  a  Nonresident  Alien — Alien  Seamen — Citizens  Treated  as 
Nonresident  Aliens — Extent  to  Which  Nonresident  Aliens  Are  Tax- 
able— Income  from  Sources  Within  the  United  States — Deductions 
Allowed — Credits — Returns — Paying  the  Tax — Abatement  and  Re- 
fund          54 

CHAPTER  5. 

RESIDENT   AGENTS    FOR   NONRESIDENT   ALIENS   AND   FOREIGN 
CORPORATIONS — NOMINAL   STOCKHOLDERS. 

Lack  of  Authority  for  Rulings — Distinction  Between  Withholding  and 
Resident  Agents — Duties  and  Liabilities  of  Resident  Agents — Pro- 
cedure in  Collecting  Income — Returns  for  Nonresident  Principal — 
Paying  the  Tax — Nominal  Stockholders 88 

ix 


X  CONTENTS 

CHAPTER  6. 
FIDUCIARIES. 

Trusts  Created  by  Employers — Definitions — Duties  of  Fiduciaries- 
Income  of  Estates  and  Trusts — Deductions — Credits — Distribution  of 
Income  of  Trust  Estates — Distributable  Income — Undistributed  In- 
come— Estates  and  Trusts  Which  Can  Not  Be  Treated  as  a  Unit — 
Returns — Returns  by  Fiduciaries— Returns  for  Beneficiaries — In- 
come to  Be  Reported  by  Beneficiaries — Returns  of  Administrators 
and  Executors — Withholding-  at  the  Source — Foreign  Fiduciaries...      102 

CHAPTER  7. 

FARMERS. 

Definition — Gentlemen  Farmers — Inventories — Income — Deductions — 
Returns — Payment  of  Tax 152 

CHAPTER  8. 

PARTNERSHIPS. 

Domestic  and  Foreign  Partnerships — Limited  Partnerships — General 
Partnerships — Partnerships  Consisting-  of  Corporations — Partner- 
ships Operating  Abi'oad — Procedure  in  Collecting  and  Paying  Out 
Income — Net  Income — Distribution  of  Partnership  Profits — Profits 
to  Be  Reported  by  Partners — Fiscal  Year — Net  Losses — Profits 
Earned  Prior  to  March  1,  1913 — Returns — Foreign  Partnerships...      166 

CHAPTER  9 

PERSONAL  SERVICE  CORPORATIONS. 

Definition — Examples — Dividends  of  Personal  Service  Corporations — 
Returns — Distributive  Shares  of  Stockholders — Credits  Allowed 
Stockholders — Procedure  in  Claiming  Personal  Service  Status — 
Corporation  Formed  to  Evade  the  Surtaxes — Alternative  Retro- 
active Tax  on  Personal  Service  Corporations 194 

CHAPTER  10. 

CORPORATIONS. 

Definition — Incorporation  of  Individual  or  Partnership  Business — • 
Doctrine  of  Corporate  Entity — Residence — Gross  Income — Deduc- 
tions— Sale  and  Retirement  of  Bonds — Credits  Against  Net  Income 
— Credits  Against  Tax — Fiscal  Year — Returns — Consolidated  Re- 
turns— Affiliated  Corporations — Special  Returns — Payment  of  Tax — 
Abatement  and  Refund — Withholding  the  Tax  at  the  Source — Trans- 
portation Systems — Telephone  Companies 209 

CHAPTER  11. 

SPECIAL  PROVISIONS  APPLYING  TO   INSURANCE  COMPANIES. 

Domestic  Life  Insurance  Companies  Under  1921  Law — Foreign  Life 
Insurance  Companies  Under  1921  Law — Insurance  Companies  Other 
than    Life    and    Mutual    Insurance    Companies    Under    1921    Law — 


CONTENTS  Xi 

Comparison  of   1921   and   1918   Laws — Insurance   Companies   Under 
1918  Law — Returns — Foreign   Insurance   Companies — Expenses.  .  .  .      274. 

CHAPTER  12. 

FOREIGN   CORPORATIONS. 

Definition — Companies  Exempt  from  and  Subject  to  Tax — Income 
from  Sources  Within  the  United  States — Deductions — Items  Not  De- 
ductible— Credits — Collection  of  the  Tax  at  the  Source — Returns — 
Domestic  Corporations  Which  Are  Taxable  Only  on  Income  from 
Sources  Within  United  States — Foreign  Governments 297 

CHAPTER  13. 

EXEMPT  CORPORATIONS. 

Foreign  Corporations — Limitation  of  Exemption — Where  Question 
Exists — Proof  of  Right  to  Exemption — Labor,  Agricultural  and  Hor- 
ticultural Organizations — Mutual  Savings  Banks— Fraternal  Bene- 
ficiary Societies — Domestic  Building  and  Loan  Associations  and  Co- 
operative Banks^Cemetery  Companies — Religious,  Charitable,  Sci- 
entific, Literary  and  Educational  Corporations — Business  Associa- 
tions— Civic  Organizations — Clubs — Mutual  or  Co-operative  Organi- 
zations of  a  Local  Character — Associations  for  Marketing  Produce 
and  Purchasing  Supplies — Corporations  Owned  by  Exempt  Corpo- 
rations— Federal  Land  Banks  and  National  Farm  Loan  Associa- 
tions— Personal  Service  Corporations— Joint  Stock  Land  Banks.  .  .  .     312 

CHAPTER  14. 

INCOME IN  GENERAL. 

What  Constitutes  Income — Income  Actually  Received— Income  Con- 
structively Received — Income  Accrued — Income  Received  in  Kind — 
Income  Received  in  Equivalent  of  Cash — Income  Received  in  the 
Form  of  Notes — Gross  Receipts  and  Gross  Income — Exempt  Income — 
Net  Income — Net  Income  Subject  to  Normal  Tax — Income  of  States 
and  Political  Subdivisions  Thereof — Foreign  Exchange 339 

CHAPTER  15. 

INCOME    FROM    PERSONAL    SERVICES. 

Salaries — Bonuses  and  Profit  Sharing — Commissions— Insurance  Pre- 
miums Paid  for  Employees — Services  in  Cancellation  of  Indebted- 
ness— Voluntary  Off'erings  Received  by  Clergymen — Rewards — Com- 
pensation Paid  Other  than  in  Cash — Services  Rendered  Prior  to 
March  1,  1913 — Compensation  for  Services  Extending  Over  a  Year 
— Compensation  to  Federal  Government  Officers  and  Employees, 
Federal  Judges,  the  President  of  the  United  States,  State  Employees     364 

CHAPTER  16. 

INCOME    FROM    BUSINESS,    TRADE    OR   COMMERCE. 

Gross  Income  from  Business — Contractors— Export  Business— Dis- 
counts— Manufacturers  Selling  on  the  Coupon  System — Inventories     385 


xii  CONTENTS 

CHAPTER  17. 

INCOME  FROM   SALES  OR  DEALINGS  IN   PROPERTY;   QUASI  CAPITAL  TRANSACTIONS. 

Taxation  of  Capital  Gains — Exchange  of  Property  Held  for  Invest- 
ment or  for  Productive  Use — Basis  for  Determining  Gain  or  Loss 
from  Sale — Cost  of  Property — Selling  Price — Market  Value — Proof 
of  Market  Value — Proof  of  Value  of  Intangible  Property — Exchanges 
for  Different  Kinds  of  Property — Organization,  Reorganization, 
Merger  and  Consolidation  of  Corporations  Under  1921  Law — Under 
1918  Law — Exchange  of  Property  for  Stock — Property  Acquired  by 
Bequest,  Devise,  or  Inheritance — Property  Acquired  by  Gift — Sales 
and  Dealings  in  Bonds — Insurance  Policies — Sales  of  Property  In- 
volving Installment  and  Deferred  Payments 407 

CHAPTER  18. 

INCOME  FROM   INTEREST,   RENT   AND   ROYALTIES. 

Interest  Exempt  from  Tax — ^Interest  Upon  United  States  Obligations 
— Tax  Exemptions  of  Liberty  Bonds  and  Victory  Notes  Under  1918 
Law — Under  1921  Law — War  Finance  Corporation  Bonds — Obliga- 
tions of  Possessions  of  the  United  States — Interest  on  Obligations  of 
States — Interest  on  Bonds  of  Exempt  Organizations — Reporting  Ex- 
empt Income — Accrued  Interest  on  Obligations  at  Time  of  Purchase 
— Bond  Interest  Paid  in  Scrip — Interest  Accruing  Prior  to  March 
1,   1913— Discount— Rent^-Royalties 479 

CHAPTER   19. 

INCOME  FROM  DIVIDENDS. 

Definitions — Distributions  Which  Are  Not  Dividends — Extent  to  Which 
Dividends  Are  Taxable — Distribution  in  Liquidation  Under  1918 
Law — Under  1921  Law — Presumption  as  to  Source  of  Distribution 
— Dividends  from  Earnings  or  Profits  Accumulated  Prior  to  March 
1,  1913 — Dividends  from  Exempt  Income— Distribution  from  De- 
pletion or  Depreciation  Reserve — Dividends  Paid  from  an  Apprecia- 
tion of  Capital  Assets — Distributions  of  Capital — Dividends  Tax- 
able in  Year  Received — Dividends  Paid  in  Equivalent  of  Cash- 
Dividends  Paid  in  Property — Stock  Dividends — Income  from  Sale  of 
Stock  Received  as  Dividend 504 

CHAPTER  20. 

RECEIPT    AND    INCOME    FROM    MISCELLANEOUS    SOURCES. 

Alimony — Option  to  Purchase  Interest  in  Royalties — Cancelled  Debts 
— Involuntary  Sale — Compensation  for  Loss — Replacement  Fund  for 
Loss — Damages — Employees'  Profit-Sharing  Fund — Discarded  or 
Destroyed  Property — Increment  to  Sinking  Funds — Legacies — Pay- 
ment of  Claims — Pensions — Property  Acquired  by  Gift — Right  to 
Subscribe  to  Stock— Sale  of  Good  Will — Shares  in  Building  and 
Loan  Association — Taxes  Paid  by  Vendee — Compensation  by  Insur- 
ance— Proceeds  of  Life  Insurance — Annuities 538 


CONTENTS  XIU 

CHAPTER  21. 
DEDUCTIONS — IN    GENERAL. 

Only  Deductions  Specified  in  the  Statute  Are  Allowed — Deductions 
Must  Be  Actual — Deductions  Not  to  Be  Duplicated — Income  and 
Deductions  Reported  on  Same  Basis — Deductions  in  the  Equivalent 
of  Cash — When  Charges  Deductible — Contributions  to  Charities — 
Items  Not  Deductible — Special  Assessments  Against  Local  Bene- 
fits         558 

CHAPTER  22. 

DEDUCTION  OF  BUSINESS  EXPENSES. 

Ordinary  and  Necessary  Expenses — Business  Expenses — Professional 
Expenses — Cost  of  Manufacturing  Products — Cost  of  Materials — 
Repairs — Buildings  Used  for  Rental  Purposes — Reserves — Insur- 
ance— Commissions — Salaries — Bonuses  and  Profit-Sharing  Pay- 
ments— Pensions — Donations     576 

CHAPTER  23. 

DEDUCTION  OF  INTEREST. 

Interest  on  Capital — Indebtedness  Incurred  or  Continued  to  Purchase 
or  Carry  Tax  Exempt  Securities — Interest  Paid  or  Accrued  Within 
the  Year — Interest  on  Taxes— Interest  on  Real  Estate  Mortgage.  . .  .     602 

CHAPTER  24. 

DEDUCTION  OF  TAXES. 

Taxes  Paid  or  Accrued  Within  the  Year — Federal  Duties  and  Excise 
Taxes — Capital  Stock  Tax — Federal  Estate  Tax — Taxes  Imposed 
by  the  Authority  of  Any  Foreign  Country — Taxing  Subdivisions  of 
Territories — Taxes  Paid  by  Vendee  for  Vendor — Taxes  Paid  by 
a  Tenant — Taxes  Not  Deductible — Taxes  Paid  by  Corporation  for 
Stockholders     607 

CHAPTER  25. 

DEDUCTION   OF  LOSSES. 

Losses  Sustained  in  Trade — Losses  Not  Sustained  in  Trade — Trade 
or  Business — Losses  Must  Be  Sustained  During  Year — Losses  of 
Income — Measure  of  Loss — Losses  from  Sales  of  Property — Losses 
from  Exchanges  of  Property — Losses  from  Fires,  Storm,  Shipwreck 
and  Other  Casualty — Losses  Arising  from  Theft — Voluntary  De- 
struction of  Property — Loss  of  Useful  Value — Shrinkage  in  Se- 
curities and  Stocks — Worthless  Stock — Sale  of  Capital  Stock — 
Losses  of  Oil  and  Gas — Reserves  for  Losses — Worthless  Debts — Re- 
coveries for  Bad  Debts  and  Charging  Off  Bad  Debts  in  Part  Under 
1921  Law — Loss  Due  to  Adverse  Judgment — Recovery  on  Losses — 
Net  Losses — Losses  in  Inventory  and  from  Rebates 621 


xiv  CONTENTS 

CHAPTER  26. 

DEDUCTION  OF  ALLOWANCE  FOR  DEPRECIATION,  OBSOLESCENCE  AND  AMORTIZATION. 

Depreciation  Under  Preceding  Income  Tax  Laws — Depreciable  Prop- 
erty— Intangible  Property — Capital  Sum  Returnable  Through  De- 
preciation Allowances — Method  of  Computing  Depreciation  Allow- 
ances— Annual  Allowance  Measured  by  Life  of  Property— Rate  of 
Depreciation — Annual  Allowance  Must  Be  Charged  Off  on  Books — 
Reserves  for  Depreciation — Obsolescence — Obsolescence  of  Intangible 
Property — Amortization    678 

CHAPTER  27. 

DEPLETION — IN   GENERAL. 

Definition  of  Terms — Capital  Recoverable  Through  Depletion — Deduc- 
tion in  Case  of  Operating  Owner — In  Case  of  Lessee — In  Case  of 
Lessor — Determination  of  Cost  of  Deposits — Determination  of  Fair 
Market  Value  of  Mineral  Property — Revaluations  Not  Allowed^ 
Computation  of  Deduction  for  Depletion  of  Mineral  Deposits — De- 
pletion and  Depreciation  Account  on  Books — Depletion  Under  1909 
Law  and  1913  Law — Rule  As  to  Mine  Under  1916  Law — Rule  As  to 
Lessees  Under  Prior  Laws — Depletion  for  Past  Years  Not  Allowed 
Under    Present    Law 713 

CHAPTER  28. 

DEPLETION    OF    MINES. 

Determination  of  Mineral  Contents  of  Mine — Discovery  of  Mines — 
Allowable  Capital  Additions  in  Case  of  Mines — Accumulated  De- 
pletion            735 

CHAPTER  29. 

DEPLETION   OF   OIL  AND  GAS  WELLS. 

Capital  Sum — Capital  Sum  and  Invested  Capital — Capital  Recover- 
able Through  Depletion  Deduction  in  Case  of  Operating  Owner — 
In  case  of  Lessee — In  Case  of  Lessor — Determination  of  Quantity  of 
Oil  in  Ground — Computation  of  Allowance  for  Depletion  of  Oil 
Wells — Computation  of  Allowance  for  Depletion  of  Gas  Wells — Gas 
Well  Pressure  Records  to  Be  Kept — Computation  of  Depletion  Allow- 
ance for  Combined  Holdings  of  Oil  and  Gas  Properties — Discovery  of 
Oil  and  Gas  Wells — Charges  to  Capital  and  to  Expenses  in  the  Case 
of  Oil  and  Gas  Wells — Depreciation  of  Improvements  in  the  Case  of 
Oil  and  Gas  Wells — Depletion  and  Depreciation  in  Years  before 
1916    740 

CHAPTER  30. 

DEPLETION    OF   TIMBER. 

Determination  of  Fair  Market  Value  of  Timber — Computation  of  Al- 
lowance for  Depletion  for  Given  Year — Revaluation  of  Timber  Not 
Allowed — Charges  to  Capital  and  to  Expense  in  the  Case  of  Timber 
— Aggregating  Timber  and  Land  for  Purposes  of  Valuation  and 
Accounting— Timber  Depletion  and  Depreciation  Accounts  on  Books 
— Information   to  be   Furnished   by   Taxpayer 767 


CONTENTS  XV 

CHAPTER  31. 

NORMAL  TAX   CREDITS — PERSONAL  EXEMPTION. 

Ciedit  of   Dividends — Credit  of   Interest — Personal  and   Specific   Ex- 
emptions—Credits to  Nonresident  Individuals 77  j 

CHAPTER  32. 

CREDIT    FOR    TAXES. 

Definition — Citizens   of    the     United     States — Resident    Aliens Non- 
resident Aliens — Citizens  of  Possessions — Domestic   Corporations 

Foreign  Corporations — Domestic  Corporations  Owning  Stock  of 
Foreign  Corporations — Members  of  Partnerships — Beneficiaries  of 
Estates  or  Trusts — Conditions  of  Allowance  of  Credit — Redetermi- 
nation of  Tax  When  Credit  Proves  Incorrect 786 

CHAPTER  33. 

METHODS  AND   PERIODS  OF  ACCOUNTING. 

Basis  of  Actual   Receipts — Reporting  Income   Upon   Accrual   Basis 

Methods  of  Accounting— When  Items  Should  Be  Reported— Chang- 
ing Basis  for  Computation  of  Net  Income — Doctrine  of  Election 

Accounting  Period — Fiscal   Year    795 

CHAPTER  34. 

RETURNS    OF    INCOME. 

By    Whom    Filed — Individual    Returns — Corporation,    Fiduciary    and 

Partnership    Returns— Where    Returns    Are    Filed — When    Filed 

Returns   when   Accounting   Period    Changed— Extension   of   Time 

Forms— Verification  of  Returns— Notice  of  Failure  to  File  Returns 

— Inspection   of    Returns    g22 

CHAPTER  35. 

ASSESSMENT,    PAYMENT    AND    COLLECTION    OF    THE    TAX. 

Suit  to  Restrain  Assessment  or  Collection — Time  of  Payment  of  Tax 

Assessment  of  Tax— Notice  and  Demand  for  Tax— Additional  As- 
sessment—Right of  Taxpayer  to  Appeal— Final  Determinations  and 
Assessments — Administrative  Review — Extension  of  Time  for  Pay- 
ment of  Tax — Interest  on  Delinquent  Taxes— Suits  for  Collection 
of  Taxes— Lien  for  Unpaid  Taxes— Taxes  Collectible  by  Distraint- 
Taxpayers  Contemplating  Removal  or  Concealment  of  Property  to 
Defeat  Collection  of  Tax— Medium  of  Payment  of  Tax— Receipts- 
Deposit  of  United  States  Bonds  in  Lieu  of  Surety— Recovery  of 
Taxes  Paid— Payment  Under  Protest— Duress— Abatement,  Credit 
and  Refund — Committee  on  Appeals  and  Review   848 

CHAPTER  36. 

PENALTIES    AND    COMPROMISES. 

Suit  to  Enjoin  Collection  of  Penalties— Failure  to   File   Return — In- 
tentional   Neglect   or    Refusal    to    Make    Returns— False    Returns— 


xvi  CONTENTS 

Fraudulent  Returns — Returns  of  Information  at  Source — Returns  of 
Withholding  Agents — Attempts  to  Evade  the  Tax — Failure  to  Pay 
Tax — Statute  of  Limitations — Compromise  of  Taxes  and  Penalties.  .      896 

CHAPTER  37. 

ABATEMENT,    CREDIT,   REFUND   AND   RECOVERY   OF   TAXES. 

Who  May  Claim  Recovery  of  Tax — Abatement — Effect  of  New  Pro- 
vision for  Appeal  from  Additional  Assessments — Credit  and  Re- 
fund— Procedure  for  Claiming  Refund — Procedure  for  Collectors — 
Claims  for  Credit  of  Taxes  Erroneously  Collected — Refund  of 
Taxes  Collected  on  Second  Assessment — Statute  of  Limitations — 
Suits  to  Recover  Taxes — Recovery  of  Interest — Costs — Reopening 
of  Cases    912 

CHAPTER  38. 

EXAMINATION  OF  TAXPAYER'S  BOOKS. 

Examination  of  Books — Requiring  Attendance  of  Witnesses — Requir- 
ing Production  of  Books — Enforcement  of  Provisions — Constitution- 
ality— Corporations — Examination  in  Cases  of  Special  Taxes  and 
Other  Cases — Inspection  of  Government  Contracts — Instructions  to 
Revenue  Agents    943 

CHAPTER  39. 

INFORMATION   AT  THE  SOURCE. 

Miscellaneous  Information,  Gains  and  Profits — Gains  and  Losses  of 
Customers  of  Brokers — Dividends — Interest — Return  of  Information 
as  to  Payment  to  Nonresident  Aliens — Foreign  Items — Procedure 
in  Paying  Income — Returns  of  Information  at  the  Source 951 

CHAPTER  40. 

COLLECTION  OF  THE  TAX  AT  THE  SOURCE. 

Definition — Appointment  of  Withholding  Agent — Fixed  or  Determin- 
able Annual  or  Periodical  Income — Bond  Interest — Scrip — Against 
Whom  the  Tax  is  Withheld— Who  Are  Required  to  Withhold  Tax- 
Exemption  from  Withholding — Ownership  Certificates — ^Withholding 
in  the  Case  of  Enemies — Return  of  Income  from  Which  Tax  With- 
held         964 

CHAPTER  41. 

COVENANTS  TO  PAY  TAXES. 

Foreign  Corporations — Definition — Rate  of  Tax  to  Be  Withheld — 
Object  of  Withholding  Provision  in  Case  of  Tax-Free  Covenant 
Bonds — Procedure  of  Corporation  Issuing  Tax-Free  Covenant  Bonds 
— Examples  of  Covenants  to  Pay  Taxes 997 


CONTENTS  XVll 

CHAPTER  42. 

CONSTITUTIONALITY   OF   THE   LAW. 

Construction  of  Constitutional  Provisions — Power  of  Congress  to  Levy 
Income  Taxes — Taxing  Gains  and  Profits  from  Sale  of  Property — 
Requiring  Disclosure  of  Interest  on  State  and  Municipal  Obliga- 
tions— Want  of  Due  Process  of  Law — Uniformity — Exempting  Cer- 
tain Corporations  from  Tax — Retroactive  Features 1006 

CHAPTER  43. 

WAR-PROFITS   AND   EXCESS-PROFITS   TAX. 

Individuals — Partnerships — Personal  Service  Corporations — Corpora- 
tions— Allocation  of  Net  Income  to  Particular  Sources^Statement 
of  the  Tax — Rates  of  Tax — Fiscal  Year — Corporations  Deriving  In- 
come from  Government  Contracts — Maximum  Limit  of  Tax — Sale  of 
Mines,  Oil  or  Gas  Wells — Invested  Capital — Cash  Paid  in — Tangible 
Property  Paid  in — Intangible  Property — Mixed  Aggregates  of 
Tangible  and  Intangible  Property — Surplus  and  Undivided  Profits — 
Reserves — Patents — Current  Profits — Additions  to  Surplus  Account 
— Borrowed  Capital — Computing  Invested  Capital — Admissible 
Assets — Inadmissible  Assets — Adjustments  Which  Increase  Book 
Value  of  Assets — Adjustments  Which  Reduce  Book  Value  of  Assets 
— Adjustments  Due  to  Changes  in  the  Taxable  Year — Invested  Capi- 
tal for  Fractional  Part  of  Year — Invested  Capital  for  Prewar  Period 
— Invested  Capital  of  Insurance  Companies,  Foreign  Corporations 
and  Domestic  Corporations  Deriving  Income  from  Possessions  of 
the  United  States — War-Profits  Credit — Excess-Profits  Credit — 
Specific  Exemption — Net  Income — Exemption  Granted  by  Merchant 
Marine  Act — Assessment  Without  Reference  to  Invested  Capital — 
Incorporation  of  Business  of  Partnership  or  Individual — Affiliated 
Corporations — Balance  Sheet — Returns — Time  and  Manner  of  Pay- 
ing Tax — Penalties — Administrative  Provisions 1015 

CHAPTER  44. 

CAPITAL    STOCK    TAX. 

Definitions — Domestic  Corporations — Foreign  Corporations — Basis  and 
Rate  of  Tax — Insurance  Companies — Corporations  Engaged  in 
Business  During  Preceding  Year  and  During  Taxable  Year — In- 
active Corporations — Carrying  On  or  Doing  Business — Doing  Busi- 
ness by  Foreign  Corporation — Exempt  Corporations — Tax  Due — 
Returns — Payment  of  the  Tax 1139 

CHAPTER  45. 

THE  STAMP   TAX. 

General  Scope  of  Law — General  Exemptions — Stamps — Bonds  of  In- 
debtedness— Bonds  of  Indemnity  and  Surety — Capital  Stock,  Issue — 
Capital  Stock,  Sales  and  Transfers — Certificates  of  Profits — Checks 
— Conveyances — Drafts — Entry  for  Withdrawal  of  Goods  or  Mer- 
chandise from  Customs  Bonded  Warehouse — Entry  of  Goods,  Wares 


xviii  CONTENTS 

or  Merchandise  at  Customhouse — Insurance  Policies — Parcel  Post 
Packa.^es — Passage  Tickets — Playing  Cards — Powers  of  Attorney — 
Sales  of  Produce  on  Exchange — Promissory  Notes — Proxies — 
Records  Required  in  Case  of  Sales  and  Transfers  of  Stock  and 
Produce  on  Exchange — Constitutionality  of  Stamp  Taxes — Injunc- 
tive  Relief — Protest  and   Duress 1162 

CHAPTER   46. 

TAX    ON    EMPLOYMENT    OF    CHILD    LABOR. 

Effective  Date  of  Act — Persons  to  Whom  the  Tax  Applies — Mill,  Can- 
nery, Work  Shop,  Factory  or  Manufacturing  Establishment — Mine 
or  Quarry — Time  (Sun  or  Clock) — Duration  of  Employment — Cer- 
tificate of  Age — Proof  of  Age — Inspection  of  Establishment— Basis 
and  Rate  of  Tax — Returns — Tax  Due — Time  Record — Penalties — 
Constitutionality      1250 

CHAPTER  47. 

CONSTRUCTION  OF  TAXING  STATUTES. 

Construction  Which  Will  Be  Constitutional — Proceedings  in  Congress 
as  Aid  to  Construction — Effect  of  Rulings  and  Practice  of  Treasury 
Department — Construction  by  Reference  to  Similar  Statutes- — 
Similar  Statutes  in  Other  Jurisdictions — Strict  or  Liberal  Construc- 
tion— Exemption  from  Taxation — Rule  of  Construction  Followed  by 
the   Treasury   Department 1261 

APPENDIX 

Revenue  Act  of  1918— Copy  of  Law 1275 

Revenue  Act  of  1921— Copy  of  Law 1333 


TABLE  OF  CASES 


^References 

Abbott  V.  St.  John,  40  Con. 
Sup.   Ct.   597 379 

Abbott  V.  Wetherby,  6  Wash. 
507,  83   Pac.   1070    45 

Abrast  Realty  Co.  v.  Maxwell, 
206  Fed.  333    885 

Adams  v.  Bancroft,  1  Fed. 
Cas.  No.  44    1263 

Adams  v.  Dale,  29  Ind.  273..  1244 

Adams  V.  U.  S.,  1  Ct.  CI.  306.   883 

Aguirre  v.  Maxwell,  3  Blatch. 
140      303 

Albany  City  National  Bank  v. 
Maher,  6  Fed.  -  417,  19 
Blatch.    175    455 

Aldridge  v.  Williams,  3  How. 
23     1265 

Alexandria  v.  Bethlehem,  16 
N.  J.   L.   119 826 

Alkan  v.  Bean,  23  Int.  Rev. 
Rec.  351    850 

Allen  V.  Allen,  60  Mich.  635, 
27  N.  W.  702   826 

Allen  V.  Pullman's  Palace  Car 
Co.,  139  U.  S.  658   850 

Alpha  Portland  Cement  Co.  v. 
Knapp,  230  N.  Y.  48,  231 
N.   Y.    8    1007 

Alpha  Portland  Cement  Co.  v. 
U.  S.,  261  Fed.  339 450 

Altheimer  Investment  Co.  v. 
Allen,  246  Fed.  270,  petition 
for  a  writ  of  certiorari  de- 
nied   November   18,    1918...   234 

Altheimer  Rawlings  Invest- 
ment Co.  V.  Allen,  248  Fed. 
688    494 

Ambrosini  v.  U.  S.,  187  U. 
S.    1     489 

Amer.  Nat.  Bank  v.  Nat.  Co., 
77    Fed.    85 223 

American  Net  &  Twine  Co.  v. 
Worthington,  141  U.  S.  468.1269 

Amer.  Pig  Iron  Co.  v.  State 
Board,  56  N.  J.  L.  389,  29 
Atl.    160    1171 


are  to  pages.] 

American  Thread  Co.  v.  Joyce, 

104  L.   T.  R.  217,  aff'd   106 

L.  T.  R.  171,  28  T.  L.  R.  233, 

6   Tax   Cas.   1,  approved  by 

House  of  Lords  108  L.  T.  R. 

353,  6   Tax  Cas.   163,  29   L. 

T.   R.  266   299 

Anderson  v.  42  Broadway  Co., 

213   Fed.  777 604 

Anderson  v.  42  Broadway  Co., 

239  U.   S.  69 234 

Anderson    v.    Morris    &    E.    R. 

Co.,  216  Fed.  83 

220,  229,  501,   1154,  1270 

Appeal   of   C.   Bolte,   18   Haw. 

241     1169 

Appeal  of  Green,  97  Pa.  342.  .   654 
Apthorpe     v.     Peter     Schoen- 

hofen  Brewing  Co.,  80  L.  T. 

R.   395,   15   T.   L.   R.   245,  4 

Tax    Cas.    41 299 

Arnson  v.   Murphy,   109   U.   S. 

238    906,   937 

Assessment  of  Taxes  of  T.  A. 

Hayes,  In  re,  16  Haw.  796.  .   568 
Assessor    v.   Osborne,   9   Wall. 

567    930 

Associated    Pipe    Line    Co.    v. 

U.    S.,    258    Fed.    800 

234,  1152,  1154 

Atchison   v.   O'Connor,  223   U. 

S.   280    889,   890 

Atlantic  C.  L.  R.  Co.  v.  River- 
side   Mills,    219    U.    S.    196, 

200    1121,    1265 

Aurora   State  Bank  v.  Oliver, 

62   Mo.   App.  390 173 

Austin    V.    Seligman,    18    Fed. 

519     390 

Bailey    v.    Railroad    Company, 

22    Wall.    603,     106     U.     S. 

109    519,   530 

Baldwin  Locomotive  Works  v. 

McCoach,  221  Fed.  59 

239,  341,  450,  1100 


XIX 


XX 


TABLE   OF   CASES 


[References 
Baltimore  v.  Baltimore  R.  R., 

10  Wall.  543 1002 

Bank  of  Greencastle  v.  U.  S., 

15    Ct.    Cls.    225 919 

Barnsdall  v.  Bradford  Gas 

Co.,  225  Pa.  338,  74  Atl. 

207  502 

Barr  v.  Simpson.  54  Tex.  Civ. 

App.    105,    117    S.   W.    1041, 

46,     49 

Bartholomay    Brewing    Co.    v. 

Wyatt    (1893)    2   Q.  B.  499, 

69  L.  T.  561 299 

Bate  Refrigerator  Co.  v.  Sulz- 
berger,  157   U.    S.   1 1266 

Bay  V.  Williams,  112  111.  91..  1084 
Bayfield    Co.    v.    Pishon,    162 

Wis.  466,  156  N.  W.  463...   149 
Beals   V.   Ares,  25   New   Mex. 

459,   185   Pac.   780 48 

Bean  v.  Flint,  204  N.  Y.  153, 

97  N.  E.  490 1179 

Beck   V.   Natalie   Oil   Co.,   143 

La.  153,  78  La.  430 48 

Beer  v.  Moffat,  192  Fed.  984.  .   885 
Bellefontaine  Building  &  Loan 

Co.   V.    McMaken,   216    Fed. 

526     319 

Bend    v.    Hoyt,    13     Pet.     263 

886,    887 

Benzinger  v.  U.  S.,  192  U.  S. 

38     1269 

Bertram    v.    Collins    Mfg.    Co. 

69    Ga.    751 1043 

Billings    V.    U.    S.,    232    U.    S. 

261. .1012,  1013, 1014,  1261,  1264 
Biwabik  Mining  Co.  v.  U.   S., 

242    Fed.    9 730 

Biwabik  Mining  Co.  v.  U.   S., 

247    U.    S.    116 725 

Black  V.  Bolen,  268  Fed.  427.  .   626 
Blakeston    v.    Cooper,    5    Tax 

Cas.    347 548 

Blanchard     v.     Hamblin,     162 

Mo.    App.    242,    144    S.     W. 

880     283 

Bleakley   v.    New     York,     139 

Fed.    807     639 

Blunt  V.  U.  S.,  255  Fed.  332.  .1261 
Boling    V.    Owsley,    122    Minn. 

190,  142  N.  W.  129 502 


are  to  pages.'] 

Boobier   v.   Boobier,  39   Maine 

406     826 

Boon  V.  Moss,  70  N.  Y.  465..  1051 
Booth    V.    Illinois,   184     U.     S. 

431     1006 

Boreing  v.  Wilson,  33   Ky.   L. 

14,   108   S.    W.    914 173 

Boske  V.  Comingore,  177  U.  S. 

459     8 

Boston   &   M.   R.   R.   v.   U.   S., 

265   Fed.   578   234 

Boston  &   P.  R.  Corp.  v.   Gill, 

257  Fed.  221 941 

Boston    Terminal    Co.    v.    Gill, 

246  Fed.  664 1154 

Boughton  V.  U.  S.,  12  Ct.  Cls. 

330    907,   909 

Boyd  V.   U.   S.,  116  U.  S.  616 

944,  945,   947,   1009 

Brady   v.   Anderson,   240   Fed. 

665,  244  U.  S.  564 35,     53 

Brady  v.   Anderson,   240    Fed. 

665,    writ    of   certiorari    de- 
nied 244  U.  S.  654.145,  266,  1014 
Bristor   v.    Chicago   &    N.    W. 

Ry.   Co.,  128   Iowa  479,   104 

N.    W.    487 826 

Brosius    V.    Barker,    154    Mo. 

App.  657,  136  S.  W.  19 826 

Brown    v.   City  of   Corry,   175 

Pa.    St.    528,    34    Atl.    854, 

855    578,    812 

Brown  v.  Cook,  9  John  361 .  .   639 
Brown  v.  Spillman,  155  U.  S. 

665     503 

Brown   v.    Walker,    161    U.    S. 

591     1006 

Brushaber  v.  Union  Pacific  R. 

R.   Co.,  240  U.  S.  1 60, 

850,  1007,  1010,  1013,  1014,  1261 
Bryant  &  May,  Ltd.  v.  Scott, 

226  Fed.  875 301,  1143 

Bryce  v.  Keith,  257  Fed.  133 

626,  627 

Buchanan    v.    Knoxville    &    O. 

R.  Co.,  71  Fed.  324 1274 

Buffum  V.  Merry,  4  Fed.  Cas. 

No.    2112 390 

Bullen    V.    Wisconsin,    240    U. 

S.  625 456,   549,  903 

Bunte    V.    Schuman,    46    Misc. 

593    429 


TABLE    OF   CASES 


XXI 


[References 

Burriss  v.  Starr,  165  N,  C. 
657,  81  S.  E.  929 907 

Burrough  v.  Abel,  105  Fed. 
366     939 

Butler  Savings  Bank  v.  Os- 
borne, 159  Pa.  10,  28  Atl. 
163     171 

Butterick  Co.  v.  U.  S.,  240 
Fed.   539 210,    1155 

Cadwalader  v.  Lederer,  273 
Fed.  879    1018 

Caha  V.  U.  S.,  152  U.  S.  211..        8 

Calkins  v.  Smietanka,  240 
Fed.  138 1210,  1245,  1249 

Cambria  Steel  Co.  v.  McCoach, 
225  Fed.  278 893,  914,  1154 

Caminetti  v.  U.  S.,  242  U.  S. 
470,   490 1265 

Campbell  v.  Shaw,  11  Haw. 
112     1012 

Campbell  v.  U.  S.,  107  U.  S. 
410    7 

Camp  Bird,  Ltd.,  v.  Howbert, 
249  Fed.  27 929 

Camp  Bird,  Ltd.,  v.  Howbert, 
262  Fed.  114 934 

Capital  Trading  Company,  In 
re,  229   Fed.  806 1206 

Carbon  Steel  Co.  v.  Lewellyn, 
258   Fed.  533 1264 

Carrick  v.  Lamar,  116  U.  S. 
423     850 

Carrol  v.  Tomlinson,  192  111. 
398,  61  N.  E.  484 654 

Cartier-Holland  Lumber  Co. 
V.  Doyle,  U.  S.  Dist.  Ct., 
W.  Dist.  Mich.  So.  Div.,  T. 
D.    3080    1023 

Cary  v.  Curtis,  3  How.  236.  . .   937 

Cassidy  v.  St.  Germain,  22 
R.  I.  53,  46  Atl.  35.  .  .1242,  1244 

Catawissa  R.  R.  Co.  v.  Phila. 
&  Reading  Co.,  255  Pa.  269, 
99  Atl.  807 35,  1002 

Cathcart  v.  Robinson,  5  Pet. 
264     1268 

Central  Building,  Loan  &  Sav- 
ings Co.  V.  Bowland,  216 
Fed.   526 319,   1265 

Central  Trust  Co.  v.  Colum- 
bus, etc.,  Co.,  92  Fed.  919..  1190 


a7-e  to  pages. '\ 

Chadwick,  In  re,  5  Fed.  Cas. 
No.  2,570,  11  Int.  Rev.  Rec. 

126,  133  944 

Chaffee    v.    United    States,    16 

Wall.    516,   542 429 

Chapin   v.    Irwin,   U.   S.   Dist. 

Ct.  No.  Dist.  of  N.  H 153 

Chapman,    In    re,    166     U.     S. 

661,    668    1009 

Chartiers  etc.  Co.  v.  McNam- 

ara,  72  Pa.  St.  278 1242 

Cheatham  v.   U.   S.,   92   U.   S. 

85     935 

Chemung   Iron    Co.    v.    Lynch, 

269   Fed.   368 502,   1154 

Chesebrough  v.   U.   S.,   192   U. 

S.  253... 883,  886,  888,  889,  1247 
Chicago  &  Alton  R.  R.  Co.  v. 

U.  S.,  53  Ct.  Cls.  41 240 

Chicago    A.    R.    R.    v.    House, 

172  111.  601,  50  N.  E.  151.  . .   578 
Chicago  Mill,  etc.,  Co.  v.  Boat- 
man's Bank,  234  Fed.  41...   223 
Chicago,  St.  Louis,  etc.,  R.  Co. 
V.    Pullman    Co.,    139    U.    S. 

79     638 

Chicago     T.     and     T.     Co.     v. 
Smietanka.     275      Fed.      60 

174,    211,    212 

Chicago,   etc.,   Ry.   v.     Kansas 
City  N.  W.  R.  R.,  75  Kans. 

167,   88   Pac.    1085 1004 

Chicago,    etc.,    R.    R.    Co.    v. 

Missouri,  120  U.  S.  569 1273 

Christ  Church  v.  Philadelphia 

County,  24   How.  300 1273 

Christie-Street    Co.    v.    U.    S., 

126   Fed.   991 888 

Christie  -  Street       Commission 
Co.   V.   U.   S.,   136   Fed.   326 

933,    935,    938 

Church  of  Holy  Trinity  v.  U. 

S.,  143  U.  S.  457 1263 

Cinn.  Gas  &  Elec.  Co.  v.  Gilli- 

gan,  T.  B.  29-21-1738 937 

Citizens   Bank   v.   Parker,    192 

U.  S.  73 1274 

Clemens   v.    Conrad,   19   Mich. 

170     1242 

Cleveland  &  T.  R.  Co.  v.  Per- 
kins, 17  Mich.  296 429 


XXll 


TABLE    OF   CASES 


^References 
Cline    V.    Hackbarth,    27    Tex. 

Civ.    App.    391,    65     S.     W. 

1086     45 

Cliquot's   Champagne,  3   Wall. 

114,  141.  145 429,  1271 

Clopton    V.    Phila.    &    Reading 

R.  R.  Co.,  54  Pa.  356 1004 

Cobb    V.    Heron,    180    111.    49, 

54    N.    E.    189,   aff'd    78    111. 

App.    654    1084 

Codman    v.    Amer.    Piano   Co., 

229    Mass.    285,    118    N.    E. 

344     1002 

Cohen  v.   Lowe,   234   Fed.  474 

188,  681,  688,  691 

Cole   et   al.   v.   Ralph,   252    U. 

S.    286     1242 

Collector  v.  Day,  11  Wall.  113 

357,    378,    489 

Collector  v.  Hubbard,  12  Wall. 

1     519 

Collector  v.  Hubbard,  12  Wall. 

13     887 

Colonial  Trust  Co.  v.  Montello 

Works,   172   Fed.   310 223 

Colquhoun    v.    Brooks,    L.     R. 

14  App.  Cas.   493,  61    L.  T. 
518     299 

Columbia  Water  Co.  v.  Colum- 
bia Co.,  172  U.  S.  475 1262 

Commercial  Bank  v.  Arm- 
strong, 148  U.  S.  50 283 

Commercial  Travelers  Ass'n 
V.  Rodway,  235  Fed.  370, 
374    313,  317,   1268 

Commissioners,  etc.,  v.  Buck- 
ner,   48    Fed.   533 884 

Commonwealth  v.  Graham, 
157    Mass.    73 826 

Commonwealth  v.  Standard 
Oil  Co.,  101  Pa.  St.  119.. 75,     77 

Commonwealth  v.  Werth,  116 
Va.  604,  82  S.  E.  695.. 339,  638 

Conant  v.  Kinney,  162  Fed. 
581     940 

Congregational  Church  So- 
ciety v.  Board,  290  111.  108, 
125   N.   E.    7 323 

Conley  v.  Mathieson  Alkali 
Works,  190  U.  S.  406,  409..    219 

Conley    v.    Mathieson    Works, 


are  to  pages."] 

I  190    U.    S.    406,    205    U.    S. 

392    224 

Connecticut  General   Life   Ins. 

Co.  V.   Eaton,  218   Fed.   188 

343,    1266 

Connecticut    Mutual    Life    Ins. 

Co.   V.   Eaton,  218    Fed.   206 

343,    586,    631 

Connole  v.  Norfolk  &  Western 

Ry.  Co.,  216  Fed.  823 1265 

Cook  v.  Knott,  2  Gt.  Br.   Tax 

Cas.  246    569 

Cooks  V.  Bremond,  27  Tex.  457  45 
Cornell  v.  Coyne,  192  U.  S. 

418  1263 

Coulan    V.     Doull,    133    U.     S. 

216     1268 

Cox   V.    Hickman,   8   H.   L.    C. 

268,  9  C.  B.  N.  S.  47 173 

Craig  V.  Dimock,  47  111.  308..  1242 
Crane  &  Co.  v.  Fry,  126  Fed. 

278    224 

Crawford  v.  New  South  Farm 

and  Home  Co.,  231  Fed.  999  1197 
Crichfield   v.   Julian,    147   Fed. 

65     424 

Crocker   v.    Malley,   249    U.   S. 

223 211,   1141,   1175,  1270 

Crocker   v.   Malley,  249   U.   S. 

223,  reversing  250  Fed.  817.   215 
Cropley   v.    Cooper,    19     Wall. 

(U.  S.)  167,  22  L.  Ed.  109..   457 
Crutwell   v.    Lye,    17    Ves.   Jr. 

335     1051 

Cryan    v.    Wardell,     263     Fed. 

248    498,   1266 

Cumberland  Tel.  &  Tel.  Co.  v. 

Louisville,     187     Fed.     637, 

654     691 

Gumming  v.  U.  S.,  22  Ct.  Cls. 

344     919 

Curtice,    Matter   of,    111    App. 

Div.    (N.   Y.)    230,  97   N.  Y. 

Supp.    444,    aff'd    185    N.    Y. 

542,  77  N.  E.  1184 430 

Darlington  v.  Mayer,  U.  S. 
Dist.  Ct.,  N.  Dist.  111.  aff'd 
by  U.  S.  Supreme  Court, 
April    18,    1921 407 

Darlington  v.  Turner,  202  U. 
S.   195    826 


TABLE  OF  CASES 


xxni 


[References 

D'Armond  v.  Dubose,  22  La. 
Ann.    131     1244 

Dartmouth  College  v.  Wood- 
ward, 4  Wheat.  518,  636...   219 

Davis  V.  Evans,  133  N.  C.  320, 
45  S.  E.  643 1242 

De  Bary  v.  Carter,  102  Fed. 
130     941 

De  Bary  v.  Dunne,  162  Fed. 
961     915 

De  Beers  Consolidated  Mines 
V.  Kowe  (1906)  App.  Cas. 
455,  95  L.  T.  221,  22  T.  L.  R. 
756,  5  Tax  Cas.  198 298 

De  Blanc  v.  Lynch  &  Co.  23 
Tex.    25     46 

Decatur  v.  Paulding,  14  Pet. 
497 850 

Deen  v.  Walker,  107  111.  540..  1084 

De  Ganay  v.  Lederer,  239  Fed. 
568     1262 

De  Ganay  v.  Lederer,  239  Fed. 
568  aff'd  250  U.  S.  376 
59,  61,  198,  1266,  1272 

Delaski  &  Thropp  Co.  v.  Ire- 
dell, 268  Fed.  377 202,  1020 

Delaware  R.  R.  Co.  v.  Pretty- 
man,  17  Int.  Rev.  Rec.  99..    850 

Dennison  Mfg.  Co.  v.  U.  S., 
72    Fed.    258 1262 

Des  Moines  Co.  v.  Chicago  Gt. 
West.  Ry.  Co.,  188  lov/a 
1019,  177  N.  W.  90 1005 

De  Vaughn  v.  McLeroy,  82 
Ga.  687,  10  S.  E.  211 457 

Disston  v.  McClain.  147  Fed. 
114     1269 

Dixon  v.  Dixon's  Exors,  4  La. 
188     48 

Dobbins  v.  Erie  Co.,  16  Pet. 
435     379 

Dobbins  v.  Erie  Co.,  16  Pet. 
444     489 

Dodge  v.  Brady,  240  U.  S.  122  850 

Dodge  v.  Osborn,  240  U.  S.  118 
850,   851 

Dodge  Stationery  Co.  v. 
Dodge,  145  Cal.  380,  78 
Pac.  879    1051 

Doerschuck  v.  U.  S.,  274  Fed. 
739     528  . 


are  to  pacjes.l 

Doerschuck  v.  U.  S.,  U.  S.  Dist. 

Ct.  E.  D.  N.  Y.,  T.  D.  3170.  .1069 
Doherty  v.   Harris,   230   Mass. 

341     430 

Dollar  Savings  Bank  v.  U.  S., 

19  Wall.  227,  86   U.   S.   227 

267,   869 

Dominici  v.  U.   S.,  72  Fed.  46       8 
Douglas  V.   Douglas,  22   Idaho 

336,   125    Pac.    796 50 

Dowell    V.    Applegate,    7    Fed. 

881     1244 

Doyle    V.    Mitchell    Bros.,    247 

U.    S.    179 340, 

341,  342,  388,  421,  431,  453, 

519,     524,     731,     732,    733,     1008 
Doyle    V.    Mitchell    Bros.,    247 

U.     S.     179,     affirming     235 

Fed.  686    556 

Duffy  V.  Hobson,  40  Cal.  240.  .1242 
Dugan   V.    U.    S.,    34    Ct.    Cls. 

458    919 

Dunavant,  In  re,  96  Fed.  542.  .    826 
Dunham  v.   Loverock,   158   Pa. 

197,  27  Atl.  990 171 

Dunks    v.    Grey,    3    Fed.     862, 

865     826 

Durham  v.  State,  6  Ind.  App. 

23,  32  N.   E.   104 455 

East  St.  Louis  Ry.  Co.  v.  Jar- 
vis,  92  Fed.   735 224 

Edison  Electric  Co.  v.  U.  S., 
38  Ct.  Cls.  208 932 

Edwards  v.  Brown,  68  Tex. 
329     46 

Edwards  v.  Chile  Copper  Com- 
pany, 273   Fed.  452 1166 

Edwards  v.  Keith,  231  Fed. 
110 7,  343,  345 

Edwards    v.    Wabash    Ry.    Co. 

264  Fed.  610 

1162,  1171,  1175,  1247,  1266 

Ehret  Magnesia  Co.  v.  Leder- 
er. 273  Fed.  689 1013,  1034 

Ehrlich  v.  Brogan,  262  Pa. 
362     1003 

Eidman  v.  Martinez,  184  U.  S. 
578     1269 

Eisner  v.  Macomber,  252  U. 
S.  189..29,  207,  219.  220.  340, 
344,    504,    525,    532,    1007,    1008 


XXIV 


TABLE    OF   CASES 


[Refer^ences 
Eisner    v.    Macomber,    254    U. 

S.    189    453 

Eldorado    Coal    Co.    v.    Mager, 

65  L.  Ed.  449 407,  1008 

Eliasberg      Bros.      Mercantile 

Co.  V.  Grimes,  204  Ala.  492, 

86   So.   56 340 

Eliot    V.    Freeman,    220    U.    S. 

178    211,    1140 

Eliot    Nat.   Bank   v.    Gill,   210 

Fed.  933    618 

Eliot   Nat.    Bank   v.    Gill,   210 

Fed.  933,  aff'd  218  Fed.  600.  '860 
Eliot    National    Bank    v.    Gill, 

218    Fed.    600 

860,  861,  862,  899,  1262 

Elliott    V.    Swartout,    10     Pet. 

137    886,   887 

Emery,    Bird    Thayer    Realty 

Co.  V.  U.  S.,  198  Fed.  242..   938 
Equitable  Trust  Co.  v.  Seldon, 

8  Fed.  Cas.  No.  4,  507 1268 

Equitable  Trust  Co.  v.  West- 
ern  Pac.   Ry.   Co.,  236    Fed. 

814    243 

Erichsen   v.   Lost,   8   Q.   B.   D. 

414,  45  L.  T.  703,  4  Br.  Tax 

Cas.  422    74 

Erie,  etc.,  R.  R.  v.  Pennsyl- 
vania   R.    R.,    208    Pa.    506, 

57   Atl.   980 1004 

Erskine    v.    Van    Arsdale,     15 

Wall.  75 886,  887,  940 

Estate    of    Moffitt,     153     Cal. 

359,  95  Pac.  653,  1025 49 

Evans     v.     Gore,     253     U.     S. 

245    377,  378 

Evanston  v.  Gunn,  99  U.  S. 

660,  17  Cyc.  306 846 

Evi^ald    V.    Hufton,     31     Idaho 

373,   173   Pac.   247 47 

Ex  parte  Kollock,  165  U.  S.  526       7 

Fairley  v.  Smith,  87  N.  C.  271  429 
Fairley  v.  Smith,  87  N.  C.  367  429 
Fairmont    Coal    Co.    v.    Jones, 

etc.  Co.,  134  Fed.  711 639 

Farmers  Loan  and  Trust 
Company  v.  Council  Bluffs 
Gas  and  Electric  Company, 
90  Fed.  806 1197 


are  to  pages.'\ 

Farrell  v.  U.  S.,  167  Fed.  639.   935 

Fav^  v.  Marsletter,  3  Cranch 
10,   23    1124 

Fechleter  v.  Palm  Bros.,  133 
Fed.  462    171 

Federal  Mining  Co.  v.  Bunker 
Hill  Co.,  187  Fed.  474 224 

Fennell  v.  Drinkhouse,  131 
CaL  447,  63  Pac.  734 45 

Fennerstein  v.  United  States, 
3  Wall.  145 429 

Fidelity  Trust  Company  v. 
Lederer,  U.  S.  Dist.  Ct., 
Eastern  Dist.  of  Pennsyl- 
vania, decided  July  14, 
1921     1189 

Field  v.  Clark,  143  U.  S.  649.  .1066 

Fink   V.    N.    W.    Mutual     Life 

Ins.    Co.,   267    Fed.   968 

290,   291,  292,   342,   343 

Fink  V.  Northwestern  Mutual 
Life  Ins.  Co.,  U.  S.  Circuit 
Court  of  Appeals,  seventh 
circuit,  June   1920 643 

First  Nat.  Bank  v.  McNeel, 
238    Fed.    559 618 

First  Trust  &  Savings  Bank 
V.  Smietanka,  268  Fed.  230 
136,    1270 

Fish  V.  Irwin,  U.  S.  Dist.  Ct. 
No.   Dist.  of   N.   Y 153 

581  Diamonds  v.  U.  S.,  119 
Fed.    556,   561 1272 

Fletcher  v.  Peck,  6  Cranch  87.1006 

Flint  v.   Stone-Tracy  Co.,  220 

U.  S.  107 211,  301, 

489,    840,   850,   1012,   1013,    1154 

Flour  City  Nat.  Bank  v.  Shire, 
88  (N.  Y.)  App.  Div.  401, 
84  N.  Y.  Supp.  810,  aff'd 
179  N.  Y.  587,  72  N.  E. 
1141     1171 

Flower  v.  Barnekoff,  20  Ore. 
132,   25   Pac.  370 172 

Fogg  V.  Blair,  139  U.  S.  118, 
127,  35  L.  Ed.  104,  107,  11 
Sup.   Ct.   Rep.  476 438 

Foley  V.  Fletcher  (1858)  3 
Hurst  &  N.  769,  157  Eng. 
Reprint,  678,  28  L.  J.  Exch. 
N.  S.  100,  5  Jur.  N.  S.  342, 


TABLE  OF  CASES 


XXV 


[References 

7    Week    Rep.    141,    4    Mor. 

Min.    Rep.    130 467 

Folk    V.    State    Capital    Ass'n, 

214  Pa.  529,  63  Atl.  1013.  .  .  319 
Ford    V.    Delta    &    Pine    Land 

Co.,  164  U.  S.  662 1263,  1273 

Forty  Fort  Coal   Co.  v.  Kirk- 

endall,    233    Fed.    704 

431,    453,    693 

Foster  v.  HoUey's  Adm'rs,  49 

Ala.     (1873)     593 1165 

Fountain  v.  Wabash,  114  Mo. 

App.    676 430 

Frank   Jones    Brewing    Co.   v. 

Apthorpe,  15  T.  L.  R.  113,  4 

Tax   Cas.    6 299 

Franta    v.    Bohemian     Union, 

164  Mo.  304,  63  S.  W.  1100.  327 
Freedman    v.    Sigel,     9     Fed. 

Cas.    No.    5,080...' 378 

Gaar,  Scott  &  Co.  v.  Shannon, 

223  U.  S.  468 889 

Galm  V.  U.   S.,  39  Ct.   Cls.  55 

374,  568,  1266 

Garland    v.    Gaines,    73    Conn. 

662,  49  Atl.  19 1242 

Gavit  V.  Irwin,  275  Fed.  643..  145 
Gill  V.  Bartlett,  224  Fed.  927.  .1269 
Goldfield     Consolidated     Mines 

Co.  V.   Scott,  247   U.   S.  126 

8,    725,    730 

Goodrich  v.  Edwards,  41   Sup. 

Ct.  Rep.  390 407,  678,  1008 

Goodrich    v.    Edwards,    65    L. 

Ed.    450    389 

Goodwine    v.    Wands,    25    Ind. 

101    1244 

Gouge  V.   Hart,  250  Fed.  802, 

appeal   dismissed   251   U.   S. 

542     851 

Gould  V.  Gould,  245  U.  S.  151 

426,   538,  1270,   1272 

Gramophone      &      Typewriter, 

Ltd.  V.  Stanley   (1906)   2  K. 

B.  856,  aff'd   (1908)  2  K.  B. 

89,  99  L.  T.  R.  39 299 

Granby    Co.    v.     Webster,     98 

Fed.  604   1217 

Grand   Rapids   &   Indiana   Ry. 

Co.   V.   Doyle,   245   Fed.   792 

272,  571,  579,  584 


are  to  pages.} 

Grangiac  v.  Arden,  10  Johns. 
(N.   Y.)    293    826 

Gray  v.  Darlington,  15  Wall. 
63 407,  525,  1008 

Great  Northern  Ry.  Co.  v. 
Lynch,  T.   D.  3147 431,  539 

Great  Northern  Ry.  Co.  v. 
Lynch,  U.  S.  Dist.  Ct.,  Dist. 
of    Minn 432 

Green,  Matter  of,  67  Hun.  527, 
20  N.  Y.  Supp.  538,  aff'd  22 
N.  Y.  Supp.   1112 32 

Greenport  Basin  Co.  v.  U.  S., 
269  Fed.  58 7,  890,  1034 

Grier  v.  Tucker,  150  Fed.  658  915 

Guaranty  Title  &  Trust  Co.  v. 
Title  Guaranty  &  Surety 
Co.,  224  U.  S.  152 873 

Gulf  Oil  Co.  V.  Lewellyn,  248 
U.  S.  71,  reversing  245  Fed. 
1  which  had  reversed  242 
Fed.    709     893 

Gulf  Oil  Corporation  v.  Lew- 
ellyn, 248  U.  S.  71,  distin- 
guished in  Walker  v.  Gulf 
&    Interstate    Co.,   269    Fed. 

885    

220,  222,  450,  453,  456,  519,  523 

Haight  V.  Railroad  Co.,  6 
Wall.  15    1002 

Haiku  Sugar  Co.  v.  Johnstone, 
249  Fed.  103 173,  175,  1270 

Hale  V.  Henkle,  201  U.  S.  43.  .   947 

Hall,  In  re,  167  U.  S.  38 930 

Hall's  Safe  Co.  v.  Herring, 
etc.,  Co.,  146  Fed.  37 223 

Hamilton  v.  Rathbone,  175  U. 
S.    414 1266,    1267 

Hamlin,  Matter  of,  226  N.  Y. 
407,    414    1265 

Hammer  v.  Dagenhart,  247 
U.  S.  251 1260 

Harms  v.  McCormick,  132  111. 
104,  22   N.   E.  511 1084 

Harriman  v.  Interstate  Com- 
merce Commission,  211  U. 
S.  407    1009 


XXVI 


TABLE    OF   CASES 


[References 
Hairison   v.   Glover,  72   N.   Y. 

451     429 

Hartman      v.      Pistorius,      248 

111.  568,  94  N.  E.  131 1084 

Harvey    v.    Wicland,    115    la. 

564,  88  N.  W.  1077 1244 

Hastings   v.    Herold,    184    Fed. 

759 914,    915,    923 

Hatch   V.   The   Boston,   3   Fed. 

807,   810    906 

Hawkins      v.      Spokane      Hy- 

diaulic  Co.,  3  Idaho  650,  33 

Pac.  40    212 

Hawley,  In  re,  22D  Fed.  372..  1206 
Hayden    v.    McMillan,    4    Tex. 

Civ.    App.    479,    23     S.     W. 

430     49 

Hayes  v.  U.  S.,  150  Fed.  63.  .  .1269 
Hays  v.  Gauley  Mountain  Coal 

Co.,  247  U.  S.  189 343, 

417,  431,  519,  559,  731,  732,  1008 
Hedden    v.    Collector,    5    Wall. 

107    1263 

Hedden  v.  Richard,  149  U.   S. 

346    1262 

Heller     v.     National     Marine 

Bank,   89    Md.   601,   43    Atl. 

800     1068 

Heller  Hirsh  &  Co.,  In  re,  258 

Fed.   208    244,   265 

Hempstead     v.     Thomas,     122 

Fed.    538     1269 

Henry  v.  North  American  Ry. 

Const.  Co.,  158  Fed.  79 424 

Herold  v.  Kahn,  159  Fed.  608 

885,    887,    893 

Herold   v.    Mutual   Benefit   In- 
surance   Co.,    198    Fed.    199, 

aff'd  201   Fed.  918 286 

Herold    v.    Parkview^    Bldg.    & 

Loan  Ass'n,  203  Fed.  876..   321 
Herold   v.    Parkview^   Building 

&  Loan  Ass'n,  210  Fed.  577.1273 
Herrington  v.   Davitt,   220   N. 

Y.  162,  115  N.  E.  476,  1  A. 

L.    R.    1700 907 

Hicks    v.    James'    Administra- 
trix, 48   Fed.  542,  aff'd   110 

U.    S.    272 935 

Hillebrant   v.   Brewer,   6    Tex. 
45     826 


are  to  pages.'\ 

Hirth,  In  re,  189  Fed.  926 171 

Ho    Ah    Kow     V.     Nunan,     5 

Sawy.    552    1264 

Holbrook     v.     Moore,     U.     S. 

Dist.  Ct.  E.  Dist.  Mo.,  Ct.  D. 

10,   T.   B.    17-21-1592 

345,  372,  801,  805 

Holly  Springs,  etc.,  v.   Super- 
visors,  52   Miss.   281 455 

Holyoke   v.    Jackson,   3    Wash. 

Terr.  235,  3  Pac.  841 46 

Holy  Trinity  Church  v.  U.  S., 

143   U.  S.   457,  463 1264 

Home    Savings    Bank    v.    Des 

Moines,  205   N.  S.  503 618 

Home   Tel.  &  Tel.   Co.   v.   Los 

Angeles     (Cal.),     181     Pac. 

815    892 

Home  Title  Ins.  Co.  v.   Keith, 

230  Fed.  905 1191,  1245 

Hook  v.  Garfield  Coal  Co.,  112 

Iowa  210,  83  N.  W.  963...  502 
Hooper  v.  Whitaker,  130  Ala. 

324,   30    So.   355 1244 

Hoops    V.     Dunham,     41     Ga. 

109     1242 

Horgan,  In  re,  97  Fed.  319...   223 
Houston  Belt  &  Terminal  Co. 

V.  U.  S.,  250  Fed.  1 500 

Hudson's    Bay    Co.    v.     Thew, 

Gt.  Br.  Tax  Cases,  Vol.  VII, 

Pt.   II,  p.  206 496 

Hunter   v.   Corning  &   Co.,   86 

Fed.    913     1272 

Hurst  V.  Lederer,  T.  D.  3221.  .   881 
Huyvaerts      v.      Roedtz,      105 

Wash.  657,  178  Pac.  801...     46 

Imperial  Fire  Ins.  Co.  v.  Coos 

Co.,  151  U.  S.  452,  462 283 

Income    Tax    Act,    In    re,      10 

Haw.   317    1012 

Income    Tax    Cases,    148    Wis. 

456,  134  N.  W.  673,  135  N. 

W.   164    

...1007,  1011,  1012,  1014,  1261 
Industrial  &   General  Trust  v. 

Tod,  180  N.  Y.  215,  73  N. 

E.  7  424 

Industrial  Trust  Co.  v.  Walsh, 

222   Fed.  437 341 


TABLE  OF  CASES 


XXVll 


[References 

In  le  Assessment  of  Taxes  of 

T.  A.  Hayes,  16  Haw.  796.  .   568 
In    re    Capital    Trading    Com- 
pany, 229   Fed.  806 1206 

In    re   Chadwick,   5    Fed.   Cas. 

No.    2,    570,     11     Int.     Rev. 

Rec.    126,    133 944 

In  re  Chapman,  166  U.  S.  661, 

668     1009 

In  re  Dunavant,  96  Fed.  542.  .   826 

In  re  Hall,  167  U.  S.  38 930 

In  re  Hawley,  220  Fed.  372..  1206 
In    re    Heller    Hirsh     &     Co., 

258   Fed.   208 244,   265 

In  re  Hirth,  189  Fed.  926 171 

In  re  Horgan,  97  Fed.  319 223 

In  re  Income  Tax  Act,  10 

Haw.  317  1012 

In  re  Lippman,  3  Ben.  95,  15 

Fed.   Cas.   No.   8,382,   9   Int. 

Rev.   Rec.   1 946 

In   re    Muncie    Pulp    Co.,    139 

Fed.  546    222 

In  re  O.  R.  &  L.  Co.,  19  Haw. 

544     1169 

In  re  Pacific  Ry.  Commission, 

32   Fed.  241 945,   1009 

In    re    Phillips,    19    Fed.    Cas. 

No.     11,097,     10     Int.     Rev. 

Rec.   107    946 

In  re  Piatt,  19  Fed.  Cas.  No. 

11,  212    945 

In   re   Rieger,   Kapner  &   Alt- 
mark,  157  Fed.  609 222 

In  re  Southern  Pacific  Co.,  82 

Fed.  311,  aff'd  87  Fed.  863.  .1267 
In  re  Strong,  1  Tax  Cas.  207.  .  548 
In   re    Strouse,   23    Fed.     Cas. 

No.  13,  548,  1  Sawy.  605,  11 

Int.    Rev.    Rec.    182 945 

In    re    Swearinger,     23     Fed. 

Cas.   No.   13,  683 1268 

In    re   Watertown    Paper    Co., 

169   Fed.   252 222,   453 

In  re   Williams,   40   Nev.   241, 

161   Pac.   741 48 

Ins.  Co.  of  North  America  v. 

McCoach,  218   Fed.  905 343 

Insurance  Co.  of  North  Amer- 
ica   V.    McCoach,    218    Fed. 

905,  reversed  224   Fed.  657, 


a7-e  to  pages.'] 

661,  writ  of  certiorari 
granted  241  U.  S.  694,  re- 
versed 244  U.  S.  585 1266 

International  Mining  Co.  v. 
Pennsylvania  Railroad  Co., 
152  Fed.  557   947 

International  Paper  Co.  v. 
Burrill,  260   Fed.  664 937 

Interstate  Commerce  Commis- 
sion V.  Brinson,  154  U.  S. 
447,  478,  155  U.  S.  3.  .  .946,  1009 

Interstate  Commerce  Commis- 
sion V.  D.  L.  &  W.  R.  Co., 
220  U.  S.  235 1268 

Interstate  Co.  v.  Baltimore  & 
O.   Co.,  51    Fed.   49 223 

Ionia  Co.  Savings  Bank  v. 
McLean,  84  Mich.  629,  48 
N.    W.    159 462 

Iron  Silver  Min.  Co.  v.  Camp- 
bell, 135  U.  S.  286,  298....   846 

Jackson     v.     Smietanka,     267 

Fed.  932    807 

Jackson     v.     Smietanka,     267 

Fed.    932,    aff'd,     272     Fed. 

970 345,   372,   805,   806 

Jacobs    and    Davies,     Inc.     v. 

Anderson,  228  Fed.  505...  593 
Jasper,  etc.,  Ry.  Co.  v.  Walk- 
er,  238   Fed.   533 1154 

Jenks    V.    Brewster,     96     Fed. 

625     224 

Jennison    v.    Kirk,    98    U.     S. 

453,   459 1264,   1265 

Jewelers  Safety  Fund  Society 

V.  Lowe,  274  Fed.  93 283 

Johnson    v.    Burford,    39    Tex. 

242     45 

Johnson  v.  Southern  Pacific 

Co.,  196  U.  S.  1 1272 

Johnson  v.  U.  S.,  215  Fed. 

679  1265 

Jones  V.  Seward  Co.,  10  Nebr. 

154,  4  N.  W.  946 455 

Kahn  v.  Herold,  147  Fed.  575, 
aff'd  159  Fed.  608 886 

Kaufman  v.  U.  S.,  96  U.  S. 
567     933 

Keely  v.  Sanders,  99  U.  S.  441  850 


XXVlll 


TABLE    OF   CASES 


[References 
Kelly    V.    Gonce,    49    111.    App. 

82     457 

Kemper     Military     School     v. 

Crutchley,   274    Fed.    125...    327 
Kennosha  v.  Lamson,  9  Wall. 

477     1217 

Keokuk  &   W.   R.   Co.  v.   Mis- 
souri, 152  U.  S.  301 1273 

Kidd   V.    Alabama,   188    U.    S. 

730     62 

Kilbourn  v.  Thompson,  103  U. 

S.  168    1009 

Kimball  v.  Cotling,  234  Mass. 

172,  125  N.  E.  551 ..1004 

King  V.  U.  S.,  99  U.  S.  229. . .   869 
King    of    Spain    v.    Oliver,     2 

Wash.   429    870 

Kings    Co.    Savings     Inst.     v. 

Blair,  116  U.  S.  200 930,  935 

Klock    Produce    Co.    v.    Hart- 
son,  212   Fed.   758 940 

Knight   V.   Kaufman,    105    La. 

35,  29  So.  711 45 

Knowlton  v.  Moore,  178  U.  S. 

41,  77 1011,  1013,  1261,  1263 

Knox  V.  Rossi,  25  Nev.  96,  57 

Pac.    179,   48    L.    R.   A.   305 

(note)     1242 

Kodak    Ltd.    v.    Clark    (1902) 

2    K.    B.    450,    aff'd     (1903) 

1    K.    B.    505,    88    L.    T.    R. 

155    299,   300 

Kohlhamer   v.   Smietanka,   239 

Fed.  408   896 

Kohny    v.    Dunbar,    21     Idaho 

258,   121   Pac.   544 47 

Kollock,   Ex   parte,   165    U.   S. 

526    7 

Komada   v.    U.    S.,   215    U.    S. 

392     1267 

La  Belle  Iron  Works  v.  U.  S., 

41  Sup.  Ct.  Rep.  528,  65  L. 

Ed.   604    

1013,  1041,   1087,  1261,  1264 

La  Belle  Iron  Works  v.  U.  S., 

decided   June    28,    1920,    Ct. 

Cls.  No.  34,  603 1266 

Lamborn    v.    Comm'rs,    97    U. 

S.   181    885,   886 

Lane  v.  Smythe,  46  N.  J.  Eq. 

443,    19    Atl.    199 1051 


are  to  pages.'] 

Lapina  v.  Williams,  232  U.  S. 

78    199,   1265 

Latimer   v.    U.    S.,   223    U.    S. 

501     1267 

La    Tourette    v.    La    Tourette, 

15  Ariz.  200,  137  Pac.  436.  .     47 
Landram  v.  U.  S.,  16  Ct.  Cls. 

74     8 

Laurence  v.  Wardell,  270  Fed. 

682,  aff'd  273   Fed.  405 45 

Laurentide  Co.,  Ltd.  v.  Durey, 

231   Fed.  223 75,   1143 

Lehigh   Valley  R.   Co.   v.   Del- 

achesa,    145    Fed.    617 223 

Leicester  v.  Hoadley,  66  Kans. 

113,   71    Pac.  318 545 

Leprohon    v.    Ottawa,    2    Ont. 

App.    522    379 

Levy  V.   U.   S.,  271   U.   S.  942 

900,    903 

Lewellyn  v.  Pittsburg,  etc.,  R. 

R.  Co.,  222  Fed.  177..  1152,  1154 
Lexington  v.  Butler,  14  Wall. 

282     1217 

Lincoln    Chemical    Co.    v.    Ed- 
wards,   272    Fed.    142 1024 

Lippman,  In  re,  3  Ben.  95,  15 

Fed.   Cas.   No.   8,382,   9   Int. 

Rev.    Rec.    1 946 

Little    V.    Bowers,    134    U.     S. 

547    886,   888 

Little    Schuylkill,    etc.    Co.    v. 

Philadelphia  &  Reading  Ry. 

Co.,  44  P.  A.  County  Court, 

Rep.  197,  aff'd  69  Pa.  Super. 

122     1004 

Logan  V.  W.  A.  R.  Co.,  87  Ga. 

533,  13  S.  E.  516   1043 

Loomis    V.    Wattles,    266    Fed. 

876    533,  915 

Loring  v.  Chase,  26  Misc.  318, 

56  N.  Y.  Supp.  312 1244 

Lowe     v.     Farbwerke-Hoechst 

Co.,  240  Fed.  671 1272 

Lumber    Mut.    Fire    Ins.    Co. 

v.     Malley,     256     Fed.     380 

284,    343 

Lutton  V.  Baker,  187  la.  753, 

174  N.  W.  599 1244 

Lynch    v.    Hornby,    236    Fed. 

661,   reversed   in   247    U.    S. 

339     518 


TABLE  OF  CASES 


XXIX 


]^References 

Lynch    v.    Hornby,   247    U.    S. 

339 228,  512,  525,  733 

Lynch   v.   Turrish,   247    U.    S. 

221 228,   344,   421,    512, 

518,  556,  731,  733,  1008,  1264 
Lynch    v.    Union     Trust     Co., 

164    Fed.    161 1270 

Mabie  v.  Whittaker,  10  Wash. 

656,   39   Pac.   172 46 

McCaskill    v.    U.    S.,    216     U. 

S.    504     453 

McClain    v.     Fleishman,     106 

Fed.    880    1225 

McCoach  V.  Continental  Pas- 
senger   Ry.    Co.,     233     Fed. 

976     1154 

McCoach   V.   Insurance   Co.   of 

North    America,    244    U.    S. 

585,  37  Sup,  Ct.  709 291,  293 

McCoach     V.     Mine      Hill     & 

Schuylkill  Haven  R.  R.  Co., 

228    U.    S.   295.. 1153 

McCray   v.    U.    S.,   195    U.    S. 

27     1010 

McCullough  V.  Hopper,  47  N. 

J.   L.  189    862 

-McCullough    V.    Maxyland,     4 

Wheat.   316    379 

McDaniel  v.  Harley,  42  S.  W. 

323     50 

McDonald  v.  Hovey,  110  U.  S. 

619     ."...1268 

McKenzie  v.  Hare,  239  U.   S. 

299     1265 

McKyring   v.   Bull,   16   N.     Y. 

297     937 

McLean   v.    U.    S.,   226    U.    S. 

374     1265 

McNally    v.    Field,    119     Fed. 

445     1269 

MacPherson  &  Co.  v.  Moore,  6 

Br.  Tax  Cas.   107 72 

Maddock  v.  Magone,  152  U. 

S.  368  1262 

Maguire  v.  Trefry,  253  U.   S. 

12,   230    Mass.   503,    120    N. 

E.    162    36 

Main   v.   Mills,   Fed.   Cas.   No. 

8974     218 

Mallard  v.  Lawrence,  16  How. 

251     1262 


are  to  pages.} 

Malley  v.  Bowditch,  259  Fed. 
809 1171,    1175,    1247 

Mallory  v.  Hanaur  Oil  Works, 
86  Tenn.  598,  8  S.  W.  396. .    173 

Mandell  v.  Pierce,  3  Cliff.  134, 
16  Fed.  Cas.  No.  9008... 53,  145 

Manning  v.  Burke,  107  La. 
456,   31    So.   862 45 

Manning  v.  Frazier,  96  111. 
279     502 

Mannington  v.  Hocking  Val- 
ley R.  R.  Co.,  183  Fed.  133.  .1262 

Mansfield  v.  Excelsior  Refin- 
ing Co.,  135  U.  S.  326 872 

Marconi  Wireless  Telegraph 
Company  of  America  v. 
Duffy,  273   Fed.   197 1182 

Markle  v.  Kirkendall,  267 
Fed.    498    852 

Marsal,  Succession  of,  118  La. 
212,    42    So.    778 48 

Marsching  v.  U.  S.,  113  Fed. 
1006     1263 

Marston  v.  Rue,  92  Wash.  129, 
159  Pac.  Ill 46 

Maryland   Casualty   Co.  v.   U. 

S.,   251   U.    S.   342 

284,  285,  291,  292, 

343,  344,  348,  349,  930,  ^35,  1266 

Matter  of  Curtice.  Ill  App. 
Div.  (N.  Y.)  230,  97  N.  Y. 
Supp.  444,  aff'd  185  N.  Y. 
542,  77  N.   E.  1184 430 

Matter  of  Green,  67  Hun.  527; 
20  N.  Y.  Supp.  538,  aff'd 
22  N.  Y.  Supp.  1112 32 

Matter  of  Hamlin,  226  N.  Y. 
407,   414    1265 

Matter  of  Osborne,  209  N. 
Y.  450   524 

Matter  of  Valentine,  147  N. 
Y.    Supp.    231 430 

Mayor,  etc.,  of  City  of  Balti- 
more V.  Chesapeake  &  Poto- 
mac Telephone  Co.,  92  Md. 
692,  48  Atl.  465,  468 578 

May,  Succession  of,  120  La. 
692,  45   So.  551 48 

Mears  v.  Bickford,  55  Maine 
528     826 

Meehan  v.  Valentine,  154  U. 
S.    161,    173 171 


XXX 


TABLE    OF   CASES 


[References 
Mente  v.  Eisner,  266  Fed.  161  626 
Merchants   Loan   &   Trust   Co. 
V.    Smietanka,   41    Sup.     Ct. 

Rep.  386 407,  525,  1008 

Merck  v.  Treat  174  Fed.  388.  935 
Merck  v.  Treat,  202  Fed.  133.  885 
Merrell  v.  Moore,  47  Tex.  Civ. 

App.  200,  104  S.  W.  514...      46 
Merritt  v.  Cameron,  137  U.  S. 

542     1266 

Miami   &   C.   R.   R.   Co.   v.   U. 

S.,   108   U.   S.   277 643 

Middlesex      Banking     Co.      v. 

Eaton,  233   Fed.  87....' 234 

Miller     v.     Gearin,     258     Fed. 

225    498,    1270 

Miller   v.    Snake   River   Valley 

R.  R.  Co.,  223  Fed.  946 1154 

Miller  &  Lux  v.  East  Side  Co., 

211  U.  S.  293 223 

Mitchell    V.    Commissioners,    9 

Kans.  344,  91  U.  S.  206....   455 
Mitchell  V.  Great  Works  Mill- 
ing, etc.   Co.,  2   Story  653..  1265 
Moffit  V.  Kelly,  218  U.  S.  400.     49 
Mohawk  Mining  Co.  v.  Weiss, 

U.    S.    Dist.    Ct.    No.    D    of 

Ohio,    L    T.    S.    1919,    par. 

3635.  Further  opinion  in  254 

Fed.  502    728 

Molly  Varnum  Chapter,  D.  A. 

R.    V.    City    of    Lovi^ell,    204 

Mass.  487,  90  N.  E.  893...   564 
Moore  v.  Moore,  47  N.  Y.  467 

1242,    1244 

Moore   v.    Stewarts   &   Lloyds, 

(1906),   8   Frasier   1129 642 

Morrill    v.    Jones,    106    U.    S. 

466     198 

Morrill  v.  Jones,  106  U.  S.  467  7 
Mosle    v.    Bidwell,     130     Fed. 

334     1265 

Mt.    Hermon    Boys'    School    v. 

Gill,  145  Mass.  139,  13  N.  E. 

354,   357    323 

Mt.    Vernon    Co.    v.    Teschner, 

108    Md.    158 430 

Muncie    Pulp    Co.,    In    re,    139 

Fed.   546    222 

Mustard  v.  Elwood,  223  Fed. 

225  1268 

Mutual    Benefit   Life    Ins.    Co. 


are  to  pages.'] 

v.    Herold,    198     Fed.     199, 

aff'd  201   Fed.  918 

343,  572,  585,  1262,  1270 

Mutual  Benefit  Life  Ins.  Co.  v. 
Herold,  198  Fed.  199,  209 
283,  287,  293,  1148 

Myers  v.  Albert,  76  Wash. 
218,  135  Pac.  1003 50 

Nash  V.  Classen,  163  111.  409, 
45    N.    E.   276    429 

Nashville,  Chattanooga  &  St. 
Louis  Ry.  Co.  v.  U.  S.,  269 
Fed.  351    690 

National  Bank  of  Commerce 
V.  Allen,  211  Fed.  743,  aff'd 
223  Fed.  472    618 

National    Bank    of     Commerce 

V.    Allen,   223    Fed.    472 

862,    901,    1262 

Nat.  Co.  V.  Connecticut  Co., 
73   Fed.  491 223 

Nat.  Life  &  Accident  Ins.  Co. 
V.  Craig,  251   Fed.  524 1262 

Neill  V.  Shamburg,  158  Pa. 
263,  27  Atl.  992 171 

Nelson  v.  U.  S.,  201  U.  S.  92.  .   947 

Newhall  v.  Jordan,  149  Fed. 
586    886,   887 

Newman  v.  Arthur,  109  U. 
S.   132    1263 

New  York  Central  v.  Gill,  219 
Fed.    184     1154 

New  York  Cent.  R.  Co.  v. 
Lockwood,  17  Wall.  357 639 

New  York  Life  Ins.  Co.  v. 
Anderson,  257  Fed.  576.  .  .8,  643 

N.  Y.  Life  Ins.  Co.  v.  Ander- 
son, 257  Fed.  576,  reversed 
in  263   Fed.  527 937 

N.  Y.  Life  Ins.  Co.  v.  Ander- 
son,  263   Fed.   527 940 

New    York    Mail,    etc.,    Co.    v. 

Anderson,  234  Fed.  590 

935,  940,  1154 

N.  Y.,  N.  H.  &  H.  R.  R.  Co. 
V.  U.  S.,  Ct.  D.  3 1010 

N.   Y.   Trust   Co.  v.   Edwards, 

42  Sup.  Ct.  Rep.  68 

220,  350,  448,   529 

New  York  Ti-ust  Co.  v.  Eisner, 
U.    S.    Dist.    Ct.,    So.    Dist.. 


TABLE  OF  CASES 


XXXI 


[References 

N.  Y.,   N.   Y.   Law  Journal, 

March    4,    1920 1270 

New  Zealand  Co.  v.   Stephens, 

24  T.  L.  R.  172 299 

Nichols  V.   Levy,   5   Wall.    (U. 

S.)     433,    442-3 457 

Nichols  V.  U.  S.,  7  Wall.  122. .  912 
Nickerson     v.     Nickerson,     65 

Tex.  281    45 

Nicol  V.  Ames,  173  U.   S.  509 

1212,    1245 

Niles  V.  Central  etc.   Ins.  Co., 

252  Fed.  564 332 

Nix   V,    Hedden,   39    Fed.    109, 

aff'd  149  U.  S.  304 1262 

Norfolk  &  W.  R.  Co.  v.  Reeves, 

97  Va.  284,  33  S.  E.  606...  429 
North      Amer.      Tel.      Co.      v. 

Northern  Pac.   Ry.   Cp.,  254 

Fed.   417    424,   425 

Northern  Central  R.  R.  Co.  v. 

Jackson,   7   Wall.   262 1004 

Northern    Commercial    Co.    v. 

U.   S.,  217   Fed.   33 1264 

Northern    Co.    v.     Lowe,     250 

Fed.    856 229,   501 

Northern   Pacific  Railway   Co. 

v.    Lynch,    U.    S.    Dist.    Ct., 

Dist.    of    Minnesota,    T.     D. 

3048     495 

Northern   Pennsylvania   R.   R. 

Co.  V.  Philadelphia  &  Read- 
ing   Ry.    Co.,   43    Pa.    C.    C. 

150,    aff'd    249    Pa.    326,    94 

Atl.   834    1003 

Northern    Trust   Co.   v.    Buck, 

263  111.  222,  104  N.  E.  1114.1004 
Northern    Trust    Co.     v.     Mc- 

Coach,  215  Fed.   991 618 

Northwestern  Ins.  Co.  v.  Fink, 

248  Fed.  568   929 

Northwestern    Life     Ass'n     v. 

Stout,  32  111.  App.  31,  38..  283 
Nye    V.    Washburn,    125    Fed. 

818     850 

Oakes  v.  U.  S.,  174  U.  S.  778.  .  846 
Ober  V.  Galligher,  93  U.  S. 

199  654 

Ohio   Oil   Co.   V.   Indiana,    177 

U.  S.  190   502 


are  to  pages.'] 

Ohio    R.    June.    R.    R.    Co.    v. 

Penna.  Co.,  222  Pa.  St.  573, 

72   Atl.   271 1244 

Old  Colony  R.  Co.  v.  Gill,  257 

Fed.  220    940,   1154 

Oliver    v.    Robertson,    41    Tex. 

422     50 

Omaha  &  C.  B.   Street  R.  Co. 

V.       Interstate       Commerce 

Commission,  230  U.  S.  324.  .1265 
O.    R.    &    L.    Co.,     In     re,     19 

Haw.    544    1169 

Oregon   Ry.   Co.   v.   Oregonian 

Ry.  Co.  130  U.  S.  1 219 

Oregon- Washington   Co.   v.   U. 

S.,  251  Fed.  211 230 

Osborne,    Matter    of,     209     N, 

Y.   450    524 

Osgood   V.   Tax   Commissioner, 

235    Mass.    88,    126     N.     E. 

371    447,   1268 

Osterberg  v.  Union  Trust  Co., 

93  U.  S.  424 872 

Pacific  Bldg.  &  Loan  Ass'n  v. 

Hartson,  201  Fed.  1011 321 

Pacific  Ry.  Commission,  In  re, 

32  Fed.  241 945,  1009 

Pargoud  v.  Richardson,  30  La. 

Ann.    1286    1242 

Park  V.  Gilligan,  Dist.  Ct.  So. 

Dist.    Ohio,    I.    T.    S.    1921, 

113067    522,   527,  940 

Parker  v.  Bethel  Co.,  96  Tenn. 

252,  34  S.  W.  209,  31  L.  R. 

A.    706    218 

Parkview     Building     &     Loan 

Ass'n    V.    Herold,    203    Fed. 

876,  aff'd  210  Fed.  577.319,  1270 
Patton    V.    Brady,    Executrix, 

184  U.  S.  608 937,  1013 

Patton    V.    U.    S.,    159     U.     S. 

500,   509    1263 

Paul  V.  Virginia,  8  Wall.  168.  .  297 
Peabody  v.   Eisner,  247  U.   S. 

347 349,  519,  528 

Peacock  v.  Pratt,  121  Fed. 

772  1012 

Pearce    v.    Jackson,     61     Tex. 

642    '    45 

Pearce    v.    Madison,     etc.,     R. 

Co.,  62  U.  S.  441 173 


XXXll 


TABLE    OF   CASES 


[References 

Peck  V.  Lowe,  247  U.  S.  165 
303,  379,  386 

Penn.  Collieries  v.  McKeever, 
183   N.    Y.    98 1152 

Penn.  Mutual  Life  Insurance 
Co.  V.  Lederer,  252  U.  S.  523 
287,  463,   1149,   1264 

Pennsylvania  R.  Co.  v.  Inter- 
national Coal  Min.  Co.,  230 
U.    S.    184 1265 

Pennsylvania  Steel  Co.  v.  New 
York  City  Railways  Co.-,  193 
Fed."  286,  198  Fed.  774 243 

Penn.  Steel  Co.  v.  N.  Y.  City 
Co.,  198  Fed,  774,  aff'd  231 
U.    S.    144 1270 

People  V.  Albany  Ins.  Co.,  92 
N.    Y.    458 455 

Peo.  V.  Amer.  Bell  Tel.  Co., 
117  N.  Y.  241,  22  N.  E. 
1057     219 

People  V.  Board  of  Super- 
visors, 60  N.  Y.  Supp.  1122.   578 

Peo.  V.  Charles  Schweinler 
Press,  214   N.  Y.  395 1264 

People  V.  Coleman,  126  N.  Y. 
433,  27  N.  E.  818 432 

Peo.  V.  Hackley,  24  N.  Y.  83.  .    946 

Peo.  V.  Mensching,  187  N.  Y. 
8     1246 

Peo.  V.  Sawyer,  27  N.  Y. 
Supp.    202    455 

Peo.  ex  rel.  Barbour  v.  Gates, 
43    N.   Y.   40 1242 

Peo.  ex  rel.  Ogdensburg  Co.  v. 
Pond,  13  Abb.  N.  C.  (N.  Y.) 
1,  appeal  dismissed  92  N. 
Y.    643     431 

Peppleton  v.  Yamhill,  8  Ore. 
337     456 

Perry  v.  Newsome,  19  Fed. 
Cas.  No.  11,009,  10  Int. 
Rev.   Rec.  1 946 

Peterson  v.  Chicago,  Rock 
Island  &  Pac.  Ry.,  205  U. 
S.   364    219 

Peterson  v.  Chicago,  etc.,  Co., 
205  U.  S.  362 224 

Pettebone  v.  Smith,  150  Pa. 
118,  24  Atl.  693 1004 

Pewabic    Min.    Co.   v.     Mason, 


a7'e  to  pdges.l 

145   U.   S.   349,  12   Sup.   Ct. 

887     1043 

Phelps-Stokes         Estates         v. 

Nixon,  22  N.  Y.  93,  118  N. 

E.    241     1179 

Philadelphia     v.     Collector,     5 

Wall.  720   887,  933 

Philadelphia  &  Reading  R.  Co. 

V.      Stichter,      11      Weekly 

Notes  of  Cases,  Pennsyl- 
vania,  325    1068 

Philadelphia    City    P.    Ry.    Co. 

v.    Philadelphia    R.    T.    Co., 

263  Pa.  561,  107  AtL  329.  .  .  1003 
Phila.  G.  &  N.  R.  Co.  v.  Phila. 

&  R.   Ry.   Co.,  265  Pa.  325, 

108   Atl.    528 1004 

Philadelphia  H.  and  P.  R.  Co. 

V.    Lederer,   242    Fed.    492.  . 

937,    1154 

Philadelphia    Traction    Co.    v. 

McCoach,   224   Fed.   800 1154 

Phillips,    In    re,    19    Fed.    Cas. 

No.     11,097,     10     Int.     Rev. 

Rec.    107    946 

Phoenix  Fire  Ins.  Co.  v.  Ten- 
nessee, 161   U.  S.  174 1273 

Pickhardt    v.    Merritt,    132    U. 

S.  252    1263 

Pittsburg    &    Buffalo     Co.     v. 

Duncan,   232    Fed.   584 222 

Pittsburgh,     etc.,     R.     Co.     v. 

Keokuk,  etc.,  Co.,  131  U.  S. 

371     173 

Piatt,  In  re,   19  Fed.  Cas.  No. 

11,212     945 

Plummer     v.     Hillsdale     Coal 

etc.,    Co.,    163    Pa.    483,    28 

Atl.   853    502 

Polk  V.  Page,  U.  S.  Dist.  Court, 

Dist.  of  Rhode  Island 851 

Pollard    V.    First    Natl.    Bank, 

47  Kans.  406,  28  Pac.  202..  455 
Pollock    V.    Farmers    Loan     & 

Trust    Co.,    157    U.     S.     429, 

584,  158  U.  S.  601 . 

4,  377,  489,  850,   1008 

Porter    v.    Lederer,    267     Fed. 

739     201 

Powder   Co.   v.   Burkhardt,   97 

U.   S.  110.. 390 


TABLE  OF  CASES 


XXXlll 


[Refer'cnces 

Powers  V.  Barney,  5  Blatch. 
202     1268 

Prentiss  v.  Eisner,  260  Fed. 
589,  aff'd  267  Fed.  16 617 

Price  V.  Forrest,  173  U.  S. 
410,   427    1263 

Providence  Bank  v.  Billings,  4 
Pet.   514    1273 

P.  S.  Ry.  Co.  V.  Herold,  219 
Fed.  301   923,  936 

P.  S.  Ry.  Co.  V.  Herold,  229 
Fed.  902,  910 937,   1154 

Public  Service  Gas  Co.  v.  Her- 
old, 227  Fed.  496,  229  Fed. 
902      923 

Pullman  Co.  v.  Missouri  Pa- 
cific Co.,  115  U.  S.  587....   219 

Railroad  Co.  v.  Comrn'rs,  98 
U.  S.  541 886 

Railroad  Co.  v.  Howard,  7 
Wall.  392    267 

Railway  Co.  v.  Humboldt,  87 
Kans.  1,  123  Pac.  727 892 

Rainey  v.  U.  S.,  232  U.  S.  310.1066 

Rankin  v.  Hoyt,  4  How.  327.  .1269 

Rankin  v.  Hoyt,  4  How.  332 
1271,    1272 

Ransom  v.  Burlington,  111 
Iowa  77,  82  N.  W.  427 455 

Rau  v.  Union  Paper  Mill  Co., 
95  Ga.  208,  22  S.  E.  146...  1043 

Rau  V.  U.  S.,  260  Fed.  131, 
136    365,  545,  909 

Real  Est.  Savings  Bank  v.  U. 
S.,  16  Ct.  Cls.  335,  Int.  Rev. 
Rec.  154,  afF'd  104  U.  S.  728  883 

Redfield  v.  Bartels,  139  U.  S. 
694      940 

Reg.  V.  Westbrook,  10  Q.  B. 
178,  205,  22  Eng.  Rul.  Cas. 
623      502 

Reiche  v.  Smythe,  13  Wall. 
162      1263 

Rensselaer  &  Saratoga  R.  R. 
Co.  V.  Irwin,  249  Fed.  726..   501 

Rensselaer  &  Saratoga  Rail- 
road Co.  V.  Irwin,  249  Fed. 
726,  writ  of  certiorari  de- 
nied, 246  U.  S.  671 229 

Re  Stanfield's  Estate,  135  N. 
Y.  292,  31  N.  E.  1013 129 


are  to  pages.'] 

Revell  V.  Directors,  3   Gr.  Br. 

Tax   Cas.    12 569 

Rice  V.  U.  S.,  53  Fed.  910 

75,    1262,    1269 

Richmond    Co.     v.     Richmond 

Co.,  68  Fed.  105 224 

Ridgway  v.  U.  S.,  18  Ct.  Cls. 

707      919 

Rieger,   In  re,  Kapner  &   Alt- 
mark,  157  Fed.  609 222 

Rio   Grande   Junction   Ry.   Co. 

V.  U.  S.,  51  Ct.  Cls.  274....  1153 
Roberts      v.      Anderson,      226 

Fed.  7    211 

Roberts  v.  Lowe,  236  Fed.  604  937 
Roberts    v.    Pacific    Nav.    Co., 

104   Fed.  577 1272 

Roberts    v.     Southern     Pacific 

Co.,  186  Fed.  934,  aff'd  219 

Fed.  1022    1265 

Robertson  v.  Downing,  127  U. 

S.   607    1266 

Robertson  v.  Pratt,  13  Haw. 

590 157,  1006,  1012 

Robinson    v.    Belt,    187    U.    S. 

41      1268 

Rockefeller     v.     O'Brien,     224 

Fed.  541,  aff'd  239  Fed.  127.1269 
Rockefeller   v.   U.    S.,   42   Sup. 

Ct.  Rep.  68.  .  .220,  350,  448,  529 
Rock    Island    &    C.    R.    Co.    v. 

U.   S.,  254   U.   S.   141 

883,  891,  914,  915,  934 

Rossman    v.    Hedden,    145     U. 

S.  561    1262 

Rounds  Bros.  v.  McDaniel,  133 

Ky.  669,  118  S.  W.  956,  958  826 
Routh  v.  Routh,  57  Tex.  589.  .  46 
Rowe   V.    Bowman,    183    Mass. 

488,  67  N.  E.  636 1242,  1244 

Sackett  v.  McCaffrey,  131  Fed. 

219    1243,   1246 

Safe   Deposit   &   Trust   Co.   of 

Baltimore    v.    Miles,    U.     S. 

Dist.  Ct.,  Dist.  of  Md.   I.  T. 

S.   1921,  113033 550 

Sage  v.  U.  S.,  250  U.  S.  33..  .  937 
St.      Clement      v.      L'Institute 

Jacques    Cartier,    95    Maine 

493,  50  Atl.  376 327 


XXXIV 


TABLE    OF   CASES 


[References 
St.    Louis    Breweries    v.     Ap- 

thorpe,  79  L.  T.   R.  551,  15 

T.    L.    R.    112,    4    Tax    Cas. 

Ill      299 

Sammons     v.      Halloway,     21 

Mich.    162     1242 

Sanborn    v.    Stetson,   21     Fed. 

Cas.  12,291,  2  Story  481...     32 
San    Francisco    Co.    v.     Scott, 

253  Fed.  854 689,  691,  697 

San  Francisco  Society  v.  Gary, 

2  Sawy.  393,  and  T.  D.  129.3, 

T.    D.    974 915 

San   Paulo   Ry.   Co.   v.   Carter 

(1896),  App.  Cas.  31,  73  L. 

T.  538    298 

Saunders  v.  Isbell,  5  Tex.  Civ. 

App.  513,  24  S.  W.  307 46 

Savings     Bank     v.     Archbold, 

104  U.  S.  708 896 

Saxonville  Mills  v.  Russell,  116 

^    U.  S.  21 1267 

*S.    C.    v.    Gaillard,    101    U.    S. 

433      930 

Schell  V.  Alston  Mfg.  Co.,  149 

Fed.  439   33 

Schneider     v.     Barney,       Fed. 

Cas.    No.    12,462 933 

Schramm  v.   Steele,  97  Wash. 

309,   166   Pac.   634 46 

Schriefer   v.    Wood,     21     Fed. 

Cas.  No.  12,481 1262 

Schuylkill  Nav.  Co.  v.  Elliott,. 

21    Fed.   Cas.   No.   12,497.  .  .1014 
Schwarzchild   &   Sulzberger  v. 

Rucker,  143  Fed.  656... 915,  935 
Scofield  et  al.  v.  Alcott  et  al., 

120   111.   362,   11   N.   E.   351, 

352     457 

Scott  V.  Schwab,  255  Fed.  57.  .1008 
Scott    V.     Western     Pac.     Ry. 

Co.,  246  Fed.  545 851,  1270 

Searchlight   Co.    v.     American 

Co.,   240   Fed.   745 223 

Searls  v.  Flora,  225  111.  167, 

80  N.  E.  98 1084 

Seldon  v.  Equitable  Trust  Co., 

8  Fed.  Cas.  No.  4,508,  aff'd 

94  U.  S.  419 1262 

Sergeant     v.     Goldsmith     Co., 

110    Tex.    482,     159     S.     W. 

1036,  221  S.  W.  259 283 


are  to  pages. 1 

Sesnon  Co.  v.  U.  S.,  182  Fed. 

573,    writ    of    certiorari    de- 
nied 220  U.  S.  609 1261,  1272 

Shaefer   v.   Ketchum,   21    Fed. 

Cas.    No.    12,693 884 

Shafer  v.  Craft,  144  Fed.  907.   934 
Shallus  V.  U.  S.,  162  Fed.  653 

1265,    1269 

Shea  V.  Nilima,  133  Fed.  209.  .    171 
Shepherd   v.    May,    115    U.    S. 

505      654 

Sherburne  v.  Hartland,  37  Vt. 

528     826 

Sherlock  v.   Denny,   28   Wash. 

170,  68  Pac.  452 45 

Shotwell    V.    Moore,     45     Ohio 

632,   16   N.   E.   470,   129    U. 

S.  590    455 

Silvey    v.    Axley,    118     N.     C. 

959,  23  S.  E.  933 654 

Simons   v.    U.    S.,   19   Ct.    Cls. 

601      888 

Simpson     v.     Brotherton,     62 

Tex.  170    46 

Simpson    v.    Treat,     126     Fed. 

1003    1218,   1246 

Singer  Mfg.  Co.  v.  McCollock, 

24    Fed.    667 1264 

Sisler  v.   Foster,  72  Ohio  437, 

74  N.  E.  649 455 

Sisson    v.    Cleveland    &    T.    R. 

Co.,  14  Mich.  489 429 

Sixty  Pipes  Brandy,  10  Wheat. 

424      1272 

Skinner  v.  Union  Pacific  Coal 

Co.,  249  Fed.  152 519 

Small  v.  Slocumb,  112  Ga.  279, 

37   S.  E.  481 1242 

Smietanka    v.    U.    S.,     decided 

by    U.    S.     Supreme     Court, 

October   24,    1921 937 

Smietanka  v.   Zibell,  263   Fed. 

883      873 

Smietanka  v.   Zibell,   U.   S.   C. 

C.  A.,  7th  Circ.  T.  D.  3000.  .1267 
Smietanka    v.     Indiana     Steel 

Co.,  42  Sup.  Ct.  Rep.  1 937 

Smith    v.     British     Steamship 

Co.,  123  Fed.  176 639 

Smith  V.  Howell,  60  N.  J.  L. 

384      490 


TABLE  OF  CASES 


XXXV 


[References 
Smythe     v.     Fiske,     23     Wall. 

374,   380    

...1263,  1266,  1269,  1271,  1272 
Smythe  v.  Pure  Ice  Co.,  193 

App.  Div.  (N.  Y.)  479 1179 

Snyder    v.    Marks,    109    U.    S. 

189      850 

Society   v.    City   of   Cleveland, 

43  0.  S.  481,  3  N.  E.  357...   218 
Sonn    V.    Magone,    159    U.     S. 

417      1262 

South      Carolina      Dispensary 

Case,  199  U.   S.   437 490 

South   Carolina   v.   U.   S.,   199 

U.  S.  437 489 

Southern     Co.     v.      Interstate 

Commerce    Commission,   219 

U.  S.  497 223 

Southern  Pacific  Co.  v.  Lowe, 

238    Fed.    847,    reversed     in 

247  U.  S.  330 519 

Southern    Pac.    Co.    v.    Low^e, 

247  U.   S.   330,  38   Sup.   Ct. 

540,  62  L.  Ed.  1142 220, 

221,  421,  450,  453,  456,  523,  556 
Southern    Pacific    Co.,    In     re, 

82    Fed.    311,    aflf'd    87    Fed. 

863    1267 

Southern  Pacific   R.   R.   Co.  v. 

Muenter,  260  Fed.  837.. 239,  341 
Southwestern    R.     R.     Co.     v. 

Wright,  116  U.  S.  231 1273 

Spencer  v.  Jones,  92  Tex.  516, 

50  S.  W.  118 172 

Spencer   v.    Merchant,   125    U. 

S.  345    1010 

Spencer    v.    Smith,    201     Fed. 

647      1068 

Spooner  v.   Phillips,  62   Conn. 

62,  24  Atl.  524 502 

Spreckels  v.  Spreckels,  116 

Cal.  339,  48  Pac.  228 49 

Spreckels    Sugar    Ref.    Co.    v. 

McClain,  192  U.  S.  397.... 

211,    1270 

Springer  v.   U.   S.,   102   U.   S. 

586     873 

Sprinkle    v.    U.    S.,    141    Fed. 

811      8 

Spruance   ex   rel.   v.    Farmers 

&       Merchants       Insurance 

Company,  10  Pac.  285,  287.  .1149 


are  to  pages.'\ 

Stanfield's   Estate,  Re,   135   N. 

Y.  292,  31  N.  E.  1013 129 

Stearns      Coal     Co.     v.     Van 

Winkle,  221  Fed.  590 1043 

Stefel  V.  Brown,  24  Mo.  App. 

102      455 

Stegall  V.  Thurman,  175   Fed. 

813      7 

Stein   V.   Hartshore,   123   App. 

Div.   (N.  Y.)   467 430 

Stevens  v.  Stevens,  132  Mo. 

App.  624  639 

Stewart  v.  Barnes,  153   U.   S. 

456     884,    939 

Stockdale    v.    Insurance    Com- 
panies, 20  Wall.  328..  1014,  1264 
Stockton  v.  Lederer,  262  Fed. 

173,  aff' d  266  Fed.  676 116 

Stone    v.    Tax    Commissioner, 

235  Mass.  93,  126  N.  E.  373  447 
Stotesbury    v.    U.    S.,    23     Ct. 

Cls.    285    920 

Standard  Oil  Co.  v.  U.  S.,  221 

U.    S.    1 1265 

Stanton  v.  Baltic   Mining  Co., 

240  U.  S.  103 850,  1012 

State   V.   Alley,   96   Miss.   720, 

51    So.  467 283 

State  V.  Evans,  99  Minn.  220, 

108   N.  W.  958 502 

State  V.  Frear,  148  Wis.  456, 

134  N.  W.  673,  135  N.  W. 

164  4,  351 

State    V.    Franklin     Bank,     10 

Ohio    91    519 

State   V.    Lee    (Wis.)    178     N. 

W.   471    431 

State   V.   Royal   Mineral   Asso- 
ciation,  132   Minn.   232,   156 

N.   W.   128 502 

State  V.  Willett,  171  Ind.  296, 

86  N.  E.  68,  70 1149 

State  ex  rel.  Arpin  v.  Eber- 

hardt,  158  Wis.  20...  1263,  1264 
State  ex  rel.  Bundy  v.  Ny- 
gaard  (Wis.),  158  N.  W. 

87  418 

State     ex     rel.     Houghton     v. 

Phelps    (Wis.),    176    N.    W. 

217    372,   805 

State  ex  rel.  Pfister  v.  Widule 
(Wis.),  163  N.  W.  641 519 


XXXVl 


TABLE    OF   CASES 


[References 

State  ex  rel.  Manitowoc  Gas 
Co.  V.  Wis.  Tax  Commis- 
sion, 161  Wis.  Ill,  152  N. 
W.  848 72,  1006 

State  ex  rel.  Moon  v.  Nygaard 
(Wis.),  175  N.  W.  810 524 

State  ex  rel.  Moon  Co.  v. 
Wisconsin  Tax  Commission, 
166  Wis.  287,  163  N.  W.  639, 
165  N.  W.  470,  appeal  dis- 
missed in  249  U.  S.  621 

35,    344,    519 

State  ex  rel.  Mosely  v.  John- 
son, 144  N.  C.  257,  56  S.  E. 
922,   929    429 

State  ex  rel.  Wisconsin  Trust 
Co.  V.  Widule,  164  Wis.  56, 

159  N.  W.  630 149,  1261 

State    Line    &    S.    R.     Co.     v. 

Davis,  228  Fed.  246... 935,  1154 
State  R.  R.  Tax  Cases,  92  U. 

S.  575    850 

Stratton's      Independence      v. 

Howbert,  231   U.   S.  399,  34 

Sup.  Ct.  136.4,340,502,693, 

725,    730,    731,    1008,    1261    1264 

Strauss  v.  Abrast  Realty  Co., 

200  Fed.  327 850 

Strong,  In  re,  1  Tax  Cas.  207.   548 
Strouse,    In    re,    23    Fed.    Cas. 
No.   13,548,  1   Sawy.  605,   11 

Int.   Rev.   Rec.   182 945 

Stuart   V.    Maxwell,    16     How. 

160     1267 

Succession  of  Marsal,  118  La. 

212,   42    So.    778 48 

Succession  of  May,  120  La. 
692,  45  So.  551 48 

Succession  of  Webre,  49  La. 
Ann.  1491,  22  So.  390 45 

Sulley  V.  Attorney-General,  5 
H.  &  N.  711,  2  Br.  Tax 
Cas.  149    70 

Suter  V.  Jordan-Marsh  Com- 
pany, 225  Mass.  34,  113  N. 
E.   580    35,  1002 

Swearinger,  In  re,  23  Fed. 
Cas.  No.  13,683 1268 

Sweetser  v.  Emerson,  236  Fed. 

161      1265 

Swift  V.   U.   S.,  Ill   U.   S.  22 

884,    890 


a7-e  to  pages.'] 

Swift  Company  v.   U.   S.,   105 

U.   S.  691 1266 

Swigart  v.   Baker,   229   U.    S. 

187     1268 

Sybrandt  v.  U.  S.,  19  Ct.  Cls. 

461      919 

Taber  v.   U.   S.,  23   Fed.   Cas. 

No.   13,722    1263 

Tannehill  v.  Tannehill,  171  S. 

W.    1050    49 

Taylor     v.    Duncan,    33     Tex. 

(1870)    440    1165 

Taylor  v.   U.   S.,  3   How.   197, 

210      1271 

Taylor   v.   Weeks,     129     Mich. 

233,  88  N.  W.  466 907 

Teagarden   v.   Garver,   24   Ind. 

399      1165 

Tennant  v.   Smith    (1892),  A. 

C.  150,  66  L.  T.  327,  3  Tax 

Cas.   158 351,  370,  452 

Tennessee    v.    Whitworth,    117 

U.   S.  139 1273 

Terry  v.  Merchants  &  P.  Bk., 

66    Ga.    177 1043 

Texas,  etc.,  Ry.  Co.  v.  Swear- 

ingen,  196  U.  S.  51,  60 846 

Thayer   v.   Clarke,   77     S.    W. 

1050,  aff'd   98   Tex.   142,   81 

S.   W.   1274    50 

The  Hattie  Law,  14  Fed.  880.  826 
Thomas  v.  Railroad,  101  U.  S. 

71      173 

Thomas    v.   U.    S.,   192    U.     S. 

363      1245 

Tinker   v.    Colwell,   193    U.    S. 

473,   487    545 

Todd    V.    Gamble,    148    N.    Y. 

382,  42   N.  E.  982 430 

Towne   v.    Eisner,   245    U.     S. 

418     531 

Towne   v.    McElligott,     U.     S. 

Dist.   Ct.   So.    Dist.   of   New 

York  decided  August  6,  1921  535 
Traction  Companies  v.  Col- 
lector of  Internal  Rev.,  223 

Fed.  984   1154 

Travis  v.  Ann  Arbor  Co.,  180 

N.    Y.    App.    Div.    799,    168 

N.    Y.    Supp.    53,    aff'd    227 


TABLE  OF  CASES 


XXXVll 


[References 

N.    Y.    640,    126    N.    E.    923 

1178,    1185 

Treat   v.    Farmers    Loan     and 

Trust    Co.,    185     Fed.     760, 

763      941 

Treat  v.  Tolman,  113  Fed.  892 

1209,    1269 

Treat  v.  White,  181  U.  S.  264 

1177,  1209,  1261,  1262,  1269 

Trefry  v.   Putnam,   227   Mass. 

522,  116   N.   E.  904 

112,   339,   340, 

519,  549,  550,  1007,  1008,  1123 
Tucker  v.  Carr,  39  Tex.  98.  .  .  45 
Turner  v.  Cupson,  2  Tax  Cas. 

422      548 

Turner  v.  Rickman,  4  Br.  Tax 

Cas.  25    .., 72 

Turton  v.  Cooper,  5  Tax  Cas. 

148      548 

Twenty-Eight    Cases,    2     Ben. 

63     1269 

Underwood  Typewriter  Co.  v. 
Chamberlain,  92  Conn.  199, 
102  Atl.  600,  254  U.  S.  113 
891,    1006 

Ulmer  v.  Luna  Rock  Co. 
(Me.),  66  L.  R.  A.  387,  98 
Me.  579,  57  AtL  1001 218 

Union  Hollywood  Water  Co.  v. 
Carter,   238   Fed.   329 572 

Union  Ins.  Co.  v.  Hoge,  21 
How.  35,  64 283,   1149 

Union  Pacific  Co.  v.  Dodge, 
98  U.   S.   541 886,   888 

Union  Transit  Co.  v.  Ken- 
tucky, 199  U.  S.  194 36 

U.  S.  V.  Acorn  Roofing  Co., 
204    Fed.    157 246,   909 

U.  S.  V.  Aetna  Life  Ins.  Co., 
260  Fed.  333    618 

U.  S.  V.  Alexander,  110  U.  S. 
325      914 

U.  S.  V.  Allen,  14  Fed.  263.  .  .    872 

U.  S.  V.  A  Lot  of  Silk  Um- 
brellas,  12    Fed.   412 1272 

U.  S.  V.  Alpha  Portland  Ce- 
ment Co.,  257  Fed.  432,  242 
Fed.  978,  261  Fed.  339 453 

U.  S.  V.  Baltimore  &  Ohio  R. 
R.  Co.,  17  Wall.  322 1004 


are  to  pages.] 

U.  S.  V.  Barrels  of  Spirits,  2 

Abb.    (U.  S.)    305,  314 1271 

U.    S.   V.   Baruch,   223     U.     S. 

191      1268 

U.    S.   V.    Bayard,    127     U.     S. 

251      939 

U.    S.   V.    Bennett,   232    U.     S. 

299      1264 

U.    S.   V.   Benowitz,   262     Fed. 

223      836 

U.   S.  V.  Biwabik  Mining  Co., 

247  U.  S.  116 502,  729,  730 

U.    S.    V.    Blacklock,     208     U. 

S.  75   871,  872 

U.  S.  V.  Black,  128  U.  S.  40.  .  .    850 
U.  S.  V.  B.  &  O.  Railroad  Com- 
pany, 17  Wall.  322 489,  490 

U.  S.  V.  Bowen,  100  U.  S.  .508.1267 
U.   S.   V.   Breed,  24    Fed.   Cas. 

No.   14,   638 1271 

U.    S.    V.    Brooklyn,    etc.,     Ry. 

Co.,  14  Fed.  284 911 

U.  S.  V.  Brown,  224  Fed.  135.  .1272 
U.   S.   V.   Capital    City    Dairy 

Co.,  252  Fed.  900 265,  268 

U.  S.  V.  Cases  of  Cloth,  Crabbe 

356     1271 

U.  S.  V.  Cerecedo  Hermanos  y 

Compania,  209  U.  S.  338..  . 

1266,    1267 

U.    S.   V.    Chamberlin,   219    U. 

S.  250    869,  1244 

U.  S.  V.  Chesbrough,  176  Fed. 

778      1262 

U.   S.  V.   Chouteau,   102   U.   S. 

603      909 

U.  S.  V.  Cleveland  C.  C.  &  St. 
'  L.  Ry.  Co.,  247  U.  S.  195... 

519,  731,  732,   1008 

U.  S.  V.  Cleveland,  Cinn.,  Chi- 
cago   &    St.    Louis    Ry.    Co., 

U.    S.    Dist.    Ct.    So.    Dist. 

Ohio,  Feb.  23,  1916   (not  re- 
ported)        659 

U.  S.  V.   Colby,  251   Fed.  982, 

aflP'd  258  Fed.  27 511 

U.  S.  V.  Cole,  134  Fed.  697.  .  .1272 
U.  S.  V.   Collier,  25  Fed.  Cas. 

No.    14,833    1267 

U.    S.   V.    Coombs,     12     Peters 

72.    80    1124 


XXXVlll 


TABLE   OF   CASES 


[References 
U.  S.  V.  Coulby,  251  Fed.  982, 

aflF'd   258    Fed.    27 

78,  166,  175,  1270,  1273 

U.   S.  V.  Curry,  201   Fed.  371 

871,    872 

U.    S.   V.   Delaware  &   H.   Co., 

213  U.   S.  366 1006 

U.   S.   V.   Distilled   Spirits,    27 

Fed.    Cas.    No.     15,960,     10 

Blatch.    428 1270,    1273 

U.  S.  V.  Distillery  No.  28,  25 

Fed.    Cas.   No.   14,966 944 

U.  S.  V.  Eaton,  144  U.  S.  677.        7 
U.    S.   V.   84   Boxes   of   Sugar, 

7   Pet.   453 1272 

U.  S.  V.  Emery,  237  U.  S.  28 

937,    1153 

U.  S.  V.  Erie  R.  R.,  106  U.  S. 

327     869 

U.   S.  V.  Falk  &  Bro.,  204  U. 

S.    143,    152 1267 

U.    S.   V.    Fidelity   Trust     Co., 

222  U.  S.  158 1262 

U.  S.  V.  Field,  decided  by  U.  S. 

Supreme     Court,     February 

28,   1921    1270 

U.  S.  V.  Fisk,  3  Wall.  445 1262 

U.   S.   V.    Frost,   25   Fed.    Cas. 

No.   15,172    651 

U.  S.  V.  Gallant,  177  Fed.  281.1272 
U.    S.    V.    General    Inspection 

and    Loading   Co.,    192    Fed. 

223,  204   Fed.   657 

249,  265,  268,  858 

U.  S.  V.  Goelet,  232  U.  S.  293.     39 
U.   S.  V.  Graft   Distilling-  Co., 

208  U.  S.  198 1272 

U.    S.   V.   Graham,   110    U.    S. 

219      1266 

U.    S.    V.    Grand    Rapids,   etc., 

Ry.  Co.,  239  Fed.  153. .  .861,  869 
U.    S.    V.    Guaranty    Trust    & 

Savings  Bank,  253  Fed.  291  618 
U.  S.  V.  Guggenheim  Explora- 
tion   Co.,   238    Fed.   231 

342,  431,  453 

U.    S.   V.   Hirsch,     100     U.     S. 

33     1267 

U.  S.  V.  Hodson,  14  Int.  Rev. 

Rec.     100,     10     Wall.      395, 

406    5,   1271 


are  to  pages.'] 

U.  S.  V.  Howell,  9  Fed.  674.  .  .   873 
U.  S.  V.  Hooslef,  237   U.  S.   1 

1198,  1218,  1246 

U.  S.  V.  Isham,  17  Wall.  476, 

84   U.    S.   496 456, 

903,      1217,     1262,     1263,     1268 
U.    S.    V.   Johnson,    124    U.    S. 

236      1266 

U.   S.   V.   Kaufman,   96   U.     S. 

567     912 

U.  S.  V.  Kelly,  97  Fed.  460.  .  .   930 
U.    S.    V.    Lamson,     162     Fed. 

165      8 

U.    S.   V.   Lehigh     Valley    Co., 

220  U.  S.  254 223,  453 

U.    S.   V.   Little   Miami   Co.,   1 

Fed.  700    869 

U.  S.  V.  Maillard,  26  Fed.  Cas. 

No.   15,709    906 

U.    S.    V.    Masters,    264    Fed. 

250      1242 

United    States   v.     Mayer,     26 

Fed.  Cas.  No.  15,753 651 

U.   S.   V.   McHatton,   266   Fed. 

602,  A.  R.  R.  565 268,  1014 

U.    S.    V.    Mellon,    U.    S.   Dist. 

Ct.    W.    Dist.    Pa.,    I.    T.    S. 

1921,   113091 530,   533 

U.  S.  V.  Merck  &  Co.,  91  Fed. 

639,  aff'd  97  Fed.  989 1269 

U.    S.    V.    Mescall,    215    U.    S. 

26     1263 

U.  S.  V.  Military  Construction 

Co.,   204    Fed.   153 246 

U.    S.    V.    Milwaukee   Co.,    142 

Fed.  247,  253 222,  453 

U.   S.   V.   Minneapolis  Thresh- 
ing Mach.  Co.,  229  Fed.  1019 

860,  868,  869 

U.  S.  V.  Nashville  Rd.  Co.,  118 

U.  S.  125   906 

U.    S,    V.    Nashville,    etc.,    Ry. 

Co.,  T.  D.  2697 869 

U.    S.    V.    Nashville,    etc.,    Ry. 

Co.,  249  Fed.  678 899 

U.  S.  V.  Nat.  Surety  Co.,  122 

Fed.   904,   909 1272 

U.    S.    V.    Nebraska    Distilling 

Co.,   80   Fed.   285 851 

U.  S.  V.  Neustaedter,  149  Fed. 

1010     1205 


TABLE   OF   CASES 


XXXIX 


[References 

U.   S.   V.   N.   Y.  &   Cuba,  etc., 

Co.,  200  U.  S.  488 

886,   887,  889,   1249 

U.  S.  V.  N.  Y.  Guaranty  Co., 
8  Ben.  269 911 

U.  S.  V.  N.  Y.,  N.  H.  &  H. 
R.  R.  Co.,  265  Fed.  331....   234 

U.  S.  V.  Ninety-Nine  Dia- 
monds, 139  Fed.  961,  writ  of 
certiorari  denied  201  U.  S. 
645 513,   1261,   1262,   1263 

U.  S.  V.  Nipissing  Mines  Co., 
202  Fed.  803,  reversed  in 
206    Fed.    431 693 

U.  S.  V.  Nipissing  Mines  Co., 
206  Fed.  431,  234  U.  S.  765 
219,  265,   938,   1154 

U.  S.  V.  Olney,  27  Fed.  Cas. 
No.   15,918    -. 1269 

U.  S.  V.  1,150^  Lbs.  of  Cellu- 
loid, 82   Fed.  627 638 

U.  S.  V.  1,150J  Pounds  Cellu- 
loid, 82   Fed.   634 1272 

U.  S.  V.  Oregon,  Washington, 
etc.,  Co.,  251  Fed.  211.. 340,  539 

U.  S.  V.  Pacific  R.  R.,  1  Fed. 
97    871,   872 

U.    S.   V.    Phellis,   42   Sup.    Ct. 

Rep.   63    220, 

350,     426,     441,     448,     433,     529 

U.  S.  V.  Philadelphia  B.  & 
W.  R.  Co.,  262  Fed.  188 531 

U.  S.  V.  Philadelphia  Knitting 
Mills  Co.,  273  Fed.  65 593 

U.  S.  V.  Pittaro,  L  T.  S.  1921, 
^  2358   881 

U.  S.  V.  Pomeroy,  152  Fed. 
279,  reversed  in  164  Fed. 
324     896 

U.  S.  V.  Railroad  Co.,  17  Wall. 
322      357 

U.  S.  V.  Ramsey,  197  Fed.  144, 
147     1272 

U.  S.  V.  Rhawn,  27  Fed.  Cas. 
No.   16,150    948 

U.  S.  V.  Richardson,  9  Fed. 
804      911 

U.  S.  V.  Ritchie,  27  Fed.  Cas. 
No.   16,168    378 

U.  S.  V.  Savings  Bank,  104 
U.   S.   728 912,  933 


are  to  pages.'] 

U.  S.  V.  St.  Louis  S.  W.  Ry., 
189   Fed.   954,   962 1272 

U.  S.  V.  St.  Paul  M.  &  M.  R. 

Co.,  247   U.   S.  310,  318 

201,  1121,  1265 

U.  S.  V.  Schellenger,  14  Blatch. 
71,  27  Fed.  Cas.  No.  16,228 
343,  351,  352 

U.  S.  V.  Sixty-Five  Terra 
Cotta  Vases,  18  Fed.  508, 
510    1263,   1267 

U.  S.  V.  Smith,  27  Fed.  Cas. 
No.  16,341 351,  352 

U.  S.  V.  Snyder,  149  U.  S.  210  871 

U.  S.  V.  Standard  Oil  Co.,  221 
U.    S.    1 1264 

U.  S.  V.  Stowell,  133  U.  S.  1.  .1271 

U.  S.  V.  Tanner,  147  U.  S. 
661      1266 

U.  S.  V.  Ten  Cases  Shawls,  28 
Fed.    Cas.   No.    16,448 1272 

U.  S.  V.  Theurer,  213  Fed. 
960      896 

U.  S.  V.  Thompson,  189  Fed. 
838     1272 

U.  S.  V.  Three  Barrels,  77 
Fed.  963    7 

U.  S.  V.  Three  Railroad  Cars, 
28  Fed.  Cas.  No.  16,513.  ..  .1263 

U.  S.  V.  Tiffany,  160  Fed. 
408      1269 

U.  S.  V.  Tilden,  28  Fed.  Cas. 
No.  16,522,  10  Ben.  566,  25 
Int.  Rev.  Rec.  352 947 

U.  S.  v.  Trans-Missouri 
Freight  Association,  166  U. 
S.  290,  318 1264,  1265 

U.  S.  v.  Turner,  28  Fed.  Cas. 
No.    16,548    871 

U.  S.  V.  Two  Barrels  of  Whis- 
ky, 96   Fed.   479 1272 

U.  S.  V.  Two  Hundred  Barrels 
of  Whisky,  95  U.  S.  571 7 

U.  S.  V.  246i  Pounds  of  To- 
bacco,  103    Fed.   791 1272 

U.  S.  V.  Union  Pacific  R.  R. 
Co.,  91  U.  S.  72 1261,  1265 

U.  S.  V.  Union  Stockyard  Co., 
192   Fed.  330 224 

U.  S.  V.  U.  S.  Fidelity  &  G. 
Co.,   144    Fed.    866 1272 


xl 


TABLE  OF  CASES 


[References 
U.    S.   V.  Watts,  28    Fed.   Cas. 

No.   16,653    1268 

U.   S.  V.   Weise,  28   Fed.   Cas. 

No.   16,659    1263 

U.    S.   V.   Wetherell,    65     Fed. 

987     1269 

U.  S.  V.  Whitridge,  231   U.   S. 

144     243 

U.  S.  V.  Wigglesworth,  2  Story 

369,  28  Fed.  Cas.  No.  16,690 

1268,    1269 

U.  S.  V.  Woodward,  65  L.  Ed. 

728,  Ct.  D.  15 126,  611 

U.  S.  V.  Wright,  11  Wall.  648.  919 
U.  S.  V.  Zemel,  137  Fed.  989.  .1272 
United   States  Brewing  Co.  v. 

Apthorpe,  .4  Tax  Cas.  17..  299 
U.   S.  Glue  Co.  V.  Oak  Creek, 

247  U.  S.  321 379 

U.  S.  Life  Ins.  Co.  v.    Spinks 

(Ky.),  96   S.   W.   889 283 

United  Mines  Co.  v.   Hatcher, 

79  Fed.  517 224 

Urquhart  v.  Marion  Hotel  Co., 

128  Ark.  283,  194  S.  W.  1.  .1002 

Valentine,    Matter   of,    147    N. 

Y.   Supp.   231 430 

Van    Beil   v.   Brogan,   65     Pa. 

Super.  384,  reversing  23  D. 

R.    1055    (Dauphin     County 

Court,  Pa.   1914)    1003 

Van  Dyke  v.  City  of  Milwau- 
kee,   159    Wis.    460,    146    N. 

W.  812.  150  N.  W.  509 

340,  519,  630,  636,  1266 

Venable    v.    Southern    Granite 

Co.,   135   Ga.   508,   69   S.    E. 

822      1043 

Vicksburg   S.   &   P.   R.    Co.    v. 

Dennis,  116   U.   S.  665    1273 

Victor    Co.    V.    American    Co., 

189    Fed.    359    223 

Village  of  Westby  v.  Bekkedal, 

172  Wis.  114,  178  N.  W.  451  69 
Virginia  v.  West  Virginia,  238 

U.  S.   202,  212,  219 

424,  429,  430,  438,  440 

Vogt   V.    Cope    (Cal.),   4    Pac. 

915      430 


are  to  pages.] 

Von  Baumbach  v.  Sargent 
Land  Co.,  242  U.  S.  503.  .  .  . 
502,  643,  725,  730,  731,  1152.  1153 

Wabash  Valley  Co.  v.  Ed- 
wards,   264    Fed.    152,    610 

1172,  1267,  1268,  1270 

Waddle  v.  Cabana,  220  N.  Y. 

18,  114  N.   E.   1054 1179 

Wadsworth     v.     Boysen,     148 

Fed.  771    1265 

Walker   v.    Bement,   94    N.    E. 

339      639 

Walker   v.    Gulf    &    Interstate 

Co.,  269  Fed.  885 233 

Walsh  V.   Brewster,  65  L.  Ed. 

451      389 

Walsh    V.    Brewster,    41    Sup. 

Ct.  *Rep.  392    

.407,  417,   678,   1008 

Ward    V.    Maryland,    12    Wall. 

418      357 

Waring  v.  The  Mayor,  60  Ga. 

93      339 

Warren  v.  King,  108  U.  S.  389, 

2   Sup.   Ct.   789 1069 

Washburn  v.  Washburn,  9 

Cal.  475  45 

Washington  Ice  Co.  v.  Webs- 
ter, 68  Maine  449   429 

Washington  Water  Power  Co. 

V.    U.     S.,    decided    by    the 

Court    of    Claims,    Feb.    14, 

1921,  T.  D.  3160 1139,  1157 

Waterbury   Co.   v.   Walsh,  228 

Fed.  54   1154 

Watertown    Paper   Co.,   In   re, 

169  Fed.  252 222,  4.53 

Weaver    v.     Ewers,    195    Fed. 

247    915 

Webb  V.   Outrin,    (1907)    App. 

Cas.  81,  95  L.  T.  850,  23  T. 

L.  R.   147    379 

Webre,   Succession  of,  49    La. 

Ann.  1491,  22  So.  390 45 

Weeks  v.  U.  S.,  232  U.  S.  383  945 
Werle    &     Co.     v.     Colquhoun, 

2  Br.  Tax  Cas.  402,  58  L.  T. 

R.    756     72 

West    End    Street    Ry.    Co.    v. 

Malley,  246  Fed.  625 1153 


TABLE   OF   CASES 


xii 


[Refere7ices 
West  Ry.  Co.    v.    Malley,    246 

Fed.  625   1154 

Whalen    v.    Lynch,    60    N.    Y. 

468,  at  p.  474 429 

Wheat  V.  Owens,  15  Tex.  241     46 
Wheeler     v.     St.     Joseph,     31 

Kans.  640,  3  Pac.  297 826 

White  V.  Arthur,  10  Fed.  80.  .   941 
Whitney    v.    Fox,    166    U.    S. 

637     1268 

Whitney      v.      Thatcher,      117 

Mass.   523 429 

Whittenton  Mills  v.  Upton,  10 

Gray   582    173 

Wilcox    V.    Middlesex    County, 

103    Mass.    544 502 

Wilder  v.  Hawaiian  Trust  Co. 

20    Haw.    589 133 

Wilder  v.  Trefry   (Mass.),  125 

N.  E.  689   506 

Wilkes-Barre,      etc..     Traction 

Co.  V.  Davis,  214  Fed.  511.1154 
Wilkins  v.  U.  S.,  96  Fed.  837  8 
Wilkinson    v.    Leland,    2    Pet. 

627    1261 

Wilkinson     v.     Wilkinson,    20 

Tex.  237    46 

Williams  v.  Conger,  125  U.  S. 

397,    410     846 

Williams,   In  re,  40   Nev.  241, 

161   Pac.    741 48 

Willmann   v.   Walsh,    Supreme 

Court  of  Errors  of  Conn.,  T. 

D.  3166,  T.  B.  23-21-1679..  851 
Wilson  V.    Youst,    43    W.    Va. 

826,  28   S.   E.   781    502 

Winn  V.  Patterson,  9  Pet.  663, 

677      846 


are  to  puf/es.} 

Wisconsin  v.  Pelican  Ins.  Co., 

127  U.  S.  265    870 

Woods  V.  Latta,  3  Mont.  9...   639 
Woods    V.    Lewellyn,   252    Fed. 

106   805,  860,  899 

Woodward    v.    De   Graffenried, 

238  U.  S.  284    1265 

Woodward  v.  Semans,  125  Ind. 

330,  25   N.   E.  444 390 

Woollcott   V.    Shubert,   217   N. 

Y.  212,  111  N.  E.  829 1264 

Woolner  v.   U.   S.,   13   Ct.   Cls. 

355      919 

Wright  V.  Blakeslee,  lOl  U.  S. 

174    884,   885 

Wright  V.  Georgia  R.  etc.,  Co., 

216  U.   S.  420   1273 

Wright    V.    Hays'    Admr.,    10 

Tex.    130     46 

Wright    V.    Michigan    Central 

R.  Co.,  130  Fed.  843..  1198,  1269 

Yake  v.  Pugh,  13  Wash.  78, 
42  Pac.  528    45 

Yates  V.  Houston,  3  Tex.   433     46 

Yazoo  &  Miss.  Valley  R.  Co. 
V.  Thomas,  132  U.  S.  174..  1273 

Young  V.  Teutonia  Bank,  134 
La.  879,  64  So.  806 283 

Young  Men's  Society  v.  City  of 
Fall  River,  160  Mass.  409, 
36  N.  E.  57   327 

Zimpelman  v.  Robb,  53  Tex. 
274 46 

Zonne  v.  Minneapolis  Syndi- 
cate, 220  U.   S.   187 1153 


REGULATIONS 


No. 

Ueg.  33, 
Keg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33. 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33. 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  .33, 
Reg.  33. 
Reg.  33, 
Reg.  .33. 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  .'53. 
Reg.  .33, 
Reg.  33, 
Reg.  .33, 
Reg.  .33, 
Reg.  33, 
Reg.  33, 
Reg.  33, 
Reg.  .33, 
Reg.  .33, 
Reg.  3.3, 
Reg.  .33, 
Reg.  33, 
Reg.  33, 
Reg.  .33, 
Reg.  .33. 


Rcf 


Reg.  .33, 

Reg.  33, 

Reg.  33, 

Reg.  33, 


Rep 
Res 


Page 

Art.   ."• 378 

Art.   S 1>1 

Art.   12 18!) 

Art.   13 179 

Art.   14 179 

Art.   17 14.5 

Art.   18 827 

Art.   33 !n3 

Art.  46 306 

Art.  47 560 

Art.  56 iJoO 

Art.   66 61 

Art.   67 90,  92,  479,  494.  969 

Art.   68 972 

Art.   72 143 

Art.   73 143 

Art.  75 135 

Art.  82 229 

Art.   83 307 

Art.  84 248 

Art.   85 249,  265 

Art.   86 168 

Art.  87 321 

Art.   95 234 

Art.  100 286 

Art.  104 227 

Art.  105 227 

Art.  106 385 

Art.  107 .385 

Art.  114 579 

Art.  115 587 

Art.  116 81 

Art.  117 .371 

Art.  118 570 

Art.  119 .593 

Art.  122 .588,  647 

Art.  127 640 

Art.  129 097 

Art.  1.30 693 

Art.  131 .584 

Art.  132 694 

Art.  133 694 

Art.  148 234 

Art.  151 2.34 

Art.  153 616 

Art.  156 608 

Art.  157 81 

Art.  1.58 60S 

Art.  177 859 

Art.  182 342 

Art.  183 .342 

Art.  184 8.59 

Art.  185 99.  209 

Art.  186 948 

Art.  196 8.39 

Rev..  Art.   4 .53.1.-2,1.57, 

1(10.  1<;2.  164. 

1(!5.  .345.  .346. 

369.  378.  49:;. 

499,  .501,  .525, 

528 
Rev.,  Art.   8 374.  499.  .565, 

.■)S:;.  .-.S!».  .-.95. 
651 .  (i.54,  (582 

Rev..  Art.   14 779 

Rev..  Art.   17 52 

Rev..  Art.   26 109. 146,  826 

Rev.,  Art.   29 103.  104.  100, 

114.  128.1.35. 

144,  145,  147. 

827 
Rov..  Art.   .30 176.178.1,87. 

189 

Rev.,  Art.   .32 66.91.93.95. 

98, 192.  967,  972 


^ 

0. 

Reg. 

33. 

Rev., 

Reg. 

33, 

Rev., 

lien. 

33, 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

3.3, 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

33, 

Rev., 

Iteg. 

;>;  J  ^ 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

,33, 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

.33, 

Rev., 

Reg. 

3;^, 

Rev., 

Reg. 

33. 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

;«, 

Rev., 

Reg. 

.33. 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

33. 

Rev., 

Reg. 

33. 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

.33, 

Rev., 

Reg. 

33. 

Rev., 

Reg. 

33, 

Rev., 

Reg. 

.•w. 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

.33. 

Rev., 

Reg. 

:!3. 

Rev., 

Reg. 

33. 

Rev., 

Reg. 

33, 

Rev. 

Reg. 

33. 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

33, 

Rev. 

He^. 

33, 

Rev. 

Reg. 

33. 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

3.3. 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

.33. 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

33. 

Rev. 

Reg. 

33. 

Rev. 

Reg. 

33. 

Rev.. 

Reg. 

33. 

Rev. 

Reg. 

33. 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

.33, 

Rev. 

Reg. 

33. 

Rev. 

Reg. 

33. 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

.33, 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

:!3, 

Rev. 

Reg. 

3.3. 

Rev. 

Reg. 

.•',3. 

Rev. 

Reg. 

33. 

Rev. 

Reg. 

:'..3. 

Rev. 

Reg. 

.33. 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

.33, 

Rev. 

Reg. 

33. 

Rev. 

Reg. 

33, 

Rev. 

Reg. 

.33. 

Rev. 

Art.   33 954 

Art.  34, 370,  952 

Art.   35 9.-.(i 

Art.   36 960 

Art.   38 10,839 

Art.   41 879 

Art.   43 193,  306,  963 

Art.   50 13 

Art.   51 896 

Art.   .52 829,  861 

Art.   53 146,  772.  778, 

898 

Art.   .54 897 

Art.  57 210 

Art.   61 2U6 

Art.   62 168 

Art.   66 .300 

Art.   67 323.  330 

Art.   68 .312.  :!37 

Art.   69 .332 

Art.   70 .321 

Art.   71 .322 

Art.   72 330 

Art.   73 315 

Art.   74 .315 

Art.   75 335 

Art.   76 3.36 

Art.   77 317 

Art.   78 314 

Art.   79 314 

Art.   80 315 

Art.   81 .312 

Art.   84 491 

Art.   86 .3.56.  .509 

Art.  87 .310 

Art.   88 314 

Art.   91 227 

Art.   92 227 

Art.   93 .3,8.5 

Art.   94 (r»8 

Art.   95 234 

Art.  101 440 

Art.  102 229 

Art.  104 229 

Art.  105 510 

Art.  106 .505 

Art.  108 .546 

Art.  113 501 

Art.  114 .3.87 

Art.  117 4C.1 

Art.  120 461 

Art.  121 .3.8(; 

Art.  123 1.52.160.162. 

164.  165 

Art.  124 440 

Art.  125 229 

Art.  126 .560.  797 

Art.  128 S.3!» 

Art.  131 689 

Art.  1.32 690 

Art.  134 .599 

Art.  136 .599 

Art.  1.38 .595 

Art.  141 .58r»,  .812 

Art.  145 2.33 

Art.  1.51 650 

Art.  15.5 640 

Art.  1.56 640 

Art.  1.59 680,  693 

Art.  162 681,  683,  690, 

698 

Art.  163 asi 

Art.  164 694 

Art.  16.5 68.S 

Art.  166 647 


xliii 


xliv 


REGULATIONS 


Ueg. 
Keg. 
Ueg. 
Ueg. 
Ueg. 
Ueg. 
Keg. 
Reg. 
Keg. 
Reg. 
Reg. 
Reg. 
Itefi. 
Reg. 
Ueg. 
Ueg. 

Ueg. 

Reg- 
Reg. 

Reg. 

Ueg. 

Ueg. 

Resi-. 

Reg. 

Reg. 

Ueg. 

Ue^-. 

Ue^-. 

Ueg. 

Ueg. 

Reg. 

Reg. 

Reg. 
Reg. 
Reg. 

Reg. 

RfiT. 


Xo. 

.   :«, 
as, 


3:!, 

:w. 
;!:5. 
•x\, 
•Si, 

Xi, 

:?3. 
:',3. 


:',s, 
:;s. 
:is, 

40. 
40, 
40. 
40, 

40. 
4(1. 


Rev., 

Rev., 

Rev., 

Rev., 

Rev., 

Rev.. 

Rev.. 

Rev., 

Rev., 

Rev., . 

Rev.. 

Rev.. 

Rev., 

Rev.. 

Rev.. 

Rev., 

Rev., 

Rev.. 

Rev.. 

Rev.. 

Rev., 

Rev., 

Rev., 

Rev.,- 

Rev.. 

Rev., 

Rev.. 

Rev.. 

Rev.. 

Rev., 

Rev.. 

Rev.. 

Rev.. 

Rev.. 

Rev.. 

Rev., 

Rev.. 


Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

.\rt. 

Art . 

.Vrt . 

Art. 
Art. 

Art. 
Art. 
Art. 
Art . 
\rt. 

Art. 
Art. 


100- - 
171— 
1  ?.">-- 
170- 

177- 
17S— 
171  • - 
1S0_- 


I'Mgf 

081^ 

■"" 7:14 

'/_ 04_' 

I     __.(J4--' 

_-0i:! 
".—I    — 00s 

■ GdH 

10."> 


iss 

107  — 

•200 

201 

2on 

200 

20s 

211 

212 

21:'. 

214 

21') 

21s 

210 

22'.> 

23() 

230- 
240- 
241 
244 
200 

*; 

12 

IS 

20 

1 


Rei:. 
lU'tx. 
Ueg. 
Ueg. 
Ueg. 
Ueii-. 


40. 
40. 
40. 
40. 
44t, 
40. 


Uev.. 

Art. 

Rev.. 

Art. 

Rev.. 

Art. 

Rev.. 

Art . 

Rev.. 

Art . 

Rev.. 

Art . 

Re: 

U«V 

Reg. 

Refi. 
Ueg. 
Itefr. 
Ueg. 
Ueg. 
Reg. 
ReK. 

Reg. 

Reg. 

Ueg. 

Ueg. 

Mvsx. 

Ueg. 

Ueg. 

Ueg. 

Reg. 

Uei:-. 


4(t. 
40. 

40. 
40. 
40. 
40. 
40. 
40. 
4<). 
40. 
40. 
40, 
40. 

40. 

40. 

40, 

40 

40. 

40. 

40. 

40. 


Uev.. 
Rev.. 

Rev.. 
Rev.. 
Rev.. 
Rev.. 
Rev., 
Uev.. 
Uev.. 
Uev.. 
Rev.. 
Rev. 
Rev. 
Uev.^ 
Uev. 
Rev. 
Rev. 
Rev. 
Rev. 
Rev. 
Uev. 


Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 
,  Art. 
,  Art. 
.  \vx. 
.  Art. 
.  Art. 
,  Art. 
,  Art. 
.  Art. 
.  Art. 
.    Art. 


»34,  070 
'""      — -  81 

"  I 300 

08,  300 

__-  240,205 
"  -248.240 
I   — 22'.t,  263 

' 260 

"  r  -2G0 
-260 
-260 

" 260 

"_     _     --S20 

S2'.t 

S4(» 

_.-70 

2S4.  317.  332 

'>84,  20:'..  200 

-201 

-I   -   -   --0<'> 

-Oi:! 

—    .11."' 

" 11.".6 

11.".7 

/ 4S 

-1170 

_   .1170 

3I     —1170.1177 

4-1172.1173.1174. 

117.'..  117t>.  11" 

)  (1.1 tl^'^ 

.-,  licit.  1171,1172. 
1173.  1174.  1170. 
120:'..  1224 

.-,  (e) 11«^ 

T  _  1170 

s "_ 1170 

'.,       _I IISO 

li::::: hts 

T'_1178.  1180.  1181. 

'"11S2.  11S3.  1184. 

llSr..  IISO.  1224 

12  (.n ti«-^ 

13-  1180.  1181.  1184. 
lis.'..  1180.  11S7 

14 }\>'>^: 

{;;::::::-::::li27 

17 l^:-" 

IS 1231 

l'.» 1231 

20 1211 

01 -1211 

00'   _   _1210, 1211 

t.V  "" 1210 

:^-,"~ 1231 

1232 

1233 

^--1234 


20 

28 

2'.l 

30 

31 


Ren-. 
Uefl. 
Ues-. 
Ueg. 
Reg. 
Reg. 

Uejr. 

Ueg. 

Uep. 

Uecr. 


40. 
40. 
40. 
40. 
41. 
41. 
41. 
41. 
41. 
41. 


U.'V. 
Rev.. 
Uev.. 
Uev.. 
Arr. 
Art. 
Art. 
Art. 
Art. 
Art. 


Art. 
Art. 
Art. 
Art. 

'ol- 


io. 

11- 


34 


1232. 123.'. 

12.3.5 

12.36 

I  l_ 12.36 

441.1170.1172. 
1174.  1177.1178. 
1182.1187.1200. 
1210.1211,1212 
— -1238 

I  \ 1230 

7   1170, 1170 

ul_ 1230 

1020 

1032 

" 10.33 

1018 

" 1026 

1020 


Reg. 

Reg. 

Uejr. 

Uejr. 

Ueg. 

Ueg. 

Ueg. 

Uejr. 

Ueg. 

Uey. 

UefT. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

U<-g. 

Ueg. 

Ueg. 

Ueg. 
Ueg. 
Ueg. 
Keg. 
U.'g. 
Ueg. 
Ueg. 
Ueg. 
Ueg. 
Ueg. 

Ueg. 
Ueu-. 
Ueg. 
Ueg. 
Ueg. 
Ueg. 
Ueg. 
Ueg. 
Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg. 

Ueg- 

Ueg. 

Ueg. 


41,  Art. 
41.  Art. 
41.  Art. 
41,  Art. 
41,  Art. 
41,  Art. 
41.  Art. 
41.  Art. 
41,  Art. 
41,  Art. 
41,  Art. 
41,  Art. 
41.  Art. 

41.  Art. 

41.  Art. 

41,  Art. 

41.  Art. 

41.  Art. 

41.  Art. 

41.  Art. 

41.  Art. 


41. 
41. 
41. 
41, 
41. 
41. 
41. 
41. 


Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 
Art. 


41,  Art. 


41. 
41. 
41. 
41. 
41. 
41. 
41, 
41. 

41. 

t1. 


.Vrl. 
Art. 
Art. 
Art. 
Art. 

.\rt. 
.\rl. 
.\rt. 
.\rt. 


12--- 
13—- 
14— 
l.j— 
16—. 
17—. 
18—. 
10— 
20—. 
21  — 


24 

25 


28— 
20_- 

;'.o_- 

31— 

32  _ 

33-1 
34- 
35- 
36— 
37- 
38- . 
30- 
40_. 
41-. 
42- 

43- 
44- 
45- 
46- 
47- 
48- 
40- 
.50- 
.51. 


15  eg. 
Ueg. 
Ueg. 
Ueg. 

Reg. 
Reg. 
Reir. 
Reg. 
Ueg. 
Reg. 
Reg. 
Reg. 
Reg. 
Reg. 
Reg. 
Reg. 


41. 

41. 

41. 

41. 

41. 

41, 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

41. 

45. 

45. 

45. 

45. 

45. 

45. 

45. 


.Vrl. 

.Vrt. 

Art. 

Art. 

.Vrt. 

Art. 

Art. 

Art. 

Art. 

Art. 

.Vrt. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 

Art. 


56- 


.58-- 
50— 
60- 
61-- 
02-. 
63  _. 
64-. 
(i5-. 
66-. 
67- 
68- 
60.. 
70- 
71- 


1018 

1018,  1020 

' 1021,1033 

1021 

i: 1023 

1023 

"_' 1136 

1033 

1033 

: 1108 

1108 

1100 

1116 

1115 

.511, 1076 

1114 

1113 

1114 

1113 

1115 

1114 

1115 

.  1115 

.  .....1113,1115 

1115 

1115 

1115 

1115 

1115 

.1041.  KI42.  104.3. 
1087.  108!t 

1006 

1067.  1074 

1078 

1076 

1048.  10.50 

1107 

1100 

1082 

1104 

-1107.  1115.112(1. 

1122,  1274 

-.  10.30.  1073.  1070 

1081,  1136 

1041 

1050 

1051 

10.51 

10.55 

1040 

1055 

10.5(i 

1046 

1065 

1030.  HOC. 

10.-.0 

1040 

1040 

1040.1055 

1041 

201,  1022 


I.') 


4- 
11- 
12- 
13- 
21- 


Reg.  45,  Art. 
Reg.  45.  Art. 


Reg.  45.  Art. 

Reg.  45.  Art. 

Reg.  45.  Art. 

Reg.  4.5,  Art. 

Reg.  4.5,  Art. 


24-- 
25- 
26.- 
31- 


1022 

1022 

1022 

11.36 

11.36 

260,263 

260,  263 

1138 

20 

.—  .36,  ,39.  42,  .54.  .59 

40.  .55 

21 

26 

. 22 

39,3.50.353. 

.^56.  r,(V).  790 

..  345.  .•',.50.  .356.  795 

..341.  .-{42.  344,  345. 

;!40.  ;!87.  796,  797. 

S12.  815,  8.39 

.342,390.797 

...  245.  815,  816,  817 

260,  818 

36,  3.50,  526.  616.  976 

367.  368,  .3(59. 

372.  547,  S06 


REGULATIONS 


xlv 


No.  Page 

livg.   45.    Art.      33 3(>i.  3G8,  369, 

370.  371,  952 

Keg.    45,    Art.      34 350,352,371 

liefT.    45,    Art.      35 385 

Keg.    45,   Art.      .36 386,433 

Kejr.   45,    Art.      37 350,546 

Keg.   45,   Art.     38—152,  l.-.(i.  157. 1.5!S,  159, 
ItUt.  161,  Km.  .3.50 

Keg.    45,    Art.      39 419,  433,  549 

Keg.    45.    Art.      40 433 

Keg.    45,    Art.      41 433 

Keg.    45.    Art.      42 464,466 

Keg.    45,    Art.      43 478 

Keg.    45,    Art.      44 474 

Keg.    45.    Art.      45 475 

Keg.    45.    Art.      46 475 

Keg.    45,   Art.     47 .5.55,5.57 

Keg.    45,    Art.      48 3.50.498.499,503 

Reg.    45,    Art.     49 541 

Keg.    4.5,    Art.      50 544.  1056 

Keg.    45.    Art.      51 2.30.368.5.39 

Keg.    45,    Art.      52 .34.5.  802,  806 

Keg.    45,    Art.      53 346,  799,  800 

Keg.    45,    Art.      54 347.  479,  494,  551 

Keg.    45.    Art.     71 39,353 

Keg.    45,    Art.      72 .555,556 

Keg.    4.5.    Art.      73 .5.38,548 

Keg.    4.5,    Art.      74 337.490,493 

Keg.    4.5,    Art.      75 3.56.488,509 

Keg.    45,    Art.      76 508 

Keg.    4.5.    Art.      77 .3.54,480,488 

Keg.   45,    Art.     78 483 

Keg.    4.5,    Art.     79 •_ 483.11.32 

Keg.    45.    Art.      80 483 

Keg.    45,    Art.      81 119 

Keg.    4.5,    Art.      82 182 

Keg.    45,    Art.      83 309.310.3 

Keg.    4.5,    Art.      84 3.57.3.58,601 

Keg.    4.5,    Art.      85 39,379 

Keg.    45,    Art.      86 37.  375,  376 

Keg.    4.5,    Art.      87 341.  .371,  463, 

495,  .589.  S-'OT 

Reg.   45,   Art.     88 812 

Keg.    45,    Art.      91 liO.  63.  68,  75 

Iteg.    45,    Art.      92 (i:'..  66.  68.  175. 

300.  :',03.  .509.  511 

Keg.   45,    Art.     92    (a  I .57.65,67. 

967,  972 

Reg.  45.  Art.     93 64 

Keg.    45.    Art.    101 578,  587 

Keg.    45.    Art.    102 .584 

Keg.   45.    Art.    103 584,  689 

Keg.    45.    Art.    104 583 

Keg.    45.    Art.    105 .593,594 

Keg.    45.    Art.    106 .3a5,  .360,  .593,  594 

Keg.    45,    Art.    107 .36.5,  .548,  595 

.596,  598 

Keg.    45.    Art.    108 .595.  599 

Keg.    4.5.    Art.    109 499.  5S1,  587,  613 

Keg.    4.5.    Art.    110 152,  162 

Keg.    45.    Art.    Ill .561.  f«9,  657. 

807.  809 

Keg.    45.    Art.    121 602.  60:!.  (W4,  606 

Keg.    45,    Art.    122 603 

Keg.    45,    Art.    1.31 608,  612,  615 

Keg.    45.    Art.    1.32 610 

Keg.   4.5,    Art.    1.3.3 616 

Keg.    4.5.    Art.    1.34 617 

Keg.    4.5,    Art.    141 621.  622.  624. 

025.  627,  631 

Keg.    4.),    Art.    142 640 

Reg.    45.    Art.    143 641,682 

Keg.    4.>.    Art.    144 (U.3.  645 

Keg.    4._.,    Art.    145 152.  164,  646 

Keg.    4;).    Art.    1.51 648,  <r>0,  651 

Keg.    4.).    Art.    1.52 649 

Keg.    4.5.    Art.    1.53 654 

Keg.    4...    Art.    1.54 655 

Keg.    45.    Art.    161 4T9,  679,'690 

Keg.    4._,.    Art     162 (iso.  (i81.  682,  695 

Iveg.    4i).    Art.    KVl 683 

Keg.    4.5.    Art.    164 499.686,690 

Keg.  4^,.  Art.  Km <i87,  691 

Keg.  4.j,  Art.  166 (581,688,695 

Keg.  4.),  Art.  167 419.68.3,684 

Keg.  4.:t,  Art.  168 685 


Xo. 

Reg 

45, 

Reg 

45, 

Reg 

45. 

Reg 

45, 

Reg 

45. 

Reg 

45. 

Keg 

45, 

Keg 

45. 

Reg 

45. 

Keg. 

45. 

Reg. 

45. 

Reg. 

45. 

Heg. 

45. 

Reg. 

45. 

Keg. 

45. 

Reg. 

45. 

Reg. 

45. 

Reg. 

45. 

Reg. 

45. 

Keg. 

45. 

Res. 

45. 

Reg. 

45. 

Reg. 

45. 

Reg. 

45, 

Reg. 

45. 

Reg. 

45. 

Reg. 

45. 

Reg. 

45. 

Reg. 

45. 

Keg. 

45, 

Reg. 

45, 

Reg. 

45. 

Reg. 

45, 

Keg. 

45. 

Reg. 

45, 

Reg. 

45. 

Reg. 

45. 

Reg. 

45, 

Reg. 

45, 

Keg. 

45. 

Keg. 

45, 

Reg. 

45, 

Reg. 

45. 

Keg. 

45. 

Keg. 

45. 

Keg. 

45. 

Keg. 

45, 

Keg. 

45, 

Reg. 

45, 

Reg. 

45, 

Reg. 

45. 

Reg. 

45, 

Reg. 

45. 

Keg. 

45. 

Reg. 

45. 

Reg. 

45. 

Reg. 

45. 

Keg. 

45 

Reg. 

45. 

Keg. 

45. 

iteg. 

45, 

Reg. 

45, 

Reg. 

45. 

Reg. 

45, 

Keg. 

45. 

Keg. 

45. 

Keg. 

45, 

Reg. 

45. 

Reg. 

45. 

Reg. 

45, 

Reg. 

45. 

Reg. 

45. 

Keg. 

45, 

Reg. 

45. 

Reg. 

45. 

Keg. 

45. 

net:. 

45. 

Keg. 

45. 

Keg. 

45. 

Keg. 

45. 

Keg. 

45. 

Keg. 

4... 

Keg. 

45. 

Keg. 

45. 

Keg. 

45. 

l'ag>- 
Art.  K;9 ^„ 

Art.  170._     ^? 

^j.f     jyj  69o 

Art!  i8i:::  ^''-- 1^ 

Art.  182-_  i^i 

Art.  183-_._::  iXi 

Art.  184 :::: 'J^ 

Art.  1,85 IVV 

Art.  186 i/J. 

Art.  187 iV*' 

Art.  18S.__   "i:         m 

Art.  189 ""._  ~:       i-h 

Art.  2oi_..__::::::ii5:vi-4:7i5: 

Art.  202-.  H;-I1H 

Art.  203.__.::::::::-— ij;^'  i^r^ 

Art.  204 :"i|^'  {li 

Art.  205 'ri,. 

Art.  206 ~i:  "_  4.,:; 

Art.  207 I"  ::      ~", 

Art.  208 "  '-rZZ 

Art.  209___  744 

Art.  210 700  T-i^'yl;, 

fi.  5lh::::::::::::::™L?i 

aS:  lis:::;:: !?; 

Art.  215 :::::        794 

Art.  216 7^4 

Art.  217 :::::::      737 

Art.  218 — ~i 

Art.  219 ::::::::—- Iss 

Art.  220 "75^ 

Art.  220  (a) IIIIIir-Tei 

Art.  221 76;r7  8 

Art.  222 Kl   7M 

Art.  223 764 

Art.  225 : i^ 

Art.  226 — -i^^; 

Art.  227 — i^7 

Art.  229 ""ria 

Art.    230 770 

Art.    2.31 """'771 

Art.    233 77.. 

Art.  2.34 :::      7,,;; 

Art.  2;i5 ~"'7W 

Art.  2.36 "":77o 

Art.  2.37 77r. 

Art.  241 -5,;,; 

*V"l-  'ill "'«2.  5(r. 

Art.  261 6(15 

Art.  262 — 6K 

Art.  263 :,„;,; 

Art.    2(i.> ,;7Q 

Art.    266 —-  i^ 

iS:  i;g::::::::::::::;:----i 

Art.  271 _     _     _ —  7!; 

Art.  291 538.  566.  .567.  .V.r. 

Art.  292 .367,  370.  374,  ,5(i,v 

Irl:  294 121.370.571.5X9 

Art.  3oi_._.::::::::::"'7f4~77(i 

Art.    302 777.  fjs  779 

Art.    .303 __7i., 

Art.    .304 7^, 

Art.  305 ::::::::7"si7824 

Arl.    .306 _  70., 

Art.    .307 ~_"  "  7S.3 

Art.  311 ::::::::::§:^:78i 

Art.  .!12 4;j.  44,  9,82 

Art.  312  (a( 57 

Art.  313 4;;,  .V,  .,8] 

Art.  314 44;  9g] 

Art.  315 ()gi'  tm-> 

'VI-    iE? '^^-  'Si.  785;  981 

Art.    321 '_i7ij 

Art.    322 iju 

Vi-    'f?, 1-^1-  182, 185 

Art.    324 107 

Art.    .325.._.  JS{ 

Art.  326 :::::::::::::  187 

Art.    .327 187 

'\'V    -1-,^ 1'«"193 

Art.    .329 205 


xlvi 


REGULATIONS 


Xo. 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg.  45, 

Reg*.  45, 


Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 

Reg.  45, 

Reg.  4.'>, 
Reg.  45. 
Reg.  45, 
Reg.  45, 
Reg.  45. 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45. 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45. 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Resr.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45. 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45. 
Reg.  45. 
Reg.  45, 


Pag' 

Art.  330 205 

Ai-t.  331 20b 

Art.  332 205 

r±  i5::;;;:::::::::::::::i 

120,  121,  125 

Art.  342 110, 112, 133, 137 

Art.  343__-  108,  110,  111,  112,  113 

Art.  344 110,  128,  136,  149 

Art.  345 110,  133, 134, 135 

Art.  346 110, 132 

Art.  351 ^1 

Art.  352 ---32 

Art.  353 33,  34 

Art.  361 05,  192,  306,  965, 

968,  976,  979, 
980,  981,  998 

Art  362 89,  967,  968,  975 

Art.  363 ^'p.  968 

Art.  363  (a) (8o,  983 

Irt.  3&4._-- 983,  984 

Art.  365 103,  987,  988 

Art.  366 087,  988 

Art.  367 987.  991 

Art.  368 958,  991 

Art.  369 86,  987,  993 

Art.  370 993,  994 

Art.  372 294,  994 

Art.  373 994 

Art.  374 979,  994 

Art.  375 995 

Art.  376 306,  996 

Art.  381 787.  791 

Art.  382 782 

Art.  383 258,  792,  793 

Art.  .385 788 

Art.  401 823,  824 

Art.  402 827 

Art.  403 52,  53,  84,  85, 

104,  825 

Art  404 53,  88,  89,  91, 

96,  306,  967 

Art.  405 95,  99, 101 

Art.  406 836,  837 

:^i.t  407 246,  836,  838 

*Art'.  411 188 

\i-t  412 188,  189 

Art.  421 53,  110, 142, 145,  822 

Art.  422 52, 110, 143,  825 

Art.  423 110, 142 

Art  424 105, 106.  109,  110 

Art.  425 -110, 144 

Art.  431 189,  829.  830 

Art.  441 5.54,  828 

Art.  442 146,  827,  828 

Art.  443 830,  831,  834 

Art.  444 832,  834 

Art.  445 831,  833 

Art.  446 8.33 

Art.  447 829 

Art.  448 41,  828 

Art.  451 838 

Art.  504 271 

Art.  .511 313,  314,  315 

Art.  .512 315,  316 

Art.  .513 317 

Art.  .514 317 

Art.  515 .319,  320,  .322 

Art.  516 322 

Art.  517 323,  325,  327,  328 

Art.  518 328,  329 

Art.  519 330 

Art.  520 330 

Art.  .521 332,  334,  335 

Art.  522 336,  508 

Art.  541 2.30,  989 

Art.  542 227,  597,  645 

Art.  543 2.30 

Art.  .544 239 

Art.  .546 229 

Art.  .547 265 

Art.  548 284 

Art.  549 285,  286.  1107 

Art.  561 231 


No. 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45. 
Reg.  45, 
Reg.  45. 
Reg.  45. 
Reg.  45. 
Reg.  45. 
Reg.  45, 
Reg.  45. 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45. 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45. 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg,  45, 
Reg,  45, 
Reg,  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  4.5, 
Reg.  45, 
Reg,  45. 
Reg.  45, 
Reg.  45, 
Reg.  45. 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45. 
Reg.  45, 
Reg.  45. 
Reg.  45. 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45 
Reg.  45, 
Reg.  45. 
Reg.  45, 
Reg.  45, 
Reg.  45, 
Reg.  45, 


Art  562 430,  589,  599 

Art.  .563 227,  233,  633,  645 

Art.  564 234 

Art.  ,5C»5 235,  236 

Art.  566 618 

Art.  567 612 

Art.  568 290 

\it.  569 291,  292,  293, 1100 

Art.  .570 294 

Art.  571 294 

Art.  572 295 

Art.  573 81 

Art.  581 231 

Art.  582 232,  233 

Art.  591 241,  774.  776 

Art.  601 --306 

Art.  611 T89.  791 

\vt     621 246,  248,1136 

Art.  622 244 

Art.  623 ---296 

Art.  624 204.  20» 

Art.  625 306 

Art.  626 2ol 

Art.  631 2o4 

Art.  632 203 

Art.  633 2oo 

Art.  634 2o< 

Art.  6.35 257,  2.59 

Art.  636 258,  259,  791 

Art.  637 2(!0 

.\rt.  6.38 2.59 

Aft.  6.51 249.  .307 

Art.  715 1031,  10.38 

Art.  7.32 1038 

Art.  733 1037, 1038 

Art.  741 1025 

Art.  742 1026 

Art.  7.51 102. 

Art.  761 1112 

Art  781 1108, 1109, 1110 

Art.  782 1108,  1109 

Art.  783 1108 

Art.  7.84 1108.  1110 

Art.  785 1108 

Art.  791 1111 

Art.  SOI 1113,  1114 

Art.  .802 1135 

Art.  811 1048,  1050 

Art.  812 1067 

Art,  813 1070 

Art.  814 1067 

Art.  815 1042, 1074, 1075, 1077 

Art.  816 1077, 1079 

Art.  ,818 1074 

Art.  ,831—  1041,  1043,  1087,  1107 

Art.  832 1045 

Art.  8.33 1048 

Art.  ,835 1054 

Art.  836 1046 

Art.  .837 1057, 1135 

Art.  838 10.58 

Art.  8.39 1091 

Art.  840 1061, 1064, 1065 

Art.  .841 1065, 1066 

Art.  842 1066 

Art.  843 815, 1061, 1062 

Art.  844 742,  1061 

Art.  845 1060,  1101,  1113 

Art.  846 1063 

Art.  S47 1062 

Art.  .848 1063 

Art.  849 1063 

Art.  8.50 1063 

Art.  8.51 1051 

Art.  8.52 1080 

Art.  .8.53 1096 

Art.  .8.5.5 1104 

Art.  .8.56 1104 

,  Art.  8.57 1099 

Art.  8,58 1097 

Art.  8.59 1099 

Art.  860 1086, 1093,  1103 

,  Art.  .861 1081 

,  Art.  .862 1082 

Art.  864 11.33 


REGULATIONS 


xlvii 


Xn.  Pilge 

Reg.  45.  Art.  865 1134 

Reg.  4.-),  Art.  866 1134 

Reg.  45,  Art.  867 1134 

Reg.  45,  Art.  868 1135 

Reg.  45,  Art.  869 1135 

Reg.  45.  Art.  870 1106,  1107 

Reg.  45.  Art.  871 1107, 1178 

Reg.  45,  Art.  901 1122,1126 

Reg.  45,  Art.  911 1128 

Reg.  45.  Art.  912 1129 

Reg.  45.  Art.  913 1130 

Reg.  45,  Art.  914 1129 

Reg.  45,  Art.  931 1135 

Reg.  45.  Art.  932 1105,  11.35 

Reg.  45,  Art.  933 661, 11.32, 11.35 

Reg.  45,  Art.  934 1104,  1135 

Reg.  45,  Art.  962 1107,1137 

Reg.  45,  Art.  971 1038 

Reg.  4.5,  Art.  1001 853,8-54,855 

Reg.  45.  Art.  1002 855 

Reg.  45,  Art.  1003 8.55,  808 

Reg.  45.  Art.  1004 85.5.  S07,  898 

Reg.  4.5.  Art.  1005 8-55,  S9S,  900 

Reg.  45,  Art.  1006 S.55,  904 

Reg.  45,  Art.  1007 852,  8.55.  ,858 

Reg.  45,  Art.  10(38 8.55,  869 

Reg.  4.5.  Art.  1009 8.55.  874 

Reg.  45,  Art.  1010 8-55,870 

Reg.  45.  Art.  1011 8.55,909 

Reg.  45.  Art.  1012 L 266,855 

Reg.  45,  Art.  1013 : 87-5,  876 

Reg.  45,  Art.  1021 882 

Reg.  45,  Art.  1031 939 

Reg.  45,  Art.  1032 915,916 

Reg.  45,  Art.  1033 942 

Reg.  4.5,  Art.  1034 926 

Reg.  45,  Art.  1035 928 

Reg.  45,  Art.  1036 923,924 

Reg.  45,  Art.  1037 851 

Reg.  45,  Art.  1038 939 

Reg.  45.  Art.  1041 896 

Reg.  45,  Art.  10,51 955,962 

Reg.  45.  Art.  1061 190,954.962 

Reg.  45,  Art.  1071 9-51,961 

Reg.  45,  Art.  1072 952 

Reg.  45,  Art.  1073 962 

Reg.  45,  Art.  1074 954,955 

Reg.  45.  Art.  1075 963 

Reg.  45,  Art.  1076 956,961 

Reg.  45,  Art.  1077 9-56,  987 

Reg.  45.  Art.  1078 957,987 

Reg.  4.5,  Art.  1078  (a) 958 

Reg.  45,  Art.  1079 9.58,959 

Reg.  45.  Art.  1080 960 

Reg.  4.5.  Art.  1091—840,841,842,844,847 

Reg.  45,  Art.  1091  (a) 847 

Reg.  45,  Art.  10a2 845 

Reg.  45.  Art.  1093 843 

Reg.  4.5,  Art.  1111 959 

Reg.  45,  Art.  1121 978 

Reg.  4.5,  Art.  1131 226 

Reg.  45,  Art.  1132 45,  789 

Reg.  45.  Art.  1133 226,  980 

Reg.  45.  Art.  1503 170,212 

Reg.  45,  Art.  1-504 215 

Reg.  45.  Art.  1-505 168 

Reg.  45,  Art.  1506 168.  170 

Reg.  45,  Art.  1507 171.172.175 

Reg.  45,  Art.  1-508 167.  283,  297.  300 

Reg.  4.5,  Art.  1509 999 

Reg.  4.5.  Art.  1.510 194,  706 

Reg.  45.  Art.  1521 103,  10<; 

Reg.  45,  Art.  1-522 103, 104 

Reg.  45.  Art.  1523 195.  19(i 

Reg.  45.  Art.  1524 195.  19(i.  19S 

Reg.  45.  Art.  1526 197 

Reg.  45,  Art.  1527 197 

Reg.  45,  Art.  1-528 19S 

Reg.  45.  Art.  1.529 198 

Reg.  45.  Art.  1.5.30 199 

Reg.  45.  Art.  1-531 199.  2(XI 

Reg.  45.  Art.  1.532 200 

Reg.  4.5.  Art.  1-5.33 795.  9»i6 

Reg.  45,  Art.  1541 505,512,525,-526 

Reg.  45,  Art.  1.542 .518 

Reg.  4.5,  Art.  1543—  .50-5.  -507.  -512.  -518.  -523 
Reg.  45.  Art.  1.544 .528,-5-30 


N«>.  I'agi- 

Reg.  45,  Art.  1-547 -535 

Reg.  45,  Art.  1.548 50-5.  .512 

Reg.  45.  Art.  1.549 .525 

Reg.  45,  Art.  1561__  158,  414,  415,  418.  429 

Reg.  45.  Art.  1.502 456,  4.59 

Reg.  45,  Art.  1563 421,423,452.461 

Reg.  45,  Art.  1-564 417,  421 

Reg.  45,  Art.  1.565 436 

Reg.  45,  Art.  1-566 451 

Reg.  4.5,  Art.  1.567 441,442 

Reg.  45.  Art.  1.568 445 

Reg.  45.  Art.  1-5(19 446,451 

Reg.  45.  Art.  1.570 185 

Reg.  45,  Art.  1.581 390,  66(; 

Reg.  45,  Art.  1582 394 

Reg.  4-5,  Art.  1583 400 

Reg.  45,  Art.  1-584 401 

Reg.  45,  Art.  1-585 402 

Reg.  45.  Art.  1.58(> 152,  154.  155 

Reg.  45,  Art.  1601 660 

Reg.  45.  Art.  I(j02 (502 

Reg.  45,  Art.  1603 «(;:; 

Reg.  45,  Art.  1621 816.  817 

Reg.  4.5,  Art.  1622 816,817,820 

Reg.  45,  Art.  1623 816,817,820 

Reg.  45.  Art.  1624 816,817.820 

Reg.  45,  Art.  1625 816,821 

Reg.  45,  Art.  1711 13 

Reg.  45,  Art.  1721 879 

Reg.  45,  Art.  1731 878,  880 

Reg.  45,  Art.  1732 , 878,  881 

Reg.  45.  Art.  173-3 878,  879 

Reg.  4.5,  Art.  1734 879 

Reg.  46,  Art.  1 1251. 1254 

Reg.  46,  Art.   2 12,50 

Reg.  46,  Art.  3 1250, 1254, 1255, 12.59 

Reg.  46,  Art.  4 1259 

Reg.  46,  Art.  5 1250 

Reg.  46,  Art.   6 1259 

Reg.  46,  Art.  7 1260 

Reg.  46,  Art.  8 1256 

Reg.  46,  Art.   9 12.57 

Reg.  46,  Art.  10 12.58 

Reg.  46,  Art.  11 1260 

Reg.  .50,  Rev.,  Art.  1 1151, 11.5(> 

Reg.  50.  Rev.,  Art.  3 1141 

Reg.  50,  Rev.,  Art.  4 1142 

Reg.  50,  Rev.,  Art.  5 1142 

Reg.  50,  Rev.,  Art.  6 1141 

Reg.  50,  Rev.,  Art.  7 1141 

Reg.  50,  Rev.,  Art.  10 1152 

Reg.  50,  Rev.  Art.  11 1155 

Reg.  50.  Rev.,  Art.  12 1155 

Reg.  50,  Rev.,  Art.  13 1143 

Reg.  50,  Rev.,  Art.  14 1144 

Reg.  50,  Rev.,  Art.  15 1144 

Reg.  -50,  Rev.,  Art.  16 1143 

Reg.  50,  Rev.,  Art.  17 11-55 

Reg.  50,  Rev.,  Art.  18 1146,1147 

Reg.  .50.  Rev.,  Art.  19 1147.  1155 

Reg.  50.  Rev.,  Art.  20 _ll-55 

Reg.  50,  Rev.,  Art.  21 114s,  11-55 

Reg.  50.  Rev..  Art.  22 1149 

Reg.  50,  Rev.,  Art.  23 1150,  1157 

Reg.  50,  Rev.,  Art.  24 1150 

Reg.  ,50,  Rev.,  Art.  26 1151 

Reg.  50,  Rev.,  Art.  28 115.S 

Reg.  -50,  Rev.,  Art.  30 11-57 

Reg.  -50,  Rev..  Art.  31 11.57 

Reg.  .50.  Rev.  Art.  32 IKiO 

Reg.  .50,  Rev.,  Art.  33 11.57,  n-5N 

Reg.  50.  Rev.,  Art.  ,34 1158 

Reg.  50.  Rev..  Art.  35 1151.  11-59 

Reg.  50.  Rev.,  Art.  .36 1160 

Reg.  50,  Rev.,  Art.  39 116(1 

Reg.  .50,  Rev.,  Art.  40 1160 

Reg.  50,  Rev.,  Art.  41 1156,  lHiO 

Reg.  .50.  Rev..  Art.  42 1160 

Reg.  50,  Rev.,  Art.  43 IHJO 

Reg.  55,  Art.  13 1168 

Reg.  55,  Art.  35 1214 

Reg.  55,  Art.  ()-3 121-3 

Reg.  55,  Art.  79 1192 

Reg.  .55,  Art.   81 1192 

Re|.  55,  Art.  82 1192 


xlviii 


REGULATIONS 


N.I  I'afTi' 

Kes,:  5:,,  Art.   95 11^ 

Keg.  55  Art.  100 IfOo 

Keg.  55,  Art.  101 11»- 

Iteg.  55,  Art.  i.\)-f 122'' 

Ketf.  55,  Art.  123 ^'.^r, 

Uel-  55;  Art.  126 ]^ 

Ilea.  55.  Art.  12< iz^f^. 

Keg.  55,  Art.  llo— {r"'' 

Re|.  55,  Rev.,  Art    1 ^11^^ 

Reg.  5o,  Rev.,  Ait. 

Keg.  oo,  Rev.,  Ait.   ^ nc/i 

Reg.  55,  Rev.,  Art.   -J |j^: 

Kei.  55,  Kev..  Art.   0 11^^ 

Rei.  55,  Rev.,  Art.   i 1}^^ 

Keg.  55,  Rev.,  Art.   S Ijb. 

Reg.  55,  Rev.,  Art.   9 118^ 

Ke^.  55,  Rev.,  Ar .  io--::::nofrlls9 

Rel.  55.,  Rev.,  Art.  13 --J^^ 

ill:  t  ^Iv:;  ir :     :::::::::--n||o 

Keg.  55,  Rev.,  Art.  lb 11^ 

Reg.  55,  Rev..  Art.  1. ]]^ 

Reg.  55',  Rev.,  Art.  18 llb< 

l^'t  ^'   Rev'  tvl     i-Tl!^:f268:i221 

Reg.  uo.  Rev.,  Ari.   .0 |.,iVi->>(»  1>'1 

Reg.  55.  Rev.,  Art  •^^-—1^18. 1--"-  };-} 

Reg.  55,  Rev.,  Art,  3b 1--1 

Reg.  55,  Rev..  Art.  37 121,,12is 

Reg  55  Rev.,  Art.  38 121H 

Keg.  .55.  Rev.,  Art.  39 121. 

Reg.  55,  Rev.,  Art.  40 1-1' 

Keg.  55.  Rev.,  Art.  41 1218 

Keg.  55.  Rev.,  Art.  42 1-1. 

Reg.  55.  Rev.,  Art.  43 1220 

Keg.  55.  Kev.,  Art   44 1220 

Keg.  55,  Rev.,  Art.  45 1220 

Reg.  55,  Kev.,  Art.  4h 12-0 

Keg.  55.  Rev.,  Art.  47 ----1220 

Rei.  55,  Rev.,  Art.  48-1213, 1214, 121. 

Rei.  55,  Rev.,  Art.  48  (b) 121o 

Keg.  5.5,  Kev.,  Art.  49 l^l;^ 

Reg.  55.  Kev.,  Art.  oO 121o 

Keg.  55.  Kev.,  Art.  51 1214 

TJpo-  -,-,  Kev  Art.  52 121«> 

Keg.  55.  Rev.,  Art.  o.j 1-^- 

Reg.  55,  Kev.,  Art.  54 122 

Keg.  55.  Rev.,  Art.  50 122- 

Reg.  55.  Kev.,  Art.  5< 1214 

Keg.  55.  Rev.,  Art.  oS 121' 

Keg.  5.5,  Kev.,  Art.  59 1215 

Keg.  55.  Rev.,  Art.  00 1214 

Keff.  55.  Rev.,  Art.  til 121.> 

Keg.  5.5.  Rev.,  Art.  62 r;i-]^f-J- 

Keg.  55:  Rev.,  Art.  03 1190.  121. 

Reg.  .55.  Rev.,  Art.  04 1221 

Reg.  55,  Rev.,  Art.  6.5 1--J 

Reg.  55,  Rev.,  Art.  66 1190 

Reg.  .55,  Rev.,  Art.  67 1192 

Reg.  55,  Kev.,  Art.  68 1191.  lli>5 

Keg.  .55,  Rev.,  Art.  69 1197 

Keg.  5.5,  Rev.,  Art.  70 1193 

Keg.  .55.  Rev.,  Art.  71 1191 

Reg.  .55,  Rev.,  Art.  72 1191 

Reg.  .55,  Rev.,  Art.  73 1191 

Reg.  55,  Rev.,  Art.  74 1197 

Keg.  55,  Rev.,  Art.  75 1193 

Keg.  .55,  Rev.,  Art.  76 11!)5.  ll'.Ki 

Keg.  .55,  Rev.,  Art.  77 1196 

Reg.  55.  Rev.,  Art.  78 1191 

Keg.  .55,  Rev.,  Art.  82 1193 

Reg.  5.5,  Rev.,  Art.  83 1195. 1196 

Keg.  .55,  Rev.,  Art.  84 1193 

Keg.  .55,  Rev.,  Art.  85 1197 

Keg.  .55,  Rev.,  Art.  86 1197 


Reg.  55,  Kev., 
Reg.  .55.  Rev., 
Reg.  55,  Rev., 
Reg.  5.5,  Rev., 
Reg.  55.  Rev., 
Reg.  55,  Rev., 
Reg.  55.  Rev.. 
Reg.  55,  Rev., 
Reg.  55,  Rev.. 
Reg.  55,  Rev., 
Reg.  55,  Rev., 
Keg.  55,  Rev., 
Reg.  55,  Rev., 
Reg.  55,  Rev., 
Reg.  55,  Rev., 
Reg.  55.  Rev., 
Reg.  55,  Rev., 
Reg.  55,  Rev., 
Reg.  55,  Rev., 
Reg.  55,  Rev., 
Reg.  55,  Rev.. 
Reg.  55,  Rev.. 
Reg.  55,  Rev., 
Reg.  55,  Rev., 
Reg.  55,  Rev., 
Reg.  55,  Rev., 
Reg.  55,  Rev., 

Reg.  .55,  Rev., 

Reg.  .55,  Rev.. 

Reg.  55.  Rev.. 

Reg.  55,  Rev., 

Reg.  55,  Rev., 

Reg.  55,  Rev., 

Reg.  .55.  Rev.. 

Reg.  55,  Rev.. 

Reg.  .55.  Rev.. 

Reg.  .55.  Rev., 

Reg.  .5.5,  Kev.. 

Reg.  .55,  Rev.. 

Reg.  .55,  Rev., 

Reg.  .5.5.  Rev.. 

Reg.  .55.  Rev.. 

Reg.  55,  Rev.. 

Reg.  .55.  Rev.. 

Reg.  .55,  Rev., 

Reg.  .5.5,  Rev., 

Reg.  .5.5.  Rev.. 

Reg.  .55,  Rev., 

Reg.  .55.  Rev.. 

Reg.  .55.  Rev. 

Reg.  .55.  Rev.. 

Reg.  55,  Rev. 

Reg.  55.  Rev. 

Keg.  .55,  Kev. 

Reg.  55,  Rev. 

Reg.  5.5,  Rev. 

Reg.  .55,  Rev. 

Reg.  .55,  Rev. 

Reg.  .55,  Kev. 

Keg.  .55,  Kev. 

Reg.  ,55,  Rev. 

Reg.  .55.  Rev. 

Reg.  55,  Rev. 

Reg.  55.  Rev. 

Reg.  r,-j,   Rev. 

Reg.  .55.  Rev. 

Reg.  .55,  Rev. 

Reg.  .55.  Itev. 
Reg.  55,  Rev. 
Reg.  55,  Rev. 
Reg.  ,55,  Rev. 
Reg.  .55,  Rev 
Reg.  55.  Rev 
Reg.  .55.  Rev 
Reg.  .5.5,  Rev 
Reg.  .55.  Rev 
Keg.  .55,  Kev 


I'age 

Art.  87 1194 

Art.  88 1194 

Art.  89 1194 

Art.  90 1194 

Art.  91 1194 

Art.  92 1194 

Art.  93 IIM 

Art.  94 1193 

Art.  97 1193 

Art.  98 1193 

Art.  99 1195 

Art.  100 1196 

Art.  102 1194 

Art.  103 1195 

Art.  104 1196 

Art.  105 1194 

Art.  106 1197 

Art.  108 1197 

Art.  110 1195 

Art.  Ill 1198 

Art.  112 1198 

Art.  113 1205 

Art.  114 1204 

Art.  115 1204 

Art.  116 12(M 

Art.  117 1204 

Art.  118 1204 

Art.  119 1203,  1204 

Art.  120 1204 

Art.  121 1223 

Art.  122 1224 

Art.  124 122;! 

Art.  125 1223 

Art.  126 1223 

Art.  .Ja 122:! 

Art.  129 12011 

Art.  130 1205 

Art.  131 1209 

Art.  132 1209 

Art.  134 1207 

Art.  135 1209 

Art.  136 1209 

Art.  137 1207 

Art.  138 120s 

Art.  140 120!' 

Art.  141 120tl 

Art.  142 1207 

Art.  143 1209 

Art.  144 1208 

Art.  146 1207 

Art.  147 1206,  1207 

,  Art.  148 120'.i 

,  Art.  149 1205 

,  Art.  1.56 1200 

,  Art.  157 1200 

,  Art.  1.58 1200 

.  Art.  159 1200 

,  Art.  160 1201 

.  Art.  161 1201 

.  Art.  162 1201 

,  Art.  163 1202 

.  Art.  1(>4 1202 

.  Art.  165 1202 

.  Art.  166 1202.1203 

,  Art.  167 1202 

.  Art.  168 1203 

,  Alt.  170 11(>. 

,  Art.  171 lim 

.  Art.  176 116:'. 

.  Art.  177 1163 

.  Art.  178 1164 

.  Art.  179 1165 

.  .\rt.  180 1165 

.  Art.  181 116:3 

.  Alt.  182 116:^ 

.  Art.  183 1164 

,.  Art.  184 1164 


TREASURY  DECISIONS 


No. 
62?. 
974 
129;i 
13  7;^ 
149)» 
1617 
1651 
1655 
1659 
1675 
1701 
1727 
1728 
1742 
1768 
1852 
1868 
1865 
1890 
1909 
1982 
1941 
1948 
1948 
1049 
1950 
1957 
1960 
1989 
1990 
1993 
2001 
2008 
2005 

2012 
2030 
2042 
2054 
2067 
2072 
2073 
2077 
2079 
2081 
2085 
2090 


81. 


Pagf. 
878 
015 
915 
878 
878 
950 
878 
821 
•   858 
725.  885 
910 
293.  636 
852 
593 
618 
268 
224 
234 
967,  972 
960 
6 
319 
136 
616 
887 
898 
175 


166. 

234.  605 
622.  626 
878 
234 
828 
859 
341.  626.  628. 
680.  697 
65 
65 
1191 
1168 
1204.  1223 
1170 
1175,  1180.  1181 
697 
373.  374 
1209 
1208 
103.  121.  144. 
145,  178,  188. 
229.  234.  248. 
249,  262,  265. 
815,  330,  364. 
367.  368.  370, 
372.  377.  417. 
546,  547,  549, 
555.  557.  573. 
587,  588.  589. 
590.  595.  598. 
599,  601.  618. 
616.  626.  645. 
646.  682.  697. 
886.  887.  966. 
96".  968.  972 
2092  40 

211J  1198.  1197 

-,}}'::  1170 

-11-'         1190.  1191. 

1192.  1193, 

1194.  1195. 

2124  'Ifl 

iJi?  '-'•  '-^ 

2134     1205,  1208,  1209 

-•l-^o       80,  40.  55.  58, 

121.  364.  372, 


\o. 


2153 

2155 
2158 
2161 


2164 
2170 

2174 

2182 
21!»(; 
22n!( 
221(1 

222(» 
2224 
222(! 
2281 
2285 
2288 
2242 

2257 

2262 

22(«5 

22<i9 

2274 

2278 

2279 

2288 

2289 

2298 

2311 

2318 

2317 

2825 

2881 

2841 

2864 

2886 

2891 

2401 

2402 

2407 

24  IS 

2428 

2425 

2427 

2488 

2441 
2442 
2448 
2446 
2450 
2451 


595, 
646. 


rag... 

556.  »il4,  618. 

628.  626,  645. 

840.  967,  968 

•  iS,  75.  91.  104, 

142.  168.  170. 

284.  247.  248, 

249.  250.  262. 

814.  887.  417. 

505.  508.  515. 

559.  586.  589. 

681,  683.  694. 

827,  884 

36,  66.  248. 

313.  378.  502. 

505,  555.  557. 

584.  598. 

598,  612. 

681,  688, 

690 

152,  159,  162. 

850.  (i46.  680 

1174.  1196 

878 

75.  289,  263, 

842,  886,  546. 

618.  647 

1166 

1215.  1216. 

1217,  1221 

886 

1183 

1208 

249.  265 

272,  571. 

579.  584 

1166 

648 

881 

186 

886 

886 

42.  48.  55.  981 

1197 

1167 

593 

1215 

1208 

531 

1192 

1192 

1190.  1196 

135,  136 

836 

910,  1191 

59,  65.  91 

10 

65 

133 

881.  910 

1150 

100 

98 

88.  800 

94 

312 

211 

1150 

310 

777,  778,  779 

156.  560,  609, 

797.  810 

234.  494 

587.  972 

923 

685 

46 

284,  344 


10. 


No. 

2452 
2467 
2481 
2501 
2511 
2519 
2541 
2.-61 
2581 
2584 
2585 
259!t 


2tl09 
2<iH; 
2625 
2649 
2(i52 
2(!59 
2660 
26f!2 
2665 

2666 
2(i69 
2670 
2(!78 

2678 
2682 

2(iS.-, 
2686 
2692 
2698 
2(i94 
2600 

2<!97 
2700 
2701 
2706 
2707 
2711 
2718 

2716 
27:!4 
2786 
27;!7 
2742 
2744 
2747 


2754 
2759 

2769 

2786 

2791 

2794 

2797 

2805 

2815 

2817 

2.S80 

2840 

2844 

2847 

2849 

2851 

2857 

2858 

2859 


Pago. 

88 
1146 
698.  694,  725 
298 
608 
578 
1055 
884 
884 
1178 
482 
1170.  1181.  1190. 
1191.  1193.  1195. 
1196.  1207.  1215, 
1224 
388,  390.  395 
595 
560,  605,  797 
388 
970 
528 
595 
260,  263,  11.84,  11.35 
152.  156.  157.  1.58, 
159.  162,  164 
879 
100 
951.  952.  958 
838.  995 
523 
1214.  1217.  1218. 
1221.   1289.  1246 
1188 
494 
777.  778.  779 
312,  314.  9(i8 
1172 
865.  366,  591.  .-,98. 
594.  595.  590 
8(i9 
528 
1221 
544 
46:: 
160 
1167.  1189,  119S. 
1216 
056 
5:!r. 
84,  528 
50N 
2.81 

:',8S 
556 
1172,  1175.  1176, 
1177.  1178,  1181, 
1182.  1185.  use 
()S5 
956.  960 
182 
968 
1184,  1198 
1060,  1101 
43.  981,  982 
1102 
260 
85 
1240 
4S8 
85  C. 
88.8 
.'37.  562.  599.  600 
835 
878,  879 
488 
181 
70!) 


1205, 


xlix 


TREASURY  DECISIONS,   OPINIONS 


No. 

28()5 

2871 

2873 

2874 

287C 

2882 

2891 

2890 

2901 

29(i;; 

291!» 

292(  t 

2924 

2925 

2927 

2929 

2931 

293:! 

2935 

2937 

2943 

2951 

2952 

295r, 

:.'!•(  ill 

2901 

29C2 

296ti 

2907 

2969 

2970 

2972 

2977 

2979 

2987 

2988. 

2992 

2998 

3018 

3019 

3024 

302S 

3030 

3031 


su 

RY  DECISl 

ONS- 

—Continued. 

Page. 

No. 

Page. 

No. 

Page. 

485 

30;!2 

818 

3154 

928 

910, 

923.  924,  926 

.•■.042 

874 

3155 

43 

.    44, 

981,   982 

815 

3043 

268 

3150 

1155 

881 

3044 

061, 

607,    818 

3100 

1189.  1157 

59 

3040 

287 

,    3160 

851 

043,   937 

3047 

401 

3170 

528.  1069 

1241 

3048 

495 

3179 

319. 

320.    322 

290 

:!04!t 

377,  378 

3183 

1024 

1134,   11.35 

3051 

1260 

3188 

847 

840,  905 

305:.> 

528,  532 

3190 

115 

1189 

305;'. 

285,   280 

319;', 

174 

,  211.  212 

785 

3056 

228,  989 

3200 

1034 

451 

3057 

290, 

291    292 

3200 

158, 

185, 

227,  341, 

676 

l!42,  "64"3 

350, 

371, 

407.  413. 

618 

3058 

403 

.  404.  405 

414, 

415, 

417.  418. 

683 

.3060 

788 

419, 

421. 

429,  433. 

1101 

3001 

088 

436, 

445. 

448,   451, 

617 

3002" 

581 

587.   686 

456, 

459. 

463.  478. 

831 

.•',065 

756 

495. 

498. 

507.  512, 

610 

3071 

49 

525, 

535, 

541.  549. 

168 

30  7S 

283 

(t33. 

641. 

643,  645. 

830 

30S0 

1023 

807 

836 

3082 

464 

406.  409 

3209 

631 

759,  761,  763 

3089 

716, 

717.    759 

:i2lo 

962 

372,  807 

3101 

568 

3215 

237,  600 

840 

310.-! 

1230 

;321(! 

874,  876 

846 

3105 

238.  900 

3220 

1089 

563 

3108 

394 

3221 

881 

991 

3109 

401 

3229 

875.  876 

995 

3110 

820 

3235 

1129.  1130 

783 

3111 

75 

3238 

535 

624.  625 

3112 

373 

3240 

942 

563 

3115 

880.    881 

3242 

375 

424 

311,S 

1171.   1172.   1177 

3243 

1089 

139 

3123 

709. 

711,    712 

:J245 

1037.  1038 

144 

.•',120 

874 

3247 

802.    800 

308.  371 

:'.133 

233 

3250 

879 

563 

3130 

852,  85(! 

3251 

919 

991 

3137 

1034 

3200 

92.'^ 

.  931 

.  932.  934 

573 

313.S 

49 

32<il 

628,  643 

.  645.  659 

403 

3143 

880 

3262 

657 

788 

3147 

431.    539 

3263 

866 

958 

.•!15:! 

285,  286,  1106.  1107 

3265 

654 

957 

No. 

1 


OPINIONS  ATTORNEY  GENERAL. 


Page. 

No 

120,    617 
lOS 

375 

13 

IS 

2S 

Page. 

No 

377,   378 

1271 

74,  170.  20S. 

;;i 

Page. 

:!0:',.   4SE0 


SOLICITOR'S   LAW   OPINIONS. 


No. 

130 
296 
797 
780 
781 
785 
790 
791 
792 
809 
812 
816 
818 
833 
844 
845 
858 
862 
872 
879 
880 
884 
907 
914 


Page. 

No. 

2;j7 

910 

241 

922 

105 

920 

625 

9'28 

4SS.   1077 

9:!2 

42 

942 

334 

957 

4;55 

962 

r:33 

968 

f-'X' 

974 

(il7 

976 

186 

979 

897 

980 

868,  914,  928.  930 

982 

394 

98S 

639.  659 

995 

m:> 

1000 

705 

1000a 

1080 

1008 

847 

1009 

401 

1012 

SOS 

1014 

!K)5.     !10!t 

1010 

.54:'. 

102:^, 

Page. 

No. 

Page. 

}2;>,    1030 

1024 

496 

000 

1028 

902 

581,    614 

1032 

285 

615 

103:: 

784 

505.  522 

1035 

645,    903 

1100 

1040 

547,    548 

916 

1045 

551.  571. 

455 

578,    592 

236,  (i21 

10.50 

295 

91S 

1051 

129 

220 

1054 

775 

563 

1055 

767 

349 

1056 

292 

787 

1059 

609 

474 

1060 

897,    1206 

554 

1061 

623 

1126 

1062 

219,    220,   455. 

1126 

645,   903 

898,    899 

1063 

283,    1149. 

243 

1150,   1156 

111.    110 

1060 

226 

308 

1072 

910 

187 

1073 

525 

1131 

1074 

708 

OPINIONS,   RECOMMENDATIONS,   ETC. 


li 


SOLICITOR'S  OPINIONS. 


No. 

Page. 

^•o. 

Page. 

Xo. 

4 

441 

57 

330 

92 

5 

«1S 

.-)!• 

349 

93 

lt07 

00 

861,  906 

97 

11 

807 

IMS 

338 

99 

14 

827 

70 

287 

100 

234 

71 

1172,  1173 

106 

•M 

404 

72 

444 

107 

itl7,  'J28 

76 

292 

110 

.■>"> 

458 

77 

854 

114 

:!0 

173 

78 

320 

115 

40 

2S5,  280,  2113 

79 

860,  861,  868, 

116 

41 

802,  1080 

919,  930 

117 

42 

180 

80 

720,  728 

118 

46 

494 

83 

294 

120 

41) 

216,  217 

86 

580,  717 

121 

"•2 

t)07 

8S 

124 

122 

403 

!I0 

824,  1263 

127 

."iC, 

21.-..  217 

;)i 

218 

845 

Page. 
861,  862 
212 
377 
334 
290 
932 
932 
526 
697 
516 
176 
171,  1021 
717 
322 
50 
379 
234 
812 


SOLICITOR'S  MEMORANDA. 


No. 

923 
926 
li:!0 
'.131 
935 
952 
957 

'.•.38 

061 

905 

969 

971 

972 

975 

983 

992 

1001 

1003 

1022 

104S 


Page. 

No. 

Page. 

No. 

800 

1052 

563 

1298 

389, 

902 

1068 

215,  216 

1305 

817 

1081 

536 

1312 

904 

1088 

137 

1315 

570 

1090 

228 

1329 

335 

1117 

33 

1334 

545 

1140 

320 

1335 

330 

1145 

232 

1337 

i:U 

11.50 

870 

1344 

(;oo 

1165 

169 

1353 

782 

1176 

563 

1301 

512 

1179 

403 

1362 

217 

1200 

1068 

1365 

072 

1202 

563 

1371 

799, 

800 

1205 

215,  216 

1373 

5ti:! 

1217 

546 

1374 

213 

1229 

131 

1384 

389 

1229a 

131 

1385 

460 

1246 

323,  326,  .564 

1387 

.560. 

.581 

1204 

443 

1.391 

503 


Page. 

234 

610 

367 

800 

545 

903 

802,  810 

215.  216 

106 

467 

174 

324.  564 

725.  726 

908 

390 

116,  357 

541 

4.55 

10.57 

104S 


ADVISORY  TAX  BOARD  RECOMMENDATIONS. 


No. 

2 

3 

4 

6 

7 

8 

10 

12 

13 

15 

16 

24 


470, 


Page. 

No. 

1106 

28 

1090 

20 

716,  1044 

32 

1065 

33 

260 

34 

22 

36 

66'J 

37 

372,  805 

38 

647,  811 

39 

668 

41 

1111 

42 

471,  474 

43 

442 

44 

1132 

46 

Page. 

No. 

485 

47 

972 

48 

354,  1047 

49 

323.  326 

54 

180,  625 

55 

258 

57 

818 

1044 

.58 

443 

59 

543 

(i3 

.533 

65 

521 

67 

703 

71 

591.  502 

521 

Page. 

12it 

341,  396,  398.  428 

1055,  11.35 

1098 

660 

420,  421,  422. 

423.  430 

203,  1023 

684 

532 

399 

1059 

.512 

256 


ADVISORY  TAX  BOARD  MEMORANDA. 


No. 


9 
17 
18 
21 
.30 
31 
32 


Page. 

No. 

33 

3t) 

1037 

41 

1053 

42 

1110 

44 

202 

49 

10.-)0 

50 

705 

51 

775 

52 

1127 

53 

396 

.55 

2.56 

56 

102.1 


'age. 
600 

Ni 
57 

10.56 

.58 

111:; 

60 

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61 

los:". 

70 

1112 

7.3 

1103 

77 

668 

81 

1124 

82 

812 

86 

1095 

103S, 


I 

'age. 

1045 

1120 

030, 

1124 

.543 

501 

415. 

549 

526 

597 

522. 

1071 

591. 

.502 

lii 


RECOMMENDATIONS,    MEMORANDA 


COMMITTEE    ON    APPEALS    AND    REVIEW    RECOMMEN- 
DATIONS. 


No. 
1 
6 
7 
9 
10 
13 
15 
16 
17 
18 
23 
24 
27 
29 
30 
31 
32 
33 
36 
43 
45 
46 
50 
53 
58 
50 
61 
65 
67 
70 
71 

78 
81 
86 
93 
06 
07 
98 
102 
104 
110 
111 
113 
116 
123 
124 
126 
127 
140 
155 
156 
161 
173 
178 
182 
185 
209 
210 
211 
217 
218 
219 
221 


Page. 

Xo. 

Page. 

No. 

Page. 

539 

22.'! 

591,  592 

404 

627 

536 

22!) 

1063 

408 

1098 

203 

232 

808 

409 

1065,  1084 

1 056 

233 

1047 

413 

1049 

1049 

237 

234,  1069 

425 

1020 

476 

242 

627 

431 

642.  736 

.•561 

247 

1020 

4.35 

592,  635,  636 

1086 

249 

152,  418,  625,  627 

430 

1062, 

1086.  1090, 

1039 

25(» 

551 

1093 

398 

252 

432,  433,  435 

444 

566,  581,  <>3S 

203 

257 

172 

448 

2.5.5 

204 

265 

968 

459 

1055.  1119 

691 

266 

569 

46:! 

197,  198,  203 

1050,  1056 

268 

1043,  1085 

464 

198,  199,  1122 

649 

269 

639 

469 

641 

591,  592 

272 

685 

473 

I0ti7 

591.  592 

275 

808 

475 

31 

424,  429,  432 

279 

692 

477 

:'>27 

1110 

280 

121 

479 

649 

268,  1020 

284 

125 

487 

401.  667 

692 

285 

249,  1083,  1086 

493 

.592 

196,  203 

289 

447,  803 

498 

642 

203 

291 

668 

499 

1108 

591,  592 

301 

564 

500 

203 

203 

307 

1053,  1055 

501 

817 

203 

315 

1023 

506 

396 

591,  592 

321 

372 

517 

394, 

1089,  1090 

1019 

326 

1124 

518 

1123 

114,  512 

328 

1050 

519 

592 

1118 

331 

676,  916 

520 

683,  1044 

nr 

6.  1058,  1062, 

332 

1122 

538 

1123,  1124 

1090 

335 

1123 

542 

639 

1071 

337 

1041,  1087 

.545 

239 

1101 

338 

1117,  1122,  1124 

.547 

1109 

1056 

339 

683 

551 

119.  681,  780 

695 

342 

816,  818 

.554 

675 

624 

346 

592 

5.56 

641,  1117 

570 

349 

706 

5.59 

2:!4 

583 

352 

652 

565 

146,  1014 

10 

To.  1073,  1098 

356 

1070,  1098 

570 

692,  743 

1126 

358 

1046 

571 

178 

1122 

360 

900 

572 

568 

1080 

363 

202 

577 

518 

125 

364 

203 

588 

571,  646 

1070 

365 

652 

589 

.501 

263 

366 

348 

590 

670 

527 

367 

548 

594 

682 

455 

373 

600 

599 

1118. 

1122,  1123 

518 

374 

589 

604 

625,  627 

394 

375 

347 

611 

1049 

667 

376 

1041 

(ilS 

1083, 

1114,  1132 

439,  452 

377 

628,  693 

()19 

1039,  1114 

1046 

378 

256 

624 

26:1 

453,  454 

379 

565 

629 

172.  1020 

582 

383 

1082 

636   1 

72,  1020, 

1021,  1117 

364,  801,  805 

384 

587,  1089 

641 

255,  263 

700 

390 

1046,  1091 

643 

791 

1117 

391 

816,  818 

(545 

1084 

1024 

393 

1083 

651 

176 

1021 

394 

1066 

652 

211,  212 

796 

396 

1050 

664 

380 

314,  324 

397 

1118 

667 

415 

314,  323 

398 

627 

678 

1047 

1106 

403 

50,  429 

COMMITTEE   ON   APPEALS   AND   REVIEW   MEMORANDA 


No. 
1 


10 
12 
13 
16 

17 


Page. 

No. 

Page. 

N... 

1031 

23 

899 

37 

563 

24 

710 

38 

669 

25 

181.  184 

;!9 

1037 

26 

609 

40 

456 

29 

609 

41 

705 

30 

591,  592 

42 

1122 

31 

652 

43 

181 

33 

395 

44 

613 

34 

431,  435,  684 

46 

739 

36 

326 

51 

Page. 

132,  150 

396 

591.  592 

1020 

1019 

203 

1136 

1071 

918 

1100 


MEMORANDA,  DECISIONS 


liii 


COMMITTEE  ON  APPEALS  AND  REVIEW  MEMORANDA— 
Continued. 


*Io. 

Page. 

No. 

56 

349,   869 

95 

59 

203 

96 

60 

1085 

100 

64 

653 

101 

67 

446,   453 

104 

68 

434 

105 

71 

1072 

10<i 

79 

315 

110 

80 

105  3.    1055 

111 

82 

521 

112 

85 

396 

114 

88 

619 

115 

89 

1120 

116 

93 

514 

120 

94 

454 

121 

<o. 

Page. 

OFI 

No. 

•2 

202,  203 

95 

3 

807 

!)7 

4 

518 

98 

5 

518 

102 

6 

547 

104 

7 

429 

105 

9 

805- 

108 

12 

383 

110 

13 

804,   805 

111 

14 

547 

112 

15 

373 

113 

16 

485,  487 

114 

19 

364,  801,  805,  806 

115 

20 

310 

117 

21 

551 

119 

23 

473 

120 

24 

470,  474 

121 

25 

471 

122 

27 

375,  873 

123 

28 

1077 

124 

30 

490 

125 

31 

487 

126 

33 

381 

127 

34 

489 

128 

35 

63 

129 

36 

374 

131 

38 

574 

133 

39 

564 

134 

40 

604 

136 

42 

625 

137 

43 

770 

138 

44 

564 

139 

47 

668 

140 

48 

566 

143 

51 

113 

144 

58 

144 

146 

60 

325 

148 

61 

329 

152 

63 

318 

153 

64 

336 

156 

65 

337 

162 

66 

230 

163 

70 

619 

165 

71 

816 

167 

73 

244 

174 

74 

868 

175 

75 

268 

177 

79 

1025 

179 

80 

1038 

180 

81 

1075 

181 

82 

1093 

182 

83 

1174 

184 

85 

1099 

185 

86 

1077 

186 

87 

1220,   1228 

187 

89 

1041 

188 

90 

1090 

189 

91 

1057 

190 

92 

1058 

191 

93 

1077 

lOL' 

94 

1129 

19:j 

Page. 

No. 

684 

122 

1115 

123 

393,  558 

124 

540 

128 

327 

129 

901 

133 

)91,  1093 

135 

763 

130 

767 

138 

694 

139 

597 

140 

548 

141 

1135 

142 

195 

164 

389,    815 

413 

SIONS. 

Page. 

No. 

1132 

194 

527 

195 

461 

196 

705 

197 

564 

198 

781 

199 

331 

202 

600 

204 

239 

205 

303 

206 

251 

207 

244 

208 

954 

211 

56 

212 

368 

213 

549 

214 

184 

215 

375 

216 

376,   777 

217 

.598 

218 

700 

219 

564 

221 

43 

222 

983 

223 

113 

224 

877 

227 

395 

228 

467 

229 

1228 
610 

231 
232 

623 

780 

233 
231 

180 

236 

982 
965,  987 

240 
241 
243 
245 
246 
248 
249 
2.^0 
252 
253 
2.54 
255 
250 
257 
258 
259 

647,  812 
250 
529 
311 
127 
957 
524 
659 
973 
105 
982 

337 
1063 

221 

260 

476 

261 

311 

263 

1112 

269 

184 

270 

674 

271 

172 

272 

31 

273 

837 

274 

314 

275 

336 

278 

485,   487 

279 

677 

280 

Page. 

542 

918 

739 

534 

392 

75,  302 

393 

669,    811 

592,   593 

173 

474 

1049,    1065 

543 

1065 

1087 


Page. 

113 

381 

311 

44 

56 

619 

1042 

441 

818 

488 

966 

144 

1132 

488 

483 

375 

588 

646 

564 

675 

112 

6,    969 

1113 

11.31 

1030 

484 

189 

273 

249 

793 

857 

861 

215 

235 

624 

179 

67 

343 

1045 

1047 

35.S 

334 

784 

983 

273 

381 

381 

984 

707 

1136 

1020,  10.30 

6C.S 

63 

874 

877 

87 

842 

X«0 

56(1 

117 

977 

331 


1101, 


liv 


DECISIONS 


OFFICE  DECISIONS— Contd. 


No. 
2S2 
283 
284 
285 
280 
287 
288 
289 
291 
292 
293 
J94 
295 
297 
298 
299 
300 
301 
302 
304 
305 
306 
308 
309 
310 
311 
312 
313 
314 
315 
.316 
317 
318 
319 
321 
322 
326 
327 
328 
329 
330 
331 
382 
334 
335 
336 
337 
339 
.340 
343 
344 
345 
346 
347 
348 
350 
352 
354 
355 
356 
357 
358 
359 
360 
362 
363 
364 
365 
366 
367 
368 
369 
370 
371 
372 
373 
374 
375 
.377 
378 
379 
380 
381 
382 


Page. 

No. 

801 

383 

6S0 

384 

9S4 

385 

50 

386 

375 

388 

610 

390 

233 

391 

395 

392 

76 

393 

148 

394 

326 

'  395 

76 

1  396 

1029 

.397 

651 

398 

700 

309 

563 

400 

783 

401 

784 

4<)i 

983 

1  403 

874 

404 

1076 

405 

0.50,  1073 

407 

461 

408 

380 

409 

580 

1  410 

192 

411 

333 

414 

905 

415 

739 

416 

57 

417 

110 

418 

787 

'  419 

334 

420 

606 

421 

1120 

422 

783 

!  423 

400 

424 

491 
358,  776 
375 
969 
876 
877 
169 
441 
311 
376 
965 
324 
516 
683 
563 

425 
426 
427 
429 
430 
431 
432 
433 
434 
435 
437 
440 
441 
442 

782 

443 

834 

444 

1044 

445 

784 

446 

251 

447 

957 

448 

841 

449 

1129 

779 

94,  980 

450 
451 
452 

1030 

454 

33,  515 

455 

183 

456 

681 

459 

783 

460 

218 

461 

900 

462 

663 

463 

489 

464 

381 

465 

376 

466 

609 

467 

611,  789 

468 

613,  633 

469 

164 

470 

647 

471 

958 

472 

1036 

473 

463 

474 

663 

475 

696 

476 

669 

477 

Page. 

No. 

775 

478 

92,  968 

479 

877 

480 

461 

482 

609 

483 

668 

484 

784 

485 

985 

48ti 

788 

4SS 

10 

28,  1031,  1032 

'489 

1039,  1124 

490 

574 

491 

582 

49.-! 

585 

494 

134,  566 

495 

44 

49ti 

953 

497 

1037 

49.S 

295 

499 

817 

500 

484 

501 

21.5.  216 

502 

905 

503 

477 

504 

1102 

507 

171 

508 

998 

509 

258 

510 

953 

511 

1056 

512 

443 

513 

358 

514 

489 

515 

601 

516 

778 

517 

996 

519 

788 

520 

103 

521 

50 

522 

292 

523 

159 

525 

664 

526 

662 

527 

364,  805,  806 

528 

554 

529 

380,  383 

530 

375,  376 

532 

783 

533 

506.  583 

534 

900 

535 

874 

536 

833 

537 

169 

5.38 

661 

539 

552 

540 

491 

.541 

310 

542 

382 

543 

580 

544 

569 

545 

571 

546 

114 

547 

205.  1000 

548 

805,  830 

549 

41 

550 

806 

551 

516,  805 

552 

375 

553 

375 

554 

64 

555 

562 

556 

783 

557 

257 

558 

56 

559 

963 

560 

963 

561 

528 

562 

699 

563 

177 

565 

778 

566 

240 

567 

249 

568 

1029 

569 

Page. 

535 

515 

803 

467 

310 

382 

375 

629 

515 

362 

555 

493 

483 

381 

376 

601 

.592.   .596 

56 

788 

877 

.545 

183.  231 

383 

591,  592 

117 

318 

324 

323.  324 

661 

364.  805.   806 

541 

369 

310 

582 

.300,  977 

997 

987 

831 

329 

.315 

.381 

637 

762 

316 

601 

906 

1028 

55 

63 

653 

57,  67 

121 

333 

910 

1029 

.391 

180 

461 

491 

382 

566 

783 

783 

969 

362,   1055 

359 

546 

382 

162 

629 

127 

244 

164 

67 

134 

231,  981 

977 

495 

5.33 

877 

478 

476 

476 


DECISIONS 


-  Iv 


OFFICE  DECISIONS— Contd. 


No. 

Page. 

No. 

570 

371.  597 

662 

571 

624 

663 

572 

144 

()64 

573 

320 

665 

574 

248 

668 

575 

149 

669 

57(5 

841 

670 

577 

231 

671 

578 

66 

672 

579 

580 

673 

580 

788 

675 

581 

206.  783 

676 

582 

147 

677 

583 

792 

678 

584 

148 

679 

585 

582 

680 

586 

92,  296 

681 

587 

520,  521.  533 

682 

588 

533 

683 

589 

530 

684 

590 

362 

686 

591 

491,  540,  802 

687 

592 

44 

688 

593 

177,  192 

689 

594 

611 

690 

595 

606 

691 

596 

304 

692 

597 

268  . 

69:5 

598 

129.  131,  215,  216 

694 

599 

169 

695 

601 

461 

696 

602 

369 

697 

603 

124.  779 

698 

604 

650 

699 

605 

783 

700 

606 

135 

701 

60t 

600 

702 

608 

833 

703 

609 

948 

705 

610 

521 

706 

611 

79 

707 

612 

554.  557 

709 

613 

124,  128 

710 

614 

207 

711 

615 

984 

712 

618 

362,  1055 

713 

619 

1099 

714 

620 

216,  217 

715 

621 

106,  141 

717 

622 

495 

718 

623 

470,  471.  474 

719 

624 

272.  974 

720 

625 

532 

721 

626 

879 

722 

627 

367 

723 

628 

310,  972 

724 

629 

638 

725 

630 

784 

726 

631 

115 

,  727 

632 

113.  126 

728 

633 

992 

729 

634 

916 

730 

635 

1050 

731 

639 

686 

13:: 

640 

779 

735 

641 

958 

73(i 

642 

802.  808 

737 

643 

331 

738 

644 

503 

739 

646 

496 

740 

647 

496 

741 

648 

181 

742 

649 

564 

743 

650 

831 

744 

651 

61.  63 

745 

652 

874 

746 

653 

960 

747 

054 

215,  217 

748 

(i55 

524 

749 

657 

995 

752 

658 

22 

753 

659 

573 

754 

(i(il 

224 

755 

rago. 

No. 

1030 

756 

376 

757 

580 

758 

778 

759 

551 

760 

565 

761 

979 

702 

793 

703 

250 

7(!4 

961 

705 

582,  959 

7<;(; 

107 

707 

1029 

7<iS 

377 

7(i9 

207 

770 

978 

772 

146 

773 

599 

774 

261 

775 

391 

776 

814 

777 

654 

778 

574 

779 

971 

780 

318 

781 

868 

782 

250 

783 

462 

784 

458 

785 

40 

786 

818 

787 

553 

788 

638 

789 

573 

790 

976 

791 

837 

792 

141 

793 

310,  326 

794 

325 

795 

905 

796 

268 

797 

895 

798 

309 

799 

574 

800 

565 

801 

974 

802 

157 

803 

4()5 

804 

364 

805,  806 

805 

484 

806 

582 

808 

682 

809 

684 

810 

147 

811 

818 

812 

464 

813 

868 

814 

462 

815 

458 

816 

353 

817 

494 

818 

571 

820 

112 

821 

916 

822 

536 

823 

5  25 

824 

4<)2 

825 

571 

826 

570 

827 

927 

828 

813 

,  829 

120 

830 

132 

832 

320 

833 

1063 

834 

418 

835 

601 

836 

655 

837 

107 

838 

376 

8:^9 

696 

840 

779 

841 

111 

843 

!66, 


r84. 


03. 


Pago. 

242 
'51 
985 
954 
1020 
836 
496 

507.  801 
644 
784 
784 
969 
320 

267.  268 
871 
359 
640 
496 

778,  781 
r80 

r98 

605 

638 

316 

536 

352 

439 

67 

580 

3:^0 

619 

953 

1083 

216.  801 

366,  507 

473 

1058 

809 

178 

763 

780.  826 

868 

293,  908 

169 

528.  534 

154 

359 

230 

579 

131 

140 

360,  361.  792 

52 

343,  1042 

877 

1047 

370 

471 

802 

491 

700 

784 

242 

1096 

373 

804 

503.  800 

383,  804 

388 

566 

125 

986 

228 

1090 

363 

477 

814 

680 

31 

620 

877 

153 

574 


Ivi 


DECISIONS 


OFFICE  DECISIONS— Contd. 


No. 

I 

'age. 

844 

471 

845 

687 

84(i 

905 

847 

630 

848 

391 

849 

580 

850 

595 

851 

581, 

686 

852 

233 

853 

245 

854 

51 

855 

661 

856 

497 

857 

622 

858 

954. 

980 

859 

534 

860 

662 

861 

41 

862 

369 

803 

76, 

267 

864 

567, 

569 

865 

569 

866 

335 

867 

924 

868 

215, 

216 

869 

802 

870 

492. 

497  i 

871 

689  ' 

872 

565, 

872  1 

873 

244  ! 

874 

952 

S75 

104 

876 

.357 

877 

580 

S78 

588 

880 

825 

881 

1136 

882 

245  ; 

8s:'> 

268 

884 

243, 

244  1 

885 

962 

88(i 

215. 

217  I 

888 

395  1 

889 

477  I 

890 

76.  77  il 

891 

653  i 

892 

566  i 

893 

568  ■ 

894 

784 

895 

358. 

784  1 

896 

172.  174.  213. 

215  1 

897 

377, 

540 

898 

359  ' 

900 

375 

9(11 

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383 

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569 

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910 

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248  , 

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549  I 

913 

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915 

371 

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918 

571 

919 

245 

246 

920 

52 

921 

374 

922 

489 

024 

569 

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571 

02C> 

1.30 

027 

923 

924 

928 

1112 

929 

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930 

1083 

No. 

Page. 

No. 

Page. 

931 

215.  216.  243. 

245 

1020 

566 

932 

447 

1021 

569 

933 

386 

1022 

784 

934 

650 

1023 

50 

935 

784 

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304 

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1025 

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937 

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434 

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3.59 

938 

360 

1028 

538 

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366 

940 

360. 

629 

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583.  590 

941 

385, 

816 

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640 

943 

623 

1032 

567,  583 

944 

620, 

901 

1033 

572 

945 

418 

1034 

1070 

946 

549 

1035 

415 

947 

177 

1036 

359 

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687,  800, 

801 

1037 

404,  554 

950 

269, 

914 

1038 

380 

951 

566 

1039 

582 

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567 

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137 

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313 

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140 

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619 

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313 

955 

424.  425, 

430 

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612 

956 

371. 

372 

1044 

1077 

957 

547 

1045 

144 

958 

310 

1046 

800 

9.59 

240 

1047 

587 

960 

824 

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962 
963 
9(>4 
965 
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854 
914 
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588 
652 
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825 
1124 
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815 
358 

1049 
1050 
1051 
1053 
1054 
1055 
1050 

571 

612,  787 

448 

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784 
784 
874 

oos 

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1077 

970 
971 
972 

1058 

441 

1060 

603,  984 

503. 

1061 
1062 

343.  1042 
64 

1063 

1029 

973 
974 
975 
976 

384 

582 

1064 
1065 

425 
359 

50 
619 

1006 
1007 

878,  952 
808 

978 

658 

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51 

979 

353.  652. 

811 

1009 

1077 

980 

801 

1070 

1098 

981 

784 

1071 

440 

982 

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478 

983 

490 

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549 

984 

566 

1074 

358 

985 

978  , 

1075 

382 

987 

619 

1070 

637 

988 
989 

68 
273 

1077 
1078 

327 
217 

990 

214 

1079 

1103 

991 

1044 

1080 

443 

992 

814 

1081 

.348 

993 

328 

1082 

572 

994 

286 

1083 

171 

995 

1.56, 

429  , 

1084 

113 

997 

364, 

806 

1085 

40,  143,  979 

998 

385, 

567  i 

1080 

972 

999 

492,  633, 

1078 

1087 

978 

1000 

484 

1088 

320 

1001 

572, 

700  i 

1089 

498 

1002 

764  i 

1090 

.382 

1003 

784  ! 

1091 

624 

1004 

784  ; 

1092 

134,  566 

1005 

824  ' 

1093 

787 

1006 

1071. 

1098 

1094 

292 

1007 

1042 

1096 

1074 

1009 

580 

1097 

1041,  1082 

1011 

89, 

574 

1098 

373 

1012 

593 

1099 

381 

loi:-, 

139, 

814 

1100 

75 

1014 

584, 

689 

1101 

205 

1015 

567 

1102 

325 

lOlC. 

217, 

248 

1103 

913 

1017 

549 

1104 

1064.  1091 

1018 

680 

1105 

1.55 

1019 

581, 

685 

1106 

813 

MIMEOGRAPHS 


Ivii 


OFFICE  DECISIONS— Continued. 


No. 

Page. 

No. 

Page. 

No. 

Page. 

1107 

474 

1114 

491 

1121 

248 

11  OS 

540 

1115 

311 

1125 

784.  788 

1 1 0{) 

574.  1064 

1116 

371 

1126 

784 

1110 

50 

1117 

581 

1127 

205 

nil 

905 

1118 

814 

1128 

50 

1112 

459 

1119 

248.  249 

1129 

319 

1113 

815 

1120 

24G.  248 

1130 

898 

No. 
2195 
2429 
24.36 

2688 


MIMEOGRAPHS 


Page. 

No. 

877 

2708 

532 

2714 

532 

2738 

569 

2739 

age. 

No. 

Pag'-. 

962 

2764 

928,  930.  931 

499 

2791 

407.  901 

818 

2848 

1089 

407 

FEDERAL  INCOME  TAX 

CHAPTER  I 
INTRODUCTION  ^ 

The  Federal  Income  Tax  is  now  imposed  by  Title  II  and  the 
Excess-Profits  Tax  by  Title  III  of  the  Revenue  Act  of  1921.2  This 
act  (referred  to  in  this  book  as  the  Revenue  Act  of  1921,  the 
1921  Law,  or  the  present  law)  became  a  law  on  November  23, 
1921,  but  the  income  tax  and  the  excess-profits  tax  titles,  as  well 
as  certain  other  specified  parts  of  the  statutes,  are  made  effective 
as  of  January  1,  1921.  The  Revenue  Act  of  1921  follows  the 
general  scheme  of  the  comprehensive  Revenue  Act  of  1918. 

That  act  was,  of  course,  a  war  measure,  introduced  into  Con- 
gress while  the  war -was  still  in  progress,  and  passed  during  the 
period  of  the  government's  maximum  need  of  revenue.  Many 
of  its  provisions  were  a  direct  result  of  economic  and  other  con- 
ditions caused  by  the  war  and  others  were  enacted  with  probable 
post-war  conditions  in  mind.  The  need  of  revenue  .s  still  tre- 
mendous after  more  i..ian  three  years  of  peace,  am  b«^  taxpayer's 
burden  under  the  new  law  will  still  be  heavy.  Tnc  normal  tax 
rates  for  individuals  remain  the  same  as  under  the  1918  Law. 
The  surtax  rates  are  not  changed  for  1921,  but  for  1922  and 
succeeding  years  the  maximum  surtax  rate  is  50%  and  some 
relief  is  also  provided  by  the  lower  rates.  For  the  year  1921, 
corporations  are  taxed  at  the  same  rates  as  formerly,  both  un- 
der the  income  and  excess-profits  tax  laws.  For  1922  and  suc- 
ceeding years,  the  income  tax  on  corporations  is  increased  from 
10%  to  121/2%,  but  the  excess-profits  tax  is  repealed.  In  addi- 
tion to  the  reduction  in  rates  the  law  is  less  rigorous  in  several 
other  respects.  In  this  regard,  the  most  notable  remedial 
changes  made  by  the  1921  Law  are  those  relating  to  exchanges 
of  property,  including  reorganizations  and  transfers  of  property 

1  The  purpose  of  this  chapter  is  to  describe  briefly  the  salient  provisions 
and  requirements  of  the  law  and  the  system  by  which  it  is  administered,  so 
that  the  reader  may  obtain  a  general  understanding  of  the  subject  before 
the  various  provisions  are  discussed  in  detail. 

2  Title  I  of  the  same  act  contains  definitions  applicable  to  the  titles  fol- 
lowing, and  must  be  consulted  in  connection  with  Titles  II  and  III.  The  act 
is  entitled  "An  Act  to  reduce  and  equalize  taxation,  to  provide  revenue,  and 
for  other  purposes,"  and  may  be  cited  as  the  "Revenue  Act  of  1921  " 
(See  §1.) 


2  FEDERAL  INCOME  TAX 

to  corporations  for  stock,  the  extension  of  the  net  loss  provision, 
and  the  provision  limiting  the  tax  on  profits  from  the  sale  of 
capital  assets  to  a  maximum  of  121/2%-  Other  important 
changes  are :  the  new  scheme  for  the  taxation  of  insurance  com- 
panies; the  abolition,  after  December  31,  1921,  of  the  special 
class  of  corporations  theretofore  known  as  personal  service  cor- 
porations ;  the  limitation  of  the  depletion  deduction  based  on  dis- 
covery value  to  the  net  income  of  the  property  upon  which  dis- 
covery is  made ;  the  provision  in  regard  to  losses  established  by 
wash  sales ;  the  provision  permitting  the  taxation  as  a  corpora- 
tion of  certain  trades  or  businesses  operated  by  individuals  and 
partnerships  in  the  event  of  incorporation  within  four  months 
from  the  passage  of  the  act;  the  provision  making  the  filing  of 
consolidated  returns  by  affiliated  corporations  optional  for  taxable 
years  beginning  after  December  31,  1921 ;  the  provision  limiting 
the  gross  income  of  citizens  and  domestic  corporations,  under 
certain  conditions,  to  gross  income  from  sources  within  the 
United  States;  the  provision  in  regard  to  income  from  the  sale 
of  property  acquired  by  gift;  the  allowance  of  interest  on 
amounts  of  tax  improperly  collected  and  certain  new  adminis- 
trative provisions.  The  provisions  of  the  former  law  dealing 
with  the  taxation  of  nonresident  aliens  and  foreign  corporations 
have  been  considerably  modified.  The  taxes  imposed  by  the  1921 
Law  are  in  lieu  of  those  imposed  by  the  1918  Law,  and  the  1918 
Law  is  repealed  except  in  so  far  as  it  remains  in  force  for  the 
assessment  and  collection  of  all  taxes  which  have  accrued  there- 
under and  for  the  imposition  and  collection  of  penalties  with 
respect  thereto.  Notwithstanding  the  changes  in  the  new  act 
just  indicated,  the  Revenue  Act  of  1921  is  in  the  main  a  re-enact- 
ment of  the  Revenue  Act  of  1918,  which  represented  a  material 
advance  in  income  tax  legislation.  Many  of  the  changes  and 
improvements  contained  in  the  present  law  are  founded  upon  the 
experience  gained  by  government  and  taxpayer  in  the  administra- 
tion of  the  1918  Law,  and  must  be  read  in  the  light  of  that  ex- 
perience. For  these  reasons,  and  because  there  are  still  many 
points  undecided,  and  many  millions  of  dollars  of  taxes  uncol- 
lected or  overpaid,  under  the  1918  Law,  it  is  necessary  in  this 
volume  to  discuss  or  refer  to  all  decisions,  regulations  and  rulings 
made  thereunder.  In  large  part,  these  will  be  as  authoritative 
under  the  new  law  as  the  old.  Even  where  the  provisions  of  the 
1918  Law  are  changed  or  repealed,  however,  a  discussion  of  such 
decisions,  regulations  and  rulings  in  this  work  remains  neces- 
sary ;  the  collection  of  taxes  due  and  settlement  of  controversies 
arising  under  that  law  will  require  several  years,  under  the  best 


INTRODUCTION  3 

of  administrative  conditions.  This  is  particularly  true  with  re- 
gard to  those  exceptional  provisions  of  the  Revenue  Act  of  1918 
designed  to  meet  the  extraordinary  situation  resulting  from  the 
abnormal  incomes,  losses,  and  tax  rates  of  the  period  which  em- 
braced the  closing  of  the  war  and  the  transition  of  business  from 
a  war  to  a  peace  basis — a  transition  still  in  progress  and  under- 
\ying  many  of  the  provisions  of  the  Revenue  Act  of  1921, 

Preceding-  Federal  Tax  Laws.  The  1918  Revenue  Bill  was  first 
introduced  in  Congress  on  May  27,  1918,  but  was  not  finally 
enacted  until  February  24,  1919,  after  many  changes  and  the 
substantial  modification  of  many  of  its  provisions.  It  was  de- 
signed to  raise  in  1918  the  greatest  amount  of  revenue  ever 
raised  in  any  year  in  any  nation  and  was  drafted  with  the  utmost 
care  in  a  form  which  it  was  hoped  would  not  be  changed  material- 
ly by  future  enactments  except  in  so  far  as  its  provisions  were 
designed  to  meet  war  conditions.  That  this  hope  was  largely 
justified  is  shown  by  a  perusal  of  the  Revenue  Act  of  1921,  which, 
as  indicated  in  the  preceding  paragraph,  follows  the  scheme  of 
the  1918  Law  very  closely  and  is  in  large  part  a  re-enactment 
thereof.  A  discussion  of  the  rates  under  the  1918  Law  and  of 
all  its  other  provisions  v/ill  be  found  in  the  appropriate  chapters 
of  this  work.  In  1917  the  Federal  Income  Tax  was  imposed  by 
two  statutes,  prescribing  separate  and  different  rates,  one  addi- 
tional to  the  other.  The  Act  of  September  8,  1916  (referred  to 
in  this  book  as  the  1916  Law),  imposed  a  tax  at  comparatively 
low  rates  and  with  comparatively  high  exemptions.  It  was 
amended  in  many  respects  by  the  Act  of  October  3,  1917  (referred 
to  in  this  book  as  the  1917  Law),  but  remained  in  force  as  a 
separate  law  imposing  a  general  income  tax  in  contradistinction 
to  the  "war  income  tax"  at  higher  rates  and  with  lower  exemp- 
tions, which  was  also  included  in  the  Act  of  October  3,  1917.  The 
1917  War  Income  Tax  Law  contained  no  administrative  provi- 
sions, but  provided  that  the  tax  it  imposed  should  be  computed, 
levied,  assessed,  collected,  and  paid  upon  the  same  basis  and  in 
the  same  manner  as  similar  taxes  imposed  by  the  1916  Law. 
Generally  speaking,  both  laws  were  administered  as  one,  and 
only  one  annual  return  of  net  income  was  required  from  each 
taxpayer,  on  the  basis  of  which  both  taxes  were  assessed.  The 
1916  Law  was  preceded  by  the  Act  of  October  3,  1913  (referred 
to  in  this  book  as  the  1913  Law).  This  law  remained  in  force 
without  change  or  amendment  up  to  September  8,  1916,  when 
the  1916  Law  was  enacted  and  made  retroactive  to  January  1, 
1916.  The  1913  Law  was  the  first  general  income  tax  law  after 
the  adoption  of  the  constitutional  amendment  permitting  the  im- 


4  FEDERAL  INCOME  TAX 

position  of  an  income  tax  without  apportionment  and  without 
regard  to  any  census  or  enumeration,  but  there  was  in  effect  in 
this  country,  from  August  5,  1909,  to  January  1,  1913,  a  corpora- 
tion excise  tax  act  (referred  to  in  this  book  as  the  1909  Law), 
which  imposed  a  special  excise  tax  on  corporations  with  respect 
to  the  carrying  on  or  doing  of  business  by  such  corporations. 
Though  the  1909  Law  was  not  intended  to  be  and  was  not  in  any 
proper  sense  an  income  tax  law,^  the  tax  was  measured  by  the  net 
income  of  corporations,  and  the  language  of  the  subsequent  in- 
come tax  laws  is  in  some  instances  either  identical  or  very  simi- 
lar. To  that  extent  decisions  and  rulings  under  the  1909  Law 
throw  light  on  the  construction  of  the  present  law  and  are  re- 
ferred to  for  that  purpose  in  this  book.  Rulings  and  decisions 
under  the  1913,  1916,  and  1917  Laws  are  referred  to  in  this  book 
so  far  as,  in  the  opinion  of  the  author,  they  may  be  of  present 
value  to  taxpayers  in  general.^ 

During  and  after  the  Civil  War  income  taxes  were  imposed 
by  the  Act  of  July  1,  1862,  the  Act  of  June  30,  1864,  and  the  joint 
resolution  of  July  4,  1864,  the  Act  of  March  3,  1865,  amending 
the  Act  of  June  30,  1864,  the  Act  of  March  2,  1867,  and  the  Act 
of  July  14,  1870.  In  1871  the  last  of  the  Civil  War  income  tax 
acts  expired  and  was  not  re-enacted.  No  further  attempt  was 
made  to  collect  income  taxes  by  the  federal  government  until  the 
Act  of  August  28,  1894,  which  was  held  unconstitutional  on  the 
ground  that  incomes  from  real  property  could  not  be  taxed  with- 
out apportionment.-"'  As  a  result,  the  Sixteenth  Amendment  ex- 
pressly authorized  the  imposition  of  a  tax  on  income  from  all 

3  See  language  of  Justice  Pitney  in  Stratton's  Independence  v.  Howbert, 
231  U.  S.  399. 

4  Rulings  and  decisions  under  all  the  prior  laws  should  be  used  with  cau- 
tion in  construing  the  1918  and  1921  Laws,  as  these  laws  contain  many  new 
features  and  change  the  old  law  radically  in  many  respects. 

5  Pollock  V.  Farmers  Loan  &  Trust  Co.,  157  U.  S.  429,  158  U.  S.  601.  With 
regard  to  the  history  of  the  income  tax,  the  Wisconsin  Court  in  State  v. 
Frear,  148  Wis.  456,  134  N.  W.  673,  135  N.  W.  164,  said  in  1912:  "It  may 
be  well  to  note,  however,  that  income  taxation  is  no  new  and  untried  experi- 
ment in  the  field  of  taxation.  It  has  been  in  use  in  various  forms,  and 
generally  with  the  progressive  feature,  by  many  of  the  civilized  govern- 
ments of  the  world  for  decades,  which  in  some  instances  run  into  centuries. 
It  has  been  used  at  various  times  by  nearly  or  quite  twenty  of  our  own 
states,  and  is  now  in  use  in  several  of  them.  It  was  used  for  a  brief  period 
by  the  government  of  the  United  States,  and  is  now  in  successful  operation 
in  practically  all  of  the  great  nations  of  the  civilized  world  except  the 
United  States.  The  fundamental  idea  upon  which  its  champions  rest  their 
argument  in  its  favor  is  that  taxation  should  logically  be  imposed  accord- 
ing to  ability  to  pay,  rather  than  upon  the  mere  possession  of  property, 
which  for  various  reasons  may  produce  no  revenue  to  the  owner." 


INTRODUCTION  5 

sources  without  apportionment  and  without  regard  to  any  census 
or  enumeration. 

Administration  of  the  Laws.     The  duty  of  administering  the 
income  tax  laws  and  collecting  income  taxes  is  imposed  on  the 
Bureau  of  Internal  Revenue,  which  is  a  part  of  the  Federal 
Treasury  Department.     The  bureau  is  under  the  charge  of  the 
Commissioner  of  Internal  Revenue   (referred  to  in  this  book  as 
the  commissioner),  who  under  the  direction  of  the  Secretary  of 
the  Treasury   (referred  to  in  this  book  as  the  secretary)    has 
general  superintendence  of  the  assessment  and  collection  of  all 
duties  and  taxes   imposed   by  any  law  providing  for  internal 
revenue.^    The  states  and  territories  are  divided  into  some  sixty- 
four  collection  districts,^  each  under  the  charge  of  a  collector 
of  internal  revenue,  with  one  or  more  deputy  collectors.    Returns 
of  net  income  are  filed  with  the  local  collector  and  the  tax  is 
paid  to  him,  although  assessments  are  made  by  the  commissioner 
at  Washington.    The  commissioner,  through  his  revenue  agents 
or  inspectors,  has  supervisory  power  over,  and  authority  to  in- 
vestigate, all  accounts,  lists  or  returns  required  to  be  made  by 
persons  liable  to  tax,s  may  examine  the  books  of  such  taxpayers, 
and  on  refusal  to  allow  an  examination,  may  summon  any  person 
or  corporation  to  produce  his  or  its  books  and  to  appear  before 
him  to  give  testimony  or  answer  interrogatories  under  oath  re- 
specting  the   matter."     Collectors   and   the   commissioner   may 
make  returns  for  taxpayers  from  their  own  knowledge  and  from 
such  information  as  they  can  obtain  through  testimony  or  other- 
wise in  cases  where  the  taxpayer  fails  to  file  a  return  or  makes 
a  false  or  fraudulent  return.^     Appeals  from  decisions  of  col- 
lectors may  be  taken  to  the  commissioner.^i 

Revenue  Agents  and  Inspectors.  The  duties  of  revenue 
agents  and  inspectors  are  to  ascertain  and  report  the  names  of 
persons  who  in  their  opinion  are  liable  to  the  income  tax  and 

6R.  s.  §321. 

7  As  a  rule  the  boundaries  of  collection  districts  coincide  with  the  bound- 
aries of  the  states,  but  sometimes  one  collection  district  embraces  two  or 
three  states,  or  one  state  is  divided  into  two  or  more  collection  districts. 
Districts  within  a  state  are  designated  by  number,  as  the  first  and  sixth 
districts  of  California,  being-  the  two  districts  of  that  state.  The  lack  of 
sequence  in  numbering  is  due  to  the  consolidation  of  districts  from  time  to 
time  since  the  period  immediately  following  the  Civil  War,  when  the  coun- 
try was  divided  into  the  maximum  number  of  districts. 

8  Revenue  Act  of  1921,  §1308;  Revenue  Act  of  1918,  §1305.  See  also 
U.  S.  v.  Hodson,  14  Int.  Rev.  Rec.  100;  10  Wall.  395,  406. 

»R.  S.  §3173,  as  amended  by  the  Revenue  Act  of  1921, 

10  R.  S.  §  3176,  as  amended  by  the  Revenue  Act  of  1921. 

11  See  Chapter  37. 


6  FEDERAL  INCOME  TAX 

who  have  failed  to  make  the  returns  required  by  law ;  to  inquire 
into  income  tax  returns  where  there  is  any  suspicion  that  the  re- 
turn made  is  erroneous;  to  examine  the  books  and  accounts  of 
persons  who  have  made  returns  for  the  purpose  of  ascertaining 
and  reporting  as  to  whether  or  not  the  law  has  been  complied 
with,  when  so  ordered  by  the  agent  in  charge  of  the  division  to 
which  they  are  assigned,  who  in  turn  reports  to  the  commissioner, 
and  to  the  collector  of  the  proper  district.  In  the  discharge  of 
their  official  duties  officers  of  this  class  are  expected  to  exercise 
sound  discretion,  treat  all  persons  with  due  courtesy,  and,  while 
acting  firmly  and  courageously,  to  avoid  all  contention  or  con- 
troversy that  would  give  just  ground  for  complaint.i- 

Committee  on  Appeals  and  Review.  Because  of  the  large  num- 
ber of  difficult  cases  arising  under  the  Internal  Revenue  Laws, 
and  the  amount  of  revenue  involved  in  the  collection  of  the  taxes 
imposed  thereby  and  to  insure  fair  and  adequate  consideration 
of  every  case  arising  under  such  laws,  an  ''Advisory  Tax  Board" 
was  created  by  the  1918  Law.^'^  The  Advisory  Tax  Board  con- 
sisted of  not  more  than  six  i^  members  appointed  by  the  commis- 
sioner with  the  approval  of  the  secretary,  and  was  to  remain  in 
existence  until  February  24,  1921,  unless  abolished  before  that 
time  by  the  commissioner  with  the  approval  of  the  secretary. 
This  board  was  dissolved  on  October  1,  1919,  and  its  work  taken 
over  by  a  "Committee  on  Appeals  and  Review".!"'  The  commis- 
sioner may,  and  on  the  request  of  any  taxpayer  directly  inter- 
ested must,  submit  to  this  committee  any  question  relating  to  the 
interpretation  or  administration  of  the  Internal  Revenue  Laws. 
The  committee  reports  its  findings  and  recommendations  to  the 
commissioner.  Particular  attention  will  be  given  to  problems 
presenting  differences  of  opinion  existing  between  the  taxpayers 
and  the  bureau.  Such  differences  occur  not  only  with  individuals 
but  also  with  groups  and  even  with  classes  of  industry.  Formal 
hearings  will  be  given  to  taxpayers  in  every  case  where  the  facts 
warrant.  The  commissioner  announced  that  his  policy  would  be 
"to  employ  every  means  available  so  that  the  scales  of  justice 
may  be  held  evenly  in  deciding  each  case."  The  committee  will 
be  called  upon  to  decide  questions  involving  general  aspects  of 

12  T.  D.  1932. 

13  Revenue  Act  of  1918,  Sec.  1301  (d)   (1). 

14  Five  memberships  on  the  Advisory  Tax  Board  were  announced  on 
March  14,  1919.  The  sixth  membership  was  reserved  as  a  roving  commis- 
sion for  experts  to  be  called  from  time  to  time  from  various  industries. 
(I.  T.  S.  1919,  113249.) 

15  Announcement  by  the  commissioner  of  internal  revenue  dated  Septem- 
ber 27,  1919;  I.  T.  S.  1919,  ^  3587. 


INTRODUCTION  7 

taxation  and  the  differentiation  of  economic  activities,  account- 
ing, forms  of  organization,  trade  customs,  industrial  management, 
legal  procedure  and  administration.  Special  studies  will  be  made 
of  such  matters  so  far  as  they  affect  federal  taxation. i*- 

Tax  Simplification  Board.  The  Revenue  Act  of  1921  estab- 
lishes a  "Tax  Simplification  Board"  to  be  composed  of  three  mem- 
bers to  represent  the  public,  to  be  appointed  by  the  President  and 
three  members  to  represent  the  bureau  of  internal  revenue,  to  be 
appointed  by  the  secretary.  The  duty  of  the  board  is  to  investi- 
gate the  procedure  of  and  forms  used  by  the  bureau  in  the  ad- 
ministration of  the  internal  revenue  laws  and  to  make  recom- 
mendations in  respect  to  the  simplication  thereof. 

Rulings  and  Regulations.  The  commissioner,  with  the  approv- 
al of  the  secretary,  is  expressly  authorized  to'  make  all  needful 
regulations  for  the  enforcement  of  the  provisions  of  the  revenue 
laws.17  Such  regulations  are  published  under  the  caption  of 
"Treasury  Decisions"  and  are  numbered  serially  for  the  purpose 
of  reference.!^  At  intervals  large  compilations  of  rulings  and 
regulations  are  published  by  the  Bureau  of  Internal  Revenue 
and  these  are  designated  as  "Regulations"  and  given  a  serial 
number.io  As  a  general  rule,  it  may  be  said  that  these  regula- 
tions have  the  force  and  effect  of  law  and  are  as  binding  as  if  in- 
corporated in  the  statute.^o  But  they  must  be  in  execution  of  or 
supplementary  to,  and  not  in  conflict  with,  the  provisions  of  the 
statute  pursuant  to  which  they  are  issued.^i  It  is  also  held  that 
they  must  be  reasonable  and  a  regulation  defeating  the  purpose 
or  enlarging  the  scope  of  the  statute  is  invalid.-    in  determining 

icSee  I.  T.  S.  1919,  113251. 

1"  Revenue  Act  of  1921,  §  1303;  Revenue  Act  of  1918,  §  1309. 

^^  Treasury  decisions  contain  rulings  on  all  subjects  over  which  the  bureau 
of  internal  revenue  has  jurisdiction.  Those  relating  to  the  income  tax  are 
therefore  not  numbered  in  sequence.  Reference  to  treasury  decisions  is 
usually  made  by  abbreviation,  thus  "T.  D.  2476." 

i!>  The  last  general  compilation  of  rulings  on  the  income  tax  is  knovm  as 
Regulations  No.  45  (1920  edition),  promulgated  January  28,  1921.  All  pre- 
vious rulings  and  decisions  or  parts  thereof,  including  Regulations  45  (Pre- 
liminary edition)  Regulations  No.  33,  issued  January  5,  1914,  and  Regula- 
tions No.  33,  Revised,  issued  February  4,  1918,  which  are  in  conflict  with 
those  contained  in  this  revised  compilation  are  thereby  superseded  and  re- 
voked, but  any  former  rulings,  not  inconsistent,  remain  in  effect. 

20  Ex  parte  Kollock,  165  U.  S.  526;  U.  S.  v.  Eaton,  144  U.  S.  677;  Stegall 
v.  Thurman,  175  Fed.  813.     See  Chapter  47. 

21  Edwards  v.  Keith,  231  Fed.  110.     See  Chapter  47. 

22  Campbell  v.  U.  S.,  107  U.  S.  410;  U.  S.  v.  Two  Hundred  Barrels  of 
Whiskey,  95  U.  S.  571;  Morrill  v.  Jones,  106  U.  S.  467;  U.  S.  v.  Three  Bar- 
rels, 77  Fed.  963;  Greenport  Basin  &  Construction  Co.  v.  U.  S.,  269  Fed.  58. 
See  Chapter  47. 


8  FEDERAL  INCOME  TAX 

whether  a  regulation  is  consistent  with  law  the  courts  apply  the 
same  rule  of  decision  which  controls  when  an  act  of  congress  is 
assailed  as  not  being  within  the  powers  conferred  upon  congress 
by  the  Constitution,  and  it  will  not  be  held  invalid  unless  it  is 
plainly  and  palpably  inconsistent  with  law  and  entirely  inappro- 
priate to  the  end  specified  in  the  Act  of  Congress.^^  The  promul- 
gation of  a  regulation  does  not  estop  the  treasury  department 
from  reassessing  the  tax  on  a  different  basis  if  the  courts  hold 
that  the  regulation  was  not  authorized  by  the  law.-^  Regula- 
tions are  admissible  in  evidence  when  pertinent  to  the  issues,  and 
as  the  courts  take  judicial  notice  of  them  as  public  records,  it  is 
unnecessary  to  introduce  them  formally  in  evidence.^-^  What 
has  been  said  of  regulations  applies  only  to  the  express  terms  of 
the  regulation  itself  regularly  promulgated  and  not  to  printed 
headings  on  a  form  additional  to  the  express  terms.^c  In  addi- 
tion to  rulings  and  regulations  the  department  issues  so-called 
mimeograph  letters  to  collectors,  more  or  less  confidential  in  their 
character  and  not  intended  for  general  publication.  Frequently 
such  letters  throw  light  on  the  administration  of  the  law  and 
such  mimeograph  letters  as  have  been  made  public  are  referred 
to  in  this  book.  Mimeograph  letters  are  addressed  to  collectors 
only  and  not  also  "to  others  concerned"  as  are  the  official  treasury 
decisions,  and  do  not  affect  or  give  notice  to  taxpayers.  Similar- 
ly, instructions  to  a  particular  collector  do  not  affect  collectors 
as  a  class.27 

Informal  Rulings.  It  was  previously  the  practice  of  the 
Bureau  of  Internal  Revenue  to  make  informal  rulings  in  the  form 
of  letters,  at  the  request  of  taxpayers,  upon  abstract  propositions 
involving  questions  of  tax  liability.  The  bureau  will  no  longer 
answer  such  inquiries  except  under  the  following  circumstances : 
(1)  The  transaction  must  be  completed  and  not  merely  a  proposi- 
tion or  plan,  (2)  the  complete  facts  relating  to  the  transaction 
together  with  abstracts  from  contracts  or  other  documents  neces- 
sary to  present  the  complete  facts  must  be  submitted,  (3)  the 
names  of  all  the  real  parties  interested  (not  "dummies"  used  in 
a  transaction)   must  be  stated  regardless  of  who  presents  the 

25Boske  V.  Comingore,  177  U.  S.  459.     See  Chapter  47. 

24  Goldfield  Consolidated  Mines  Co.  v.  Scott,  247  U.  S.  126;  N.  Y.  Life  Ins. 
Co.  V.  Anderson,  257  Fed.  576. 

25  Sprinkle  v.  U.  S.,  141  Fed.  811;  Caha  v.  U.  S.,  152  U.  S.  211;  Dominici 
V.  U.  S.,  72  Fed.  46;  Wilkins  v.  U.  S.,  96  Fed.  837. 

2B  U.  S.  V.  Lamson,  162  Fed.  165. 
27  Landram  v.  U.  S.,  16  Ct.  Cls.  74. 


INTRODUCTION  9 

question,  whether  attorney,  accountant,  tax  service,  or  other 
representative.-"^ 

Bureau  of  Internal  Revenue  Income  Tax  Bulletin  Serv- 
ice. Treasury  decisions,  certain  court  decisions  and  amend- 
ments to  or  modifications  of  existing  regulations  affecting  the 
income  and  excess-profits  taxes  are  published  in  weekly  bulletins 
issued  by  the  bureau  of  internal  revenue.  In  addition,  these 
bulletins  contain  a  statement  of  rulings  made  in  cases  arising 
before  the  bureau.  These  informal  rulings  include  committee 
on  appeals  and  review  memoranda,  recommendations,  mimeo- 
graph letters,  solicitor's  law  opinions,  opinions  of  the  attorney- 
general,  solicitor's  memoranda,  solicitor's  opinions,  and  office 
decisions.  Reference  is  made  in  this  book  to  these  rulings  by 
the  abbreviations  shown  in  the  table  at  the  front  of  this  volume. 
The  "income  tax  bulletin  service"  of  the  bureau  of  internal 
revenue  consists,  in  addition  to  the  weekly  bulletins,  of  bi- 
monthly digests  of  rulings  published  in  the  weekly  bulletins 
and  semi-annual  cumulative  bulletins  containing  in  full  the  rul- 
ings in  the  weekly  bulletins  during  the  previous  six  months. 
The  scope  and  purpose  of  the  above  "service"  may  best  be  gath- 
ered from  the  statement  issued  with  each  weekly  bulletin  which 
reads  as  follows: 

"The  income  tax  rulings  constitute  a  service  of  information 
from  which  taxpayers  and  their  counsel  may  obtain  the  best 
available  indication  of  the  trend  and  tendency  of  official  opinion 
in  the  administration  of  the  income  and  profits  tax  provisions 
of  the  revenue  acts.  The  rulings  have  none  of  the  force  or  effect 
of  treasury  decisions  and  do  not  commit  the  department  to  any 
interpretation  of  law  which  has  not  been  formally  approved  and 
promulgated  by  the  secretary  of  the  treasury.  Each  ruling  em- 
bodies the  administrative  application  of  the  law  and  treasury 
decisions  to  the  entire  state  of  facts  upon  which  a  particular 
case  arises.  It  is  especially  to  be  noted  that  the  same  result 
will  not  necessarily  be  reached  in  another  case  unless  all  the 
material  facts  are  identical  with  those  of  the  reported  case.  As 
it  is  not  always  feasible  to  publish  a  complete  statement  of  the 
facts  underlying  each  ruling,  there  can  be  no  assurance  that  any 
new  case  is  identical  with  the  reported  case.  As  bearing  out 
this  distinction,  it  may  be  observed  that  the  rulings  published 
from  time  to  time  may  appear  to  reverse  rulings  previously 
published. 

2S  statement  by  the  bureau  of  internal  revenue  dated  August  26,  1919, 
I.  T.  S.  1919,  H  3538. 


10  FEDERAL  INCOME  TAX 

"Officers  of  the  bureau  of  internal  revenue  are  especially  cau- 
tioned against  reaching  a  conclusion  in  any  case  merely  on  the 
basis  of  similarity  to  a  published  income  tax  ruling,  and  should 
base  their  judgment  on  the  application  of  all  pertinent  provisions 
of  the  law  and  treasury  decisions  to  all  of  the  facts  in  each  case. 
The  income  tax  rulings  should  be  used  merely  as  aids  in  studying 
the  law  and  the  treasury  decisions," 

Retroactive  Effect  of  Rulings.  Treasury  department  de- 
cisions promulgating  rulings  of  the  internal  revenue  bureau 
become  effective  upon  the  date  of  approval  unless  otherwise 
stated  therein.  Cases  previously  adjusted  in  contravention  of 
law  as  pronounced  in  such  decisions,  are  subject  to  readjustment 
in  accordance  with  the  decisions.^^  Generally  speaking,  any 
ruling  or  regulation  made  by  the  treasury  department  supersedes 
all  prior  rulings  and  regulations  and  is  retroactive  to  the  time 
the  law  was  enacted,  since  a  ruling  or  regulation  is  merely  an 
interpretation  of  the  meaning  of  the  law,  and  in  theory  the  mean- 
ing has  been  the  same  from  the  beginning.  The  treasury  depart- 
ment recognizes,  however,  that  in  some  instances  it  would  be 
unjust  or  impracticable  to  reopen  returns,  adjustments  or  assess- 
ments which  have  been  made  in  accordance  with  previous  rulings, 
and  where  such  rulings  are  superseded,  an  express  limitation  is 
made  in  the  superseding  ruling  or  regulation  as  to  the  retro- 
active effect  thereof.""^  The  Revenue  Act  of  1921  expressly  per- 
mits amending  regulations  to  be  applied  without  retroactive 
effect.3i 

United  States.  The  term  "United  States"  where  used  in  a 
geographical  sense  in  the  law  includes  only  the  states,  the  terri- 
tories of  Alaska  and  Hawaii,  and  th^  District  of  Columbia.-"^- 

Possessions  of  the  United  States.  The  Revenue  Act  of  1921 
does  not  extend  to  possessions  of  the  United  States.  An  indi- 
vidual who  is  a  citizen  of  any  possession  of  the  United  States 
(but  not  otherwise  a  citizen  of  the  United  States)  and  who  is 
not  a  resident  of  the  United  States,  is  taxable  only  on  income 
derived  from  sources  within  the  United  States.  In  such  cases 
the  tax  is  computed  and  paid  in  the  same  manner  as  in  the  case 
of  other  persons  who  are  taxable  only  as  to  income  from  such 
sources.^3 

29  Reg.  33  Rev.,  Art.  38. 

30  See  last  paragraph  of  mimeograph  letter  to  collectors  dated  August  14, 
1914;  I.  T.  S.  1918,  1111392  and  1344;  also  the  last  paragraph  of  T.  D.  2313 
and  T.  D.  2317. 

31  Revenue  Act  of  1921,  §  1314. 

32  Revenue  Act  of  1921,  §2  (5);  Revenue  Act  of  1918,  §1. 

33  Revenue  Act  of  1921,  §260;  Revenue  Act  of  1918,  §260. 


INTRODUCTION  11 

Porto  Rico  and  the  Philippines.  The  Revenue  Act  of  1921  pro- 
vides that  in  Porto  Rico  and  the  Philippine  Islands  the  income 
tax  shall  be  levied,  assessed,  collected  and  paid  as  provided 
by  lav\^  prior  to  its  passage,  and  that  the  Porto  Rican  or  Philip- 
pine legislature  shall  have  power  by  due  enactment  to  amend, 
alter,  modify,  or  repeal  the  income  tax  laws  in  force  in  Porto 
Rico  or  the  Philippine  Islands  respectively.*^^  The  Revenue  Act 
of  1918,  which  went  into  effect  on  February  24,  1919,  provided  a 
local  income  tax  law  for  these  possessions  by  making  the  Reve- 
nue Act  of  1916,  as  amended,  apply  to  them,  and  gave  the  legis- 
latures of  these  possessions  the  same  power  as  is  given  by  the 
present  law  to  amend,  alter,  modify  or  repeal  the  income  tax 
laws  in  force  in  such  possessions.^-"'  On  July  26,  1919,  the  Porto 
Rican  legislature  repealed  the  1916  law,  as  amended,  with  respect 
to  Porto  Rico,-'"  and  on  March  7,  1919,  the  1916  Law,  as  amended, 
was  similarly  superseded  with  respect  to  the  Philippine  Islands.^*^ 
Under  the  present  law  a  citizen  or  resident  of  the  United  States, 
and  a  domestic  corporation,  is  entitled,  with  certain  limitations, 
to  deduct  the  amount  of  income,  war-profits  and  excess-profits 
taxes  paid  to  those  possessions  from  the  amount  of  such  taxes 
due  to  the  United  States.^^ 

Gross  Income.  Gross  income  is  defined  in  the  law  to  include 
income,  gains  or  profits  of  all  kinds  except  those  enumerated 
as  exempt  from  taxation.  A  more  complete  definition  will  be 
found  in  a  subsequent  chapter.-*5'^ 

Net  Income.  Net  income  is  defined  as  gross  income  less  the 
deductions  allowed  by  the  law,  as  is  more  fully  stated  in  a  sub- 
sequent chapter.^o  -phe  Revenue  Act  of  1918-^1  for  the  first  time 
required  net  income  to  be  computed  on  the  bas-is  of  the  tax- 
payer's annual  accounting  period  (fiscal  year  or  calendar  year 
as  the  case  might  be)  in  accordance  with  the  method  of  account- 
ing employed  in  keeping  the  books  of  such  taxpayer.  This  pro- 
vision was  retained  in  the  present  law.^-  If  no  method  of  ac- 
counting has  been  employed  or  if  the  method  employed  does  not 
clearly  reflect  the  income,  the  computation  is  to  be  made  upon 

34  Revenue  Act  of  1921,  §  261. 
33  Revenue  Act  of  1918,  §  261. 

30  See  Laws  of  Porto  Rico,  §  77,  The  Income  Tax  Law. 
3"  See  Laws  of  the  Philippines,  §  2,  An  Act  Establishing  the  Income  Tax. 
38  Revenue  Act  of  1921,  §§222,  238,  Reg.  45,  Arts.   1132  and  1133.     No 
limitation  existed  under  the  1918  law.    See  Revenue  Act  of  1918,  §§  222,  238. 
3!t  See  Chapter  14. 
•*<•  See  Chapter  14. 
•11  Revenue  Act  of  1918,  §212   (b). 
42  Revenue  Act  of  1921,  §212   (b). 


12  FEDERAL  INCOME  TAX 

such  basis  and  in  such  manner  as  in  the  opinion  of  the  commis- 
sioner does  clearly  reflect  the  income.^'' 

Deductions  and  Credits.  The  law  specifies  that  certain  deduc- 
tions may  be  made  from  gross  income  in  ascertaining  the  net 
income  of  the  taxpayer.  "Deductions"  reduce  income  for  all 
purposes.  "Credits"  do  not  reduce  net  income  for  all  purposes, 
but  reduce  the  net  income  of  an  individual  for  the  purpose  of 
the  normal  tax  and  not  the  surtax,  or,  in  the  case  of  a  corpora- 
tion, reduce  net  income  for  the  purpose  of  the  income  tax  and 
not  the  excess-profits  tax.  Another  form  of  credit  provided  by 
the  law  may  be  applied  directly  against  the  tax  and  not  against 
the  net  income.  These  distinctions  are  more  fully  stated  and 
explained  in  subsequent  chapters.^^ 

Reporting  Net  Income.  Taxpayers  are  required  to  file  annually 
a  return  showing  the  amount  of  gross  income  received,  the  de- 
ductions, credits  and  exemptions  claimed  and  the  net  income 
upon  which  the  tax  is  to  be  imposed.  This  return  is  filed  in  the 
collection  district  in  which  the  taxpayer  resides  or  has  his 
principal  place  of  business.  Nonresidents  having  no  place  of 
business  in  this  country  file  their  returns  with  the  collector  of 
internal  revenue  at  Baltimore,  Maryland.^-'^  Except  in  the  case 
/  /)f  nonresident  aliens  and  foreign  corporations,  the  returns  are 
required  to  be  filed  on  or  before  March  15,  if  the  report  is  made 
for  the  preceding  calendar  year,  or  if  made  for  a  fiscal  year,  the 
returns  are  required  to  be  filed  on  or  before  the  15th  day  of  the 
third  month  following  the  close  of  the  fiscal  year.  In  the  case 
of  nonresident  aliens  and  foreign  corporations,  returns  are  re- 
quired to  be  filed  on  or  before  the  15th  day  of  the  sixth  month 
following  the  close  of  the  fiscal  year,  or,  if  the  return  is  made 
on  a  calendar  year  basis,  then  on  or  before  June  15.  The  com- 
missioner may  grant  a  reasonable  extension  of  time  for  filing  re- 
turn whenever,  in  his  judgment,  good  cause  exists.^*''  Under  both 
the  present  law  and  the  1918  law  individuals  and  corporations  are 
required  to  file  their  returns  for  their  fiscal  years  instead  of  for 
the  calendar  year  if  they  keep  books  of  account  which  are  regu- 
larly closed  each  year  at  the  end  of  some  month  other  than  De- 
cember. An  important  change  initiated  by  the  1918  law  and 
retained  by  the  present  law  is  that  partnerships  are  required  to 

43  Revenue  Act  of  1921,  §212;  Revenue  Act  of  1918,  §212. 

44  See  Chapters  31  and  32. 

45  Revenue  Act  of  1921,  §§  229  and  241.  Revenue  Act  of  1918,  §§  227  and 
241.  This  district  is  the  one  in  which  Washington,  the  national  capital,  is 
located. 

46  Revenue  Act  of  1921,  §§227  and  241.  Revenue  Act  of  1918,  §§227 
and  241. 


INTRODUCTION  13 

file  annual  returns  showing  their  net  income  although  they  are 
not  subject  to  tax  as  partnerships.^^ 

Record  to  Be  Kept.  Every  individual,  partnership  or  corpora- 
tion liable  to  any  tax  imposed  by  the  internal  revenue  laws  of 
the  United  States,  or  for  the  collection  thereof,  is  required  to 
keep  such  records,  to  render  such  statements  and  returns  under 
oath,  and  to  comply  with  such  regulations  as  shall  be  prescribed 
by  the  commissioner.  The  commissioner  may  also  examine  any 
books,  papers,  records  or  memoranda  of  a  taxpayer.^"* 

Individuals.  Ordinarily,  no  person  whose  net  income  is  less 
than  $1,000  in  any  calendar  year  is  required  to  file  a  return  for 
that  year,  but  the  commissioner  may  require  any  person,  whether 
liable  to  tax  or  not,  to  file  returns  of  income  or  such  statements 
as  he  may  deem  sufficient  to  show  whether  or  not  such  person 
is  liable  to  tax.-*'^  Under  both  the  1918  Law  and  the  present  law 
unmarried  persons  and  married  persons  not  living  with  husband 
or  wife  and  receiving  $1,000  or  more  net  income  during  the  cal- 
endar year,  and  married  persons  living  with  husband  or  wife 
and  receiving  $2,000  or  more  net  income  during  the  same  period, 
are  required  to  file  annual  returns.^o  Under  the  1921  Law,  in 
addition  to  the  above,  every  individual  having  a  gross  income 
for  the  taxable  year  of  $5,000,  or  over,  regardless  of  the  amount 
of  his  net  income,  must  file  a  return,  and  if  a  husband  and  wife 
living  together  have  an  aggregate  net  income  for  the  taxable 
year  of  $2,000  or  over,  or  an  aggregate  gross  income  for  such 
year  of  $5,000,  or  over,  separate  returns  or  a  joint  return  must 
be  made.51  Minors  are  required  to  file  returns  if  they  have  re- 
ceived the  minimum  amount  of  income  specified  in  the  law. 
Prior  to  1918  returns  were  required  only  of  persons  of  lawful 
age.52 

Personal  Exemption.  The  personal  exemption,  or  credit,  is 
an  arbitrary  amount  of  net  income  on  which  residents  and  citi- 
zens (in  some  cases  nonresident  aliens)  are  not  liable  to  the 
normal  tax.^^  j^  may  be  said  to  be  an  amount  allowed  for  per- 
sonal or  family  expenses,  the  actual  amount  of  such  expenses  not 
being  deductible  in  ascertaining  net  income.    The  amount  of  the 

47  Revenue  Act  of  1918,  §  224,  see  Chapter  8. 

48  Revenue  Act  of  1921,  §§1300,  1308  and  1309;  Revenue  Act  of  1918, 
§  1805;  Reg.  45,  Art.  1711;  Reg.  33  Rev.,  Art.  50. 

49  Revenue  Act  of  1921,  §  1307. 

50  Revenue  Act  of  1921,  §  223;  Revenue  Act  of  1918,  §  223. 
•■^i  Revenue  Act  of  1921,  §  223. 

52  See  Chapter  34  for  a  further  discussion  of  this  subject. 

53  Revenue  Act  of  1921,  §§216  and  217;  Revenue  Act  of  1918,  §§216 
and  217. 


14  FEDERAL  INCOME  TAX 

personal  exemption  allowed  to  an  individual  depends  upon  his 
status.  Married  persons  living  together  and  heads  of  families, 
whether  married  or  not,  are  entitled  to  an  exemption  of  $2,000, 
unless  the  net  income  is  less  than  $5,000,  in  which  case  the 
exemption  is  $2,500.  Others  are  entitled  to  $1,000.  An  addi- 
tional exemption  of  $400  is  allowed  to  any  taxpayer,  whether 
single  or  married  or  head  of  a  family,  for  each  person  (other 
than  husband  or  wife)  dependent  upon  and  receiving  his  chief 
support  from  the  taxpayer,  if  such  dependent  person  is  under 
eighteen  years  of  age  or  is  incapable  of  self-support  because 
mentally  or  physically  defective."'^  Under  the  1918  Law,  a  non- 
resident alien  was  entitled  to  claim  these  exemptions  to  the  same 
extent  as  a  citizen  or  resident,  unless  he  was  a  citizen  or  subject 
of  a  country  which  imposed  an  income  tax  and  did  not  allow  a 
similar  exemption  or  credit  to  citizens  of  the  United  States  not 
residing  in  such  country.  Under  the  present  law,  nonresident 
alien  individuals  and  certain  citizens  whose  income  is  largely 
from  sources  within  a  possession  of  the  United  States  ^^  are  en- 
titled only  to  a  personal  exemption  of  $1,000  and  are  not  entitled 
to  any  exemption  on  account  of  dependents."'^  The  personal  ex- 
emption may  be  deducted  only  in  computing  the  normal  tax.^^ 
r  The  1918  Law  provided  that  domestic  corporations  should  be 
entitled  to  an  exemption  of  $2,000.^^  Under  the  present  law  a 
specific  credit  of  $2,000  is  allowed  to  domestic  corporations  whose 
net  income  is  $25,000  or  less,  but  if  the  net  income  is  more  than 
$25,000,  the  income  tax  is  limited  to  an  amount  not  in  excess 
of  that  which  would  be  payable  if  the  credit  of  $2,000  were  al- 
lowed, plus  the  amount  of  net  income  in  excess  of  $25,000.^^ 

Normal  Tax.  The  normal  tax  is  a  tax  imposed  upon  all  the 
net  income  of  an  individual  in  excess  of  (a)  dividends  received 
from  domestic  and  certain  foreign  corporations;  (b)  interest 
upon  bonds  and  other  obligations  of  the  United  States  issued 
after  September  1,  1917;  (c)  interest  upon  bonds  issued  by  the 
War  Finance  Corporation;  (d)  the  personal  exemption  and  (e) 

54  Revenue  Act  of  1921,  §216.  This  exemption  was  $200  under  the  1918 
Law  (Revenue  Act  of  1918,  §  216).  Prior  to  the  1918  Law  this  exemption  of 
$200  was  limited  to  cases  of  children  dependent  upon  the  taxpayer. 

&5  See  Revenue  Act  of  1921,  §  262. 

50  See  Revenue  Act  of  1921,  §  216  (e). 

5'^  For  a  further  discussion  of  the  personal  exemption,  see  Chapter  31. 

58  Prior  to  the  1918  Law,  corporations  were  not  allowed  an  exemption 
similar  to  the  personal  exemption  allowed  to  individuals. 

59  Revenue  Act  of  1921,  §  236  (b). 


INTRODUCTION  15 

the  exemption  for  dependent  persons. ^o  por  the  year  1919  and 
subsequent  years  the  rate  of  normal  tax  in  the  case  of  citizens 
and  residents  of  the  United  States  is  4%  on  the  first  $4,000  of 
income  subject  to  normal  tax  and  8%  on  the  remainder;  and  in 
the  case  of  nonresident  aliens  8%  on  all  net  income  from  sources 
within  the  United  States  subject  to  normal  tax.^i 

Surtax.  A  surtax  (sometimes  called  "supertax"  or  "addi- 
tional tax")  is  imposed  upon  the  entire  net  income  of  individuals 
in  excess  of  $5,000  without  deducting  the  personal  exemption 
and  including  dividends  and  interest  on  United  States  obligations, 
issued  after  September  1,  1917,  and  bonds  of  the  War  Finance 
Corporation.  The  surtaxes  are  imposed  by  a  series  of  graduated 
rates.  The  first  rate,  for  the  taxable  years  1918  to  1921,  inclu- 
sive, is  imposed  on  that  part  of  the  net  income  which  exceeds 
$5,000  and  does  not  exceed  $6,000.  Each  additional  $2,000  of 
net  income  is  subject  to  a  higher  rate  of  tax  than  the  preceding 
one  up  to  and  including  $100,000,  and  thereafter  the  surtax  is 
increased  at  less  frequent  intervals  on  income  up  to  $1,000,000, 
the  final  rate  being  65  %  on  the  amount  by  which  the  net  income 
exceeds  $1,000,000.^2     For  1922  and  succeeding  years  the  first 

fio  Revenue  Act  of  1921,  §216;  Revenue  Act  of  1918,  §216.  The  distinc- 
tion made  between  incomes  subject  to  normal  tax  and  incomes  subject  to 
surtax  is  artificial  and  necessary  only  for  the  purpose  of  granting  certain 
partial  exemptions  or  taxing  various  kinds  of  income  at  different  rates. 
The  distinction  between  normal  taxes  and  surtax  seems  to  have  originated 
in  England,  where  the  income  tax  was  first  imposed  at  a  proportional  rate 
on  all  income  and  later  graduated  rates  were  applied  to  incomes  over  a 
minimum  limit.  One  reason  for  distinguishing  between  normal  taxes  and 
surtaxes  under  our  1913  Law  lay  in  the  fact  that  the  statute  provided  for 
withholding  at  the  source  of  the  normal  tax,  as  does  the  English  Law.  Under 
the  1913  Law  and  the  1916  Law  the  normal  tax  was  the  rate  which  applied 
to  corporations  and  individuals  alike,  but  under  the  1918  Law  and  the  pres- 
ent law  this  characteristic  is  destroyed  since  the  normal  tax  is  also  a 
graduated  tax.  The  law  will  no  doubt  always  retain  the  distinction  between 
normal  and  surtaxes,  since  bonds  of  the  United  States  are  issued  exempt 
from  "normal  tax,"  an  exemption  which,  by  the  way,  is  uncertain  and  pre- 
carious since  it  is  within  the  power  of  congress  to  reduce  the  normal  tax 
at  any  time  to  a  minimum  and  thereby  practically  destroy  the  tax  exemp- 
tion or  raise  the  normal  tax  as  is  done  by  the  present  law  in  order  to  in- 
crease the  exemption. 

Gi  Revenue  Act  of  1918,  §  210;  Revenue  Act  of  1921,  §  210.  For  the  year 
1918  the  rate  of  normal  tax  in  the  case  of  citizens  and  residents  of  the 
United  States  was  6%  on  the  first  $4,000  of  income  subject  to  normal  tax 
and  12%  on  the  remainder.  Nonresident  aliens  were  subject  to  a  normal  tax 
at  the  rate  of  12%  on  all  of  the  net  income  subject  to  normal  tax  received 
from  all  sources  in  the  United  States. 

<i-' Revenue  Act  of  1918,  §211;  Revenue  Act  of  1921,  §211  (a)  (1).  See 
Chapter  2  for  a  schedule  of  rates  of  this  tax. 


16  FEDERAL  INCOME  TAX 

rate  of  surtax  is  1%,  and  applies  to  the  amount  of  net  income 
between  $6,000  and  $10,000.  In  general,  each  additional  $2,000 
of  net  income  is  subject  to  a  higher  rate  up  to  and  including 
$100,000.  The  maximum  surtax  rate  for  such  years  is  50%, 
which  applies  to  all  net  income  in  excess  of  $200,000."^ 

Corporation  Tax.  The  income  tax  imposed  on  corporations  is 
at  the  rate  of  10%,  for  the  calendar  year  1921,  and  121/2  7"  for 
succeeding  years.^^  This  rate  might  formerly  be  said  to  measure 
the  normal  tax  imposed  on  corporations  in  contradistinction  to 
the  graduated  excess-profits  tax  which  was  also  imposed  on  cor- 
porations. But  this  is  hardly  true  after  1921,  when  the  excess- 
profits  tax  is  abolished,  and  the  income  tax  on  corporations  raised 
in  lieu  thereof.  For  the  purpose  of  the  income  tax  the  net  in- 
come which  is  subject  to  the  excess-profits  tax  is  reduced  by 
deducting  therefrom  certain  credits  consisting  of  (a)  interest 
on  the  bonds  and  obligations  of  the  United  States  issued  after 
September  1,  1917,  and  bonds  issued  by  the  War  Finance  Cor- 
poration; (b)  the  amount  of  any  excess-profits  tax  imposed  on 
the  net  income  for  the  same  taxable  year;  and  (c)  in  the  case 
of  a  domestic  corporation  the  sum  of  $2,000  subject  to  the  con- 
ditions stated  in  a  previous  paragraph.''-^  Certain  classes  of  cor- 
porations not  organized  for  profit,  both  domestic  and  foreign,  are 
exempt  from  this  tax.^s 

Personal  Service  Corporations.  The  1918  Law  recognized  a 
new  class  of  corporations — those  whose  income  is  due  primarily 
to  the  activities  of  the  principal  owners  or  stockholders  who  are 
themselves  regularly  engaged  in  the  active  conduct  of  the  affairs 
of  the  corporation  and  in  which  capital  is  not  a  material  income- 
producing  factor.  Such  corporations  are  recognized  as  being 
taxable  in  the  same  manner  as  partnerships ;  that  is,  the  corpo- 
ration is  required  to  pay  no  tax  but  the  stockholders  are  required 
to  include  in  their  personal  returns  their  distributive  shares  of 
all  the  profits  of  such  corporations  whether  distributed  or  not. 
Personal  service  corporations  are  composed,  for  instance,  of  pro- 
fessional men  or  agents  who  have  adopted  the  corporate  form 
merely  as  an  incidental  convenience.  The  law  expressly  provides 
that  no  foreign  corporation  shall  be  considered  to  be  a  personal 
service  corporation,  nor  shall  any  corporation  be  so  considered 
if  50%  of  its  gross  income  consists  either  of  gains,  profits  or 

63  Revenue  Act  of  1921,  §211  (a)   (2). 

64  This  rate  was  12%  for  the  year  1918  and  10%  for  1919  and  1920.  See 
Revenue  Act  of  1918,  §  230,  and  Revenue  Act  of  1921,  §  230. 

65  Revenue  Act  of  1921,  §§230  and  236;  Revenue  Act  of  1918,  §§230  and 
236.     This  subject  is  more  fully  discussed  in  Chapter  10. 

66  See  Chapter  13  for  list  of  exempt  corporatio^ns. 


INTRODUCTION  17 

income  derived  from  trading  as  a  principal  or  of  gains,  profits, 
commissions  or  other  income,  derived  from  government  contracts 
made  between  April  6,  1917,  and  November  11,  1918,  both  dates 
inclusive.'"'^  Under  the  present  law,  such  corporations  are  taxed 
as  above  for  1921  only,  after  which  they  will  be  subject  to  tax 
as  other  corporations.^^ 

Partnerships.  A  partnership  itself  is  not  taxable,  but  the 
members  of  the  partnership  are  required  to  report  their  dis- 
tributive shares  of  the  partnership  income,  whether  such  income 
is  actually  distributed  or  not.  All  partnerships  are  required  to 
file  annual  returns  of  income  for  the  purpose  of  showing  the 
amount  of  net  income  distributable  to  each  partner."'-* 

Collection  of  the  Tax  at  the  Source.  Collection  at  the  source, 
deduction  at  the  source,  withholding  at  the  source  and  stoppage 
at  the  source,  are  synonymous  terms  meaning  that  the  one  pay- 
ing income  to  anoth.er  deducts  or  withholds  an  amount  equal  to 
the  tax  on  the  sum  so  paid  and  turns  it  over  to  the  government 
to  the  credit  of  the  one  against  whom  it  is  withheld.  This 
method  is  used  in  order  to  facilitate  the  collection  and  to  prevent 
evasion  of  the  tax.  Under  the  1913  Law,  and  the  1916  Law  dur- 
ing the  year  1916,  the  normal  tax  was  withheld  on  payments  to 
individuals,  whether  citizens,  residents  or  nonresident  aliens. 
Under  the  1916  Law,  as  amended  by  the  1917  Law,  the  tax  was 
not  withheld  on  payments  of  income  to  citizens  and  residents 
(except  in  the  case  of  bonds  containing  tax-free  covenants)."^" 
Collection  at  the  source  applies  at  the  present  time  only  to  (1) 
payments  of  fixed  and  determinable  annual  or  periodical  income 
to  nonresident  aliens,  or  partnerships  composed  in  whole  or  in 
part  of  nonresident  aliens,  in  which  case  the  tax  is  to  be  with- 
held at  the  rate  of  8%  (and  if  the  commissioner  so  rules  the 
nonresident  alien  may  claim  exemption  from  withholding  to  the 
extent  of  his  personal  exemption)  ;  (2)  payments  of  the  same 
kind  of  income  to  nonresident  foreign  corporations  not  engaged 
in  trade  or  business  within  the  United  States  and  not  having  an 
office  or  place  of  business  therein,  in  which  case  the  tax  is  to  be 
withheld  at  the  rate  of  10  ""^  for  1921,  and  1214^  for  subsequent 
years;  and   (3)  the  commissioner  may  authorize  deduction "'  at 

'■'7  Revenue  Act  of  1918,  §200;  Revenue  Act  of  1921,  §200.     For  further 
discussion  of  this  subject  see  Chapter  9. 
88  Revenue  Act  of  1921,  §  218  (d). 
«'J  Revenue  Act  of  1921,  §  224;  Revenue  Act  of  1918,  §  224. 

70  Revenue  Act  of  1916,  §9  (c)  as  amended  by  Revenue  Act  of  1917. 

71  The  law  is  not  clear  whether  the  commissioner  may  authorize  deduction 
at  the  rate  of  8%  or  lO^r  or  121/2%  in  the  case  of  bonds  not  having  "tax- 
free  covenants"  and  it  seems  to  be  within  his  discretion. 


18  FEDERAL  INCOME  TAX 

the  source  in  the  case  of  payments  of  any  interest  upon  any 
securities  the  owners  of  which  are  not  known  to  the  withholding 
agent;  (4)  in  the  case  of  payments  of  interest  on  bonds  and 
similar  obligations  of  domestic  corporations  which  contain  a 
so-called  "tax-free  covenant,"  the  tax  to  be  withheld  in  all  such 
cases  to  be  limited  to  2%,  whether  the  owner  be  a  citizen  or 
resident  or  a  nonresident  alien  or  a  foreign  corporation  or  a 
domestic  or  foreign  partnership.  The  only  bondholders  to  which 
the  last  mentioned  provision  does  not  apply  are  domestic  and 
resident  corporations.  The  commissioner  may  authorize  the  tax 
of  2%  to  be  withheld  on  interest  on  ''tax-free  covenant"  bonds 
where  the  owner  is  not  known.''^  It  is  to  be  noted  that  the  only 
case  in  which  withholding  against  citizens  or  residents  of  this 
country  takes  place  is  (4)  above.  In  such  cases  the  law  is  made 
to  operate  in  order  that  the  debtor  corporation  issuing  such 
"tax-free  covenant"  bonds  may  be  compelled  to  assume  a  part 
of  the  tax  of  the  bondholder,  since  withholding  does  not  actually 
take  place.'^s 

Information  at  the  Source.  For  the  purpose  of  checking  up  the 
returns  of  taxpayers  the  law  provides  for  a  system  of  informa- 
tion at  the  source,  whereby  every  corporation  may  be  required 
to  report  to  the  commissioner  the  names  and  addresses  of  its 
stockholders  and  the  amount  of  dividends  paid  to  each;'''^  brokers 
may  also  be  required,  when  called  upon,  to  report  the  names  and 
addresses  of  customers  and  furnish  information  as  to  the  profits 
and  losses  of  each ;  "-^  and  all  persons,  corporations  or  partnerships 
may  be  required  to  report  the  names  and  addresses  of  any  per- 
sons to  whom  they  pay  fixed  or  determinable  gains,  profits  or 
income  of  $1,000  or  more  in  any  taxable  year.  In  the  case  of 
payments  of  interest  to  the  bondholders  of  corporations  the 
names  and  addresses  of  such  bondholders  are  required  to  be  re- 
ported, regardless  of  the  amount  paid  during  the  year,  and  this 
is  also  true  in  the  case  of  the  collection  of  foreign  items  of  inter- 
est and  dividends.'^'^ 

Payment  of  the  Tax.  The  income  tax  is  due  and  payable  in 
four  installments,  each  consisting  of  one-fourth  of  the  total  tax. 
The  first  installment  is  payable  at  the  time  when  the  return  is 
due  to  be  filed,  unless  an  extension  of  time  for  filing  the  return 
is  granted,  in  which  case  the  first  installment  is  due  at  the 

T2  Revenue  Act  of  1921,  §§221  and  237;  Revenue  Act  of  1918,  §§221 
and  237. 

'73  For  a  further  discussion  of  this  subject  see  Chapter  40. 

74  Revenue  Act  of  1921,  §  254;  Revenue  Act  of  1918,  §254. 

75  Revenue  Act  of  1921,  §255;  Revenue  Act  of  1918,  §255. 

76  Revenue  Act  of  1921,  §256;  Revenue  Act  of  1918,  §256. 


INTRODUCTION  19 

expiration  of  such  extended  period  with  interest  at  the  rate  of 
one-half  of  1  per  cent,  per  month  from  the  date  on  which  the 
return  was  originally  due  to  be  filed.  Such  an  extension  does 
not  postpone  the  time  of  payment  of  subsequent  installments. 
In  the  event  of  default  in  the  payment  of  any  installment  the 
whole  amount  of  tax  still  unpaid  becomes  due  and  payable  upon 
notice  and  demand  by  the  collector.  The  above  provisions  do 
not  apply  to  taxes  collected  at  the  source.  The  tax  may  be  paid 
in  a  single  payment  instead  of  in  installments.''"^  No  discount  is 
allowed  where  such  an  advance  payment  is  made.  Receipts  are 
not  given  for  taxes  paid,  except  upon  the  request  of  the  tax- 
payer.'^s 

Abatement  and  Refund.  The  collection  of  the  income  tax  can- 
not be  restrained  by  injunction,  but  the  commissioner  is  author- 
ized to  remit  and  pay  back  to  the  taxpayer  any  taxes  which  have 
been  erroneously  or  illegally  collected.  The  importance  of  col- 
lecting revenue  is  so  great  that  the  law  permits  no  taxpayer  to 
interpose  a  hindrance  to  the  orderly  assessment  of  the  tax.    He 

must  allow  the  tax  to  be  assessed  and  claim  abatement  or  refund 
thereafter.'^^ 

77  Revenue  Act  of  1921,  §  250  (a) ;  Revenue  Act  of  1918,  §  250  (a). 
7S  Revenue  Act  of  1921,  §  251;  Revenue  Act  of  1918,  §  251. 
7U  See  Chapter  38. 


CHAPTER  2 

THE  INCOME  TAX  RATES 

As  indicated  in  the  foregoing  chapter,  the  income  tax  is  im- 
posed generally  at  two  rates  (called  the  normal  tax)  on  a  part 
of  the  net  income,  and  at  a  series  of  progressive  rates  (called  the 
surtax)!  on  the  net  income  over  $6,000.  In  the  case  of  corpora- 
tions no  surtax  is  imposed,  the  income  tax  rate  being  uniform  on 
all  amounts  of  net  income.  For  the  year  1921  and  subsequent 
years,  the  income  tax  is  imposed  by  the  Revenue  Act  of  1921.  It 
was  imposed  by  the  Revenue  Act  of  1918  for  the  years  1918,  1919 
and  1920. 

Normal  Tax.  Under  both  the  Revenue  Act  of  1918  and  the 
Revenue  Act  of  1921  a  normal  tax  of  4%-  is  imposed  upon  the 
first  $4,000  of  taxable  net  income  of  citizens  and  residents  for 
the  calendar  year  1919  and  subsequent  years,  and  a  normal  tax 
of  8% 3  upon  the  remainder  of  such  taxable  net  income.^  In  the 
case  of  nonresident  alien  individuals  the  rate  is  8  %  •''  on  the  tax- 
able net  income.^  The  following  items  are  deducted  from  net  in- 
come, under  the  Revenue  Act  of  1921,  to  determine  taxable  net 
income  in  assessing  the  normal  tax  of  citizens  or  residents:  (a) 
dividends  from  a  domestic  corporation  (except  a  domestic  cor- 
poration deriving  the  greater  part  of  its  income  from  sources 
within  a  possession  of  the  United  States)  and  a  foreign  corpora- 
tion deriving  more  than  50%  of  its  income  from  sources  within 
the  United  States;  (b)  interest  upon  obligations  of  the  United 
States  issued  after  September  1,  1917,  and  bonds  issued  by  the 
War  Finance  Corporation  which  is  included  in  gross  income;  (c) 
the  personal  exemption  and  credit  for  dependents.^     No  credit 

1  In  1917  the  income  tax  was  assessed  and  collected  under  two  laws  (the 
Revenue  Act  of  1916  and  the  Revenue  Act  of  1917) ;  but  it  is  now,  as  in 
1918-1921,  assessed  and  collected  under  one  law — the  Revenue  Act  of  1918 
for  the  years  1918-1920  and  the  Revenue  Act  of  1921  for  1921  and  subsequent 
years. 

-  This  rate  was  6%  for  the  calendar  year  1918  under  the  1918  Law. 

S  This  rate  was  12  9r  for  the  calendar  year  1918  under  the  1918  Law. 

4  Revenue  Act  of  1921,  §210;  Revenue  Act  of  1918,  §210  (b);  Reg.  45, 
Art.  2.    The  subject  of  income  is  treated  fully  in  Chapter  14  et  seq. 

5  This  rate  was  12%  for  the  calendar  year  1918  under  the  1918  Law. 

6  In  the  case  of  nonresident  alien  individuals  only  income  from  sources 
within  the  United  States  is  taxable;  Revenue  Act  of  1921,  §  213  (c);  Reve- 
nue Act  of  1918,  §213  (c). 

7  Revenue  Act  of  1921,  §§  210,  216  and  262.  This  is  different  from  the 
corresponding  provision  of  the  Revenue  Act  of  1918  (§  216)  in  regard  to  the 

20 


THE  INCOME  TAX  RATES  21 

for  dependents  is  allowed  in  assessing  the  normal  tax  of  nonresi- 
dent alien  individuals,  the  remaining  above  items  are  deducted 
only  on  the  condition  that  the  nonresident  alien  files  a  return  of 
his  total  income  received  from  all  sources,  corporate  or  otherwise, 
in  the  United  States,  including  therein  all  information  which  the 
commissioner  may  deem  necessary  for  the  calculation  of  his 
credits  and  deductions."^  On  all  the  net  income  in  excess  of  the 
above  items  the  normal  tax  rates  apply." 

Comparative  Statement  of  Normal  Tax  Rates.  The  rates 
of  normal  tax  under  the  various  laws  since  March  1,  1913,  are  as 
follows : 

1913—1%;  1916—2%;  1917—2%;  1918—6%  and  129^  for 
the  year  1918  and  4%  and  8'%  for  1919  and  1920;  1921—4%. 
and  8%.  The  corporation  tax  for  each  of  the  years  up  to  1917 
was  the  same  as  the  normal  tax.  In  1917  the  normal  tax  rates 
imposed  by  the  1916  and  1917  Laws  were  applied  to  incomes  of 
citizens  and  residents,  but  only  the  1916  rate  to  nonresident 
aliens,  while  the  corporation  tax  was  6%  .  For  the  year  1918, 
the  corporation  tax  was  the  same  as  the  higher  of  the  normal  tax 
rates  for  individuals  (12%  )  ;  for  1919  and  1920,  it  was  10%.  It 
remains  at  10 /r  under  the  present  law  for  1921,  but  goes  up  to 
121/^%  for  1922  and  subsequent  years.i" 

Surtax.  In  addition  to  the  normal  tax  a  surtax  is  imposed  at 
various  and  graduated  rates  under  the  present  law.  For  the  pur- 
pose of  assessing  the  surtax  the  items  deductible  from  net  income 
for  normal  tax  purposes  and  the  personal  exemption  are  not  de- 
ducted.^^ 

Limitation  in  Case  of  Sales  of  Mines,  Oil,  or  Gas  Wells. 
In  the  case  of  a  boiia  fide  sale  of  mines,  oil  or  gas  wells,  or  any 
interest  therein,  where  the  principal  value  of  the  property  has 

dividends  which  may  be  credited.  Under  that  law  dividends  from  a  corpora- 
tion taxable  on  its  net  income  could  be  credited,  and  also  from  a  personal 
service  corporation  out  of  earnings  subject  to  income  tax.  With  regard  to 
dividends  from  a  personal  service  corporation  under  the  present  law,  see 
Chapter  31. 

•'<  Revenue  Act  of  1921,  §217  (g);  Revenue  Act  of  1918,  §217.  Under 
the  1918  Law  (§216  (e)  ),  in  the  case  of  nonresident  alien  individuals  who 
are  citizens  or  subjects  of  a  foreign  country  imposing  an  income  tax,  the 
personal  exemption  was  allowed  only  if  such  country  allowed  a  similar 
credit  to  citizens  of  the  United  States  not  residing  in  such  country. 

9  Revenue  Act  of  1921,  §  210;  Revenue  Act  of  1918,  §  210. 

i«  Cf.  Revenue  Act  of  1921,  §§  230,  210,  and  Revenue  Act  of  1918,  §§  230, 
210. 

11  Revenue  Act  of  1921,  §211;  Revenue  Act  of  1918,  §211  (a);  Reg.  45, 
Art.  11.  The  surtax  was  called  "the  additional  tax"  in  the  1916  law  and 
the  1917  law. 


22  FEDERAL  INCOME  TAX 

been  demonstrated  by  prospecting  or  exploration  and  discovery 
work  done  by  the  taxpayer,  the  surtax  attributable  to  such  sale 
cannot  exceed  for  the  calendar  year  1921,  20 '/( ,  and  for  each  cal- 
endar year  thereafter  16  7o  of  the  selling  price.^-  Exploration 
work  alone  without  discovery  is  not  sufficient  to  bring  a  case 
within  this  provision.  Shares  of  stock  in  a  corporation  owning 
mines,  oil  or  gas  wells  do  not  constitute  an  interest  in  such  prop- 
erty. To  determine  the  application  of  this  provision  to  a  particu- 
lar case,  the  taxpayer  should  first  compute  the  surtax  in  the  or- 
dinary way  upon  his  net  income,  including  his  net  income  from 
any  such  sale.  The  proportion  of  the  surtax  indicated  by  the  ratio 
which  the  taxpayer's  net  income  from  the  sale  of  the  property, 
bears  to  his  total  net  income  is  the  portion  of  the  surtax  at- 
tributable to  such  sale,  and  if  it  exceeds  the  above  percentage 
of  the  selling  price  of  the  property,  such  portion  of  the  surtax 
should  be  reduced  to  that  amount.i^  Where  individuals  transfer 
property  to  a  corporation  which  later  demonstrates  the  principal 
value  of  such  property  as  oil-producing  property  "by  prospecting 
or  exploration  and  discovery  work"  and  then  dissolves,  trans- 
ferring the  property  to  the  individuals,  who  had  remained  stock- 
holders without  change  in  interests,  and  such  stockholders  sell 
the  property,  the  portion  of  the  surtax  attributable  to  such  sale 
is  not  limited  to  20%  or  16%  of  the  selling  price  of  such  prop- 
erty or  interests.!^  The  limitation  with  respect  to  the  tax  at- 
tributable to  the  sale  of  mines,  oil  or  gas  wells,  or  any  interest 
therein  has  no  application  to  the  tax  on  profits  realized  from  the 
sale  of  oil  and  gas  produced  in  the  operation  of  such  wells.^^ 
Limitation  in  the  Case  of  Capital  Gains.  If  the  taxpayer 
so  elects,  neither  the  normal  nor  the  surtaxes  imposed  for  the 
year  1922  and  subsequent  years  apply  to  net  gains  from  the 
sale  or  exchange  of  capital  assets  consummated  after  December 

12  Revenue  Act  of  1921,  §211  (b);  Revenue  Act  of  1918,  §211  (b). 

13  Reg.  45,  Art.  13.  It  should  be  noted  that  this  construction  of  the  statute 
is  reached  from  the  government's  viewpoint.  The  courts  would  perhaps  under 
some  circumstances  hold  that  shares  of  stock  in  a  corporation  owning  the 
property  constitute  an  interest  in  the  property  within  the  meaning  of  the 
statute.  See  discussion  of  the  doctrine  of  corporate  entity  in  Chapter  10. 
It  seems  also  that  the  method  here  presented  for  calculating  the  surtax 
applicable  to  such  sale  is  open  to  question.  The  portion  of  the  tax  attribut- 
able to  such  sale  is  clearly  the  difference  between  the  amount  of  surtax 
computed  on  the  entire  net  income  and  the  amount  computed  on  the  net 
income  less  the  profit  on  the  sale — and  not  the  proportion  indicated  in  the 
text. 

14  T.  B.  R.  8,  T.  B.  3-19-176. 

15  0.  D.  658,  T.  B.  37-20-1190. 


THE  INCOME  TAX  RATES 


23 


31,  1921,  such  net  gains  being  the  amount  over  and  above  (a) 
losses  resulting  from  the  sale  of  capital  assets  consummated 
after  that  date  and  (b)  deductions  properly  allocable  to  or 
chargeable  against  capital  gains.  At  the  election  of  the  tax- 
payer, an  ungraduated  tax  of  12V2%  is  imposed  on  such  capital 
net  gains,  the  balance  of  the  taxpayer's  income  being  liable  to 
the  normal  and  surtaxes.i^ 

Comparative  Statement  of  Surtax  Rates.  The  rates  of  sur- 
tax under  the  various  laws  since  March  1,  1913,  are  as  follows: 

On  the  amount  by  which  the  total  net  income 


But  does  not 

1921 

1918 

1917 

1916 

1913 

Exceeds 

exceed 

Law* 

Law** 

Law 

Law 

Law 

B      5,000 

$       6,000 

None 

1% 

1% 

None 

None 

6,000 

7,500 

1% 

2% 

1% 

None 

None 

7,500 

8,000 

1% 

2% 

2%o 

None 

None 

8,000 

10,000 

1% 

3% 

2% 

None 

None 

10,000 

12,000 

2% 

4% 

3% 

None 

None 

12,000 

12,500 

3% 

5%. 

3% 

None 

None 

12,500 

14,000 

3% 

5% 

4% 

None 

None 

14,000 

15,000 

4% 

6% 

4% 

None 

None 

15,000 

16,000 

4% 

6% 

5% 

None 

None 

16,000 

18,000 

5% 

7% 

5% 

None 

None 

18,000 

20,000 

6% 

8% 

5% 

None 

None 

20,000 

22,000 

8% 

9% 

7% 

1% 

1% 

22,000 

24,000 

9% 

10% 

7% 

1% 

1% 

24,000 

26,000 

10% 

11% 

7% 

1% 

1% 

26,000 

28,000 

11% 

12% 

7% 

1% 

1% 

28,000 

30,000 

12% 

13% 

7% 

1% 

1% 

30,000 

32,000 

13% 

14% 

7% 

1% 

1% 

32,000 

34,000 

15  7o 

15%) 

7% 

1% 

1% 

34,000 

36,000 

15%) 

16% 

7% 

1% 

1% 

36,000 

38,000 

16% 

17% 

7% 

1% 

1% 

38,000 

40,000 

17% 

18% 

7% 

1% 

1% 

40,000 

42,000 

18%^ 

19% 

10  7o 

2% 

1% 

42,000 

44,000 

19% 

20% 

10% 

2% 

1% 

44,000 

46,000 

20% 

21% 

10% 

2% 

1% 

46,000 

48,000 

21% 

22% 

10% 

2% 

1% 

48,000 

50,000 

22% 

23% 

10% 

2% 

1% 

^6  Revenue 

Act  of  1921, 

§  206.     This  subject 

is   more 

fully  discussed  in 

Chapter  17. 

*  For  1922 

and  subsequent  years. 

**Also  the 

1921  Law  for  1921. 

24  FEDERAL  INCOME  TAX 


But  does  not 

1921 

1918 

1917 

1916 

1913 

Exceeds 

exceed 

Law* 

Law** 

Law 

Law 

Law 

$    50,000 

$    52,000 

23%- 

24% 

10% 

2% 

27o 

52,000 

54,000 

24% 

25  7o 

10% 

27o 

2% 

54,000 

56,000 

25% 

26% 

10  7o 

27o 

27o 

56,000 

58,000 

26  7o 

27% 

10% 

2% 

27o 

58,000 

60,000 

27  7o 

28% 

10  7o 

2% 

27c 

60,000 

62,000 

28  7o 

29% 

14%, 

3% 

27c 

62,000 

64,000 

29% 

30% 

14% 

S% 

27c 

64,000 

66,000 

30% 

31% 

14% 

3% 

2% 

66,000 

68,000 

31% 

32  7o 

14% 

3% 

27o 

68,000 

70,000 

32% 

33% 

14% 

S7o 

27o 

70,000 

72,000 

33% 

34% 

14% 

37o 

27o 

72,000 

74,000 

34% 

35% 

U% 

37o 

2% 

74,000 

75,000 

35% 

36% 

14% 

37o 

2% 

75,000 

76,000 

35% 

36% 

14% 

37o 

S7o 

76,000 

78,000 

36% 

37% 

14  7o 

37o 

S7c 

78,000 

80,000 

37  7o 

38% 

14% 

37o 

Z7c 

80,000 

82,000 

38% 

39%, 

18% 

47c 

Z7o 

82,000 

84,000 

39% 

40% 

18% 

47c 

S7c 

84,000 

86,000 

407^ 

41% 

18% 

4% 

3% 

86,000 

88,000 

41% 

42% 

18% 

4% 

3% 

88,000 

90,000 

42% 

43% 

18% 

47c 

S7c 

90,000 

92,000 

43% 

44% 

18% 

4% 

37o 

92,000 

94,000 

44%) 

45% 

18  7o 

4% 

3% 

94,000 

96,000 

45% 

46  7o 

18% 

47c 

3% 

96,000 

98,000 

46% 

47% 

1S% 

4% 

S7c 

98,000 

100,000 

47% 

48% 

18% 

4% 

3% 

100,000 

150,000 

48% 

52%, 

22% 

5%. 

47c 

150,000 

200,000 

49%, 

56% 

25% 

6% 

4% 

200,000 

250,000 

50% 

60% 

30% 

77o 

4% 

250,000 

300,000 

50% 

60% 

34% 

87o 

5% 

300,000 

500,000 

50% 

63% 

37  7^ 

97o 

5% 

500,000 

750,000 

50% 

64% 

40% 

10% 

6% 

750,000 

1,000,000 

50%. 

64% 

45% 

10% 

6% 

1,000,000 

1,500,000 

50% 

65% 

507c 

n7o 

6% 

1,500,000 

2,000,000 

50% 

65% 

50% 

127o 

6% 

2,000,000 

50% 

65% 

50% 

13% 

6% 

*  For  1922  and  subsequent  years. 
**Also  the  1921  Law  for  1921. 

The  1913  rates  applied  in  1913,  1914,  and  1915;  the  1916  rates 
in  1916;  the  1916  and  1917  rates  were  both  imposed  in  1917;  the 


THE  INCOME  TAX  RATES  25 

1918  rates  apply  to  1918,  1919,  1920  and  1921,i"  and  the  1921 
rates  to  1922  and  subsequent  years. 

Surtax  Tables  for  1921  and  Prior  Years.  The  following 
table  shows  the  surtax  for  1918,  1919,  1920,  and  1921  on  net 
incomes  of  the  specified  amounts.  In  each  instance  the  first 
figure  of  net  income  in  the  net  income  column  is  to  be  excluded 
and  the  second  figure  included.  The  percentage  given  opposite 
applies  to  the  excess  of  income  over  the  first  figure  in  the  net  in- 
come column,  and  the  sum  in  the  next  column  is  the  tax  on  the 
entire  difference  between  the  first  figure  and  the  second  figure  in 
the  net  income  column.  The  final  column  gives  the  total  surtax 
on  a  net  income  equal  to  the  second  figure  in  the  net  income 
column. 

Net  income  Per  cent  Surtax        Total  surtax 

$   5,000  to  $   6,000 1    $  10    $    10 

6,000  to    8,000 2  40        50 

8,000  to   10,000 3  60        110 

10,000  to    12,000 4  80        190 

12,000  to    14,000 5  100        290 

14,000  to   16,000 6  120        410 

16,000  to   18,000 .•  7  140       550 

18,000  to   20,000 8  160       710 

20,000  to   22,000 9  180       890 

22,000  to   24,000 10  200  1,090 

24,000  to   26,000 11  220  1,310 

26,000  to   28,000 12  240  1,550 

28,000  to   30,000 18  260  1,810 

30,000  to   32,000 14  280  2,090 

32,000  to   34,000 15  300  2,390 

34,000  to   36,000 16  320  2,710 

36,000  to   38,000 17  340  3,050 

38,000  to   40,000 18  360  3,410 

40,000  to   42,000 19  380  3,790 

42,000  to   44,000 20  400  4,190 

44,000  to   46,000 21  420  4,610 

46,000  to   48,000 22  440  5,050 

48,000  to   50,000 23  460  5,510 

50,000  to   52,000 24  480  5,990 

52,000  to   54,000 25  500  6,490 

54,000  to   56,000 26  520  7,010 

56,000  to   58,000 27  540  7,550 

58,000  to   60,000 28  560  8,110 

17  The  1918  rates  apply  to  1921,  but  they  are  imposed  by  the  1921  Law. 


26  FEDERAL  INCOME  TAX 

Net  income  Per  cent  Surtax        Total  surtax 

$  60,000  to  $  62,000 29     $  580    $8,690 

62,000  to   64,000 30       600      9,290 

64,000  to   66,000 31        620      9,910 

66,000  to   68,000 32       640     10,550 

68,000  to   70,000 33       660     11,210 

70,000  to   72,000 34       680     11,890 

72,000  to   74,000 35       700     12,590 

74,000  to   76,000 36       720     13,310 

76,000  to   78,000 37       740     14,050 

78,000  to   80,000 38       760     14,810 

80,000  to   82,000.  : 39       780     15,590 

82,000  to   84,000 40       800     16,390 

84,000  to   86,000 41        820     17,210 

86,000  to   88,000 42       840     18,050 

88,000  to   90,000 43       860     18,910 

90,000  to   92,000 44       880  .    19,790 

92,000  to   94,000 45       900     20,690 

94,000  to   96,000 46       920     21,610 

96,000  to   98,000 47       940     22,550 

98,000  to   100,000 48       960     23,510 

100,000  to   150,000 52     26,000     49,510 

150,000  to   200,000 56     28,000     77,510 

200,000  to   300,000 60     60,000    137,510 

300,000  to   500,000 63     126,000    263,510 

500,000  to  1,000,000 64     320,000    583,510 

1,000,000  up 65     

The  surtax  for  any  amount  of  net  income  not  shown  in  the 
above  table  is  computed  by  adding  to  the  total  surtax  for  the 
largest  amount  shown  which  is  less  than  the  income,  the  surtax 
upon  the  excess  over  that  amount  at  the  rate  indicated  in  the 
table.  For  example,  if  the  amount  of  net  income  is  $63,128,  the 
surtax  is  the  sum  of  $8,690  (the  surtax  upon  $62,000  as  shown  by 
the  table)  plus  30  per  cent,  of  $1,128,  or  $338.40,  making  a  total 
surtax  of  $9,028.40.18 

Surtax  Tables  For  1922  and  Subsequent  Years.  The  follow- 
ing table  shows  the  surtax  for  1922  and  subsequent  years  on  net 
incomes  of  the  specified  amounts.  This  table  is  prepared  in  a 
manner  similar  to  the  above  table  for  1921  and  prior  years,  and 
the  surtax  for  any  amount  not  shown  is  computed  by  adding  to 
the  total  surtax  for  the  largest  amount  shown  which  is  less  than 
the  income,  the  surtax  upon  the  excess  at  the  rate  indicated  in 
the  table. 

18  Reg.  45,  Art.  12. 


THE  INCOME  TAX  RATES 


27 


6,000 
10,000 
12,000 
14,000 
16,000 
18,000 
20,000 
22,000 
24,000 
26,000 
28,000 
30,000 
32,000 
36,000 
38,000 
40,000 
42,000 
44,000 
46,000 
48,000 
50,000 
52,000 
54,000 
56,000 
58,000 
60,000 
62,000 
64,000 
66,000 
68,000 
70,000 
72,000 
74,000 
76,000 
78,000 
80,000 
82,000 
84,000 
86,000 
88,000 
90,000 
92,000 
94,000 


Net 
to  $ 
to 
to 
to 
to 
to 
to 
to 
to 
to 
to 
to 
to 
to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 

to 
to 
to 
to 


income                           Per  cent  Surtax        Total  surtax 

10,000 1    $   40     $   40 

12,000 2  40  80 

14,000 3  60  140 

16,000 4  80  220 

18,000 5  100  320 

20,000 6  120  440 

22,000 8  160  600 

24,000 9  180  780 

26,000 10  200  980 

28,000 11  220  1,200 

30,000 12  240  1,440 

32,000 13  260  1,700 

36,000 15  300  2,000 

38,000 16  320  2,320 

40,000 17  340  2,660 

42,000 18  360  3,020 

44,000 19  380  3,400 

46,000 20  400  3,800 

48,000 21  420  4,220 

50,000 22  440  4,660 

52,000 23  460  5,120 

54,000 24  480  5,600 

56,000 25  500  6,100 

58,000 26  520  6,620 

60,000 27  540  7,160 

62,000 28  560  7,720 

64,000 29  580  8,300 

66,000 30  600  8,900 

68,000 31  620  9,520 

70,000 32  640  10,160 

72,000 33  660  10,820 

74,000 34  680  11,500 

76,000 35  700  12,200 

78,000 36  720  12,920 

80,000 37  740  13,660 

82,000 38  760  14,420 

84,000 39  780  15,200 

86,000 40  800  16,000 

88,000 41  820  16,820 

90,000 42  •  840  17,660 

92,000 43  860  18,520 

94,000 44  880  19,400 

96,000 45  900  20,300 


28  FEDERAL  INCOME  TAX 

Net  income  Per  cent  Surtax  Total  surtax 

$  96,000  to  $  98,000 46  $  920  $21,220 

98,000  to  100,000 47       940     22,160 

100,000  to  150,000 48  24,000     46,160 

150,000  to  200,000 49  24,500     70,660 

200,000  up  50  

Computing  the  Tax — Illustration  for  1921.  The  tax  on  a 
married  person  living  with  husband  or  wife,  with  a  net  income  of 
$15,000  for  the  year  1921,  assuming  that  none  of  such  income 
consists  of  (a)  dividends  or  (b)  interest  upon  obligations  of  the 
United  States  or  bonds  issued  by  the  War  Finance  Corporation, 
is  computed  as  follows : 

Normal  Tax  ^^^^   Amt.oftax 

$15,000  minus  $2,000  (personal  exemption) 
equals  $13,000 

First  $4,000  at 4%       $160 

Remaining     9,000  at 8%         720 

Surtax 
On  first  $5,000 0%  0 

On  next     1,000 1%  10 

(. 15.000  to  .fr.,000) 

On  next    2,000 2%  40 

($6,000   to   $8,000) 

On  next    2,000 3%  60 

($8,000  to  $10,000) 

On  next    2,000 4%  80 

($10,000  to  $12,000) 

On  next    2,000 57c         100 

($12,000  to  $14,000) 

On  next     1,000 6%  60 

($14,000  to  $15,000)  

Total  $1,230 

The  tax  on  an  unmarried  person  would  be  increased  by  8  %  on 
$1,000  or  $80,  since  the  personal  exemption  is  $1,000  less,  and 
the  balance  of  taxable  net  income  over  $4,000  would  be  increased 
accordingly.  In  case  the  married  person  or  head  of  a  family  in 
the  above  computation  is  entitled  to  further  exemption  because 
of  persons  dependent  upon  him,  the  normal  tax  will  be  reduced  at 
the  rate  of  $32  for  each  such  dependent,  that  is,  8%  on  $400.i9 
If  the  above  net  income  were  $5,000  or  less,  the  tax  would  be 
computed  as  follows; 

$5,000  minus  $2,500   (personal  exemption) 

equals  $2,500  taxed  at  4%  equals $100 

19  Revenue  Act  of  1921,  §216  (d);  Revenue  Act  of  1918,  §216  (d). 


THE  INCOME  TAX  RATES  29 

Computing  the  Tax — Illustration  for  1922.  The  tax  on 
a  married  person  with  a  net  income  of  $15,000  for  the  year  1922, 
assuming  that  none  of  such  income  consists  of  (a)  dividends  or 
(b)  interest  upon  obligations  of  the  United  States  or  bonds  is- 
sued by  the  War  Finance  Corporation,  is  computed  as  follows: 

Normal  Tax  ^^^^   Amt.oftax 

$15,000  minus  $2,000  (personal  exemption) 
equals  $13,000 

First  $4,000  at 47o       $160 

Remaining    9,000  at 8%         720 

Surtax 

On  first  $6,000 0%  0 

On  next    4,000 1%  40 

(iffi.OOO  to   yiO.OOO) 

On  next    2,000 2%  40 

(?10,000   to  S12,000) 

On  next    2,000 3%  60 

(.'F12,000   to  $14,000) 

On  next     1,000 4%  40 

($14,000  to  $15,000)  

Total  $1,060 

Surtax  on  Stockholders  in  Respect  of  Undistributed  Profits  of 
Corporations.-o  The  surtax  is  ordinarily  assessed  only  upon  in- 
come actually  received  by  the  taxpayer.  But  if  any  corporation, 
however  created  or  organized,  is  formed  or  availed  of  for  the  pur- 
pose of  preventing  the  imposition  of  the  surtax  upon  its  stock- 
holders or  members  through  the  medium  of  permitting  its  gains 
and  profits  to  accumulate,  instead  of  being  divided  or  distrib- 
uted, the  corporation  is  subject  to  an  additional  income  tax 
of  25%  ;  or  if  all  the  stockholders  or  members  agree  thereto,  the 
commissioner  may,  in  lieu  of  all  income,  war-profits  and  excess- 
profits  taxes  for  the  taxable  year,  tax  the  stockholders  or  mem- 
bers upon  their  distributive  shares  in  the  net  income  as  the  mem- 
bers of  a  partnership  are  taxed.  This  second  above  alternative 
is  similar  to  the  corresponding  provision  of  the  1918  Law,  ex- 
cept that  no  unanimous  consent  of  stockholders  was  necessary 

-"  It  is  to  be  seriously  doubted  whether  this  provision  of  the  statute  and 
the  corresponding  provision  of  the  Revenue  Act  of  1918  (§220)  is  con- 
stitutional, particularly  in  view  of  the  decision  of  the  Supreme  Court  in 
Eisner  v.  Macomber,  252  U.  S.  189.  Such  expressions  as  "the  substantial 
difference  between  corporation  and  stockholders";  we  cannot  "look  upon 
stockholders  as  partners,  when  they  are  not  such";  we  cannot  treat  stock- 
holders "as  having  in  equity  a  right  to  partition  of  the  corporate  assets, 
when  they  have  none";  we  cannot  "indulge  in  the  fiction  that  they  have 
received  and  realized  a  share  of  profits,  which,  in  truth,  they  have  never 
received  nor  realized."     It  is  only  by  treating  a  corporation  as  an  entity 


30  FEDERAL  INCOME  TAX 

under  that  law.  Under  the  1918  Law  the  excess-profits  tax  paid 
by  the  corporation  was  deductible  from  the  net  income  before  the 
computation  of  the  proportionate  share  of  each  stockholder  or 
member.  It  does  not  seem  to  be  within  the  discretion  of  the 
Commissioner  to  apply  either  of  the  two  alternative  methods  of 
taxation  provided  by  the  Revenue  Act  of  1921.  The  stockholders 
or  members  may,  of  course,  oblige  the  Commissioner  to  resort 
to  the  25  %  tax  by  withholding  consent.  The  history  of  the  pro- 
vision indicates  that  they  may  oblige  him  to  use  the  second  alter- 
native by  giving  consent.-^ 

This  provision  applies  only  where  the  accumulation  is  per- 
mitted for  the  purpose  of  avoiding  the  surtax.  Ordinarily,  the 
stockholder  of  a  corporation  has  no  need  to  concern  himself  with 
or  to  make  any  inquiry  as  to  the  undistributed  income  of  the  cor- 
poration.— The  1918  provision  applies  only  to  the  income  of  1918, 
1919  and  1920,  and  cannot  be  utilized  to  force  a  distribution  of 

separate  from  its  stockholders  that  a  dividend  which  is  paid  may  be  regarded 
as  income.  The  following  remark  of  the  Supreme  Court  in  the  same  case 
is  also  interesting  in  this  connection:  "If  profits  have  been  made  and  not 
divided  they  create  additional  bookkeeping  liabilities  under  the  head  of 
'profit  and  loss',  'undivided  profits',  'surplus  account',  or  the  like.  None 
of  these,  however,  gives  to  the  stockholders  as  a  body,  much  less  to  any 
one  of  them,  either  a  claim  against  the  going  concern  for  any  particular 
sum  of  money,  or  a  right  to  any  particular  portion  of  the  assets  or  any 
share  in  them  unless  or  until  the  directors  conclude  that  dividends  shall 
be  made  and  a  part  of  the  company's  assets  segregated  from  the  common 
fund  for  the  purpose."  Neither,  it  seems,  can  the  tax  imposed  by  this 
section  be  sustained  as  a  property  tax.  The  attempt  was  made  to  sustain 
the  tax  on  stock  dividends  as  a  tax  upon  the  shareholders  upon  their 
property  interest  in  the  stock  of  corporations.  The  Supreme  Court,  how- 
ever, denominated  such  a  tax  as  a  tax  upon  property  which  could  not  be 
imposed  without  apportionment.  Whether  the  tax  imposed  by  §  220  is  con- 
stitutionally justifiable  as  being  in  the  nature  of  a  penalty  is  a  question 
which  only  the  courts  can  satisfactorily  determine.  These  considerations 
apply  equally  to  the  tax  imposed  by  §  II-A-2  of  the  1913  Law,  and  §  3  of 
the  1916  Law.  The  doubt  as  to  the  constitutionality  of  §  220  of  the  1918  Law 
is  the  reason  for  the  imposition  by  Congress  of  the  flat  additional  tax  of 
25%  on  corporations  of  the  above  character,  with  the  alternative  tax  on  the 
stockholders  discussed  above.  (See  report  of  the  Revenue  Bill  of  1921  by 
the  senate  committee  on  finance,  p.  16.) 

21  Cf.  Revenue  Act  of  1921,  §  220,  and  Revenue  Act  of  1918,  §  220.  The 
provision  of  the  1918  Law  was  broader  than  the  provision  contained  in  the 
1916  Law,  which  authorized  the  commissioner  to  assess  a  tax  on  the  share- 
holders with  respect  to  the  undistributed  profits  only  in  cases  where  such 
profits  were  allowed  to  accumulate  with  fraudulent  intent  to  avoid  the 
surtax.     Compare  the  section  with  section  8  of  the  Revenue  Act  of  1916. 

22  See  T.  D.  2135. 


THE  INCOME  TAX  RATES  31 

unnecessary  surplus  accumulated  in  prior  years.-^  The  fact 
that  a  corporation  is  in  the  process  of  liquidation  has  been  held 
not  to  render  this  provision  of  the  law  inapplicable.-^ 

The  fact  that  a  corporation  is  a  mere  holding  company,-'^  or 
that  the  gains  and  profits  are  permitted  to  accumulate  beyond 
the  reasonable  needs  of  the  business  is  prinm  facie  evidence  of  a 
purpose  to  escape  the  surtax.  The  collectors,  however,  have  no 
authority  to  decide  when  gains  and  profits  are  accumulated  be- 
yond the  reasonable  needs  of  the  business  so  as  to  be  taxable  as 
indicated  above.  The  commissioner  must  first  certify  that  in  his 
opinion  the  accumulation  is  unreasonable.-*^  In  any  case  the 
commissioner  or  a  collector  may  require  a  corporation  to  furnish 
a  statement  of  its  gains  and  profits  and  of  the  names,  addresses, 
and  shareholdings  of  the  stockholders,  and  if  upon  the  basis  of 
such  statement  or  other  evidence  the  commissioner  certifies  that 
in  his  opinion  its  accumulation  of  profits  is  unreasonable  for 
the  purposes  of  the  business,  the  corporation  and  its  stockhold- 
ers must  make  their  returns  accordingly.-"  Under  the  1918  law, 
when  the  commissioner  had  so  certified,  the  stockholders  were 
notified  and  called  upon  to  add  the  amount  of  their  respective 
shares  in  the  undistributed  gains  and  profits  of  the  corporation 
for  the  year  to  their  income  from  other  sources  and  to  pay  the 
surtax  accordingly. 

Purpose  to  Escape  Surtax.  The  application  of  the  rule  stated 
in  the  foregoing  paragraph  depends  upon  the  two  elements  of 

(a)  purpose  to  escape  the  surtax  and  (b)  unreasonable  accumu- 
lation of  gains  and  profits.  Pri7na  facie  evidence  of  (a)  exists 
where  a  corporation  has  practically  no  business  except  holding 
stocks,  securities  or  other  property  and  collecting  the  income 

-3  O.  D.  188,  T.  B.  8-19-326.  To  such  unnecessary  accumulations,  however, 
the  provisions  of  the  Acts  of  October  3,  1913,  September  8,  1916,  and  October 
3,  1917,  will  be  applicable  according  to  the  respective  years  in  which  such 
acts  were  in  effect  and  such  portions  of  the  surplus  were  accumulated.  The 
applicable  provision  of  the  Act  of  September  8,  1916,  is  §  3  and  not  §  10 

(b)  added  by  the  Revenue  Act  of  1917,  which  provided  for  a  tax  on  the 
undistributed  income  of  corporations  without  reference  to  whether  such 
earnings  were  accumulated  with  a  fraudulent  purpose  of  preventing  the 
imposition  of  the  surtaxes. 

24  O.  D.  838,  T.  B.  10-21-1499. 

25  "A  mere  holding  company"  within  the  meaning  of  this  provision  of  the 
law  would  seem  to  be  a  company  which  does  nothing  but  hold  the  stock 
of  other  corporations,  or  which  merely  holds  or  acts  as  a  receptacle  for 
property  and  which  is  not  actively  engaged  in  business.  (A.  R.  R.  475, 
T.  B.  21-21-1653.) 

2C  Revenue  Act  of  1921,  §220;  Revenue  Act  of  1918,  §220. 
27  Reg.  45,  Art.  351. 


32  FEDERAL  INCOME  TAX 

therefrom,  or  where  a  corporation  other  than  a  mere  holding 
company  permits  its  gains  and  profits  to  accumulate  beyond  the 
reasonable  needs  of  the  business. 

Both  the  Revenue  Act  of  1921  and  the  Revenue  Act  of  1918 
require  that  a  corporation  be  "formed"  or  "availed  of"  for  the 
purpose  of  preventing  the  imposition  of  the  surtax.  The  statutes 
differ  from  prior  laws  in  that  they  do  not  specifically  require  that 
a  corporation  be  "fraudulently"  availed  of.-'^  It  is  to  be  doubted, 
however,  whether  this  distinction  is  not  more  apparent  than 
real.-9  In  any  event,  however,  it  should  be  remembered  that 
there  is  a  presumption  against  fraud.  Good  faith  is  presumed 
and  the  burden  of  proving  fraud  is  on  the  party  asserting  it.^*^ 
The  evidence  by  which  fraud  or  a  fraudulent  purpose  may  be 
proved  should  be  clear  and  unequivocal  and  should  not  admit  of 
any  innocent  construction.  The  certificate  by  the  commissioner 
that  in  his  opinion  the  accumulation  of  profits  of  a  corporation 
is  unreasonable  can  have  no  greater  probative  force  than  the 
facts  upon  which  it  is  predicated  and  is  certainly  open  to  re- 
buttal by  evidence  to  the  contrary. 

The  business  of  a  corporation  is  not  limited  to  that  which  it 
has  previously  carried  on,  but  in  general  includes  any  line  of 
business  which  it  may  legitimately  undertake.  However,  a  rad- 
ical change  of  business  when  a  considerable  surplus  has  been 
accumulated  may  afford  evidence  of  a  purpose  to  escape  the 
surtax.  When  one  corporation  owns  the  stock  of  another  cor- 
poration in  the  same  or  a  related  line  of  business  and  in  effect 
operates  the  other  corporation,  the  business  of  the  latter  may 
be  considered  in  substance  the  business  of  the  first  corporation. 
Gains  and  profits  of  the  first  corporation  put  into  the  second 
through  the  purchase  of  stock  or  otherwise  may  therefore,  if  a 
subsidiary  relationship  is  established,  constitute  employment  of 
the  income  in  its  own  business.  To  establish  that  the  business 
of  one  corporation  can  be  regarded  as  including  the  business  of 
another  it  is  ordinarily  essential  that  the  first  corporation  own 
substantially  all  of  the  stock  of  the  second.  Investment  by  a 
corporation  of  its  income  in  stock  and  securities  of  another  cor- 
poration is  not  of  itself  to  be  regarded  as  employment  of  the 
income  in  its  business.^i 

2RSee  footnote  21,  and  also  cf.  Revenue  Act  of  1921,  §220;  Revenue  Act 
of  1918,  §  220;  Revenue  Act  of  1913,  §  II-A-2. 

29  See  §  252  of  the  1918  and  1921  Laws,  which  prescribe  a  penalty  for 
any  wilful  attempt  to  defeat  or  evade  the  tax  "in  any  manner". 

30  Sanborn  v.  Stetson,  21  Fed.  Cas.  12,  291,  2  Story,  481;  Matter  of 
Green,  67  Hun.  527,  20  N.  Y.  Supp.  538,  affirmed  22  N.  Y.  Supp.  1112. 

31  Reg.  45,  Art.  352. 


THE  INCOME  TAX  RATES  33 

Unreasonable  Accumulation  of  Profits.    An  accumulation 
of  gains  and  profits  is  unreasonable  if  it  is  not  required  for  the 
purposes  of  the  business,  considering  all  the  circumstances  of  the 
case.     No  attempt  can  be  made  to  enumerate  all  the  ways  in 
which  gains  and  profits  of  a  corporation  may  be  accumulated  for 
the  reasonable  needs  of  the  business.-^^    Whether  a  corporation  is 
unreasonably  accumulating  its  profits  cannot  be  determined  in 
advance;  it  must  be  determined  at  a  later  date  in  the  light  of 
what  has  actually  been  done  with  the  profits  retained.-"^-^     The 
question  is  one  of  fact  to  be  decided  upon  consideration  of  the 
volume  of  business  done  and  the  principles  of  sound  business 
management."^     In  determining  what  are  the  reasonable  needs 
of  a  business,  the  general  rule  is  applicable  that  the  amount  of 
capital  necessary  to  accomplish  the  objects  of  a  business  is  a 
matter  largely  in  the  discretion  of  the  directors  of  a  corporation, 
particularly  directors  who  may  be,  by  reason  of  many  years  of 
service,  particularly  familiar  with  the  requirements  of  a  business. 
The  exercise  of  the  discretion  of  such  directors  will  not  be  dis- 
turbed in  the  absence  of  a  clear  or  gross  abuse  thereof.-'^    Where 
a  company  has  been  in  existence  for  a  long  period,  part  of  which 
antedates  the  imposition  of  the  surtax  with  respect  to  undis- 
tributed corporate  profits  and  a  conservative  dividend  policy  has 
been  pursued  prior  to  the  enactment  of  the  tax  on  undistributed 
corporate   profits,   this   fact   will   be   important   in   determining 
whether  there  is  any  unreasonable  accumulation  of  profits.^^*^    A 
retirement  of  capital  stock  indicates  that  additional  capital  is 
not  required  by  a  corporation  and  if  upon  such  a  retirement  sur- 
plus is  permitted  to  stand,  such  surplus  will  be  deemed  an  unrea- 
sonable accumulation."^    Undistributed  income  is  properly  accu- 
mulated if  invested  in  increased  inventories  or  additions  to  plant 
reasonably  needed  by  the  business.    It  is  properly  accumulated  if 
retained  for  working  capital  required  by  the  business  or  in  accord- 
ance with  contract  obligations  placed  to  the  credit  of  a  sinking 
fund  for  the  purpose  of  retiring  bonds  issued  by  the  corporation. 

32  Reg.  45,  Art.  353. 

33  T.  B.  M.  2,  T.  B.  1-19-72. 

34  S.  1117,  T.  B.  15-19-448.  The  fact  that  a  corporation  having;  a  capital 
of  $10,000  and  doing  an  annual  business  in  excess  of  $150,000,  has  an 
accumulation  of  $55,000  in  undivided  profits,  is  not  sufficient  basis  for  the 
finding  that  there  has  been  an  unreasonable  accumulation  of  profits. 

•''>  See  Cook  on  Corporations,  5th  edition,  §  545.  Kester  on  "Accounting 
Theory  and  Practice",  Vol.  II,  p.  210.  Schell  v.  Alston  Mfg.  Co.,  149  Fed. 
439. 

3«  See  A.  R.  R.  475,  T.  B.  21-21-1563. 

37  0.  D.  360,  T.  B.  2-20-667. 


34  FEDERAL  INCOME  TAX 

In  the  case  of  a  banking  institution  the  business  of  which  is  to 
receive  and  loan  money,  using  capital,  surplus  and  deposits  for 
that  purpose,  undistributed  income  actually  represented  by  loans 
or  reasonably  retained  for  future  loans  is  not  accumulated 
beyond  the  reasonable  needs  of  the  business.  The  nature  of  the 
investment  of  gains  and  profits  is  immaterial  if  they  are  not  in 
fact  needed  in  the  business.^^ 

38  Reg.  45,  Art.  353.  In  connection  with  the  interpretation  of  the  phrase 
"reasonable  needs  of  the  business,"  see  the  interpretation  placed  upon  the 
phrase  "reasonable  requirements  of  business",  as  used  in  §  10-b  of  the  1916 
Law.    (See  T.  D.  2736.) 


CHAPTER  3. 

INDIVIDUALS  TO  WHOM   THE  LAW  IS  APPLICABLE 

The  theory  upon  which  the  income  tax  is  imposed  seems  to  be 
two-fold.  The  law  imposes  the  tax  upon  the  net  income  of  all 
persons  within  its  jurisdiction,  regardless  of  the  source  of  such 
income,  and  upon  all  income  arising  from  sources  within  the 
United  States,  regardless  of  whether  or  not  the  United  States 
has  jurisdiction  of  the  recipient.  The  tax  has  been  defined  as  a 
tax  on  the  person,  measured  by  his  ability  to  pay,  that  is,  his  net 
income,!  and  as  a  tax  on  the  income  itself .2  As  a  matter  of  fact, 
it  is  both.  The  government  claims  personal  jurisdiction  over  all 
of  its  citizens  wherever  they  reside  and  over  all  aliens  who  reside 
within  the  borders  of  the  United  States.  Hence,  as  to  citizens 
and  resident  aliens,  the  tax  is  imposed  on  income  from  all  sources 
whether  arising  in  this  country  or  in  a  foreign  country.^    No  jur- 

1  In  Brady  v.  Anderson,  240  Fed.  665,  writ  of  certiorari  denied,  244  U.  S. 
564,  the  court  said :  "In  our  opinion  the  tax  is  against  the  citizens  and  resi- 
dents of  the  United  States  personally.  They  are  chargeable  in  respect  to 
income  received  by  them."  In  State  ex  rel,  Moon  Co.  v.  Wisconsin  Tax 
Commission  166  Wis.  287;  163  N.  W.  639;  165  N.  W.  470,  appeal  dismissed 
by  U.  S.  Supreme  Court,  249  U.  S.  621;  the  court  said:  "Much  confusion 
of  thought  arises  from  regarding  the  income  tax  as  a  tax  that  is  levied  upon 
or  attaches  to  property  as  such,  irrespective  of  the  person  sought  to  be 
taxed.  It  is  the  recipient  of  the  income  that  is  taxed,  not  his  property;  and 
the  vital  question  in  each  case  is,  has  the  person  sought  to  be  taxed  re- 
ceived an  income  during  the  tax  year?  If  so,  such  income,  unless  specifical- 
ly exempted,  is  subject  to  a  tax  though  the  property  out  of  which  it  is  paid 
may  have  been  exempt  from  an  income  tax  in  the  hands  of  the  payer.  It 
is  the  relation  that  exists  between  the  person  sought  to  be  taxed  and  specific 
property  claimed  as  income  to  him  that  determines  whether  there  shall  be 
a  tax.  If  the  person  sought  to  be  taxed  is  the  recipient  during  the  tax 
year  of  such  specific  property  as  income  in  its  ordinary  significance,  then 
the  person  is  taxed.  But  the  tax  is  upon  the  right  or  ability  to  produce, 
create,  receive,  and  enjoy,  and  not  upon  specific  property.  Hence  the 
amount  of  the  tax  is  measured  by  the  amount  of  the  income,  irrespective 
of  the  amount  of  specific  property  or  ability  necessary  to  produce  or  create 
it.  In  the  ordinary  acceptation  of  the  term  this  may  be  said  to  be  a  tax 
upon  income  as  the  statute  denominates  it.  But  the  tax  does  not  seek  to 
reach  property,  or  an  interest  in  property  as  such.  It  is  a  burden  laid  upon 
the  recipient  of  an  income." 

2  In  a  case  decided  by  the  Supreme  Judicial  Court  of  Massachusetts.  Suter 
V.  Jordan-Marsh  Company,  225  Mass.  34.,  113  N.  E.  580,  it  was  held  that 
the  tax  was  levied  upon  the  rent  paid  by  the  defendant  to  the  plaintiff'.  See 
also  Catawissa  R.  Co.  v.  Phila.  &  Reading  Co.,  255  Pa.  St.  269,  99  Atl.  807. 

•■^This  is  generally  true;  the  1921  Law,  however,  contains  a  provision  that 
the  gross  income  of  citizens  and  domestic  corporations  with  a  substantial  pro- 

35 


36  FEDERAL  INCOME  TAX 

isdiction  can  be  claimed  over  the  persons  of  nonresident  aliens, 
but  insofar  as  their  income  is  received  from  sources  within  this 
country,  it  is  taxed  on  the  theory  that  the  government  has  juris- 
diction over  the  income,  grants  protection  to  the  creation  of  such 
income,  and  is,  therefore,  entitled  to  a  share  thereof  to  defray 
the  expenses  of  government.*  The  fact  that  a  person  is  taxable 
in  foreign  countries  on  all  or  part  of  his  income  does  not  relieve 
him  from  tax  liability  on  the  same  income  in  this  country ,•'"'  al- 
though he  is  entitled  under  the  Revenue  Act  of  1921  and  the 
Revenue  Act  of  1918,  to  a  credit  in  certain  cases  against  his  tax 
liability  in  this  country  by  reason  of  the  payment  of  taxes  to 
foreign  countries.^ 

Persons  Exempt  from  the  Tax.  Individuals  may  enjoy  exemp- 
tion from  the  income  tax  by  reason  of  the  amount  or  character^ 
of  their  income. 

Exemption  Based  on  Amount  of  Income.  Citizens  and 
residents  receiving  less  than  $1,000  of  net  income  during  the  year, 
if  single,  or  less  than  $2,500,  if  the  head  of  a  family  or  a  mar- 
ried person  living  with  husband  or  wife,  are  exempt  from  the 
tax.  Such  persons  are  not  required  to  file  returns,  unless  they 
have  a  gross  income  of  $5,000  or  over,  or,  if  husband  and  wife, 
an  aggregate  gross  income  of  $5,000  or  over.  But  on  demand 
of  the  commissioner  they  may  be  required  to  file  a  statement 
sufficient  to  satisfy  him  that  they  are  not  liable.'''  Nonresident 
aliens  and  citizens  deriving  a  substantial  proportion  of  income 
from  sources  within  a  United  States  possession  are  allowed  a 
personal  exemption  of  $1,000  on  income  received  from  sources 
within  the  United  States  if  they  file  the  required  returns.^ 

portion  of  income  from  sources  within  United  States  possessions  shall  be 
limited  to  income  from  United  States  sources   (Revenue  Act  of  1921,  §  262). 

4  Reg.  45,  Art.  3.  See  Union  Transit  Co.  v.  Kentucky,  199  U.  S.  194; 
Mag-uire  v.  Trefry,  253  U.  S.  12,  230  Mass.  503,  120  N.  E.  162. 

5T.  D.  2152. 

6  Revenue  Act  of  1921,  §§222,  238;  Revenue  Act  of  1918,  §§222,  238. 
This  credit  against  a  person's  tax  should  not  be  confused  w^ith  the  deduction 
of  taxes  in  order  to  determine  net  income. 

7  Revenue  Act  of  1921,  §§  223,  1307.  Under  the  1918  Law  a  married  per- 
son was  exempt  only  to  the  extent  of  $2,000;  and  that  law  determined 
whether  a  return  should  be  filed  on  the  basis  of  net,  not  gross,  income  in 
all  cases   (Revenue  Act  of  1918,  §§223,  1305). 

8  Revenue  Act  of  1921,  §§  216  (e),  217  (g).  Under  the  1918  Law,  non- 
resident aliens  were  allowed  a  personal  exemption  of  $2,000  provided  the 
country  of  which  they  were  subjects,  if  it  imposed  an  income  tax,  allowed 
a  similar  credit  to  citizens  of  the  United  States. 


individuals  to  whom  the  law  is  applicable  37 

Exemption  Based  on  Character  of  Income  or  Status  of 
Recipient.    Individuals  may  also  enjoy  an  exemption  from  the 
tax  because  of  the  character  of  their  income,   or  because   of 
their  status,  or  both,  since  the  law  expressly  provides  that  cer- 
tain kinds  of  income  shall  not  be  included  in  gross  income  and 
shall  be  exempt  from  the  tax.     Among  the  items  of  income  so 
exempt''  are:     (a)   the  proceeds  of  life  insurance  policies  paid    <- 
upon  the  death  of  the  insured  ;^o   (b)   the  amount  received  by 
the   insured   as   return   of  premiums   paid   by   him    under   life 
insurance,   endowment   or  annuity  contracts;    (c)    property   ac-  *- 
quired  by  gift,  bequest,  devise  or  descent  (but  the  income  from 
such  property  is  taxable)  ;   (d)   amounts  received  through  acci- 
dent or  health  insurance  or  under  Workmen's  Compensation  Acts 
as  compensation  for  personal  injuries  or  sickness  and  the  amount 
of  any  damages  received  whether  by  suit  or  agreement  on  ac- 
count of  such  injuries  or  sickness;    (e)    the  income  of  a  non- 
resident alien  or  foreign   corporation  consisting  exclusively  of 
earnings  derived  from  the  operation  of  ships  documented  under 
the  laws  of  a  foreign  country  which  grants  an  equivalent  exemp- 
tion to  citizens  of  the   United  States  and  to  corporations   or- 
ganized in  the  United  States;    (f)    compensation,  family  allot- 
ments and  allowances   under  the  provisions   of  the   War  Risk 
Insurance   and  the  Vocational  Rehabilitation   Act,   or  pensions 
from  the  United  States  for  service  of  the  beneficiary  or  another 
in  the  military  or  naval  forces  of  the  United  States  in  time  of 
war;"  (g)  so  much  of  the  amount  received  by  an  individual  after  H[ 
December  31,  1921,  and  before  January  1,  1921,  as  interest  or  J) 
dividends  from  domestic  building  and  loan  associations i^  oper- 
ated exclusively  for  the  purpose  of  making  loans  to  members, 

9  Revenue  Act  of  1921,  §213   (b)  ;  Revenue  Act  of  1918,  §213   (b). 

10  Such  proceeds  must  be  paid  "to  individual  beneficiaries,  or  to  the 
estate  of  the  insured,"  under  the  1918  Law. 

11  Such  compensation  was  taxable  under  the  Revenue  Act  of  1918  (letter 
from  treasury  department  dated  April  7,  1921;  I.  T.  S.  1921,  T|2975). 
The  term  "active  services"  is  used  in  the  sense  of  services  in  all  military 
and  naval  branches  at  home  or  abroad,  as  contradistinguished  from  the 
retired  or  reserve  list  and  is  not  confined  merely  to  services  in  the  field  or 
the  theatre  of  war.  The  term  "military  or  naval  forces"  includes  the  Marine 
Corps,  the  Coast  Guard,  the  Army  Nurse  Corps,  Female,  and  the  Navy 
Nurse  Corps,  Female,  but  this  definition  does  not  exclude  other  units  other- 
wise included  (Revenue  Act  of  1921,  §2  [10]).  The  term  also  includes 
army  contract  surgeons,  but  does  not  include  members  of  draft  boards. 
(Reg.  45,  Art.  86.)  It  does  not  include  the  Public  Health  Service  (T.  D. 
3242).  Under  the  1918  Law,  so  much  of  the  amount  received  during  the  war 
with  Germany  by  a  person  in  the  military  or  naval  forces  as  salary  or 
compensation  in  any  form  from  the  United  States  for  active  services  in 
such  forces,  as  did  not  exceed  $3,500,  was  exempt. 

12  For  a   definition   of  building  and   loan   associations   see   Chapter  13. 


38  FEDERAL  INCOME  TAX 

as  does  not  exceed  $300 ;  and  (h)  the  rental  value  of  a  dwelling 
house  and  appurtenances  thereof  furnished  to  a  minister  of  the 
gospel  as  part  of  his  compensation.  Income  derived  from  the 
operation  of  a  public  utility  and  the  receipts  of  shipowners' 
mutual  protection  and  indemnity  associations  is  also  exempt  to 
a  certain  extent  and  under  certain  conditions,  as  is  indicated 
more  fully  in  another  chapter.^^  Interest  upon  (1)  the  obligations 
of  a  state,  territory  or  any  political  subdivision  thereof,  the 
District  of  Columbia,  or  any  possession  of  the  United  States, 
(2)  securities  issued  under  the  provisions  of  the  Federal  Farm 
Loan  Act,  (3)  the  obligations  of  the  United  States,  issued  prior 
to  September  1,  1917,  is  exempt.  The  interest  upon  obligations 
of  the  United  States  issued  after  September  1,  1917  (other  than 
postal  savings  certificates  of  deposit)  and  bonds  issued  by  the 
War  Finance  Corporation  is  exempt  only  if  and  to  the  extent 
provided  in  the  acts  authorizing  the  issue  thereof,  as  amended 
and  supplemented,  and  may  be  excluded  from  gross  income  only 
if  and  to  the  extent  it  is  wholly  exempt  from  taxation  to  the  tax- 
payer both  under  the  income  and  excess-profits  taxes.^^  The 
1916  Law  expressly  exempted  the  compensation  of  the  present 
President  of  the  United  States,  during  the  term  for  which  he  has 
been  elected,  and  the  compensation  of  the  judges  of  the  Supreme 
Court  and  inferior  courts  of  the  United  States,  in  office  at  the 
time  the  Act  was  passed,  but  the  Revenue  Act  of  1921,  and 
the  Revenue  Act  of  1918  expressly  tax  the  compensation-received 
as  such  of  the  President,  the  judges  of  the  Supreme  Court  and 
inferior  courts  of  the  United  States,  and  all  other  officers  and 
employees,  whether  elected  or  appointed,  of  the  United  States, 
Alaska,  Hawaii,  or  any  political  subdivision  thereof,  or  the  Dis- 
trict of  Columbia.15  Neither  the  Revenue  Act  of  1921  nor  the 
Revenue  Act  of  1918  expressly  exempts  "the  compensation  of 
all  oflJicers  and  employees  of  a  state,  or  any  political  subdivision 
thereof,  except  when  such  compensation  is  paid  by  the  United 
States  Government,"!*^  as  did  the  1916  law.  It  seems  to  have 
been  the  intent  of  congress  in  the  present  statute  and  the 
1918  Law  to 'tax  such  salaries  and  to  leave  the  constitutional 

13  See  Chapter  14. 

14  Revenue  Act  of  1921,  §§213  (b)  4,  233;  Revenue  Act  of  1918,  §§214 
(b)   4,  233. 

15  Revenue  Act  of  1916,  §4.    But  see  Chapter  15. 

16  Revenue  Act  of  1921,  §213  (a);  Revenue  Act  of  1918,  §213  (a). 
The  constitutional  question  involved  in  taxing  such  salaries  is  discussed  in 
Chapter  15. 


INDIVIDUALS  TO  WHOM  THE  LAW  IS  APPLICABLE  39 

question  involved  in  levying  the  tax  to  the  courts, ^^  but  the 
treasury  department  has  ruled  that  compensation  paid  to  its 
officers  and  employees  by  a  state  or  any  political  subdivision 
thereof,  will  not  be  taxed.'"'  Exempt  income  is  omitted  from 
the  returns  of  individuals  and  corporations, i-'  but  income  exempt 
only  from  normal  tax  and  not  from  surtax,  or  from  the  income 
tax,  but  not  from  the  excess-profits  tax,  must  be  included  in  the 
return. 

Citizens  of  the  United  States.  Citizens  of  the  United  States 
are  ordinarily  taxable  upon  their  net  income  from  all  sources, 
whether  they  reside  in  this  country  or  not.-"  With  the  exception 
of  citizens  deriving  a  substantial  proportion  of  their  income 
from  sources  within  a  possession  of  the  United  States,  it  makes 
no  difference  that  they  may  own  no  assets  within  the  United 
States  and  may  receive  no  income  from  sources  within  the  United 
States.-'  They  are  taijcable  for  the  purpose  of  the  surtax  upon 
their  entire  net  income  received  in  each  year  from  all  sources 
and  for  the  purpose  of  the  normal  tax  upon  net  income  less 
statutory  credits.—  Income  wholly  exempt  is  not  included  in 
gross  income,  the  foundation  for  the  computation  of  net  income.^^ 
On  dividends  of  domestic  and  certain  foreign  corporations  they 
are  liable  only  for  the  surtax;  and  so  also  with  respect  to  inter- 
est on  bonds  of  the  United  States  issued  after  September  1,  1917, 
and  bonds  of  the  War  Finance  Corporation.-^  The  regulations 
and  rulings  respecting  taxable  and  nontaxable  income  are,  as 
a  rule,  applicable  both  to  individuals  and  corporations,  and  are 
discussed  in  detail  in  the  later  chapters  on  income.--^ 

17  Revenue  Act  of  1921,  §213  (a);  Revenue  Act  of  1918,  §213  (a). 
The  constitutional  question  involved  in  taxing  such  salaries  is  discussed  in 
Chapter   15. 

18  Reg.  45,  Art.  85.     This  subject  is  more  fully  discussed  in  Chapter  15. 

19  Reg.  45,  Art.  71.  The  exclusion  of  such  income  should  not  be  confused 
with  the  reduction  of  taxable  income  by  the  application  of  allowable  de- 
ductions. 

20  In  U.  S.  V.  Goelet,  232  U.  S.  293,  the  court  held  that  a  United  States 
citizen  permanently  residing  or  domiciled  aboard  was  not  liable  to  the  tax 
on  foreign-built  yachts  imposed  by  the  tariff  act  of  August  5,  1909.  The 
court  said  that  "the  taxing  power,  when  exerted,  is  not  usually  applied  to 
those  even  albeit  they  are  citizens,  who  have  a  permanent  domicile  or  resi- 
dence outside  of  the  country  levying  the  tax." 

21  Reg.  45,  Art.  3.     See  Revenue  Act  of  1921,  §  262. 

22  Reg.  45,  Art.  21. 

23  Revenue  Act  of  1921,  §§213,  212;  Revenue  Act  of  1918,  §§213,  212; 
Reg.  45,   Art.  21. 

24  Revenue  Act  of  1921,  §216;  Revenue  Act  of  1918,  §216. 

25  See  Chapters  14-20. 


40  FEDERAL  INCOME  TAX 

Who  Is  a  Citizen.  Every  person  born  in  the  United  States 
subject  to  its  jurisdiction,  or  naturalized  in  the  United  States, 
is  a  citizen.  An  individual  born  in  the  United  States  of  citizen 
or  resident  alien  parents,  who  has  long  since  moved  to  a  foreign 
country  and  established  a  domicile  there,  but  who  never  has  been 
naturalized  therein  or  taken  an  oath  of  allegiance  thereto  is  still 
a  citizen  of  the  United  States.-*''  Married  women  are  considered 
to  have  the  same  citizenship  as  their  husbands.  An  American 
woman  who  marries  a  foreigner  consequently  loses  her  status 
as  an  American  citizen  and  is  thereafter  treated  as  an  alien.-"^ 
Determination  by  the  state  department  of  the  status  of  an 
individual  is  not  conclusive  upon  the  treasury  department  in 
fixing  citizenship  for  income  tax  purposes.-*^  Under  the  natural- 
ization laws  of  the  United  States,  the  naturalization  of  a  father 
operates  to  confer  the  right  of  citizenship  upon  his  minor  child, 
who  is  dwelling  at  the  time  of  the  father's  naturalization  within 
the  jurisdiction  of  the  United  States  or  who  dwells  within  that 
jurisdiction  subsequent  to  the  father's  naturalization  and  dur- 
ing the  child's  minority.  If,  after  attaining  his  majority,  the 
son  returns  to  his  native  land,  but  registers  with  the  American 
consul  under  the  rules  and  regulations  prescribed  by  the  depart- 
ment of  state  as  an  American  citizen  residing  abroad,  his  status 
under  American  law  is  that  of  an  American  citizen.  A  minor, 
an  alien  by  birth,  living  with  and  subject  to  the  authority  and 
guardianship  of  a  mother  who  became  an  American  citizen  by 
marriage,  the  minor  having  been  physically  present  in  the  United 
States  at  the  time  of  such  marriage,  and  the  mother  at  that  time 
having  intended  this  country  to  be  the  minor's  permanent  place 
of  residence  or  domicile,  is  an  American  citizen  and  cannot  elect 
another  nationality  or  expatriate  himself  while  he  is  a  minor. 
No  election  which  he  may  make  after  his  majority  will  affect  his 
status  as  a  citizen  during  his  minority.^^  A  naturalized  citizen, 
over  the  age  of  majority,  who  takes  an  oath  of  allegiance  to 
a  foreign  government  has  expatriated  himself.'^"  He  does  not 
become  repatriated  by  subsequently  applying  to  an  American 
consul  for  registration  as  an  American  citizen  residing  abroad, 
even  though  his  registration  is  accepted  by  the  department  of 
state.     The  oath  of  allegiance  taken  upon  such  registration  is 

2<iReg.   45,   Art.   4. 

27  T.   D.   2092. 

28  T.  D.  2135. 

2!>0.  D.   695,  T.  B.  43-20-1256;   O.  D.  1085,  T.   B.  44-21-1897. 
30  See  Act  of  March  2,  1907,  §  2. 


INDIVIDUALS  TO  WHOM  THE  LAW  IS  APPLICABLE  41 

not  the  one  prescribed  by  the  naturalization  law  and  regulations, 
which  oath  must  be  taken  as  a  condition  to  repatriation.'''^ 

Citizens  Residing  in  the  United  States.  Citizens  residing 
in  the  United  States  report  and  pay  the  tax  in  the  district  in 
which  they  legally  reside  or  have  their  principal  place  of  busi- 
ness, regardless  of  where  their  income  may  arise."^^ 

Citizens  Residing  Abroad.  If  a  citizen  residing  abroad  has 
no  office  or  place  of  business  in  this  country,  he  files  his  return 
and  pays  his  tax  to  the  collector  at  Baltimore,  Maryland.^^  with 
the  exception  indicated  in  the  next  paragraph,  he  is  required 
to  report  his  income  from  all  sources,  whether  within  or  with- 
out the  United  States.  Income  received  by  a  citizen  of  the 
United  States  residing  abroad  from  foreign  sources  in  foreign 
money  or  credits  should  be  reported  in  terms  of  United  States 
money  on  the  basis  of  the  rate  of  exchange  in  effect  at  the  time 
it  was  actually  received."'^  Although  the  question  as  to  the 
liability  of  a  nonresident  citizen  is  determined  by  the  treasury 
department,  not  by  the  state  department,  still,  in  the  case  of 
a  naturalized  citizen  against  whom  the  presumption  of  expatria- 
tion has  arisen,  the  fact  that  he  has  paid  the  income  tax  will 
receive  due  consideration  by  the  state  department  in  connection 
with  other  evidence  submitted  to  overcome  such  presumption 
in  connection  with  applications  for  passports  or  for  registra- 
tion in  a  consulate  or  for  actual  protection  in  a  foreign  coun- 
try. The  payment  of  the  income  tax  will  also  be  duly  considered 
by  the  state  department  in  passing  upon  rights  to  the  continued 
protection  of  this  government  in  cases  of  native  American  citi- 
zens who  have  resided  abroad  for  a  period  sufficiently  prolonged 
to  raise  the  natural  presumption  that  they  have  abandoned  citi- 
zenship in  this  country."^^ 

Citizens  Deriving  Income  From  United  States  Possessions. 
Citizens  who  for  three  years  immediately  preceding  the  close 
of  the  taxable  year  derive  80  ^c  or  more  of  their  gross  income 
from  sources  within  a  possession  of  the  United  States  and  507c 
for  the  same  period  from  the  active  conduct  of  a  trade  or  busi- 
ness within  a  possession  of  the  United  States,  either  on  their 

31  See  Act  of  May  9,  1918,  §4;  O.  D.  861,  T.  B.  14-21-1540. 

32  Revenue  Act  of  1921,  §  227  (b)  ;  Revenue  Act  of  1918,  §  227  (b)  ;  Reg. 
45,  Art.  448. 

33  Revenue  Act  of  1921,  §227    (b)  ;   Revenue  Act  of  1918,  §227    (b). 

34  0.  D.  459,  T.  B.  16-20-873.  For  the  rates  of  exchange  prevailing  on 
various  dates,  see  Chapter  14. 

35  Letter  from  secretary  of  state  to  American  diplomatic  and  consular 
officers,  dated  March  18,  1914;  I.  T.  S.  1918,  ^5;  Revenue  Act  of  1918, 
§227   (b). 


42  FEDERAL  INCOME  TAX 

own  account  or  as  employees  or  agents  of  another,  are  treated 
as  nonresident  aliens  under  the  Revenue  Act  of  1921,  except 
that  all  amounts  received  by  such  citizens  within  the  United 
States,  whether  derived  from  sources  within  or  without  the 
United  States,  must  be  included  in  their  gross  income.s^ 

Aliens  Residing  in  the  United  States.  All  residents  of  this 
country,  even  though  they  may  be  aliens,  are  generally  classified 
with  citizens  of  the  United  States  for  the  purpose  of  income 
tax,  and  are  taxable  upon  their  entire  net  income  from  all 
sources.''''''  Where  a  nonresident  alien  taxpayer  becomes  a  citizen 
or  resident  of  the  United  States  during  the  taxable  year,  he  is 
taxable  for  the  entire  year  upon  income  derived  from  all 
sources.38  The  question  whether  or  not  an  alien  resides  in  this 
country  is  sometimes  difficult  to  determine.  The  Treasury  Depart- 
ment holds  that  the  term  "nonresident  alien  individual"  means 
an  individual  (a)  whose  residence ■■'■^  is  not  withii?  the  United 
•States,  and  (b)  who  is  not  a  citizen  of  the  United  States.  Any 
alien  actually  present  in  the  United  States,  who  is  not  a  mere 
transient  or  sojourner,  is  a  resident  of  the  United  States  for 
purposes  of  the  income  tax.  Whether  he  is  a  transient  or  not 
is  determined  by  his  intentions  with  regard  to  his  stay  and 
the  length  and  nature  of  his  stay.  If  he  lives  in  the  United 
States  and  has  no  definite  intention  as  to  his  stay,  he  is  a  resi- 
dent. A  mere  floating  intention,  indefinite  as  to  time,  to  return 
to  another  country  is  not  sufficient  to  constitute  him  a  transient. 
One  who  comes  to  the  United  States  for  a  definite  purpose  which 
in  its  nature  may  be  promptly  accomplished  is  a  transient ;  but  if 
his  purpose  is  of  such  a  nature  that  an  extended  stay  may  be 
necessary  for  its  accomplishment,  and  to  that  end  the  alien 
makes  his  home  temporarily  in  the  United  States,  he  becomes 
a  resident,  though  it  may  be  his  intention  at  all  times  to  return 
to  his  domicile  abroad  when  the  purpose  for  which  he  came  has 
been  consummated  or  abandoned. 

Proof  of  Residence  of  Alien.  The  following  rules  of  evi- 
dence will  govern  in  determining  whether  or  not  an  alien  within 

-^fi  Revenue  Act  of  1921,  §  262.  The  Virgin  Islands  are  not  a  possession 
of  the  United  States  within  the  meaning  of  this  provision. 

37  Reg.  45,  Art.  3. 

38  0.  785,  T.  B.  1-19-66. 

39  The  treasury  department  has  adopted  the  follow^ing  definition  of  the 
word  "residence"  as  used  in  the  income  tax  laws:  "That  place  where  a 
man  has  his  true,  fixed  and  permanent  home  and  principal  establishment, 
and  to  which,  whenever  he  is  absent,  he  has  the  intention  of  returning; 
and  indicates  permanency  of  occupation  as  distinct  from  lodging  or  board- 
ing, or  temporary  occupation."    (T.  D.   2242.) 


INDIVIDUALS  TO  WHOM  THE  LAW  IS  APPLICABLE  43 

the  United  States  has  acquired  residence  therein.  An  alien,  by 
reason  of  his  alienage,  is  presumed  to  be  a  nonresident  alien. 
Such  presumption  may  be  overthrown  (1)  in  the  case  of  an 
alien  who  presents  himself  for  determination  of  tax  liability 
prior  to  departure  for  his  native  country,  by  (a)  proof  that  the 
alien,  at  least  six  months  prior  to  the  date  he  so  presents  him- 
self, has  filed  a  declaration  of  his  intention  to  become  a  citizen 
of  the  United  States  under  the  naturalization  laws,  (b)  proof 
that  the  alien,  at  least  six  months  prior  to  the  date  he  so  presents 
himself,  has  filed  Form  1078  (revised)  or  its  equivalent  with  the 
withholding  agent  charged  with  the  duty  of  withholding  the 
tax  on  income  paid  to  nonresident  aliens,  or  (c)  proof  of  acts 
and  statements  of  the  ahen  showing  a  definite  intention  to 
acquire  residence  in  the  United  States  or  showing  that  his  stay 
in  the  United  States  had  been  of  such  an  extended  nature  as  to 
constitute  him  a  resident;  (2)  in  all  other  cases  by  (a)  proof 
that  the  alien  has  filed  a  declaration  of  his  intention  to  become 
a  citizen  of  the  United  States  under  the  naturalization  laws, 
(b)  proof  that  the  alien  has  filed  Form  1078  (revised)  or  its 
equivalent,  or  (c)  proof  of  acts  and  statements  of  an  alien  show- 
ing a  definite  intention  to  acquire  residence  in  the  United  States 
or  showing  that  his  stay  in  the  United  States  has  been  of  such 
an  extended  nature  as  to  constitute  him  a  resident.  In  any  case 
in  which  an  alien  seeks  to  overcome  the  presumption  of  non- 
residence  under  (1)  (c)  or  (2)  (c)  above,  if  the  officer  who 
examines  the  alien  is  in  doubt  as  to  the  facts,  such  officer  may, 
to  assist  him  in  determining  the  facts  require  an  affidavit  or 
affidavits  setting  forth  the  facts  relied  upon,  executed  by  some 
credible  person  or  persons,  other  than  the  alien  and  members 
of  his  family,  who  have  known  the  alien  at  least  six  months 
prior  to  the  date  of  execution  of  the  affidavit  or  affidavits.^*^ 

Loss  OF  Residence  by  Alien.  An  alien  who  has  acquired  resi- 
dence in  the  United  States  retains  his  status  as  a  resident  until 
he  abandons  the  same  and  actually  departs  from  the  United 
States.  An  intention  to  change  his  residence  does  not  change 
his  status  as  a  resident  alien  to  that  of  a  nonresident  alien. 
Thus  an  alien  who  has  acquired  a  residence  in  the  United  States 
is  taxable  as  a  resident  for  the  remainder  of  his  stay  in  the 

40  Reg.  45,  Alts.  312  and  313,  as  amended  by  T.  D.  3155,  T.  B.  17-21-1599; 
Reg.  45,  Art.  362;  T.  D.  2794;  T.  D.  2242.  See  O.  D.  127,  T.  B.  3-19-195. 
This  rule  differs  from  the  English  rule  which  provides  that  a  person  within 
the  United  Kingdom,  for  some  temporary  pui-pose  only,  for  less  than  six 
months  during  the  year,  is  not  taxable  as  a  resident,  but  after  a  residence 
of  six  months  he  becomes  chargeable  with  the  duties  for  the  year  com- 
mencing on   April   6th   preceding. 


44  FEDERAL  INCOME  TAX 

United  States.  The  status  of  an  alien  on  the  last  day  of  his 
taxable  year  or  period  determines  his  liability  to  tax  for  such 
year  or  period  as  a  resident  or  nonresident.^^  A  British  citizen, 
a  member  of  a  British  partnership,  who  is  within  the  terri- 
torial limits  of  the  United  States  seven  or  eight  months  of 
the  year  for  the  purpose  of  transacting  business  for  the  part- 
nership and  who  returns  to  Europe  when  the  purpose  which 
necessitates  his  presence  in  the  United  States  is  accomplished 
is  considered  a  nonresident  alien.^-  The  fact  that  Germans 
who  were  resident  aliens  of  the  United  States  prior  to  the  war 
with  Germany  were  registered  as  alien  enemies  will  not  de- 
prive them  of  their  status  as  residents  if  the  conduct,  acts,  and 
declarations  of  the  aliens  indicate  their  intention  to  maintain 
their  status  as  residents.^*'  The  treasury  department  holds 
that  residence  in  the  United  States  by  an  alien  for  as  much  as 
one  year  establishes  a  presumption  that  such  alien  is  a  resident 
of  the  United  States  and  this  presumption  will  be  indulged  in 
the  absence  of  known  facts  showing  that  the  alien  is  in  fact 
a  transient.^^  The  distinction  between  resident  and  nonresi- 
dent aliens  is  also  discussed  elsewhere  in  this  book.-^-^ 

Nonresident  Aliens.^*'  Nonresident  aliens  are  those  individ- 
uals who  are  neither  citizens  nor  residents  of  this  country.^'^  As 
stated  above,  they  are  taxable  only  on  that  part  of  their  income 
which  is  from  sources  within  the  United  States.^^ 

Taxation  of  Individuals  Between  United  States  and  Porto  Rico 
and  Philippine  Islands.  A  citizens  of  the  United  States  who  re- 
sides in  Porto  Rico,  and  a  citizen  of  Porto  Rico  who  resides  in 
the  United  States,  may  be  taxed  in  both  places,  but  the  income 
tax  in  the  United  States  may  be  credited  with  the  amount  of 
any  income,  war-profits  and  excess-profits  taxes  paid  in  Porto 
Rico.  If  a  resident  of  the  United  States,  who  is  not  a  citizen 
of  Porto  Rico,  is  taxed  in  Porto  Rico,  as  a  nonresident  alien 
individual  on  any  income  derived  from  sources  within  Porto 
Rico,  the  income  tax  in  the  United  States  may  be  credited  with 
the  tax  paid  in  Porto  Rico.  A  resident  of  Porto  Rico,  who  is 
not  a  citizen  of  the  United  States,  is  taxable  in  the  United 
States  as  a  nonresident  alien  individual  on  any  income  derived 

«  Reg.  45,  Art.  314,  as  amended  by   T.  D.  3155,   T.   B.   17-21-1599. 

42  0.  D.  592,  T.  B.  29-20-1072. 

43  0.  D.  400,   T.  B.   6-20-731. 

44  0.  D.  197,  T.  B.  9-19-342. 

45  See  Chapter  4. 

4*>  The  term  "nonresident  alien"  is  defined  more  fully  in  Chapter  4. 

47  Reg.  45,  Art.  312;  O.  D.  333,  T.  B.  28-19-619. 

4.^  Revenue  Act  of  1921,  §§213   (c),  217;  Revenue  Act  of  1918,  §213   (c). 


INDIVIDUALS  TO  WHOM  THE  LAW   IS  APPLICABLE  45 

from  sources  within  the  United  States,  and  receives  no  credit. 
The  same  principles  apply  in  the  case  of  the  Philippine  Islands.^'' 
But  citizens  of  the  United  States  who  have  derived  for  a  three- 
year  period  preceding  the  close  of  the  taxable  year,  80' t  of 
their  gross  income  from  sources  within  a  possession  of  the 
United  States  and  50'/<  of  their  gross  income  from  the  active 
conduct  of  a  trade  within  a  United  States  possession,  may  be 
taxed,  as  to  the  United  States,  as  nonresident  aliens.''" 

Husband  and  Wife.  In  so  far  as  possible  the  family  is  treated 
as  a  unit  for  purposes  of  the  income  tax,  and  the  husband  and 
wife  may  make  joint  returns."'^  The  matter  of  filing  returns  by 
husband  and  wife  is  treated  more  fully  in  another  chapter,"'-  ex- 
cept as  to  the  efi^'ect  of  the  "community  property  system"  which  is 
treated  below. 

"Community"  Property  and  Income  of  Husband  and 
Wife.  What  is  known  as  the  "community  property  system" 
prevails  in  Texas,  Arizona,  California,.  Washington,  Louisiana, 
Idaho,  Nevada  and  New  Mexico.  It  seems  to  have  had  its  origin 
in  France  and  Spain  and  to  have  been  brought  thence  into  the 
judicial  systems  of  the  above  states.  Community  property 
laws  provide  generally  that  all  property  acquired  during  mar- 
riage by  the  industry  and  labor  of  either  husband  or  wife, 
or  both  together,  with  the  produce  and  increase  thereof,  be- 
longs to  both  in  equal  shares  during  the  continuance  of  the 
marital  relation."'-'  The  foundation  of  this  community  property 
system  lies  in  the  fact  or  the  legal  assumption  that  all  property 
acquired  during  marriage  otherwise  than  by  gift,  devise  or 
descent,  is  acquired  by  the  joint  efforts  of  husband  and  wife."'^ 
Their  relation  partakes  of  the  nature  of  a  partnership  in  which 
each  partner  may  have  separate  assets  or  property  as  well  as 
common  stock  of  acquisitions  and  gains.  The  business  of  the 
firm  generally  is  transacted  in  the  name  of  the  husband  and 

•it»  Revenue  Act  of  1921,  §222;  Reg.  45,  Art.  1132;  Lawrence  v.  Wardell, 
270  Fed.  682,  affirmed  273  Fed.  405.     See  Chapter  32. 

•"•"  See  Chapter  4  for  a  full  discussion  of  this  subject. 

■"'1  Revenue  Act  of   1921,  §223;   Revenue  Act  of   1918,  §223. 

^'-See   Chapter  34. 

•>"  See  Tucker  v.  Carr,  39  Tex.  98;  Cooks  v.  Bremond,  27  Tex.  457;  Fennell 
V.  Drinkhouse,  131  Cal.  447,  63  Pac.  734;  Washburn  v.  Washburn,  9  Cal. 
475;  Succession  of  Webre,  49  La.  Ann.  1491,  22  So.  390;  Knight  v.  Kauf- 
man, 105  La.  35,  29  So.  711;  Manning  v.  Burke,  107  La.  456,  31  So.  862; 
Abbott  v.  Wetherby,  6  Wash.  507,  33  Pac.  1070;  Yake  v.  Pugh,  13  Wash. 
78,  42  Pac.  528;  Sherlock  v.  Denny,  28  Wash.  170,  68  Pac.  452;  Cline  v. 
Hackbarth,  27  Tex.  Civ.  App.  391,  65  S.  W.  1086;  Johnson  v.  Burford,  39 
Tex.  242;  Pearce  v.  Jackson,  61  Tex.  642. 

•"•^  Nickerson  v.  Nickerson,  65  Tex.  281. 


S" 


46  FEDERAL  INCOME  TAX 

he  prosecutes  and  defends  its  suits  with  the  same  effect  as  if 
his  partner  were  named  in  the  case,^^  and,  although  community- 
property  has  not  all  the  incidents  of  partnership  property,  it 
has  many  of  them  and  is  commonly  spoken  of  as  partnership 
property.56  In  a  conventional  partnership  the  gains  of  the 
partners  are  in  proportion  to  their  respective  shares  of  stock 
and  services,  but  in  the  conjugal  partnership  implied  in  the 
community  property  system,  the  division  is  equal  although  one 
spouse  may  have  brought  in  the  greater  part  if  not  all  of  the 
property  from  which  the  profits  are  derived  or  may  have  con- 
tributed all  his  or  her  skill  and  services  unaided  by  the  other.^^ 
The  fact  that  one  or  the  other  of  the  spouses  may  do  all  the 
work  does  not  change  the  character  of  community  property's 
and  though  the  management  and  disposal  of  community  prop- 
erty during  marriage  are  usually  given  to  the  husband,  this  is 
said  to  be  for  reasons  of  public  policy  and  social  economy  and 
not  on  the  ground  that  the  husband  has  any  greater  interest 
in  it  than  the  wife. 

It  appears  that  in  all  of  the  community-property  states  except 
California  their  own  courts  have  held  that  the  wife  has,  during 
the  existence  of  the  marriage  relation,  a  vested  interest  in  one- 
half  of  the  community  property.  Her  rights  in  the  property  of 
the  community  are  perhaps  most  fully  recognized  in  the  state  of 
Washington,  where  both  spouses  have  testamentary  disposition 
over  one-half  of  the  community  property,  and  where,  in  the 
absence  of  such  disposition,  it  descends  to  their  issue,  or,  in  the 
absence  of  issue,  to  the  survivor ;  while  the  husband  is  manager 
of  the  community  estate  in  Washington  he  may  not  sell,  convey, 
or  encumber  real  estate  unless  the  wife  join  with  him  in  the 
conveyance;  and  the  separate  debt  of  the  husband  cannot  be 
satisfied  out  of  community  property  where  it  is  not  incurred 
in  connection  with  the  community  business,  nor  for  the  benefit 
of  the  community.'^ 

55  Simpson  v.  Brotherton,  62  Tex.  170. 

50  De  Blanc  v.  Lynch  &  Co.,  23  Tex.  25;  Wilkinson  v.  Wilkinson,  20  Tex. 
237;  Holyoke  v.  Jackson,  3  Wash.  Terr.  235,  3  Pac.  841. 

57  Wheat  V.  Owens,  15  Tex.  241;  Routh  v.  Routh,  57  Tex.  589;  Merrell  v. 
Moore,  47  Tex.  Civ.  App.  200,  104  S.  W.  514;  Edwards  v.  Brown,  68  Tex. 
329;  Saunders  v.  Isbell,  5  Tex.  Civ.  App.  513,  24  S.  W.  307;  Barr  v.  Simp- 
son, 54  Tex.  Civ.  App.  105,  117  S.  W.  1041;  Wright  v.  Hays'  Admr.,  10 
Tex.  130;  Zimpelman  v.  Robb,  53  Tex.  274;  T.  D.  2450. 

58  Yates  v.  Houston,  3  Tex.  433. 

59  Pierce's  Washington  Code  of  1919,  §  1424-6.  Holyoke  v.  Jackson,  3 
Wash.  T.  235;  Mabie  v.  Wittaker,  10  Wash.  656,  39  Pac.  172;  Martson  v. 
Rue,  92  Wash.  129,  159  Pac.  Ill;  Schramm  v.  Steele,  97  Wash.  309,  166 
Pac' 634;  Huyvaerts  v.  Roedtz,  105  Wash.  657,  178  Pac.  801. 


INDIVIDUALS  TO  WHOM  THE  LAW  IS  APPLICABLE  47 

In  Idaho  the  limitation  upon  the  ahenation  of  the  community 
real  property  is  the  same  as  in  Washington.  But  while  the 
wife's  earnings  and  the  rents  and  profits  of  her  separate  estate 
are  community  property  she  is  given  the  management  and  con- 
trol of  same.  The  Idaho  rule  governing  the  disposition  of  com- 
munity property  on  the  death  of  either  spouse  is,  with  minor 
variations,  the  same  as  that  of  Washington.  In  neither  state 
is  an  inheritance  tax  payable  on  the  one-half  of  the  community 
that  goes  to  the  one  spouse  on  the  death  of  the  other.^'O 

In  Arizona  the  husband  only  may  dispose  of  community  per- 
sonal property,  but  the  wife  must  join  him  in  deeds  or  mortgages 
affecting  real  estate,  except  unpatented  mining  claims.  One- 
half  of  the  community  property  is  subject  to  the  testamentary 
disposition  of  either  spouse,  and  in  absence  of  such  disposition 
goes  to  his  or  her  descendants;  where  there  is  neither  testa- 
mentary disposition  nor  descendants  it  is  subject  to  distribution 
in  the  same  manner  as  the  separate  property  of  the  husband. 
On  decree  of  divorce  the  court  may  divide  the  property  as  it 
sees  fit,  but  in  the  absence  of  provision  for  the  community  prop- 
erty the  parties  from  the  date  of  the  decree  hold  as  tenants 
in  common.  The  courts  of  Arizona  hold  that  the  wife  is  equal 
owner  with  her  husband.^i 

In  Nevada,  the  husband  has  the  entire  management  and  con- 
trol of  the  community  property,  except  that  the  wife  has  entire 
control  of  her  earnings  when  living  separate  from  her  husband. 
Upon  her  death  the  husband  takes  the  whole  community  estate, 
except  that  where  he  has  abandoned  her  without  good  cause 
she  may  by  will  dispose  of  half  and  in  absence  of  such  disposi- 
tion it  goes  to  her  heirs,  exclusive  of  her  husband.  On  the 
death  of  the  husband  the  wife  takes  half  and  the  husband  may 
dispose  of  the  other  half  by  will,  or  it  goes  to  his  surviving 
children ;  if  there  is  no  will  and  no  children  survive,  the  whole 
goes  to  the  wife  without  administration,  subject  to  certain  pro- 
visos. On  dissolution  of  community  by  divorce  for  any  other 
ground  than  adultery  or  extreme  cruelty,  the  community  prop- 
erty must  be  equally  divided  between  the  parties.  The  wife 
pays  no  inheritance  tax  under  the  inheritance  tax  law  of  Nevada 
on  her  interest  in  community  property,  the  courts  holding  that 
she  takes  not  as  heir  but  by  a  right  vested  in  her  at  all  times 

•>0  Compiled  statutes  of  Idaho,  Art.  4656,  4659,  1666  as  Amended  by  the 
Laws  of  1913;  Art.  4667  enacted  in  1915.  Ewald  v.  Hufton,  31  Idaho  373, 
173  Pac.  247;  Kohny  v.  Dunbar,  21  Idaho  258,  121  Pac.  544. 

fii  Civil  code  of  Arizona,  Art.  1100,  2061,  3848,  3850.  La  Tourette  v. 
La  Tourette,  15  Ariz.  200,  137  Pac.  426. 


48  FEDERAL  INCOME  TAX 

during  marriage.  It  is  to  be  noted  that  the  constitution  of 
Nevada  recognizes  the  wife's  interest  in  community  property.^- 

In  Neiv  Mexico,  while  the  husband  is  manager  of  the  commu- 
nity estate,  he  may  not  transfer  real  property  without  a  valuable 
consideration  without  the  written  consent  of  his  wife;  and  under 
certain  circumstances  the  wife  may  be  substituted  as  manager; 
prior  to  1915  he  could  not  transfer  community  personal  prop- 
erty except  for  a  valuable  consideration  without  her  written 
consent;  on  dissolution  of  the  community  by  the  death  of  the 
wife  the  husband  takes  all  except  such  portion  as  may  have  been 
set  aside  to  the  wife  by  judicial  decree,  which  portion  goes  to 
her  heirs  unless  she  ha's  disposed  of  same  by  will;  on  death  of 
the  husband  one-half  goes  to  the  wife  and  the  other  half  is 
subject  to  testamentary  disposition  by  the  husband.  If  he 
makes  no  will  one-fourth  of  his  one-half  goes  to  the  wife  and 
the  remainder  to  the  children.  On  separation  either  may  peti- 
tion for  division  of  community  property  and  after  divorce  con- 
tinue to  hold  as  tenants  in  common  where  no  disposition  has 
been  made  in  the  divorce  decree.  New  Mexico  has  no  state 
inheritance  tax  act.^^ 

In  Loidsiaym  the  community  property  comprehends  all  prop- 
erty acquired  during  the  marriage  by  either  husband  or  wife 
except  that  acquired  with  separate  funds  or  by  inheritance  or 
particular  donation,  and  excepting  the  earnings  of  the  wife  when 
she  is  living  separate  from  her  husband;  the  husband  is  man- 
ager of  the  community,  but  he  may  not  convey  community  im- 
movables by  gratuitous  title,  and  can  not  dispose  of  movables 
in  fraud  of  the  wife;  either  spouse  may  dispose  of  one-half  the 
community  property  by  will  and  the  laws  governing  the  descent 
of  such  property  in  the  absence  of  testamentary  disposition 
apply  equally  to  both  spouses,  the  survivor  taking  the  deceased 
spouse's  half  by  inheritance  when  there  is  no  will,  and  neither 
father,  mother,  or  descendants.  The  survivor  pays  no  inher- 
itance tax  on  his  or  her  one-half  of  the  community  property, 
but  does  pay  on  that  part  inherited  from  the  deceased  spouse.^^ 

62  Revised  laws  of  Nevada,  §§2155-6,  2160,  2164-5.  In  re  Williams,  40 
Nev.  241,  161  Pac.  741. 

63  Compiled  statutes  of  New  Mexico,  §§  2757-8,  2764-5,  2766  as  amended 
in  1915,  2767,  2770,  2774,  2781,  1845,  1841.  Beals  v.  Ares,  25  N.  Mex.  459, 
185  Pac.  780. 

64  Revised  civil  code  of  Louisiana,  Arts.  915-6  as  amended  in  1920;  Arts. 
2332-4,  2385-6,  2399,  2402,  2404,  2406.  Succession  of  May,  120  La.  692,  45 
So.  551.  Dixon  v.  Dixon's  Executors,  4  La.  188;  Beck  v.  Natalie  Oil  Co., 
143  La.  153,  78  So.  430;  Succession  of  Marsal,  118  La.  212,  42  So.  778. 


INDIVIDUALS  TO  WHOM  THE  LAW  IS  APPLICABLE  49 

In  Texas  the  control  of  community  property  is  divided  between 
the  husband  and  wife;  in  that  state  on  the  death  of  eithel' 
spouse  without  issue  the  survivor  takes  the  whole  and  where 
there  is  issue,  takes  one-half,  the  other  half  going  to  said  issue 
or  their  descendants.  Under  the  state  inheritance  tax  law  the 
wife  pays  no  tax  on  her  half  of  the  community  property.''-''  /[y^ 

In  California  the  wife  has  no  power  of  testamentary  disposi-    {^^'^  ^  -^ 
tion  of  community  property  except  of  such  as  may  have  been  L^^'^^'^ 

set  aside  to  her  by  judicial  decree;  she  takes  one-half  as  heir 
on  the  death  of  the  husband;  but  on  the  death  of  the  wife  the 
entire  community  property  belongs  to  the  husband  without 
administration.  The  California  courts  have  held  that  under 
the  law  as  it  stood  prior  to  1917  the  wife  had  no  vested  interest 
in  community  property  prior  to  the  dissolution  of  the  marriage.'''*^ 

Basing  his  conclusion  upon  the  several  state  decisions  inter- 
preting state  laws  governing  property  rights,  the  attorney- 
general  has  decided  that  in  Washington,  Arizona,  Idaho,  New 
Mexico,  Louisiana,  Texas  and  Nevada,  the  husband  and  wife 
domiciled  therein  rendering  separate  income  tax  •  returns  may 
each  report  as  gross  income  one-half  of  the  income  which,  under 
the  laws  of  the  respective  states  becomes,  simultaneously  with 
its  receipt,  community  property;  that  this  is  not  based  upon 
any  statute  enacted  subsequent  to  March  1,  1913,  and  applies 
under  the  income  tax  acts  prior  to  the  Revenue  Act  of  1918, 
as  well  as  that  act.'''^ 

63  Under  the  Laws  of  Texas  it  has  been  held  that — (1)  The  earnings  of 
husband  and  wife  belong  to  them  jointly  in  equal  shares;  (2)  The  com- 
munity interest  attaches  as  soon  as  the  right  to  the  wage  comes  into  exist- 
ence; and  (3)  The  increase  and  revenues  from  the  seporoie  property  of  each 
spouse  (except  the  increase,  rents  and  revenues  from  lands)  is  also  com- 
munity property  in  which  the  interests  of  husband  and  wife  are  equal. 
(Tannehill  v.  Tannehill  (Tex.  Civ.  App.),  171  S.  W.  1050).  This  before  the 
amendment  of  §  4621  in  1917  made  the  rents  from  separate  lands  the  sepa- 
rate property  of  the  owner  of  the  land  (Barr  v.  Simpson,  54  Tex.  Civ.  App. 
105,  117  S.  W.  1041 ;  Hayden  v.  McMillan,  4  Tex.  Civ.  App.  479,  23  S.  W.  430.) 
It  has  therefore  been  ruled  that: — (1)  The  earnings  of  husband  and  wife 
and  the  revenues  from  their  comnmnify  lyroj^erty  and  separate  personal 
jyroperty  are  community  income  under  the  provisions  of  the  Revenue  Act 
of  1918;  and  (2)  That  the  husband  and  wife  in  rendering  separate  income 
tax  returns  may  each  report  as  gross  income  one-half  the  total — (a)  Earn- 
ings of  the  husband  and  wife;  (b)  Income  from  separate  property;  and 
(c)    Income   from   community  property.     (T.   D.   3071,    T.   B.   39-20-1218.) 

B«  Civil  code  of  California,  §§162-4,  172-172  (a),  1401-2;  Spreckels  v. 
Spreckels,  116  Cal.  339,  48  Pac.  228;  Estate  of  Moffitt,  153  Cal.  359,  95 
Pac.  653,  1025;  Moffitt  v.  Kelly,  218  U.  S.  400. 

67  T.  D.  3138,  containing  opinion  of  attorney-general,  dated  February  26, 
1921,  T.  B.  11-21-1515;  T.  D.  3071  containing  opinion  of  attorney-general, 


50  FEDERAL  INCOME  TAX 

In  returns  in  which  community  income  is  divided  between 
husband  and  wife  domiciled  in  states  where  such  income  is 
divisible  for  income  tax  purposes,  both  husband  and  wife  should 
report  in  detail  the  gross  income  from  such  community  property. 
The  deductions  properly  chargeable  against  such  income  should 
be  equally  divided  between  husband  and  wife.*^'^  Where  a  hus- 
band and  wife,  domiciled  in  a  state  other  than  a  community 
property  state,  purchase  lands  located  in  Texas  with  the  separate 
funds  of  one  of  the  spouses,  the  rents  and  revenues  therefrom 
constitute  the  income  of  the  spouse  whose  funds  purchased  the 
land,  and  are  so  returnable;  and  where  a  husband  and  wife, 
domiciled  in  a  state  .  other  than  a  community  property  state, 
purchase  land  located  in  the  state  of  Texas  with  funds  furnished 
in  part  by  the  husband  and  in  part  by  the  wife,  then  the  rents 
and  revenues  are  income  of  each  in  proportion  to  their  interest 
in  the  land  and  are  so  returnable.  This  is  so  though  the  spouses 
thereupon  become  domiciled  in  the  state  where  the  land  is 
situated.'''*  Where  husband  and  wife  acquire  community  property 
while  domiciled  in  the  state  of  Idaho,  and  then  take  up  domicile 
in  California,  they  may  continue  to  render  separate  returns 
of  the  income  from  such  property,  since  the  wife  has  a  vested  in- 
terest in  the  property,  which  is  not  affected  by  change  of 
domicile.'''^  When  a  husband  and  wife  acquire  with  community 
earnings  real  property  in  the  state  of  Washington  while  domi- 
ciled therein  and  then  move  to  another  state,  the  wife's  inter- 
est is  not  affected  and  they  may  file  separate  returns  in  which 
the  income  from  community  property  in  Washington  is  divided 
between  them.'^'i  The  guardian  of  a  taxpayer,  non  compos  mentis, 
whose  legal  domicile  is  Texas,  and  whose  wife  has  been  main- 
taining a  residence  in  Virginia  since  prior  to  the  enactment 
of  the  income-tax  law,  may,  if  the  marital  relation  has  not  been 
dissolved,  report  one-half  of  the  income  from  the  property 
which  is  within  the  state  of  Texas.'^^ 

dated  August  24,  1920,  T.  B.  39-20-1218;  modifying  O.  D.  285,  T.  B.  21-19- 
528  and  O.  D.  426,  T.  B.  13-28-15.  See  also  A.  R.  R.  403,  T.  B.  10-21-1492. 
^_^  In  California  a  wife  may  not  include  in  her  separate  return  salary  and 
wages  received  by  her.     (O.  D.  1128,  T.  B.  49-21-1964.) 

fiS  O.  D.  909,  T.  B.  19-21-1625. 

fi9  0.  D.  975,  T.  B.  28-21-1727;  Oliver  v.  Robertson,  41  Tex.  422;  McDaniel 
V.  Harley  (Tex.),  42  S.  W.  323;  Thayer  v.  Clarke,  77  S.  W.  1050,  affirmed 
98  Tex.  142,  81  S.  W.  1274;  Douglas  v.  Douglas,  22  Idaho  336,  125  Pac.  796; 
Myers  v.  Albert,  76  Wash.  218,  135  Pac.  1003. 

70  Sol.  Op.  121,  T.  B.  39-21-1845. 

71  O.  D.  1110,  T.  B.  47-21-1933. 

72  0.  D.  1023,  T.  B.  36-21-1805, 


individuals  to  whom  the  law  is  applicable         51 

Abatement,  Credit  and  Refund  in  Case  of  Community 
Income,  The  following  procedure  has  been  approved  with 
regard  to  amended  returns  and  claims  for  refund,  credit,  or 
abatement  under  the  ruling  contained  in  the  preceding  para- 
graph with  regard  to  community  income  under  the  laws  of  Texas, 
in  so  far  as  taxpayers  in  the  state  of  Texas  are  concerned: 
Amended  separate  returns  may  be  filed  for  each  of  the  taxing 
years  in  which  the  law  of  Texas  contains  a  provision  giving 
husband  and  wife  equal  rights  to  community  property,  subject 
to  the  five-year  statute  of  limitations.  A  claim  for  credit  of  ^ 
the  net  amount  of  taxes  overpaid  for  any  of  the  taxable  years  ( 
may  be  filed  for  the  amount  of  assessment  outstanding  and 
claim  for  refund  filed  for  the  balance.  A  claim  for  abatement  f 
instead  of  a  claim  for  credit,  however,  should  be  filed  for  exces-  \ 
sive  tax  assessed  for  1919  over  the  tax  due  for  1919  under 
amended  separate  returns.  A  claim  for  refund  may  be  filed 
for  the  entire  net  overpayment  if  no  assessment  is  outstanding.'^^ 
Where  such  claims  for  the  refund  of  taxes  erroneously  paid  for 
1919  and  prior  years  have  been  filed  they  may  be  converted  into 
claims  for  credit  to  be  applied  against  any  taxes  due  from  the 
husband  or  wife,  as  shown  by  separate  returns  filed  by  them 
for  the  taxable  year  1920  and  subsequent  years,  subject  to  the 
provision  of  §  252  of  the  Revenue  Act  of  1918."^  The  adjust- 
ment of  taxes  between  husband  and  wife  due  on  amended  sepa- 
rate returns  will  be  made  as  a  matter  of  accounting  and  no 
claim  for  credit  should  be  filed.  Any  claim  for  abatement,  re- 
fund or  credit  must  be  accompanied  by  an  agreement  signed  by 
husband  and  wife,  consenting  to  adjustments  therein  de- 
manded.'^s  j^  all  cases  in  which  it  appears  that  amended  sepa- 
rate returns  are  filed  and  the  income  shown  in  the  returns  now 
filed  was  disclosed  in  a  prior  return  or  returns  no  penalty  on 
account  of  delinquency  will  be  asserted  and  interest  on  account 
of  failure  to  pay  the  tax  shown  by  the  returns  on  the  date 
payment  was  required  by  law  will  not  be  assessed.  Where  a 
claim  for  credit  is  filed,  bond  will  not  be  required."*^  A  husband 
and  wife  domiciled  in  Texas  January  1,  1918,  and  who  abandoned 
that  domicile  August,  1919,  the  husband  having  included  in  his 
1918  and  1919  income  tax  returns  income  received  from  all 
sources,  including  personal  earnings,  and  no  returns  having 
been  filed  by  the  wife,  may  file  amended  separate  returns  for 

73  0.  D.  757,  T.  B.  51-20-1358. 

74  0.  D.  854,  T.  B.  12-21-1525. 

75  O.  D.  1068,  T.  B.  42-21-1873. 

76  0.  D.  757,  T.  B.  51-20-1358. 


52  FEDERAL  INCOME  TAX 

1918,  each  reporting  as  gross  income  one-half  the  income  re- 
ceived during  that  year  which  constituted  "community"  income. 
They  may  also  file  amended  separate  returns  for  1919,  each 
reporting  as  gross  income  one-half  the  income  received  prior 
to  the  abandonment  of  the  marital  domicile  in  Texas,  which  con- 
stituted "community"  income."  In  the  case  of  a  deceased  tax- 
'payer,  the  proper  person  to  file  the  amended  return  or  claim  is  the 
executor  or  administrator.  Where  the  estate  has  been  placed 
in  the  hands  of  trustees,  the  amended  return  or  claim  is  accept- 
able only  when  filed  by  the  trustees.  Where  the  administrator 
or  executor  has  been  discharged  or  there  has  been  no  administra- 
tion upon  the  estate  an  amended  return  and  claim  should  be 
filed  by  a  duly  authorized  representative  of  all  the  individuals 
claiming  any  portion  of  the  property  of  the  deceased,  ^n^all 
cases  involving  the  filing  of  a  separate  amended  return  and 
claim  for  a  deceased  taxpayer,  an  agreement,  signed  by  the 
surviving  spouse  and  the  duly  authorized  agent  or  representa- 
tive of  the  deceased  taxpayer,  consenting  to  the  adjustments 
therein  demanded,  must  accompany  such  return  and  claim.'''^  _ 

Minors."'^  Minors  are  required  to  make  returns  unless  their 
income  is  included  in  the  return  of  the  parent  or  reported  by  a 
fiduciary.*^" 

Incompetents.  Incompetents  or  insane  persons  are  unable  to 
make  their  own  returns,  and  their  returns  must  be  made  by  the 
guardian  or  other  person  charged  with  the  care  of  the  person 
or  property  of  such  incompetent  or  insane  person.^^ 

Agents.  The  return  of  a  taxpayer  may  be  made  by  an  agent 
when  by  reason  of  illness,  absence,  or  nonresidence  the  person 
liable  for  the  return  is  unable  to  make  it,  the  agent  assuming 
the  responsibility  for  making  the  return  and  incurring  liability 
to  the  specific  penalties  provided  for  erroneous,  false,  or  fraudu- 

77  0.  D.  810,  T.  B.  7-21-1451. 

78  0.  D.  920,  T.  B.  20-21-1643. 

79  A  minor  is  a  person  under  21  years  of  age  or  under  the  statutory  age 
of  majority  where  he  or  she  lives  (Reg.  45,  Art.  403).  The  statutory  ages 
of  majority  in  the  different  states  are  set  forth  in  Chapter  34. 

80  Revenue  Act  of  1921,  §223;  Revenue  Act  of  1918,  §223;  Reg.  45,  Art. 
403.  Under  the  1916  and  1917  Laws,  minors  were  not  required  to  make  re- 
turns, such  returns  being  made  by  their  guardians  (Reg.  33,  Rev.,  Art.  17; 
letter  from  treasury  department  dated  April  11,  1918;  I.  T.  S.  1918,  ^3295). 
The  change  to  the  present  rule  was  accomplished  by  the  omission  of  the 
words  "of  lawful  age"  from  the  section  requiring  returns  of  individfials. 
Compare  Revenue  Act  of  1916,  §  8    (b)   with  Revenue  Act  of  1918,  §  223. 

81  Revenue  Act  of  1921,  §223;  Revenue  Act  of  1918,  §223;  Reg.  45,  Art. 
422. 


INDIVIDUALS   TO   WHOM    THE   LAW    IS   APPLICABLE  53 

lent  returns.^-  Responsible  representatives  of  nonresident  aliens 
having  charge  of  the  property  of  nonresident  aliens  may  be 
charged  with  the  duty  of  making  a  return  and  paying  the  tax 
normal  and  additional,  on  the  income  passing  through  their 
hands.^ 

Fiduciaries.  Guardians,  trustees,  executors,  administrators, 
receivers,  conservators  or  any  persons  acting  in  a  fiduciary  ca- 
pacity are  charged  with  special  duties  under  the  law.  These 
duties  are  fully  discussed  in  another  chapter.^^ 

Persons  Dying  During  the  Year.  When  a  person  dies  during 
any  calendar  year,  it  is  the  duty  of  the  executor  or  administrator 
or  person  taking  charge  of  his  property  to  make  a  return  for 
the  deceased  from  the  beginning  of  the  year  to  the  date  of 
death.^5  If  the  decedent  was  a  citizen  or  resident  and  died  after 
the  close  of  the  calendar  year,  but  before  March  15  of  the  fol- 
lowing year,  and  has  not  made  a  return  for  the  preceding  calen- 
dar year,  a  return  should  be  made  for  the  full  year  preceding 
and  in  addition  a  return  from  January  1  of  the  current  year  to 
the  date  of  death.  If  during  the  period  in  which  the  decedent 
lived  he  was  not  in  receipt  of  $1,000  of  net  income,  if  unmarried, 
or  $2,500  if  married  or  the  head  of  a  family,  no  return  need  be 
filed,'^'^  unless  he  was  a  nonresident  alien,  in  which  case  a  return 
should  be  filed,  whether  he  was  married  or  single,  regardless  of 
amount.s^  The  fact  that  a  person  may  have  died  before  the  pas- 
sage of  the  law  does  not  relieve  his  estate  from  liability  to  tax, 
if  he  lived  after  the  incidence  of  the  tax.^^ 

S2  Revenue  Act  of  1921,  §223;   Revenue  Act  of  1918,  §  223. 

83  Revenue  Act  of  1921,  §223;  Revenue  Act  of  191?,  §223;  Reg.  45,  Art. 
404.    See  Chapter  5. 

84  Revenue  Act  of  1921,  §  225;  Revenue  Act  of  1918,  §  225.   See  Chapter  6. 

85  Reg.  45,  Art.  421;  Mandell  v.  Pierce,  3  Cliff.  134,  16  Fed.  Cas.  No.  9008. 

86  Reg.  45,  Art.  421. 

8' Reg.  33,  Rev.,  Arts.  4  and  14;  Reg.  45,  Art.  403.  Nonresident  aliens 
reporting  on  the  calendar  year  basis  are  not  obliged  to  file  returns  until 
June  15. 

88  Brady  v.  Anderson,  240  Fed.  665,  writ  of  certiorari  denied,  244  U.  S. 
654.  Thus,  a  person  dying  after  January  1,  1919,  but  before  February  25, 
1919,  the  date  on  which  the  1918  Law  went  into  effect,  will  be  held  to  be 
taxable  thereunder.  The  effect  of  making  the  act  retroactive  is  to  apply  it 
to  him  exactly  as  if  it  had  been  enacted  on  January   1,  1918. 


CHAPTER  4 

NONRESIDENT  ALIENS 

The  law  imposes  a  tax  upon  the  net  income  received  by  non- 
resident alien  individuals  "from  sources  within  the  United 
States."^  The  Revenue  Act  of  1921  contains  many  new  provisions 
dealing  with  the  taxation  of  nonresident  aliens,  but  in  general 
these  provisions  do  not  change  the  basic  scheme  for  the  taxation 
of  this  class  of  taxpayers.  In  large  part  the  new  provisions,  as 
will  be  seen  in  the  following  paragraphs,  are  an  amplification 
of  definition  of  the  troublesome  term  "sources  within  the  United 
States,"  an  expression  which  had  received  a  more  detailed  defini- 
tion in  the  1918  Law  than  ever  before.  Some  of  the  provisions 
defining  this  term  are  a  statutory  enactment  of  previous  de- 
partmental regulations. 

Who  Is  a  Nonresident  Alien.^  The  definition  of  the  term 
"nonresident  alien"  would  seem  to  remain  the  same  under  the 
Revenue  Act  of  1921  as  it  was  under  the  1918  Law,  with  an 
exception  indicated  below.  Therefore  the  regulations  issued 
under  that  law  are  generally  applicable  under  the  present  statute. 
Ordinarily  it  is  a  simple  matter  to  determine  whether  an  indi- 
vidual is  or  is  not  a  nonresident  alien ;  he  falls  into  this  class  if 
he  is  neither  a  citizen  nor  a  resident.  Any  individual  who  is  a 
citizen  of  any  possession  of  the  United  States  (but  not  other- 
wise a  citizen  of  United  States)  and  who  is  not  a  resident  of 
the  United  States  is  subject  to  income  tax  upon  income  derived 
from  sources  within  the  United  States,  and  his  tax  is  computed 
and  paid  in  the  same  manner  and  subject  to  the  same  condi- 
tions as  the  tax  of  nonresident  aliens  who  are  citizens  or  sub- 
jects of  foreign  countries.-"^  The  term  "nonresident  alien,"  there- 
fore, is  used  in  this  chapter  to  include  any  nonresident  citi- 
zen of  any  possession  of  the  United  States.  Difficulty  may  arise 
in  determining  whether  an  individual  is  or  is  not  a  nonresident 

1  Revenue  Act  of  1921,  §213  (c). 

2  The  term  "nonresident  aliens,"  as  used  in  several  places  in  the  1916  Law, 
was  not  defined  therein,  but  clearly  referred  to  individuals  only  and  not 
to  partnerships,  corporations,  or  associations.  The  Revenue  Act  of  1918, 
however,  removed  all  doubt  by  using  the  expression  "nonresident  alien 
individuals,"  and  the  Revenue  Act  of  1921  uses  the  same  expression  (Reve- 
nue Act  of  1921,  §§213  (c),  216  (e);  Revenue  Act  of  1918,  §213  (c);  Reg. 
45,  Art.  3). 

3  Revenue  Act  of  4921,  §  260;  Revenue  Act  of  1918,  §260. 

54 


NONRESIDENT   ALIENS  55 

alien,  where  a  nonresident  citizen,  naturalized  or  native,  has 
resided  abroad  for  a  period  sufficient  to  raise  a  presumption 
that  he  has  abandoned  his  citizenship,^   and   again   where   an 
alien  has  resided  in  this  country  for  a  period  so  long  as  to 
raise  a  presumption  of  residence.     In  either  of  these  cases  the 
intent  of  the  individual  is  important.    The  treasury  department 
holds  that  the  status  of  a  nonresident  native  or  naturalized  citi- 
zen remains  unchanged  until  some  affirmative  action  is  taken, 
or  the  right  to  citizenship  is  forfeited  by  some  overt  act.''  When 
any  naturalized  citizen  has  left  the  United  States  and  resided 
for  two  years  in  the  foreign  country  from  which  he  came,  or 
for  five  years  in  any  other  foreign  country,  he  is  presumed  to 
have  lost  his  American  citizenship;  but  this  presumption  does 
not  apply  to  residence  abroad  while  the  United  States  is  at  war. 
An  Italian,  who  has  come  to  the  United  States  and  filed  his 
declaration  of  intention  to  become  a  citizen,  but  who  has  not 
yet  received  his  final  citizenship  papers,  is  an  alien.     A  Swede, 
who,  after  having  come  to  the  United  States  and  become  natu- 
ralized here,  returned  to  Sweden  and  resided  there  for  two  years 
prior  to  April  6,  1917,  is  presumed  to  be  once  more  an  alien.^ 
On  the  other  hand,  an  alien,  coming  to  the  United  States  with  the 
intention  of  becoming  a  resident  within  the  meaning  and  intent 
of  the  income  tax  statute,  may  indicate  that  fact  and  thereupon 
will  be  taxed  as  a  resident,  regardless  of  the  length  of  time  he 
has  been  here."   The  tests  as  to  the  residence  of  aliens  located 
within  this  country  have  been  set  forth  in  another  chapter."^ 
4  The  Act  of  March  2,  1907,  provides,  briefly,  that  any  American  citizen 
becomes  an  alien  by  becoming  naturalized  in  a  foreign  state  or  taking  an 
oath  of  allegiance  to  any  foreign  state.     A  naturalized  citizen  residing  for 
two  years  in  the  country  from  which  he  came  or  for  five  years  in  any  other 
foreign  country,  is  presumed  to  have  renounced  his  American  citizenship  in 
the  absence  of  satisfactory  evidence  to  the  contrary.    A  woman  assumes  the 
nationality  of  her   husband,  but   may  resume   her  original   citizenship   on 
becoming  a  widow;  she  assumes  or  retains  her  American  citizenship  as  a 
widow  if,  living  abroad,  she  registers  with  a  United  States  consul,  or  without 
formal  action   if  she  resides  here.     Minor   children  of  naturalized   citizens 
are  deemed  to  be  citizens  from  the  time  they  begin  to  reside  permanently 
in  this  country.     Children  born  outside  of  the  United  States  of  citizens,  and 
continuing  to  reside  abroad  must  at  the  age  of  18  declare  their  intention  as 
to  citizenship.     Determination  of  citizenship  by  the  state  department  under 
this  act  is  not  conclusive  upon  the  treasury  department;  other  factors  may 
also  be  considered,  as  indicated  in  the  text.     See  also  O.  D.  533,  T.  B.  23-20- 
983  as  to  resumption  of  citizenship  by  widow  of  nonresident  alien. 
5T.  D.  2135. 
«  Reg.  45,  Art.  4. 

7  Reg.  45,  Art.  313;  T.  D.  2242.    See  Chapter  3  for  status  of  resident  aliens. 

8  See  Chapter  3. 


56  FEDERAL  INCOME  TAX 

The  status  of  an  alien  leaving  the  United  States  during 
the  taxable  year  is  determined  by  his  status  on  the  last  day  of 
his  taxable  period.  If  the  alien  had  formed  no  intention  of  leav- 
ing the  United  States  he  will  be  taxed  as  a  resident  alien.  If  his 
intention  to  depart  was  formed  prior  to  the  departure,  he  will  be 
taxed  as  a  nonresident  alien  for  such  period.  In  either  case  the 
alien  is  entitled  to  the  full  exemption  to  which  he  would  have  been 
entitled  if  his  return  had  been  filed  for  the  full  taxable  year.  If 
the  absence  of  a  resident  alien  is  to  be  only  temporary,  he  will  not 
lose  his  status  as  resident  by  reason  of  such  absence.^  An  alien 
who  established  a  residence  in  the  United  States  in  1910  and  sub- 
sequently acquired  property  interests  in  this  country  and  who  en- 
listed in  the  army  of  his  native  country  in  1917,  serving  abroad 
until  1919,  when  he  returned  to  the  United  States  in  accordance 
with  an  intention  to  do  so  expressed  prior  to  his  departure,  will 
not  be  considered  to  have  lost  his  status  of  resident  alien  and  will 
be  required  to  render  returns  as  such,  including  in  gross  income 
the  compensation  received  for  services  in  the  foreign  army  as 
well  as  his  taxable  income  from  all  other  sources. ^^  A  nonresident 
alien  who  has  served  in  the  United  States  army  for  a  period 
of  one  year  is  considered  a  resident  for  income  tax  purposes.^! 
The  members  of  families  of  foreign  ambassadors  and  ministers 
are  considered  nonresident  aliens.^^ 

Residence  of  Alien  Seamen.  In  order  to  determine  whether 
an  alien  seaman  is  a  resident,  it  is  necessary  to  decide  whether 
the  presumption  of  nonresidence  is  overcome  by  facts  showing 
that  he  has  established  a  residence  in  the  territorial  United 
States,  which  consists  of  the  states,  the  District  of  Columbia,  and 
the  territories  of  Hawaii  and  Alaska,  and  excludes  other  places. 
Residence  may  be  established  on  a  vessel  regularly  engaged  in 
coastwise  trade,  but  the  mere  fact  that  a  sailor  makes  his  home 
on  a  vessel  flying  the  United  States  flag  and  engaged  in  foreign 
trade  is  not  sufficient  to  establish  residence  in  the  United  States, 
even  though  the  vessel,  while  carrying  on  foreign  trade,  touches 
at  American  ports.  An  alien  seaman  may  acquire  an  actual 
residence  in  the  territorial  United  States,  although  the  nature 
of  his  calling  requires  him  to  be  absent  from  the  place  where  his 

9  0.  D.  468,  T.  B.  16-20-867. 

10  O.  D.  498,  T.  B.  19-20-921. 

11  O.  D.  117,  T.  B.  3-19-175. 

12  0.  D.  198,  T.  B.  9-19-343. 


NONRESIDENT   ALIENS  57 

residence  is  established  for  a  long  period.  An  alien  seaman  may 
acquire  such  a  residence  at  a  sailor's  boarding  house  or  hotel, 
but  such  a  claim  should  be  carefully  scrutinized  in  order  to 
make  sure  that  such  residence  is  bona  fide.  The  filing  of  Form 
1078  (Revised),  or  taking  out  first  citizenship  papers,  is  proof 
of  residence  in  the  United  States  from  the  time  the  form  is 
filed  or  the  papers  taken  out,  unless  rebutted  by  other  evidence 
showing  an  intention  to  be  a  transient.  The  fact  that  a  head 
tax  has  been  paid  on  behalf  of  an  alien  seaman  entering  the 
United  States  is  no  evidence  that  he  has  acquired  residence, 
because  the  head  tax  is  payable  unless  the  alien  who  is  entering 
the  country  is  merely  in  transit  through  the  country.  An  alien 
may  remain  a  nonresident  although  he  is  not  in  transit  through 
the  country .13  It  has  been  held  that  vessels  plying  between  the 
continental  United  States  and  Porto  Rico  are  engaged  in  "foreign 
trade."  A  citizen  and  resident  of  Porto  Rico  employed  as  sea- 
man aboard  such  a  vessel  and  who  has  not  established  him- 
self otherwise  as  a  resident  of  the  United  States  occupies  the 
status  of  a  nonresident  alien.i^  The  term  "foreign  trade"  in- 
cludes the  transportation  upon  the  high  seas  of  passengers  and 
freight  between  the  United   States  and  foreign   countries.!-^ 

Citizens  Who  Are  Treated  As  Nonresident  Aliens.  The  Reve- 
nue Act  of  1921  contains  a  new  provision  giving  a  certain  class 
of  United  States  citizens  the  privilege  of  being  treated  as  non- 
resident aliens  and  being  taxable  only  upon  gross  income  "from 
sources  within  the  United  States."  In  order  to  be  entitled  to  this 
privilege  a  citizen  of  the  United  States  must  satisfy  the  follow- 
ing conditions:  (1)  80%  or  more  of  his  gross  income  (computed 
with  the  benefit  of  being  treated  as  a  nonresident  alien)  for  the 
three-year  period  immediately  preceding  the  close  of  the  taxable 
year  (or  for  such  part  of  such  period  immediately  preceding 
the  close  of  such  taxable  year  as  may  be  applicable)  must  be 
derived  from  sources  within  a  possession  of  the  United  States; 
and  (2)  50%  or  more  of  his  gross  income  (computed  without 
the  benefit  of  being  treated  as  a  nonresident  alien)  for  the 
same  three-year  period  or  the  applicable  part  thereof,  must  be 
derived  from  the  active  conduct  of  a  trade  or  business  within  a 
possession  of  the  United  States,  either  on  his  own  account  or  as 
an  employee  or  agent  of  another.  The  gross  income  of  such 
citizen,   however,    includes    any   amounts    received   within   the 

13  Reg.  45,  Art.  312a;  T.  D.  2869.     As  to  when  the  wages  of  alien  seamen 
are  subject  to  tax,  see  Reg.  45,  Art.  92a  and  p.  67. 

14  0.  D.  536,  T.  B.  23-20-987. 

15  0.  D.  315,  T.  B.  26-19-591. 


58  FEDERAL  INCOME  TAX 

United  States,  whether  derived  from  sources  within  or  without 
the  United  States. ^'^  The  term  ''nonresident  ahen"  or  "nonresi- 
dent ahen  individual"  as  used  in  this  chapter  includes  citizens 
of  the  United  States,  as  thus  defined.  The  term  "foreign  cor- 
poration" includes  domestic  corporations  entitled  under  this 
provision  of  the  statute  to  classification  as  a  foreign  corporation 
and  subject  only  to  tax  upon  gross  income  from  sources  within 
the  United  States,  when  they  fulfill  the  same  conditions  which 
have  been  detailed  above  in  respect  to  United  States  citizens. 

Rate  of  Tax.  The  rate  of  normal  tax  upon  nonresident  aliens 
is  the  same  as  in  the  case  of  citizens  and  residents  (8%),  but 
nonresident  aliens  do  not  secure  the  benefit  of  the  lower  rate 
(4%)  on  the  first  $4,000  of  income.  The  surtax  rates  upon  non- 
resident aliens  are  the  same  as  the  rates  upon  citizens  and 
residents.!''' 

Extent  to  Which  Nonresident  Aliens  are  Taxable.  Nonresi- 
dent aliens  are  subject  to  the  normal  tax  and  the  surtax  imposed 
by  the  Revenue  Act  of  1921,  upon  their  net  income  received 
from  all  "sources  within  the  United  States."  The  Revenue  Act 
of  1918  also  subjected  nonresident  aliens  to  tax  on  income  from 
such  "sources."  The  chief  difference  between  the  two  statutes 
lies  in  the  definition  adopted  for  this  term.  The  definition  con- 
tained in  the  present  law  is  much  more  ample  and  detailed,  and, 
in  one  or  two  respects,  different.  Little  progress  has  been  made 
in  determining  the  taxes  of  nonresident  aliens  under  the  1918 
Law,  and  for  that  reason  it  seems  advisable  to  consider  in  this 
chapter  not  only  the  present  law,  but  the  provisions  in  force 
with  regard  to  nonresident  aliens  for  the  last  few  years.  It 
may  be  noted  in  passing  that,  irrespective  of  any  rules  of  statu- 
tory construction,  the  present  law  no  doubt  to  a  considerable 
extent  expresses  the  intention  of  congress  in  the  vaguer  and 
less  detailed  statutes  which  preceded  it,  the  greater  definiteness 
of  the  present  law  being  founded  upon  the  experience  of  the 
treasury  department  in  administering  those  previous  laws.  Not- 
withstanding the  increased  precision  of  the  Revenue  Act  of  1921, 
the  difficult  problem  of  taxing  nonresident  aliens  justly  and 
upon  a  basis  consistent  with  economics  and  reason  is  by  no 
means  solved.  The  diflSculty  of  the  problem  is  inherent  and  can 
only  be  finally  solved  in  each  case  which  arises  by  the  fairest 
possible  application  of  the  rules  set  forth  in  the  statute  and  a 

16  Revenue  Act  of  1921,  §  262.  The  term  "possession  of  the  United  States", 
as  used  in  the  text  above,  does  not  include  the  Virgin  Islands. 

17  Revenue  Act  of  1921,  §§  210,  211. 


NONRESIDENT   ALIENS  59 

certain  disregard  of  technicalities  and  forms,  in  favor  of  sub- 
stantial considerations.  Inasmuch  as  the  present  law,  like  the 
1918  Law,  taxes  foreign  corporations  in  the  same  manner  as  non- 
resident alien  individuals  on  income  "from  sources  within  the 
United  States"  ^^  the  convenience  of  the  reader  will  probably  be 
furthered  by  a  consideration  of  that  term  in  one  place,  as  it 
applies  to  both  nonresident  aliens  and  foreign  corporations.  This 
has  b6en  done,  except  that  any  rulings  having  sole  bearing  upon 
foreign  corporations  are  reserved  for  a  later  chapter.i'-^ 

Income  From  Sources  Within  the  United  States.  The  Revenue 
Act  of  1918  defined  income  from  sources  within  the  United 
States  as  including  "interest  on  bonds,  notes,  or  other  interest- 
bearing  obligations  of  residents,  corporate  or  otherwise,  divi- 
dends from  resident  corporations,  and  including  all  amounts  re- 
ceived (although  paid  under  a  contract  for  the  sale  of  goods  or 
otherwise)  representing  profits  on  the  manufacture  and  dispo- 
sition of  goods  within  the  United  States." -^ 

IS  Revenue  Act  of  1921,  §234  (b). 

19  See  Chapter  12. 

20  Revenue  Act  of  1918,  §213  (c);  Reg.  45,  Art.  3,  T.  D.  2876.  The  1913 
Lavi^  imposed  a  tax  in  the  net  income  of  nonresident  aliens  "from  all  property- 
owned  and  from  every  business,  trade,  or  profession  carried  on  in  the 
United  States."  This  language  was  held,  under  two  opinions  of  the  attorney- 
general,  not  to  include  interest  or  dividends  received  by  nonresident  alien 
investors  from  domestic  corporations,  but  on  March  21,  1916,  the  treasury- 
department  reversed  this  holding  and  thereafter  claimed  the  tax  from  non- 
resident aliens  on  these  classes  of  income.  (T.  D.  2313.)  In  De  Ganay  v. 
Lederer,  239  Fed.  568,  the  district  court  held  a  nonresident  alien  taxable 
on  such  income  if  the  stock  certificates  and  bonds  were  kept  in  this  country, 
as  then  they  acquired  a  situs  here  for  purposes  of  the  income  tax.  This 
decision  has  now  been  affirmed  by  the  United  States  Supreme  Court  (250 
U.  S.  376),  which  takes  the  position  that  stock  certificates,  bonds,  and 
mortgages  are  "property"  within  the  meaning  of  the  statute,  having  a  situs 
within  the  United  States  in  spite  of  the  maxim  mohilia  sequnnUir  personam. 
The  court  said:  "In  the  case  under  consideration  the  stocks  and  bonds  were 
those  of  corporations  organized  under  the  laws  of  the  United  States,  and  the 
bonds  and  mortgages  were  secured  upon  property  in  Pennsylvania.  The 
certificates  of  stock,  the  bonds  and  mortgages  were  in  the  Pennsylvania  Com- 
pany's offices  in  Philadelphia.  Not  only  is  this  so,  but  the  stocks,  bonds 
and  mortgages  were  held  under  a  power  of  attorney  which  gave  authority 
to  the  agent  to  sell,  assign,  or  transfer  any  of  them,  and  to  invest  and  re- 
invest the  proceeds  of  such  sales  as  it  might  deem  best  in  the  management 
of  the  business  and  affairs  of  the  principal.  It  is  difficult  to  conceive  how 
property  could  be  more  completely  localized  in  the  United  States.  There  can 
be  no  question  of  the  power  of  Congress  to  tax  the  income  from  such  securi- 
ties. Thus  situated  and  held,  and  with  the  authority  given  to  the  local 
agent  over  them,  we  think  the  income  derived  is  clearly  from  property  within 
the   United   States   within   the   meaning   of   Congress   as   expressed   in   the 


60  FEDERAL  INCOME  TAX 

Following  the  statutory  definition  the  most  comprehensive 
ruling  issued  under  the  1918  Law  defining  gross  income  from 
sources  within  the  United  States  includes  in  the  term,  in  addi- 
tion to  the  items  specified  in  the  statutes,  rentals,  and  royalties 
from  property,  and  income  from  business  carried  on  in  the 
United  States,  interest  on  deposits  in  banks  located  within  the 
United  States,  income  from  capital  otherwise  invested  in  the 
United  States,  and  income  from  services  rendered  or  labor  per- 
formed within  the  United  States.-^ 

The  language  just  quoted  and  the  regulations  adopted  in  pur- 
suance thereof  are  evidently  an  attempt  to  tax  income  arising 
from  "sources  within  the  United  States,"  rather  than  the  right 
of  doing  any  thing  or  enjoying  any  privilege  in  the  United 
States."  It  will  be  noted  that  the  1916  Law  was  the  first  law 
using  the  expression  "sources  within  the  United  States," --"^  the 
1913  Law  having  used  the  phrase  "business  transacted  and  capi- 

statute  under  consideration."  The  language  of  the  1916  Law  and  the  present 
law  expressly  included  such  income,  regardless  of  where  the  securities  might 
be  kept. 

21  Reg.  45,  Art.  91.  In  the  earliest  edition  of  Regulations  45  income  from 
isolated  transactions  or  activities  directly  resulting  in  gain,  carried  on  within 
the  United  States  by  a  nonresident  or  his  representative  in  person,  was 
stated  to  be  from  sources  within  the  United  States,  but  the  treasury  depart- 
ment later  apparently  abandoned  this  position. 

22  This  conclusion  is  supported  by  a  consideration  of  the  historical  cir- 
cumstances under  which  the  acts  of  1909,  1913  and  1916  and  1918  were 
passed.  The  act  of  August  5,  1909,  which  has  been  held  to  be  an  excise  tax 
law,  imposing  a  tax  measured  by  net  income,  was  necessarily  so,  because 
the  constitutional  authority  of  Congress  "to  lay  and  collect  taxes  on 
incomes  from  whatever  source  derived,  without  apportionment"  was  first 
granted  by  the  Sixteenth  Amendment  to  the  Constitution,  which  was  adopted 
in  1913,  and  the  constitutionality  of  the  1913  Law  has  been  sustained  as  an 
income  tax  on  the  basis  of  this  constitutional  amendment  (Brushhaber  v. 
Union  Pacific  R.  R.  Co.,  240  U.  S.  1).  The  Sixteenth  Amendment  was 
adopted  plainly  with  the  view  of  relieving  income  taxes  from  apportion- 
ment and  the  Revenue  Act  of  1916,  and  the  Revenue  Act  of  1918,  as  well 
as  the  act  of  October  3,  1913,  were  passed  as  income  taxes  in  consequence 
of  the  relief  granted  by  the  Sixteenth  Amendment.  Furthermore  (as  to 
foreign  corporations)  the  socalled  capital  stock  tax,  imposed  by  the  Reve- 
nue Act  of  1918,  (§  1000  et  seq.)  and  the  Revenue  Act  of  1921  (§  1000  et 
seq.)  are  excise  taxes  for  the  privilege  of  doing  business  and  it  is  self- 
evident  that  Congress  did  not  intend  to  impose  two  taxes  for  the  same 
privilege. 

23  This  law  provided  that  nonresident  aliens  should  be  taxed  upon  income 
"from  sources  within  the  LTnited  States  *  *  *  including  interest 
on  bonds,  notes,  or  other  interest-bearing  obligations  of  residents,  corporate 
or  otherwise"  (Revenue  Act  of  1916,  §  1  (a));  and  that  the  income  tax  should 
be   "levied,  assessed,   collected   and   paid   annually   upon   the   total    net   in- 


NONRESIDENT   ALIENS  61 

tal  invested  within  the  United  States."  ^4  xhe  word  "source"  con- 
veys only  one  idea — that  of  origin.-''  It  is  defined  in  the  Standard 
Dictionary  as  follows:  "That  from  which  any  act,  movement, 
or  effect  proceeds;  a  person  or  thing  that  originates,  sets  in 
motion,  or  is  a  primary  agency  in  producing  any  course  of  action 
or  result;  an  originator;  creator;  origin.  A  place  where  some- 
thing is  found  or  whence  it  is  taken  or  derived."  This  is  its 
natural,  ordinary,  and  familiar  meaning,  and  it  is  particularly 
true  that  terms  used  in  statutes  describing  objects  of  taxation 
should  be  construed  according  to  their  popular  signification.^c 
The  "source"  should  not  be  restricted  to  the  place  where  pay- 
ment is  made,  since  such  place  may  be  arbitrarily  selected 
without  relation  to  the  nature  of  the  transaction  and  is  not  in- 
dicative of  source.-'  The  same  considerations  apply  to  the  place 
where  title  passes  under  a  contract  of  sale.  The  intention  of 
Congress  seems  to  have  been  to  discard  the  1913  basis  of  taxing 
nonresident  aliens  and  foreign  corporations  on  income  accruing 
from  "business  transacted  and  capital  invested"  in  the  United 
States  (as  well  as  the  1909  excise  basis)  and  to  tax  these  classes 
of  taxpayers  on  income  arising  from  "sources  within  the  United 
States."  The  object  of  this  phrase  may  well  be,  on  the  one  hand, 
to  prevent  nonresident  aliens  and  foreign  corporations  from  de- 
riving income  from  the  United  States  free  from  tax  by  virtue  of 
a  technical  construction  of  the  phrase  "business  transacted  and 
capital  invested"  2s  and,  on  the  other  hand,  to  prevent  the  undue 

come  received  in  the  preceding  calendar  year  from  all  sources  within  the 
United  States  by  every  corporation,  joint-stock  company  or  association,  or 
insurance  company,  organized,  authorized,  or  existing  under  the  laws  of  any 
foreign  country  including  interest  on  bonds,  notes,  or  other  interest-bearing 
obligations  of  residents,  corporate  or  othervi^ise,  and  including  the  income 
derived  from  dividends  on  capital  stock  or  from  net  earnings  of  resident 
corporations,  joint-stock  companies  or  associations,  or  insurance  companies, 
whose  net  income  is  taxable  under  this  title."  (Revenue  Act  of  1916,  § 
10   (a).) 

2-1  Under  the  1913  Law  nonresident  aliens  and  foreign  corporations  were 
taxable  only  upon  the  "net  income  accruing  from  business  transacted  and 
capital  invested  within  the  United  States."  The  similarity  between  the 
1913  Law  and  the  British  law  taxing  nonresident  foreign  corporations  on 
gains  arising  or  accruing  from  "any  trade  as  exercised  within  the  United 
Kingdom"  should  be  noted. 

2r.  The  word  "source"  has  been  defined  by  regulation  to  mean  "the  place 
of  origin  of  income."     (Reg.  33,  Art.  66:) 

26  De  Ganay  v.  Lederer,  250  U.  S.  376,  decided  June  9,  1919.  See  Chapter 
47  for  other  cases  on  this  point. 

27  0.  D.  651,  T.  B.  35-20-1174. 

28  See  attorney-general's  opinions  under  date  of  October  23,  1913,  and 
July  15,  1914,  as  to  taxability  of  interest  on  bonds  and  dividends  on  stock 


62  FEDERAL  INCOME  TAX 

imposition  of  a  tax  when  the  real  source  of  income  is  not  within 
this  country.  The  Revenue  Act  of  1918  goes  further  than  the 
1916  Law  in  expressly  citing  certain  kinds  of  income^^^  as  being 
from  "sources  within  the  United  States"  and  together  with  the 
1916  Law  marks  a  long  step  in  advance  towards  international 
comity  in  taxation ^^ — a  sincere  regard  for  the  essentially  just 
and  proper  jurisdictional  limitation  upon  the  exercise  of  the 
sovereign  power  and  an  avoidance  of  taking  constructive  juris- 
diction for  the  purpose  of  taxing  income  which  rightly  should 
not  be  levied  upon  to  defray  the  burdens  of  government  in  the 
United  States. 

With  this  statutory  and  departmental  definition  of  the  term 
''sources  within  the  United  States"  in  mind,  and  in  the  light 
of  the  general  principles  which  have  just  been  discussed,  it 
seems  best  to  consider  the  term  as  defined  by  the  present  law 
separately  in  respect  of  the  several  classes  of  income  referred  to 
in  the  statute. 

Income  From  Interest.  The  Revenue  Act  of  1921  provides"^ 
that  the  following  shall  constitute  income  from  "sources  within 
the  United  States,"  and  that  all  other  interest  shall  be  regarded 
as  from  "sources  without  the  United  States": 

"Interest  on  bonds,  notes,  or  other  interest-bearing  obliga- 
tions of  residents,  corporate  or  otherwise,  not  including  (a) 
interest  on  deposits  with  persons  carrying  on  the  banking  busi- 
ness paid  to  persons  not  engaged  in  business  within  the  United 
States  and  not  having  an  office  or  place  of  business  therein,  or 
(b)  interest  received  from  a  resident  alien  individual  or  a  resi- 
dent foreign  corporation  when  it  is  shown  to  the  satisfaction 
of  the  commissioner  that  less  than  20  per  centum  of  the  gross  in- 
come of  such  resident  payor  has  been  derived  from  sources  with- 
in the  United  States,  as  determined  under  the  provisions  of 
this  section,  for  the  three-year  period  ending  with  the  close  of 
the  taxable  year  of  such  payor,  or  for  such  part  of  such  period 

under  the  language  of  the  Act  of  October  3,  1913,  with  respect  to  nonresi- 
dent aliens,  as  one  of  the  reasons  for  adopting  the  phrase  "sources  within 
the  United  States." 

29  Cf.  Revenue  Act  of  1918,  §  233  (b),  and  Revenue  Act  of  1916,  §  10  (a). 

30  The  evil  of  double  taxation  as  between  the  states  of  this  country  was 
deprecated  by  Mr.  Justice  Holmes  in  Kidd  v.  Alabama,  188  U.  S.  730,  at 
p.  732,  where  he  said:  "No  doubt  it  would  be  a  great  advantage  to  the 
country  and  to  the  individual  states  if  principles  of  taxation  could  be  agreed 
upon  which  did  not  conflict  with  each  other,  and  a  common  scheme  could  be 
adopted  by  which  taxation  of  substantially  the  same  property  in  two  juris- 
dictions could  be  avoided." 

31  Revenue  Act  of  1921,  §  217  (a)   1,   (c)   1. 


NONRESIDENT   ALIENS  63 

immediately  preceding  the  close  of  such  taxable  year  as  may  be 
applicable." 

This  provision  is  a  repetition  of  the  Revenue  Act  of  1918, 
except  that  the  interest  specified  under  (a)  and  (b)  is  excluded 
from  gross  income  from  "sources  within  the  United  States." ^2 
The  interest  specified  under  (a)  was  taxable  under  the  1918 
Law.33  It  was  also  ruled  under  that  law  that  where  a  bank  in 
the  United  States  collects  interest  upon  foreign  securities  for 
its  nonresident  alien  customers  and  credits  same  to  their  ac- 
count, allowing  interest  on  the  balance  so  maintained,  the  iden- 
tity of  the  interest  derived  from  foreign  securities  is  lost  so  that 
the  interest  thus  paid  or  credited  was  subject  to  tax  and  with- 
holding.''^ Where  nonresident  aliens  purchase  British  Govern- 
ment treasury  bills  at  a  discount  in  United  States  markets  and 
collect  the  same  at  maturity  either  in  the  foreign  country  or 
from  the  paying  agent  of  that  government  in  the  United  States, 
such  discount  is  not  income  from  sources  within  the  United 
States.35 

The  place  where  interest  is  payable  is  immaterial ;  the  test  is 
whether  or  not  it  is  paid  on  bonds,  notes,  or  other  interest- 
bearing  obligations  of  residents,  corporate,  or  otherwise.^*'  In- 
terest upon  obligations  of  corporations  organized  in  the  United 
States,  but  doing  no  business  and  owning  no  property  therein, 
is  not  taxable  when  paid  to  nonresident  aliens.s^  Where  bonds, 
notes  or  other  obligations  of  a  foreign  government  are  under- 
written by  a  United  States  banking  establishment  and  are  by 
their  terms  payable  at  an  oflSce  of  such  banking  establishment 
in  the  United  States,  interest  paid  from  the  United  States  office 
to  nonresident  alien  individuals  or  foreign  corporations  who  are 
holders  of  such  securities  is  not  regarded  as  income  from 
"sources  within  the  United  States." ^s  A  domestic  firm  opened  a 
credit  with  a  foreign  bank  which  was  to  be  used  by  drafts  which 
the  foreign  bank  agreed  to  accept.  Various  acceptances  and 
renewals  were  effected  during  a  certain  period,  the  last  accepted 
draft  having  come  due  in  1914.  The  domestic  firm  settled  most 
of  its  debt  in  London  with  a  correspondent  of  the  bank,  and 
at  the  end  of  1919,  the  balance,  representing  part  of  the  interest 

32  Cf.  Revenue  Act  of  1921,  §217  (a)  1;  Revenue  Act  of  1918,  §213  (b). 

33  Reg.  45,  Art.  91. 

34  O.  D.  269,  T.  B.  18-19-485. 

35  0.  D.  534,  T.  B.  23-20-985. 

36  0.  D.  35,  T.  B.  1-19-47;  O.  D.  239,  T.  B.  13-19-417;  O.  D.  651,  T.  B. 
35-20-1174. 

37  Reg.  45,  Art.  92;  0.  D.  908,  T.  B.  18-19-478. 
3S  O.  D.  786,  T.  B.  1-19-16. 


64  FEDERAL  INCOME  TAX 

and  commissions,  was  paid  in  the  foreign  country  in  foreign 
money.  It  was  held  under  the  1918  Law  that  the  obligation  of 
the  domestic  firm  to  pay  the  drafts  which  were  accepted  by  the 
foreign  bank,  and  the  interest  thereon,  is  such  an  "interest- 
bearing  obligation"  as  is  contemplated  by  the  statute,  regardless 
of  the  fact  that  the  debt  was  incurred  outside  the  jurisdiction  of 
the  United  States  and  the  interest  was  paid  in  a  foreign  country 
in  foreign  money.  The  commissions  were  paid  for  services 
rendered  by  a  nonresident  foreign  corporation  in  a  foreign  coun- 
try and  were  not  income  from  a  source  within  the  United  States, 
but  the  amount  paid  as  interest  was  subject  to  tax.-'^ 

Interest  Upon  Obligations  of  the  United  States.  Interest 
received  on  and  after  March  3,  1919,  on  bonds,  notes  and  certifi- 
cates of  indebtedness  of  the  United  States,  and  bonds  of  the 
War  Finance  Corporation,  while  beneficially  owned  by  a  non- 
resident alien  individual,  or  a  foreign  corporation,  partnership 
or  association,  not  engaged  in  business  in  the  United  States  is 
exempt  from  all  income  and  war-profits  and  excess-profits 
taxes.^°  Where  trustees  hold  United  States  Liberty  bonds  or 
Victory  notes  in  trust  for  a  nonresident  alien  life  beneficiary  and 
are  to  distribute  the  income  periodically,  the  bonds  and  notes 
are  held  to  be  "beneficially  owned"  by  such  nonresident  alien.^^ 

Income  From  Dividends.  The  Revenue  Act  of  1921  provides  ^^ 
that  the  following  shall  constitute  income  from  "sources  within 
the  United  States"  and  that  all  other  dividends  shall  be  regarded 
as  from  "sources  without  the  United  States": 

"The  amount  received  as  dividends  (a)  from  a  domestic  corpo- 
ration other  than  a  corporation  entitled  to  the  benefits  of  Section 
262,  or  (b)  from  a  foreign  corporation  unless  less  than  50  per 
centum  of  the  gross  income  of  such  foreign  corporation  for  the 
three-year  period  ending  with  the  close  of  its  taxable  year  pre- 
ceding the  declaration  of  such  dividends  (or  for  such  part  of  such 
period  as  the  corporation  has  been  in  existence)  was  derived  from 
sources  within  the  United  States  as  determined  under  the  provi- 
sions of  this  section." 

The  Revenue  Act  of  1918  provided  that  gross  income  "from 
sources  within  the  United  States"  included  dividends  from  "res- 

39  0.  D.  1062,  T.  B.  41-21-1863. 

40  Reg.  45,  Art.  93;  Act  of  July  9,  1918  (Public  No.  192),  §3,  as  amended 
by  Act  of  March  3,  1919,  §  4.  This  is  true  notwithstanding  the  provisions  of 
the  Second  Liberty  Bond  Act  (Act  of  September  24,  1917,  Public  No.  43), 
the  Third  Liberty  Bond  Act  (Act  of  April  4,  1918,  Public  No.  120),  and  the 
War  Finance  Corporation  Act  (Act  of  April  5,  1918,  Public  No.  121). 

41  O.  D.  464,  T.  B.  16-20-861. 

42  Revenue  Act  of  1921,  §  217  (a)  2,  (c)  2. 


NONRESIDENT  ALIENS  65 

ident"  corporations,  but  permitted  a  credit  for  purposes  of  the 
normal  tax  (in  the  case  of  nonresident  alien  individuals)  and 
the  deduction  (in  the  case  of  foreign  corporations)  of  divi- 
dends from  a  corporation  taxable  upon  its  net  income,  or  from 
a  personal  service  corporation  out  of  earnings  or  profits  upon 
which  income  tax  had  been  imposed.^^  If  a  foreign  payor  cor- 
poration paid  any  tax  upon  its  income,  however  small  that  tax 
(or  the  income  from  United  States  sources  upon  which  it  was 
paid)  might  be,  its  dividends  might  be  so  credited  or  deducted 
by  nonresident  alien  individuals  and  foreign  corporations  re- 
spectively.^^ The  exemption  of  dividends  from  the  normal  tax 
applied  not  only  to  dividends  received  direct  from  a  corporation, 
but  also  to  dividends  received  through  the  medium  of  fiduciaries 
or  partnerships.^-^  Dividends  of  nonresident  foreign  corpora- 
tions (that  is,  corporations  not  engaged  in  trade  or  business 
within  the  United  States  and  not  having  any  office  or  place  of 
business  in  this  country)  were  not  taxable  in  the  hands  of  a 
nonresident  alien,  even  though  such  dividends  were  payable  in 
this  country.^'^  Dividends  on  stock  of  corporations  organized  in 
the  United  States,  but  doing  no  business  in  the  United  States 
and  owning  no  property  therein,  were  held  not  to  be  taxable 
when  paid  to  nonresident  aliens.^"* 

^■'-  See  Revenue  Act  of  1918,  §§  213  (c),  216  (a),  233  (c),  234  (a)  6,  (b). 
■i^  Letter  from   treasury  department  dated  June   9,   1919;   L   T.   S.   1921, 
^  1661. 

45  See  Chapter  19  for  a  further  discussion  of  this  subject. 

46  Revenue  Act  of  1918,  §213  (c).  See  also  T.  D.  2012,  T.  D.  2030,  T.  D. 
2313,  T.  D.  2325.  Letter  from  treasury  department  dated  April  5,  1916, 
L  T.  S.  1919,  11  687.  In  two  provisions  of  the  1916  Law  (Revenue  Act  of 
1916,  §§1  (b)  and  8(b))  nonresident  aliens  were  excepted  from  the  require- 
ments of  making  reports  on  and  paying  the  surtax  on  "such  income  (income 
derived  from  dividends  on  the  capital  stock  or  from  the  net  earnings  of  any 
corporation)  derived  from  sources  without  the  United  States."  Although 
this  language  was  not  construed  by  the  courts  or  by  any  regulation,  it  un- 
doubtedly applied  to  dividends  received  from  foreign  corporations  where  the 
earnings  of  such  foreign  corporations  were  derived  from  sources  without 
the  United  States  even  though  the  dividends  were  payable  in  this  country, 
and  there  seems  to  be  ground  for  the  contention  that  it  also  applied  with 
equal  force  whether  the  corporation  was  foreign  or  domestic.  Under  the 
1918  Law  it  is  provided  (Revenue  Act  of  1918,  §  213  (c)),  that  in  the  case 
of  nonresident  aliens  "gross  income  includes  only  the  gross  income  from 
sources  within  the  United  States,  including  *  *  *  and  including  dividends 
from  resident  corporations."  It  may,  therefore,  be  said  that  this  language 
removes  the  doubt  existing  under  the  provisions  of  the  1916  Law,  and  places 
the  taxability  of  nonresident  aliens  in  respect  to  dividends  on  the  ground 
of  the  residence  of  the  corporation  paying  the  dividends. 

47  Reg.  45,  Art.  92.     The  English  law  taxes  an  English  company  which 


66  FEDERAL  INCOME  TAX 

Under  the  Revenue  Act  of  1921,  while  dividends  from  domestic 
corporations  (except  those  taxed  as  foreign  corporations)  ■•'^  are 
to  be  included  in  gross  income  by  nonresident  alien  individuals 
and  foreign  corporations,  they  may  be  credited  for  purposes  of 
the  normal  tax  by  nonresident  alien  individuals,  and  deducted  in 
ascertaining  net  income  by  foreign  corporations.^''  This  makes 
them  subject  to  the  surtaxes  in  the  case  of  individuals,  but  would 
seem  to  free  them  from  tax  in  the  case  of  foreign  corporations. 
The  same  considerations  would  seem  to  apply  to  dividends  from 
foreign  corporations  with  a  gross  income,  for  the  three-year 
period  preceding  the  close  of  the  taxable  year  preceding  the  date 
of  declaration,  of  50 /<  or  more  from  sources  within  the  United 
States.  Since  dividends  from  foreign  corporations  with  a  gross 
income,  as  indicated  above,  of  less  than  50%  from  sources  within 
the  United  States  are  income  from  sources  without  the  United 
States,  all  dividends  would  seem  to  be  free  from  tax  under  the 
present  law,  in  the  case  of  a  foreign  corporation. 

Income  From  Personal  Services.  The  Revenue  Act  of  1921 
provides  ""O  that  "compensation  for  labor  or  personal  services  per- 
formed in  the  United  States"  shall  constitute  income  from 
"sources  within  the  United  States,"  and  that  "compensation  for 
labor  or  personal  service  performed  ivithout  the  United  States" 
shall  constitute  income  "from  sources  without  the  United  States." 
This  provision  is  a  statutory  enactment  of  departmental  regula- 
tions under  the  1918  Law.'"'!  A  nonresident  alien  individual  em- 
ployed by  a  domestic  corporation  on  a  monthly  salary  basis  as 
its  salesman  in  a  foreign  territory,  who  visits  the  home  office  of 
the  company  the  first  part  of  each  year  for  the  purpose  of  re- 
porting on  sales  and  conditions  generally  in  the  foreign  markets 
and  receiving  instructions  in  sales  methods  and  in  regard  to  new 
app-aratus,  is  not  subject  to  tax  on  the  salary  he  receives  while 
in  the  United  States. s- 

has  permanently  located  its  business  and  seat  of  management  abroad  only 
with  respect  to  the  profits  of  the  English  shareholders. 
4S  See  Revenue  Act  of  1921,  §  262. 

49  See  Revenue  Act  of  1921,  §§213  (c),  216  (a),  217,  233  (b),  234  (a), 
6,  (b). 

50  Revenue  Act  of  1921,  §217  (a)  3,  (c)  3. 

51  Reg.  45,  Art.  92.  Under  the  1913  Law  it  was  held  that  compensation 
paid  to  nonresident  aliens  for  services  rendered  in  a  foreign  country,  in- 
cluding business  and  traveling  expenses,  was  not  taxable.  (T.  D.  2152.) 
The  1916  Law  by  imposing  a  tax  on  "income  from  all  sources  within  the 
United  States"  raised  a  question  as  to  the  taxability  of  such  compensation. 
(Reg.  33,  Rev.,  Art.  32.) 

52  O.  D.  578,  T.  B.  28-20-1053.  Compensation  received  by  nonresident  alien 
munitions  inspectors  and  purchasing  agents,  from  foreign  governments  is 
not  subject  to  tax.     (Reg.  45,  Art.  92.) 


NONRESIDENT   ALIENS  67 

Wages  of  Alien  Seamen.    While  resident  alien  seamen  are 
taxable    like    citizens    on    their   entire    income   from    whatever 
sources  derived,  nonresident  alien  seamen  are  taxable  only  on 
income  from  sources  within  the  United  States.  Ordinarily,  wages 
received  for  services  rendered  inside  the  territorial  United  States 
are  to  be  regarded  as  from  sources  within  the  United  States.  The 
wages  of  an  alien  seaman  earned  on  a  coastwise  vessel  are  from 
sources  within  the  United  States,  but  wages  earned  by  an  alien 
seaman  on  a  ship  regularly  engaged  in  foreign  trade  are  not  to 
be  regarded  as  from  sources  within  the   United   States,  even 
though  the  ship  flies  the  American  flag,  or  although  during  a 
part  of  the  time  the  ship  touched  at  United  States  ports  and  re- 
mained there  a  reasonable  time  for  the  transaction  of  its  busi- 
ness.    The  presence  of  a  seaman  aboard  a  ship  which  enters 
a  port  for  such  purposes  of  foreign  trade  is  merely  transitory 
and  wages  earned  during  that  period  by  a  nonresident  alien  sea- 
man are  not  taxable.'--^    The  wages  earned  by  persons  serving 
aboard   vessels   plying   between   the   continental   United   States 
and  Porto  Rico  do  not  constitute  income  from  sources  within 
the  United  States  since  such  vessels  are  held  to  be  engaged  in 
foreign  trade."'^   A  steamer  engaged  in  foreign  trade  which  lies 
for  a  period  of  two  weeks  in  a  United  States  port  for  the  pur- 
pose of  completing  repairs  is  deemed  to  be  in  such  port  a  reason- 
able time  for  the  transaction  of  business,  and  wages  paid  to  its 
nonresident  seamen  during  such  period  are  income  from  sources 
without  the  United  States."-"-  Wages  earned  by  a  nonresident  alien 
on  an  occasional  coastwise  voyage  on  a  vessel  generally  making 
foreign   voyages   are   income  from   sources   within   the   United 
States.^'" 

A  vessel  sailing  from  a  port  in  the  United  States  on  the  Paci- 
fic coast  to  a  port  in  the  United  States  on  the  Atlantic  coast,  or 
vice  versa,  via  the  Panama  Canal,  does  not  come  within  the 
meaning  of  the  term  "a  vessel  engaged  in  foreign  trade."  The 
wages  of  nonresident  alien  seamen  received  for  services  ren- 
dered on  such  vessels  are  subject  to  withholding."  There  is  no 
withholding  from  the  wages  of  alien  seamen  unless  they  are  non- 
residents."^^  An  employer  is,  however,  required  to  render  a  re- 

•'•^  Reg.  45,  Art.  92a.    As  to  the  status  of  alien  seamen  as  residents  or  non- 
residents, see  Reg.  45,  Art.  312a. 
54  O.  D.  536,  T.  B.  23-20-987. 
^5  O.  D.  559,  T.  B.  26-20-1027. 
5«  O.  D.  245,  T.  B.  13-19-424. 
37  O.  D.  784,  T.  B.  5-21-1416. 
^  Reg.  45,  Art.  92a. 


68  FEDERAL  INCOME  TAX 

turn  of  information  in  all  cases  where  he  has  made  payment  of 
$1,000  or  over  of  wages  to  resident  alien  seamen  in  any  taxable 
year.^^ 

Income  From  Rentals  or  Royalties.  The  Revenue  Act  of  1921 
provides  ^0  that  the  following  shall  constitute  income  from 
"sources  within  the  United  States":  "Rentals  or  royalties  from 
property  located  in  the  United  States  or  from  any  interest  in 
such  property,  including  rentals  or  royalties  for  the  use  of  or  for 
the  privilege  of  using  in  the  United  States,  patents,  copyrights, 
secret  processes  and  formulas,  good  will,  trade-marks,  trade 
brands,  franchises,  and  other  like  property;"  and  that  the  follow- 
ing shall  constitute  income  from  "sources  without  the  United 
States" :  "Rentals  or  royalties  from  property  located  without  the 
United  States  or  from  any  interest  in  such  property,  including 
rentals  or  royalties  for  the  use  of  or  for  the  privilege  of  using 
without  the  United  States,  patents,  copyrights,  secret  processes 
and  formulas,  good  will,  trade-marks,  trade  brands,  franchises, 
and  other  like  property,"  The  same  rule  in  regard  to  rentals 
prevailed  under  the  Revenue  Act  of  1918/'^  Profits  derived  by  a 
nonresident  alien  author  from  the  sale  of  all  rights  of  serial 
publication  to  a  domestic  corporation  of  certain  stories  were  held 
not  to  be  income  from  "sources  within  the  United  States"  under 
the  1918  Law,  inasmuch  as  the  author  had  no  domicile  within  the 
United  States  and  as  the  income  received  by  him  from  such  sale 
could  not  be  said  to  issue  out  of  property  or  business  having  a 
situs  in  the  United  Statgs.^- 

Income  From  Sales  and  Dealings  in  Real  Property.  The 
Revenue  Act  of  1921  provides  ^^  that  "gains,  profits,  and  income 
from  the  sale  of  real  property  located  in  the  United  States" 
shall  constitute  income  from  "sources  within  the  United  States," 
and  that  "gains,  profits,  and  income  from  the  sale  of  real  prop- 
erty located  tvithoiit  the  United  States"  shall  constitute  income 
from  "'sources  without  the  United  States."    The  same  rule  es- 

59  Letter  from  treasury  department,  dated  September  30,  1919;  L  T.  S. 
1919,  113069. 

("•o  Revenue'  Act  of  1921,  §  217  (a)  4,  (c)  4.  Under  the  1913  Law  royalties 
paid  to  nonresident  aliens  under  an  agreement  for  the  purchase  of  certain 
patent  rights,  the  patents  being  based  upon  the  quantity  of  goods  produced 
by  the  use  of  such  patents,  have  been  held  to  be  income  accruing  to  non- 
resident aliens  by  reason  of  property  owned  or  business  carried  on  within 
the  United  States.     (T.  D.  2137).     See  Reg.  45,  Art.  91. 

"Ji  Reg.  45,  Art.  92. 

62  O.  D.  988,  T.  B.  32-21-1759. 

63  Revenue  Act  of  1921,  §  217  (a)  5,  (c)  5. 


NONRESIDENT   ALIENS  69 

tablishing  the  location  of  the  property  aa  the  test  of  source  ap- 
plies to  exchanges  of  real  property/'^  The  same  rule  prevailed 
under  the  Revenue  Act  of  1918. 

Miscellaneous  Income:  Income  From  Manufacturing  and  Sell- 
ing Property.  It  is  provided''"'  further  in  the  Revenue  Act  of 
1921  that  items  of  gross  income  other  than  those  enumerated  in 
the  preceding  paragraphs  "shall  be  allocated  or  apportioned  to 
sources  within  or  without  the  United  States  under  rules  and  reg- 
ulations prescribed  by  the  commissioner  with  the  approval  of  the 
secretary";  and  also  that:  ''Gains,  profits  and  incoine  from  (1) 
transportation  or  other  services  rendered  partly  within  and  part- 
ly without  the  United  States,  or  (2)  from  the  sale  of  personal 
property  produced  (in  whole  or  in  part)  by  the  taxpayer  within 
and  sold  without  the  United  States,  or  produced  (in  whole  or  in 
part)  by  the  taxpayer  without  and  sold  within  the  United  States, 
shall  be  treated  as  derived  partly  from  sources  within  and  partly 
from  sources  without  the  United  States.  Gains,  profits  and  in- 
come derived  from  the  purchase  of  personal  property  within  and 
its  sale  without  the  United  States  or  from  the  purchase  of  per- 
sonal property  without  and  its  sale  within  the  United  States, 
shall  be  treated  as  derived  entirely  from  the  country  in  which 
sold."  The  words  "sale"  or  "sold"  include  "exchange"  or  "ex- 
changed"; and  the  word  "produced"  includes  "created,"  "fabri- 
cated," "manufactured,"  "extracted,"  "processed,"  "cured,"  or 
"aged."66 

This  provision  should  be  read  in  the  light  of  the  following 
statement  made  by  Senator  Penrose  in  his  report'"  on  the  Reve- 
nue Act  of  1921 : 

"The  present  law  is  both  obscure  and  economically  unsound, 
inasmuch  as  the  attorney-general  has  held  that  where  goods  are 
manufactured,  or  produced  in  the  United  States  and  sold  abroad, 

64  Revenue  Act  of  1921,  §  217  (f ) 

63  Revenue  Act  of  1921,  §217  (e).  Where  a  Wisconsin  partnership  and 
a  New  York  partnership  entered  into  a  partnership  agreement  under  which 
the  Wisconsin  partnership  furnishes  40%  of  necessary  capital  and  has  exclu- 
sive control  of  purchasing,  handling,  storing  and  shipping  of  Wisconsin 
tobacco,  and  the  New  York  firm  furnishes  60%  of  the  capital  and  has  exclu- 
sive control  of  the  sale  and  disposition  of  the  tobacco,  all  sales  being  made 
without  the  state  of  Wisconsin,  the  portion  of  the  income  going  to  the  New 
York  firm  has  been  held  under  the  Wisconsin  Income  Tax  Law  to  be  income 
derived  partly  from  property  and  business  within  the  state  of  Wisconsin 
and  partly  from  business  transacted  without  the  state,  which  should  be 
allocated.     (Village  of  Westby  v.  Bekkedal,  172  Wis.  114,  178  N.  W.  451.) 

66  Revenue  Act  of  1921,  §  217  (f). 

67  See  report  of  finance  committee  on  Internal  Revenue  Bill  of  1921,  p.  16. 


70  FEDERAL  INCOME  TAX 

no  part  of  the  profit  is  derived  from  a  source  within  the  United 
States." 

In  the  opinion  referred  to  by  Senator  Penrose  the  attorney- 
general  dealt  with  the  following  five  specific  cases: 

1.  A  corporation  organized  under  the  laws  of  Scotland  owns 
and  operates  two  sawmills  in  the  United  States.  The  mills  saw 
logs  into  plank  squares  called  "handle  blanks"  and  also  roughly 
turn  hammer  handles.  These  products  are  all  exported  to  Glas- 
gow, where  they  are  finished  at  the  home  mill.  In  addition 
the  manager  of  the  American  plant  buys  logs  in  the  United 
States  and  exports  them  as  such  to  Great  Britain.  No  part  of 
the  products  of  the  mills  located  in  this  country  or  of  the  logs 
purchased  here  is  sold  in  the  United  States,  but  the  entire  output 
is  sold  in  Great  Britain.  The  plants  and  operations  of  the  man- 
ager in  the  United  States  are  conducted  solely  from  funds  sent 
to  this  country  from  the  home  office  in  Glasgow^  Scotland,  and 
no  funds  are  sent  to  the  home  office  from  the  American  plants. 
No  income  is  derived  from  the  mere  manufacture  of  goods;  be- 
fore there  can  be  income  there  must  be  sale ;  and  there  is  no 
income  from  sources  within  the  United  States  from  goods  man- 
ufactured here  unless  there  is,  in  the  language  of  the  statute,*'*'^ 
"both  manufacture  and  disposition  of  goods  within  the  United 
States."  The  obvious  purpose  of  this  section  is  to  tax  only 
income  that  accrues  within  the  United  States.  Congress  does 
not  attempt  to  tax  profits  arising  from  goods  manufactured  in 
this  country  but  sold  after  being  shipped  abroad  and  without 
being  disposed  of  by  the  owner  in  this  country.  When  the  corpo- 
ration manufactures  or  partially  manufactures  articles  in  this 
country  but  does  not  sell  or  dispose  of  them  until  they  are  taken 
to  Scotland,  there  is  no  income  from  sources  within  the  United 
States.  As  to  the  purchase  and  exportation  of  logs,  since  profits 
that  may  accrue  from  such  transactions  are  not  specifically  pro- 
vided for  in  the  section  of  the  statute  taxing  profits  on  the  "man- 
ufacture and  disposition  of  goods  within  the  United  States,"  they 
are  taxable,  if  at  all,  because  they  represent  compensation  from 
trades,  businesses,  commerce,  etc.,  as  enumerated  in  another  sec- 
tion,*'^ which  are  carried  on  within  the  United  States.  For  the 
reasons  given  in  cases  quoted  from  in  the  footnote  below  "^  it  is 
concluded  that  income  which  may  accrue  to  the  corporation  in 
England  by  sale  of  logs  purchased  in  the  United  States  is  not 
income  from  sources  within  the  United  States. 

fis  Revenue  Act  of  1918,  §  233  (b). 
69  Revenue  Act  of  1918,  §  213  (a). 

™ln  Sulley  v.  Attorney-General,  5  H.  &  N.  711  (2  Br.  Tax  Cas.  149),  un- 
der a  statute  taxing-  the  income  of  nonresidents  "from  any  property  what- 


NONRESIDENT  ALIENS  71 

2.  The  second  case  involved  an  English  corporation  acting 
through  a  New  York  corporation.  Under  an  agreement  between 
them  the  latter  corporation  is  granted  the  exclusive  right  to 
handle  the  merchandise  of  the  former  in  the  United  States  and 
Canada.  Orders  for  the  goods  are  taken  bj^  the  New  York  cor- 
poration on  net  terms,  payment  to  be  made  10  days  after  delivery. 
A  minimum  net  price  for  the  sale  of  the  goods  by  the  New  York 
corporation  is  fixed  by  the  English  corporation  at  an  amount  not 
to  exceed  the  price  obtained  for  similar  goods  in  England.  The 
New  York  corporation  assumes  credit  risks  and  advances  50%  of 
the  minimum  net  price  against  the  bills  of  lading  or  packers  re- 
ceipts. The  amount  advanced  is  deducted  by  it,  together  with 
freight  charges,  commissions,  etc.,  when  remitting  to  the  Eng- 
lish corporation  the  amounts  collected  from  the  customers.  The 
New  York  corporation  receives  a  5%  commission  on  the  sale  of 
the  goods  and  any  excess  over  the  minimum  net  price,  after  de- 
ducting such  commission,  and  charges  for  freight,  duties,  insur- 
ance, etc.,  are  shared  equally  between  the  two  corporations.  No 
price  that  is  insufficient  to  cover  the  minimum  net  price,  plus 
freight,  duty,  and  other  charges,  is  accepted  without  the  approval 

ever  in  the  United  Kingdom,  or  profession,  trade,  employment,  or  voca- 
tion exercised  within  the  United  Kingdom,"  the  facts  are  similar  to  those 
above  stated.  Sulley  was  a  partner  in  a  firm  of  general  merchants  and 
drapers  carrying  on  business  in  both  the  United  States  and  England.  Sulley 
resided  in  England  and  the  other  petitioners  in  the  United  States.  Sulley 
transacted  the  business  of  the  firm  in  England,  which  consisted  of  pur- 
chasing goods  in  England  and  shipping  them  to  the  United  States.  No 
money  was  received  in  England  except  what  was  sent  from  the  United 
States,  and  the  profits  of  the  business  were  made  by  the  resale  of  goods 
at  an  increased  price  in  the  United  States.  The  court  held  that  the  liability 
to  income  tax  attached  only  to  such  profits  as  came  home  to  England  as  the 
share  of  Sulley,  the  partner  resident  there.  The  Lord  Chief  Justice  said: 
"The  question  is,  whether  there  is  a  carrying  on  or  exercise  of  the  trade 
in  this  country.  I  think  there  is  not,  looking  at  the  sense  in  which  the 
term  is  used  and  having  regard  to  the  subject-matter  of  the  statute.  Where- 
ever  a  merchant  is  established,  in  the  course  of  his  operations  his  dealings 
must  extend  over  various  places;  he  buys  in  one  place  and  sells  in  another. 
But  he  has  one  principal  place  in  which  he  may  be  said  to  trade,  viz.,  where 
his  profits  come  home  to  him.  That  is  where  he  exercises  his  trade.  It 
would  be  very  inconvenient  if  this  were  otherwise.  If  a  man  were  liable 
to  income  tax  in  every  country  in  which  his  agents  are  established,  it  would 
lead  to  great  injustice.  The  argument  for  the  Crown  must  be  carried  to 
this  extent,  that  merely  buying  goods  in  this  country  is  a  trade  exercised 
here  so  as  to  subject  the  purchaser  of  the  goods  to  income  tax.  In  the 
present  case  the  defendant  is  a  partner;  but  if  the  argument  is  well  founded, 
this  American  firm  might  be  taxed  in  the  same  way  if  he  had  been  merely 
an  agent.  It  would  be  most  impolitic  thus  to  tax  those  who  come  here  as 
customers.     The  subject  of  a  foreign  state,  not  resident  here,  can  not  be 


72  FEDERAL  INCOME  TAX 

of  the  English  corporation.  The  latter  accepts  all  merchandise 
risks.  If  goods  are  refused  or  returned  to  the  New  York  corpo- 
ration by  its  customers,  it  is  required  to  make  every  effort  to  dis- 
pose of  them.  Unless  goods  are  sold  at  a  profit  above  all  ex- 
penses, the  New  York  corporation  receives  no  commission  there- 
on. The  goods  are  covered  by  insurance  for  the  joint  account  of 
both  corporations  and  are  invoiced  to  the  customer  by  the  New 
York  corporation.  This  case  is  the  converse  of  the  situation  in  1, 
above.  The  English  corporation  in  this  case  purchases  goods  in 
England  and  sells  them  within  the  United  States,  and  profits 
accruing  from  such  transactions  are  plainly  profits  derived  from 
business  carried  on  within  the  United  States."^  The  gross  income 
from  such  business  is  income  from  sources  within  the  United 
States  and  is  to  be  estimated  in  the  same  way  that  such  income 
is  estimated  where  both  manufacture  and  sale  are  had  within  the 
United  States. 

o.  The  third  case  involves  a  partnership  organized  in  England, 
consisting  of  two  members  who  are  citizens  and  residents  of  that 
country.  The  principal  office  of  the  firm  is  at  Liverpool,  Eng- 
land, but  it  maintains  an  ofl^ice  at  Dallas,  Texas,  which  is  operated 
under  a  somewhat  similar  name.  The  Dallas  office  is  in  charge 
of  a  manager,  who  receives  a  fixed  salary  and  a  stipulated  com- 
mission based  upon  the  net  earnings  of  the  firm  in  accordance 
with  a  contract  of  employment  made  by  him  with  the  members 
of  the  firm.  The  business  of  the  firm  is  that  of  cotton  merchants 
and  importers.  The  branch  office  is  engaged  in  buying  cotton  in 
the  United  States  in  behalf  of  the  firm  and  in  shipping  it  to  the 
parent  office  in  England  for  disposition.  It  is  the  custom  of  the 
branch  office  to  draw  on  the  parent  office  for  amounts  sufficient 
to  make  such  purchases,  together  with  a  liberal  margin  to  cover 
estimated  charges  and  expenses,  so  that  at  the  end  of  the  season 

made  amenable  to  our  laws.  How  then  are  their  profits  to  be  made  amen- 
able to  the  fiscal  law?  Simply  by  the  provision  that  whosoever  carries  on 
the  business  and  receives  the  profits  here  shall  be  assessed.  But  in  the 
present  case  no  profits  are  received  by  the  firm,  or  exist  in  this  country. 
*  *  *  The  profits  of  the  firm  in  America  do  not  accrue  in  respect  of  any 
trade  carried  on  in  this  country,  but  in  respect  to  the  trade  carried  on  in  New 
York,  where  the  main  business  is  conducted."  In  State  ex  rel.  Manitowoc 
Gas  Co.  V.  Wisconsin  Tax  Commission,  161  Wis.  Ill,  152  N.  W.  848,  the 
Supreme  Court  of  Wisconsin  said:  "If  an  income  be  taxed,  the  recipient 
thereof  must  be  domiciled  within  the  state,  or  the  property  or  business  out 
of  which  the  income  issues  must  be  situated  within  the  state  so  that  the 
income  may  be  said  to  have  a  situs  therein." 

nSee  Werle  &  Co.  v.  Colquhoun,  2  Br.  Tax  Cas.  402,  58  L.  T.  R.  756; 
Turner  v.  Rickman,  4  Br.  Tax  Cas.  25;  MacPherson  &  Co.  v.  Moore,  6  Br. 
Tax  Cas.  107. 


NONRESIDENT  ALIENS  73 

the  branch  office  may  show  a  balance  to  its  credit.  The  branch 
office  does  not  make  any  sales.  It  was  held  that  the  firm  is  not 
deriving  income  from  sources  within  the  United  States. 

4.  The  fourth  case  is  that  of  a  partnership  organized  in  Eng- 
land consisting  of  six  members,  five  of  whom  are  British  subjects 
residing  in  London  and  the  other  a  citizen  of  the  United  States, 
residing  in  New  York.  The  home  office  of  the  firm  is  in  London, 
but  it  maintains  a  branch  office  in  New  York  city  in  charge  of 
and  conducted  under  the  name  of  the  partner  resident  of  that 
city.  The  business  of  the  firm  is  that  of  commission  merchant  in 
raw  furs.  The  furs  are  consigned  to  it  from  various  parts  of  the 
world,  including  the  United  States,  the  sales  being  made  almost 
entirely  in  London  at  auction  by  auctioneers  employed  by  the 
firm  or  at  private  sale.  The  firm  does  not  at  any  time  take  title 
to  the  goods,  but  title  remains  in  the  consignor  until  the  sale, 
when  it  passes  to  the  purchaser.  The  principal  function  of  the 
New  York  office  is  to- solicit  consignments  of  raw  furs  to  the  firm 
at  London,  which  requires  the  resident  partner  to  travel  to  vari- 
ous points  in  the  United  States  and  Canada.  The  majority  of 
goods  consigned  from  Canada  are  sent  to  New  York  for  ship- 
ment to  London.  The  New  York  office  also  acts  as  disbursing 
agent  for  the  firm  in  paying  to  consignors  in  the  United  States 
and  Canada  the  proceeds  of  sales  of  their  goods  in  London,  at- 
tends to  the  shipment  of  the  goods  to  London,  and  their  storage 
and  insurance  in  New  York  while  waiting  for  steamers,  and 
further  makes  advances  to  consignors  on  the  security  of  bills  of 
lading  or  express  receipts.  The  money  required  to  maintain  the 
New  York  office  is  obtained  by  selling  drafts  on  London,  and  a 
balance  of  about  $20,000  is  usually  carried  by  it  with  a  New  York 
bank.  The  income  of  the  partnership  is  derived  from  a  commis- 
sion of  about  6/(  on  the  proceeds  of  sales  from  furs  consigned 
to  it.  It  collects  the  proceeds  of  the  sales  and  deducts  its  commis- 
sion, the  expenses,  if  any,  incurred  by  it  for  freight,  insurance, 
or  storage,  and  also  the  amount  of  any  advances  made  to  the  con- 
signors. The  balance  of  the  proceeds  is  remitted  to  the  consign- 
ors. No  profit  is  made  on  the  freight  or  other  charges.  It  has 
been  held  that  only  the  income  of  the  partner  resident  within  the 
United  States  is  taxable. 

5.  In  the  fifth  case  a  corporation  organized  under  the  laws 
of  Great  Britain,  with  its  home  office  at  Manchester,  England, 
operates  a  line  of  freight  steamships  between  Philadelphia,  Pa., 
and  foreign  ports.  The  corporation  has  no  office  in  the  United 
States,  but  consigns  its  steamships  to  a  corporation  at  Philadel- 
phia, who  handles  them  as  agents  and  brokers,  together  with 


74  FEDERAL  INCOME  TAX 

steamships  consigned  to  them  by  other  owners.  The  agents  see 
to  the  entry  and  clearance  of  each  steamer  and  the  discharge  and 
loading  of  the  cargo  and  supplies,  collect  such  part  of  the  freight 
as  is  prepayable  in  this  country  for  the  ocean  carriage,  deduct  the 
amount  of  the  agents'  disbursements  and  charges  for  their  serv- 
ices, and  remit  the  balance  to  the  steamship  corporation  at  Man- 
chester upon  the  departure  of  the  vessel.  Frequently  a  large  part 
of  the  freight  is  not  prepayable,  but  is  payable  upon  delivery  of 
the  goods  at  Manchester.  In  an  opinion"-  rendered  by  the  at- 
torney-general under  the  1909  Law  it  was  decided  that  foreign 
steamship  companies  engaged  in  the  business  of  transporting 
passengers,  goods,  and  merchandise  between  ports  in  the  United 
States  and  foreign  ports,  and  maintaining  passenger  and  freight 
agencies  in  this  country  were  taxable  under  that  act.  The  attor- 
ney-general said : 

"*  *  *  Their  business  consists  entirely  in  transporting 
passengers  and  goods  and  merchandise  between  ports  in  this 
country  and  those  of  foreign  countries,  and  receiving  and  dis- 
charging the  same.  Through  agents  located  here  all  contracts 
and  arrangements  incident  to  such  a  business  at  this  end  of  their 
lines  are  made,  and  all  exports  are  delivered  to  their  warehouses 
and  loaded  upon  their  vessels,  and  the  passengers  embark,  while 
they  are  within  the  limits  of  the  United  States ;  and  likewise  here 
their  imports  are  unloaded  and  passengers  from  foreign  ports 
disembark.  If  these  companies  do  not  transact  business  in  the 
United  States  they  transact  no  business  in  any  foreign  port,  and 
their  entire  business  is  carried  on  upon  the  high  seas.  To  such 
a  conclusion  I  am  unable  to  give  assent."  A  similar  conclusion 
was  arrived  at  in  an  English  case"-^  which  held  that  a  cable  cor- 
poration established  at  Copenhagen,  with  an  agent  and  an  office 
in  London,  with  cables  extending  between  England  and  Den- 
mark, was  carrying  on  trade  in  England  from  which  profit  arose 
on  account  of  contracts  entered  into  with  persons  in  England  to 
send  messages  from  England  to  other  countries.  Brett,  L.  J., 
said: 

"  *  *  *  That  which  earns  the  profit,  as  I  said  at  first, 
or  that  out  of  which  they  get  the  profit  is  the  better  phrase, 
is  the  money  to  be  paid  to  them  out  of  the  contract,  which  con- 
tract is  made  in  England,  and  such  contracts  being  habitually 
made  by  them- in  England,  it  seems  to  me,  they  carry  on  in  Eng- 
land the  trade  or  business  of  making  such  contracts.  Therefore, 
it  seems  to  me,  that  these  people  are  properly  said  to  be  persons 

7-' 28  Op.  Atty.  Gen.,  dated  March  9,   1910. 

7.-?  Erichsen  v.  Last,  8  Q.  B.  D.  414;  45  L.  T.  703,  4  Br.  Tax  Cas.  422. 


NONRESIDENT   ALIENS  75 

from  whom  this  duty  must  be  collected."  It  was  held  that  the 
English  corporation  derives  income  from  sources  within  the 
United  States  to  the  extent  that  it  derives  income  from  freight 
and  passenger  traffic  originating  within  the  United  States."^ 

The  1918  Law,  upon  which  this  opinion  was  based,  taxed  as 
income  from  "sources  within  the  United  States"  all  "amounts 
received  (although  paid  under  a  contract  for  the  sale  of  goods  or 
otherwise)  representing  profits  on  the  manufacture  and  disposi- 
tion of  goods  within  the  United  States,""'  It  was  held  under  this 
provision  that  where  the  products  of  certain  foreign  corpora- 
tions, the  entire  capital  stock  of  which  was  owned  by  a  domestic ' 
corporation,  were  sold  by  mail  or  through  United  States  repre- 
sentatives visiting  the  foreign  plants,  to  United  States  citizens 
and  domestic  corporations  f.  o.  b.  shipping  point  in  a  foreign 
country,  no  income  was  derived  by  such  foreign  corporations 
from  "sources  within  the  United  States,"  even  though  invoices 
were  made  by  a  United  States  office  and  payments  were  made 
through  the  office  of  the  domestic  holding  company."'"'  Under  the 
provision  just  quoted,  it  was  held  that  the  mere  selling  of  raw- 
materials  in  this  country  through  the  medium  of  a  mail  order 

T-iT.  D.  3111,  T.  B.  3-21-1401.     See  also  A.  R.  M.  133,  T.  B.  26-21-1703. 

")  Revenue  Act  of  1918,  §§213  (c),  233  (b).  The  use  of  the  word  "and" 
between  "manufacture"  and  "disposition"  was  important.  The  word  "and" 
is  never  to  be  construed  as  "or"  in  the  absence  of  cogent  reasons  (Rice  v. 
U.  S.,  53  Fed.  910).  In  an  early  edition  of  Regulations  45  (Reg.  45,  Art. 
91)  the  treasury  department  violated  this  rule  of  construction.  Under  the 
1913  Law,  under  which  a  foreign  corporation  was  subject  to  the  tax  on  income 
accruing  from  "business  transacted  and  capital  invested"  within  the  United 
States,  the  court  held  a  foreign  corporation  taxable  where  (a)  it  sent  agents 
into  the  United  States  to  solicit  purchasers  for  its  products,  hiring  desk 
room  in  the  United  States  and  empowering  the  salesmen  to  make  written 
contracts,  (b)  shipped  its  product  consigned  to  itself  in  the  United  States 
to  different  points,  where  it  hired  storage  rooms  and  stored  the  product 
in  its  own  name  and  at  its  own  risk  to  insure  delivery  according  to  contract, 
and  to  meet  anticipated  demands.  (Laurentide  Co.,  Ltd.  v.  Durey,  231  Fed. 
223.)  Under  the  1913  Law  the  department  held  also  that  where  a  foreign 
corporation  sent  a  representative  to  this  country  to  solicit  business,  the 
merchandise  thus  sold  to  be  shipped  direct  to  the  consignee,  the  corporation 
was  transacting  business  in  this  country.  The  fact  that  the  solicitor  or 
representative  had  only  a  mailing  address  in  this  country  was  immaterial, 
as  he  was  none  the  less  an  agent  of  the  foreign  corporation.  (T.  D.  2161.) 
An  agent  who  was  doing  business  in  this  country,  buying  and  selling  certain 
products  of  the  foreign  corporation,  was  held  to  be  a  branch  of  the  foreign 
corporation,  as  through  and  by  him  the  foreign  corporation  was  transacting 
business  here.  (T.  D.  2137.)  As  to  the  propriety  of  buying  as  a  test  of 
doing  business,  see  Commonwealth  v.  Standard  Oil  Co.,  101  Pa.  St.  119. 

7«  O.  D.  1100,  T.  B.  46-21-1920. 


76  FEDERAL  INCOME  TAX 

business  or  unsolicited  orders,  did  not  constitute  transacting  busi- 
ness within  the  United  States,  and  any  income  received  from 
such  transactions  would  not  be  subject  to  tax;'^^  but  that  an  alien 
who  comes  to  the  United  States  with  merchandise  which  he  dis- 
poses of  in  this  country  is  subject  to  tax  on  the  profit  derived 
from  such  activities  even  though  within  the  United  States  for  a 
period  of  less  than  30  daysJ*^  Where  a  foreign  corporation  pur- 
chased through  an  agent  in  this  country  bank  acceptances  at  a 
certain  rate  of  discount  and  sold  such  acceptances  through  that 
agent  or  some  other  agent,  for  a  price  greater  than  the  price  for 
which  purchased,  the  amount  of  income  received  as  a  result  of 
the  transaction  was  held  under  the  1918  Law  to  represent  income 
from  "sources  within  the  United  States.""^  The  purchase  of 
bonds  and  sale  thereof  in  the  United  States  was  also  held  to  create 
income  from  "sources  within  the  United  States."  ^'^  Where  secu- 
rities have  been  purchased  in  the  United  States  for  a  foreign 
estate  by  a  domestic  company  upon  an  order  transmitted  to  that 
company  by  the  estate,  the  securities  then  having  been  held  by 
the  company  for  safekeeping  and  to  prevent  delay  in  trading  and 
sold  by  the  company  upon  an  order  from  the  executors  of  the 
estate,  it  has  been  held  that  profits  from  the  sale  are  income  from 
sources  within  the  United  States.^i 

Broadly  speaking,  the  commercial  history  of  any  marketable 
article  involves  two  main  considerations.  The  article  is  (a) 
manufactured — made  from  other  products  into  its  present  state 
or  form — and  (b)  disposed  of.  These  two  considerations  indi- 
cate the  well  known  distinction  between  a  "manufacturing"  and 
a  "mercantile"  business.  Economically,  either  or  both  of  the 
processes  may  bring  a  profit.  The  earnings  of  a  mercantile  busi- 
ness may  be  just  as  truly  due  to  intelligent  and  well  directed 
buying  as  the  earnings  of  a  manufacturing  business  are  due  to 
cheap  and  efficient  manufacturing  business.  The  profits  of  a 
manufacturing  business  are  due  to  two  practically  indivisible 
factors:  (1)  efficient  manufacturing,  and  (2)  efficient  market- 
ing. Similarly,  the  profits  of  a  mercantile  business  are  due  to 
two  indivisible  factors:  (1)  efficient  buying,  and  (2)  efficient 
selling.  But  Congress  has  seen  fit  to  differentiate  in  the  present 
law  between  the   mercantile  business   and  the   manufacturing 

77  0.  D.  294,  T.  B.  23-19-543. 

78  O.  D.  291,  T.  B.  23-19-543. 
7y  O.  D.  221,  T.  B.  11-19-387. 

80  0.  D.  890,  T.  B.  17-21-1593.  But  the  profit  on  retirement  of  such 
bonds  is  held  not  to  create  taxable  income. 

81  0.  D.  863,  T.  B.  14-21-1546. 


NONRESIDENT   ALIENS  77 

business.  Profits  from  the  sale  of  property  produced  within  the 
United  States  and  sold  without  the  United  States  is  income  part- 
ly from  sources  within  and  partly  from  sources  without  the 
United  States,  but  profits  from  the  sale  of  property  purchased 
within  the  United  States  and  sold  without  the  United  States  is 
income  from  sources  without  the  United  States.  Conversely, 
profits  from  the  sale  of  property  produced  without  the  United 
States  and  sold  within  the  United  States  is  income  partly  from 
sources  within  and  partly  from  sources  without  the  United 
States,  but  profits  from  the  sale  of  property  purchased  without 
the  United  States  and  sold  within  the  United  States  is  income 
from  sources  within  the  United  States.  In  other  words,  produc- 
tion, but  not  purchasing,  is  treated  as  an  income  factor.  Selling 
is  always  such  a  factor.--  Under  the  provision  giving  the  com- 
missioner broad  authority  and  discretion  to  apportion  to  sources 
within  and  sources  without  the  United  States,  it  seems  to  be 
within  his  power  to  give  due  weight  to  the  fact,  when  it  obtains, 
that  property  is  produced  only  in  part  in  this  country.  When  only 
part  of  the  production  of  property  takes  place  in  the  United 
States,  the  proportion  of  income  attributable  to  "sources  within 
the  United  States"  should  not  be  so  large  as  it  would  be  if  com- 
plete production  took  place  here. 

Income  Received  From  Fiduciaries.  Where  a  nonresident 
alien  is  the  beneficiary  of  a  trust,  or  of  the  estate  of  a  deceased 
person,  or  is  the  recipient  of  income  from  any  property  held  by 
another,  such  income  is  taxable  to  the  extent  that  it  arises  from 
sources  within  the  United  States.  The  intervention  of  an  agent, 
trustee  or  other  fiduciary  between  the  nonresident  alien  and  the 
source  of  the  income  does  not  render  income  subject  to  taxation, 
which  otherwise  would  not  be  taxable,  nor  does  it  serve  to  re- 

s-'  See  Revenue  Act  of  1921,  §  217  (e).  See  also  0.  D.  890,  T.  B.  17-21-1593. 
This  is  in  line  with  the  theory  of  such  cases  as  Commonwealth  v.  Standard 
Oil  Co.,  101  Pa.  St.  119,  in  which  the  court  said:  "That  the  purchase  of 
oil  in  the  state  by  a  foreign  corporation  for  the  purpose  of  shipping  to  its 
refineries  without  the  state,  is  doing  business  within  the  state,  is  a  proposi- 
tion that  does  not  need  serious  discussion.  *  *  *  Thousands  of  corporations 
and  individuals  in  other  states  make  their  purchases  of  supplies  of  raw 
materials  here,  but  it  has  never  been  seriously  asserted  that  they  were 
doing  business  within  the  state.  It  has  not  been  the  policy  of  the  state  at 
any  time,  as  evidenced  by  its  tax  laws  to  embarrass  the  development  and 
sale  of  her  rich  products,  agricultural  and  mineral,  by  levying  taxes  upon 
strangers  who  come  here  to  buy,  and  it  is  not  the  province  of  the  courts 
to  erect  a  judicial  Chinese  wall  around  the  state,  which  could  not  fail  to 
affect  injuriously  the  best  interests  of  the  people."  But  the  question  in  this 
case  was  whether  the  buyer  transacted  business  in  Pennsylvania,  not  whether 
it  had  income  from  sources  within  the  state. 


78  FEDERAL  INCOME  TAX 

lieve  from  taxation  income  whicii  otherwise  would  be  taxed.""-' 
Dividends,  for  instance,  would  not  be  subject  to  the  normal  tax 
for  the  reason  that  they  are  paid  to  a  trustee  and  by  him  distrib- 
uted to  nonresident  aliens."'^  Similarly,  interest  upon  3%'/'  notes 
of  the  Fifth  Liberty  Loan  is  not  made  taxable  by  passing  through 
the  hands  of  a  fiduciary  to  the  beneficiary."''' 

Income  From  Partnerships.  Nonresident  aliens,  who  are 
members  of  partnerships  deriving  all  their  income  from  sources 
within  this  country,  are  taxable  on  their  entire  distributive 
shares.'"*"  If  a  partnership  derives  only  part  of  its  income  from 
sources  within  the  United  States,  nonresident  alien  partners  are 
taxable  only  on  that  part  of  their  respective  distributive  shares 
of  the  partnership  profits  which  represent  income  of  the  partner- 
ship from  such  sources.*^' 

Deductions  Allowed  in  Computing  Net  Income.  A  nonresident 
alien  is  required  to  report  all  his  taxable  income  from  sources 
within  this  country,  but  from  the  gross  income  so  reported  is 
entitled  to  make  certain  deductions  before  the  tax  is  assessed 
on  the  remainder,  which  constitutes  his  net  income.  The  deduc- 
tions are  ordinarily  similar  in  kind  to  those  allowed  to  residents 
and  citizens  but,  in  general,  are  confined  to  expenditures  con- 
nected with  the  production  of  the  income  subject  to  tax  as  being 
from  sources  within  the  United  States.'^"'  In  the  case  of  a  non- 
resident alien  individual  the  deduction  for  losses  incurred  in  any 
transaction  entered  into  for  profit  is  confined  to  transactions  the 
profit  of  which,  if  they  had  resulted  in  profit,  would  have  been 
taxable.  The  deduction  for  losses  arising  from  fires,  storms, 
shipwreck,  or  other  casualty,  or  from  theft,  is  confined  to  prop- 

^•' Letter  from  treasury  department  dated  March  25,  1915;  I.  T.  S.   1918, 

mio. 

•*-*■!  Letter  from  treasury  department  dated  April  5,  1916;  L  T.  S.  1918, 
M  32,  62,  and  873. 

•"'•I  Exempt  income  is  not  reported  by  the  fiduciary  as  income  accruing  to 
the  estate  for  the  purpose  of  tax.  See  Revenue  Act  of  1921,  §§  219  (b),  212 
(a)  and  213;  Revenue  Act  of  1918,  §§219  (b),  212  (a)  and  213. 

•^"Revenue  Act  of  1921,  §  218;  Revenue  Act  of  1918,  §  218.  See  Chapters 
8  and  9. 

^"t  This  is  one  of  the  many  questions  on  which  the  treasury  department 
has  not  as  yet  made  any  clear  public  statement  of  its  position.  The 
status  of  a  partner  differs  materially  from  that  of  a  stockholder  in  a  cor- 
poration, since  in  the  case  of  a  partnership  no  separate  entity  is  interposed 
between  the  recipient  of  the  income  and  its  original  source.  See  U.  S.  v. 
Coulby,  251  Fed.  982,  affirmed  258  Fed.  27. 

88  Revenue  Act  of  1921,  §214   (b);  Revenue  Act  of  1918,  §214  (b). 


NONRESIDENT   ALIENS  79 

erty  within  the  United  States.^'*  The  deduction  for  charitable 
contributions  excludes  gifts  to  foreign  corporations,  and  includes 
gifts  to  domestic  corporations,  community  chests,  funds,  or  foun- 
dations created  in  the  United  States,  and  the  Vocational  Rehabih- 
tation  Fund.'"' 

The  other  deductions  (for  business  expenses,  interest,  taxes, 
losses  in  trade,  bad  debts,  depreciation,  amortization,  depletion, 
and  gains  arising  from  a  replacement  of  property)  are  allowed 
only  if  and  to  the  extent  that  they  are  connected  with  income 
arising  from  sources  within  the  United  States,  and  the  proper 
apportionment  and  allocation  of  the  deductions  with  respect  to 
sources  within  and  without  the  United  States  is  to  be  determined 
by  the  commissioner.''^  A  "net  loss,"  within  the  meaning  of  the 
1918  Law,  attributable  to  operations  in  the  United  States  was  held 
deductible  under  that  law  by  a  foreign  concern.'-'-  An  extended 
discussion  of  deductions  is  contained  in  other  chapters,'-^'5  the  dis- 
cussion in  this  chapter  being  limited  to  the  provisions  which 
apply  particularly  to  nonresident  aliens,  and  to  some  new  provi- 
sions of  importance  contained  in  the  Revenue  Act  of  1921.  In 
general,  the  deductions  allowed  nonresident  alien  individuals  and 
foreign  corporations  and  the  principles  governing  their  computa- 
tion are  the  same,  and  for  the  convenience  of  the  reader,  the  dis- 
cussion of  the  deductions  applying  to  both  will  be  found  below. 
Some  rulings  having  reference  particularly  to  foreign  corpora- 
tions will  be  found  in  a  later  chapter.''^ 

Apportionment  of  Deductions.  The  Revenue  Act  of  1921 
contains  some  provisions''"'  regarding  the  allocation  and  appor- 
tionment of  deductions  which  are  so  important  that  they  are 
quoted  below: 

"From  the  items  of  gross  income  *  *  (from  sources  within  the 
United  States)  *  *  there  shall  be  deducted  the  expenses,  losses, 
and  other  deductions  properly  apportioned  or  allocated  thereto 

89  Cf.  Revenue  Act  of  1921,  §234  (a)  5,  6,  and  Revenue  Act  of  1918, 
§234  (a),  5,  6.  Under  the  1918  Law  deductible  losses  in  transactions 
entered  into  for  profit  had  to  be  losses  in  transactions  within  the  United 
'  States.    Probably  the  intent  of  the  two  laws  is  the  same. 

wCf.  Revenue  Act  of  1921.  §234  (a)  11;  Revenue  Act  of  1918,  §234 
(a)  11.  The  1921  Law  is  broader  in  permitting  the  deduction  of  gifts  to 
community  chests,  funds,  or  foundations  created  in  the  United  States. 

yi  Revenue  Act  of  1921,  §214  (b);  Revenue  Act  of  1918,  §214  (b).  Reg. 
45,  Art.  271. 

'J^O.  D.  611,  T.  B.  31-20-1099. 

'■»a  See  Chapters  21-30. 

n^  See  Chapter  12. 

'.'.-- Revenue  Act  of  1921,  §217  (b).  (d),  (e). 


80  FEDERAL  INCOME  TAX 

and  a  ratable  part  of  any  expenses,  losses,  or  other  deductions 
which  cannot  definitely  be  allocated  to  some  item  or  class  of  gross 
income.  The  remainder,  if  any,  shall  be  included  in  full  as  net 
income  from  sources  within  the  United  States. 

"From  the  items  of  gross  income  *  *  (from  sources  without 
the  United  States)  *  *  there  shall  be  deducted  the  expenses, 
losses,  and  other  deductions  properly  apportioned  or  allocated 
thereto,  and  a  ratable  part  of  any  expenses,  losses,  or  other  de- 
ductions which  cannot  definitely  be  allocated  to  some  item  or  class 
of  gross  income.  The  remainder,  if  any,  shall  be  treated  in  full 
as  net  income  from  sources  without  the  United  States. 

"Items  of  *  *  *  expenses,  losses  and  deductions,  other  than 
those  specified  in  subdivisions  (a)  and  (c),  shall  be  allocated  or 
apportioned  to  sources  within  or  without  the  United  States  under 
rules  and  regulations  prescribed  by  the  commissioner  with  the 
approval  of  the  secretary.  Where  items  of  gross  income  are 
separately  allocated  to  sources  within  the  United  States,  there 
shall  be  deducted  (for  the  purpose  of  computing  the  net  income 
therefrom)  the  expenses,  losses  and  other  deductions  properly 
apportioned  or  allocated  thereto  and  a  ratable  part  of  other  ex- 
penses, losses  or  other  deductions  which  cannot  definitely  be  allo- 
cated to  some  item  or  class  of  gross  income.  The  remainder,  if 
any,  shall  be  included  in  full  as  net  income  from  sources  within 
the  United  States.  In  the  case  of  gross  income  derived  from 
sources  partly  within  and  partly  without  the  United  States,  the 
net  income  may  first  be  computed  by  deducting  the  expenses, 
losses  or  other  deductions  apportioned  or  allocated  thereto  and  a 
ratable  part  of  any  expenses,  losses  or  other  deductions  which 
cannot  definitely  be  allocated  to  some  item  or  class  of  gross  in- 
come ;  and  the  portion  of  such  net  income  attributable  to  sources 
within  the  United' States  may  be  determined  by  processes  or 
formulas  of  general  apportionment  prescribed  by  the  commis- 
sioner with  the  approval  of  the  secretary." 

The  1918  Law  did  not  contain  any  such  explicit  provisions  re- 
garding the  allocation  and  apportionment  of  the  deductions  of 
nonresident  aliens,  except  a  provision"^  permitting  the  deduction 
by  a  nonresident  alien  (and  foreign  corporation)  of  that  "pro- 
portion" of  interest  paid  or  accrued  within  the  taxable  year 
"which  the  amount  of  his  gross  income  from  sources  within  the 
United  States  bears  to  the  amount  of  his  gross  income  from  all 
sources,"  and  the  vague  provision^'^  that  the  deductions  should 
be  allowed,  in  the  case  of  a  nonresident  alien  (and  foreign  corpo- 

96  Revenue  Act  of  1918,  §§214  (a)  2,  234  (a)  2. 

97  Revenue  Act  of  1918,  §§214  (b),  234  (b). 


NONRESIDENT   ALIENS  81 

ration)  "only  if  and  to  the  extent  that  they  are  connected  with 
income  arising  from  a  source  within  the  United  States ;  and  the 
proper  apportionment  of  the  deductions  with  respect  to  sources 
of  income  within  and  without  the  United  States  shall  be  deter- 
mined under  rules  and  regulations  prescribed  by  the  commis- 
sioner with  the  approval  of  the  secretary."    Under  these  provi- 
sions and  under  the  1916  and  1913  Laws,  the  attempt  was  made 
to  allocate  deductions  by  processes  of  formulas  of  general  appor- 
tionment in  a  few  cases ;  but  little  progress  toward  any  solution 
of  this  problem  had  been  made.    In  one  ruling  a  Canadian  manu- 
facturing corporation  which  sold  part  of  its  product  in  the  United 
States  and  part  in  Canada  was  required  to  report  its  deductions 
for  cost  of  manufacture,  exclusive  of  interest  paid  on  its  indebt- 
edness, in  the  same  proportion  as  the  quantity  of  its  product  sold 
in  the  United  States  bore  to  the  total  quantity  sold.'*"'     Where 
under  the  1916  and  prior  laws  certain  expenses,  such  as  coal, 
ships,  stores,  etc.,  in  the  case  of  foreign  steamship  companies, 
could  not  be  segregated,  the  total  expenses  of  foreign  corpora- 
tions for  such  items  were  pro-rated  in  such  proportion  as  the 
gross  income  of  the  corporation  from  sources  within  the  United 
States  bore  to  the  gross  income  derived  from  all  sources  both 
within  and  without  the  United  States ;  that  is  to  say,  if  one-half 
of  the  gross  income  of  the  foreign  corporation  was  from  sources 
within  this  country,  one-half  of  such  expense  was  a  proper  deduc- 
tion."9    It  was  required  under  the  1916  Law  that  the  deductions 
of  a  foreign  corporation  should  as  nearly  as  possible  represent 
the  actual  expenses  and  authorized  charges  incident  to  the  income 
derived  from  this  country,  and  must  not  comprehend  either  di- 
rectly or  indirectly  any  expenditures  or  charges  incurred  in  the 
transaction  of  business  or  the  investment  of  capital  without  the 
United  States.^""  A  corporation  deriving  its  sole  income  from  this 
'  country  in  the  form  of  dividends  or  interest  on  domestic  stocks 
and  bonds  was  permitted  under  the  1916  Law  to  deduct  from  the 
income  so  received  such  items  of  disbursement,  loss,  etc.,  as  would 
be  properly  deductible,  if  the  income  were  derived  from  any  other 
source.     The  deduction  comprehended  only  such   expenditures, 
losses,  etc.,  as  were  incurred  in  or  were  incidental  to  the  creation 
of  the  income  against  which  they  were  charged,  and  in  all  cases 

98  Reg.  45,  Art.  573. 

99  T.  D.  1675;  Reg.  33,  Art.  116.     Letter  from  treasury  department  dated 
December  8,  1916. 

K'OReg.  33,  Rev.,  Art.  197;  Reg.  33,  Art.  157. 


82  FEDERAL  INCOME  TAX 

were  required  to  be  within  the  Hmits  fixed  by  the  1916  Law.i*'i 
The  principle  followed  by  the  treasury  department  under  the  1913 
Law  was  that  all  allowable  deductions  should  be  computed  upon 
a  basis  which  recognized  that  the  income  arising  and  accruing 
from  business  done  in  and  from  this  country  should  bear  its 
share,  and  no  more,  of  expense  incident  to  the  earning  or  creation 
of  such  income  in  the  ratio  that  the  gross  income  arising  in  and 
from  this  country  bore  to  the  entire  gross  income  arising  from 
business  done  both  within  and  without  this  country. i"- 

The  new  provisions  of  the  1921  Law  quoted  at  the  beginning 
of  this  paragraph  represent  a  distinct  progress  from  the  indefi- 
nite rulings  which  had  previously  been  the  sole  guide  of  the  tax- 
payer in  determining  net  (as  distinguished  from  gi'oss)  income 
from  "sources  within  the  United  States."  Particularly  signifi- 
cant is  the  provision  that  a  "ratable  part  of  any  expenses,  losses 
or  other  deductions  which  cannot  be  definitely  allocated  to  some 
item  or  class  of  gross  income"  shall  be  deducted  from  gross  in- 
come from  "sources  within  the  United  States,"  and  the  corre- 
sponding provision  for  the  allocation  of  a  "ratable  part"  of 
deductions  to  income  from  "sources  without  the  United  States," 
and  the  corresponding  provision  for  the  allocation  of  a  "ratable 
part"  of  deductions  to  income  from  "sources  partly  within  and 
partly  without  the  United  States."  i"'"'  These  provisions  will  prop- 
erly allow  for  a  just  proportion  of  foreign  overhead  expense,  de- 
preciation on  property  without  the  country,  and  any  such  items 
which  enter  into  the  production  of  the  income  from  "sources 
within  the  United  States"  as  well  as  the  income  from  other 
sources. 

Condition  to  Allowance  of  Deductions.  As  a  condition  to 
obtaining  the  benefit  of  the  deductions  allowed  by  the  Revenue 
Act  of  1921,  nonresident  aliens  are  required  to  file  a  true  and 
accurate  return  of  total  income  received  from  all  sources,  cor- 
porate or  otherwise,  in  the  United  States,  including  therein  all 
the  information  which  the  commissioner  may  deem  necessary  for 
the  calculation  of  such  deductions. ^^'^  The  same  requirement  was 
contained  in  the  Revenue  Act  of  1918.^"-' 

101  Letter  from  treasury  department  dated  June  6,  1916;  L  T.  S.  1921, 
H 1095. 

102  Letter  from  treasury  department  dated  July  18,  1916;  L  T.  S.  1921, 
U 1082. 

loy  Revenue  Act  of  1921,  §217  (b),  (d),  (e). 

104  Revenue  Act  of  1921,  §217  (g). 

lo-T  Revenue  Act  of  1918,  §  217.  .'  i 


NONRESIDENT   ALIENS  83 

Credits.  Nonresident  aliens  are  permitted  a  credit  of  divi- 
dends for  the  purpose  of  the  normal  tax  in  certain  cases.  They 
are  also  permitted  a  credit  for  purposes  of  the  normal  tax  of  any 
interest  upon  obligations  of  the  United  States  and  bonds  issued 
by  the  War  Finance  Corporation  which  is  included  in  gross  in- 
come.i"*'  This  subject  is  discussed  elsewhere  in  this  chapter.107 
A  nonresident  alien  individual  may  receive  the  benefit  of  credits 
only  by  filing  a  true  and  accurate  return  of  his  total  income 
received  from  all  sources,  corporate  or  otherwise,  in  the  United 
States,  including  therein  all  the  information  which  the  commis- 
sioner may  deem  necessary  for  the  calculation  of  the  credits. ^o'^ 

Credit  of  Tax  Withheld  at  the  Source.  As  the  law  re- 
quires the  normal  tax  to  be  withheld  by  the  one  in  this  country 
who  pays  fixed  or  determinable  and  annual  or  periodical  income 
to  a  nonresident  alien,^"''  a  due  credit  for  the  amount  so  withheld 
may  be  claimed  by  the  nonresident  alien  in  filing  his  return."" 
The  nonresident  alien  should  therefore  keep  a  record  of  the 
amount  of  tax  withheld  at  the  source  from  time  to  time  on  pay- 
ments made  to  him,  and  should  report  the  aggregate  sum  so  with- 
held in  his  return,  in  order  that  the  normal  tax  may  not  be  twice 
collected  with  respect  to  the  same  income. 

Personal  Exemption.  Under  the  present  law  a  nonresident 
alien  is  entitled  to  a  personal  exemption  of  only  $1,000  and  to  no 
credit  for  dependents. "^  This  credit  will  not  be  allowed  unless 
the  nonresident  alien  files  a  true  and  accurate  return  of  income 
from  all  sources,  but  the  commissioner  may,  in  his  discretion, 
allow  the  personal  exemption  upon  the  filing  of  a  claim  with  a 
withholding  agent.i^^ 

Returns.  A  nonresident  alien  individual  must  make  or  have 
made  on  his  behalf  a  full  and  accurate  return  of  income  received 

10c  Revenue   Act   of   1921,   §216    (a),    (b);    Revenue   Act   of    1918,    §216. 
As  to  interest  received  after  March  3,  1919,  see  Chapter  18. 
lOT  See  p.  64. 
los  Revenue  Act  of  1921,  §217  (g);  Revenue  Act  of  1918,  §217. 

109  See  Chapter  40. 

110  Revenue  Act  of  1921,  §  221  (d) ;  Revenue  Act  of  1918,  §  221  (d).  Tele- 
gram from  treasury  department  dated  March  5,  1919;  I.  T.  S.  1919,  1|  3244. 

111  Revenue  Act  of  1921,  §216  (e).  A  nonresident  alien  individual,  sim- 
ilarly to  a  citizen  or  resident,  was  entitled,  under  the  1918  Law,  to  a  personal 
exemption,  and  to  a  credit  of  $200  for  each  dependent,  except  that  if  he 
was  a  citizen  or  subject  of  a  country  which  imposed  an  income  tax  the 
personal  exemption  was  allowed  only  if  his  country  allowed  a  similar  credit 
to  citizens  of  the  United  States  not  residing  in  such  country.  The  subject 
of  the  personal  exemption,  both  as  to  citizens  and  residents  and  as  to  non- 
resident aliens,  is  fully  treated  in  another  chapter.     See  Chapter  31. 

"2  Revenue  Act  of  1921,  §  217  (g).     See  Chapter  40. 


84  FEDERAL  INCOME  TAX 

from  sources  within  the  United  States,  regardless  of  amount, 
unless  the  tax  on  such  income  has  been  fully  paid  at  the  source.^i^ 
A  nonresident  alien  may  have  had  the  tax  on  all  his  income  aris- 
ing from  sources  within  this  country  withheld  at  the  source, 
although  he  may  be  taxable  on  a  lesser  amount  by  reason  of 
expenses,  interest,  losses  and  other  deductible  items  or  credits. 
Only  by  filing  a  return  may  he  claim  these  deductions  and  credits 
and  secure  the  return  to  him  of  any  amount  withheld  in  excess  of 
his  tax  liability.  His  return  must  include  such  information  as 
may  be  deemed  necessary  by  the  commissioner  for  the  calculation 
of  any  deductions  and  credits  to  which  he  may  be  entitled.  The 
personal  exemption  may  be  allowed  to  nonresident  aliens  in  the 
discretion  of  the  commissioner  without  the  filing  of  the  above 
return  of  income  from  all  sources  within  the  United  Stateg,  credit 
being  received  in  such  case  by  the  filing  of  a  claim  therefor  with 
the  withholding  agent. "^  The  commissioner  has  ruled,  however, 
that  for  the  present  the  benefit  of  the  credits  allowed  against  net 
income  for  the  purpose  of  the  normal  tax  may  not  be  received 
by  a  nonresident  alien  by  filing  a  claim  with  the  withholding 
agent,  but  only  by  claiming  them  upon  filing  a  return  of  income. 
Unless  a  nonresident  alien  individual  renders  a  return  of  income, 
the  tax  will  as  a  general  rule^^-^  be  collected  on  the  basis  of  his 
gross  income  (not  his  net  income)  from  sources  within  the 
United  States.  Where  a  nonresident  alien  has  various  sources  of 
income  within  the  United  States,  so  that  from  any  one  source  or 
from  all  sources  combined  the  amount  of  income  calls  for  the 
assessment  of  a  surtax,  and  a  return  of  income  is  not  filed  by  or 
on  his  behalf,  the  commissioner  will  cause  a  return  of  income  to 
be  made,  and  include  therein  the  income  of  such  nonresident  alien 
from  all  sources  concerning  which  he  has  information,  and  he 
will  assess  the  tax  and  collect  it  from  one  or  more  of  the  sources 
of  income  within  the  United  States  of  such  nonresident  alien, 
without  allowance  of  deductions  or  credits,  and  may  distrain  for 

113  Revenue  Act  of  1921,  §  223;  Revenue  Act  of  1918,  §  223;  Reg.  45,  Art. 
403.  Form  1040C  was  used  for  this  purpose  under  the  1918  Law.  For  the 
year  1918  the  same  form  (Form  No.  1040)  was  prescribed  for  the  use  of  all 
individuals,  resident  and  nonresident.  A  nonresident  alien  made  such 
changes  as  were  necessary  to  indicate  that  the  return  covered  in  his  case 
only  income  from  sources  within  this  country.  The  additional  information 
required  in  order  to  compute  the  amount  of  deductible  interest  (deductions 
and  credits  under  the  present  law)  was  made  on  a  supplementary  state- 
ment attached  to  the  return. 

114  Revenue  Act  of  1921,  §  217  (g);  Revenue  Act  of  1918,  §  217. 

115  For  the  exceptions  to  this  rule  see  Reg.  45,  Art.  316.  The  exceptions 
are  discussed  in  Chapter  31. 


NONRESIDENT   ALIENS  85 

the  tax  any  property  belonging  to  such  nonresident  alien."'-  For 
the  purpose  of  obtaining  a  refund  of  any  amount  withheld  in 
excess  of  his  tax  liability  as  above  indicated,  a  nonresident  alien 
is  required  to  attach  to  his  return  a  statement  showing  accurately 
the  amounts  of  tax  withheld,  with  the  names  and  postoffice  ad- 
dresses of  all  withholding  agents.""  Upon  the  basis  of  such  in- 
formation the  treasury  department  thereupon  orders  the 
withholding  agent  to  release  the  excess  withheld."^ 

Returns  by  Agents.  If  a  nonresident  alien  is  unable  to  make 
his  own  return,  it  may  be  made  on  his  behalf  by  a  duly  authorized 
agent  and  in  proper  cases  ntey  also  be  made  by  guardians  or 
other  persons  charged  with  the  care  of  the  person  or  property  of 
such  taxpayer.113  It  should  be  borne  in  mind  that  a  nonresident 
alien  may  have  an  agent  in  this  country  for  the  purpose  of 
making  returns  without  having  appointed  one.  The  responsible 
representatives  of  nonresident  aliens  in  connection  with  any 
sources  of  income  which  such  nonresident  aliens  may  have  within 
the  United  States  must  make  a  return  of  such  income,  and  must 
pay  any  and  all  tax,  normal  and  additional,  assessed  upon  the 
income  received  by  them  in  behalf  of  their  nonresident  alien 
principals,  in  all  cases  where  the  tax  on  income  so  in  their  re- 
ceipt, custody  or  control  shall  not  have  been  withheld  at  the 
source.  The  agent  of  a  nonresident  alien  is  responsible  for  a 
correct  return  of  all  income  accruing  to  his  principal  within  the 
purview  of  the  agency.  The  agency  appointment  will  determine 
how  completely  the  agent  is  substituted  for  the  principal  for  tax 
purposes.120  Any  individual,  partnership  or  corporation  having 
the  control,  receipt,  custody,  disposal  or  payment  of  fixed  or  de- 
terminable income  payable  to  any  nonresident  alien,  such  income 
with  certain  exceptions  being  required  to  be  withheld  at  the 
source,  makes  a  return  thereof  on  or  before  March  1st  of  each 
year  and  pays  the  tax  due  thereon  on  or  before  June  15th. ^-^ 

Where  Filed.  A  nonresident  alien  files  his  return  in  the  dis- 
trict in  which  he  has  his  principal  place  of  business  in  this 
country,  and  if  he  has  none,  then  with  the  collector  of  internal 
revenue  at  Baltimore,  Maryland.^-- 

ii«  Revenue  Act  of  1921,  §217   (g);  Reg.  45,  Art.  311. 
117  Reg.  45,  Art.  403;  T.  D.  2815. 

11*^  Telegram  from  treasury  department  dated  January  25,  1917;  I.  T.  S. 
1918,  1I9L 

119  Revenue  Act  of  1921,  §  223;  Revenue  Act  of  1918,  §  223. 

120  Reg.  45,  Art.  403.    See  Chapter  5  for  a  discussion  of  this  ruling. 

i-'i  Revenue  Act  of  1921,  §  221;  Revenue  Act  of  1918,  §  221.  See  Chapters 
40  and  5. 

122  Revenue  Act  of  1921,  §227  (b);  Revenue  Act  of  1918,  §227  (b). 


86  FEDERAL  INCOME  TAX 

When  Filed.  The  return  of  a  nonresident  alien  should  be 
filed  on  or  before  June  15th  or  on  or  before  the  15th  day  of  the 
sixth  month  following  the  close  of  such  nonresident's  fiscal  year, 
accordingly  as  he  reports  for  income  tax  purposes  on  the  basis 
of  the  calendar  or  a  fiscal  year.i-'' 

Extension  of  Time.  Nonresident  aliens  are  allowed  a  reason- 
able extension  of  time  for  filing  returns  whenever  in  the  judg- 
ment of  the  commissioner  good  cause  exists  therefor.^-^ 

Failure  to  File  Return.  In  general,  nonresident  aliens  are 
subject  to  the  same  penalties  for  failure  to  file  returns  as  are  citi- 
zens and  residents.!-""  If  a  return  is  not  filed,  the  deductions  and 
credits  allowed  by  the  -statute  cannot  be  claimed  and  the  collector 
will  collect  the  tax  on  the  income  of  a  nonresident  alien  and  all 
property  in  the  United  States  belonging  to  such  nonresident  alien 
will  be  liable  to  distraint  for  the  tax.^-'"' 

Paying  the  Tax.  Except  in  so  far  as  the  income  tax  payable 
by  a  nonresident  alien  is  collected  at  the  source i-'''  the  general 
provisions  in  regard  to  the  payment  of  income  taxes  apply  to 
nonresident  aliens  as  well  as  to  citizens  and  residents.  The  tax 
is  payable  in  four  installments,  the  first  installment  being  paid  at 
the  time  the  return  is  filed;  the  second  installment  on  the  15th 
day  of  the  third  month;  the  third  installment  on  the  15th  day  of 
the  sixth  month ;  and  the  fourth  installment  on  the  15th  day  of 
the  ninth  month,  after  filing  the  return.  This  subject  is  dis- 
cussed more  fully  in  another  chapter.i-s 

Abatement  and  Refund.  If  upon  the  filing  of  the  return  it 
appears  that  the  nonresident  alien  is  liable  for  less  tax  than  the 
amount  which  has  been  withheld  at  the  source,  the  treasury  de- 
partment will  issue  instructions  to  the  withholding  agents 
(whose  names  and  addresses  should  be  given  by  the  nonresident 
alien  in  his  return)  to  release  at  once  the  proper  amounts.!-^ 
After  the  tax  has  been  assessed  against  the  withholding  agents 
by  the  government,  abatement  may  be  claimed,  and  after  the  tax 

i-':i  Revenue  Act  of  1921,  §  227  (a) ;  Revenue  Act  of  1918,  §  227  (a).  Under 
the  1918  Law^  this  date  w^as  the  same  as  in  the  case  of  citizens  and  residents. 

124  Revenue  Act  of  1921,  §227  (a);  Revenue  Act  of  1918,  §227  (a).  See 
Chapter  34. 

i-'5  See  Chapter  36. 

12«  Revenue  Act  of  1921,  §217  (g);  Revenue  Act  of  1918,  §217. 

127  See  Chapter  40. 

128  See  Chapter  35. 

129  Revenue  Act  of  1921,  §221  (d) ;  Revenue  Act  of  1918,  §221  (d);  Reg. 
45,  Art.  369.  Telegram  from  treasury  department  dated  January  25,  1917; 
I.  T.  S.  1918,1191. 


NONRESIDENT   ALIENS  87 

has  been  paid,  refund  may  be  claimed,  in  the  manner  outlined  in 
a  later  chapter.^"" 

When  a  claim  for  refund  is  filed  by  aliens,  resident  or  nonresi- 
dent, on  Form  46,  a  copy  of  the  form  upon  which  the  alien  was 
assessed  and  taxed  should  be  attached  to  Form  46.^"^^ 

i-'io  See  Chapter  37. 

131  O.  D.  272,  T.  B.  18-19-488. 


CHAPTER  5 

RESIDENT  AGENTS  FOR  NON-RESIDENT  ALIENS  AND  FOREIGN 
CORPORATIONS — NOMINAL  STOCKHOLDERS 

The  Revenue  Act  of  1921  expressly  provides  for  the  collection 
of  the  tax  at  the  source  on  payment  of  certain  specified  forms  of 
income  to  nonresident  aliens,  partnerships  composed  in  ivhole  or 
in  part  of  nonresident  aliens  and  noresident  foreign  corpora- 
tions.^ The  persons  required  to  withhold  and  account  for  the 
tax  are  designated  in  the  law  as  withholding  agents.^  The  treas- 
ury department,  in  addition,  has  followed  under  the  1918  Law 
a  method  of  collecting  the  tax  on  income  liable  to  pass  out  of 
its  jurisdiction,  which  it  evolved  under  the  1916  Law  and  which 
consists  in  impressing  upon  residents,  under  certain  circum- 
stances, the  duty  of  filing  returns  and  paying  the  normal  tax 
and  the  surtax  on  any  and  all  income  of  nonresident  aliens  and 
nonresident  foreign  corporations  over  which  they  have  custody 
or  control.^  Under  the  present  law  this  duty  will  also  be  imposed 
with  respect  to  income  of  partnerships  composed  in  whole  or  in 
part  of  nonresident  aliens.  Such  persons  are  held  to  be  agents 
of  the  nonresidents  and  to  stand  in  the  place  of  their  principals.* 
A  withholding  agent  may  or  may  not,  depending  on  the  circum- 
stances, be  an  agent  within  the  meaning  of  this  chapter.^ 

Lack  of  Authority  Under  Present  Law.  Neither  the  Revenue 
Act  of  1918  nor  the  Revenue  Act  of  1921  contain  any  provision 
expressly  making  an  agent  liable  for  the  surtax — or  the  normal 
tax  upon  income  which  is  not  both  fixed  or  determinable  and 
annual  or  periodical  imposed  upon  his  principal  with  respect  to 
income  passing  through  the  hands  of  such  agent.*'  The  com- 
missioner has  nevertheless  ruled  that  the  responsible  representa- 

1  Revenue  Act  of  1921,  §§  221  and  237.  Partnerships  were  not  included 
under  the  1918  Law.  Revenue  Act  of  1918,  §§  221,  237.  Under  the  1916 
Law  agents  for  foreign  partnerships  were  not  required  to  make  any  returns 
or  pay  any  taxes  for  the  foreign  partnerships  unless  and  until  they  were  so 
instructed  by  the  commissioner.  (T.  D.  2401.)  This  was  because  a  part- 
nership was  not  itself  subject  to  tax  or  required  to  make  returns. 

2  Revenue  Act  of  1921,  §200;  Revenue  Act  of  1918,  §200.  See  Chapter 
40. 

3  Reg.  45,  Art.  404. 

4  Reg.  45,  Art.  404;   T.  D.  2135. 

5  See  p.  89  for  a  discussion  of  this  distinction. 

6  See  Revenue  Act  of  1916,  §9  (g).  The  treasury  department  evidently 
based  its  authority  to  impose  upon  resident  agents  the  duties  discussed  in 
this  chapter  upon  this  section  of  the  1916  Law  (T.  D.  2452). 

88 


RESIDENT  AGENTS   FOR  NONRESIDENT  ALIENS  89 

lives  of  nonresident  aliens  in  connection  with  any  sources  of  in- 
come which  such  nonresident  aUens  may  have  within  the  United 
States,  must  make  a  return  of  such  income,  and  must  pay  any 
and  all  tax,  normal  and  additional,  assessed  upon  the  income 
received  by  them  in  behalf  of  their  nonresident  alien  principals, 
in  all  cases  where  the  tax  on  income  so  in  their  receipt,  custody 
or  control  shall  not  have  been  withheld  at  the  source.  The  agent 
of  a  nonresident  alien  is  responsible  for  a  correct  return  of  all 
income  accruing  to  his  principal  within  the  purview  of  the  agency. 
The  agency  appointment  will  determine  how  completely  the  agent 
is  substituted  for  the  principal  for  tax  purposes.'^ 

Distinction  Between  Withholding  and  Resident  Agents.  The 
distinction  between  withholding  agents  and  resident  agents  may 
be  indicated  from  two  angles:  (a)  Their  respective  services  in 
securing  to  the  government  the  payment  of  the  income  tax  of 
nonresident  alien  individuals,  partnerships  composed  in  whole  or 
in  part  of  nonresident  aliens  and  nonresident  foreign  corporations 
and  (b)  the  character  of  their  respective  relationships  to  the 
taxpayer  for  whose  tax  they  are  responsible.  As  appears  more 
fully  in  a  subsequent  chapter,  the  provisions  for  the  collection 
of  the  tax  at  the  source  apply  only  to  the  normal  tax  and  then 
only  in  the  case  of  income  which  is  both  (1)  fixed  or  determinable 
and  (2)  annual  or  periodical.^  Obviously,  a  large  part  of  the 
income  accruing  to  nonresident  aliens,  individually  and  in  part- 
nership, and  nonresident  foreign  corporations  from  sources 
within  the  United  States  is  not  both  fixed  or  determinable  and 
annual  or  periodical,  and  a  large  part  would,  because  of  its  amount 
(combined  or  not  with  other  items  of  income  to  the  same  recipi- 
ent from  sources  within  the  United  States)  be  liable  to  the  sur- 

">  Reg.  45,  Art.  404.-  It  may  be  argued  that  the  commissioner  has  author- 
ity under  §  223  of  the  Revenue  Act  of  1921  and  the  Revenue  Act  of  1918 
which  provides  that  "if  a  taxpayer  is  unable  to  make  his  own  return,  the 
return  shall  be  made  by  a  duly  authorized  agent  *  *  *  qj.  other 
person  charged  with  the  care  of  the  person  or  property  of  such  taxpayer" 
to  compel  resident  agents  to  file  returns  on  behalf  of  their  nonresident 
principals,  but  this  section  certainly  gives  no  authority  for  imposing  the 
duty  to  pay  any  tax.  It  seems  clear  that  this  deficiency  of  authority  in 
the  present  law  should  be  remedied  by  prompt  amendment,  since  otherwise 
large  sums  of  just  taxes  payable  by  nonresident  aliens  and  nonresident  for- 
eign corporations  may  be  lost  to  the  government.  A  resident  fiduciary  is 
not  liable  for  surtax  on  the  income  which  it  received  as  trustee  for  a  non- 
resident alien  beneficiary,  under  the  Revenue  Act  of  1917,  provided  the 
income  was  returned  for  the  purpose  of  the  tax  by  the  beneficiary.  (0.  D. 
1011,  T.  B.  12-20-798.) 

8  Reg.  45,  Art.  362.    See  Chapter  40. 


90  FEDERAL  INCOME  TAX 

taxes.  The  ordinary  withholding  provisions'*  of  the  present  law 
therefore  provide  insufficient  security  for  the  collection  of  the 
normal  tax  upon  the  income  of  nonresident  aliens  and  nonresident 
foreign  corporations  from  sources  within  the  United  States  and 
no  security  whatever  for  the  collection  of  the  .'Surtax  upon  such 
income.  The  placing  of  a  responsibility  upon  so-called  resident 
agents  fills  this  deficiency.  Withholding  agents  insure  the  col- 
lection of  the  normal  tax  upon  income  which  is  both  fixed  or 
determinable  and  annual  or  periodical;  resident  agents  insure 
the  collection  of  the  normal  tax  upon  income  not  falling  within 
these  rigid  classifications  and  of  the  surtax  upon  income  with- 
out regard  to  any  classification.  The  distinction  between  with- 
holding agents  and  resident  agents  from  the  viewpoint  of  their 
respective  relationships  with  the  taxpayer  is  not  so  clear.  A 
withholding  agent  is  defined  in  the  law^"  as  "any  person  required 
to  deduct  and  withhold  any  tax."  In  brief,  a  person  is  required 
to  deduct  and  withhold  the  normal  tax,  in  the  case  of  nonresident 
aliens,  partnerships  with  nonresident  alien  members  and  non- 
resident foreign  corporations,  upon  the  payment  of  fixed  or  de- 
terminable and  annual  or  periodical  income. ^^  The  relationship 
of  the  withholding  agent  to  the  taxpayer  whose  tax  is  withheld 
is  an  artificial  relationship  and  arises  in  all  cases  where  the  rela- 
tionship of  debtor  and  creditor  exists  and  the  parties  contemplate 
payment  in  a  certain  manner.  As  a  matter  of  fact,  a  withholding 
agent  is  primarily  an  agent  of  the  government,  not  the  taxpayer. 
On  the  other  hand,  a  resident  agent's  status  depends  neither  on 
the  relationship  of  debtor  and  creditor  nor  on  the  manner  of 
payment  contemplated  for  the  debt.  Thus,  a  bank  is  not  a  resi- 
dent agent  for  its  nonresident  depositors  where  the  relationship 
is  merely  that  of  bank  and  depositor^-  (i.  e.,  ordinarily  debtor 
and  creditor) ,  but  a  bank  acting  as  the  custodian  of  securities  on 
which  it  collects  and  disburses  interest  would  be  a  resident 
agent.i'^  In  other  words,  a  resident  agent  is  at  least  to  some 
degree  an  agent  of  the  taxpayer  as  well  as  of  the  government; 
and  being  an  agent  of  the  taxpayer,  he  must  derive  his  appoint- 
ment and  authority  from  some  act  or  conduct  of  the  principal, 

!>  Revenue  Act  of  1921,   §§221,   237;    Revenue   Act   of   1918,   §§221,   237. 

10  Revenue  Act  of  1921,  §200;  Revenue  Act  of  1918,  §200. 

11  Revenue   Act  of  1921,  §§221,  237;    Revenue  Act  of  1918,  §§221,  237. 

12  Reg.  33,  Art.  67;  letter  from  treasury  department  dated   February  8, 
1917;  I.  T.  S.  1918,  TI106. 

IS  Letter  from  treasury  department  dated  April   10,   1916;   L  T.   S.   1919, 
^560. 


RESIDENT  AGENTS   FOR  NONRESIDENT  ALIENS  91 

such  as  a  power  of  attorney,  or  fiduciary  relation  existing  be- 
tween himself  and  the  taxpayer.^-* 

Definition.  In  order  to  simplify  the  discussion  in  the  following 
pages  of  this  chapter  the  term  "nonresidents"  will  be  used  to 
include  nonresident  alien  individuals,  partnerships  composed  in 
whole  or  in  part  of  nonresident  aliens  and  nonresident  foreign 
corporations,  i.  e.,  foreign  corporations  having  no  office  or  place 
of  business  in  this  country. 

Who  Are  Resident  Agents.  A  resident  corporation,  partner- 
ship or  individual  may  be  an  agent  within  the  meaning  of  this 
chapter.  The  following  have  been  held  to  be  such  resident 
agents:  (a)  Residents  acting  by  power  of  attorney  for  non- 
residents; (b)  responsible  heads  or  representatives  in  charge  of 
property  owned  or  business  carried  on  by  non-residents  in  this 
country;^''  (c)  resident  nominal  stockholders  holding  stock  in 
their  names  for  nonresident  actual  owners;^''  (d)  residents  hav- 
ing custody  of  securities  of  nonresidents  on  which  they  collect 
the  income,  both  with  respect  to  the  income  and  with  respect  to 
any  profits  made  from  the  sale  of  the  securities  ;i7  (e)  residents 
purchasing  patent  rights  from  nonresidents  and  paying  royalty 
thereon  ;^'^  (f)  real  estate  agents  managing  buildings  owned  by 
nonresidents. 1^  A  domestic  corporation  purchased  abroad  from 
a  foreign  corporation  goods  at  a  minimum  price  for  resale  in  the 
United  States.  If  sold  for  more  than  the  minimum  price,  the 
domestic  corporation  was  to  receive  a  commission  and  after 
deducting  certain  expenses  and  the  commission,  the  net  profit 
was  divided  between  the  domestic  corporation  and  the  fpreign 
corporation.  The  share  of  the  profits  so  received  by  the  foreign 
corporation  represents  income  from  sources  within  the  United 
States,  but  is  not  subject  to  the  withholding  provisions  of  the 
Revenue  Act  of  1918,  since  it  is  not  "fixed  or  determinable  in- 
come" within  the  meaning  of  the  act.  However,  the  domestic 
corporation  acting  as  agent  of  the  foreign  corporation  with  re- 

1^  The  following  language  of  Reg.  45,  Art.  404,  should  be  noted  in  this  con- 
nection: "The  agency  appointment  will  determine  how  completely  the  agent 
is  substituted  for  the  principal  for  tax  purposes."  (See  also  Reg.  33,  Rev., 
Art.  32.) 

15  Reg.  33,  Art.  8;  T.  D.  2313. 

ic  See  p.  95. 

17  Letter  from  treasury  department  dated  May  31,  1916;  I.  T.  S.  1918, 
II 105.  For  the  purpose  of  reporting  profits  made  from  the  sale  of  the 
securities  such  agents  are  required  to  obtain  all  facts  necessary  to  ascertain 
the  profit  in  any  transaction. 

1ST.  D.  2137. 

15)  Letter  from  treasury  department  dated  January  19,  1915;  I.  T.  S.  1918, 
1199. 


92  FEDERAL  INCOME  TAX 

spect  to  goods  sold  in  the  United  States  must  file  a  return  of 
income  for  the  foreign  corporation  and  pay  any  tax  found  to 
be  due.-o  An  insurance  broker  in  the  United  States  who  solicits 
and  procures  insurance  in  nonresident  alien  corporations,  collects 
the  premiums  thereon,  and  credits  the  account  of  the  respective 
corporations  with  the  net  proceeds  after  deductions  for  losses 
are  made,  is  considered  the  resident  agent  of  such  foreign  cor- 
porations with  respect  to  the  business  obtained  through  his 
efforts.  Where  the  insurance  broker  transacts  business  in  the 
United  States  for  certain  nonresident  foreign  corporations  and 
pays  the  premiums  to  a  nonresident  alien  individual  who  acts  as 
agent  for  the  nonresident  foreign  corporations  it  has  been  held 
that  the  insurance  broker  must  file  returns  for  each  nonresident 
foreign  corporation,  covering  the  gross  income  received  from 
sources  within  the  United  States  within  the  purview  of  his 
agency,  claiming  therein  any  deductions  to  which  the  corpora- 
tions are  entitled  bj^  reason  of  losses  sustained  and  pay  the  total 
tax  due  thereon.21 

Who  Are  Not  Resident  Agents.  The  following  have  been  held 
not  to  be  resident  agents  within  the  meaning  of  this  chapter: 
(a)  Corporations  paying  interest  on  their  own  bonds  or  dividends 
on  their  own  stock  to  nonresidents,  bondholders  or  stockholders, 
although  they  are  withholding  agents  for  the  purpose  of  collec- 
tion of  the  tax  at  the  source ;  (b)  resident  debtors,  individual  or 
partnership,  although  they  are  required  to  withhold  the  tax  at 
the  source  on  interest  paid  to  nonresident  aliens;  (c)  banks, 
where -their  relation  to  their  nonresident  depositors  is  merely 
that  of  bank  and  depositor ;22  (d)  banks  receiving  interest  or 
dividends  direct  from  domestic  corporations  to  be  credited  to 
the  accounts  of  nonresident  depositors  ;23  (e)  banks  holding  for 
the  account  of  foreign  banks  and  bankers  securities  on  which 
they  collect  and  disburse  interest  to  the  foreign  banks  and 
bankers  ;2i  (f)  an  individual,  partnership,  or  corporation,  occupy- 
ing or  standing  in  the  ordinary  relation  of  broker  towards  a 

20  0.  D.  384,  T.  B.  4-20-708. 

21  O.  D.  586,  T.  B.  28-20-1062. 

22  Banks  are  held  not  to  be  withholding  agents  with  respect  to  interest  paid 
on  deposits.     (Reg.  33,  Art.  67.) 

23  Letter  from  treasury  department  dated  February  8,  1917;  I.  T.  S.  1918, 
11106. 

24  Letter  from  treasury  department  dated  April  10,  1916;  L  T.  S.  1919, 
If  560.  Where  the  bank  however  acts  as  custodian  of  securities  for  nonresi- 
dents other  than  banks  it  seems  that  it  is  a  resident  agent.  Rulings  however 
are  not  clear  or  consistent  on  this  point. 


RESIDENT  AGENTS   FOR  NONRESIDENT  ALIENS  93 

nonresident  as  client,  although  he  or  it  may  be  required  to  with- 
hold the  tax  as  a  withholding  agent.-'' 

Duties  and  Liabilities  of  Resident  Agents.  The  responsible 
heads  or  representatives  of  nonresident  aliens  in  connection  with 
any  sources  of  income  which  such  nonresident  aliens  may  have 
within  the  United  States,  are  required  to  make  a  return  of  such 
income  and  to  pay  any  and  all  tax,  normal  and  additional,  as- 
sessed upon  the  income  received  by  them  in  behalf  of  their  non- 
resident alien  principals,  in  all  cases  where  the  income  tax  on 
income  so  in  their  receipt,  custody,  or  control  shall  not  have  been 
withheld  at  the  source.-*'  They  are  under  no  duty  to  inquire  into 
or  report  any  income  of  the  nonresident  principal  received  from 
other  sources  in  this  country,  but  may,  if  authorized  by  the  non- 
resident principal,  make  a  complete  return  of  all  income  from 
sources  within  this  country.  Where  the  same  nonresident  has 
several  agents,  none  of  whom  is  authorized  to  make  a  return 
of  all  the  principal's  income,  each  agent  reports  separately  the 
income  coming  into  his  hands,  and  the  treasury  department  takes 
into  consideration  the  aggregate  amount  of  net  income  covered 
by  all  of  the  returns,  in  assessing  the  tax,  making  a  further  as- 
sessment to  cover  any  surtax  which  may  be  due,  in  the  case  of 
individuals,  on  the  aggregate  income.^^  Of  course,  if  the  non- 
resident principal  files  a  return  of  all  his  income  from  sources 
within  this  country,  the  agents  are  not  also  required  to  file  re- 
turns. Resident  agents,  therefore,  ascertain  in  due  time  whether 
or  not  their  nonresident  principals  intend  to  report  their  income 
from  sources  within  the  United  States  and  to  pay  the  tax  due 
thereon,  and  govern  themselves  accordingly. 

Procedure  in  Collecting  Income  for  Nonresidents.  In  collect- 
ing income  subject  to  withholding  of  the  tax  at  the  source,  the 
resident  agent  is  required  to  execute  the  ownership  certificate 
required  of  his  nonresident  principal,  signing  it  with  the  name  of 
the  principal  and  affixing  his  own  signature  as  agent.-^  In  brief, 
with  respect  to  such  income,  he  is  required  to  proceed  as  if  he 

25  Letter  from  treasury  department  dated  April  17,  1918;  L  T.  S.  1921, 
11 1723.  In  the  hypothetical  case  upon  which  this  ruling  was  based  the  non- 
resident client  maintained  an  account  with  the  broker,  occasionally  buying 
some  securities  on  margin  and  selling  some  from  time  to  time,  interest  being 
charged  on  balances  due  and  dividends  as  paid  on  the  stocks  carried  and 
credited  to  the  account.  All  dealings  were  in  response  to  directions  from 
the  nonresident. 

2«Reg.  45,  Art.  404;  Reg.  33  Rev.,  Art.  32. 

27  Letter  from  treasury  department  dated  March  6,  1917;  I.  T.  S.  1918, 
11114. 

28  See  Chapter  40. 


94  FEDERAL  INCOME  TAX 

were  the  nonresident  principal,  in  whose  place  he  stands  for 
the  purpose  of  the  income  tax.  The  fact  that  the  nonresident  has 
an  agent  here  does  not  relieve  his  income  from  withholding  at 
the  source  when  paid  to  such  agent.  The  appointment  by  a  non- 
resident alien  banking  corporation  of  a  resident  agent  in  the 
United  States  who  has  authority  to  make  returns  for  the  corpo- 
ration will  relieve  a  domestic  bank  from  the  responsibility  of 
withholding  the  tax  from  the  interest  credited  to  the  account 
of  the  foreign  bank  provided  the  agent  furnishes  a  certificate 
stating  that  the  foreign  corporation  has  an  office  or  place  of 
business  in  the  United  States  and  that  he  will  make  all  necessary 
returns  and  pay  the  taxes  shown  to  be  due.^^ 

Making  Returns  for  Nonresident  Principal.  In  making  the 
annual  return  for  his  nonresident  principal  a  resident  agent  is 
required  to  use  the  same  form  as  would  be  used  by  the  principal  "^^ 
and  follow  the  provisions  of  the  law  and  the  regulations  relating 
to  nonresident  aliens  or  foreign  corporations,  as  the  case  may 
be,  in  claiming  deductions.  In  the  affidavit  at  the  end  of  the 
individual's  form,  to  be  executed  by  the  agent,  a  statement  is 
required  to  be  made  that  the  return  covers  only  the  income 
received  by  the  agent,  or  that  it  covers  all  the  income  of  the 
principal  from  sources  within  the  United  States,  as  the  case  may 
be.  The  affidavit  on  the  corporation's  form  is  prepared  for  exe- 
cution by  two  officers  of  the  corporation,  when  the  return  is 
signed  by  an  agent  for  a  foreign  corporation,  an  affidavit  that 
he  is  the  properly  authorized  agent,  and  that  the  report  covers 
income  from  all  sources  within  the  United  States,  or  income 
passing  through  his  hands,  as  the  case  may  be,  is  required  to 
be  attached  to  the  return  and  duly  executed.  The  return  may  be 
filed  in  the  district  in  which  the  agent  resides  or  has  his  principal 
place  of  business. 

Paying  the  Tax  for  Nonresident  Principal.  Under  the  1918 
Law  the  tax  of  a  nonresident  became  due  and  payable  at  the  same 
time  and  in  the  same  manner  as  the  tax  of  a  resident,  and  might 
be  paid  in  the  same  way.'^     Under  the  present  law  the  tax  on 

29  O.  D.  358,  T.  B.  1-20-661. 

30  See   Chapter   34   for   forms. 

31  A  special  ruling  was  made  to  cover  cases  in  1916,  where  the  agent  for 
a  nonresident  alien  had  received  income  from  corporate  interest  or  divi- 
dends and  paid  the  same  over  to  his  principal  prior  to  September  8th.  In 
such  cases,  if  the  agent  did  not  have,  between  September  8th  and  the  end 
of  the  year,  any  income  of  the  nonresident  alien  from  which  to  pay  the 
tax  he  was  relieved  from  liability,  leaving  the  tax  a  charge  against  the 
nonresident  alien  to  be  collected  direct  from  him  by  the  treasury  department, 
(T.  D.  2402.)     A  like  special  ruling  was  made  to  cover  cases  in  1917  where 


RESIDENT  AGENTS   FOR  NONRESIDENT  ALIENS  95 

nonresidents  does  not  become  due  and  payable  until  three  months 
after  the  due  date  for  residents.  Upon  paying  the  tax,  the  agent 
may  demand  a  separate  receipt  for  the  amount  paid  on  behalf 
of  his  nonresident  principal,  and  such  receipt  is  sufficient  evidence 
to  justify  the  agent  in  withholding  the  amount  therein  stated 
from  his  next  payment  to  the  principal,  if  he  has  not  already 
withheld  an  amount  sufficient  to  satisfy  the  tax.  The  principal 
may  demand  this  receipt  from  the  agent  upon  giving  him  a  full 
written  receipt  acknowledging  the  payment  of  the  tax  as  a  satis- 
faction of  the  agent's  debt  to  that  extent."'- 

Nominal  Stockholders,  For  convenience  in  handling  financial 
transactions,  stock  certificates  are  sometimes  issued  in  the  names 
of  others  than  the  actual  owners  of  the  stock.  The  individuals, 
partnerships  or  corporations  so  holding  the  nominal  title  to  the 
stock  are  known  as  nominal  stockholders  or  stockholders  of 
record.'*-'  A  nominal  stockholder  is  not  a  withholding  agent, 
although  under  the  1916  Law  he  might  have  been  one  if  the 
actual  owner  was  a  nonresident  foreign  corporation.  The  dis- 
tinction between  a  nominal  stockholder  and  a  fiduciary  lies  in  the 
fact  that  the  latter  holds  legal  title  to  stock  (if  that  is  the  subject 
of  the  trust),  while  a  nominal  stockholder  may  hold  no  title  at 
all,  the  stock  merely  standing  in  his  name  on  the  books  of  the 
corporation.  Nominal  stockholders  may  acquire  their  status  by 
arrangement  with  the  actual  owners,  as  where  a  broker  carries 
in  his  name  the  stock  of  a  customer,  in  which  event  fhe  name 
and  status  of  the  actual  owner  is  known ;  but  in  some  cases  the 
names  of  the  actual  owners  may  not  be  known  to  the  nominal 
stockholder  as,  for  instance,  where  the  actual  ownership  is  evi- 
denced by  bearer  certificates.-'^  In  other  cases,  notably  when 
large  amounts  of  stock  are  left  in  the  names  of  stock  exchange 

the  agent  for  a  nonresident  alien  had  received  income  and  paid  the  same 
over  to  his  principal  prior  to  October  3,  but  where  the  agent  received  the 
income  of  his  principal  subsequent  to  October  3  he  v^^as  obliged  to  pay  the 
total  tax  due  for  the  entire  year  1917  and  subsequent  years.  (Reg.  33 
Rev.,  Art.  32.)  As  the  1918  Law  did  not  go  into  effect  until  February  25, 
1919,  the  agent  would  undoubtedly  only  be  held  for  tax  on  income  passing 
through  his  hands  up  to  that  date,  at  the  rates  prescribed  by  the  Revenue 
Act  of  1916.  Under  the  present  law  no  change  in  rates  occurs  until  Jan- 
uary 1,  1922,  and  the  same  rule  should  apply.  (See  Reg.  45,  Art.  361,  where 
this  situation  is  treated  in  connection  with  the  collection  of  the  tax  at  the 
source.) 

••52  Revenue  Act  of  1921,  §  251;  Revenue  Act  of  1918,  §  251. 

<53  They  are  generally  called  "record  owner"  in  the  regulations.  See  Reg. 
45,   Art.  405. 

•5-*  The  procedure  under  the  1916  Law  applicable  to  such  situations  is  in- 
dicated at  the  end  of  this  chapter. 


96  FEDERAL  INCOME  TAX 

houses,  one  may  become  a  nominal  stockholder  without  knowing 
the  identity  of  the  actual  owner.  Thus,  stock  certificates  en- 
dorsed in  blank  by  an  actual  owner,  and  sold  on  the  market, 
may  pass  by  delivery  to  several  consecutive  purchasers  before 
the  stock  is  transferred  on  the  books  of  the  corporation.  In  such 
cases,  the  original  transferor  remains  the  record  owner  until  the 
transfer  is  made  on  the  corporate  books,  and,  as  such,  he  is  pre- 
sumed to  be  the  real  owner  of  dividends  declared  on  the  stock, 
unless  he  proves  that  actual  ownership  of  the  stock  does  not  rest 
in  him.ss  If,  however,  a  nominal  stockholder  not  only  parts  with 
the  certificate  of  stock,  endorsed  in  blank,  but  also  gives  the 
corporation  a  ''dividend  order"  to  pay  dividends  to  another,  his 
responsibility  for  tax  on  such  dividends  ceases,  and  the  one  to 
whom  the  corporation  pays  the  dividend  becomes  liable  for  any 
tax  thereon,  unless  he  in  turn  shows  that  actual  ownership  does 
not  rest  in  him.  A  nominal  stockholder  receiving  dividends  and 
paying  them  over  to  one  claiming  to  be  the  actual  owner  is  re- 
quired to  ascertain  the  name  and  address  of  such  claimant  and 
proceed  as  indicated  below.'"'*^ 

Application  of  1918  Law  and  Present  Law  to  Nominal 
Stockholders.  The  treasury  department  based  its  authority 
for  the  rules  and  regulations  issued  under  the  1916  Law  in  regard 
to  withholding  on  dividend  income  against  nonresident  foreign 
corpo7-ations  on  the  basis  of  apparent  ownership,  upon  the  pro- 
vision^^  of  the  1916  Law  that  "all  the  provisions  of  this  title 
relating  to  the  tax  authorized  and  required  to  be  deducted  and 
withheld  and  paid  to  the  officer  of  the  United  States  govern- 
ment authorized  to  receive  the  same  from  the  income  of  non- 
resident alien  individuals  from  sources  within  the  United  States 
shall  be  made  applicable  to  income  derived  from  dividends  upon 
the  capital  stock  or  from  the  net  earnings  of  domestic  or  other 
resident  corporations,  joint-stock  companies  or  associations,  and 
insurance  companies  by  nonresident  alien  companies,  corpora- 
tions,'joint-stock  companies,  or  associations,  and  insurance  com- 
panies not  engaged  in  business  or  trade  within  the  United  States 
and  not  having  any  oflftce  or  place  of  business  therein."  This 
provision  was  separate  from  and  additional  to  the  general  with- 
holding provision's  Qf  i\^q  1916  Law  which  expressly  excepted 

35  Letter  from  treasury  department  dated  December  28,  1916;  I.  T.  S. 
1918,  11274. 

30  The  regulations  on  this  subject  refer  only  to  dividends  of  domestic  cor- 
porations and  resident  foreign  corporations.    Reg.  45,  Art.  404. 

37  Revenue  Act  of  1916,  §  13   (f). 

38  Revenue  Act  of  1916,  §9   (b). 


RESIDENT  AGENTS  FOR  NONRESIDENT  ALIENS  97 

from  its  scope  "income  derived  from  dividends  on  capital  stock, 
or  from  the  net  earnings  of  a  corporation,  joint-stock  company 
or  association,  or  insurance  company,  which  is  taxable  upon  its 
net  income  as  provided  in  this  title."  The  treasury  department 
based  its  authority  for  requiring  the  tax  to  be  paid  on  dividend 
income  of  nonresident  alien  individuals  by  nominal  stockholders 
or  record  owners  upon  the  provision  "^  of  the  1916  Law  that  "the 
intent  and  purpose  of  this  title  is  that  all  gains,  profits,  and  in- 
come of  a  taxable  class,  as  defined  by  this  title,  shall  be  charged 
and  assessed  with  the  corresponding  tax,  normal  and  additional, 
prescribed  by  this  title,  and  said  tax  shall  be  paid  by  the  owner 
of  such  income,  or  the  proper  representative  having  the  receipt, 
custody,  control,  or  disposal  of  the  same."  The  general  with- 
holding provision  ^0  of  the  Revenue  Act  of  1918  expressly  ex- 
cepted from  its  scope  "income  received  as  dividends  from  a  cor- 
poration which  is  taxable  under  this  title  on  its  net  income," 
and  contains  no  provision  corresponding  to  the  provision  of  the 
1916  Law  quoted  abov6  applying  its  general  withholding  require- 
ments to  income  derived  from  dividends  received  by  nonresident 
foreign  corporations  or  making  an  agent  liable  for  the  surtax 
imposed  upon  his  principal  with  respect  to  income  passing 
through  the  hands  of  such  agent.  The  1918  Law  does  provide 
for  withholding  in  the  case  of  dividends  other  than  those  in- 
cluded in  the  above  exception,  but  as  such  other  dividends  would 
not  be  taxable  in  the  hands  of  nonresidents,  the  law  in  that  re- 
spect appears  to  be  an  anachronism.  The  reason  for  the  failure 
(with  the  exception  just  mentioned)  of  the  1918  Law  to  provide 
for  withholding  against  nonresident  foreign  corporations  as  to 
income  derived  from  dividends  is  that  foreign  corporations,  as 
well  as  domestic  corporations,  were  entitled  to  deduct  from 
gross  income,  in  computing  net  income,  "amounts  received  as 
dividends  from  a  corporation  which  is  taxable  upon  its  net  in- 
come, and  amounts  received  as  dividends  from  a  personal  service 
corporation  out  of  earnings  or  profits  upon  which  income  tax 
has  been  imposed  by  act  of  Congress." ^i  Under  the  1918  Law,  in 
practical  effect,  no  withholding  from  corporate  dividends  was 
required  in  any  case,^^  ^nd  the  responsibility  of  a  nominal  stock- 
holder pertained  only  to  the  surtax  for  which  a  nonresident  in- 
dividual actual  owner  might  be  liable.    He  was  a  resident  agent 

39  Revenue  Act  of  1916,   §  9    (g) . 

40  Revenue  Act  of  1918,  §§  221  and  237. 

41  Revenue  Act  of  1918,  §  234  (a)  6  and  (b).    Reg.  45,  Art.  363. 

42  See  p.  88  in  regard  to  the  deficiency  of  authority  in  the  commissioner 
under  the  present  law  in  this  connection. 


98  FEDERAL  INCOME  TAX 

within  the  meaning  of  this  chapter  as  to  dividend  income,  but 
since  the  dividends  of  domestic  or  resident  corporations  were 
in  no  case  subject  to  the  normal  tax,  his  liabihty  was  some- 
what narrower  than  the  liability  of  other  resident  agents,-^"^ 

A  full  discussion  of  the  taxability,  under  the  present  law,  of 
dividends  in  the  hands  of  nonresidents  is  contained  in  the  pre- 
ceding chapter  and  it  will  be  seen  from  that  discussion  that  the 
duties  of  withholding  agents  and  resident  agents  with  respect 
to  income  from  dividends  will  be  the  same  under  the  present  law 
as  under  the  1918  Law. 

Procedure  when  Nominal  Stockholder  Is  a  Resident  and 
Actual  Owner  Is  a  Resident.  In  cases  where  both  the  nominal 
stockholder  and  the  actual  owner  are  residents  of  the  United 
States,  the  nominal  stockholder  is  not  required  to  obtain  any 
certificate  disclosing  the  name  of  the  actual  owner.  The  primary 
purpose  of  requiring  disclosure  of  the  actual  owner  is  to  assist 
in  administering  that  provision  of  the  law  which  makes  dividends 
on  the  stock  of  domestic  or  resident  foreign  corporations  liable 
to  surtax  when  paid  to  nonresident  alien  individuals.^^  The 
actual  owner  is,  of  course,  in  all  cases  obligated  to  report  the 
dividends  and  pay  the  surtax  thereon,  if  he  is  liable ;  the  nominal 
stockholder  is  under  no  duty  to  report  the  dividends  as  his  in- 
come, but  should  be  prepared  to  show  conclusively,  if  question 
arises,  that  actual  ownership  does  not  rest  in  him.'*^  If  a  nominal 
stockholder  pays  over  the  dividends  to  a  resident  whom  he  knows 
to  be  the  agent  of  a  nonresident  alien,  he  is  under  no  duty  as 
agent,  since  it  is  the  one  who  collects  the  dividend  for  a  non- 
resident, or  who  finally  pays  it  over  to  a  nonresident,  who  has 
impressed  upon  him  the  duty  of  a  resident  agent. 

Procedure  Where  Nominal  Stockholder  Is  Resident  and 
Actual  Owner  Is  Non-Resident.^'^  In  this  case  it  is  immaterial 
whether  the  nominal  stockholder  is  an  individual,  partnership,  or 
corporation,  since  irrespective  of  his  or  its  individual  or  corporate 
status,  the  nominal  stockholder  may  be  held  responsible  as  resi- 
dent agent  for  the  surtax  payable  by  the  actual  owner  upon  divi- 
dends.   It  was  ruled  under  the  1918  Law  that  in  all  cases  where 

43  See  letter  from  treasury  department  dated  November  21,  1916;  I.  T.  S. 
1918,  T[  272,  dealing  with  the  1916  Law. 

4-1  Letter  fi*om  treasury  department  dated  November  21,  1916;  I.  T.  S. 
1918,  11272. 

45  Letter  from  treasury  department  dated  November  21,  1916;  I.  T.  S. 
1918,  Tl  272. 

46  For  the  procedure  under  the  1916  Law  see  Reg.  33  Rev.,  Arts.  32  and  201 ; 
T.  D.  2301;  letter  from  treasury  department  dated  June  6,  1918;  I.  T.  S. 
1918,  113528. 


RESIDENT  AGENTS  FOR  NONRESIDENT  ALIENS  99 

the  actual  owner  is  a  nonresident  alien  individual  and  the  record 
owner  is  a  person  in  the  United  States,  the  record  owner  will  be 
considered  for  tax  purposes  to  have  the  receipt,  custody,  control 
and  disposal  of  the  dividend  income  and  will  be  required  to  make 
return  for  the  actual  owner,  regardless  of  the  amount  of  the 
income,  and  to  pay  any  surtax  found  by  such  return  to  be  due.-'^ 
If  the  actual  owner  is  an  individual,  the  return  made  by  the 
nominal  stockholder  on  his  behalf  may  show  that  a  surtax  is 
due,  since  individuals  are  liable  to  the  surtax.  If,  however,  the 
actual  owner  is  a  partnership  or  corporation,  the  return  made  by 
the  nominal  stockholder  on  its  behalf  will  not  show  any  surtax 
to  be  due,  since  partnerships  are  not  subject  to  any  income 
tax  as  such,-^s  and  corporations  are  not  liable  to  the  surtax.-*^ 

Procedure  Where  Nominal  Stockholder  Is  Non-Resident 

AND  Actual  Owner  Is  Resident.''^    In  this  case,  whether  the 

actual   owner   is   an   individual,   partnership,   or   corporation   is 

immaterial,  since  the  residence  of  the  actual  owner  within  the 

United  States  dispenses  with  the  necessity  of  impressing  the  duty 

of  the  resident  agent  on  the  nominal  stockholder.  It  was  ruled 

under  the  1918  Law  that  dividends  on  the  stock  of  domestic 

or  resident  foreign  corporations  are  prima  facie  income  of  the 

record  owner  of  the  stock,  and  such  record  owner  will  be  liable 

for  any  additional  tax  based  thereon,  unless  a  disclosure -^i  of  the 

actual  ownership  is  made  to  the  commissioner  which  shall  show 

that  the  record  owner  is  not  the  actual  owner  and  who  the  owner 

is  and  his  address.-^^    jf  the  nominal  stockholder  is  an  individual 

and  fails  to  make  this  disclosure,  the  dividends  will,  therefore, 

be  subject  to  surtax  as  if  they  belonged  to  the  individual  nominal 

stockholder.     If  the  nominal  stockholder  is  a  partnership,  and 

fails  to  make  such  disclosure,  the  dividends   will   be  regarded 

as  incomers  of  the  partnership,  to  be  reported  in  the  information 

return  of  the  partnership,   and  such  dividends  will   ultimately 

be  subject  to  surtax  in  the  hands  of  the  individual  partners.     If 

the  nominal  stockholder  is  a  corporation  and  fails  to  make  such 

disclosure,   the    dividends   will   be   regarded   as    income   of  the 

corporation.     But  since  dividends  paid  by  domestic  or  resident 

foreign   corporations   are   deductible   from   gross    income   when 

47  Reg.  45,  Art.  405. 

48  Revenue  Act  of  1921,  §218;  Revenue  Act  of  1918,  §218. 

49  Reg.  33,  Art.  185. 

-'"•0  See  Note  46.  : 

=•1  This  disclosure  is  made  on  Form  No.  1087    (revised). 
•^2Reg.  45,  Art.  405. 
53  Revenue  Act  of  1921,  §224;  See  Revenue  Act  of  1918,  §224. 


100  FEDERAL  INCOME  TAX 

received  by  corporations,  domestic  or  foreign/^^  they  will  not  be 
taxable  income  in  this  event  and  it  follows  that  a  corporation 
need  not  make  such  disclosure. 

Procedure  in  Case  of  Dutch  Administration  Offices.  Un- 
der the  1916  Law  a  special  ruling  having  application  to  many 
similar  situations  in  foreign  countries  was  made  with  respect 
to  the  so-called  "Administration  Offices"  in  Holland.  It  appears 
that  the  Dutch  Administration  Offices  are  the  registered  owners 
of  large  blocks  of  American  stocks,  against  which  they  have 
issued  bearer  certificates,  with  coupons  attached.  These  coupons, 
upon  presentation  and  surrender,  entitle  the  bearer  to  dividends 
declared  on  the  stocks.  The  administration  offices  were  held  to 
be  prima  facie  liable  for  the  tax  on  dividends  paid  on  the  stock 
standing  in  their  names,  unless  they  disclosed  the  names  of  the 
actual  owners  by  use  of  the  proper  certificates.^-'^  By  appointing 
an  agent  in  the  United  States  they  could  avoid  having  the  tax 
withheld  at  the  source.  Such  agent  was  required  to  make  returns 
of  income  for  the  Dutch  administration  office  represented  by  him 
and  pay  the  corporation  tax  of  2%  on  all  dividends  received  by 
it,  except  such  amounts  as  were  shown  by  certificates  disclosing 
actual  ownership  to  have  been  received  for  the  account  of  non- 
resident alien  individuals  or  partnerships.  Such  certificates  were 
attached  to  and  made  the  basis  of  the  return  when  filed.^*^ 

Certificates  Issued  to  Bearer.  When  stock  of  an  American 
corporation  is  floated  in  some  European  countries,  where  in- 
vestors are  accustomed  to  bearer  stock  certificates,  a  block  of 
the  stock  is  sometimes  issued  to  a  trust  company  in  this  country 
which  in  turn  issues  bearer  certificates  entitling  the  holder  to 
certificates  of  stock  for  the  number  of  shares  designated,  upon 
the  surrender  of  the  bearer  certificates,  and  to  any  dividends 
which  may  be  declared  on  such  shares  while  the  bearer  certificate 
is  outstanding.  The  bearer  certificates  pass  by  delivery,  the  divi- 
dends being  claimed  through  foreign  banks  by  presentation  and 
surrender  of  numbered  coupons,  attached  thereto.  In  such  cases 
the  trust  company  was,  under  the  1916  Law,  in  the  position  of  a 
resident  nominal  stockholder.     Under  the  present  law  the  rule 

54  Revenue  Act  of  1921,  §234  (a)  (6);  Revenue  Act  of  1918,  §234  (a) 
6,    (b). 

55  Disclosure  was  made  on  Form  No.  1087. 

56  T.  D.  2386;  T.  D.  2669.  This  ruling  was  based  on  the  theory  that  the 
Dutch  Administration  offices  were  "nonresident  alien  corporations,"  subject 
to  tax  on  dividends  and  to  having  the  tax  withheld  at  the  source.  Since  the 
Revenue  Acts  of  1918  and  1921  do  not  tax  corporations  on  dividends  re- 
ceived by  them,  it  seems  that  only  on  some  other  theory  can  they  be  re- 
quired to  ascertain  and  disclose  the  names  of  the  owners  of  their  bearer 


RESIDENT  AGENTS  FOR  NONRESIDENT  ALIENS  101 

would  still  seem  to  apply,  and  where  the  actual  owner  is  a  non- 
resident alien  individual  the  trust  company  will  be  required  to 
make  return  for  such  actual  owner  and  pay  the  surtax  found 
to  be  due.^''' 

certificates,  under  the  present  law.  Neither  the  law  nor  the  latest  regula- 
tions have  provided  for  the  case  of  a  foreign  corporation  nominal  stock- 
holder and  a  nonresident  alien  actual  owner. 

57  See  Reg.  45,  Art.  405.    Form  1087  should  be  used  to   disclose  actual 
ownership  when  the  owner  is  a  nonresident  alien. 


CHAPTER  6 

FIDUCIARIES 

The  Revenue  Acts  of  1918  and  1921  have  in  general  clarified 
rather  than  changed  the  provisions  of  the  1916  Law  fixing  the 
special  duties  and  responsibilities  of  fiduciaries.  Fiduciaries  are 
classed  as  individuals  under  the  law,  irrespective  of  their  status, 
individual  or  corporate,  and  may  be  required  to  make  returns  of 
income  or  returns  of  information,  according  to  the  character 
of  their  relationship  with  their  beneficiaries  or  the  nature  of 
the  income  constituting  the  subject  of  the  trust.  In  certain 
cases  trust  estates  are  taxed  as  entities  in  which  cases  the  fidu- 
ciary is  required  to  pay  the  tax  for  the  estate ;  in  other  cases  the 
law,  ignoring  the  entity  of  the  trust  estate,  taxes  the  income  in 
the  hands  of  the  beneficiary,  in  which  event  the  fiduciary  is  not 
required  to  pay  any  tax  upon  the  estate.  The  Revenue  Act  of 
1921  contains  a  new  provision  concerning  trusts,  part  of  the 
income  of  which  is  distributable  and  part  of  which  is  to  be  held 
for  future  distribution^  as  well  as  a  provision  with  respect  to 
trusts  created  by  employers  as  part  of  a  stock  bonus  or  profit- 
sharing  plan.-  The  provisions  of  law  and  regulations  pertaining 
particularly  to  fiduciaries  and  trust  estates  are  indicated  below. 

Trusts  Created  by  Employers.  The  Revenue  Act  of  1921  con- 
tains a  new  provision  with  respect  to  trusts  created  by  employ- 
ers as  a  part  of  a  stock  bonus  or  profit-sharing  plan  for  the 
benefit  of  employees.  It  provides  that  a  trust  created  by  an 
employer  as  a  part  of  a  stock  bonus  or  profit-sharing  plan 
for  the  exclusive  benefit  of  some  or  all  of  his  employees,  to  which 
contributions  are  made  by  such  employer,  or  employees,  or 
both,  for  the  purpose  of  distributing  to  such  employees  the  earn- 
ings and  principal  of  the  fund  accumulated  by  the  trust  in  ac- 
cordance with  such  plan,  shall  not  be  taxable  as  an  estate  or  trust, 
but  the  amount  actually  distributed  or  made  available  to  any 
distributee  will  be  taxable  to  him  in  the  year  in  which  so  distrib- 
uted or  made  available  to  the  extent  that  it  exceeds  the  amounts 
paid  in  by  him.  Such  distributees  will  for  the  purpose  of  the 
normal  tax  be  allowed  as  credits  that  part  of  the  amount  so 
distributed  or  made  available  as  represents  the  items  ordinarily 
allowed  as  credits  to  individuals.^ 

1  Revenue  Act  of  1921,  §219  (e). 

2  Revenue  Act  of  1921,  §219  (f). 

3  Revenue  Act  of  1921,  §219  (f). 

102 


FIDUCIARIES  103 

Who  Are  Fiduciaries.  The  term  "fiduciary"  is  defined  to  mean 
a  "guardian,  trustee,  executor,  administrator,  receiver,  conserva- 
tor, or  any  person  acting  in  any  fiduciary  capacity  for  any  person, 
trust  or  estate.""^  In  view  of  the  definition  of  the  word  "person" 
used  in  this  definition,"'  a  corporation,  partnership,  joint-stock 
company  or  insurance  company  may  be  a  fiduciary  under  the 
law.  It  has  been  held  that  a  fiduciary  for  income  tax  purposes  is 
one  who  holds  in  trust  an  estate  to  which  another  has  the  benefi- 
cial title  or  in  which  another  has  a  beneficial  interest,  or  receives 
and  controls  the  income  of  another,  as  in  the  case  of  receivers." 
It  has  also  been  ruled  that  the  term,  "fiduciary"  applies  to  all 
persons  or  corporations  who  occupy  positions  of  peculiar  con- 
fidence towards  others,  such  as  trustees,  executors,  or  adminis- 
trators.^ Some  rulings  and  regulations  issued  in  explanation  of 
the  term  "fiduciary"  are  given  below  as  indicative  of  the  treasury 
department's  attitude  in  interpretation  of  the  broad  term  "any 
person  acting  in  any  fiduciary  capacity  for  any  person,  trust 
or  estate." 

Agents.  An  agent,  as  such,  is  not  a  fiduciary  for  his  principal 
even  though  he  may  have  complete  charge  of  the  property  of 
his  principal."*  There  may  be  a  fiduciary  relationship  between  an 
agent  and  a  principal,  but  the  word  "agent"  standing  alone  does 
not  denote  a  fiduciary  within  the  meaning  of  the  law."  An  oral 
agreement  whereby  one  of  a  number  of  brothers  and  sisters  acts 
as  agent  for  all  of  them  in  managing  property  held  by  them  as 
tenants  in  common  under  the  father's  will,  and  in  distributing 
the  income  therefrom,  is  not  a  legal  trust  for  income  tax  pur- 
poses, nor  is  the  agent  a  fiduciary.  Each  principal  should  file 
a  separate  return,  including  therein  his  share  of  the  income 
from  the  property  and  claiming  a  proportionate  share  of  any 
allowable  deductions. i^'  By  an  agreement  addressed  to  a  certain 
company  setting  forth  that  the  persons  signing  such  agreement 
are  the  owners  of  a  royalty  interest  in  certain  oil  wells,  each 

4  Revenue  Act  of  1918,  §200;  Revenue  Act  of  1921,  §200.  This  defini- 
tion is  the  same  in  both  laws  and  the  rulings  discussed  below,  issued  under 
the  1918  Law,  should  be  applicable  under  the  present  law. 

■^  In  the  Revenue  Act  of  1921,  §  2,  and  in  the  Revenue  Act  of  1918,  §  1, 
the  term  "person"  is  defined  to  include  "partnerships  and  corporations,  as 
well  as  individuals."  The  term  "corporation"  includes  associations,  joint- 
stock  companies  and  insurance  companies. 

"Reg.  45,  Art.  1521;  T.  D.  2090. 

7  Reg.  45,  Art.  1521 ;  Reg.  33  Rev.,  Art.  29. 

SReg.  45,  Art.  1522;  T.  D.  2135. 

«  Reg.  45,  Art.  1522;  Reg.  33  Rev.,  Art.  29;  T.  D.  2090. 

i"0.  D.  425,  T.  B.  13-20-814. 


104  FEDERAL  INCOME  TAX 

owning  the  respective  interest  set  opposite  his  name,  and  that 
on  account  of  the  diversity  of  ownership  in  said  property  it  is 
impracticable  for  the  signers,  as  well  as  for  the  company  as 
purchaser  of  the  oil  and  gas,  to  keep  separate  books  of  account 
showing  the  respective  interests  of  the  several  owners,  an  indi- 
vidual was  selected  and  appointed  as  trustee  of  the  owners  to 
collect  from  the  purchaser  of  the  oil  and  gas  any  and  all  moneys 
arising  from  the  sale  of  oil  and  gas  from  the  property  and  to 
account  therefor  to  them.  The  trustee  was  also  given  authority 
to  sign  division  orders  respecting  the  sale  and  the  running  of  oil 
and  gas  from  the  land.  It  has  been  held  that  as  no  property 
was  conveyed  to  the  individual  named  as  trustee  by  the  agree- 
ment, his  duties  being  merely  to  receive  from  the  company  in- 
come payable  to  the  signers  of  the  agreement,  to  account  to  such 
signers  for  the  income  so  received  and  to  sign  division  orders, 
he  is  not  a  trustee  within  the  meaning  of  the  law,  but  an  agent 
of  the  persons  signing  the  agreement.  He  is  not,  therefore, 
required  to  make  a  return,  either  of  income  or  of  information, 
as  a  fiduciary.il 

Power  of  Attorney.  A  person  cannot,  by  power  of  attorney, 
appoint  another  to  act  as  a  fiduciary.  A  power  of  attorney  can- 
not create  a  fiduciary  relationship.  An  agent  having  entire 
charge  of  property  with  authority  conferred  upon  him  by  a 
power  of  attorney  to  effect  and  execute  leases  with  tenants 
entirely  on  his  own  responsibility  and  without  consulting  his 
principal,  paying  taxes  and  expenses  and  all  other  charges  in 
connection  with  the  property  out  of  funds  in  his  hands  from 
the  rents  collected,  merely  turning  over  the  net  profits  from  the 
property  periodically  to  his  principal  is  not  a  fiduciary.  In 
cases  where  no  legal  trust  has  been  created  in  the  estate  con- 
trolled by  the  agent  and  attorney,  the  liability  under  the  law 
to  make  returns  and  pay  the  taxes  rests  with  the  principal.i- 

GUARDIANS.  A  legal  guardian  is  a  fiduciary,  but  it  does  not 
seem  that  a  natural  guardian  comes  within  the  definition.  Under 
the  Revenue  Acts  of  1918  and  1921  minors  are  required  to  file  re- 
turns, but  if  a  minor  is  dependent  upon  his  parent,  who  appro- 
priates or  may  appropriate  his  earnings,  such  earnings  are  in- 
come of  the  parent  and  not  of  the  minor  for  the  purpose  of  the 
normal  tax  and  surtax.  In  the  absence  of  proof  to  the  contrary 
a  parent  will  be  assumed  not  to  have  emancipated  his  minor  child 
and  must  include  in  his  return  any  earnings  of  the  minor.i^    j^ 

11  O.  D.  875,  T.  B.  16-21-1569. 

12  Reg.  45,  Art.  1522;  Reg.  33  Rev.,  Art.  29;  T.  D.  2137. 

13  Reg.  45,  Art.  403. 


FIDUCIARIES  105 

seems,  therefore,  that  if  a  minor  exercises  independent  control 
of  any  of  his  own  income,  the  guardian  should  not  make  a  sepa- 
rate return  for  the  minor  of  income  from  a  separate  estate  nor 
should  the  parent  include  the  minor's  income  in  his  own  return. 

Ancillary  Administrator.  An  ancillary  administrator  is 
merely  an  agent  of  the  domiciliary  administrator  and  should 
transmit  to  him  all  information  as  to  income  of  the  estate  re- 
ceived by  the  ancillary  administrator,  to  the  end  that  the  original 
administrator  may  make  a  return  covering  the  entire  income 
of  the  estate.'* 

Trustees  in  Bankruptcy.  A  trustee  in  bankruptcy  is  a 
fiduciary  and  is  required  to  file  a  return  for  the  bankrupt  estate 
if  its  net  income  exceeds  the  specific  exemption  of  $1000.1'' 

Receivers.  A  receiver  for  an  individual  is  a  fiduciary,  but 
it  seems  that  a  receiver  for  a  corporation  is  not,i^  notwithstand- 
ing the  broad  definition  ^'^  of  the  words  "fiduciary"  and  "person" 
and  the  general  provisions  of  the  law'^  governing  fiduciaries. i*^ 
Receivers  appointed  by  authority  of  law,  in  possession  of  part 
only  of  the  property  of  an  individual,  are  expressly  excepted 
from  the  requirement  that  fiduciaries  shall  make  returns.-'* 

Temporary  Receiver  Held  to  Be  Fiduciary.  Under  the  1916 
Law  it  was  held  that  one  appointed  under  interlocutory  orders 
of  the  United  States  district  court  to  act  as  receiver  of  an  indi- 
vidual in  a  proceeding  wherein  certain  persons  complaining  as 
creditors  were  seeking  to  have  the  property  of  the  individual 
distributed  among  them,  was  a  fiduciary,  notwithstanding  that 
title  to  the  property  in  question  (cash  and  securities)  remained 
in  the  individual  sued  and  that  his  possession  and  right  to  deal 
with  the  same  were  only  suspended.     The  receiver,  having  re- 

14  Reg.  33  Rev.,  Art.  180. 

1"'  0.  D.  174,  T.  B.  7-19-297. 

1^  Reg.  45,  Art.  424.  See  letter  from  treasury  department  dated  Feb- 
ruary 27,  1915;  I.  T.  S.  1917,  ^597,  and  letter  from  treasury  department 
dated  June  22,  1916;  I.  T.  S.  1918,  H  1097. 

17  Revenue  Act  of  1921,  §§  2  and  200;  Revenue  Act  of  1918,  §§  1  and  200. 

18  Revenue  Act  of  1921,  §§219  and  225;  Revenue  Act  of  1918,  §§219 
and  225. 

1^  This  is  true  because  it  is  specifically  provided  elsewhere  that  receivers, 
trustees  in  bankruptcy,  or  assignees  operating  the  property  or  business  of 
corporations  shall  make  returns  for  such  corporations  in  the  same  manner 
and  form  as  corporations  are  required  to  make  returns,  and  that  any  tax  due 
on  the  basis  of  such  returns  will  be  collected  in  the  same  manner  as  if  col- 
lected from  the  corporations  of  whose  business  or  property  they  have  cus- 
tody and  control.  (Revenue  Act  of  1921,  §239;  Revenue  Act  of  1918. 
§  239.) 

20  Revenue  Act  of  1921,  §225;  Revenue  Act  of  1918,  §225. 


106  FEDERAL  INCOME  TAX 

ceived  income  from  the  property  in  his  possession,  was  required 
to  file  a  return  as  a  fiduciary .-^ 

Mortgage  Foreclosure  Receivers.  A  receiver,  appointed 
in  a  mortgage  foreclosure  action  in  the  state  of  New  York  by 
a  court  of  equity  in  aid  of  its  jurisdiction,  who  is  not  a  receiver 
of  all  the  property  of  the  mortgagor  corporation,  but  is  a  com- 
mon-law receiver  in  charge  of  only  a  part  of  the  mortgaged 
property  of  the  corporation  and  a  receiver  merely  of  the  rents 
and  profits  of  such  mortgaged  property,  need  not  file  a  return 
of  income  but  he  is  required  to  file  a  return  of  information  at 
the  source. " 

Committee  for  an  Incompetent.  The  committee  for  the 
property  of  an  incompetent  person  is  regarded  as  a  fiduciary .^^ 

Deeds  of  Trust.  A  deed  of  trust  must  be  absolute  so  far 
as  the  conveyance  of  title  is  concerned  and  irrevocable  by  the 
donor,  otherwise  the  income  from  the  property  in  question  will- 
accrue  to  the  donor  and  must  be  accounted  for  by  him.--^  Where 
a  person  transfers  funds  or  property  to  trustees  to  pay  to  him 
during  his  lifetime  so  much  of  the  income  as  he  may  demand 
and  from  time  to  time  as  much  of  the  principal  as  such  trustees 
might  deem  advisable,  all  unwithdrawn  income  at  the  date  of  the 
death  of  the  settlor  to  become  a  part  of  the  trust  fund,  the 
settlor  should  return  in  any  one  year  all  the  income  accruing 
from  such  trust  fund  whether  actually  withdrawn  by  him  or  not. 
The  trustees  under  such  deed  must  make  return  of  all  income 
from  the  trust,  but  are  relieved  from  paying  a  tax  thereon.^s 

Where  under  the  terms  of  an  irrevocable  trust  the  income 
from  the  trust  property  was  to  be  paid  to  the  donor  during  her 
life  and  upon  her  death  to  certain  named  persons  or  institutions, 
or  to  such  other  persons  or  institutions  as  the  trustee  should  see 

21  Letter  from  treasury  department  dated  January  22,  1917. 

22  Reg.  45,  Art.  424.  Letter  from  treasury  department  dated  May  1, 
1918;  I.  T.  S.  1919,  ^  1433.  This  letter  stated  that  the  same  ruling  extended 
to  receivers  of  partnerships  under  the  excess  profits  tax.  It  was  first  held 
by  the  treasury  department  under  the  1916  Law  that  a  receiver  in  foreclos- 
ure proceedings  of  the  rents,  issues  and  profits  of  mortgaged  premises,  even 
though  for  only  a  part  of  the  property  of  the  mortgagor,  was  required  to 
file  a  return  of  income,  reporting  the  entire  operations  transacted  by  the 
receiver  during  the  year  1917.  Upon  further  consideration  the  treasury 
department  changed  this  ruling  to  that  stated  in  the  text  above.  (Letter 
from  treasury  department  dated  March  28,  1918;  I.  T.  S.  1918,  1|3293.) 

23  Reg.  45,  Art.  1521 ;  Reg.  33  Rev.,  Art.  29.  Letter  from  treasury  depart- 
ment dated  February  21,  1916;  I.  T.  S.  1918,  11128.  Letter  from  treasury 
department  dated  May  1,  1918;  I.  T.  S.  1919,  111433. 

24  Reg.  45,  Art.  341 ;  Reg.  33  Rev.,  Art.  29. 

25  S.  1344,  T.  B.  10-20-780;  O.  D.  621,  T.  B.  32-20-1116. 


FroUCIARIES  107 

fit  and  in  such  amounts  as  he  mig-ht  deem  proper,  the  trust  prop- 
erty to  be  sold  upon  the  death  of  the  trustee  and  the  proceeds 
distributed  among  certain  named  persons  or  institutions,  it  was 
held  that  during  the  life  of  the  donor  the  entire  income  of  the 
trust  was  taxable  to  her  whether  distributed  or  not,  inasmuch  as 
it  was  distributable  to  her.  If  the  net  income  of  the  estate  was 
$1,000  or  more,  Form  1041  should  have  been  filed  by  the  trustee. 
All  income  received  after  the  death  of  the  donor  and  during  the 
life  of  the  trustee  is  to  be  entirely  distributed  and  if  any  bene- 
ficiary is  not  exempt,  he  must  include  in  his  income  tax  return 
all  income  received  in  any  year.  If  the  trustee  fails  to  distribute 
the  entire  income  and  the  amount  so  retained  is  $1,000  or  more, 
Form  1040  must  be  filed  and  payment  made  of  any  tax  found 
to  be  due.  If  the  entire  net  income  of  the  trust  estate  for  any 
year  is  $1,000  or  more,  a  return  on  Form  1041  must  be  filed  to 
show  the  amount  of  net  income  distributed  to  each  beneficiary 
and  to  show  any  amount  retained  by  the  estate.-" 

Where  a  declaration  of  trust  provides  that  during  the  life  of 
the  donor  he  may  indicate  the  manner  in  which  the  trustee  shall 
exercise  the  powers  conferred  by  the  trust  agreement;  that  the 
donor  shall  have  a  voice  in  determining  the  amount  of  net  in- 
come to  be  distributed  to  the  beneficiaries ;  and  that  the  estate  cre- 
ated and  the  interests  vested  thereunder  shall  be  subject  to 
revocation  by  the  donor  at  any  time,  in  whole  or  in  part,  it  is 
held  that  the  amount  of  income  received  by  the  beneficiaries  is 
m  the  nature  of  a  gift,  and  that  the  trustee  merely  acts  as  agent 
for  the  donor.  The  income  of  the  trust  should  therefore  be  in- 
cluded in  the  gross  income  of  the  donor.  The  trustee  should  file 
a  return  for  the  trust  on  Form  1041,  revised,  showing  the 
grantor  as  beneficiary  under  the  trust  and  the  grantor  should 
include  the  net  income  of  the  trust  in  gross  income  in  his  individ- 
ual return  under  the  item  of  income  from  fiduciaries.-^ 

Alien  Property  Custodian.  The  alien  property  custodian 
appointed  by  the  President  during  the  war,  under  the  authori- 
ty of  the  Trading  With  the  Enemy  Act,  is  not  a  fiduciary 
within  the  meaning  of  the  law,  but  is  a  mere  official  of  the  gov- 
ernment, or  agent  of  the  President  in  taking  over  and  preserving 
the  property  of  alien  enemies  and  is  therefore  not  required  to 
make  return  or  pay  taxes  in  behalf  of  alien  enemies  whose  money 
or  property  is  taken  over  by  him.  This  does  not  mean  that  if 
income  shall  have  accrued  during  the  period  when  the  property 

2«  O.  D.  749,  T.  B.  50-20-1344. 
-'7  O.  D.  676,  T.  B.  40-20-1224. 


108  FEDERAL  INCOME  TAX 

has  been  held  by  the  alien  property  custodian  the  former  alien 
enemy  owners  are  not  liable  for  tax.  Before  paying  out  any 
funds  representing  such  income,  the  treasury  department  may 
ascertain  the  taxes  due  and  require  them  to  be  paid.^s 

Who  Are  Beneficiaries.  A  beneficiary  within  the  meaning  of 
the  law  and  regulations  and  in  the  sense  used  in  this  book  is 
the  ward,  cestui  que  trust,  legatee,  distributee,  creditor,  or  other 
person  entitled  to  any  part  of  the  net  income  of  a  trust  or  estate 
in  the  charge  of  a  fiduciary.  The  trust  estate  itself  is  the  bene- 
ficiary with  respect  to  (1)  income  received  by  estates  of  de- 
ceased persons  during  the  period  of  administration  or  settlement 
of  the  estate  and  not  properly  credited  to  any  legatee,  heir,  or 
other  beneficiary;  (2)  income  accumulated  in  trust  for  the 
benefit  of  unborn  or  unascertained  persons,  or  persons  with  con- 
tingent interests;  (3)  income  held  for  future  distribution  under 
the  terms  of  the  will  or  trust.-^ 

Duties  of  Fiduciaries  Generally.  Every  fiduciary  is  required 
by  the  law  to  make  under  oath  a  return  for  the  individual,  es- 
tate or  trust  for  which  he  acts.^o  xhis  return  may  be  of  two 
kinds :  (a)  a  return  of  income,  or  (b)  a  return  of  hiformation, 
according  to  the  nature  of  the  income  constituting  the  subject 
of  the  trust.  If  the  income  is  (1)  received  by  estates  of  deceased 
persons  during  the  period  of  administration  or  settlement,^!  and 
not  properly  paid  or  credited  to  any  legatee,  heir,  or  other  bene- 
ficiary during  that  period,  (2)  accumulated  in  trust  for  the 
benefit  of  unborn  or  unascertained  persons,  or  persons  with 
contingent  interests,  or  (3)  held  for  future  distribution  under 
the  terms  of  the  will  or  trust,  the  return  is  one  of  income.  If 
the  income  (4)  is  to  be  distributed  to  the  beneficiaries  periodi- 
cally, whether  or  not  at  regular  intervals,  (5)  is  collected  by  the 
guardian  of  an  infant  to  be  held  or  distributed  as  the  court  may 
direct,  or  (6)  is  properly  paid  or  credited  to  any  legatee,  heir, 
or  other  beneficiary  during  the  period  of  administration  or  set- 
tlement of  an  estate,  the  fiduciary's  return  is  merely  an  infor- 
mation return.  It  is  the  duty  of  every  fiduciary  who  is  required 
to  make  a  return  of  income  to  pay  the  tax  computed  in  the  return 

28  Op.  A.  G.  2,  T.  B.  30-20-1092. 

29  See  Revenue  Act  of  1921,  §  219,  and  Revenue  Act  of  1918,  §  219. 

30  Revenue  Act  of  1921,  §  225;  Revenue  Act  of  1918,  §  225. 

31  The  "period  of  administration  or  settlement  of  the  estate"  is  the  period 
required  by  the  executor  or  administrator  to  perform  the  ordinary  duties 
pertaining  to  administration,  in  particular  the  collection  of  assets  and  the 
payment  of  debts  and  legacies.  It  is  the  time  actually  required  for  this  pur- 
pose, whether  longer  or  shorter  than  the  period  specified  in  the  local  statute 
for  the  settlement  of  estates.     (Reg.  45,  Art.  343.) 


FIDUCIARIES  109 

to  be  due.  Cases  in  which  the  fiduciary  is  required  to  pay  the 
tax  are  divided  into  two  classes:  (1)  Cases  in  which,  by  reason 
of  the  nature  of  the  income  constituting  the  subject  of  the  trust, 
the  tax  is  imposed  upon  the  trust  estate  as  an  entity  and  the 
fiduciary's  return  is  one  of  income,  and  (2)  cases  in  which  the 
fiduciary's  return  is  merely  one  of  information  but,  by  reason 
of  the  status  of  the  beneficiary,  the  tax,  although  laid  upon  the 
beneficiary,  must  be  paid  by  the  fiduciary  on  his  behalf. 

Duties  of  Receivers.  Receivers  who,  as  officers  of  a  court, 
stand  in  the  stead  of  some  principal,  are  required  to  account  for 
income  tax  as  the  principal  would  be  required  to  account.-"^- 
Where  a  receiver  for  an  individual,  acting  under  interlocutory 
orders  of  the  court,  receives  income  during  any  year  or  funds 
which  he  holds  in  trust  as  such  receiver,  such  income  must  be 
accounted  for  and  the  tax  paid  thereon  for  that  year.  Having 
been  thus  freed  from  tax  liability,  the  income  assumes  the  status 
of  capital  and  may  thereafter  be  distributed  by  the  receiver  in 
the  same  manner  as  other  capital.  The  fact  that  all  or  any  part 
of  the  income  received  by  a  receiver  may  be  used  to  pay  creditors 
does  not  relieve  the  receiver  from  first  paying  the  tax  on  all 
income  received  by  him,  since  the  government  has  a  prior  lien 
for  the  amount  of  the  tax  and  only  what  remains  after  the  tax 
is  paid  may  be  distributed  to  creditors  or  others."'" 

Duties  of  Executors  and  Administrators.  In  addition  to 
the  duties  of  fiduciaries  generally,  executors  and  administrators 
are  charged  with  the  duty  of  making  returns  of  income  of  the 
decedent  for  the  period  during  which  he  lived  and  made  no 
return  prior  to  his  death.^* 

32  Reg.  45,  Art.  424;  Reg.  33  Rev.,  Art.  26.  Form  No.  1040  (revised)  or 
1040A  (revised)  is  used  by  a  receiver  for  an  individual.  The  1916  Law  con- 
tained a  general  provision  (Revenue  Act  of  1916,  §  9  (g)  )  which  charged 
all  gains,  profits  and  income  of  a  taxable  class  with  the  corresponding  tax, 
and  provided  further  that  such  tax  should  be  paid  by  "the  owner  of  such 
income,  or  the  proper  representative  having  the  receipt,  custody,  control  or 
disposal  of  the  same."  The  Revenue  Acts  of  1918  and  1921  contain  no 
similar  provision.  However  strong  the  implication  may  be  that  receivers 
are  to  pay  the  tax  on  income  of  the  persons  for  whom  they  act,  the  absence 
of  a  mandatory  provision  imposing  this  duty  and  indemnifying  them 
against  all  claims  and  demands  of  every  beneficiary  for  all  payments  of 
taxes  they  are  required  to  make,  may  place  receivers  in  embarrassing  situa- 
tions, since  they  are  held  rigidly  to  account  for  all  their  acts,  and  any 
moneys  paid  out  under  doubtful  authority  may  involve  them  in  personal  lia- 
bility.    The  same  considerations  apply  to  guardians. 

33  Letter  from  treasury  department  dated  February  9,  1917;  I.  T.  S.  1919, 
II 1242. 

34  See  p.  146  for  a  more  complete  statement  of  this  liability. 


110  FEDERAL  INCOME  TAX 

Income  of  Estates  and  Trusts.  The  income  of  estates  and 
trusts  received  during  any  taxable  year  is  subject  to  tax  either 
(a)  in  the  hands  of  the  beneficiaries  on  their  respective  shares 
paid  or  credited  to  them  by  the  fiduciary  during  the  year  or  (b) 
in  the  hands  of  the  fiduciary,  if  the  income  is  not  paid  or  credited 
to  a  beneficiary.  In  other  words,  all  or  a  part  of  the  net  income 
of  an  estate  or  trust  may  be  distributable  to  beneficiaries  •'"'  and  if 
so,  there  is  to  be  included  in  computing  the  net  ihcome  of  each 
beneficiary  his  distributive  share,  whether  distributed  or  not, 
and  the  fiduciary  is  required  to  make  a  return  showing  the  net 
income  of  the  estate  or  trust  and  the  distributable  shares  of  each 
beneficiary.  The  fiduciary's  return  is  one  of  information  and 
he  is  not  required  to  pay  any  tax  unless  the  beneficiary  is  a  non- 
resident alien,  a  minor,  an  incompetent,  or  otherwise  incapaci- 
tated. On  the  other  hand,  all  or  a  part  of  the  net  income  of  an 
estate  or  trust  may  be  retained  for  future  distribution  and  at  the 
end  of  the  year  added  to  the  corpus  of  the  estate."'"  Such  income 
is  taxed  to  the  fiduciary  and  he  is  required  to  file  a  return  show- 
ing the  amount  thereof  and  the  tax  due  thereon,  just  as  individ- 
uals are  required  to  report  income  and  pay  the  tax.'^^  If  part  of 
the  income  is  distributable  and  part  is  retained  by  the  estate,  the 
tax  is  imposed  on  the  respective  parts  as  above  indicated,  the 
fiduciary,  under  the  present  law,  being  required  to  make  a  re- 
turn of  the  entire  income  and  being  allowed  to  deduct  the  amount 
of  distributable  income.--'^  Where  the  same  trustee  is  designated 
in  a  will  to  administer  several  trusts,  the  accumulated  income 
of  each  separate  trust  will  be  taxable  as  an  entity,  not  the  income 
of  the  trusts  combined.^^ 

A  testator  by  his  will  directed  that  his  executor  pay  an  an- 
nuity to  two  individuals  jointly  during  their  joint  lives  and  a 
like  amount  to  the  survivor  during  his  life.     As  no  provision 

Sy  Income  to  be  distributed  to  beneficiaries  periodically,  whether  or  not  at 
regular  intervals,  income  collected  by  the  guardian  of  an  infant  to  be  held 
or  distributed  as  the  court  may  direct,  or  income  properly  paid  or  credited 
to  beneficiaries  during  the  period  of  administration  or  settlement  of  an 
estate,  is  here  referred  to. 

36  Income  received  by  estates  of  deceased  persons  during  the  period  of 
administration  or  settlement  (not  paid  or  credited  as  indicated  in  note  35), 
income  accumulated  in  trust  for  the  benefit  of  unborn  or  unascertained  per- 
sons, or  persons  w^ith  contingent  interests,  or  income  held  for  future  distri- 
bution under  the  terms  of  the  will  or  trust,  is  here  referred  to. 

37  Revenue  Act  of  1921,  §  219;  Revenue  Act  of  1918,  §  219;  Reg.  45,  Arts. 
341  to  346,  incl.,  and  Arts.  421  to  425,  inch 

38  Revenue  Act  of  1921,  §  219  (e) . 

39  O.  D.  316,  T.  B.  26-19-592. 


FIDUCIARIES  111 

was  made  as  to  a  fund  from  which  this  annuity  was  to  be  paid, 
the  executor  purchased  out  of  the  funds  of  the  estate  a  single- 
payment  two-year  term  endowment  insurance  poHcy  covering 
the  life  of  another  individual.  The  policy  provided  that  at  its 
maturity  the  insurance  company  would  enter  into  a  trust  agree- 
ment to  retain  the  proceeds  of  the  policy,  pay  over  to  the  an- 
nuitants the  amount  of  the  annuity,  and  at  their  deaths  to  dis- 
tribute the  principal  and  any  accrued  income  among  the  resid- 
uary legatees.  As  the  amount  of  the  annuity  may  reasonably 
be  expected  to  be  earned  by  the  principal  of  the  trust  fund,  no 
part  of  the  corpus  of  the  estate  would  be  distributed.  It  has 
been  held  that  the  amounts  received  by  the  annuitants  are  not 
received  by  bequest  nor  are  they  a  return  of  capital  invested 
by  them  nor  proceeds  of  an  insurance  policy  exempt  under  the 
law,^"  but  income  received  from  a  trust  and  taxable  as  such.  It 
was  also  held  that  the  amount  by  which  the  proceeds  of  the  policy 
upon  its  maturity  exceeded  its  cost  is  income  to  the  insurance 
company  in  its  fiduciary  capacity  and  should  be  included  in  its 
return  for  the  year  in  which  the  policy  matured.  The  entire 
amount  paid  over  to  the  residuary  legatees  upon  the  death  of 
the  annuitants  will  be  exempt  from  income  tax  in  the  hands  of 
the  residuary  legatees."^! 

Corpus  of  Estates  and  Trusts.  The  corpus,  that  is,  the  amount 
of  capital  transferred  to  the  estate  or  trust  at  the  time  of  its 
creation  is  not  income.'^-  In  the  case  of  estates  of  deceased 
persons,  the  appraised  value  of  the  property  at  the  time  of  the 
death  of  the  decedent  is  capital,  regardless  of  the  fact  that  the 
cost  of  that  property  to  the  decedent  may  have  been  less  than 
such  appraised  value.  Similarly,  the  value  of  the  property  con- 
stituting the  subject  of  a  trust  at  the  time  the  trust  is  created 
is  its  capital.  Income  received  by  a  decedent  before  his  death 
is  capital  when  received  by  the  estate.*^ 

40  Revenue  Act  of  1921,  §  213  (b)  1;  Revenue  Act  of  1918,  §  213  (b)  1. 

41  O.  D.  755,  T.  B.  51-20-1355. 

42  In  the  case  of  estates  of  deceased  persons  the  appraised  value  of  the 
property  at  the  time  of  death  (not  the  date  of  distribution  of  the  assets) 
constitutes  the  corpus.  In  the  case  of  estates  created  by  trust  instruments 
the  value  of  the  property  constituting  the  subject  of  the  trust  at  the  time 
the  trust  is  created  constitutes  the  corpus.  (O.  1012,  T.  B.  12-20-792.)  But 
see  Chapter  17  as  to  gifts  made  after  December  31,  1920. 

43  Telegram  from  treasury  department  dated  February  3,  1917;  I.  T.  S. 
1921,  ^697;  Reg.  45,  Art.  343.  A  loss  can  not  be  claimed  for  a  decedent 
covering  the  taxable  period  to  the  date  of  his  death  where  the  cost  of  se- 
curities, or  their  fair  market  value  as  at  March  1,  1913,  if  acquired  prior 
thereto,  is  in  excess  of  the  value  established  by  appraisal  for  the  purposes 
of  administering  the  estate,  except  in  the  case  of  a  decedent  who  was  a 


112  FEDERAL  INCOME  TAX 

Gross  Income  of  Estates  and  Trusts.  The  gross  income  of  an 
estate  or  trust  embraces  income  from  all  sources,  as  in  the  case 
of  individuals.^^  In  general,  this  corpus  may  produce  income  in 
two  ways:  (1)  by  investment  of  the  corpus  producing  income 
in  the  form  of  interest,  rents,  or  other  return  on  capital,  and 
(2)  by  profit  derived  from  a  sale  or  exchange  of  the  corpus. 
Both  these  forms  of  increase  of  the  corpus  of  an  estate  constitute 
taxable  income  to  the  estate.  The  rules  laid  down  by  the  courts 
with  respect  to  the  distinction  between  income  and  capital  in 
cases  involving  the  respective  rights  of  life-tenant  and  remain- 
derman do  not  necessarily  apply  under  the  provisions  of  the 
income  tax  law,  so  far  as  assessing  the  tax  is  concerned.'^^  Thus, 
extraordinary  dividends  received  by  an  estate  are  held  to  be 
income  to  the  same  extent  as  if  received  by  an  individual,  al- 
though a  part  of  the  surplus  or  undivided  profits  from  which 
the  dividends  are  declared  may  have  been  earned  by  the  corpo- 
ration prior  to  the  creation  of  the  estate.  As  an  intestate's  real 
estate  does  not  pass  to  his  administrator,  upon  a  sale  by  the 
heirs,  whether  before  or  after  settlement  of  the  estate,  each  heir 
is  taxed  individually  on  any  profit  derived.^*^  The  income  of  a 
revocable  trust  must  be  included  in  the  gross  income  of  the 
grantor.4'^  Where  during  the  period  of  administration  an 
executor  converts  the  estate  in  his  possession  into  money  for 
the  purpose  of  settling  the  estate  and  closing  the  administration, 
the  gain  or  loss  on  the  sale  of  such  property  is  determined  by 
deducting  from  the  selling  price  (or  vice  versa)  the  appraised 
value  of  the  property  at  the  time  of  the  death  of  the  decedent  or, 
if  the  estate  was  created  prior  to  March  1,  1913,  the  fair  market 
price  or  value  on  that  date.^^  If  the  corpus  of  an  estate  or  trust 
is  delivered  in  kind  to  beneficiaries  no  income  is  realized  by  the 

dealer  in  securities  and  regularly  inventoried  his  securities.  The  executor 
should  not  make  returns  of  book  gains  or  losses,  either  up  to  the  date  of 
death  or  on  transfer  of  the  property  to  the  legatee  or  to  a  trustee  under  the 
will,  or  from  one  trustee  to  a  succeeding  trustee,  the  appraised  value  re- 
maining as  the  basis  for  computing  all  subsequent  realizations  of  losses  or 
gains  in  cash.  (O.  D.  219,  T.  B.  11-19-383.)  No  taxable  income  or  de- 
ductible loss  results  from  the  passage  of  property  to  the  executor  or 
administrator  on  the  death  of  the  decedent,  even  though  such  property  has 
appreciated  or  depreciated  in  value  since  the  decedent  acquired  it.  (O.  D. 
731,  T.  B.  46-20-1306.) 

44  Revenue  Act  of  1921,  §  219;  Revenue  Act  of  1918,  §  219. 

45  See  Trefry  v.  Putnam,  227  Mass.  522,  116  N.  E.  904. 

46  Reg.  45,  Art.  342. 

47  Reg.  45,  Art.  341. 

48  Reg.  45,  Art.  343.     See,  however,  Ch.  17. 


FIDUCIARIES  113 

estate  or  trust,  although  the  value  of  the  property  when  delivered 
may  be  greater  than  its  appraised  value  at  the  time  of  its  trans- 
fer to  the  estate  or  trust. ^'^  If  securities  held  in  trust  and  form- 
ing the  corpus  of  a  trust  estate  are  sold  and  the  selling  price 
exceeds  their  value  at  the  time  the  trust  is  created,  such  excess 
constitutes  taxable  income  to  the  estate,  even  though  under  the 
terms  of  the  trust  the  income  from  the  securities  is  payable  to 
individual  beneficiaries/'"'"  An  executor  who  pays  to  another,  as 
agent,  a  commission  upon  the  sale  of  property  belonging  to  the 
estate  may  deduct  from  the  selling  price  the  amount  so  paid  in 
determining  the  gain  or  loss.  An  executor  who  retains  as  his 
commission  a  portion  of  the  amount  received  by  him  from  the 
sale  of  property  belonging  to  the  estate  may  not  deduct  the 
amount  in  the  return  for  the  estate,  since  any  service  performed 
by  him  in  that  connection  is  deemed  to  be  a  part  of  his  duties 
as  executor.  Such  a  commission,  however,  should  be  included 
in  the  gross  income  reported  in  the  executor's  personal  return 
for  the  year  in  which  received.^i  Where  the  trustee  of  assets 
of  an  oil  company  sells  oil  or  gas  wells  and  the  principal  value 
of  the  property  has  been  demonstrated  by  prospecting  or  ex- 
ploration or  discovery  work  done  by  the  trustee,  the  limitation 
upon  the  surtax  attributable  to  such  sale  is  applicable.^- 
Amounts  paid  by  an  executor  of  an  estate  out  of  his  personal 
funds  in  discharge  of  obligations  of  the  estate,  such  amounts 
being  credited  against  the  executor's  liability  for  interest  to 
the  estate,  are  nevertheless  income  to  the  estate  to  the  extent 
that  they  represent  interest  accrued  since  the  death  of  the  testa- 
tor on  obligations  of  the  executor  to  the  estate."-"' 

Amount  Received  in  Settlement  of  Claims.  Where  a  cor- 
poration turns  over  a  real  estate  mortgage  to  the  executors  of 
an  estate  in  process  of  administration  in  part  payment  of  a 
claim  held  against  it  by  the  estate,  the  executors  accepting  such 
mortgage  at  its  face  value,  no  part  of  such  mortgage  will  con- 
stitute taxable  income  to  the  estate,  unless  the  face  value  is 
greater  than  the  fair  market  value  of  the  decedent's  claim  against 
the  company  at  the  date  of  death.""^  Where  a  corporation  in 
liquidation  turned  over  its  assets  to  the  executor  of  an  estate  to 
which  it  was  indebted  and  which  owned  all  of  its  outstanding 


49  See  Reg.  45,  Art.  343. 

50  O.  D.  129,  T.  B.  3-19-198. 

51  O.  D.  632,  T.  B.  33-20-1135. 

52  O.  D.  194,  T.  B.  9-19-337.     See  Chapter  2. 

53  O.  D.  51,  T.  B.  1-19-70. 
^0.  D.  1084,  T.  B.  44-21-1896. 


114  FEDERAL  INCOME  TAX 

capital  stock,  any  excess  in  the  value  of  the  assets  so  received 
over  the  indebtedness  of  the  corporation  to  the  estate  plus  the 
value  of  the  stock  at  the  time  of  the  owner's  death  constitutes 
profit  in  the  hands  of  the  executor  of  the  estate.^^ 

Income  Constructively  Received  by  Decedent  Prior  to 
Death.  Where  dividends  are  declared  on  stock  and  interest 
accrues  on  bonds  and  mortgages  during  the  lifetime  of  a  decedent 
keeping  his  accounts  upon  a  cash  receipt  and  disbursement  basis, 
but  such  dividends  and  interest  are  not  paid  until  after  his  death, 
the  dividends  are  incom.e  of  the  decedent  when  credited  to  or  set 
apart  for  him,  although  not  collected  prior  to  his  death.  If  the 
interest  is  upon  matured  coupons  not  cashed,  but  nevertheless 
available  to  the  decedent  prior  to  his  death,  it  is  constructively 
received  when  made  available.  If  the  interest  is  mortgage  in- 
terest, it  should  be  included  in  the  decedent's  gross  income  for 
the  year  in  which  it  becomes  due  and  payable.^*''  It  follows  that 
such  dividend  and  interest  income,  having  been  constructively 
received  by  the  decedent  during  his  lifetime,  should  be  treated 
as  capital  of  the  estate,  and  will  not  be  taxable  in  the  hands 
of  his  estate.  Interest  accrued  on  bonds  owned  by  an  individual 
at  the  date  of  his  death  should  be  included  in  the  return  filed 
for  the  decedent  by  the  executor  or  administrator,  if  the  books 
of  the  decedent  were  kept  on  an  accrual  basis;  if  the  books 
were  kept  on  the  basis  of  actual  receipts  and  disbursements, 
only  the  amount  of  interest  on  coupons  falling  due  prior  to  de- 
cedent's death  should  be  included.  Interest  accruing  or  falling 
due  subsequent  to  the  decedent's  death  should  be  reported  in  the 
return  of  the  estate.^'^ 

Proceeds  of  Life  Insurance  Policies.  The  proceeds  of  life 
insurance  policies  paid  to  an  estate  upon  the  death  of  the  insured 
are  exempt  from  income  tax  under  the  present  law  as  well  as 
under  the  1918  Law.""'^ 

55  A.  R.  R.  67,  T.  B.  17-20-877. 

56  Letter  from  treasury  department  dated  May  31,  1919;  I.  T.  S.  1919, 
TI3407. 

57  0.  D.  454,  T.  B.  15-20-851. 

58  Revenue  Act  of  1921,  §213  (b)  (1);  Revenue  Act  of  1918,  §213  (b) 
(1).  Under  the  1916  Law  the  proceeds  of  life  insurance  policies  were  exempt 
only  if  paid  to  individual  beneficiaries  (Revenue  Act  of  1916,  §4;  Act  of 
October  3,  1913,  B).  It  was  first  held  under  the  1916  Law  that  the  proceeds 
of  life  insurance  policies  payable  to  the  estate  of  a  decedent,  when  re- 
ceived by  an  executor  or  administrator,  were,  in  the  amount  by  which  they 
exceeded  the  premium  or  premiums  paid  by  the  decedent,  income  of  the 
estate,  to  be  accounted  for  by  the  executor  or  administrator.  (Reg.  33  Rev., 
Art.  29.)     It  has  since  been  ruled  that  proceeds  of  life  insurance  policies 


FroUCI  ARIES  115 

Installment  Sales  of  Real  Property.  In  February,  1919, 
an  individual  contracted  for  the  sale  of  certain  land,  receiving 
$1,000  in  cash,  the  balance  of  $11,000  to  be  paid  in  April,  1919. 
The  vendor  died  before  April,  1919,  and  the  contract  was  not 
completed  until  September  of  that  year  when  the  deed  was  passed 
and  possession  taken  by  the  purchaser.  The  treasury  depart- 
ment has  held  that  the  decedent  did  not  receive  taxable  income 
from  the  transaction  inasmuch  as  the  contract  was  not  consum- 
mated during  his  life  and  since  the  $1,000  received  by  him  prior 
to  his  death  was  mere  earnest  money  to  bind  the  contract. 
Neither  was  any  taxable  gain  realized  by  the  estate  because  of 
the  transaction.  Although  the  legal  title  to  the  land  vested  in 
the  executor  for  purposes  of  administration,  the  substantial  thing 
that  went  to  the  executor  was  the  right  under  the  contract  to 
the  unpaid  balance  of  the  purchase  price  in  trust  for  the  devisees. 
Under  the  law  the  basis  for  determining  the  gain  or  loss 
upon  the  sale  or  conversion  of  property  acquired  by  bequest, 
devise  or  descent,  is  the  value  of  the  property  at  the  death  of 
the  testator.-^'!J  In  this  case  the  value  of  the  right  or  contract 
and  not  the  value  of  the  land  should  be  considered.  As  the  right 
or  contract  was  in  this  case  valued  for  federal  estate  tax  pur- 
poses at  $11,000,  which  was  the  amount  received  by  the  estate, 
there  could  be  no  gain  or  loss  to  the  estate.^'o  This  ruling  modi- 
fies a  previous  decision  of  the  department,  where  under  some- 
what similar  circumstances  it  was  held  that  the  executor  should 
report  as  income  to  the  estate  the  difference  between  the  fair 
market  value  of  the  property  at  the  date  of  death  and  the  total 
price  received  for  the  property.''^ 

Income  Bequeathed  to  a  Governmental  Agency  of  a  State. 
Where  executors  under  a  will  hold  property  specifically  be- 
queathed to  a  university,  state  owned,  controlled  and  operated 
in  every  sense,  and  conducted  by  officers  appointed  in  accord- 
ance with  the  state  Constitution,  supported  by  state  funds  and 
all  the  property  of  which  is  vested  in  the  state,  and  the  other 
assets  of  the  decedent's  estate  are  sufficient  to  pay  all  debts, 
income  received  by  the  executors  during  the  period  of  adminis- 

payable  to  the  estate  of  a  decedent  are  not  to  be  accounted  for  as  income 
of  the  estate  by  the  executor  or  administrator  under  the  provisions  of 
§2    (b).  Act  of  September  8,  1916.     (T.  D.  3190,  T.  B.  29-21-1732.) 

59  If  the  property  was  acquired  prior  to  March  1,  1913,  see  the  rules  set 
forth  in  Chapter  17.  The  present  law  contains  a  new  provision  respecting 
profits  from  the  sale  of  property  acquired  as  a  gift  after  December  31, 
1920.     See  Chapter  17. 

f!0  O.  D.  907,  T.  B.  7-21-1448. 

61  See  O.  D.  631,  T.  B.  33-20-1134. 


116  FEDERAL  INCOME  TAX 

tration  from  such  property  is  not  taxable  in  the  hands  of  the 
executors.  The  education  of  the  citizens  of  a  state,  when  con- 
ducted by  the  state  or  by'  its  subdivisions  or  agencies,  is  consid- 
ered to  be  one  of  the  public  governmental  functions  of  the 
state.62 

Accumulations  for  Charitable  Purposes.  Where  a  testa- 
tor by  will  bequeaths  and  devises  his  whole  estate  to  his  execu- 
tors in  trust  to  invest  and  keep  invested  and  to  pay  annuities  to 
certain  beneficiaries,  the  corpus  of  the  estate,  together  with  ac- 
cumulated income  to  be  paid  to  a  designated  charity  after  the 
coming  of  age  of  one  beneficiary  and  the  death  of  the  survivor 
of  the  others,  it  has  been  argued  that  the  income  of  the  trust 
estate  is  taxable,  notwithstanding  the  fact  that  it  ultimately  goes 
to  charity.  This  argument  was  based  upon  the  theory  that  while 
the  estate  might  be  large  and  the  income  therefrom  many  times 
the  sum  required  to  meet  the  annuities,  there  was  no  legal  cer- 
tainty that  anything  would  go  to  the  charity.  The  court  held, 
on  the  contrary,  that  such  income  was  exempt  from  tax  on  two 
grounds :  ( 1 )  That  one  part  of  the  income  was  exempt  because 
of  the  exemption  in  favor  of  charity,  and  the  other  part  because 
it  was  below  the  taxable  limit,  such  parts  taking  in  the  whole 
income;  (2)  that  the  income  was  not  the  income  of  the  estate 
but  of  the  parties  to  whom  it  was  given,  the  legal  representa- 
tives of  the  testator  being  nothing  more  than  the  reservoir  and 
conduit  pipe  through  which  the  income  reached  the  beneficia- 
ries.'^2 

It  has  been  held  by  the  treasury  department,  on  the  other  hand, 
that  income  from  the  corpus  of  an  estate  which  at  some  uncer- 
tain date  in  the  future  will,  together  with  the  accumulation  of 
income  of  a  certain  character,  be  paid  over  to  exempt  corpora- 
tions is  taxable  in  the  hands  of  the  trustee,  there  being  no 
exemption  in  the  law  to  trustees  who  are  to  hold  income  for 
future  distribution  to  exempt  corporations.^^* 

62  S.  1374,  T.  B.  18-20-896.  This  conclusion  was  strengthened  by  the  fact 
that  under  the  laws  of  the  state  in  question  title  to  the  property  specifi- 
cally devised  or  bequeathed  passed  by  will.  The  title  to  the  stocks  be- 
queathed, therefore,  vested  immediately  upon  the  death  of  the  testator  in  the 
state  university  and  under  such  circumstances  a  tax  directed  against  the 
income  from  such  property  would  be  a  tax  upon  income  from  property 
the  title  to  which  has  vested  in  a  state  university.  The  ruling  was  made 
under  the  1916  Law,  as  amended,  but  it  would  be  equally  applicable  under 
the  present  law. 

63  Stockton  V.  Lederer,  262  Fed.  173,  affirmed  266  Fed.  676. 

64  0.  1012,  T.  B.  12-20-792. 


FIDUCIARIES  117 

Where  under  the  tenns  of  a  will  or  trust  deed  income  is  to  be 
paid  to  or  permanently  set  aside  for  a  charitable  or  exempt 
organization,  such  income  is  not  deductible  by  the  estate  or  trust 
where  the  exempt  organization  has  received  its  charter,  but  has 
not  been  completely  organized  or  has  not  begun  to  operate  suf- 
ficiently to  establish  its  exemption. ^"^ 

In  another  case  a  testator  gave  property  to  a  trust  company 
to  be  held  in  trust  for  his  wife  and  daughter  for  the  period  of 
their  lives,  the  income  accruing  to  be  divided  equally  between 
them.  It  was  provided  that  upon  the  death  of  the  wife  she  might 
appoint  a  certain  portion  of  the  estate  by  her  will  and  a  similar 
provision  was  made  in  the  case  of  the  daughter.  The  principal 
remaining  at  the  termination  of  the  trust  was  directed  to  be 
paid  over  to  certain  charitable  and  educational  corporations. 
In  case  the  corpus  of  the  estate  remaining  upon  the  death  of 
the  life  beneficiaries  was  not  in  excess  of  the  amount  which  might 
be  appointed  by  the  life  beneficiaries  in  their  respective  wills 
the  charitable  and  educational  corporations  would  receive  no 
part  thereof,  since  it  would  go  to  the  persons  designated  by  the 
wife  and  daughter  under  the  power  of  appointment  given  to 
them  by  the  will  of  the  testator.  In  1918,  prior  to  the  termina- 
tion of  the  trust,  a  certain  sum  was  received  by  the  trustee  from 
the  sale  of  subscription  rights  on  stock,  vv^hich  sum  was  added 
to  the  corpus  of  the  estate.  Upon  the  assumption  that  the  sub- 
scription rights  on  stock  which  were  sold  were  granted  directly 
to  the  trust  company  as  trustee,  it  was  held  that  the  entire  pro- 
ceeds from  their  sale,  which  was  added  to  the  corpus  of  the 
estate  for  future  distribution,  must  be  reported  by  the  trustee 
in  a  return  for  the  estate  on  Form  1040  (Revised),  together 
with  all  other  income  so  accumulated  during  the  taxable  year.'''' 

An  individual  died  in  August,  1916,  and  by  his  will  devised 
to  his  wife  certain  specific  property  together  with  one-half  of 
all  his  remaining  estate.  After  making  several  other  specific 
bequests  he  then  directed  that  all  the  rest  and  residue  of  his 
estate  should  be  given  to  his  wife.  With  respect  to  the  one-half 
interest  given  and  the  residuary  estate  left  to  her,  the  will  spe- 
cifically provided  that  these  properties  were  given  to  his  wife, 
"to  have  and  to  hold  the  same  to  her  for  and  during  her  natural 
life,  with  full  power  of  disposing  of  the  same  by  deed,  will,  or 
other  mode  of  transfer,  my  intention  being  not  to  vest  in  my 
said  wife  an  absolute  estate  or  an  estate  in  fee  simple  in  said 
residue  of  my  property,  but  an  estate  for  life  only,  with  the  use 

65  O.  D.  278,  T.  B.  20-19-511. 
coo.  D.  507,  T.  B.  20-20-939. 


118  FEDERAL  INCOME  TAX 

and  enjoyment  thereof  during  her  life  as  her  needs  or  pleasure 
may  require  and  with  the  power  of  disposing  of  the  same  as 
aforesaid."  Another  clause  of  the  will  provided  that  if  the  wife 
should  at  her  death  leave  unused  or  undisposed  of  any  portion 
of  the  property  thus  given,  it  should  be  transferred  to  certain 
persons  and  institutions  named  in  the  will.  In  September,  1916, 
the  wife  executed  a  will  making  certain  bequests  and  giving  the. 
residue  of  her  estate  to  certain  charitable,  religious  and  educa- 
tional institutions.  These  institutions  were  unquestionably 
exempt  organizations.  In  1917,  the  wife  executed  a  trust  inden- 
ture by  which  she  transferred  to  a  corporation  as  trustees,  all 
her  interest  and  right  in  the  estate  of  her  husband  making  spe- 
cific reference  thereto.  The  trustees  were  to  have  full  control 
of  the  property  during  her  life  and  were  to  pay  over  to  her  the 
entire  income  and  upon  her  death  the  whole  of  such  trust  fund 
then  in  the  hands  of  the  trustees  was  to  be  paid  over,  delivered 
and  conveyed  to  the  persons  named  in  her  will.  The  will  was 
by  reference  made  a  part  of  the  trust  agreement  for  the  purpose 
of  providing  for  the  distribution  of  the  trust  fund  and  the  desig- 
nation of  the  beneficiaries  of  the  trust.  The  trust  was  by  its 
own  terms  declared  irrevocable.  The  funds  were  paid  over  to 
the  trustees  in  accordance  with  the  directions  of  the  trust  instru- 
ment and  the  trustees  assumed  full  control.  During  the  life- 
time of  the  wife,  the  trustees  paid  over  to  her  the  entire  income 
from  the  trust  funds  and  returned  it  as  her  income.  The  wife 
died  in  July,  1918,  and  the  former  trustees  held  the  trust  prop- 
erty for  some  time  before  conveyance  was  made  to  the  bene- 
ficiaries. It  was  held  that  the  income  from  such  property  was 
the  income  of  the  beneficiaries  and  since  they  were  exempt,  was 
not  taxable.  The  trustees  were  required  to  make  a  return  on 
Form  1041,  taking  as  a  deduction  all  amounts  paid  to  or  perma- 
nently set  aside  during  the  taxable  year  for  the  named  exempt 
institutions.  It  was  the  opinion  of  the  treasury  department 
that  the  husband  bequeathed  to  his  wife  a  life  estate  in  the  prop- 
erty coupled  with  the  power  of  disposition  by  deed,  will,  or  other 
mode  of  transfer.  The  wife's  will,  since  it  made  no  reference 
whatever  either  to  the  property  or  to  the  power  granted  in 
connection  therewith,  could  not  be  considered  an  execution  of 
the  power  of  disposition.  The  trust  instrument  executed  by  the 
wife  referred  specifically  to  the  property  bequeathed  to  her  by 
her  husband  and  although  it  did  not  specifically  refer  to  the 
power,  was  an  exercise  of  the  power  of  disposition  granted.  The 
trust  instrument  was  by  its  own  terms  declared  irrevocable. 
Even  if  the  will  was  revoked   (which  it  was  not)   and  became 


FIDUCIARIES  119 

ineffective  as  a  will,  it  was  incorporated  and  made  a  part  of  the 
trust  disposition  by  reference,  for  the  purpose  of  providing  for 
the  distribution  of  the  trust  fund  and  the  designation  of  the 
beneficiaries.  When  the  precise  nature  of  a  trust  and  the  par- 
ticular persons  who  are  to  take  and  their  interests  can  be  ascer- 
tained, the  trust  will  be  executed,  and  it  was  concluded,  there- 
fore, that  the  trust  instrument  was  irrevocable  and  effective  to 
convey  the  property  according  to  its  terms.  The  effect  of  the 
delivery  of  the  trust  property  to  the  trustees  was  to  vest  title  in 
the  beneficiaries  immediately  and  they  were,  therefore,  entitled 
immediately,  upon  the  death  of  the  wife,  to  the  trust  property 
and  it  at  no  time  constituted  a  part  of  the  wife's  estate.'''^ 

Liberty  Bond  Exemption  in  Case  of  Estates  and  Trusts. 
When  income  is  taxable  to  beneficiaries,  as  in  the  case  of  a  trust 
the  income  of  which  is  to  be  distributed  to  the  beneficiaries  peri- 
odically, each  beneficiary  is  regarded  as  the  owner  of  a  propor- 
tionate part  of  the  bonds  held  in  trust  and  is  entitled  to  exemp- 
tion on  account  of  such  ownership  as  if  he  owned  such  propor- 
tionate part  of  the  bonds  directly.    In  such  a  case  a  subscription 
by  a  trustee  for  bonds  of  the  Fourth  Liberty  Loan,  or  notes  of  the 
Victory  Liberty  Loan,  constitutes  each  beneficiary  existing  at  the 
time  of  such  subscription  an  original  subscriber  for  his  propor- 
tionate part  of  such  bonds  or  notes,  as  the  case  may  be,  and 
entitles  such  beneficiary  to  the  appropriate  collateral  exemption 
of  interest  on  bonds  of  previous  issues,  whether  owned  by  such 
beneficiary  or  by  the  trustee,  as  if  the  beneficiary  had  himself 
originally  subscribed  for  such  proportionate  part  of  the  bonds  or 
notes ;  and  a  subscription  by  such  beneficiary  for  bonds  of  the 
Fourth  Liberty  Loan  or  notes  of  the  Victory  Liberty  Loan,  as  the 
case  may  be,  entitles  him  to  the  appropriate  collateral  exemption 
of  interest  on  bonds   of  previous   issues  held  by  the  trustee. 
When,  on  the  other  hand,  income  is  taxable  to  the  trustee,  as  in 
the  case  of  a  trust  the  income  of  which  is  accumulated  for  the 
benefit  of  unborn  or  unascertained  persons,  the  trustee  is  re- 
garded as  the  owner  of  all  the  bonds  held  in  trust  and  the  trust 
is  entitled  to  exemption  on  account  of  such  ownership.    In  such 
a  case  a  subscription  by  a  trustee  constitutes  the  trustee  as  such 
the  original  subscriber  and  entitles  the  trust,  on  account  of  such 
subscription,  to  the  collateral  exemption  of  interest  on  bonds  of 
previous  issues.'-^    Where  a  testator  died  in  February,  1920,  and 

ti7A.  R.  R.  551,  T.  B.  24-21-1688. 

'W  ReR.  45,  Art.  81.  The  Liberty  bond  tax  exemptions  are  now  consoli- 
dated in  §  1328  of  the  Revenue  Act  of  1921.  This  section  as  of  January  1, 
1921,  abolishes  the  exemptions  founded  upon  original  subscription  to  the 
Fourth  Liberty  Loan  and  the  Victory  Liberty  Loan. 


120  FEDERAL  INCOME  TAX 

at  the  date  of  his  death  owned  certain  Fourth  Liberty  Loan 
bonds  for  which  he  was  the  original  subscriber,  and  by  his  will 
his  widow,  who  is  the  residuary  legatee  of  his  estate  is  entitled 
to  the  bonds,  it  was  held  that  neither  the  estate  of  the  testator 
nor  the  widow  is  entitled  to  the  collateral  exemption  provided  by 
the  supplement  to  the  Second  Liberty  Bond  Act,  because  neither 
the  estate  nor  the  widow  was  the  original  subscriber  to  the 
Fourth  Liberty  Loan  bonds  owned  by  the  decedent  at  the  date  of 
his  death.  It  has  been  held,  also,  that  the  collateral  exemption 
cannot  be  properly  claimed  in  the  return  of  the  decedent  for 
the  period  from  January  1,  1920,  to  the  date  of  his  death,  be- 
cause the  bonds  having  passed  to  his  estate  at  his  death  coulc^ 
not  in  fact  be  owned  by  him  on  the  date  such  return  was  filed 
with  the  collector.*'^ 

Deductions  Allowed  to  Estates  and  Trusts.  In  computing  the 
net  income  of  trust  estates  the  law  allows  the  same  deductions 
as  are  allowed  to  individuals  with  the  exception  indicated  in  the 
next  following  paragraph  J"  The  treasury  department,  however, 
has  made  several  special  rulings  with  respect  to  the  deductions 
which  may  be  claimed  by  fiduciaries  against  the  income  of  estates 
or  trusts  and  these  rulings  are  given  in  the  succeeding  para- 
graphs. 

Contributions  to  Charities.  In  lieu  of  the  deduction  au- 
thorized in  the  case  of  citizens  or  residents  for  charitable  contri- 
butions, trust  estates  are  allowed  to  deduct  without  limitation 
any  part  of  the  gross  income  which,  pursuant  to  the  terms  of 
the  will  or  deed  creating  the  trust,  is  during  the  taxable  year 
paid  to  or  permanently  set  aside  for  the  use  of:  (a)  The  United 
States,  any  state,  territory,  or  any  political  sujpdivision  thereof, 
or  the  District  of  Columbia,  for  exclusively  public  purposes; 
(b)  any  corporation,  or  community  chest,  fund,  or  foundation, 
organized  and  operated  exclusively  for  religious,  charitable, 
scientific,  literary,  or  educational  purposes,  including  posts  of 
the  American  Legion  or  the  women's  auxiliary  units  thereof, 
or  for  the  prevention  of  cruelty  to  children  or  animals,  no  part 
of  the  net  earnings  of  which  inures  to  the  benefit  of  any  private 
stockholder  or  individual;  or  (c)  the  special  fund  for  vocational 

09  O.  D.  742,  T.  B.  49-20-1333.     See  footnote  68. 

70  Revenue  Act  of  1921,  §  219  (b)  ;  Revenue  Act  of  1918,  §  219  (b)  ; 
Reg.  45,  Art.  341. 


FIDUCIARIES  121 

rehabilitationJi  No  deduction  may  be  taken  for  an  amount  of 
income  retained  or  permanently  set  aside  for  the  benefit  of  a 
religious,  charitable,  scientific  or  educational  corporation  where 
such  corporation  is  not  fully  in  existence  at  the  time  the  income 
is  so  retained  or  set  aside. ''- 

Ordinary  and  Necessary  Expenses.  The  ordinary  and 
necessary  expenses  of  carrying  on  a  business  conducted  by  a 
fiduciary,  including  a  reasonable  allowance  for  salaries,  rentals, 
repairs  to  business  properties,  etc.,  have  been  held  to  be  prop- 
erly deductible,  since  they  are  expenses  which  reduce  the.  income 
accruing  to  the  beneficiaries.""^  A  distinction  has  been  made 
between  expenses  properly  chargeable  against  the  corpus  of  an 
estate  at  the  time  of  its  creation,  and  expenses  incident  to  ad- 
ministration arising  from  the  nature  of  the  properties  of  an 
estate  and  the  details  of  its  business  management.  Thus,  court 
costs,  attorneys'  fees,  executors'  commissions,  etc.,  have  been 
held  generally  to  be  expenses  that  reduce  the  corpus  of  the  estate 
in  the  fiduciary's  hands  and  not  expenses  which  directly  reduce 
the  income  accruing  to  the  beneficiaries.  For  this  reason  such 
expenses  are  ordinarily  not  a  proper  deduction."^ 

In  a  recent  case  before  the  department  the  question  arose  as 
to  whether  various  expenses  were  deductible  as  business  ex- 
penses or  must  be  classed  as  expenses  of  administration.  A 
testatrix  left  an  estate  consisting  principally  of  corporate  secu- 
rities. After  numerous  specific  bequests,  the  residuary  estate 
was  given  to  executors  and  trustees  with  instructions  that  for 
a  period  of  two  years  after  the  death  of  the  testatrix  they  should 
collect  the  rents,  income  and  profits  therefrom,  applying  a  part 
thereof  to  the  payment  of  the  debts,  taxes  and  charges,  govern- 
mental or  otherwise,  payable  by  or  out  of  the  estate,  and  apply- 
ing as  much  as  they  should  deem  advisable  for  the  support,  edu- 
cation and  maintenance  of  a  certain  beneficiary.  At  the  end  of 
the  two-year  period,  the  residuary  estate  was  to  be  divided  into 
two  parts  and  the  income  therefrom  paid  to  two  named  bene- 
ficiaries. The  ordinary  and  necessary  expenses  incurred  in 
managing  the  property  were  admittedly  deductible  in  computing 

f 

71  Revenue  Act  of  1921,  §  219  (b)  ;  Revenue  Act  of  1918,  §  219  (b)  ;  Reg. 
45,  Art.  341.  It  will  be  noted  that  the  1918  Law  did  not  include  the  words 
"for  exclusively  public  purposes,"  or  "community  chest,  fund  or  founda- 
tion," or  "including  posts  of  the  American  Legion  or  the  Women's  Auxil- 
iary units  thereof." 

72  A.  R.  R.  280,  T.  B.  46-20-1305. 

73  Revenue  Act  of  1921,  §§219  (b)  and  214  (a)  (1);  Revenue  Act  of 
1918,  §§219  (b)   and  214  (a)  1;  O.  D.  537,  T.  B.  23-20-988. 

74  Reg.  45,  Art.  293;  T.  D.  2090,  T.  D.  2135;  O.  D.  537,  T.  B.  23-20-788. 


122  FEDERAL  INCOME  TAX 

net  income,  since  where  substantially  the  entire  income  of  the 
taxpayer  is  received  from  investments  and  dealings  in  securities, 
such  investments  and  dealings  in  securities  constitute  the  carry- 
ing on  of  a  trade  or  business.  The  difficulty  arose  in  distinguish- 
ing between  business  expenses  and  administration  expenses.  In 
this  case  the  executors  were  engaged  in  trade  or  business  only 
to  the  extent  that  they  continued  the  business  of  the  decedent 
and  only  expenses  incurred  in  continuing  the  business  were  al- 
lowable deductions.  On  the  other  hand,  the  ordinary  duties  of 
the  executors  as  such  are  to  secure  the  necessary  processes  and 
orders  of  the  probate  court,  collect  the  assets  of  the  estate,  satisfy 
the  debts  of  the  decedent  and  the  estate  and  inheritance  taxes, 
preserve  the  assets  of  the  estate  until  distributed,  and  distribute 
such  assets  to  the  beneficiaries,  if  necessary  reducing  them  to 
cash  for  this  purpose.  Expenses  incurred  in  discharging  these 
and  similar  duties  are  clearly  expenses  of  administration.  Cer- 
tain expenses,  however,  such  as  salaries  of  clerks  and  office  rents, 
contribute  both  to  the  administration  of  the  estate  and  the  con- 
tinuance of  the  business  of  the  decedent.  With  regard  to  these 
expenses  it  was  held  that  a  segregation  should  be  made  and  there 
should  be  estimated  the  proportion  of  the  personal  services  or 
facilities  secured  by  the  expenditure  which  contributed  to  the 
administration  of  the  estate  and  the  proportion  which  contrib- 
uted to  the  continuance  of  the  business.  It  was  held  immaterial 
whether  the  expenses  were  paid  from  the  corpus  of  the  estate  or 
from  income.  Expenses  derive  their  character  not  from  the 
funds  out  of  which  they  are  paid,  but  from  the  purposes  for 
which  they  are  incurred.  The  executors  were  allowed  a  com- 
mission upon  cash  received  and  paid  out  by  them  in  the  course 
of  the  administration.  They  retained  this  commission  upon 
funds  received  by  them  from  sales  of  securities  and  upon  funds 
paid  out  by  them  for  the  purchase  of  securities,  including  in- 
vestments and  reinvestments  as  well  as  upon  receipts  and  dis- 
bursements made  by  them  in  the  ordinary  course  of  adminis- 
tration. These  fees  were  held  to  be  administration  or  business 
expenses,  according  to  the  transactions  for  which  they  are  al- 
lowed. The  same  rule  was  applied  to* attorneys'  fees  and  fees 
of  expert  accountants  paid  upon  itemized  bills.  Payments  made 
upon  unitemized  bills  of  attorneys  and  accountants  were  treated 
as  expenses  contributing  both  to  the  administration  of  the  estate 
and  the  continuance  of  the  business  of  the  decedent,  and  the 
proportional  parts  of  such  expenditures  attributable  to  business 
or  administration  expenses,  respectively,  were  required  to  be  esti- 
mated.    Office  expenses  and  salaries  of  bookkeepers  and  clerks. 


FIDUCIARIES  123 

including  executors'  commissions  thereon,  also  contributed  both 
to  the  administration  of  the  estate  and  the  continuance  of  the 
business,  and  were  required  to  be  apportioned  in  the  same  man- 
ner. Expenses  connected  with  the  sale  of  property,  including 
executors'  commissions  and  attorneys'  fees,  were  held  to  be  ex- 
penses of  administration  in  all  cases  in  which  the  sale  was  made 
for  the  purpose  of  securing  cash  to  satisfy  legacies  or  to  satisfy 
items  which  were  themselves  expenses  of  administration  or 
necessary  in  the  administration  of  the  estate,  such  as  court  costs, 
estate  and  inheritance  taxes,  etc.  On  the  other  hand,  when  the 
sale  was  made  to  secure  cash  for  the  purpose  of  continuing  the 
business,  as  for  reinvestment  or  to  satisfy  business  expenses  or 
the  income  tax,  the  expenses  of  the  sale  were  held  to  be  expenses 
of  business.  When  property  was  sold  to  secure  cash  for  both 
administration  purposes  and  purposes  connected  with  the  con- 
tinuance of  the  business,  the  expenses  of  the  sale  were  required 
to  be  allocated  in  the  percentages  in  which  the  proceeds  of  the 
sale  were  used  for  administration  and  business  purposes.  Ex- 
penses, including  executors'  commissions  and  attorneys'  fees, 
incurred  in  collecting  dividends  and  interest,  investing  funds, 
preparing  income  tax  returns  and  paying  the  tax,  were  made 
necessary  by  reason  of  the  continuance  of  the  business  and  con- 
sequently were  held  to  be  business  expenses.  Expenses,  includ- 
ing executors'  commissions  and  attorneys'  fees,  incurred  in  the 
preparation  of  the  return  for,  and  the  payment  of,  the  federal 
estate  tax  and  state  inheritance  taxes  were  necessary  for  pur- 
poses which  are  within  the  ordinary  duties  of  the  executors  as 
such,  and  were  held  to  be  administration  expenses.  All  ad 
valorem  taxes  (except  taxes  assessed  against  local  benefits)  were 
held  to  be  deductible  from  gross  income."^  However,  the  ex- 
penses of  paying  the  taxes,  including  the  executors'  commissions 
thereon,  might  be  deducted  only  if  expended  in  the  trade  or 
business;  they  were  business  expenses  when  the  property  taxed 
was  used  in  the  trade  or  business,  and  administration  expenses 
when  the  property  is  not  so  used,  as  where  property  was  held 
for  future  distribution  to  legatees  or  devisees.  The  executors 
of  this  estate  were  independent  executors  under  the  Texas  Laws, 
and  after  qualifying  them  and  receiving  and  approving  the  in- 
ventory, appraisement,  and  list  of  claims,  the  probate  court  had 
no  further  jurisdiction  over  them.  They  were  not  required  to 
report  to  the  court  for  discharge,  nor  was  there  any  date  upon 

75  See  Revenue  Act  of  1921,  §214   (a)    (3);  Revenue  Act  of  1918,  §214 
(a)    (3). 


124  FEDERAL  INCOME  TAX 

which  they  formally  ceased  to  be  executors  and  became  trustees. 
However,  when  they  completed  the  ordinary  duties  of  adminis- 
tration, the  period  of  administration  ended,  and  thereafter  office 
expenses  and  other  expenses  which  during  the  period  of  admin- 
istration contributed  both  to  the  administration  of  the  estate  and 
the  continuance  of  the  business,  constituted  business  expenses. 
Executors'  commissions,  attorneys'  fees,  fees  of  expert  account- 
ants and  salaries  of  bookkeepers  and  clerks  paid  by  the  estate, 
in  continuing  the  business,  were  held  deductible  only  to  the  extent 
that  they  were  reasonable  compensation."*^ 

Amounts  expended  by  an  estate  on  account  of  special  assess- 
ments for  the  maintenance  or  repair  of  streets  or  for  sidewalk 
improvements  levied  upon  property  used  in  a  trade  or  business, 
if  the  same  is  necessary  in  the  conduct  of  such  trade  or  business, 
constitute  allowable  deductions.  In  case  any  of  the  property  of 
the  estate  is  used  for  residential  purposes  by  anyone  beneficially 
interested  in  the  estate,  the  amounts  expended  in  payment  of 
assessments  levied  upon  such  property  for  maintenance  and  re- 
pairs cannot  be  deducted  by  the  estate,  unless  the  rental  value  of 
the  property  is  included  in  the  gross  income  of  the  estate. 
Amounts  expended  for  replacements  can,  under  no  circum- 
stances, be  claimed  as  a  business  expense;  such  items  are  in- 
vestments of  capital.'^ 

An  amount  paid  by  the  committee  for  a  taxpayer,  who  has 
been  declared  mentally  incompetent,  in  settlement  of  attorney's 
fees  incurred  by  the  taxpayer  in  resisting  the  proceedings  looking 
to  declare  him  incompetent,  is  not  a  necessary  expense  incurred 
in  the  management  of  the  affairs  of  such  taxpayer,  but  is  a 
personal  expense  and  therefore  not  deductible  by  the  committee 
in  computing  the  net  income  of  the  taxpayer.'^  Where  trustees 
under  a  will  hold  real  estate  and  are  obliged  to  pay  attorney's 
fees  for  services  in  connection  with  litigation  brought  by  one 
claiming  an  interest  in  the  property,  it  has  been  held  that  such 
fees  are  not  deductible  from  the  income  of  the  trust  as  ordinary 
and  necessary  expenses  even  though  the  trustees  are  not  author- 
ized to  sell  any  part  of  the  property  out  of  which  to  satisfy  the 
attorney's  fees  or  the  tax  imposed.     Such  expenses  are  held  to 

76  Sol.  Op.  88,  T.  B.  8-21-1463. 

77  O.  D.  613,  T.  B.  31-20-1102.  If  such  replacements,  however,  are  used 
in  connection  with  the  business  of  the  estate,  a  reasonable  amount  may  be 
claimed  for  exhaustion,  wear  and  tear  of  the  property,  including  obso- 
lescence. 

78  0.  D.  603,  T.  B.  30-20-1089. 


FIDUCIARIES  125 

be  a  part  of  the  cost  of  the  property  and  chargeable  against  the 
corpus  of  the  estate  J^ 

Executors'  Commissions.  If  under  the  laws  of  the  state, 
the  terms  of  the  will  appointing  an  executor,  or  the  decree  of  a 
court  having  jurisdiction  of  an  estate,  executors'  commissions 
are  deductible  from  the  corpus  of  the  estate,  it  has  been  held 
that  they  should  not  be  deducted  by  the  fiduciary,  but  if  they 
are  to  be  deducted  from  the  income  of  the  estate  distributable 
among  the  beneficiaries  they  have  been  held  to  be  deductible  as 
a  legitimate  and  necessary  expense.^'' 

Statutory  Allowance  to  Widow.  A  statutory  allowance 
paid  to  a  widow  from  the  corpus  of  an  estate  is  not  deductible 
from  gross  income.^i  Since  the  law  provides  that  "in  determining 
the  net  income  of  the  estate  of  any  deceased  person  during  the 
period  of  administration  or  settlement  there  may  be  deducted 
the  amount  of  any  income  properly  paid  or  credited  to  any  lega- 
tee, heir  or  other  beneficiary,"  it  has  been  held  that  where  an 
executor,  of  an  estate  in  process  of  administration  paid,  under 
an  order  of  the  probate  court,  a  monthly  allowance  to  the  widow 
of  the  testator,  the  court  order  providing  that  the  amount  should 
be  payable  out  of  the  personal  property  and  the  income  of  the 
real  estate,  and  the  income  from  the  personal  property  being 
more  than  sufficient  to  pay  the  allowance,  such  payment  may  be 
claimed  as  a  deduction  in  the  return  to  be  filed  by  the  executor 
the  amounts  being  "properly"  paid.  The  widow  should  include 
such  amounts  in  her  individual  return.^- 

Interest,  Where  interest  has  accrued  on  notes  of  a  de- 
cedent and  been  deducted  from  the  estate  in  determining  the 
amount  of  the  gross  estate  for  estate  tax  purposes  it  has  been 
held  that  such  interest,  where  paid  by  the  administrator,  is 
deductible  from  the  income  of  the  estate,  unless  the  decedent 
kept  his  books  on  some  basis  other  than  that  of  actual  receipts 
and  disbursements.  Only  the  accrued  interest  on  outstanding 
obligations  may  be  deducted,  and  where  interest  upon  an  old 
note  has  been  capitalized  by  giving  a  new  note,  representing 
the  aggregate  of  the  old  note  with  the  interest  accrued,  only  the 
amount  of  interest  accrued  upon  the  new  note  can  be  deducted, 
the  new  note  representing  payment  of  both  principal  and  interest 
of  the  old.83 

79  A.  R.  R.  284,  T.  B.  42-20-1248. 

80  Letter  from  treasury  department  dated  March  2,  1915;  I.  T.  S.  1919, 
^  1255.     See  also  the  paragraph  "Business  Expenses,"  supra. 

81  Reg.  45,  Art.  341. 

82  O.  D.  829,  T.  B.  9-21-1482. 

83  A.  R.  R.  113,  T.  B.  21-20-953. 


126  FEDERAL  INCOME  TAX 

Taxes.  Any  tax  paid  by  a  trust  estate  is  a  proper  deduction 
to  the  same  extent  as  in  the  case  of  individuals  or  corporations/'^^ 
The  United  States  Supreme  Court  has  recently  held  that  the 
federal  estate  tax  is  deductible  by  an  estate  in  determining  its 
net  taxable  income  for  the  year  in  which  the  estate  tax  is  paid 
or  accrues  under  the  broad  provision  of  the  law  permitting  the 
deduction  of  "taxes  paid  or  accrued  within  the  taxable  year  im- 
posed (a)  by  the  authority  of  the  United  States,  except  income, 
war-profits  and  excess-profits  taxes." ^^  Where  property  owned 
by  an  estate  is  sold,  the  amount  of  the  stamp  tax  upon  the  deed 
conveying  title  to  the  property  constitutes  an  allowable  deduction 
in  the  return  of  the  estate.^*^ 

Losses.  Losses  sustained  during  the  taxable  year,  and  not 
compensated  for  by  insurance  or  otherwise,  (a)  if  incurred  in 
trade  or  business,  (b)  if  incurred  in  any  transaction  entered  into 
for  profit,  though  not  connected  with  the  trade  or  business,  or 
(c)  if  of  property  not  connected  with  the  trade  or  business  if 
arising  from  fires,  storms,  shipwreck,  or  other  casualty,  and 
from  theft,  or  losses  in  inventory  or  from  rebates  (under  the 
Revenue  Act  of  1918)  and  net  losses  may  be  deducted  by  fidu- 
ciaries under  the  rules  applicable  to  individuals.^' 

The  cost  of  property,  sold  for  purposes  of  determining  loss, 
upon  a  sale  or  exchange  thereof,  is  the  appraised  value  at  the 
time  the  decedent  died,  or  the  estate  was  created.  The  deductible 
loss  should  be  computed  in  accordance  with  the  rules  discussed 
in  another  chapter.^s 

Net  loss  resulting  from  the  sale  of  stocks,  bonds,  or  other 
property  owned  by  a  trust,  which  would  be  an  allowable  deduc- 
tion from  the  gross  income  of  an  individual  is  an  allowable 
deduction  from  the  gross  income  of  a  trust,  whether  or  not  the 
income  of  such  trust  is  "to  be  distributed  to  the  beneficiaries 
periodically,  whether  or  not  at  regular  intervals,"  and  whether 
or  not  there  is  any  requirement  in  the  instrument  creating  the 
trust,  a  decree  of  court,  or  a  general  law,  that  the  principal  of 
the  trust  shall  be  kept  intact  at  the  expense  of  income  as  against 
such  loss.  Such  a  deduction  is  not  allowable  as  against  the  cur- 
rent or  future  gross  income  of  the  present  beneficiaries,  or  of 

8-1  See  Chapter  24  and  the  paragraph  "Business  Expenses,"  supra. 

^^>  U.  S.  V.  Woodward,  65  L.  ed.  728.  This  case  reverses  Prentiss  v. 
Eisner,  267  Fed.  16,  and  the  previous  rulings  of  the  treasury  department 
to  the  contrary.     See  Op.  A.  G.  1,  T.  B.  16-20-875. 

80  0.  D.  632,  T.  B.  53-20-1135. 

87  See  Chapter  25. 

88  See  Chapter  17.    See  also  Chapter  25. 


FIDUCIARIES  127 

those  who  will  receive  the  property  at  the  termination  of  the 
trust.    The  beneficiary  is  not  required  to  include  in  his  personal 
return  as  a  part  of  "his  distributive  share  whether  distributed 
or  not,  in  the  net  income  of  the    *    *    =^'    trust  for  the  taxable 
year"  any  part  of  the  amounts  allowed  to  the  trust  as  a  whole 
as  a  deduction  for  loss  resulting  from  the  sale  of  the  property .«» 
Worthless  Debts.    Worthless  debts  may  be  deducted  to  the 
same  extent  as  in  the  case  of  individuals.    Where  a  decedent  was 
coindorser  on  the  note  of  a  corporation  in  process  of  liquidation 
at  the  time  of  his  death,  and  his  share  of  the  liability  was  not 
known  at  the  time  of  his  death,  but  was  determined  at  the  end 
of  1918  and  paid  by  the  administrator  in  the  early  part  of  1919, 
the  payment  was  held  deductible  in  the  administrator's  return 
in  the  year  in  which  the  liability  was  paid  and  charged  off  on 
the  administrator's  books,  provided  all  the  circumstances  indi- 
cated the  debt  to  be  worthless  and  uncollectible,  and  that  legal 
action  to  enforce  payment  would  in  all  probability  not  have  re- 
sulted in  the  satisfaction  of  execution  on  a  judgment.    The  same 
decedent  was  not  permitted  to  deduct  the  difference  between  the 
appraised  value  of  a  subrogated  claim  against  a  company  whose 
past  due  note  decedent  had  been  obliged  to  pay  as  indorser  and 
the  amount  paid  to  the  bank  payee.    The  theory  of  this  decision 
was  that  the  transaction  was  not  a  closed  and  completed  one.    So 
long  as  the  claim  against  the  company  was  not  disposed  of  by 
the  administrator,  the  exact  amount  of  the  loss,  if  any,  could 
not  be  definitely  determined,  and,  therefore,  could  not  be  claimed 
as  a  deduction.^f'    The  Revenue  Act  of  1921  contains  a  new  pro- 
vision to  the  effect  that  when  satisfied  that  a  debt  is  recoverable 
only  in  part,  the  commissioner  may  allow  such  debt  to  be  charged 
oflf  in  part.^i 

Depreciation.  An  individual  who  receives  income  from  a 
trust  estate  is  not  permitted  to  claim  a  deduction  in  his  personal 
return  for  any  depreciation  sustained  during  the  year  on  real 
estate  or  other  assets  of  the  estate.  It  is  permissible,  however, 
for  the  fiduciary  in  ascertaining  the  net  income  of  the  estate  or 
trust  for  which  he  acts  to  deduct  a  proper  amount  for  the  de- 
preciation sustained  during  the  taxable  year,  whether  or  not  the 

89  Letter  from  treasury  department  dated  October  13,  1919;  I.  T.  S. 
1919,  TI  3626.  Where  the  income  of  an  estate  is  to  be  distributed  periodically 
and  the  trustees  sell  part  of  the  principal  or  corpus  of  the  estate  at  a  loss, 
the  beneficiaries  are  not  allowed  to  deduct  any  part  of  the  loss  m  their, 
returns.     (0.  D.  156,  T.  B.  5-19-255.) 

90  0.  D.  556,  T.  B.  25-20-1017. 

91  Revenue  Act  of  1921,  §  214  (a)   (7).     See  Chapter  25. 


128  FEDERAL  INCOME  TAX 

terms  of  the  will  or  agreement  creating  same  or  a  decree  of 
court  provides  for  the  taking  care  of  depreciation  which  may  be 
sustained  on  the  property  held  in  trust.-'-  Replacements  to 
streets  and  sidewalks  used  in  connection  with  the  business  of 
an  estate  are  not  deductible  as  business  expense,  but  will  consti- 
tute the  subject  of  an  annual  allowance  for  depreciation.^-"^ 

Net  Income  of  Estates  or  Trusts.  The  gross  income  minus  the 
deductions  permitted  to  an  estate  or  trust,  as  enumerated  above, 
constitutes  its  net  income.  If  such  net  income  is  (1)  received  by 
estates  of  deceased  persons  during  the  period  of  administration 
or  settlement  and  not  properly  paid  or  credited  to  any  legatee, 
heir,  or  other  beneficiary  during  that  period,  (2)  accumulated  in 
trust  for  the  benefit  of  unborn  or  unascertained  persons,  or  per- 
sons with  contingent  interests,  or  (3)  held  for  future  distribu- 
tion under  the  terms  of  the  will  or  trust,  it  is  to  be  treated  as 
taxable  income  of  the  estate  or  trust  on  which  the  fiduciary  must 
pay  the  tax  from  the  funds  of  the  estate  or  trust.^*  When  the 
income  upon  which  the  fiduciary  has  so  paid  the  tax  is  later  dis- 
tributed among  the  beneficiaries,  it  is  a  distribution  of  capital 
and  no  tax  is  at  that  time  required  to  be  paid  by  the  beneficiary 
with  respect  thereto."-"*  If,  on  the  other  hand,  the  net  income  is 
(4)  to  be  distributed  to  the  beneficiaries  periodically,  whether 
or  not  at  regular  intervals,  or  (5)  is  collected  by  the  guardian 
of  an  infant,  to  be  held  or  distributed  as  the  court  may  direct, 
or  (6)  is  properly  paid  or  credited  to  any  legatee,  heir,  or  other 
beneficiary  during  the  period  of  administration  of  an  estate,  the 
amount  of  the  distributable  share  of  each  beneficiary  is  assessed 
to  the  beneficiary.""^  In  such  cases  the  fiduciary  may  be  respon- 
sible for  the  payment  of  the  tax,  as,  for  instance,  when  the  bene- 
ficiary is  a  minor  or  a  nonresident  alien,  but  the  tax  is  still  the 
tax  of  the  beneficiary,  and  the  fiduciary,  in  paying  such  tax,  does 
not  act  for  the  estate  or  trust.  Under  the  1921  Law,  in  the  case 
of  an  estate  or  trust  the  income  of  which  consists  partly  of  the 
class  included  in  (1),  (2)  and  (3)  above  and  partly  of  the  class 
included  in  (4),  (5)  and  (6),  the  net  income  of  the  estate  or 
trust  is  required  to  be  computed  by  the  fiduciary  as  in  the  case 
of  (1),  (2)  and  (8)  and  the  tax  must  be  paid  by  the  fiduciary, 

92  Letter  to  treasury  department  dated   October  6,  1919;   L   T.   S.   1919, 
Ij  3632. 

93  0.  D.  613,  T.  B.  31-20-1102. 

94  Revenue  Act  of  1921,  §  219;  Revenue  Act  of  1918,  §  219. 

95  Reg.  45,  Art.  344 ;  Reg.  33  Rev.,  Art.  29. 

96  Revenue  Act  of  1921,  §  219;  Revenue  Act  of  1918,  §  219. 


FIDUCIARIES  129 

but  there  is,  in  such  cases,  allowed  as  an  additional  deduction 
the  income  of  the  class  included  in  (4),  (5)  and  (6).  Such 
income  will  be  included  in  the  returns  of  the  beneficiaries."" 

Decedent's  Estate  During  Administration.  During  the 
period  of  administration  it  is  the  duty  of  the  administrator  or 
executor  to  make  return  and  pay  whatever  tax  may  be  due  on 
income  received  by  the  estate  of  a  deceased  person.'^*^  Income 
of  an  estate  during  the  period  of  administration  not  paid  or 
credited  to  the  beneficiaries  is  taxable  to  the  estate,  even  though 
the  beneficiaries  are  as  a  matter  of  law  entitled  to  be  paid  or 
credited  with  such  income  during  the  year.''"  An  executor  or 
administrator  of  an  estate  in  process  of  administration  may 
not,  at  his  option,  in  rendering  the  return,  Form  1040,  for  the 
estate,  either  claim  as  a  deduction  the  amount  of  income  prop- 
erly paid  or  credited  during  the  year  to  any  heir,  legatee,  or 
other  beneficiary,  or  compute  the  net  income  without  the  benefit 
of  such  deduction  and  pay  the  entire  tax  himself.^*^" 

In  a  case  ruled  upon  by  the  treasury  department  an  individual 
died  in  1917,  his  widow  qualifying  as  administratrix  in  1918. 
The  entire  estate  was  left  to  the  widow,  with  the  exception  of 
a  legacy  which  was  paid  in  1918,  during  which  year  all  debts, 
taxes  and  costs  of  administration  were  paid  in  full,  the  widow 
as  sole  beneficiary  reducing  whatever  remained  to  her  possession 
as  her  personal  estate.    Upon  making  final  report  and  settlement 

9"  Revenue  Act  of  1921,  §  219  (e).  For  the  procedure  in  such  cases  under 
the  1918  Law,  see  p.  140. 

98  0.  D.  598,  T.  B.  29-20-1082. 

99  T.  B.  R.  47,  T.  B.  16-19-46.  The  rule  in  New  York  that  one  who  re- 
ceives a  bequest  of  the  income  of  a  specified  sum,  the  property  of  the  de- 
cedent being  income  producing  at  the  time  of  his  death,  is  entitled  to  such 
income  from  the  date  of  death.  Re  Stanfield's  Estate,  135  N.  Y.  292,  31  N. 
E.  1013  has  no  application  to  interests  arising  under  a  will  creating  a  trust 
of  the  residuary  estate,  and  directing  the  payment  of  the  income  of  certain 
portions  thereof  to  specified  individuals.  The  trust  being  created  only  at 
the  expiration  of  administration,  the  right  to  the  income  of  the  trust  fund 
accrues  only  at  that  time;  and  consequently,  under  the  Revenue  Act  of  1916, 
no  part  of  it  is  taxable  to  the  individual  beneficiary  during  the  period  of 
administration,  but  the  whole  of  it  is  taxable  to  the  estate  as  an  entity. 
(Revenue  Act  of  1916,  §2  (b).)  The  result  is  the  same  where  the  will 
creates  a  right  in  the  legatee  to  income  from  the  date  of  the  death,  since 
such  income  is  not  payable  until  the  completion  of  administration,  and 
until  that  time  the  property  producing  the  income  is  part  of  the  estate  in 
process  of  administration.  Under  the  Revenue  Acts  of  1918  and  1921, 
however,  the  estate  is  entitled  to  deduct  income  properly  paid  or  credited 
to  legatees  during  the  period  of  administration,  and  such  income  is  tax- 
able to  the  beneficiary.    (L.  0.  1051,  T.  B.  38-20-1206,  revoking  S.  M.  783.) 

100  0.  D.  967,  T.  B.  27-21-1714. 


130  FEDERAL  INCOME  TAX 

in  1921,  a  court  order  was  issued  discharging  the  widow  from 
liability  as  administratrix.     It  was  held  that  inasmuch  as  the 
estate  of  the  testator  was  in  process  of  administration  until 
1921,  the  widow  as  administratrix  is  required  to  file  a  return 
for  the  estate  for  the  period  from  the  date  of  the  testator's 
death  to   December  31,   1917,  for  each   of  the  calendar  years 
1918,  1919  and  1920,  and  for  the  period  January  1,  1921,  to  the 
date  of  her  discharge,  during  any  of  which  periods  the  net  in- 
come of  the  estate  amounted  to  $1,000  or  more.    The  return  for 
the  first  period  should  be  on  Form  1040  or  1040a,  and  the  ad- 
ministratrix was  required  to  pay  the  tax  upon  the  basis  of  such 
returns.    If  the  income  of  the  estate  for  any  of  the  other  periods 
in  question  was  $1,000  or  more,  as  computed  without  deducting 
the  amount  paid  or  credited  to  the  beneficiary,  returns  covering 
such  periods  were  also  required  to  be  made  on  Form  1040  or 
1040a,  as  the  case  might  be.     The  returns  were  required  to  be 
accompanied  by  a  statement  showing  that  during  each  period 
the  entire  net  income  was  paid  or  credited  to  the  widow  as  sole 
beneficiary.ioi    In  another  case,  by  a  certain  article  of  his  will, 
a  testator  created  a  trust  in  favor  of  his  wife,  directing  that 
one  year  after  her  death  a  certain  part  of  the  principal  of  the 
trust  estate  should  be  paid  to  her  heirs,  and  that  the  remainder 
of  such  principal  should  revert  to  and  become  a  part  of  his 
residuary  estate.     In  accordance  with  the  terms  of  the  trust, 
after  the  death  of  the  widow  and  after  making  certain  payments, 
the  trustees  during  1920  paid  over  to  the  husband's  adminis- 
trators all  of  the  property  remaining  in  their  hands  and  the 
administrators   in   their   turn   distributed   to   the   beneficiaries 
under  the  will  all  of  the  property  of  the  estate  which  they  held, 
including  the  property  received  from  the  trustees.     This  prop- 
erty so  paid  over  included  certain  income  received  by  the  trus- 
tees during  1920.    With  regard  to  the  distributions  made  by  the 
administrators,  all  amounts  so  distributed  were  held  deductible  in 
the  final  return  of  the  administrators  to  be  filed  for  the  estate 
for  the  period  from  January  1,  1920,  to  the  date  of  settlement 
in  1920.     As  under  the  terms  of  the  will  of  the  husband  the 
trustees  were  required  to  distribute  at  the  termination  of  the 
trust  the  entire  property  of  the  estate,  including  the  net  income 
received  by  them,  the  income  was  properly  distributable  and 
the  trustees  were  not  required  to  file  a  return  on  Form  1040  or 
1040a  for  the  year  in  which  such  distribution  was  made.     A 
return  on  Form  1041  was  required  to  be  filed,  however,  showing 
the  gross  income  of  the  trust  for  such  year  and  the  deductions 

101  O.  D.  926,  T.  B.  21-21-1652. 


FroUCIARIES  131 

claimed,  as  well  as  the  amount  of  income  paid  over  to  the  admin- 
istrators and  any  amount  of  such  income  paid  over  to  the  heirs 
of  the  wife.  If  the  entire  net  income  of  the  estate  for  1920, 
including  income  received  through  the  trustees,  was  $1,000  or 
more,  the  administrators  were  required  to  file  a  return  on  Form 
1040  or  1040a,  claiming  a  deduction  for  the  entire  amount  of 
income  received  during  the  year,  either  directly  or  through  the 
trustees,  and  properly  paid  over  or  credited  to  the  beneficiaries 
under  the  will.  This  applied  to  the  final  distribution  made  in  the 
settlement  of  the  estate,  as  well  as  to  distributions  made  during 
the  period  of  administration.i*^^ 

Where  the  deceased  owner  of  real  estate  has  not  in  his  will 
directed  the  sale  of  real  estate  or  devised  the  same  upon  trust 
to  be  sold  to  pay  debts,  legacies,  or  for  other  purposes,  or  done 
such  other  act  as  to  effect  equitable  conversion  of  his  real  estate 
at  his  death,  and  the  personal  property  is  sufficient  to  pay  all 
the  debts  and  legacies,  the  real  property  does  not  form  part 
of  the  estate  and  the  executor  will  not  be  required  to  make  a 
single  return  for  the  income  from  the  real  estate  and  the  per- 
sonal estate  of  the  decedent  during  the  period  of  administra- 
tion, even  though  the  real  estate  was  devised  to  a  trustee.^'^^ 
The  demand  of  the  Alien  Property  Custodian  for  the  interest 
of  a  beneficiary,  who  is  an  alien  enemy,  entitles  the  Alien 
Property  Custodian  to  receive  from  the  administrator  or  ex- 
ecutor the  net  amount  found  to  be  due  by  the  court  adminis- 
tering the  estate  of  the  alien  enemy.  After  the  distribution 
and  receipt  by  the  Alien  Property  Custodian  of  the  enemy's 
share  in  the  estate  no  further  tax  can  be  required  to  be  reported 
or  paid  by  the  Alien  Property  Custodian.  However,  up  to  the 
date  of  the  distribution  of  the  estate  it  is  incumbent  upon  the 
administrator  or  executor  to  report  and  pay  the  income  tax 
due  on  the  estate,  the  Alien  Property  Custodian  being  concerned 
only  with  the  net  amount  found  to  be  due  the  enemy  on  distri- 
bution.104 

Credits  to  Trust  or  Beneficiary.  In  the  case  of  an  estate  or 
trust  taxed  to  the  fiduciary  it  is  allowed  the  same  credits  against 
net  income  as  a  single  person,  including  a  personal  exemption  of 
$1,000,  but  no  credit  for  dependents.  In  the  case  of  an  estate  or 
trust  taxed  to  the  beneficiaries  each  beneficiary  is  allowed  for 
the  purpose  of  the  normal  tax,  in  addition  to  his  individual  cred- 

102  0.  D.  806,  T.  B.  7-21-1447. 

103  s.  1229-A,  T.  B.  13-20-811,  revoking  1229.  The  same  ruling  applies 
under  §  2  (b)  of  the  Revenue  Act  of  1916,  as  amended. 

104  O.  D.  598,  T.  B.  29-20-1082. 


132  FEDERAL  INCOME  TAX 

its,  his  proportionate  share  of  such  dividends  ordinarily  allowed 
as  a  credit  to  individuals  and  of  such  interest  not  entirely  ex- 
empt from  tax  upon  obligations  of  the  United  States  and  bonds 
of  the  War  Finance  Corporation  as  are  received  by  the  estate 
or  trust.  Each  beneficiary  is  entitled  to  but  one  personal  ex- 
emption, no  matter  from  how  many  trusts  he  may  receive  in- 
come.i""'  The  undistributed  net  income  of  a  trust  estate  under 
the  control  of  a  resident  fiduciary  and  subject  to  the  jurisdiction 
of  a  state  or  territory  of  the  United  States,  or  of  the  District  of 
Columbia,  is  taxable  in  the  same  manner  as  income  accruing  to 
an  unmarried  resident  individual,  irrespective  of  the  fact  that 
the  creator  of  the  trust  may  be  a  nonresident  alien  and  irrespec- 
tive of  the  fact  that  the  ultimate  beneficiaries  may  be  nonresi- 
dent aliens.  The  exemption  to  which  a  single  person  is  entitled 
may  properly  be  claimed  regardless  of  the  citizenship  or  resi- 
dence of  the  creator  of  the  trust  or  of  the  beneficiaries  for  whom 
the  income  is  retained.  The  income  of  an  estate  in  process  of 
administration  in  the  courts  of  a  state  or  territory  of  the  United 
States  or  of  the  District  of  Columbia  by  resident  fiduciaries 
is  taxable  as  an  entity,  irrespective  of  the  fact  that  the  deced- 
ent may  have  been  a  nonresident  individual  and  the  benefici- 
aries or  distributees  may  be  nonresident  aliens  and  the  income 
may  be,  in  part  or  whole,  derived  from  foreign  sources.  The 
same  specific  exemption  may  properly  be  claimed  as  that  to 
which  a  single  person  is  entitled  regardless  of  the  citizenship 
or  residence  of  the  creator  of  the  trust  or  of  the  beneficiaries. i*'" 

Credit  of  Tax  Paid  at  the  Source.  If  the  trust  estate  is  the 
owner  of  bonds  on  the  interest  of  which  the  debtor  corporation 
has  agreed  to  pay  any  tax  withheld  at  the  source,  the  law  re- 
quires the  debtor  corporation  to  pay  for  the  bondholder  an 
amount  equal  to  2%  of  the  interest  paid  during  the  year.  This 
amount  is  a  credit  against  the  tax  to  be  paid  on  the  income  of  the 
estate  or  trust,  and  should  be  divided  proportionately  among 
the  beneficiaries  and  the  estate  according  to  the  respective  shares 
of  the  income  to  which  each  is  entitled. 

Credit  for  Taxes.  The  estate  may  be  in  a  position  to  claim 
credit  for  taxes  paid  in  foreign  countries  or  possessions  of  the 
United  States  on  income  derived  from  sources  in  such  foreign 
countries  or  possessions,^"^  in  which  case  the  amount  of  such 

105  Revenue  Act  of  1921,  §  219  (d)  ;  Revenue  Act  of  1918,  §  219  (d)  ;  Reg. 
45,  Art.  346. 

io<^A.  R.  M.  37,  T.  B.  13-20-810;  O.  D.  743,  T.  B.  49-20-1335. 

i<»7  See  Revenue  Act  of  1921,  §  222  (a)  ;  Revenue  Act  of  1918,  §  222  (a). 


FIDUCIARIES  133 

taxes  is  divided  between  the  beneficiaries  and  the  estate  accord- 
ing to  their  respective  shares  of  the  income. 

Distribution  of  Income  of  Trust  Estates.  The  Revenue  Act  of 
1921  provides  that  the  tax  shall  be  imposed  upon  the  net  income 
of  the  estate  or  trust  and  shall  be  paid  by  the  fiduciary  upon 
income  (1)  received  by  estates  of  deceased  persons  during  the 
period  of  administration  or  settlement  and  not  paid  or  credited 
to  any  legatee,  heir  or  other  beneficiary  during  that  period,  (2) 
accumulated  in  trust  for  the  benefit  of  unborn  or  unascertained 
persons,  or  persons  with  contingent  interests,  and  (3)  held  for 
future  distribution  under  the  terms  of  a  will  or  trust. ^*^^  It  pro- 
vides also  that  the  tax  shall  not  be  paid  by  the  fiduciary  upon 
income  (4)  to  be  distributed  to  the  beneficiaries  periodically, 
whether  or  not  at  regular  intervals,  (5)  collected  by  a  guardian 
of  an  infant  to  be  held  or  distributed  as  the  court  may  direct, 
and  (6)  properly  paid  or  credited  to  any  legatee,  heir  or  other 
beneficiary  during  the  period  of  administration  or  settlement  of 
an  estate. 1*^*^  For  purposes  of  convenience  income  included  in  (1) , 
(2),  and  (3)  above  are  referred  to  hereinafter  as  "undistributed 
income,"  and  the  income  referred  to  in  (4),  (5),  and  (6)  above 
will  be  referred  to  as  "distributable  income"  in  the  following 
discussion.  The  object  of  the  law  is  to  tax  (1)  the  respective 
beneficiaries  upon  any  income  of  estates  or  trusts  which  can  be 
definitely  and  legally  assigned  to  them  during  the  year,  and  (2) 
to  tax  the  estate  or  trust  as  an  entity  upon  all  income  which  can- 
not be  definitely  and  legally  assigned  to  some  beneficiary.  In 
other  words,  beneficiaries  are  taxed  when  their  distributive 
shares  can  be  definitely  determined,  and  if  their  distributive 
shares  cannot  be  definitely  determined  at  the  close  of  the  year, 
the  tax  is  imposed  upon  the  estate  itself.^^'*  A  profit  from  the 
sale  of  property  during  life  tenancy  which  is  held  for  future 
distribution   to   remaindermen   is   "undistributed"   income   and 

108  Revenue  Act  of  1921,  §219    (c)  ;   Revenue  Act  of  1918,  §219    (c). 

109  Revenue  Act  of  1921,  §  219  (d)  ;  Revenue  Act  of  1918,  §  219  (d)  ; 
Reg-.  45,  Arts.  342  and  345. 

110  See  T.  D.  2231 ;  letter  from  treasury  department  dated  October  19, 
1915;  I.  T.  S.  1919,  TI1235;  Revenue  Act  of  1921,  §219;  Revenue  Act  of 
1918,  §  219.  This  distinction  is  illustrated  by  a  Hawaiian  case  in  which  it 
was  held  that  income  tax  on  an  annuity  paid  out  of  income  derived  from 
property  held  in  trust  is  assessable  against  the  annuitant,  not  the  trustee; 
but  that  surplus  income  from  property  held  in  trust  and  accumulating  in 
the  hands  of  the  trustee  pursuant  to  the  terms  of  the  will  is  not  taxable 
prior  to  the  arrival  of  the  time  for  its  distribution  (Wilder  v.  Hawaiian 
Trust  Co.,  20  Haw.  589).  This  surplus  income  is  taxable  against  the 
estate  as  an  entity  under  the  American  law. 


134  FEDERAL  INCOME  TAX 

is  taxable  as  an  entity  in  the  hands  of  the  trustee  of  the  estate.^ 
When  a  trust  provides  for  the  distribution  of  income  "when 
received"  the  beneficiary  should  account  for  it  personally,  wheth- 
er distributed  or  not.  The  creator  of  the  trust  is  not  liable  for 
income  tax  with  respect  thereto.ii- 

Distributable  Income.  In  the  case  of  ''distributable"  income 
the  fiduciary  is  required  to  report  ^^^  the  respective  amounts  paid 
or  credited  to  each  beneficiary.  In  such  case  there  is  included  in 
computing  the  net  income  of  each  beneficiary  his  distributive 
share,  whether  distributed  or  not,  of  the  net  income  of  the  trust 
estate,  for  the  taxable  year,  or  if  his  net  income  for  such  taxable 
year  is  computed  upon  the  basis  of  a  period  different  from  that 
upon  the  basis  of  which  the  net  income  of  the  trust  estate  is  com- 
puted, then  his  distributive  share  of  the  net  income  of  the  trust 
estate  for  any  accounting  period  of  such  trust  estate  ending 
within  the  fiscal  or  calendar  year,  upon  the  basis  of  which  such 
beneficiary's  net  income  is  computed. i^^  The  beneficiaries  are  re- 
quired to  report  "distributable  income"  in  their  personal  returns 
and  to  add  the  same  to  any  income  they  may  have  received  from 
other  sources  in  order  to  determine  their  respective  tax  liabilities. 
They  are  entitled  to  their  proportionate  shares  of  the  credits  for 
purposes  of  the  normal  tax  as  indicated  in  the  preceding  para- 
graphs. The  regulations  governing  partnerships  are  generally 
applicable  to  an  estate  or  trust  which  is  taxed  to  the  benefici- 
aries.ii"^  Where  a  taxpayer  established  a  trust  fund,  the  in- 
come from  which  by  agreement  is  to  be  paid  to  his  former  wife  in 
lieu  of  alimony,  maintenance  and  support,  any  excess  over  a 
certain  stipulated  sum  which  it  was  agreed  the  trustee  must 
pay  to  the  former  wife  annually  to  be  paid  to  the  creator  of  the 
trust  and  in  event  the  former  wife  and  sons  predecease  the 
grantor  the  principal  of  the  trust  to  revert  to  him,  it  has  been 
held  that  the  instrument  in  question  created  a  valid  trust  which 
is  irrevocable  and  beyond  the  control  of  the  grantor,  the  income 
of  which  is  distributable  periodically  and  is  taxable  to  the  bene- 
ficiary,ii6 

Income  Not  Actually  Paid  to  Beneficiaries  in  Year.  It 
will  be  noted  that  in  the  case  of  so-called  "distributable  income" 
the  tax  is  paid  by  the  beneficiary  upon  his  distributable  share 

1110.  D.  560,  T.  B.  26-20-1029. 

112  S.  961,  T.  B.  1-19-69. 

113  This  return  is  made  on  Form  No.  1041,  but  like  the  return  required 
of  partnerships,  as  such,  it  is  essentially  a  return  of  information  only. 

114  Revenue  Act  of  1921,  §219  (d)  ;  Revenue  Act  of  1918,  §219   (d). 

115  Reg.  45,  Art.  345. 

116  O.  D.  1092,  T.  B.  45-21-1910,  overruling  O.  D.  399,  T.  B.  6-20-730. 


FIDUCIARIES  135 

ivhether  or-  not  it  is  actualhi  distributed.  In  other  words,  there 
may  be  an  actual  or  a  constructive  distribution  of  the  income  of 
an  estate.  When  it  is  credited  or  made  available  to  the  benefici- 
ary, it  is  to  be  accounted  for  by  the  beneficiary  as  if  it  were  ac- 
tually paid  over  to  him.  Where  the  tax  on  such  income  construc- 
tively distributed  has  been  paid  by  the  beneficiary,  it  is  not  again 
payable  when  at  a  later  date  the  income  is  actually  received  by 
him.^i^  Under  a  will  a  trust  fund  was  established,  the  income 
to  be  distributed  to  the  beneficiary  periodically  during  her  natural 
life.  The  trust  fund  was  invested  in  two  mortgages  on  prop- 
erty owned  by  the  beneficiary  and  by  verbal  agreement  it  was 
provided  that  the  beneficiaiy  should  pay  no  interest  upon  the 
mortgages  and  that  the  trustees  should  pay  her  no  income 
from  the  trust.  It  was  ruled  that  the  fact  that  the  trust  fund 
was  invested  in  a  mortgage  belonging  to  the  beneficiary  and 
that  the  contract  was  entered  into  by  which  the  trustees  agreed 
not  to  collect  the  interest  due  them,  the  beneficiary  agreeing 
to  receive  no  income  from  the  trust  estate,  did  not  alter  the  fact 
that  income  had  accrued  to  the  credit  of  the  estate  and  that 
the  beneficiary  was  in  constructive  receipt  of  income  from  the 
trust.  If  for  any  taxable  period  the  net  income  of  the  estate 
should  be  $1000  or  more,  including  the  entire  amount  of  interest 
receivable  upon  the  mortgage,  the  trustees  would  be  required 
to  render  a  return  on  Form  1041  and  the  beneficiary  would  be 
required  to  make  a  return  of  her  distributable  share  of  the  in- 
come of  the  trust  fund.  She  would,  of  course,  be  entitled  to  de- 
duct the  amount  of  interest  payable  within  the  year  upon  the 
mortgages  on  her  property.i^'^' 

Distribution  of  Income  of  Several  Years.  Where  a  de- 
cedent died  in  1913,  leaving  a  will  devising  a  part  of  his  estate 
in  trust  to  pay  the  income  therefrom  to  one  beneficiary  during 
life,  and  other  parts  to  be  divided  among  other  beneficiaries,  and 
it  was  impracticable  for  the  executors  to  complete  distribution  of 
the  estate  or  determine  the  amount  of  net  income  until  1916,  at 
which  time  an  account  was  prepared  showing  the  net  income  ac- 
cruing to  each  beneficiary  during  the  last  three  months  of  1913 
and  during  the  years  1914  and  1915,  a  large  part  of  the  accumu- 
lated income  being  distributed  in  1916,  it  was  held  that  the 
executors  should  make  a  fiduciary  return  for  each  of  the  years 

11"  Reg.  45,  Art.  345;  Reg.  33  Rev.,  Art.  29;  T.  D.  2289;  Reg.  33,  Art.  75. 
The  theory  seems  to  be  that  such  income  is  separated  from  the  estate  when 
it  is  credited  to  the  beneficiary,  the  fiduciary  thereafter  holding  it,  not  as 
fiduciary,  but  as  agent  for  the  beneficiary. 

IISO.  D.  606,  T.  B.  30-20-1093. 


136  FEDERAL  INCOME  TAX 

1913,  1914,  1915,  and  1916,  reciting  therein  the  respective  bene- 
ficiaries and  their  interests  and  the  beneficiaries  could  make 
amended  returns  for  any  of  those  years  in  which  they  would  be 
taxable  by  reason  of  the  amount  so  distributed. ^i'^  In  this  case, 
apparently,  the  respective  shares  of  the  beneficiaries  were  known 
at  all  times,  but  the  amount  of  net  income  of  the  estate  was  not 
determinable  until  1916. 

Undistributed  Income.  Where  the  tax  has  been  paid  on  the 
"undistributed"  income  of  an  estate  or  trust  by  the  fiduciary 
such  income  is  free  from  tax  when  it  is  actually  distributed  to  the 
beneficiaries.120  Where  under  the  terms  of  the  will  or  deed  the 
trustee  may  in  his  discretion  distribute  the  income  or  accumu- 

119  Letter  from  treasury  department  dated  March  24,  1917;  L  T.  S.  1918, 
TI728. 

120  Revenue  Act  of  1921,  §219;  Revenue  Act  of  1918,  §-219.  See  also 
Reg.  45,  Art.  344.  The  1913  Law  was  silent  as  to  the  taxability  of  "undis- 
tributed" income.  It  was  first  held  by  the  treasury  department  that  if 
income  was  added  to  the  corpus  of  the  estate,  under  the  provisions  of  the 
will  or  under  a  statute,  no  tax  would  accrue  with  respect  thereto,  but 
it  was  later  held  under  that  law  that  such  income  was  taxable,  on  the 
theory  that  an  estate  could  not  be  without  a  beneficiary  for  income  tax 
purposes.  Where  the  beneficiaries  and  their  beneficial  interest  were  known, 
the  income  was  to  be  reported  as  accruing  to  them,  and  the  estate  itself 
was  to  be  listed  as  a  beneficiary  with  respect  to  any  of  its  income  not 
otherwise  beneficially  assigned  or  accounted  for.  (T.  D.  2231.)  The  exe- 
cutor or  administrator  of  an  estate  was  required  to  make  no  return  of 
the  income  until  the  settlement  of  the  estate  had  reached  the  stage  where 
the  beneficiaries  and  their  respective  interests  in  the  income  were  deter- 
m.inable,  at  which  time  returns  should  be  made  showing  the  annual  accrual, 
a  separate  return  being  required  for  each  tax  year  involved.  (Letter 
from  treasury  department  dated  March  4,  1916;  I.  T.  S.  1917,  ^576;  T.  D. 
2289;  T.  D.  2231  and  T.  D.  1943.)  In  First  Trust  &  Savings  Bank  v. 
Smietanka,  268  Fed.  230,  the  court  held  that  the  earliest  ruling  of  the 
treasury  department  was  the  correct  interpretation  of  the  statute  and 
that  T.  D.  2231  is  contrary  to  law.  The  1916  Law  provided  that  "income 
received  by  estates  of  deceased  persons  during  the  period  of  administration 
or  settlement  of  the  estate,  shall  be  subject  to  the  normal  and  additional 
tax  and  taxed  to  their  estates.  *  *  *  "  (§2  (b).)  It  has  been  in- 
dicated by  the  treasury  department  that  under  the  1916  Law  the  income 
received  by  an  estate  of  a  decedent  during  the  period  of  administration  or 
settlement  was  intended  to  be  taxed  as  an  entity  whether  or  not  any 
amounts  were  paid  over  to  legatees,  heirs,  or  other  beneficiaries  during  that 
period,  but  the  language  of  §  2  (b)  of  the  1916  Law  seems  to  indicate  that 
the  law  intended  the  tax  to  be  imposed  on  the  estate  "except  where  the 
income  is"  returned  for  the  purpose  of  the  tax  by  the  beneficiary,"  and  the 
construction  generally  placed  upon  the  provisions  of  the  1917  Law  was 
that  the  executor  or  administrator  became  liable  for  the  tax  only  on  the 
amount  not  paid  over  to  a  legatee  or  heir  during  the  year.  This  point  was 
settled  by  the  1918  law. 


FIDUCIARIES 


137 


late  it,  the  income  is  taxed  to  the  trustee,  irrespective  of  the  ex- 
ercise of  his  discretion.    The  imposition  of  the  tax  is  not  affected 
by  the  fact  that  an  ultimate  beneficiary  may  be  a  person  exempt 
from  tax.i-i    j^  1915  a  woman  died  intestate,  owning  real  prop- 
erty in  the  state  of  New  York  and  leaving  surviving  a  husband 
and  a  son  of  full  age,  who  was  her  sole  heir  at  law  and  next  of 
kin.    The  property  was  sold  at  a  profit  in  1920  and  the  proceeds 
by  consent  of  the  father  and  the  son  were  placed  in  a  bank  in  a 
special  account  in  the  name  of  the  husband  with  an  agreement 
between  the  father  and  the  son  that  the  father  was  to  have  the 
income  from  the  fund  for  life  and  that  upon  his  death  the  prin- 
cipal was  to  go  to  the  son.    Under  the  laws  of  New  York,  where 
a  life  estate  with  remainder  over  is  created  in  personal  property, 
the  life  tenant  is  entitled  to  possession,  and  upon  possession  be- 
comes a  trustee  for  the  remainderman.     The  profits  from  the 
sale  of  the  property  accrued  to  and  constituted  a  part  of  the 
corpus  of  the  trust  fund  in  the  possession  of  the  father,  of  which 
the  son  was  the  ultimate  beneficiary.     It  was  not  distributable 
to  the  son  or  to  the  father,  but  under  the  law  was  required  to  be 
held  in  the  fund  during  the  life  of  the  father.     Such  profits, 
therefore,   represented  the   undistributable   income   of   a   trust 
entity,  and  the  father,  as  trustee,  was  required  to  file  a  return 
showing  the  profit  from  the  sale  as  income  of  the  trust  and  pay 
the  tax  thereon.i" 

Estates  and  Trusts  Which  Cannot  Be  Treated  as  a  Unit.  The 
Revenue  Act  of  1921  provides  that  in  the  case  of  an  estate  or 
trust  the  income  of  which  consists  both  of  distributable  and 
undistributed  income,  the  net  income  of  the  estate  or  trust 
shall  be  computed  and  a  return  thereof  made  by  the  fiduciary  m 
the  same  manner  as  in  the  case  of  undistributed  income  and 
that  the  tax  thereon  shall  be  paid  by  the  fiduciary,  except  that 
there  shall  be  allowed  as  an  additional  deduction  in  computing 
the  net  income  of  the  estate  or  trust  the  amount  of  distributable 
income.  In  such  cases  the  distributable  income  must  be  included 
in  the  returns  of  the  beneficiaries.i^^  The  following  rulings  were 
made  to  provide  for  such  cases  under  the  1918  Law: 

121  Reg  45  Art.  842,  is  applicable  only  under  the  Revenue  Acts  of  1918 
and  1919  Where  the  income  of  a  trust  fund  is  payable  only  in  the  discre- 
tion of  the  trustee,  such  income  as  the  trustees  distributed  to  the  bene- 
ficiaries during  the  years  1916  or  1917  was  taxable  to  the  recipient  per- 
sonally.    (Revenue  Act  of  1916,  §2-B;   S.   1088,  T.  B.  11-19-382.) 

122  o.  D.  1040,  T.  B.  38-21-1830. 

123  Revenue   Act   of   1921,   §219    (e). 


138  FEDERAL  INCOME  TAX 

In  the  case  of  certain  estates  and  trusts  it  is  recognized  that 
the  estate  or  trust  can  not  be  treated  as  a  unit  for  income  tax 
purposes  and  may  represent  an  aggregate  of  distinct  interests  to 
all  of  which  the  fiduciaries  are  responsible;  in  such  cases  the 
procedure  stated  in  this  paragraph  should  govern.  The  follow- 
ing are  recognized  as  cases  which  can  not  be  treated  as  a  unit: 
(a)  When  there  is  income  distributable  periodically  and  also 
income  which  is  to  be  accumulated  in  trust,  held  for  future  distri- 
bution, or  added  to  the  corpus;  (b)  when  there  is  income  dis- 
tributable periodically  and  also  income  (according  to  the  federal 
income  tax  statutes  and  regulations)  which  is  not  distributable 
periodically  under  state  law,  e.  g.,  gains  from  sale  of  capital 
assets,  stock  dividends ;  (c)  when  there  is  income  distributable 
periodically  and  deductions  (according  to  federal  income  tax 
statutes  and  regulations)  which  are  not  deductible  under  state 
law  from  the  distributable  income,  e.  g.,  losses  from  the  sale  of 
capital  assets,  depletion,  depreciation.  In  ascertaining  whether 
an  estate  or  trust  comes  within  any  one  of  the  cases  just  enumer- 
ated, the  provisions  of  the  federal  statutes  and  regulations — 
rather  than  the  provisions  of  the  will  or  trust  and  the  provisions 
of  state  laws — will  determine  what  items  constitute  taxable 
gross  income  or  allowable  deductions ;  the  provisions  of  the  will 
or  trust  and  of  state  laws  will  determine  the  allocation  of  items 
of  gross  income  or  deductions ;  that  is,  to  which  of  the  different 
interests  making  up  the  whole  such  items  shall  be  charged  or 
allowed.  In  cases  in  which  an  estate  or  trust  cannot  be  treated 
as  a  unit  the  items  of  gross  income  and  deductions,  as  determined 
by  the  federal  income  tax  statutes  and  regulations,  must  be 
scrutinized  and  classified  in  accordance  with  the  provisions  of 
the  will  or  trust,  or  rules  of  local  law,  into  two  classes.  The  first 
class  will  include  the  items  of  gross  income  and  deductions  so 
determined  which  relate  to  "undistributed"  income,  with  re- 
spect to  which  the  estate  or  trust  is  treated  as  a  taxable  entity 
and  upon  which  income  the  tax  is  paid  by  the  fiduciary.  The 
second  class  will  include  the  items  of  gross  income  and  deduc- 
tions so  determined  which  relate  to  the  "distributable"  income, 
the  tax  upon  which  is  not  paid  by  the  fiduciary  but  by  the  bene- 
ficiary. The  result  will  be  that  the  beneficiary  to  whom  income 
is  to  be  distributed  periodically  must  include  in  computing  his 
net  income  the  amount  actually  distributable  to  him  (except 
exempt  income)  even  though  the  aggregate  of  the  distributive 
shares  should  be  larger  than  the  net  income  of  the  estate  or 
trust  computed  as  a  unit.  Any  gain,  profit,  or  income  which  is 
not  periodically   distributable  must  be   included   in   computing 


FIDUCIARIES  139 

the  net  income  of  the  estate  or  trust  so  that  the  fiduciary  will 
pay  the  tax  upon  any  excess  of  the  net  income  of  the  estate  or 
trust  computed  as  a  unit  over  the  aggregate  distributive  shares.^-^ 
Under  a  will  a  trust  was  created  for  the  period  of  the  life 
of  a  certain  individual,  a  part  of  the  income  of  which  was  to 
be  paid  to  a  charitable  institution  and  an  educational  institution 
and  the  remainder  to  the  individual.  At  the  termination  of  the 
trust  the  property  was  bequeathed  to  the  charitable  and  educa- 
tional institutions,  A  portion  of  the  trust  property  was  shares  of 
stock.  In  1919,  the  right  was  given  to  shareholders  to  subscribe 
to  additional  shares  of  this  stock  which  right  was  sold  by  the 
trustee.  It  was  held  that  the  amount  received  by  the  trustee 
from  the  sale  of  the  right  was  taxable  income,  the  imposition  of 
the  tax  not  being  affected  by  the  fact  that  the  ultimate  beneficia- 
ries might  be  a  charitable  and  an  educational  institution ;  and  it 
was  further  held  that  the  trust  could  not  be  treated  as  a  unit  for 
income  tax  purposes,  there  being  income  distributable  periodical- 
ly and  also  income  which  was  not  distributable  periodically  under 
the  law  of  the  state  in  which  the  testator  resided.  The  trustee 
was  required  to  file  Form  1040,  returning  as  income  the  amount 
received  from  the  sale  of  the  right  which  was  not  distributable 

124  T,  D.  2987,  T.  B.  10-20-781,  revoking  all  previous  rulings  inconsistent 
therewith  and  retroactive  to  January  1,  1918;  O.  1013,  T.  B.  12-20-795-6. 
For  example,  a  trust  is  created  the  income  of  w^hich  is  distributable  periodi- 
cally for  the  life  of  the  beneficiary,  the  remainder  over  to  others.  The  trust 
has  the  following  items  of  income:  Rent,  $3,000;  interest,  $2,000;  gain  on 
sale  of  capital  assets,  $1,500;  cash  dividend,  $1,000;  and  deductions,  gener- 
al expenses  (all  deductible  from  distributable  income),  $700;  depreci- 
ation, $300;  loss  on  sale  of  capital  assets,  $3,000.  Under  the  terms  of  the 
trust  $5,300  will  be  distributed  to  the  beneficiary,  viz,  rent,  $3,000;  plus 
interest,  $2,000;  plus  dividend,  $1,000;  less  general  expenses  $700.  The 
gain  and  loss  on  the  sale  of  capital  assets  will  be  considered  capital  items 
affecting  the  corpus  only,  and  the  items  of  depreciation  will  not  affect  the 
amount  to  be  distributed,  there  being  no  rule  of  state  law  or  provision  of 
the  trust  requiring  this  deduction  from  distributable  income.  In  such 
a  case  the  fiduciary  must  report  on  Form  1041,  showing  a  net  income  for 
the  trust  of  $3,500,  and  must  show  as  the  distributive  share  of  the  bene- 
ficiary the  $5,300  to  which  he  is  entitled.  The  beneficiary  must  account  for 
the  amount  actually  distributable  to  him  as  income,  viz.  $5,300  as  provided 
in  §  219  (d)  and  will  be  entitled  to  a  credit  of  $1,000  on  account  of  the  divi- 
dends in  computing  the  normal  tax,  but  not  to  any  deduction  on  account  of 
depreciation  or  capital  losses.  If  there  had  been  no  loss  on  the  sale  of  capi- 
tal assets  so  that  the  net  income  of  the  estate  or  trust  was  $6,500.  Foi-m  1041 
should  show  the  distributive  share  of  the  beneficiary  as  $5,300,  and  the 
distributive  share  of  the  fiduciary  as  $1,200;  and  the  fiduciary  should  file 
a  separate  return  on  Form  1040 A,  reporting  $1,200  for  taxation. 


140  FEDERAL  INCOME  TAX 

periodically  and  also  Form  1041  showing  the  distributive  shares 
of  the  beneficiaries  in  that  portion  of  the  trust  income  which  was 
distributable  periodically.'-"' 

Where  under  the  terms  of  the  will  of  a  decedent  a  trust  was 
created  part  of  the  income  of  which  was  distributable  periodical- 
ly to  the  beneficiaries  and  a  portion  of  which  was  to  be  accumu- 
lated and  added  to  the  principal  of  the  trust  or  held  for  future 
distribution,  and  during  the  taxable  year  1920,  real  estate  owned 
by  the  trust  was  sold  at  a  loss  and  the  return  for  the  trust  for 
that  year  showed  a  net  loss  as  a  result  of  the  sale,  it  was  held  that 
the  amount  of  the  loss  might  be  deducted  from  the  gross  income 
of  the  trust  for  the  taxable  year  in  computing  the  net  income 
of  the  trust  as  a  unit ;  but  since  the  loss  on  the  sale  of  the  capital 
assets  of  the  trust  affected  the  corpus  of  the  trust  only,  each 
beneficiary  was  required  to  include  in  computing  his  net  income 
the  amount  of  the  income  of  the  trust,  if  any,  distributable  to 
him,  even  though  the  aggregate  of  the  distributive  shares  of  the 
beneficiaries  was  larger  than  the  net  income  of  the  trust  com- 
puted as  a  unit.i2« 

Receiver  in  Partition  Proceedings.  A  receiver  in  partition  pro- 
ceedings was  required  under  the  1916  law  to  report  at  the  close 
of  each  year  during  the  pendency  of  the  partition  suit,  the  net 
income  collected  from  the  property  during  such  year,  and  pay 
the  tax  thereon.i-"  Where  an  executor  under  a  will  is  also  re- 
ceiver in  partition  proceedings  the  income  accruing  to  him  as 
receiver  should  be  reported  separately  and  not  added  to  the 
income  received  by  him  as  executor,  if  the  receivership  is  sepa- 
rate and  apart  from  the  administration  and  settlement  of  the 
estate. 

Returns  by  Fiduciaries.  A  fiduciary  is  responsible  for  making 
a  return  for  the  estate  or  trust  for  which  he  acts.^-^  The  re- 
turn is  required  to  state  specifically  the  items  of  gross  income  re- 
ceived and  the  deductions  and  credits  allowed  against  such  gross 
income,  the  net  income,  and  the  respective  amounts  distributed 
to  the  respective  beneficiaries  or  retained  by  the  estate  as  undis- 
tributed income. 1-^  The  return  is  prepared  in  the  manner  indi- 
cated on  the  form  supplied  by  the  government.    No  special  rules 

125  0.  D.  808,  T.  B.  7-21-1449.     See,  however,  Chapter  20  as  to  income 
from  the  sale  of  such  rights. 
120  O.  D.  1041,  T.  B.  38-21-1831. 

127  Letter  from  treasury  department  dated  March  14,  1917;  L  T.  S.  1918, 
11 1004. 

128  Revenue  Act  of  1921,  §219    (b)  ;  Revenue  Act  of  1918,  §219    (b). 

129  Revenue  Act  of  1921,  §  225;  Revenue  Act  of  1918,  §  225. 


FIDUCIARIES  141 

are  applicable  to  fiduciaries,  except  that  in  case  of  income  which 
is  to  be  distributed  to  the  beneficiaries  periodically,  whether  or 
not  at  regular  intervals,  and  in  the  case  of  income  collected  by  a 
g-uardian  of  an  infant  to  be  held  or  distributed  as  the  court  may 
direct,  the  fiduciary  is  required  to  include  in  his  return  a  state- 
ment of  each  beneficiary's  distributive  share  of  the  net  income  of 
the  estate  or  trust,  whether  or  not  distributed  before  the  close 
of  the  taxable  year  for  which  the  return  is  made.^"-" 

By  Whom  Filed.  The  return  is  filed  by  the  fiduciary  having 
charge  of  the  trust  estate.  Fiduciaries  required  to  make  re- 
turns are  subject  to  all  the  provisions  of  the  law  which  apply  to 
individuals.  Under  such  regulations  as  the  commissioner,  with 
the  approval  of  the  secretary,  may  prescribe,  a  return  made 
by  one  of  two  or  more  joint  fiduciaries  and  filed  in  the  office  of 
the  collector  of  the  district  where  such  fiduciary  resides,  is  a 
sufficient  compliance  with  the  requirements  of  the  law.'='^  In 
case  no  necessity  exists  for  the  appointment  of  an  administrator, 
the  beneficiaries  may  act  jointly,  or  may  duly  appoint  one  of 
their  number  as  the  agent  of  the  estate  for  the  purpose  of  filing 
the  income  tax  return  of  the  decedent.  In  doing  so,  however, 
the  agent  assumes  the  responsibility  for  making  the  return  and 
incurs  the  liability  to  the  specific  penalties  provided  for  in  the 
case  of  the  filing  of  erroneous,  false,  and  fraudulent  returns. ir- 
revocable Trusts.  The  trustee  under  a  revocable  trust  is 
required  to  file  a  return  on  Form  1041,  revised,  showing  the 
grantor  as  the  beneficiary  under  the  trust.  The  trustee  must 
also  file  a  return  of  information  upon  which  should  be  entered 
the  name  and  address  of  the  grantor  in  whose  return  the  income 
should  be  included.!"^" 

When  a  Return  Is  Required.  Every  fiduciary  (except  re- 
ceivers appointed  by  authority  of  law  in  possession  of  part  only 
of  the  property  of  an  individual)  or  at  least  one  of  joint  fiduci- 
aries, were  required,  under  the  1918  law,  to  make  a  return  of  in- 
come (a)  for  the  individual  whose  income  is  in  his  charge,  if  the 
net  income  of  such  individual  is  $2,000  or  over,  if  married  and 
living  with  husband  or  wife,  or  is  $1,000  or  over  in  other  cases, 
or  (b)  for  the  estate  or  trust  for  which  he  acts,  if  the  net  income 
of  such  estate  or  trust  is  $1,000  or  over,  or  if  any  beneficiary  of 

130  Revenue  Act  of  1921,  §219    (b)  ;  Revenue  Act  of  1918,  §219    (b). 
i:'.i  Revenue  Act  of  1921,  §  225  (b)  ;  Revenue  Act  of  1918,  §  225. 

132  0.  D.  702,  T.  B.  43-20-1264. 

133  0.  D.  621,  T.  B.  32-20-1116. 


142  FEDERAL  INCOME  TAX 

such  estate  or  trust  is  a  nonresident  alien. ^^^  Under  the  1921 
Law,  in  the  case  of  (a)  above,  a  return  must  be  made  for  every 
individual  for  whom  he  acts  if  such  individual  has  a  gross  in- 
come for  the  taxable  year  of  $5,000  or  over,  regardless  of  the 
amount  of  his  net  income,  and  in  the  case  of  (2)  above,  for  every 
estate  or  trust  the  net  income  of  which  for  the  taxable  year  is 
$1,000  or  over  and  for  every  estate  or  trust  of  which  any  bene- 
ficiary is  a  nonresident  alien.^-"^-"' 

Fiduciaries  Acting  in  More  Than  One  Estate.  In  the  case 
of  two  or  more  trusts  the  income  of  which  is  taxable  to  the  bene- 
ficiaries, which  were  created  by  the  same  person  and  are  in 
charge  of  the  same  trustee,  the  trustee  is  required  to  make  a 
single  return  on  Form  1041  (revised)  for  all  such  trusts,  not- 
withstanding that  they  may  arise  from  different  instruments. 
When,  however,  a  trustee  holds  trusts  created  by  different  per- 
sons for  the  benefit  of  the  same  beneficiary,  he  is  required  to 
make  a  return  on  Form  1041  (revised)  for  each  trust  sepa- 
rately.136 

Where  Filed.  The  return  of  a  fiduciary  should  be  filed  in  the 
collection  district  in  which  the  fiduciary  resides  or  has  his 
place  of  business,  regardless  of  the  residence  of  the  benefici- 
aries.i^?  Where  an  estate  has  two  or  more  joint  fiduciaries,  the 
return  may  be  filed  by  one  of  them  in  the  district  where  he  re- 
sides, such  filing  being  a  suflflcient  compliance  with  the  law.^^^ 

When  Filed.  The  return  must  be  filed  on  or  before  March 
15th  in  each  year,  or  on  or  before  the  fifteenth  day  of  the  third 
month  following  the  close  of  the  fiscal  year  of  the  estate  or  trust, 
accordingly  as  it  reports  upon  the  basis  of  the  calendar  or  a  fiscal 
year.  Foreign  fiduciaries  must  file  returns  on  or  before  June 
15th  if  they  report  upon  the  basis  of  the  calendar  year,  and  on 
or  before  the  close  of  the  sixth  month  following  the  close  of  their 
fiscal  year.^39 

Extension  of  Time.  The  same  extension  of  time  may  be 
granted  for  filing  the  returns  of  fiduciaries  as  may  be  granted  to 
individuals. 

134  Revenue  Act  of  1918,  §  225;  Reg.  45,  Art.  421.  The  return  in  case  (a) 
and  also  in  case  (b)  if  the  tax  is  payable  by  the  fiduciary  should  be  made  on 
Form  1040  (revised),  except  that  it  may  be  on  short  Form  1040- A  (revised) 
where  the  net  income  does  not  exceed  $5,000.  The  return  may  be  made  on 
Form  1041   (revised)  in  case  (b)   if  the  tax  is  payable  by  the  beneficiaries. 

135  Revenue  Act  of  1921,  §225   (a). 

130  Reg.  45,  Art.  423;  T.  D.  2090;  T.  D.  2137. 

137  Revenue  Act  of  1921,  §227  (b)  ;  Revenue  Act  of  1918,  §227   (b). 

138  Revenue  Act  of  1921,  §  225  (b) ;  Revenue  Act  of  1918,  §  225. 

139  See  Chapter  34. 


FIDUCIARIES  143 

How  Signed  and  Sworn  to.  The  law  provides  that  the  fidu- 
ciary shall  make  oath  that  he  has  sufficient  knowledge  of  the  af- 
fairs of  the  individual,  trust,  or  estate  for  which  he  acts,  to  en- 
able him  to  make  the  return  and  that  the  same  is,  to  the  best  of 
his  knowledge  and  belief,  true  and  correct.'^"  When  the  return 
is  signed  and  sworn  to  by  an  individual  as  a  fiduciar>'  his  full 
address  is  required  to  be  stated.  If  the  fiduciary  is  an  organ- 
ization, the  return  is  signed  and  sworn  to  by  the  president,  secre- 
tary or  treasurer. ^^1 

Returns  for  Beneficiaries.  As  a  general  rule,  the  fiduciary  is 
not  required  to  make  any  return  of  "distributable"  income,  as 
that  term  is  defined  in  a  previous  paragraph, i^-  for  and  on  behalf 
of  his  beneficiary.^^'^  If,  however,  the  fiduciary  has  been  legally 
authorized  to  act  as  agent  for  the  beneficiary,  or  is  an  attorney- 
in-fact  for  him,  he  may  also  make  and  file  the  personal  return  of 
the  beneficiary  in  the  same  manner  as  any  other  duly  authorized 
agent. 1-*^  If  the  beneficiary  is  unable  to  make  his  own  return,  or 
is  a  nonresident  alien,  the  fiduciary  is  required  to  make  the  per- 
sonal return  for  him,  as  indicated  in  the  following  paragraphs. 

For  Minors  or  Insane  Persons.  A  fiduciary  acting  as  the 
guardian  of  a  minor  having  a  net  income  of  $1,000  or  $2,000  ac- 
cording to  the  marital  status  of  such  person,  or  a  gross  income 
of  $5,000,  must  make  a  return  for  such  minor  and  pay  the  tax, 
unless  such  minor  himself  makes  a  return  or  causes  it  to  be 
made.  A  fiduciary  acting  as  the  committee  of  an  insane  person 
having  a  net  income  of  $1,000  or  $2,000,  according  to  the  marital 
status  of  such  person,  or  a  gross  income  of  $5,000,  must  make, 
a  return  for  such  incompetent  and  pay  the  tax.^^"' 

For  Non-Resident  Alien  Beneficiaries.  Where  a  citizen  or 
resident  fiduciary  has  the  distribution  of  trust  income  for  which 
there  is  a  nonresident  alien  beneficiary,  the  fiduciary  must  make 
a  return  for  such  nonresident  alien  and  pay  the  tax.  If  there 
are  two  or  more  beneficiaries,  the  fiduciary  should  render  a  re- 

!■>'•  Revenue  Act  of  1921,  §225   (b);  Revenue  Act  of  1918,  §225. 

1^1  Reg.  33,  Art.  73.    See  instructions  on  Form  1041. 

1^-'  See  p.  133. 

143  See,  however,  the  paragraph  "Estates  and  Trusts  Which  Cannot  Be 
Treated  as  an  Entity,"  p.  137. 

1-14  See   Reg.  33.   Art.   72. 

14'>  Reg.  45,  Art.  422.  Form  Nos.  1040  (revised)  or  1040-A  (revised)  are 
used  for  this  purpose.    See  O.  D.  1085,  T.  B.  44-21-1897. 


144  FEDERAL  INCOME  TAX 

turn  on  Form  1041  (revised)  and  also  a  return  for  each  non- 
resident alien  beneficiary.i-^^' 

It  was  held  under  the  1918  law  that  a  fiduciary  should  file 
Form  1040  for  a  nonresident  alien  beneficiary,  even  though  the 
individual's  distributive  share  of  income  is  derived  from  divi- 
dends and  is  less  than  $5,000.^^"  Where  two  separate  trusts  are 
created  for  the  same  nonresident  alien  beneficiary,  each  trustee 
is  required  to  render  a  personal  return  on  Form  1040  or  1040a 
on  behalf  of  the  nonresident  alien,  and  pay  any  and  all  normal 
tax  found  by  such  return  to  be  due  and  any  and  all  surtax,  pro- 
vided the  income  is  not  returned  for  the  purpose  of  the  tax  by 
the  beneficiary.  If  one  of  the  trustees  is  the  representative  or 
authorized  agent  of  the  nonresident  alien,  he  may  render  a  com- 
plete return  on  Form  1040  or  1040a,  combining  the  entire  net 
income  from  both  trusts  and  take  credit  on  the  return  for  any 
tax  paid  by  the  other  fiduciary  in  behalf  of  the  nonresident  alien. 
If  the  nonresident  alien  beneficiary  of  the  two  trusts  should 
appoint  a  resident  agent  for  the  purpose  of  filing  his  return  and 
paying  the  tax  in  his  behalf,  it  would  not  be  necessary  for  the 
two  trustees  to  file  returns  on  Form  1040  or  1040a,  provided 
they  have  received  notice  of  such  appointment.  The  fiduciaries, 
however,  would  not  be  relieved  from  liability  for  rendering  re- 
turns as  such  on  Form  lOll.i^^ 

Fiduciary  Who  is  Also  Beneficiary.  A  fiduciary  who  is 
also  the  beneficiary  of  the  trust  should  file  a  return  for  the 
estate  or  trust,  and  should  also  file  an  individual  return  show- 
ing his  entire  income  derived  from  the  estate  and  from  all  other 
sources."'' 

Income  to  Be  Reported  by  Beneficiary.  Unless  the  beneficiary 
is  under  some*  disability  which  requires  a  fiduciary  to  act,  the 
beneficiary  makes  his  own  personal  return  and  accounts  for  the 
tax  upon  his  entire  net  income,  including  that  which  has  been 
received  from  the  estate.^^"  The  fiduciary  is  not  under  any  duty 
to  account  for  or  pay  the  tax  on  amounts  distributed  to  benefi- 
ciaries where  the  beneficiary  is  capable  of  making  his  own  return 
and  is  not  a  nonresident  alien.  The  beneficiary  reports  the  in- 
come for  the  year  in  which  it  is  received  by  him  or  credited  to 

i-ic  Reg.  45,  Art.  425.  Form  Nos.  1040  (revised)  or  1040-A  (revised)  are 
used  for  this  purpose.  See  Reg.  33  Rev.,  Art.  29,  as  amended  by  T.  D.  2988, 
T.  B.  11-20-785;  0.  D.  1085,  T.  B.  44-21-1897. 

147  0.  D.  58,  T.  B.  1-19-79. 
,       148  0.  D.  572,  T.  B.  27-20-1042. 

149  O.  D.  208,  T.  B.  10-19-360. 

150  See  T.  D.  2090.     See  p.  133. 


FIDUCIARIES  145 

him, — that  is,  for  the  year  in  which  it  is  actually  or  construc- 
tively received.  All  amounts  paid  by  fiduciaries  to  beneficiaries 
of  trust  estates  from  the  income  of  such  trust  estates,  whether 
from  reserves  or  otherwise,  are  held  to  be  distributions  of  income 
and  will  be  treated  for  income  tax  purposes  in  accordance  with 
the  provisions  of  law  and  regulations  applicable  to  income  of 
such  beneficiaries.  The  beneficiary  will  be  required  in  the  case 
of  trust  estates  to  account  for  the  actual  amounts  distributed  or 
credited  to  him.^''^ 

Returns  of  Executors  and  Administrators.  In  addition  to  the 
duties  which  executors  and  administrators  have  in  common  with 
other  fiduciaries,  they  are  also  required  to  report  the  income  of 
the  decedent  for  that  part  of  the  last  taxable  year  during  which 
he  lived ;  and  also  for  the  preceding  taxable  year,  if  the  decedent 
died  before  the  time  for  filing  returns  for  such  year  had  expired 
and  no  return  had  been  filed  by  him.  Thus,  if  a  decedent  died 
in  February,  1920,  without  having  made  a  return  for  1919  the 
executor  or  administrator  is  required  to  file  a  return  for  1919 
and  a  return  for  the  part  of  1920  in  which  the  decedent  lived. ^•^- 
If  the  net  income  of  the  decedent,  from  January  1  of  the  year 
in  which  he  died  to  the  date  of  his  death,  was  less  than  the  sum 
which  would  have  made  him  liable  to  make  a  return  if  living, 
no  return  is  required  by  the  executor  or  administrator.^"'^  The 
personal  exemption  which  may  be  deducted  from  the  decedent's 
income  so  reported  is  the  full  amount  allowed  to  living  persons 

i-"»i  Reg.  33  Rev.,  Art.  29.  See  Revenue  Act  of  1921,  §  219  and  Revenue 
Act  of  1918,  §219.  In  a  recent  case  (Gavit  v.  Irwin,  275  Fed.  643),  it  has 
been  decided  that  there  is  no  provision  of  the  1913  Law  by  which  it  can  be 
held  that  the  moneys  received  by  a  beneficiary  under  a  trust  fund  established 
by  the  will  of  a  decedent,  no  part  of  the  capital  of  which  inures  to  the  benefit 
of  such  beneficiary,  are  taxable  income.  Such  moneys  are  held  to  be  income 
to  the  estate  but  not  to  the  beneficiary.  As  to  him  they  are  property  acquired 
by  bequest  or  devise  and  therefore  not  taxable.    (I.  T.  S.  1921,  113177.) 

^•''-  Revenue  Act  of  1918,  §  223.  Returns  seem  to  be  required  of  executors 
or  administrators  in  such  cases  on  the  theory  that  by  reason  of  death  the 
decedent  is  unable  to  make  his  own  i-eturn,  a  return  therefore  being  required 
by  the  "person  charged  with  the  care  of  the  person  or  property  of  such  tax- 
payer." See  Brady  v.  Anderson,  240  Fed.  665,  writ  of  certiorari  denied, 
244  U.  S.  654;  Mandell  v.  Pierce,  3  Cliff.  134,  16  Fed.  Cas.  No.  9008;  Reg. 
33  Rev.,  Arts.  4  and  14. 

153  Revenue  Act  of  1921,  §223;  Revenue  Act  of  1918,  §223;  Reg.  45, 
Art.  421.     See  also  T.  D.  2090  and  Reg.  33,  Art.  17. 


146  FEDERAL  INCOME  TAX 

of  the  same  status  as  that  of  the  decedent  at  the  time  of  his 
death.15^ 

Time  for  Filing  Return  Upon  Death  or  Termination  of 
Trust.  As  soon  as  possible  after  his  appointment  and  qualifi- 
cation, without  waiting  for  the  close  of  the  taxable  year,  an 
executor  or  administrator  should  file  a  return  of  income  for  the 
decedent.  Upon  the  completion  of  the  administration  of  an 
estate  and  final  accounting  an  executor  or  administrator  should 
file  a  return  of  income  of  the  estate  for  the  portion  of  the  taxable 
year  in  which  the  administration  was  closed,  attaching  to  the 
return  a  certified  copy  of  the  order  for  his  discharge.  An 
ancillary  administrator  need  make  no  separate  return  if  the 
domiciliary  administrator  includes  in  his  return  the  entire  in- 
come of  the  estate.  Similarly,  upon  the  termination  of  any  other 
trust  the  trustee  should  make  a  return  without  waiting  for  the 
close  of  the  taxable  year.  In  any  such  case  the  requirements 
with  respect  to  the  payment  of  the  tax  are  the  same  as  if  the 
return  were  for  a  full  taxable  year  closing  at  the  end  of  the 
month  during  which  the  decedent  dies  or  the  estate  is  settled  or 
the  trust  is  terminated,  as  the  case  may  be.  The  payment  of  the 
tax  before  the  end  of  the  taxable  year  in  such  circumstances 
does  not  relieve  the  taxpayer  from  liability  for  any  additional  tax 
which  might  subsequently  be  imposed  upon  income  of  the  taxable 
year.i"-"'  Where  a  testator  died  in  May,  1917,  and  the  adminis- 
tration of  the  estate  was  closed  and  the  executor  discharged  ia 
October,  1918,  it  has  been  held  that  the  tax  for  the  period  from 
January  1,  1918,  to  the  close  of  the  administration  of  the  estate 
must  be  computed  and  paid  at  the  rates  imposed  by  the  Revenue 
Act  of  1918,  even  though  the  return  was  filed  and  the  tax  paid 
before  that  act  became  law.^''"'  Where  a  taxpayer  who  was 
granted  an  extension  of  time  in  which  to  file  his  1919  return, 
died  before  the  expiration  of  such  extension  without  rendering 
a  return,  the  return  was  required  to  be  filed  by  the  executor  or 
administrator  as  soon  as  possible  after  appointment  or  qualifi- 
cation and  be  accompanied  by  the  amount  of  any  tax  due,  to- 
gether with  interest  at  the  rate  of  one-half  of  1  per  cent,  per 
month  on  the  amount  of  any  deferred  installments  from  their 
respective  original  due  dates  until  paid.i^'^ 

if>^  Revenue  Act  of  1921,  §216  (f).  See  Reg.  33  Rev.,  Art.  14.  See 
Chapter  31. 

155  Reg.  45,  Art.  442;  Reg.  33  Rev.,  Art.  26. 

158  A.  R.  R.  565,  T.  B.  29-21-1737.  > 

157  O.  D.  681,  T.  B.  41-20-1234.  ' 


FIDUCIARIES  147 

Liability  of  Executors  for  Tax.  Liability  for  payment  of 
the  income  tax  attaches  to  the  person  of  an  executor  or  admin- 
istrator up  to  and  after  his  discharge,  where  prior  to  distribu- 
tion and  discharge  he  had  notice  of  his  tax  obligations  or  failed 
to  exercise  due  diligence  in  determining  whether  or  not  such 
obligations  existed.  Liability  also  follows  the  estate  itself,  and 
when,  by  reason  of  the  distribution  of  the  estate  and  the  dis- 
charge of  the  executor  or  administrator,  it  appears  that  the  col- 
lection of  the  tax  cannot  be  made  from  the  executor  or  adminis- 
trator, the  legatees  or  distributees  must  account  for  their  propor- 
tionate share  of  the  tax  due  and  unpaid.  The  same  considerations 
apply  to  other  trusts.^"''* 

Collection  of  the  Tax  From  Distributees.  In  a  case  in 
which  a  taxpayer  in  October,  1919,  converted  all  of  his  prop- 
erty into  cash  and  distributed  it  to  his  wife  and  sister,  so  that 
at  the  time  of  his  death  in  Ja,nuary,  1920,  nothing  remained 
to  be  administered  or  to  satisfy  his  income  tax  liability,  it  has 
been  held  that  the  gift  tended  to  defeat  the  intent  and  purpose 
of  the  income  tax  law,  and  that  liability  for  income  tax  attaches 
to  and  follows  the  property  distributed  into  the  hands  of  the 
recipients ;  also  that  a  return  for  1919  should  be  filed  on  behalf 
of  the  decedent  and  payment  of  the  tax  assessed  against  the 
estate  of  the  decedent  should  be  demanded  of  the  recipients  of 
the  gift.i''-'  Inasmuch  as  a  residuary  estate  is  the  gross  estate 
of  the  decedent  less  proper  expenses  and  bequests  of  specific 
amounts  or  specific  property,  and  the  specific  bequests  must  be 
paid  in  full  after  all  debts  and  expenses  are  paid,  even  though 
nothing  remains  to  constitute  a  residue,  it  follows  that  if  an 
estate  is  distributed  and  no  provision  made  for  any  part  of  such 
expenses  or  specific  bequests,  a  proper  residue  is  not  obtained 
and  the  residuary  legatee  has  received  an  amount  in  excess  of 
that  to  which  he  is  entitled.  Therefore,  where  the  estate  of  a 
deceased  person  has  been  settled,  no  provision  being  made  for 
the  payment  of  income  tax,  the  tax  assessable  is  properly  col- 
lectible from  the  residuary  legatee. i*'" 

Returns  by  Ancillary  Executors.  The  ancillary  executor  of 
the  estate  of  a  nonresident  alien  should  make  returns  for  the 
estate  and  pay  the  taxes  due,  as  agent  of  the  foreign  executor, 

158  Reg.  45,  Art.  344;  Reg.  33  Rev.,  Art.  29. 

159  0.  D.  582,  T.  B.  28-20-1058. 
16<)0.  D.  722,  T.  B.  45-20-1295. 


148  FEDERAL  INCOME  TAX 

and  file  personal  returns  for  each  nonresident  alien  benefi- 
ciary.i*'^ 

In  a  case  where  a  decedent,  a  resident  of  New  York,  but  at 
the  time  of  her  decease  living  in  California,  left  property  in 
both  states,  an  executor  being  appointed  in  each  state,  it  has 
been  held  that  since  the  entire  will  was  probated  in  New  York 
and  only  that  part  pertaining  to  property  located  in  California 
was  probated  in  that  state  in  conformity  with  its  laws,  the 
executor  in  California  was  in  fact  an  ancillary  executor  and 
was  not  required  to  file  a  return  for  the  estate,  if  the  domiciliary 
executor  includes  in  his  return  the  entire  income  of  the  estate.^^'^ 

Withholding  at  the  Source  Against  Fiduciaries.  The  provi- 
sions with  respect  to  withholding  the  tax  at  the  source  apply  in 
the  case  of  payments  to  fiduciaries  in  the  same  manner  as  in  the 
case  of  payments  to  individuals.  There  is,  generally  speaking, 
no  withholding  at  the  source  on  payments  to  citizens  and  resi- 
dents of  this  country  and  it  follows  that  there  is  no  withholding 
at  the  source  in  the  case  of  a  fiduciary  who  is  a  citizen  or  a 
resident,  or  has  an  office  or  place  of  business  in  this  country. 
The  one  exception  to  this  rule  is  the  withholding  of  a  tax  equal 
to  2%  on  interest  paid  on  obligations  of  corporations  containing 
a  tax-free  covenant.  In  such  cases  the  tax  is  in  theory 
withheld,  but  not  in  actual  fact,  since  the  paying  corporation 
assumes  the  burden  of  the  tax,  paying  the  interest  in  full  to 
its  bondholder.  Although  the  fiduciary  may  be  a  corporation,  in 
its  capacity  as  fiduciary  it  is  subject  to  the  provisions  of  law 
applicable  to  individuals  and  not  to  corporations ;  hence  on  pay- 
ments of  such  interest  as  that  referred  to  in  the  preceding  sen- 
tence, the  paying  corporation  will  be  required  to  treat  the 
corporation  fiduciary  as  an  individual  and  assume  the  burden 
of  the  2%  tax.i«'' 

Withholding  at  the  Source  by  Fiduciaries.  A  fiduciary  is  ex- 
pressly required  to  withhold  the  tax  at  the  source  in  the  same 
cases  in  which  individuals,  corporations  and  partnerships  are 
required  so  to  do ;  that  is,  the  tax  must  be  withheld  at  the  source 
by  a  fiduciary  upon  all  annual  or  periodical  payments  of  fixed 
and  determinable  income  to  nonresident  aliens  and  nonresident 
foreign  corporations.^^* 

101  O.  D.  292,  T.  B.  23-19-547.  The  personal  returns  are  filed  on  Forms 
1040  (revised)  or  1040  (a)  (revised).  The  ancillary  executor  should  also 
file  a  withholding  return  on  Form  1042  (revised)  accompanied  by  certi- 
ficate 1098   (revised). 

ifi2  O.  D.  584,  T.  B.  28-20-1060. 

163  See   Chapter  40. 

IM  See  Chapter  40. 


FIDUCIARIES  ^^^ 


Information  at  the  Source.  Fiduciaries  are  expressly  subject 
to  all  the  provisions  of  the  law  requiring  mtormat.on  at  the 
source  These  requirements  are  discussed  in  full  in  a  .subsequent 
chapter"-  A  fiduciary  is  required  to  file  with  h,s  return  on 
Form  1041,  an  information  return  on  Form  109'J.  covering  the 
di°tdbutabe  .share  of  each  beneficiary,  regardless  of  the  amount 
or  character  of  the  income  comprising  such  distributable  share. 
This  is  true  even  though  the  entire  income  of  the  estate  consist 
If  div  dends  which  may  be  taken  as  a  credit  agamst  the  normal 

tax  in  the  case  of  individuals  or  deducted  by  corporations  •"■ 
Penalties     The  law  provides  that  fiduciaries  required  to  make 

reU^    'hall  be  subject  to  all  the  provisions  which  apply  to 

Ind    "duals  "^      Fiduciaries  are   liable   to   the   same   penalties, 
0     arTs  thev  are  applicable,  a.s  those  which  may  attach  to 

IndfvWuals     These  penalties  are  discussed  at  length  in  another 

'^Foreigr  Fiduciaries.  The  term  "foreign  fiduciary"  as  here 
used  means  a  fiduciary  who  neither  resides  in  this  countty  no. 
hat  an  office  or  place  of  business  here,  that  -•  o"-f  1  ^^ - 
within  the  iurisdiction  of  this  government.    The  law  Pro^'ae^ 

ha^'-fidutiiries  required  to  make  i.turns  muler^his  act  shaH 
ua  «,ihipct  to   all  the  provisions  of  this  act  which   appiy   i" 

n^di  SI"-'     The  la^.  implies  that  foreign  Mucianessha, 
be  subject  to  its  provisions  to  the  same  extent  as  nonresident 

''trusIes'tTtes.    The  trust  estate  under  the  control  of  a  for- 

-"  -  thTn  ir^ruC  '-:i:i:=^^ 
^EHSSr^  =i-  =ty  i:t^^ 

nonresident  aliens.         i  relating  to   fiduciaries   in 

fiduciary  are  governed  by  the  luies  reiauug 

* 

if.5  See  Chapter  39. 

i<!«0.  D.  575,  T.  B.  27-20-1045.  a   ,  „f  ioiq    5  2" 5 

.    X     4;  1001    s  99t^   (h^  ■  Revenue  Act  01  ivn»,  s  ^-•'• 
Um  Revenue  Act  of  1921,  § /^o   {O)  ,  ivevcuuc 

i<>>^  See  Chapter  36.  ,  .,0,0    <-:>2b 

..Revenue  Act  of  1921,  §225   (b);  ^-e-e  Act  o     l^^^^  -^  ^^  ^.^ 

170  See  Chapter  4.  In  state  ex  re  .  W^^,^«"""  ^^^^f^t^^liJ-Jd  interest  upon 
56,  159  N.  W.  630,  it  was  held  that  f^^f/^JlZ^^^^^^^^^^^  or  corpo- 

notes,  mortgages,  etc.,  received  by  a  ^^^fjf ";  \\"^^i  \h,  tru.t  fund,  were 
ration)  as  a  gain  or  profit  from  ^^.^J^^'!^.^;"^';';'^,"!;,  though  the  person 
taxable  as  income  from  sources  withm  ^  ^^«"^  "'  7"  ^^  ,,,',  ,,as  a  non- 
entitled  to  the  enjoyment  and  to  whom  ^^y^^'\ll  ^J'the  three  trustees 
resident  and  also  a  co-trustee  -^.;;j.  ^^^^f  ^^rheld  to  be  the  recipient 
resided  without  the  state.  The  ^f/^^"!^^ ^'^'f^, B^^.^eld  Co.  v.  Pishon,  162 
of  the  income.  It  has  also  been  held  -  W.scons  n  (Ba>fie  d  Co  ^^^^^^^^^ 
Wis.  466,  156N.W.463)  that  where  income  of  a  nonie.ia 


150  FEDERAL  INCOME  TAX 

general,  except  so  far  as  they  are  limited  by  rules  relating  to 
the  deductions  allowed  to  nonresident  aliens.  The  same  rules 
applicable  to  domestic  fiduciaries  with  respect  to  "distributed" 
and  "undistributed"  income  apply  to  foreign  fiduciaries.  Non- 
resident alien  fiduciaries  of  trusts  subject  to  the  jurisdiction 
of  a  foreign  country  are  taxable  on  undistributed  net  income 
from  sources  within  the  United  States,  irrespective  of  the  fact 
that  the  creator  of  the  trust  or  estate  may  be  either  a  citizen 
or  resident  of  the  United  States  or  a  nonresident  alien  and  the 
beneficiaries  may  be  either  citizens  or  residents  of  the  United 
States  or  nonresident  aliens.  A  personal  exemption  allowed  a 
single  person  may  properly  be  claimed.^'!  The  income  of 
estates  in  process  of  administration  in  the  courts  of  a  foreign 
country  by  nonresident  alien  fiduciaries  is  taxable  as  an  entity  in 
so  far  as  the  income  received  is  from  sources  within  the  United 
States,  irrespective  of  the  fact  that  the  decedent  may  have  been 
either  a  nonresident  alien  or  citizen  of  the  United  States  and 
the  beneficiaries  in  the  distribution  may  be  either  nonresident 
aliens  or  citizens  or  residents  of  the  United  States.  The  same 
specific  exemption  as  provided  for  above  may  be  claimed. i"- 

Returns  of  Foreign  Fiduciaries.  Under  the  law  a  foreign 
fiduciary  is  required  to  make  under  oath  a  return  for  the  in- 
dividual, estate  or  trust  for  which  he  acts,  stating  specifically 
the  items  of  the  gross  income  received  from  sources  within  this 
country,  and  the  deductions  and  credits  allowed  by  the  law, 
and  the  respective  shares  distributable  to  beneficiaries.  The 
fiduciary  is  required  to  make  oath  that  he  has  sufficient  knowl- 
edge of  the  affairs  of  the  individual,  estate  or  trust  for  which 
he  acts  to  enable  him  to  make  the  return,  and  that  the  same  is, 
to  the  best  of  his  knowledge  and  belief,  true  and  correct.!^''  In 
making  the  return  he  should  comply  with  the  law  and  regulations 
respecting  returns  by  nonresident  aliens. 

Where  Filed.  In  the  case  of  foreign  fiduciaries  the  return 
should  be  filed  with  the  collector  at  Baltimore,  Maryland. i*"^ 

trustee  was  derived  from  sources  without  the  state,  the  fact  that  the  trust 
was  being  administered  by  a  Wisconsin  court  was  insufficient  to  subject  the 
income  to  tax;  that  it  was  not  sufficient  that  "sources"  be  constructively 
within  the  state. 

171  Under  the  1918  Law  such  exemption  including  the  credit  for  depend- 
ents might  be  claimed  only  provided  the  fiduciary  was  a  citizen  or  subject 
of  a  country  which,  if  it  imposed  an  income  tax,  allowed  a  similar  credit 
to  citizens  of  the  United  States  not  residing  in  such  country. 

172  A.  R.  M.  37,  T.  B.  13-20-810. 

173  Revenue  Act  of  1921,  §225;   Revenue  Act  of  1918,  §225. 

174  Revenue  Act  of  1921,  §227   (b)  ;  Revenue  Act  of  1918,  §227   (b). 


FIDUCIARIES 


151 


WHEN  Filed.  Returns  of  foreign  fiduciaries  are  filed  at  the 
same  time  as  those  of  nonresident  aliens. i"''  The  same  general 
rules  are  applicable  to  the  filing  of  returns  by  nonresident 
aliens  and  by  foreign  fiduciaries.  The  same  extensions  of  time 
may  be  granted  and  the  same  penalties  imposed  for  neglect  or 
failure  to  file.'"'' 

Withholding  at  the  Source  Against  F^oreign  Fiduciaries. 
The  provisions  with  respect  to  withholding  the  tax  at  the  source 
apply,  in  the  case  of  payments  to  foreign  fiduciaries,  in  the 
same  manner  as  in  the  case  of  payments  to  nonresident  aliens. 
A  foreign  fiduciary  may  not  receive  the  benefit  of  the  specific 
exemption  by  filing  a  claim  therefor  with  the  withholding 
agent/ '^  and  cannot  otherwise  claim  exemption  from  withhold- 
ing of  the  tax  at  the  source.i"^  He  may  claim  the  benefit  of  de- 
ductions and  credits  and  obtain  a  refund  of  any  amounts  with- 
held in  excess  of  the  tax  liability  of  the  estate,  in  the  same 
manner  as  is  prescribed  with  respect  to  nonresident  alien  in- 
dividuals.^"^ 

Withholding  at  the  Source  by  Foreign  Fiduciaries.  Since 
a  foreign  fiduciary  is  not  personally  within  the  jurisdiction 
of  this  government,  the  requirements  imposed  upon  domestic 
or  resident  fiduciaries  to  withhold  the  tax  in  paying  income  to 
nonresident  aliens  do  not  apply  to  such  fiduciaries. 

Information  at  the  Source  of  Foreign  Fiduciaries.  A  for- 
eign fiduciary  is  under  no  duty  to  supply  the  government  with 
information  at  the  source  as  to  payments  made  to  others,  except 
so  far  as  information  is  supplied  with  respect  to  beneficiaries 
in  the  return  of  income. 

I7r.  Revenue  Act  of  1921,  §§  225  and  227  (a)  ;  Revenue  Act  of  1918,  §§  225 

and  227  (a). 

I7f,  See  Chapters  34  and  36. 

m  Revenue  Act  of  1921,  §217;  Revenue  Act  of  1918.  §217.  This  provi- 
sion of  the  law  authorizes  the  Commissioner  to  permit  nonresident  aliens  to 
claim  exemption  at  the  source,  but  no  such  permission  has  been  frranted 
except  as  to  alien  employees.     See  Chapter  40.  ,„    ,a,^     i    t    c 

iTfl  Letter  from   treasury  department  dated  December  28,  IJIR;    1.    1.   b. 

1919,  Tl  546. 

170  See  Chapter  4. 


CHAPTER  7. 

FARMERS 

The  application  of  the  income  tax  law  in  the  case  of  farmers 
presents  certain  peculiar  difficulties  and  has  been  the  subject  of 
particular  consideration  on  the  part  of  the  treasury  department. 
A  number  of  rulings  and  regulations  relating  specifically  to  farms 
and  farming  have  resulted.^  These  rules  pertain  mainly  to 
special  items  of  a  farmer's  income,  the  methods  permitted  for  the 
computation  of  his  gross  income,  and  the  application  of  the 
statutory  deductions  to  the  transactions  usually  involved  in  the 
business  of  farming. 

Definition.  The  term  "farm"  is  defined  as  embracing  the 
farm  in  the  ordinarily  accepted  sense  and  includes  stock  farms, 
dairy  farms,  poultry  farms,  fruit  farms,  truck  farms,  plantations, 
ranches,  and  all  land  used  for  farming  operations;  and  the  term 
"farmer"  is  defined  as  all  corporations,  partnerships  or  indi- 
viduals who  cultivate,  operate,  or  manage  such  farms  for  gain 
or  profit,  either  as  owners  or  tenants.- 

"Gentlemen  Farmers."  A  person  cultivating  or  operating  a 
farm  for  recreation  or  pleasure,  and  not  upon  the  basis  of  the 
recognized  principles  of  commercial  farming,  the  usual  result  of 
which  is  a  loss  from  year  to  year,  is  not  regarded  as  a  farmer. 
In  such  cases,  if  the  operation  of  a  farm  results  in  a  net  gain 
for  the  year,  such  gain  must  be  reported  as  income.  If,  how- 
ever, the  expenses  and  losses  incurred  in  connection  with  the 
farm  are  in  excess  of  the  receipts  therefrom,  the  entire  receipts 
from  the  sale  of  products  may  be  ignored  in  rendering  a  return 
of  income ;  and  the  expenses,  being  regarded  as  personal  expenses, 
will  not  be  allowed  as  a  deduction  from  the  income  derived  from 
other  sources.^ 

1  Reg.  45,  Arts.  38,  110,  145,  171,  1586;  T.  D.  2665,  amending  T.  D.  2153; 
Reg.  33  Rev.,  Arts.  4  and  123. 

2  Reg.  45,  Art.  38;  T.  D.  2665. 

3  Reg.  45,  Arts.  38  and  110;  Reg.  33  Rev.,  Art.  4.  If  a  farmer  buys  a 
farm  which  is  much  run  down,  with  the  intention  of  making  it  a  profit  pay- 
ing property,  to  do  which  he  is  obliged  to  expend  large  amounts  for  labor 
in  plowing  and  cultivating  the  land,  for  fertilizer,  lime,  etc.,  so  that  for 
several  years  the  expenses  will  greatly  exceed  the  gross  receipts,  the  excess 
of  auch  expenses  over  such  receipts  may  be  claimed  as  a  loss  against  other 
income,  provided  the  farm  continues  to  be  operated  on  a  strictly  commercial 
basis.  (Income  Tax  Primer  for  Farmers,  Question  80.)  See  A.  R.  R.  249,  T. 
B.  35-20-1168. 

152 


FARMERS  153 

In  two  recent  cases  ^  the  question  arose  as  to  whether  certain 
taxpayers  owning  large  farms  were  engaged  in  the  business 
of  farming.  In  the  first  case,  the  phiintiff  owned  two  farms. 
The  first  farm  consisted  of  1300  acres — 900  of  woodland  and  400 
of  cultivated  land.  The  place  was  equipped  with  cow  barns, 
there  were  40  cows  and  there  was  evidence  of  it  being  a  cattle 
farm.  There  were  no  profits  from  the  farm,  although  there  was 
reasonable  probability  that  some  day  there  would  be.  The  plain- 
tiff was  held,  in  this  case,  to  be  carrying  on  the  business  of  a 
farmer.  The  second  farm  consisted  of  480  acres  and  only  70 
were  cultivated,  and  the  testimony  was  that  there  never  was 
a  profit  or  reasonable  expectancy  thereof,  that  the  expenses 
were  far  in  excess  of  what  legitimately  would  be  a  farm  venture 
and  that  the  raising  of  crops  was  more  of  a  hobby  than  a  busi- 
ness. The  court  sustained  the  finding  of  the  jury  that  the  plain- 
tiff could  not  be  said  to  be  carrying  on  the  business  of  farming 
with  respect  to  this  latter  farm.  In  the  second  case  two  questions 
were  submitted  to  the  jury;  (1)  was  the  plaintiff  engaged  in 
carrying  on  the  business  of  farming  and  (2)  were  the  expenses 
incurred  in  connection  with  such  farm  necessary  expenses  of 
carrying  on  business.  The  jury  answered  the  first  question  in 
the  aflfirmative  and  the  second  in  the  negative,  the  only  reason 
for  this  appearing  to  be  that  while  they  considered  the  plaintiff 
engaged  in  carrying  on  a  business,  they  also  considered  the  ex- 
penses to  be  so  gross  and  unreasonable  as  not  to  be  necessary. 
In  the  case  of  a  second  farm  owned  by  the  same  plaintiff,  the 
jury  found  that  he  was  merely  a  gentleman  farmer,  running  the 
place  as  a  forest  preserve  for  his  own  pleasure.  The  plaintiff 
also  had  an  office  in  New  York  city,  where  he  went  to  receive 
his  mail  and  through  which  he  contended  he  conducted  his  busi- 
ness of  farming.  The  jury,  strangely  enough,  found  in  this  con- 
nection that  the  expenses  of  the  office  were  necessary  expenses. 

Inventories.  Farmers  may  change  (without  formal  permis- 
sion) •''  the  basis  of  their  returns  from  that  of  receipts  and  dis- 
bursements to  that  of  an  inventory  basis,  which  necessitates  the 
use  of  opening  and  closing  inventories  for  the  year  in  which  the 
change  is  made.  There  should  be  included  in  the  opening  in- 
ventory all  farm  products  (including  live  stock)  purchased  or 
raised  which  were  on  hand  at  the  date  of  the  inventory,  and 
there  must  be  submitted  with  the  return  for  the  current  tax- 
able year  an  adjustment  sheet  for  1917  and  each  year  thereafter 

4  Fish  V.  Irwin  and  Chapin  v.   Irwin,  U.  S.  Dist.  Ct..  No.  Dist.  of  New 
York,  motions  to  set  aside  the  jury  verdicts  denied,  July  29.  1921. 
=■'0.  D.  841,  T.  B.  11-21-1504. 


154  FEDERAL  INCOME  TAX 

(prior  to  the  year  in  which  the  change  is  made)  based  on  the 
inventory  method;  upon  the  amount  of  which  adjustments  the 
tax  shall  be  assessed  and  paid  (if  any  be  due)  at  the  rate  of 
tax  in  effect  for  each  respective  year.  Where  it  is  impossible  to 
render  complete  inventories  from  the  beginning  of  the  taxable 
year  1917,  the  department  will  accept  estimates  which  in  its 
opinion  substantially  reflect  the  income,  on  the  inventory  basis, 
for  the  year  1917  and  thereafter;  but  inventories  must  not  in- 
clude real  estate,  buildings,  permanent  improvements,  or  any 
other  assets  subject  to  depreciation."  Adjustment  of  taxes  for 
years  prior  to  1917,  in  cases  in  which  farmers  change  to  the 
inventory  basis  in  rendering  their  income  tax  returns  for  the 
current  taxable  year,  is  not  required,  because  in  most  cases 
records  for  such  prior  years  are  not  available.  If,  however, 
adequate  records  for  the  years  1915  and  1916  are  available,  ad- 
justments may  be  made  for  those  years  also.*^  Because  of  the 
difficulty  of  ascertaining  actual  cost  of  live  stock  and  other  farm 
products,  farmers  who  render  their  returns  upon  an  inventory 
basis  may,  at  their  option,  value  their  inventories  for  the  current 
taxable  year  according  to  the  "farm-price  method"  of  determining 
costs,  which  provides  for  a  valuation  of  inventories  at  market 
price  less  cost  of  mm'keting.  If  the  use  of  the  "farm-price 
method"  of  valuing  inventories  for  any  taxable  year  involves 
a  change  in  method  of  pricing  inventories  from  that  employed 
in  prior  years,  the  opening  inventory  for  the  taxable  year  in 
which  the  change  is  made  should  be  brought  in  at  the  same  value 
as  the  closing  inventory  for  the  preceding  taxable  year  (this 
being  the  same  in  effect  as  valuing  the  opening  inventory  on 
the  new  basis  and  crediting  income  with  the  excess  valuation 
brought  in).  If  such  valuation  of  the  opening  inventory  for  the 
taxable  year  in  which  the  change  is  made,  results  in  an  ab- 
normally large  income  for  that  year,  there  may  be  submitted 
with  the  return  for  such  taxable  year,  an  adjustment  sheet  for 
1917  and  each  year  thereafter  (prior  to  the  year  in  which  the 
change  is  made),  based  on  the  "farm-price  method"  of  valuing 
inventories;  upon  the  amount  of  which  adjustments  the  tax  will 
be  assessed  and  paid,  as  provided  above.  Where  returns  have 
been  made  in  which  the  taxable  net  income  has  been  computed 
upon  incomvlete  inventories,  the  abnormality  must  be  corrected 
by  submitting  with  the  return  for  the  current  taxable  year  an 
adjustment  sheet  for  1917  and  each  year  thereafter   (prior  to 

*5  Reg.  45,  Art.  1586. 

7  0.  D.  802,  T.  B.  7-21-1443. 


FARMERS  155 

the  year  in  which  the  change  is  made),  upon  which  such  adjust- 
ments shall  be  made  as  are  necessary  to  bring  the  closing  in- 
ventory for  the  preceding  year  into  agreement  with  the  opening 
complete  inventory  for  the  current  taxable  year;  upon  the 
amount  of  which  adjustments  the  tax  will  be  assessed  and  paid, 
as  provided  above.*^  The  above  regulations  and  rulings  are  in- 
tended to  revoke  all  previous  rulings  and  instructions  inconsistent 
therewith.  Where  a  change  is  made  by  farmers  in  the  basis 
of  making  their  returns  from  that  of  cash  receipts  and  disburse- 
ments to  that  of  an  accrual  basis  with  inventories,  many  items 
of  gross  income  and  deductions  may  be  duplicated  or  entirely 
omitted  as  a  result  of  the  change  unless  an  adjustment  is  made 
of  the  net  income  for  the  prior  years,  and  it  is  the  purpose  of 
the  above  provisions  requiring  an  adjustment  sheet  from  the 
beginning  of  the  taxable  year  1917  to  reduce  any  discrepancies 
caused  by  sucH  omissions  and  duplications  to  a  minimum  and 
properly  to  allocate  over  the  period  from  1917  to  date,  the  net 
difference  in  gain  or  loss  due  to  changing  from  a  cash  basis  to 
an  inventory  basis.  It  is  also  necessary  from  an  administrative 
standpoint  that  a  uniform  procedure  be  followed  in  such  cases. 
It  is,  therefore,  not  permissible  for  farmers  in  changing  to  the 
inventory  basis  of  making  their  returns  to  make  adjustments 
by  calculating  their  net  income  for  the  current  taxable  year 
without  taking  as  a  credit  the  inventory  of  live  stock,  crops,  and 
other  products  at  the  beginning  of  the  year  in  accordance  with 
the  instructions  on  page  4  of  Form  1040-F."  Opening  and  clos- 
ing inventories  for  the  years  from  1917  to  date  are  first  ascer- 
tained from  the  best  source  of  information  available,  and  the 
gross  income  of  each  year  is  adjusted  by  adding  or  subtracting, 
as  the  case  may  be,  the  additional  gain  or  loss  due  to  the  differ- 
ence between  the  opening  and  closing  inventory  in  each  year. 
A  separate  adjustment  sheet  should  be  made  for  each  year 
from  1917  to  date,  in  order  that  the  sheet  for  each  year  may 
be  attached  to  the  return  for  that  particular  year.  The  net  income 
is  then  adjusted  conformably,  and  from  this  information  the 
tax  on  each  return  is  recomputed  by  the  commissioner  at  the 
rate  at  which  the  tax  was  originally  computed. ^^  Florists  are  not 
required  to  use  inventories  of  growing  plants  for  the  purpose  of 
calculating  their  net  income  for  income  tax  purposes  and  should 
not  compute  the  cost  of  goods  sold  during  the  year  by  using 

s  Reg.  45,  Art.  1586. 

9  0.  D.  939,  T.  B.  23-21-1671;  O.  D.   1105,  T.  B.  47-21-1928. 

10  0.  D.  1105,  T.  B.  47-21-1928. 


156  FEDERAL  INCOME  TAX 

an  inventory  value  of  growing  plants  on  hand  at  the  beginning 
and  end  of  the  taxable  year.^i 

Accounting  on  an  Accrual  Basis.  Farmers  keeping  books  are 
required  to  report  their  income  on  the  cash  or  accrual  basis, 
according  to  the  method  of  accounting  employed  by  them  in 
keeping  their  books. ^^  jn  the  case  of  a  farmer  reporting  on  the 
accrual  basis,  (in  which  an  inventory  to  determine  profits  is 
used)  his  gross  profits  are  ascertained  by  adding  to  the  inventory 
value  of  live  stock  and  products  on  hand  at  the  end  of  the  year 
the  amount  received  from  the  sale  of  live  stock  and  products, 
and  miscellaneous  receipts  for  hire  of  teams,  machinery,  and 
the  like,  during  the  year,  and  deducting  from  this  sum  the 
inventory  value  of  live  stock  and  products  on  hand  at  the  begin- 
ning of  the  year  and  the  cost  of  live  stock  and  products  pur- 
chased during  the  year.  In  such  cases  all  live  stock  raised  or 
purchased  for  sale  should  be  included  in  the  inventory  at  their 
proper  valuation  determined  in  accordance  with  the  method 
authorized  and  adopted  for  the  purpose.  Also  live  stock  acquired 
for  draft,  breeding,  or  dairy  purposes  and  not  for  sale  may  be 
included  in  the  inventory,  instead  of  being  treated  as  capital 
assets  subject  to  depreciation,  provided  such  practice  is  followed 
consistently  by  the  taxpayer.  In  case  of  the  sale  of  any  live 
stock  included  in  an  inventory  their  cost  must  not  be  taken  as 
an  additional  deduction  in  the  return  of  income,  as  such  deduc- 
tion will  be  reflected  in  the  inventory, ^-"^ 

Farmers  Not  Keeping  Books  and  Not  Taking  Inventories.  All 
farmers  not  keeping  books  and  not  taking  inventories  must 
report  on  the  basis  of  actual  receipts  and  disbursements,  in  order 
that  their  returns  may  permit  of  audit  for  the  purpose  of  verifica- 
tion."^^ 

Income.  The  income  of  a  farmer  may  be  in  cash  or  in  kind; 
that  is,  like  the  income  of  any  other  individual  or  corporation 
subject  to  tax,  it  may  consist  of  money  or  of  a  money  equivalent. 
In  general,  the  income  of  a  farmer  may  be  said  to  be  determined 
according  to  the  same  principles  which  determine  the  income 
of  other  taxable  individuals  or  corporations,  but  certain  special 
rules  are  set  forth  in  the  following  paragraphs. 

11  0.  D.  995,  T.  B.  34-21-1774. 

12  Revenue  Act  of  1921,  §212;  Revenue  Act  of  1918,  §212;  T.  D.  2665; 
T.  D.  2433.     This  subject  is  discussed  in  Chapter  33. 

13  Reg.  45,  Art.   38. 

14  T.  D.  2665.    See  Chapter  33. 


FARMERS  157 

Value  of  Products  Consumed  by  Farmer.  A  farmer  is  not 
required  to  report  as  income  the  value  of  farm  products  con- 
sumed by  himself  and  family.^"' 

Income  from  Rents  Received  in  Kind.  Rents  received  in 
crop  shares  are  to  be  reported  as  income  for  the  year  in  which 
the  crop  shares  are  sold  or  otherwise  reduced  to  money  or  a 
money  equivalent.^*^ 

Income  from  Sale  or  Exchange  of  Annual  Produce.  All 
gains,  profits  and  income  derived  from  the  sale  of  annual  produce, 
whether  produced  on  the  farm  or  purchased  and  resold  by  the 
farmer,  must  be  reported  as  income  for  the  year  in  which  the 
product  is  actually  marketed  and  sold,  unless  an  inventory  is 
used.^*"  Where  a  farmer  exchanges  farm  produce  for  merchandise, 
groceries,  or  mill  products,  the  market  value  of  the  article  or 
property  received  should  be  reported  as  income. '"'  Where  a 
farmer  purchases  for  a  certain  price  land  together  with  crops 
growing  thereon,  the  basis  for  determining  gain  or  loss  upon 
a  subsequent  sale  of  the  crops  is  the  difference  between  the 
cost,  or  if  no  part  of  the  purchase  price  was  assigned  to  the 
crops,  the  fair  market  value  thereof  at  the  time  of  purchase, 
and  the  selling  price  less  cost  of  harvesting  and  marketing. i-' 

Income  from  Sale  of  Live  Stock.  For  the  purpose  of  this 
discussion  live  stock  may  be  divided  into  three  classes:  (1)  live 
stock  raised  on  the  farm,  (2)  live  stock  purchased  by  the  farmer 
for  the  purpose  of  resale  at  a  later  time,  and  (3)  live  stock 
raised  or  purchased  for  draft,  breeding  or  dairy  purposes,  or 
any  purpose  other  than  resale.     Where  a  farmer  keeps  books 

13  T.  D.  2665.  Under  this  rule  a  farmer  may  use  100  bushels  of  potatoes 
for  himself  and  family  without  being  subject  to  tax,  but  if  he  should 
sell  the  potatoes,  and  use  the  proceeds  in  buying  other  potatoes  for  his 
family,  he  would  be  taxable.  The  rule  seems  incongruous,  but  may  be  the 
only  practicable  one  under  the  circumstances.  Speaking  of  a  somewhat 
similar  provision  of  the  Hawaiian  law  the  court  said  in  Robertson  v.  Pratt, 
13  Haw.  590:  "  *  *  *  tax  laws  must  be  practical.  It  would  be  next 
to  impossible  for  everyone  to  keep  an  account  and  estimate  the  value  of 
everything   he  produced  and  consumed." 

K'-Reg.  45,  Art.  38;  Reg.  33  Rev.,  Art.  4. 

17  Reg.  45,  Art.  38;  T.  D.  2665.  The  sale  of  crops,  dairy  products,  eggs 
and  fruit,  falls  within  this  rule.  (See  Income  Tax  Primer  for  Farmers. 
Question  30.) 

18  Reg.  45,  Art.  38;  T.  D.  2665.  The  rulings  do  not  cover  cases  where 
farm  products  are  exchanged  or  bartered  for  other  articles  or  property 
having  no  definitely  ascertainable  market  value,  as  for  instance,  the  ex- 
change of  one  horse  for  another,  and  it  would  seem  no  taxable  income  ac- 
crues to  either  party  in  such  transaction.    See  Chapter  14. 

19  0.  D.  714,  T.  B.  45-20-1285. 


158  FEDERAL  INCOME  TAX 

and  carries  the  value  of  his  live  stock  in  annual  inventories,  the 
total  amount  received  on  the  sale  of  any  such  stock  should  be 
entered  on  his  books  as  gross  receipts,  and  the  income  therefrom 
will  be  reflected  through  the  inventories.-^  Where  the  farmer 
does  not  keep  books  and  take  inventories,  the  profit  or  income 
from  the  sale  of  live  stock  is,  generally  speaking,  the  difference 
between  the  cost  thereof  and  the  amount  received  on  the  sale.^i 
This  general  rule  is,  however,  subject  to  several  qualifications 
or  exceptions,  as  follows:  (a)  When  the  live  stock  was  owned 
on  March  1,  1913.  For  the  purpose  of  determining  gain  or  loss 
from  the  sale  or  exchange  of  live  stock  owned  on  March  1,  1913, 
the  basis  is  the  cost  of  such  live  stock.  But  when  its  fair 
market  value  as  of  that  date  is  in  excess  of  its  cost,  the  gain 
which  is  taxable  is  the  excess  of  the  amount  realized  therefor 
over  such  fair  market  value.  Where  its  fair  market  value  as 
of  that  date  is  lower  than  its  cost,  the  deductible  loss  is  the 
excess  of  such  fair  market  value  over  the  amount  realized 
therefor.  No  gain  or  loss  is  recognized  in  the  case  of  live  stock 
sold  or  exchanged  (a)  at  more  than  cost,  but  at  less  than  its 
fair  market  value  as  of  March  1,  1913,  or  (b)  at  less  than  cost, 
but  at  more  than  its  fair  market  value  as  of  March  1,  1913.— 

(b)  When  the  live  stock  was  raised  on  the  farm.  If  the  live 
stock  was  raised  on  the  farm,  the  farmer  has  no  purchase  price 
to  deduct  and  the  entire  selling  price  is  income,  unless  the  live 
stock  was  owned  on  March  1,  1913,  in  which  case  the  rules  stated 
in  the  preceding  paragraph  will  apply.  The  cost  of  raising  such 
stock  is  not  deducted  from  the  selling  price,  since  such  cost 
is  an  item  of  annual  expense,  which  should  be  deducted  from 
year  to  year,  as  incurred. 

(c)  When  the  live  stock  has  been  purchased.  When  the  live 
stock  has  been  purchased,  the  purchase  price  thereof  should 
be  deducted  from  the  selling  price,  unless  the  stock  was  acquired 
before  March  1,  1913,  in  which  case  the  rules  stated  in  paragraph 
(a)  above  will  apply.  The  expense  of  care,  feeding  and  marketing 
such  stock  is  not  deducted  from  the  selling  price,  but  is  treated 
as  an  item  of  annual  expense.23  A  special  rule  may  apply  in 
the  cases  referred  to  in  this  paragraph.    Under  a  former  regula- 

20  T.  D.  2665.  The  rulings  require  the  value  of  live  stock  raised  on  the 
farm  to  be  carried  in  inventory. 

21  Reg.  45,  Art.  38.  Of  course,  if  the  selling  price  is  less  than  the  cost 
the  result  will  be  a  loss. 

22  Revenue  Act  of  1918,  §  202.  See  Reg.  45,  Art.  1561,  as  amended  by 
T.  D.  3206,  T.  B.  33-21-1767.    See  Chapter  17. 

23  T.  D.  2665. 


FARMERS  159 

tion  of  the  treasury  department-^  a  farmer  was  permitted  to 
charge  to  expense  the  cost  of  live  stock  purchased  for  resale. 
Where  the  cost  of  live  stock  has  been  charged  to  expense  and 
claimed  as  a  deduction  under  that  regulation  in  any  past  year, 
the  entire  proceeds  from  the  sale  of  such  live  stock  must  be 
returned  as  income  for  the  reason  that  the  farmer  is  not  again 
entitled  to  the  benefit  of  a  deduction  which  he  has  already 
received.-'' 

(d)  Live  stock  used  for  draft,  breeding  or  dairy  purposes. 
Where  live  stock  has  been  purchased  or  raised  for  draft,  breeding 
or  dairy  purposes,  and  is  sold,  the  income  is  ascertained  in  the 
manner  indicated  in  the  preceding  paragraph,  unless  the  farmer 
has  claimed  a  deduction  for  the  depreciation  of  such  stock  in  any 
year.-*^  In  such  cases  the  aggregate  amount  allowed  for  depre- 
ciation in  preceding  years  must  be  added  to  the  selling  price  in 
order  to  ascertain  the  taxable  profit.-"  Thus,  if  $35  has  been 
claimed  for  depreciation  in  each  of  three  years  on  a  horse  pur- 
chased for  $500  and  sold  for  $550,  the  taxable  profit  will  be 
ascertained  by  adding  the  depreciation  for  three  years,  amount- 
ing to  $105,  to  the  selling  price,  making  a  total  of  $655,  and  sub- 
tracting from  such  total  the  purchase  price  of  $500,  leaving  a 
taxable  profit  of  $155. 

Income  from  Sale  of  Other  Farm  Property.  Income  from 
the  sale  of  other  farm  property  should  be  reported  in  accord- 
ance with  the  general  rules  set  forth  in  another  chapter.-^  In 
every  case  of  the  sale  of  machinery,  farm  equipment,  or  other 
capital  assets  (which  are  not  to  be  included  in  an  inventory 
if  one  is  used  to  determine  profits)  any  excess  over  the  cost 
thereof  less  the  amount  of  depreciation  theretofore  sustained 
must  be  included  in  gross  income.'-"' 

Exchange  of  Farm  Property.  The  exchange  of  farm  lands 
in  all  cases  in  which  the  farm  land  exchanged  has  a  market 
value  has  been  held,  under  the  1918  Law,  to  constitute  a  com- 
pleted or  closed  transaction  from  which  a  gain  or  loss  is  realized, 

24  T.  D.  2153,  dated  February  12,  1915. 

25  T.  D.  2665,  Income  Tax  Primer  for  Farmers,  Question  30.  In  such 
cases,  however,  it  seems  the  return  for  the  year  in  which  the  stock  was 
purchased  might  be  amended  to. conform  to  present  rulings  and  the  return 
for  the  year  in  which  the  stock  was  sold  prepared  accordingly. 

26  Reg.  45,  Art.  38.     See  Chapter  26  for  the  rules  regarding  depreciation. 

27  Reg.  45,  Art.  38.    The  same  rule  applies  when  farm  machinery  is  sold. 

28  See  Chapter  17. 
20  Reg.  45,  Art.  38. 

30  O.  D.  429,  T.  B.  14-20-821.  See  Revenue  Act  of  1921,  §202.  See 
Chapter  17. 


160  FEDERAL  INCOME  TAX 

even  though  the  land  received  in  exchange  may  be  of  a  similar 
kind  and  of  similar  value.  A  different  rule  would  apply  under  the 
present  law."" 

Dividends  from  Co-operative  Associations.  All  dividends 
from  co-operative  associations  must  be  included  in  a  farmer's 
gross  income.  They  are  not  exempt  from  the  normal  tax  for 
the  reason  that  the  association  itself  is  not  taxed  upon  its  earn- 
ings. They  sim^ply  represent  additional  amounts  accruing  to  the 
farmer  upon  sales  through  the  association.  Dividends  from  co- 
operative buying  associations  are  to  be  treated  in  the  same 
manner  as  dividends  from  co-operative  selling  associations.^^ 

Proceeds  of  Insurance.  Proceeds  of  insurance,  such  as  hail 
and  fire  insurance,  on  growing  crops  should  be  included  in  gross 
income  to  the  amount  received  in  cash  or  its  equivalent  for  the 
crop  injured  or  destroyed."'- 

Income  from  Other  Sources.  If  the  cost  of  produce,  Kve 
stock  or  other  property  which  has  been  lost  or  destroyed  is 
deducted  as  a  loss  and  subsequently  the  farmer  is  reimbursed  in 
whole  or  in  part  by  the  state  or  federal  authorities  (e.'g.  where 
the  stock  has  been  killed  to  avoid  the  spreading  of  disease)  or 
by  insurance  or  indemnity,  the  amount  so  received  as  reimburse- 
ment is  income.^*^  This  contemplates  a  case  where  the  loss  may 
have  been  deducted  in  one  year  and  the  reimbursement  is 
received  in  another  year.  It  is  allowable,  however,  and  advisable 
that  no  loss  be  claimed  in  such  cases  until  the  reimbursement 
has  been  received,  as  until  that  time  the  net  loss  is  not  ascer- 
tainable. When  the  reimbursement  is  received,  it  should  then 
be  treated  the  same  as  if  it  represented  the  selling  price  and  the 
gain  or  loss  determined  according  to  the  rules  set  forth  in  the 
preceding  paragraphs  relative  to  sales.  If  a  farmer  works  out 
his  road  or  other  taxes  and  claims  such  taxes  as  a  deduction  he 
must  also  include  the  same  amount  as  income,  as  by  the  work 
he  earns  sufficient  to  pay  the  taxes.  If  he  does  not  claim  deduc- 
tion for  such  taxes  he  need  not  include  a  corresponding  amount 
as  income.  All  amounts  received  for  board  of  persons,  board  and 
pasturage  of  animals,  labor  of  men  and  teams,  and  the  hire  or  use 
of  machinery  must  be  reported  as  income  by  a  farmer."*^^ 

31  Income  Tax  Primer  for  Farmers,  Questions  49  and  50. 

32  Reg.  45,  Art.  38. 

33  Reg.  33  Rev.,  Arts.  4  and  123. 

3^  Income  Tax  Primer  for  Farmers,  Question  28.  These  items  are  reported 
under  the  head  of  "Income  From  Business  or  Profession"  on  the  Tax 
Return. 


FARMERS  161 

Computing  Income  Upon  Crop  Basis.  If  a  farmer  is  engaged 
in  producing  crops  which  take  more  than  a  year  from  the  time 
of  planting  to  the  time  of  gathering  and  disposing,  the  income 
therefrom  may  be  computed  upon  the  crop  basis ;  but  in  any  such 
case  the  entire  cost  of  producing  the  crop  must  be  taken  as  a 
deduction  in  the  year  in  which  the  gross  income  from  the  crop 
is  realized.'-"' 

Deductions.  The  special  rules  in  regard  to  the  deductions 
permitted  to  farmers  are  set  forth  in  the  following  paragraphs. 
In  the  case  of  statutory  deductions  not  treated  below  the  gen- 
eral rules  relative  to  all  taxpayers  apply. 

Expense.  A  farmer  who  operates  a  farm  for  profit  is  entitled 
to  deduct  from  gross  income  as  necessary  expenses  all  amounts 
actually  expended  in  the  carrying  on  of  the  business  of  farming. 
The  cost  of  ordinary  tools,  of  short  life  or  small  cost,  such  as 
hand  tools,  including  shovels,  rakes,  etc.,  may  be  included.  The 
purchase  of  a  cultivator  and  mowing  machine  constitute  im- 
provements. They  have  an  estimated  life  of  more  than  one  year 
and  payment  for  them  should  be  considered  a  capital  expendi- 
ture. A  reasonable  amount  of  depreciation  of  the  machines  may 
be  deducted  from  gross  income.  The  same  principles  apply  to  the 
purchase  of  a  threshing  machine.  The  cost  of  feeding  and  raising 
live  stock  may  be  treated  as  an  expense  deduction,  in  so  far  as 
such  cost  represents  actual  outlay,  but  not  including  the  value 
of  farm  produce  grown  upon  the  farm  or  the  labor  of  the  tax- 
payer. Where  a  farmer  is  engaged  in  producing  crops  which 
take  more  than  a  year  from  the  time  of  planting  to  the  process 
of  gathering  and  disposal,  expenses  deducted  may  be  determined 
upon  the  crop  basis,  and  such  deductions  must  be  taken  in  the 
year  in  which  the  gross  income  from  the  crop  has  been  realized. 
The  cost  of  farm  machinery  and  farm  buildings  represents  a 
capital  investment  and  is  not  an  allowable  deduction  as  an  item 
of  expense.  Amounts  expended  in  the  development  of  farms, 
orchards,  and  ranches  prior  to  the  time  when  the  productive 
state  is  reached  may  be  regarded  as  investments  of  capital.  An 
individual  bequeathed  to  his  widow,  for  the  teiTn  of  her  natural 
life,  various  orange  groves  in  Florida,  a  great  many  of  the 
trees  of  which,  during  a  severe  frost,  were  so  seriously  injured 
that  grafting,  special  fertilizing,  etc.,  had  to  be  resorted  to,  to 
restore  them,  in  spite  of  which  some  of  the  trees  died.  The 
widow  expended  a  sum  of  money  from  her  personal  income  for 
the  grafting  and  fertilizing.     It  has  been  held  that  the  amounts 

sr.  Reg.   45,  Art.   38. 


*/" 


162  '  FEDERAL  INCOME  TAX 

expended  are  properly  allowable  as  a  deduction  for  the  ordinary 
and  necessary  expense  of  business  but  the  widow  may  not 
deduct  any  amount  on  account  of  loss  of  trees  totally  destroyed 
since  while  the  loss  tends  to  reduce  the  income  of  the  estate, 
it  is  not  a  loss  to  the  life  tenant,  but  is  a  decrease  in  the  corpus 
of  the  estate.''^  The  amount  expended  in  purchasing  draft  or 
work  animals  or  live  stock,  either  for  resale  or  for  breeding 
purposes,  is  regarded  as  an  investment  of  capital.  The  pur- 
chase price  of  an  automobile,  even  when  wholly  used  in  carrying 
on  farming  operations,  is  not  deductible,  but  is  regarded  as 
an  investment  of  capital.  The  cost  of  gasoline,  repairs  and 
upkeep  of  an  automobile  if  used  wholly  in  the  business  of  farm- 
ing is  deductible  as  an  expense,  if  used  partly  for  business  pur- 
poses and  partly  for  the  pleasure  or  convenience  of  the  taxpayer 
or  his  family,  such  cost  may  be  apportioned  according  to  the 
extent  of  the  use  for  purposes  of  business  and  pleasure  or  con- 
venience, and  only  the  proportion  of  such  cost  justly  attributable 
to  business  purposes  is  deductible  as  a  necessary  expense.^^ 
Any  payments  which  a  farmer  is  compelled  to  make  as  a  result 
of  a  collision  between  his  automobile  and  a  vehicle  is  an  allow- 
able deduction  if  the  automobile  was  being  used  in  connection 
with  his  business  at  the  time  of  the  collision.  The  rule  is 
otherwise  if  he  was  riding  for  pleasure.^s  -phe  cost  of  digging 
irrigation  ditches  is  not  an  allowable  deduction,  but  the  cost  of 
repairing  such  ditches  may  be  deducted. 

Salaries.  Amounts  paid  to  a  male  employee  assisting  a  farmer 
in  operating  the  farm  are  an  allowable  deduction.    A  line  must 

S<>0.   D.   554,   T.   B.   25-20-1014. 

3T  Rev.  45,  Art.  110;  Income  Tax  Primer  for  Farmers,  Questions  59  and 
72.  Under  Reg.  33  Rev.,  Art.  4  and  T.  D.  2153,  dated  February  12,  1915, 
the  deduction  of  expenses  in  the  return  for  the  year  in  which  they  were 
made,  even  though  the  crops  and  stock  in  connection  with  which  they 
were  incurred  may  not  have  been  marketed  during  the  year  for  which  the 
return  was  rendered,  was  only  permissible.  Where  under  the  former 
rulings  a  farmer  had  not  deducted  the  cost  of  producing  the  farm  products 
he  might  deduct  the  same  from  the  selling  price  and  report  only  the  dif- 
ference as  income.  T.  D.  2665  limited  such  deduction  to  the  year  in  which 
the  expenditures  were  made.  The  above  ruling  in  relation  to  crops  which 
take  more  than  a  year  from  the  time  of  planting  to  the  process  of  gather- 
ing and  disposal  limits  the  deduction  to  the  year  in  which  the  gross  in- 
come from  the  crop  is  realized.  It  was  formerly  held  that  the  (^ost  of  stock 
purchased  for  resale  might,  at  the  option  of  the  farmer,  be  deducted  as  an 
expense,  or  taken  into  consideration  upon  the  sale  of  such  stock,  but  that 
money  expended  for  stock  for  breeding  purposes  was,  as  now,  to  be  re- 
garded as  capital  invested  and  therefore  not  deductible,  except  as  the  stock 
depreciated  in  value.     (See  also  Reg.  33  Rev.,  Arts.  4  and  123.) 

38  Income  Tax  Primer  for  Farmers,  Questions  71  and  73. 


FARMERS  163 

be  drawn  as  to  compensation  paid  to  a  female  employee  who 
assists  a  farmer  about  the  house.  If  her  time  is  employed  entirely 
in  taking  care  of  milk  and  cream  produced  for  sale,  in  the 
production  of  butter,  cheese,  etc.,  the  care  of  milk  cans  and 
churns,  or,  if  a  separate  table  is  maintained  for  laborers  em- 
ployed on  the  farm  and  her  services  are  used  entirely  in  the 
preparation  and  serving  of  the  meals  furnished  the  laborers 
and  in  caring  for  their  rooms,  the  compensation  paid  her  con- 
stitutes an  allowable  deduction.  If,  however,  she  is  employed 
to  assist  in  caring  for  the  farmer's  own  household,  no  deduc- 
tion can  be  claimed.  Salaries  paid  to  minor  children  may  not 
be  claimed  as  a  deduction."''' 

Irrigation  Company  Assessments.  In  California  and  other 
states,  fruit  growers,  ranchers  and  farmers-  are  shareholders  in 
irrigation  companies,  which  are  mutual  in  character,  and  they 
are  often  assessed,  in  proportion  to  their  holdings  of  stock,  for 
sufficient  amounts  to  make  repairs  to  the  irrigation  system,  clean- 
ing out  pipes,  laterals,  etc.  Such  assessments  can  be  claimed 
as  a  deduction  under  the  heading  of  business  expenses  where  ^ 
their  purpose  is  merely  to  raise  funds  to  keep  the  irrigation 
system  in  usable  condition,  and  not  to  make  extensions  and 
betterments.^" 

Taxes.  In  general,  the  rules  respecting  the  deduction  of  taxes 
by  farmers  are  the  same  as  the  rules  respecting  the  deducting  of 
taxes  by  other  individuals  or  corporations  subject  to  tax,  and 
are  discussed  elsewhere  in  this  book.^^  Farmers  who  work  out 
road  or  other  taxes  may  deduct  the  amount  thereof,  but  if  they 
do  so  they  must  also  report  the  same  amount  as  income. 

Losses.  Losses  incurred  in  the  operation  of  farms  as  business 
enterprises  are  deductible  from  gross  income.  If  farm  products 
are  held  for  favorable  markets,  no  deduction  on  account  of 
shrinkage  in  weight  or  physical  value  or  by  reason  of  deteriora- 
tion in  storage  will  be  allowed.  The  total  loss  by  frost,  storm, 
flood  or  fire  of  a  prospective  crop,  or  of  a  crop  which  has  not  been 
sold,  is  not  a  deductible  loss  in  computing  net  income.^-  In 
the  case  of  orchards  and  vineyards  acquired  subsequent  to 
March  1,  1913,  and  later,  destroyed  any  deduction  for  loss 
should  be  confined  to  the  amounts  of  capital  originally  invested 

^^  Income  Tax  Primer  for  Farmers,  Questions  (i(i  and  67. 

40  Income  Tax  Primer  for  Farmers,  Question  70. 

■11  See  Chapter  24. 

•*2  The  value  of  such  a  crop  has  never  entered  into  grross  income,  and  the 
cost  of  raising  the  same  is  deductible  as  a  necessary  expense.  (Income  Tax 
Primer  for  Farmers,  Question  78.) 


164  FEDERAL  INCOME  TAX 

in  the  growing  trees  and  in  the  new  nursery  stock  which  was 
totally  destroyed  and  the  amount  expended  from  date  of  acquire- 
ment to  date  of  destruction  in  an  endeavor  to  bring  such  trees 
and  stock  to  an  income-producing  stage,  if  not  previously  de- 
ducted as  expenses,  eliminating  all  expenditures  on  account  of 
permanent  improvements  or  on  account  of  trees  and  vines  the 
growth  of  which  was  merely  retarded  and  not  entirely  de- 
stroyed.'*-''' A  farmer  engaged  in  raising  and  selling  stock,  cattle, 
sheep,  horses,  etc.,  is  not  entitled  to  claim  as  a  loss  the  value 
of  animals  that  perish  from  among  those  animals  that  were 
raised  on  the  farm.  If  live  stock  has  been  purchased  for  any 
purpose,  and  afterwards  dies  from  disease,  exposure  or  injury, 
or  is  killed  by  order  of  the  authorities  of  a  state  of  the  United 
States,  the  actual  purchase  price  of  such  stock,  less  any  de- 
preciation which  may  have  been  previously  claimed  with  respect 
to  such  perished  live  stock,  less  also  any  insurance  or  indemnity 
recovered,  may  be  deducted  as  a  loss.  The  actual  cost  of  other 
property,  less  depreciation  already  allowed,  destroyed  by  order  of 
the  authorities  of  a  state  or  of  the  United  States  may,  in  like 
manner,  be  claim.ed  as  a  loss;  but  if  reimbursement  is  made  by 
a  state  or  the  United  States,  in  whole  or  in  part,  on  account  of 
stock  killed  or  property  destroyed,  the  amount  received  must 
be  reported  as  income  for  the  year  in  which  reimbursement  is 
made.  In  determining  the  cost  of  stock  for  the  purpose  of 
ascertaining  the  deductible  loss  there  shall  be  taken  into  account 
only  the  purchase  price,  and  not  the  cost  of  any  feed,  pasturage, 
or  care  which  has  been  deducted  as  an  expense  of  operation. 
If  an  individual  owns  and  operates  a  farm,  in  addition  to  being 
engaged  in  another  trade,  business,  or  calling,  and  sustains  a 
loss  from  such  operation  of  the  farm,  then  the  amount  of  loss 
sustained  may  be  deducted  from  gross  income  received  from 
all  sources,  provided  the  farm  is  not  operated  for  recreation 
or  pleasure.^^ 

Net  Losses.  A  farmer  who  in  1919  suffered  a  net  loss  may 
adjust  his  1918  tax  in  accordance  with  the  net  loss  provision  of 
the  Revenue  Act  of  1918.«  The  Revenue  Act  of  1921  has  extended 
the  net  loss  provision  so  that  it  now  applies  in  the  case  of  a  net 
loss  sustained  in  any  taxable  year  beginning  after  December 
31,  1920.46 

«0.  D.  374,  T.  B.  3-20-690. 

44  Reg.  45,  Art.  145;  Reg.  33  Rev.,  Arts.  4  and  123;  T.  D.  2665. 

45  O.  D.  558,  T.  B.  26-20-1025.  For  a  definition  of  the  term  "net  loss" 
and  the  procedure  under  §  204  of  the  Revenue  Act  of  1918,  see  Chapter  25. 

40  See  Chapter  25. 


FARMERS 


165 


Depreciation.    A  reasonable  allowance  for  depreciation  may 
be  claimed  on  farm  buildings   (other  than  a  dwelling  occupied 
by  the  owner),  farm  machinery,  and  other  physical  property, 
including  live  stock  purchased  for  draft,  dairy,  or  breeding  pur- 
poses, but  no  claim  for  depreciation  on  live  stock  raised  or  pur- 
chased for  resale  will  be  allowed.     If  an  inventory  is  not  used, 
a  reasonable  allowance  for  depreciation  may  be  claimed,  based 
upon  the  cost  and  the  estimated  life  of  draft  and  work  animals 
and  animals  kept  solely  for  breeding  purposes  and  not  for  re- 
sale.-*^    An  owner  of  an  orchard  which  has  reached  an  income- 
producing   stage   is   entitled   to   deduct   from   gross    income   an 
annual  allowance  for  depreciation,  based   upon   the   capital   in- 
vested, which  comprises  the  original  purchase  price  of  the  trees 
together  with  the  necessary  expenditures  incurred  in  bringing 
them  to  the  producing  age,  the  rate  of  depreciation  to  be  deter- 
mined by  the  average  life  of  the  trees  under  normal  conditions'^ 
Returns  of  Farmers.     Farmers  are  required  to  make  returns 
of  annual  income  or  special  returns  with  respect  to  withholding 
at  the  source,  information  at  the  source,  and  other  matters  in  the 
same  manner  and  according  to  the  same  rules  as  those  prevailing 
in  the  case  of  all  individuals  and  corporations.     This  subject  is 
treated  elsewhere  in   this  book.^»     In  addition   to   the   annual 
return  of  income,  farmers  who  either  keep  no  records  or  only 
records  of  cash  receipts  and  disbursements  are  required  to  pre- 
pare and  file  a  "schedule  of  farm  income  and  expenses"   (Form 
1040F) ,  copies  of  which  may  be  obtained  from  the  local  collector. 
Its  use  is  optional  with  other  farmers.^'" 

Payment  of  Tax;  Penalties.  Farmers  pay  the  tax  in  the  same 
manner  as  other  individuals  and  corporations.-^'^  They  are  also 
subject  to  all  the  penalties  which  may  be  imposed  upon  other 
individuals  and  corporations.''- 

47  Reg.  45,  Art.  171;  Reg.  33  Rev.,  Arts.  4  and  123.    For  the  rule  when 
an  inventory  is  used,  see  p.  153. 
4R0.  797,  T.  B.   1-19-52. 
40  See  Chapter  34. 
-"Ki  Reg.  45,  Art.  38. 
•"•1  See   Chapter  35. 
52  See  Chapter  36. 


CHAPTER  8. 

PARTNERSHIPS 

The  Revenue  Act  of  1921,  like  the  Revenue  Act  of  1918,  pro- 
vides^  that  individuals  carrying  on  business  in  partnership  shall 
be  liable  for  income  tax  only  in  their  individual  capacity  and 
that  there  shall  be  included  in  computing  the  net  income  of  each 
partner  his  distributive  share,  whether  distributed  or  not,  of 
the  net  income  of  the  partnership  for  the  taxable  year,  or  if  his 
net  income  is  computed  upon  the  basis  of  a  period  different 
from  the  basis  upon  which  the  net  income  of  the  partnership  is 
computed,  then  his  distributive  share  of  the  net  income  of  the 
partnership  for  any  annual  accounting  period  of  the  partnership 
ending  within  the  fiscal  or  calendar  year  upon  the  basis  of  which 
the  partner's  net  income  is  computed.-  The  Revenue  Act  of  1918 
contained  a  new  provision,  requiring  partnerships  to  file  returns 
for  each  taxable  year/*  The  Revenue  Act  of  1921  is  identical 
with  the  1918  Law  in  its  provisions  regarding  the  taxation  of 
partnerships.  All  rulings  and  regulations  promulgated  under 
the  1918  Law  will,  therefore,  be  authoritative  under  the  present 
law. 

Domestic  and  Foreign  Partnerships.  General  partnerships  are 
divided  into  two  classes,  domestic  and  foreign.  A  domestic  part- 
nership is  one  organized  or  created  in  the  United  States,  includ- 

1  Revenue  Act  of  1921,  §218  (a);  Revenue  Act  of  1918,  §218  (a). 
Partnerships  as  such  were  not  taxable  under  the  1916  Law,  the  partners 
thereof  being  taxable  in  their  individual  capacity.  (Revenue  Act  of  1916, 
§  8  (e)  ;  T.  D.  1957.)  Partnerships  were  expressly  excepted  from  the  tax 
on  corporations.  (Revenue  Act  of  1916,  §  10.)  In  U.  S.  v.  Coulby,  251  Fed. 
982,  affirmed  258  Fed.  27,  arising  under  the  1913  Law,  the  court  said  in  part: 
"This  law,  therefore,  ignores  for  taxing  purposes  the  existence  of  a  part- 
nership. The  law  is  so  framed  as  to  deal  with  the  gains  and  profits  of  a 
partnership  as  if  they  were  the  gains  and  profits  of  the  individual  partner. 
*  *  *  'p]^g  law  looks  through  the  fiction  of  a  partnership  and  treats 
its  profits  and  its  earnings  as  those  of  the  individual  taxpayer.  Unlike  a 
corporation,  a  partnership  has  no  legal  existence  aside  from  the  members 
who  compose  it.  The  Congress,  consequently,  it  would  seem,  ignored,  for 
taxing  purposes,  a  partnership's  existence  and  placed  the  individual  part- 
ner's share  in  its  gains  and  profits  on  the  same  footing  as  if  his  income  had 
been  received  directly  by  him  without  the  intervention  of  a  partnership 
name." 

-  See  page  187  as  to  rates  of  tax  applicable  where  the  fiscal  year  of  a  part- 
nership falls  in  calendar  year  in  which  rates  are  changed. 

3  See  Revenue  Act  of  1918,  §  224;  Revenue  Act  of  1921,  §  224. 

166 


PARTNERSHIPS  167 

ing  only  the  states,  the  territories  of  Alaska  and  Hawaii,  and 
the  District  of  Columbia,  and  a  foreign  partnership  is  one  organ- 
ized or  created  outside  the  United  States  as  so  defined.  In 
general,  the  nationality  or  residence  of  members  of  a  partnership 
does  not  affect  its  status.''  A  partnership  created  by  articles 
entered  into  in  San  Francisco  between  residents  of  the  United 
States  and   residents  of  China   is  a   domestic   partnership.^ 

Limited  Partnerships.  So-called  limited  partnerships  of  the 
type  authorized  by  the  statutes  of  New  York  and  most  of  the 
states  are  partnerships  and  not  corporations  within  the  mean- 
ing of  the  statute.  Such  limited  partnerships,  which  can  not 
limit  the  liability  of  the  general  partners,  although  the  special 
partners  enjoy  limited  liability  so  long  as  they  observe  the 
statutory  conditions,  which  are  dissolved  by  the  death  or  at- 

■i  The  Revenue  Act  of  1921  contains  a  new  provision  requiring  withhold- 
ing at  the  source  in  the  case  of  certain  income  paid  to  partnerships,  com- 
posed in  whole  or  in  part  of  nonresident  aliens  (Revenue  Act  of  1921, 
§221).   See  Chapter  40. 

5  Reg.  45,  Art.  1508.  According  to  this  definition  (which  is  practically 
unavoidable  in  view  of  the  definitions  contained  in  §  1  of  the  statute),  a  part- 
nership composed  entirely  of  citizens  and  residents  and  doing  all  its  business 
here  would  be  a  "foreign"  partnership  if  created  by  articles  entered  into 
in  a  foreign  country.  The  intention  of  the  parties  as  to  the  place  where 
the  principal  business  is  to  be  carried  on  (which  is  best  evidenced  by  the 
subsequent  acts  of  the  partnership)  would  seem  to  be  a  sounder  basis  for  a 
distinction  between  domestic  and  foreign  partnerships.  Thus,  a  domestic 
partnership  would  be  one  which  has  its  principal  place  of  business  in  this 
country  and  directs  all  or  the  greater  part  of  its  business  from  its  office 
or  offices  in  this  country,  whether  or  not  the  partners  are  citizens  or  aliens, 
residents  or  noni-esidents,  and  a  foreign  partnership  would  be  one  which  has 
its  principal  place  of  business  in  a  foi'eign  country  and  directs  all  or  the 
principal  part  of  its  business  from  its  office  outside  the  jurisdiction  of  the 
United  States,  whether  or  not  the  partners  are  citizens  or  aliens,  residents 
or  nonresidents.  The  1916  Law  expressly  mentioned  foreign  partnerships 
in  only  one  provision  (Revenue  Act  of  1916,  §  13  (e)  )  that  which  required 
the  withholding  of  the  tax  on  payments  of  income  from  interest  upon  bonds 
and  mortgages  or  deeds  of  trust  or  similar  obligations  of  domestic  or  other 
resident  corporations,  to  nonresident  alien  firms  and  copartnerships  not 
engaged  in  business  or  trade  within  the  United  States  and  not  having 
any  office  or  place  of  business  therein.  No  definition  of  the  term  "alien 
partnership"  was  given  in  the  law  or  was  to  be  found  in  the  regulations. 
The  law  also  referred  to  "nonresident  alien  firms"  and  to  "nonresident 
alien  copartnerships"  synonymously,  and  applied  the  terms  without  regard 
to  whether  or  not  the  firm  or  copartnership  was  engaged  in  business  or 
trade  within  the  United  States  or  had  an  office  or  place  of  business  in  this 
country.  The  term  may  be  argued  to  have  had  reference  to  the  status 
of  the  partners  composing  the  firm,  and  in  this  respect  it  was  indefinite 
as  a  firm  may  be  composed  of  nonresident  aliens  and  resident  aliens  or 
citizens. 


168  FEDERAL  INCOME  TAX 

tempted  transfer  of  the  interest  of  a  general  partner  and 
which  can  not  take  real  estate  or  sue  in  the  partnership  name, 
are  so  like  common-law  partnerships  as  to  render  impracticable 
any  differentiation  in  their  treatment  for  tax  purposes.  Illinois 
limited  partnerships  are  held  to  be  partnerships.  A  California 
special  partnership  is  a  partnership.  On  the  other  hand,  limited 
partnerships  of  the  type  of  partnerships  with  limited  liability 
or  partnership  associations  authorized  by  the  statutes  of  Penn- 
sylvania and  of  a  few  other  states  are  only  nominally  partner- 
ships. Such  so-called  limited  partnerships,  oifering  opportunity 
for  limiting  the  liability  of  all  the  members,  providing  for  the 
transferability  of  partnership  shares,  and  capable  of  holding 
real  estate  and  bringing  suit  in  the  common  name,  are  more 
truly  corporations  than  partnerships  and  must  make  returns 
of  income  and  pay  the  tax  as  corporations.  In  all  doubtful  cases 
limited  partnerships  will  be  treated  as  corporations  unless  they 
submit  satisfactory  proof  that  they  are  not  in  effect  so  organized. 
A  Michigan  partnership  is  a  corporation.  Such  a  corporation 
may  or  may  not  be  a  personal  service  corporation.^ 

6  Reg.  45,  Art.  1505,  Art.  1506  as  amended  by  T.  D.  2943.  In  Art.  1506 
as  first  promulgated  Virginia  partnership  associations,  also,  were  held  to  be 
corporations.  Under  the  1909  Law  it  was  held  that  a  limited  partnership  was 
liable  for  the  tax,  if  organized  for  profit  and  having  a  capital  stock  repre- 
sented by  shares,  although  no  "certificates  of  stock"  were  issued.  (Op. 
Atty.  Gen.  Feb.  14,  1910.)  Limited  Partnerships  were  first  broadly  and 
without  any  qualifications  held  to  be  in  the  same  category  as  corporations 
or  associations  under  the  1916  Law  and  subject  to  the  income  tax  imposed 
on  such  entities.  The  profits  of  limited  partnerships  so  reporting  were 
treated  as  dividends  and  were  not  subject  to  the  normal  tax  in  the  hands  of 
the  partners  receiving  them  but  were  subject  to  the  additional  or  sur- 
taxes in  the  hands  of  such  partners.  (Reg.  33  Rev.,  Art.  62;  Reg.  33,  Art. 
86;  T.  D.  2137.)  A  limited  partnership  was  defined  as  a  form  of  business 
organization  created  by  statute  in  many  of  the  United  States,  wherein 
the  liability  of  certain  special  partners,  who  contribute  a  specific  amount 
of  capital,  is  limited  to  the  amount  so  contributed,  while  the  general 
partners  of  the  same  partnership  are  jointly  and  severally  responsible 
as  in  ordinary  partnerships.  (Reg.  33  Rev.,  Art.  62.)  It  was  held  that  a 
limited  partnership  would  be  classed  as  a  quasi-corporation  or  association 
within  the  meaning  of  the  law.  In  a  letter  dated  January  19,  1916,  written 
with  particular  reference  to  limited  partnerships  of  the  type  created  under 
the  New  York  Statute,  Laws  of  1897,  Ch.  427;  §  3D,  the  treasury  depart- 
ment gave  its  reasons  for  classifying  limited  partnerships  with  corpo- 
rations. After  quoting  the  language  of  Revenue  Act  of  1916,  §10  (a), 
which  imposed  a  tax  on  "every  corporation,  joint-stock  company  or  associ- 
ation, or  insurance  company  *  *  *  but  not  including  partnerships" 
the  letter  stated  that  the  term  "partnership"  as  there  used  was  a  common- 
law  term  and  applied  only  to  such  partnerships  as  were  known  to  the 
common  law.     The  treasury  department  later  modified  this  ruling,  drawing 


PARTNERSHIPS  169 

In  addition,  the  following  types  of  limited  partnership  are  held 
not  to  be  taxable  as  corporations  or  associations:  1.  A  limited 
partnership  organized  under  the  laws  of  Mississippi."  2.  A 
partnership  organized  under  the  laws  of  Pennsylvania  which 
does  not  use  the  word  "limited"  in  the  firm  name,  has  no  pro- 
vision for  a  common  seal  or  for  limiting  the  liability  of  the 
members,  or  for  annual  meetings  of  the  partners,  but  which 
is  not  dissolved  by  the  death  of  one  or  more  partners, "*  where 
in  addition,  the  liability  of  only  one  partner  is  limited,  there 
is  no  provision  in  the  partnership  agreement  for  the  free  trans- 
ferability of  partnership  shares,  and  the  books  of  account  are 
to  be  open  and  accessible  to  each  of  the  copartners  at  any  time 
so  that  each  copartner  may  at  any  and  all  times  be  fully  cog- 
nizant and  aware  of  the  conduct  of  the  business,  has  been  held 
to  be  taxable  as  a  partnership.''  The  following  types  of  limited 
partnerships  are  held  to  be  taxable  as  corporations  or  associa- 
tions: 1.  A  partnership  association  or  limited  partnership  or- 
ganized under  the  Ohio  code.'"  2.  A  partnership  association  or 
limited  partnership  organized  under  the  Virginia  code  of  1904.^^ 

Partnership  Associations.  Under  the  1909  law  the  attor- 
ney-general held  that  partnership  associations  organized  under 

a  distinction  between  limited  partnerships  of  the  Pennsylvania  type  and 
New  York  type  and  holding  that,  for  purposes  of  the  income,  excess- 
profits  and  capital  stock  taxes,  limited  partnerships  of  the  New  York 
type  were  partnerships  and  limited  partnerships  of  the  Pennsylvania  type 
were  corporations  or  joint-stock  companies.  (T.  D.  2711;  letter  from 
treasury  department  dated  May  4,  1918;  I.  T.  S.  1918,  ^3355;  telegram 
from  treasury  department  dated  April  24,  1918;  I.  T.  S.  1918,  ^3325.) 

7  Hemingway's  Ann.  Miss.  Code  (1917),  §§  5467-5484.  See  S.  1165,  T. 
B.  20-19-501.  The  above  sections  of  the  Mississippi  Code  show  that  limited 
partnerships  formed  thereunder  are  similar  to  those  formed  under  the 
New  York  laws,  in  that  general  partners  are  not  afforded  limited  liability 
although  special  partners  do  enjoy  limited  liability  under  certain  condi- 
tions, and  further,  in  that  Mississippi  limited  partnerships  do  not  sue  in 
the  partnership  name  and  are  in  general  so  like  common-law  partnerships 
that  they  should  be  treated  as  such. 

^-  O.  D.  .599,  T.  B.  30-20-1084.  The  partnership  involved  in  this  case 
had  no  provision  for  the  free  transferability  of  the  interest  of  a  member. 
It  is  to  be  noted  that  as  a  general  rule  limited  partnerships  of  the  Penn- 
sylvania type  are  treated  for  income  tax  purposes  as  corporations.  See 
p.  168. 

9  0.  D.  800,  T.  B.  7-21-1440. 

1"§§  8059-8078;  see  O.  D.  444,  T.  B.  15-20-840. 

11  §§  2878-2886.  The  status  of  Virginia  limited  partnerships  formed  under 
the  Act  of  March  14,  1918,  must  be  determined  in  each  case  by  a  con- 
sideration of  the  certificate  of  partnership  and  other  pertinent  facts.  (0.  D. 
334,  T.  B.  29-19-671.) 


170  FEDERAL  INCOME  TAX 

the  laws  of  Pennsylvania  (referred  to  in  the  foregoing  paragraph 
as  limited  partnerships  of  the  Pennsylvania  type),  possessing 
every  privilege  and  power  essential  to  a  corporation  were  prop- 
erly taxable  as  corporations.^-  Such  associations  have  capital 
contributed  by  the  partners,  who  are  not  individually  liable 
beyond  the  unpaid  capital  subscribed  by  each.  The  other  charac- 
teristics of  such  associations  which  are  more  in  the  nature  of  a 
corporation  than  of  a  partnership  are  that  the  word  "Limited" 
must  be  a  sufRx  to  the  name,  the  interest  of  a  partner  may  be 
transferred  and  new  partners  may  be  taken  in  by  vote  of  a  ma- 
jority of  the  partners,  and  the  association  may  sue  or  be  sued 
in  the  association  name.  Michigan  partnership  associations  are 
of  this  type  and  are  held  to  be  taxable  as  corporations. ^^ 

Dividends  from  Limited  Partnerships.  The  profits  of  lim- 
ited partnerships  of  the  Pennsylvania  type  should  be  treated  by 
the  members  of  the  partnership  as  dividends  of  corporations  are 
treated  by  stockholders.^*  Members  of  limited  partnerships 
should  ascertain  if  the  partnership  is  paying  a  tax  according  to 
this  requirement,  and  if  so  the  normal  tax  should  not  again  be 
paid  on  their  shares  of  the  profits. 

Private  or  Partnership  Banks.  A  partnership  bank  con- 
ducted like  a  corporation  and  so  organized  that  the  interests  of 
its  members  may  be  transferred  without  the  consent  of  the  other 
members  is  a  joint-stock  company  or  association  within  the 
meaning  of  the  statute.  A  partnership  bank,  the  interests  of 
whose  members  can  not  be  so  transferred,  is  a  partnership.^^ 

Certain  persons  entered  into  an  agreement  to  carry  on  a  pri- 
vate banking  business.  Each  member  is  liable  for  all  debts,  and 
in  case  of  failure  no  "stockholder's"  property  is  exempt.  Profits 
are  divided  according  to  the  amount  each  member  has  contrib- 
uted. The  interests  of  members  are  represented  by  certificates 
which  can  not  be  disposed  of  without  the  consent  of  the  other 
members.  The  bank  has  been  taxed  as  a  partnership  in  the  state 
where  located.  Although  the  bank  issued  certificates  of  owner- 
ship, the  individuals  possessing  same  were  not  exempt  from  the 
payment  of  debts  of  the  bank  out  of  their  individual  property. 
The  fact  that  certificates  can  not  be  transferred  without  the  con- 
sent of  the  other  members  makes  it  appear  that  new  members  can 
only  get  into  the  organization  by  mutual  agreement,  and  that 

12  28  Op.  Atty.  Gen.  189   (1910). 

13  Reg.  45,  Art.  1506.    See  note  6. 

14  T.  D.  2137. 

15  Reg.  45,  Art.   1503;   T.  D.  2137. 


PARTNERSHIPS  171 

such  agreement  constituted  a  new  firm  upon  every  change  of  cer- 
tificate ownership.  It  was  held  that  the  bank  must  be  treated  as 
a  partnership  for  the  purpose  of  taxation.^'' 

Joint  Ownership  and  Joint  Adventure.  Joint  investment 
in  and  ownership  of  real  and  personal  property  not  used  in  the 
operation  of  any  trade  or  business  and  not  covered  by  any  part- 
nership agreement  does  not  constitute  a  partnership.  Co-owners 
of  oil  lands  engaged  in  the  joint  enterprise  of  developing  the 
property  through  a  common  agent  are  not  necessarily  partners. ^" 
It  has  been  held  that  several  persons  who  contributed  severally 
to  a  fund  used  to  develop  and  operate  an  oil  field,  with  an  agree- 
ment that  they  were  to  share  pro  rata  in  the  profits,  did  not  con- 
stitute a  partnership.!^  Participation  in  the  profits  of  an  enter- 
prise, while  one  of  the  well-known  tests  in  determining  whether 
any  given  agreement  constitutes  the  parties  thereto  partners,  is 
not  conclusive,  but  merely  raises  a  presumption  of  partnership.^^ 
It  has  been  held  in  several  oil  cases  that  no  presumption  of  part- 
nership between  co-owners  of  oil  lands  arises  from  the  fact  that 
they  are  jointly  engaged  in  producing  oil.-"  The  use  of  the  joint 
names  of  the  individuals  in  the  enterprise  operates  only  to  estop 
such  individuals  from  denying  a  partnership  liability  in  the  case 
of  third  parties  who  were  misled  and  dealt  with  the  finn  relying 
on  such  misrepresentation.  It  does  not  create  a  partnership 
where  one  does  not  exist.-'  The  intention  of  the  parties  as  gath- 
ered from  the  whole  circumstances  and  evidence  in  each  case 
should  be  considered.--  In  the  absence  of  special  facts  afl[irma- 
tively  showing  an  association  or  partnership,  where  a  vessel  is 
owned  by  several  individuals  and  operated  by  a  managing  owner 
or  agent  for  the  account  of  all,  the  relation  does  not  constitute 
either  a  joint-stock  association  or  a  partnership.-^  An  organiza- 
tion is  not  a  joint  venture  if  a  majority  in  interest  controls  the 
business,  has  authority  to  elect  a  manager  and  the  legal  title  to 
the  property  involved  is  in  trustees  for  the  benefit  of  a  syndicate 

16  0.  D.  1083,  T.  B.  44-21-1895. 

17  Reg.  45,  Art.  1507. 

18  Sol.  Op.  117,  T.  B.  33-21-1772. 

i9Meehan  v.  Valentine,  145  U.  S.  Gil;  Fechteler  v.  Palm  Bros.,  133  Fed. 
462. 

20Neill  V.  Shamburg,  158  Pa.  263,  27  Atl.  992;  Butler  Savings  Bank  v. 
Osborne,  159  Pa.  10,  28  Atl.  163;  Dunham  v.  Loverock,  158  Pa.  197,  27  Atl. 
990. 

21  Rowley  on  Partnership,  Tj  210. 

22  Shea  V.  Nilima,  133  Fed.  209;  In  re  Hirth,  189  Fed.  926. 

2.".  Reg.  45,  Art.  1507.  Art.  1507  of  Reg.  45  Rev.,  applies  to  situations 
arising  under  the  Revenue  Act  of  1917  and  1918  (0.  D.  411,  T.  B.  12-20-790). 


172  FEDERAL  INCOME  TAX 

and  not  the  particular  members,  the  organization  being  created 
expressly  for  the  purpose  of  preserving  the  real  estate  of  a  dis- 
solved corporation.-^  In  case  two  partnerships  enter  into  a  single 
adventure  under  an  agreement  to  terminate  in  two  years,  no  part 
of  the  profit  to  be  distributable  and  no  drawings  to  be  allowed 
during  such  period,  the  amount  of  profit  realized  and  determin- 
able each  taxable  year  should  be  reported  proportionately  in  the 
respective  returns  of  the  partnerships  regardless  of  the  agree- 
ment. The  individual  members  of  each  partnership  are  likewise 
subject  to  tax  each  year  on  their  distributive  shares  of  the  profit 
allocable  to  each  partnership.-'^  A  partnership  may  exist  in  a 
single  transaction  as  well  as  in  a  series  of  ventures,  or  an  estab- 
lished business.2c  Two  parties  on  several  occasions  had  engaged 
in  the  enterprise  of  buying  cattle  in  the  fall,  feeding  them  and 
selling  them  in  the  spring,  the  profits  being  equally  divided  be- 
tween them.  The  two  parties  paid  for  the  cattle  by  giving  the 
commission  merchants  their  joint  note,  secured  by  a  chattel  mort- 
gage on  the  cattle.  Feed  was  purchased  through  the  proceeds  of 
another  joint  note,  which  M^as  discounted  at  a  bank.  After  they 
were  sold  the  notes  were  taken  up  and  the  profits  divided  equally. 
The  same  procedure  had  been  followed  in  previous  years  and  it 
was  also  followed  in  subsequent  years.  In  one  of  the  later  years 
a  resulting  loss  was  borne  equally  by  the  two  parties.  There 
were  no  written  articles  of  partnership,  although  it  was  admitted 
that  the  commission  merchants  with  whom  they  dealt  probably 
considered  them  to  be  partners,  and  a  joint  bank  account  was 
maintained  in  the  names  of  both  parties.  The  treasury  depart- 
ment held  that  the  enterprise  was  taxable  as  a  partnership.-"^  A 
married  woman  may  become  a  partner  in  business  with  her  hus- 
band.28  The  participation  of  two  United  States  corporations  in 
a  joint  enterprise  or  adventure  does  not  constitute  them  part- 
ners.29  As  a  general  rule,  a  corporation  cannot  enter  into  a  part- 
nership for  the  reason  that  to  allow  a  corporation  to  do  so  would 
be  to  place  the  power  of  binding  the  corporation  in  hands  other 
than  the  duly  elected  directors  and  to  place  upon  the  stockholders 

24  0.  D.  896,  T.  B.  18-21-1603. 

25  O.  D.  187,  T.  B.  8-19-325. 

2f'18  L.  R.  A.  (N.  S.)  p.  976,  citing-  Flower  v.  Barnekoff,  20  Ore.  132, 
25  Pac.  370,  and  other  cases.  See  also  Spencer  v.  Jones,  92  Tex.  516,  50 
S.  W.  118. 

27  A.  R.  R.  257,  T.  B.  35-20-1160.     See  also  A.  R.  R.  629,  T.  B.  40-21-1850. 

28  A.  R.  R.  636,  T.  B.  41-21-1865. 
2tt  Reg.  45,  Art.  1507. 


PARTNERSHIPS  ^^'^ 


burdens  other  than  those  to  which  they  consent  ■■•"  A  corporation 
will  not  be  held  as  a  mining  partner  against  its  express  refusal  to 
be  liable  for  any  portion  of  the  expense  of  operation,  or  to  be 
responsible  for  the  operation  of  mining  property  in  which  it  has 
a  one-eighth  interest,  merely  because  it  receives  a  proportion  ol 
the  profits  realized  from  such  operation  equal  to  its  interest  in 
such  property ;5i  It  has  been  held  that  corporations  organized 
under  the  laws  of  Arkansas  may  not  become  members  of  a  part- 

nership  ^~ 

General   Partnerships.      A   general    partnership,    or   what    is 
known  as  a  common-law   partnership,   which   Congress   clearly 
intended  to  be  exempt  from  the  income  tax  law,  is  one  which 
does  not  have  a  separate  entity,  but  is  composed  of  two  or  more 
individuals  associated  together  for  the  purpose  of  carrying  on  a 
given  business  or  transaction.    Such  a  partnership  has  been  de- 
fined by  the  courts  as  "a  business  organization  in  which  every 
partner  possesses  full  power  and  absolute  authority  to  bind  all 
the  partners  by  his  acts  or  contracts  in  relation  to  the  business 
of  the  firm,  in  the  same  manner  and  to  the  same  extent  as  if  he 
held  full  power  of  attorney  from  them.""'^'-    Among  the  principal 
elements  of  a  general  partnership  are  community  of  ownership 
of  the  partnership  property,  mutual  responsibility  and  powers  in 
the  conduct  of  the  partnership  business,  mutual  liability,  30in, 

-,    ,.  .„    R     pn     fi2   U     S    441;    Thomas   v.   Railroad, 

sopearce   v.   Madison,   etc.    R.    Co.,   bz3    u.    "^^  ^*'-' 
-.m   TT    Q    71-  Pittsbure-h    etc.,  R.  Co.  v.  Keokuk,  etc.  Co.,  131    U.  b.  6ii., 
Z:^i:u"^r..  XO  G..av   58.;   A-^  ^^t  59^1  S  '  W  "S;: 

3.;  A.  R.  M.  139,  T.  B.  42-21-1866.  ,a,q,K    Thi,  letter 

»  Letter  from  treasury  department  dated  January  19,  1°'^-  J^'jjf  ^ 
.e>d  an  UmUed  partners.n>.  to  be  -por-;-^^;  ^ZTJTr:^  " 
rutirney'^n"  ^^  crfttc- tr^rn.  neither  ^^r^y^^-^ 

:eiv:^?r;aVn:rStpTr^^^^^^^^^ 

ex  Lnce  of  a  relation  of  mutual  agency  is  the  very  question  ^t  issue^  (See 
Bo\lTv  Wilson,  33  Ky.  L.  14,  108  S.  W.  914.  Thei.  .  ^re^^^^_ 
authority  in  the  American  decisions  on  ^^^  ^^^^  .^'^^  J^'t,^  ,^1:  to  third 
tion"  test  is  usually  applied  as  bet^voen  the  P«^^";^  ^J  J  ^^^^^  to  be 
persons  the  profit-sharing  test  is  o/ten  app  i  d.  ^0  0-*^^*  -em 
inclusive,  the  existence  of  a  Partnership  b  ng  a  Q-s  n  of  ^^^  ^P  ^ 
which  all  the  various  ^ests  may  bear.    (See  Meehan  v.  ^^_^^  ^^^ 

611;   Haiku  Sugar  Co.  v.  J°^"f.^°"^vf  „',  f ',,\'^^^^^^  foTits  debts.    Sharing 
ments  of  a  partnership  is  the  liability  of  ^  P^J*"^^  ;\    ^.^^,^tted  by  other 
of  profits  is  but  evi.lence  of  a  partnership  ^^^^^  ^^^^^^g    9  C.  B    N.  S. 
evidence  to  the  contrary.    (Cox  v.  Hickman,  8  H.  L.  C.  .b«. 
47;   Sol.  Op.  36,  T.  B.  36-20-1179.) 


174  FEDERAL  INCOME  TAX 

and  several,  for  the  debts  of  the  partnership  and  mutual  interest 
in  the  profits  of  the  same.  Such  partnerships  are  not  subject  to 
the  tax,  but  the  partners  are  taxed  on  their  respective  shares  of 
the  profits.^^ 

If  the  interests  of  members  of  an  organization  are  evidenced 
by  negotiable  certificates  and  the  organization  continues  despite 
the  death  of  a  member,  the  organization  is  not  a  partnership.-^^ 
An  agreement,  referred  to  as  "Articles  of  Partnership,"  by  the 
terms  of  which  two  individuals  associate  themselves  as  copart- 
ners in  business  under  the  name  of  A  (one  of  the  individuals)  & 
Company  for  the  period  of  five  years,  and  under  which  one  of  the 
so-called  partners  is  paid  the  same  salary  which  he  had  thereto- 
fore received  as  an  employee  from  the  other  individual,  one- 
fourth  of  said  salary  being  deductible  from  said  individual's 
share  of  the  profits,  and  which  provides  also  that  all  capital  is  to 
be  contributed  by  the  individual  whose  name  is  used  in  the  firm 
title,  three-fourths  of  the  profits  going  to  said  individual  and  one- 
fourth  (less  one-fourth  of  his  salary)  going  to  the  other  indi- 
vidual, losses  to  be  borne  by  the  partners  in  the  same  ratio  as 
profits  except  that  the  excess  of  losses  over  gains,  if  any,  are 
payable  by  the  individual  receiving  three-fourths  of  the  profits, 
the  business  to  be  carried  on  for  the  benefit  of  the  firm  by  the 
survivor  of  either  of  the  partners  until  the  close  of  the  current 
fiscal  year  in  which  the  other  partner  may  die,  and  upon  final 
settlement  the  entire  capital  of  the  partnership  and  any  increase 
thereof  to  go  to  the  individual  receiving  three-fourths  of  the 
profits,  or  his  estate,  is  held  to  be  a  partnership  under  the  laws 
of  Pennsylvania.-"^*^ 

Partnerships  Consisting  of  Corporations.  In  a  case  arising 
under  the  1913  law  several  corporations,  organized  under  the 
laws  of  Hawaii,  entered  into  a  partnership  with  one  another,  the 
laws  of  Hawaii  permitting  such  a  combination  for  the  transac- 
tion of  any  lawful  business.  The  by-laws  provided  for  manage- 
ment by  representatives  selected  by  the  several  partners,  who 
were  to  represent  the  partners  according  to  their  respective  in- 
terests. There  were  no  special  partners  and  there  was  no 
partnership  capital  stock.  The  by-laws  provided  for  the  exist- 
ence of  the  association  for  45  years  unless  sooner  terminated  by 
mutual  consent.    It  was  held  that  this  provision  did  not  show  any 

34  Revenue  Act  of  1921,  §218;  Revenue  Act  of  1918,  §218. 

35  O.  D.  896,  T.  B.  18-21-1603.  See  Chicago  T.  &  T.  Co.  v.  Smietanka,  275 
Fed.  60;  T.  D.  3193,  T.  B.  30-21-1741. 

36  S.  1361,  T.  B.  14-20-820. 


PARTNERSHIPS  175 

plan  for  changeability  in  the  membership;  that  dissolution  would 
probably  be  effected  through  the  transfer  of  any  partner's  inter- 
est; and  that  the  association  must  be  treated  for  income  tax 
purposes  as  a  partnership.-'"  But  the  participation  of  two  cor- 
porations in  a  joint  enterprise  would  not  constitute  them 
partners.-''^^ 

Partnerships  Operating  Abroad.  No  distinction  is  made  in  the 
law  or  regulations  between  domestic  partnerships  which  operate 
entirely  within  this  country  and  those  which  operate  partly 
abroad.  A  partner's  share  of  the  net  profits  of  the  partnership 
is  in  all  cases  taxable  in  full  if  the  partner  is  a  resident  or  citizen 
of  this  country.  If  a  partner  is  a  nonresident  alien  many  ques- 
tions arise  as  to  the  extent  to  which  he  is  properly  taxable  on  the 
gains  from  business  of  the  partnership  conducted  abroad.  If  the 
partnership  is  a  limited  partnership  association  under  the  pro- 
visions of  some  statute,  similar  to  the  Pennsylvania  statute,  the 
government  will  undoubtedly  hold  that  the  partner  is  taxable  to 
the  same  extent  as  though  it  were  a  corporation,  but  if  it  is  a 
general  partnership,  operating  partly  in  a  foreign  country,  the 
entire  income  therefrom  can  scarcely  be  considered  as  income 
arising  within  the  United  States,  even  though  the  partnership 
has  an  office  in  this  country  and  the  income  is  paid  to  the  partner 
from  that  office,  since  a  general  partnership  is  not  a  separate 
entity  interposed  between  the  individual  and  the  source  of  the 
income.2^ 

Procedure  in  Collecting  Income.  With  one  exception,  a  do- 
mestic partnership  is  not  subject  to  withholding  at  the  source. 
But  a  partnership  may  be  required  to  establish  its  identity  and 
status  by  filing  a  certificate  or  statement  showing  it  to  be  a  part- 
nership.'*" A  new  provision  first  inserted  in  the  Revenue  Act  of 
1918  and  continued  in  the  present  law  requires  withholding  at 
the  source  against  partnerships  in  the  case  of  interest  on  bonds, 
mortgages,  or  deeds  of  trust,  or  other  similar  obligations  con- 
taining a  so-called  "tax-free  covenant,"  thus  giving  partnerships 

"Haiku  Sugar  Co.  v.  Johnstone,  249  Fed.  103.  This  case  contains  a 
discussion  of  the  distinction  between  joint-stock  companies  and  partnerships. 

38  Reg.  45,  Art.  1507. 

sau.  S.  V.  Coulby,  251  Fed.  982,  affirmed  258  Fed.  27.  A  distinction  is 
made  by  the  treasury  department  under  the  1918  Law  between  domestic 
corporations  operating  entirely  within  this  country  and  those  operating 
entirely  abroad.    (Reg.  45,  Art.  92.) 

^0  Revenue  Act  of  1921,  §221;  T.  D.  1957,  T.  D.  1998;  telegram  from 
treasury  department  dated  May  17,  1918;  I.  T.  S.  1918,  113362.  See  Chapter 
40. 


176  FEDERAL  INCOME  TAX 

as  well  as  individuals  the  benefit  of  such  covenants.^^  Partner- 
ships as  well  as  all  other  recipients  of  income  will  be  required  to 
disclose  their  identity  in  the  case  of  receiving  fixed  and  deter- 
minable income  from  another  under  the  provisions  of  law  re- 
quiring information  at  the  source.^- 

Duty  in  Paying  Out  Income.  A  partnership  is  under  the  same 
duty  in  paying  out  income  as  is  an  individual  or  a  corporation; 
that  is,  in  all  cases  required  by  law  the  tax  must  be  withheld  on 
payments  of  income  to  nonresident  aliens,  partnerships  composed 
in  whole  or  in  part  of  nonresident  aliens,  and  nonresident  for- 
eign corporations,"^"'  and  information  as  to  the  name  and  address 
of  the  recipient  must  be  obtained  upon  the  payment  of  income  to 
other  individuals,  partnerships  or  corporations.^^ 

Net  Income  of  Partnerships.  The  net  income  of  a  partnership 
is  computed  in  the  same  manner  and  on  the  same  basis  as  the 
net  income  of  an  individual  except  that  a  partnership  is,  unlike 
individuals,  not  allowed  to  deduct  charitable  contributions  or 
gifts  made  within  the  taxable  year.^"'  The  proceeds  of  life  insur- 
ance policies  paid  upon  the  death  of  the  insured  to  partnership 
beneficiaries  need  not  be  included  in  the  gross  income  of  the  part- 
nership under  the  1918  lav/.^''     Under  the  present  law  the  pro- 

41  Revenue  Act  of  1921,  §221;  Revenue  Act  of  1918,  §221.  See  Chapter 
40. 

42  See  Chapter  39. 

43  Revenue  Act  of  1921,  §221;  Revenue  Act  of  1918,  §§221  and  237. 

44  See  Chapters  39  and  40. 

45  Revenue  Act  of  1921,  §  218  (c)  ;  Revenue  Act  of  1918,  §  218  (d)  ;  Reg. 
45,  Art.  321.  For  the  m&nner  of  computing  the  net  income  of  partner- 
ships under  the  1916  Law,  see  Reg.  33  Rev.,  Art.  30.  It  seems  that  the  part- 
ners may  consider  the  contributions  of  the  partnership  as  their  own  con- 
tributions, pro  rata.  Until  very  recently  the  rule  under  the  1916  Law  was 
that  partnerships  were  not  permitted  to  deduct  the  amount  of  their  Red 
Cross  contributions,  but  the  partners  in  computing  their  individual  in- 
come taxes  might  deduct  their  proportionate  amounts  of  such  contribu- 
tions subject,  of  course,  to  the  159r  limitation.  (Telegram  from  treasury 
department  dated  May  23,  1918;  I.  T.  S.  1918,  T13436.)  Certain  donations 
immediately  and  closely  connected  with  the  business  of  a  partnership  were 
held  deductible  under  the  1916  Law.  (Letter  from  the  treasury  department 
dated  May  23,  1918;  I.^  T.  S.  1921,  Tj  553.) 

It  is  now  ruled  that  partnerships  are  entitled  to  deduct,  under  the  1916 
Law,  as  amended  by  the  Revenue  Act  of  1917,  the  amount  of  their  charitable 
contributions  (including  contributions  to  the  Red  Cross)  even  though  such 
contributions  were  not  so  closely  connected  with  the  trade  or  business  as 
to  secure  to  it  some  definite  benefit  or  consideration,  subject,  of  course, 
to  the  15%  limitation  (A.  R.  R.  651,  Sol.  Op.  116,  T.  B.  45-21-1914).  This 
subject  is  more  fully  considered  in  a  later  paragraph. 

46  Letter  from  treasury  department  dated  November  18,  1919;  I.  T.  S. 
1921,  H 1208. 


PARTNERSHIPS  1'?'^ 

ceeds  of  life  insurance  policies  paid  upon  the  death  of  the  insured 
is  exempt  income  irrespective  of  who  the  beneficiary  may  be.^" 

Deductions.  The  deductions  to  which  a  partnership  is  entitled 
are  the  same  as  those  allowed  to  individuals  with  the  exception 
noted  in  the  preceding  paragraph.'^  In  the  case  of  limited  part- 
nerships of  the  Pennsylvania  type  reporting  as  corporations,  the 
deductions  should  be  made  under  the  rules  applicable  to  corpora- 
tions. An  individual  may  deduct  from  his  gross  income  the  ordi- 
nary and  necessary  expenses  of  his  business,  but  this  does  not 
permit  an  individual  who  is  a  member  of  a  partnership  to  deduct 
from  his  personal  income  any  amounts  expended  therefrom  for 
and  on  account  of  the  partnership.  The  individual  members  of 
a  partnership  and  the  partnership  itself  are  treated  separately 
for  income  tax  purposes,  and  the  individuals  comprising  the 
partnership  are  not  considered  to  be  engaged  in  the  business 
conducted  by  the  partnership  merely  because  they  are  members 
of  the  firm.^"  Certain  special  rulings  made  with  respect  to  de- 
ductions by  partnerships  are  given  below. 

Business  Expense.  Under  the  rules  of  various  exchanges, 
seats  must  be  issued  in  the  names  of  individuals  and  may  not 
be  issued  in  the  name  of  a  partnership.  In  the  case  of  a  part- 
nership which  purchased  seats  on  various  exchanges  from 
partnership  funds,  the  seats  being  issued  in  the  names  of  the 
individual  members  of  the  partnership,  who  might  buy  and  sell 
for  themselves  as  well  as  for  the  account  of  other  persons,  the 
amount  expended  being  charged  to  "membership  account"  and 
carried  as  a  capital  expenditure  on  the  partnership  books,  it  has 
been  held  that  the  amounts  so  expended  are  investments  of  capi- 
tal and  not  deductible  as  business  expenses."'*'  Where  by  the 
terms  of  a  partnership  agreement  one  of  the  members  of  the 
partnership  is  required  to  pay  out  of  his  own  funds  the  compen- 
sation of  one  of  the  employes  of  the  partnership  who  performs 
a  part  of  the  duties  delegated  to  said  member,  it  has  been  held 
that  the  amount  so  paid  constitutes  a  proper  deduction  in  the 
income  tax  return  of  the  member.-'^ 

Losses.  Where  a  corporation,  all  the  stock  of  which  is  owned 
by  a  partnership,  sustained  a  loss  for  each  of  the  years  from 

47  Revenue  Act  of  1921,  §213   (b)    (1). 

4S  Revenue  Act  of  1921,  §218  (c)  ;  Revenue  Act  of  1918,  §5?  218  (d).  ^\Z. 

49  o.  D.  593,  T.  B.  29-20-1073. 

50  O  D  473,  T  B.  17-20-885.  In  this  case  the  partnership  agreement 
contained 'no  provision  as  to  the  disposition  of  the  seats  upon  the  termi- 
nation of  the  partnership. 

r>i  O.  D.  947,  T.  B.  24-21-1686. 


178  FEDERAL  INCOME  TAX 

1915  to  1919  inclusive,  it  has  been  held  that  the  partnership  may 
not  reduce  its  income  by  transferring  partnership  funds  for  the 
purpose  of  liquidating  the  loss  of  the  corporation.  The  partner- 
ship and  corporation  are  separate  entities  and  no  provision 
exists  in  the  law  under  which  a  partnership  and  a  corporation 
may  file  consolidated  returns. s-  Where  on  July  1,  1920,  the  indi- 
viduals comprising  a  partnership  incorporated  and  acquired  the 
entire  capital  stock  in  payment  for  the  assets  of  the  partnership 
with  the  exception  of  a  few  shares  which  were  held  by  two  em- 
ployes, the  partnership  having  shown  a  profit  for  the  first  six 
months  of  the  year  while  for  the  last  six  months  the  return  of 
the  corporation  showed  a  loss,  it  has  been  held  that  the  loss  of 
the  corporation  is  not  deductible  in  computing  the  net  income  of 
the  predecessor  partnership  since  there  was  no  provision  in  the 
1918  law  for  the  taxing  of  partnership  profits  as  profits  of  a  suc- 
cessor corporation  where  the  corporation  comes  into  existence 
subsequent  to  July  1,  1919.^^^ 

Profit  Sharing.  It  has  been  held  that  an  arrangement 
whereby  a  partnership  agreed  with  an  expert  to  take  charge  of 
one  of  its  departments  upon  a  participation  of  profits  basis,  by 
which  the  expert  served  without  salary  and  received  his  compen- 
sation in  the  form  of  20%  of  the  net  profits  of  the  department 
at  the  end  of  the  year,  established  the  relation  of  employer  and 
employe,  and  that  the  compensation  paid  to  the  expert  consti- 
tuted a  proper  item  of  business  expense  to  be  deducted  in  com- 
puting the  net  income  accruing  to  the  partnership  members.** 

Insurance  Premiums.  Premiums  paid  on  life  insurance  poli- 
cies covering  the  life  of  an  officer,  employe  or  of  any  person 
financially  interested  in  any  business  conducted  as  a  partnership 
are  not  permitted  to  be  deducted  in  computing  the  profits  of  a 
partnership  for  the  purpose  of  determining  the  distributive 
shares  of  the  partners.^s     Premiums  paid  by  a  partnership  for 

52  0.  D.  795,  T.  B.  6-21-1431. 

53  A.  R.  R.  571,  T.  B.  29-21-1736.  See  Revenue  Act  of  1918,  §  330.  The 
Revenue  Act  of  1921,  however,  contains  such  a  provision.  See  Revenue  Act 
of  1921,  §  229.    See  Chapter  10. 

54  Letter  from  treasury  department  dated  June  30,  1916;  I.  T.  S.  1919, 
H  1297. 

55  Revenue  Act  of  1921,  §  215  (a)  (4)  ;  Revenue  Act  of  1918,  §  215  (d)  ; 
Revenue  Act  of  1916,  as  amended  by  the  Revenue  Act  of  1917,  §  32  (the  ref- 
erence to  §  9  is  apparently  a  mistake,  the  reference  being  intended  to  §  8 
(e)  ).  See  Reg.  33  Rev.,  Art.  30.  Under  the  1916  Law,  prior'  to  the  1917 
amendment,  the  treasury  department  permitted  such  premiums  on  life  in- 
surance to  be  deducted  from  year  to  year  as  paid  and  required  the  amount 
of  the  policy  to  be  included  in  gross  income  in  the  year  in  which  the  policy 
matured  and  such  amount  was  received.    (T.  D.  2090.) 


PARTNERSHIPS  179 

accident  and  health  insurance  policies  covering  the  lives  of  the 
individual  partners  are  not  deductible'  Trom  gross  income  of  the 
partnership."''' 

Distribution  of  Partnership  Protits.  The  law  has  not  been 
construed  at  any  time  to  require  the  collection  of  the  tax  at  the 
source  on  the  distribution  and  payment  of  the  profits  of  a  part- 
nership to  the  partners.  No  ruling  has  appeared  under  the  1918 
law  expressly  requiring  such  deduction  on  payments  to  non- 
resident alien  partners," 

Profits  to  Be  Reported  by  Partners.  The  distributive  share 
of  the  net  income  of  a  partnership  which  a  partner  is  required 
to  include  in  his  return  is  his  proportionate  share  of  the  net  in- 
come of  the  partnership,  either  (a)  for  the  taxable  year  upon 
the  basis  of  which  the  partner's  net  income  is  computed,  or  (b) 
if  the  partner's  net  income  is  computed  upon  the  basis  of  a  period 
different  from  that  upon  the  basis  of  which  the  net  income  of  the 
partnership  is  computed,  for  any  taxable  year  of  the  partnership 
ending  within  the  taxable  year  upon  the  basis  of  which  the 
partner's  net  income  is  computed.  Amounts  earned  and  distrib- 
uted to  a  partner  by  a  partnership  after  the  end  of  its  taxable 
year  and  before  the  end  of  his  corresponding  taxable  year  should 
be  accounted  for  both  by  the  partnership  and  by  the  partner  in 
their  returns  for  their  next  succeeding  taxable  years. •"''^  Both 
normal  and  surtaxes  must  be  paid,  upon  this  distributive  share, 
except  as  noted  below.  When  the  annual  profits  are  not  distrib- 
uted and  paid  to  the  partners,  the  respective  interests  of  each 
partner  in  the  undistributed  profits  for  the  year  should  be  ascer- 
tained and  the  partners  entitled  thereto  should  include  the 
amount  of  their  respective  interests  in  their  returns  as  if  the 
profits  had  been  distributed  and  paid  to  them."'-'  Such  undivided 
annual  profits  of  partnerships  having  been  reported  by  the  indi- 
vidual members  thereof  and  the  tax  having  been  paid  thereon, 
are  not  again  taxable  to  the  partners  when  actually  distributed 
at  a  later  date.*'"  The  distributive  interests  of  the  partners  in 
the  firm's  net  income  should  be  the  amount  shown  by  the  books 
when  closed  and  not  their  distributive  interests  in  the  amount 
of  income  of  the  partnership  represented  by  actual  cash  receipts, 
unless  the  partnership  keeps  its  books  on  the  basis  of  cash  re- 

56  0.  D.  243,  T.  B.  13-19-422. 

57  See  I.  T.  S.  1918,  Ij  665.    See  Chapter  40. 

58  Reg.  45,  Art.  322. 

50  Reg.  33,   Art.    13.    Revenue   Act  of   1921,  §218    (a);    Revenue   Act  of 
1918,  §218    (a). 
60  Reg.  33,  Art.  14. 


180  FEDERAL  INCOME  TAX 

ceipts  and  disbursements.  Where  accounts  receivable,  for  in- 
stance, are  entered  on  the  books  of  the  partnership  as  income 
and  are  treated  as  debts  due  from  customers  or  chents,  the  part- 
ners' returns  are  required  to  be  based  on  the  total  sum  of  such 
accounts  receivable  and  not  on  the  amount  thereof  that  has  ac- 
tually been  paid.^^ 

Where  a  distribution  of  partnership  profits  is  made  in  securi- 
ties the  partners  will  nevertheless  be  taxable  with  respect  to  their 
distributive  shares  of  the  net  income  of  the  partnership  for  the 
taxable  year.  No  gain  need  be  reported  nor  can  any  loss  be 
claimed  on  account  of  any  difference  between  the  book  value  of 
the  securities  distributed  and  their  market  value  at  the  date 
of  distribution.  In  other  words,  the  distribution  of  partner- 
ship profits  in  the  form  of  securities,  like  a  distribution  of  part- 
nership assets  upon  dissolution,  does  not  constitute  a  closed  and 
completed  transaction.  To  hold  otherwise  would  be  to  hold 
that  a  person  might  sell  at  a  profit  or  a  loss  to  himself.  The 
realization  of  any  gain  or  loss  with  respect  to  such  securities 
depends  upon  their  subsequent  sale  after  distribution."-  In- 
come from  a  particular  source  can  not  be  allocated  to  one  part- 
ner, but  must  be  divided  2^'f'o  rata  among  the  several  partners.*'^ 
Where  a  member  of  a  partnership  died  owning  certain  shares 
of  the  common  stock  of  a  company  subsequently  becoming 
insolvent  and  under  the  plan  of  reorganization  of  such  com- 
pany holders  of  the  common  stock  were  required  to  pay  a  certain 
assessment  per  share,  which  assessment  the  decedent's  estate 
was  unable  to  meet,  and  where  the  partnership  advanced  the 
sum  called  for  and  underwrote  the  reorganization  receiving  for 
its  services  certain  shares  of  stock  of  the  reorganized  company, 
as  well  as  an  amount  of  money,  all  of  which  was  turned  over  to 
the  decedent's  estate  and  never  entered  upon  the  partnership's 
books,  it  has  been  held  that  since  the  stock  and  cash  received  by 
the  partnership  were  for  services  performed  by  it  as  under- 
writer, such  compensation  represented  taxable  income  to  the 
members  of  the  partnership  regardless  of  the  fact  that  no 
distribution  of  such  funds  was  made  to  them  and  irrespective  of 
the  reason  for  which  the  partnership  entered  into  the  transac- 
tion.64  Where  an  individual  member  of  a  partnership  received 
a  salary  for  services  performed  as  an  employee  of  a  city  and, 

61  Letter  from  treasury  department  dated  February  28,  1916;  L  T.  S.  1919, 
111285. 

62  T.  B.  R.  34,  T.  B.  10-19-354. 

63  0.  D.  140,  T.  B.  4-19-221. 

64  0.  D.  542,  T.   B.  24-20-998. 


PARTNERSHIPS  181 

in  accordance  with  his  contract  with  the  firm,  turned  over  to  it 
as  the  value  of  his  time  the  entire  amount  so  received,  it  has 
been  ruled  that  the  individual  partner  might  deduct  the  amount 
of  the  salary  in  his  personal  return  as  a  business  expense,  but 
that  no  exemption  could  be  claimed  by  the  partnership,  since 
to  allow  the  amount  received  by  it  to  be  treated  as  exempt  in- 
come would  in  effect  be  to  regard  it  as  an  employee  of  the  city, 
which  was  not  the  fact.""'  The  same  rule  applies  where  a  partner 
turns  over  to  the  partnership  the  fees  received  by  him  as  notary 
public  under  commission  from  a  state/'"  A  portion  of  the  net 
income  of  the  partnership  for  the  taxable  year  may  represent 
dividends  or  interest  exempt  from  normal  tax,  interest  from 
corporate  bonds  containing  "tax-free  covenants"  and  interest 
on  bonds  which  may  be  wholly  exempt  from  income  tax,  in  which 
case  the  rules  stated  in  the  following  paragraphs  apply. 

Dividends.  For  the  purpose  of  the  normal  tax  a  partner  is 
allowed  a  credit  of  his  proportionate  share  of  the  income  re- 
ceived by  the  partnership  as  dividends  from  a  domestic  corpo- 
ration (except  domestic  corporations  receiving  a  substantial  por- 
tion of  their  income  from  sources  within  a  possession  of  the 
United  States)  and  foreign  corporations  50 7^  or  more  of  the 
income  of  which  for  a  certain  period  has  been  from  sources 
within  the  United  States.'"'  Under  the  1918  law,  the  credit 
was  allowed  with  respect  to  dividends  from  (a)  a  corporation 
taxable  upon  its  net  income,  and  (b)  a  personal  service  corpora- 
tion out  of  earnings  or  profits  upon  which  income  tax  was  im- 
posed."'^ In  the  case  of  a  partnership  sustaining  an  operating 
loss  and  receiving  dividends  liable  to  surtax  in  the  hands  of 
the  individual  partners,  such  operating  loss  is  to  be  appli;?d  to 
the  reduction  of  such  dividends  so  that  only  the  urt  distfibutive 
shares  of  the  partnership  income  will  be  included  for  purposes  of 
the  surtax."^ 

Interest  on  National  Bonds.  For  the  purpose  of  the  normal 
tax  only,  a  partner  is  allowed  a  credit  of  his  proportionate  share 
of  the  income  received  by  the  partnership  as  interest  upon  the 
obligations  of  the  United  States  and  bonds  issued  by  the  War 
Finance  Corporation  which  is  included  in  the  gross  income  of  the 

•■'•^A.  R.  M.  25,  T.  B.  4-20-702. 
«''0.  D.  648,  T.  B.  35-20-1167. 
••'7  Revenue   Act  of   1921,   §218    (b). 

«•*<  Revenue  Act  of  1918,  §218  (a);  Rep:.  45,  Art.  .32.'?;  T.  D.  2858.  See 
Chapter    19. 

0!>A.  R.  M.  13,  T.  B.  1-20-659. 


182  FEDERAL  INCOME  TAX 

partnership^*^  This  credit  of  interest  on  national  bonds  for  the 
purpose  of  the  normal  tax  is  unrestricted,  because  the  interest 
on  all  national  bonds  is  exempt  from  the  normal  tax.  Interest 
upon  obligations  of  the  United  States  issued  after  September  1, 
1917,  other  than  postal  savings  certificates  of  deposits  "^  and 
War  Finance  Corporation  bonds  is  exempt  from  the  surtax  only 
to  a  limited  extent  and  as  provided  in  the  respective  acts  author- 
izing the  issue  of  such  obligations  or  bonds,  as  amended  and 
supplemented^^  The  Revenue  Act  of  1918  and  the  Revenue 
Act  of  1921  provide  that  in  the  case  of  such  obligations  or  bonds 
the  interest  shall  be  exempt  only  if  and  to  the  extent  provided  in 
the  respective  acts  authorizing  the  issue  thereof,  as  amended  and 
supplemented,  and  shall  be  excluded  from  gross  income  only  if 
and  to  the  extent  it  is  wholly  exempt  from  taxation  to  the  tax- 
payer both  under  the  income  and  war-profits  and  excess-profits 
taxesjs  As  income  of  a  partnership  is  taxable  to  the  individual 
partners,  each  partner  is  treated  as  the  owner  of  a  proportionate 
part  of  the  bonds  held  by  the  partnership  and  is  entitled  to 
exemption  on  account  of  such  partnership  as  if  such  partner 
owned  such  proportionate  part  of  the  bonds  directly.  Such 
partner,  if  a  partner  at  the  time  of  the  original  subscription  by 
the  partnership  for  bonds  of  the  Fourth  Liberty  loan  or  notes 
of  the  Victory  Liberty  loan,  as  the  case  may  be,  is  treated  as  an 
original  subscriber  for  a  proportionate  part  of  such  bonds  or 
notes  subscribed  for  by  the  partnership  and  is  entitled  to  the 
appropriate  collateral  exemption  of  interest  on  bonds  of  previous 
issues  on  account  of  such  original  subscription  for  bonds  or 
notes  as  if  he  had  subscribed  directly  for  such  proportionate 
part.'''-^  Where  Liberty  bonds  are  subscribed  for  and  continuously 
held  by  a  partnership  and  one  of  the  partners  purchases  the 
bonds  directly  from  the  partnership,  the  purchaser  is  entitled 

70  Revenue  Act  of  1921,  §218   (b)  ;  Revenue  Act  of  1918,  §§218  (a),  216 
(b)  ;  Reg.  45,  Art.  323. 
n  Revenue  Act  of  1921,  §213   (b)    (4). 

72  The  amount  of  the  exemption  in  the  case  of  each  issue  is  discussed  in 
Chapter  18. 

73  Revenue  Act  of  1921,  §  213  (b)  (4)  ;  Revenue  Act  of  1918,  §  213  (b) 
(4). 

74  Reg.  45,  Art.  82;  T.  D.  2762.  This  principle  also  applies  to  stockholders 
in  personal  service  corporations.  Under  the  1916  Law,  as  amended,  in- 
terest upon  the  obligations  of  the  United  States  issued  after  September  24, 
1917,  was  required  to  be  included  in  gross  income  of  a  partnership  only  to 
the  extent  to  which  the  partnership's  holdings  exceeded  $5,000  par  value 
(see  Foi-m  No.  1065),  this  being  the  exemption  granted  in  the  Second  Liber- 
ty Bond  Act  for  purposes  of  the  surtaxes  then  in  force.  Under  the  present 
law  "original  subscription"  and  "continuous  holding"  are  unimportant. 


PARTNERSHIPS 


183 


to  the  exemption  which  is  conditioned  upon  original  subscrip- 
tion to  and  continuous  holding  of  the  bonds.     The  basis  of  the 
exemption  will  be  an  amount  of  the  bonds  not  in  excess  of  (1) 
his  original  share  of  the  bonds  held  by  the  partnership,  or  (2) 
his  share  of  such  bonds  not  sold  by  the  partnership  plus  the 
amount  bought  by  him  from  the  partnership ;  whichever  amount 
is  smaller.     However,  if  the  bonds  are  purchased  from  another 
partner  or  they  are  sold  by  the  partnership  and  repurchased 
by  him  in  the  open  market,  he  can  not  claim  such  exemption  in 
respect  to  any  amount  of  the  bonds  so  acquired."'     Where  a 
partnership  was  an  original  subscriber  to  Liberty  bonds  of  the 
Fourth  Liberty  Loan  and  was  reorganized  as  a  corporation,  an 
individual  member  of  the  partnership  purchasing  from  the  cor- 
poration certain  of  such  bonds  taken  over  will  not  be  considered 
the  "original  subscriber"  thereof.'" 

INTEREST   ON    BONDS   OF   STATES,    POSSESSIONS  AND  POLITICAL 

Subdivisions.  The  interest  received  by  the  partnership  on  the 
obligations  of  a  state  or  any  political  or  taxing  subdivision  there- 
of and  upon  the  obligations  of  the  possessions  of  the  United 
States  might,  under  the  1916  law,  be  deducted  by  a  partner  in 
proportion  to  his  share  of  the  total  partnership  profits."  It 
was  unnecessary  to  provide  for  this  deduction  or  credit  under 
the  Revenue  Act  of  1918,  or  the  Revenue  Act  of  1921,  since  such 
interest  as  well  as  interest  upon  obligations  of  a  territoi-y  or  any 
political  subdivision  thereof  or  the  District  of  Columbia  and 
securities  issued  under  the  Federal  Farm  Loan  Act,  is  excluded 
from  gross  income,"''  and  will  not  appear  in  the  net  income  of  the 

75  0    D.  362,  T.  B.  2-20-672. 

76  0.  D.  502,  T.  B.  20-20-932. 

77  This  was  undoubtedly  intended  to  give  the  partner  the  beneht  of  the 
same  exemption  as  was  accorded  to  individuals  or  corporations  ^jn^^^^  §  4 
of  the  Revenue  Act  of  1916,  although  that  section  referred  only  to  J^oh  ica 
subdivisions"  while  the  provision  relating  to  partnerships  refers  to  political 
and  taxing  subdivisions."  However,  political  subdivision  has  been  construed 
to  mean  any  subdivision  of  a  state  having  the  power  to  levy  taxes  -  that  the 
inclusion  of  the  phrase  "taxing  subdivision"  apparently  did  not  extend 
any  greater  exemption  to  partners  than  to  others.  ^n^o   (h\ 

78  Revenue  Act  of  1921,  §  213  (b)  (4)  ;  Revenue  Act  of  1918  §213  jb). 
It  was  provided  in  the  1918  Law  that  every  person  (the  term  Person  in- 
cluding partnerships)  owning  any  of  the  obligations  securities  or  bonds 
enumerated  in  the  law  to  be  absolutely  exempt  from  f «  '"--^.  ^^r""  ^f 
includes  the  bonds  referred  to  in  the  text  above-should  in  his  ^ -turn  of 
income  submit  a  statement  showing  the  number  and  amount  of  ^^^^^  «bli- 
gations,  securities  or  bonds  owned  by  him  and  the  income  received  theiefiom 
fn  such  form  and  with  .uch  information  as  the  commissioner  ."^^J^t  re- 
quire. (Revenue  Act  of  1918,  §  213  (b)  (4).)  This  provision  is  omitted  from 
the  1921  Law. 


184  FEDERAL  INCOME  TAX 

partnership,  which  consists  of  its  gross  income  less  deductions. 

Income  Exempt  to  Partners.  A  member  of  a  partnership 
who  performed  services  in  the  military  forces  of  the  United 
States  during-  the  war,  and  according  to  agreement  turned  over 
to  the  partnership  the  compensation  received  for  such  services, 
might,  under  the  1918  law,  in  reporting  his  distributive  share 
of  the  partnership's  income,  exclude  from  his  return  an  amount 
equal  to  the  sum  received  for  military  services  and  turned  over 
to  the  partnership,  but  not  in  excess  of  $3,500.  The  other  part- 
ner was  required  to  report  his  entire  distributive  share  of  the 
income  regardless  of  the  fact  that  a  portion  of  it  was  derived 
from  his  partner's  compensation  for  military  service.'^^  An  in- 
dividual member  of  a  partnership  receiving  a  salary  for  services 
performed  as  an  employee  of  a  city,  who  turns  over  the  entire 
amount  so  received  to  his  firm  as  the  value  of  his  time,  may  de- 
duct the  amount  of  the  salary  in  his  personal  return  as  a  business 
expense,  but  the  partnership  may  claim  no  deduction  with  re- 
spect thereto. so 

Contributions  to  Charities.     The  proportionate  share  of 
contributions  to  charities  made  by  a  partnership  may  be  claimed ' 
by  the  individual  members  of  the  partnership  to  an  amount  not 
in  excess  of  15%  of  the  net  income  of  the  individual  partners 
as  computed  without  such  deduction. '^i 

Credit  for  Taxes.  The  provisions  of  the  Revenue  Act  of 
1921  that  the  tax  computed  shall  be  credited  with  the  amount  of 
any  income,  war-profits  and  excess-profits  taxes  paid  during 
the  taxable  year  to  any  foreign  country  or  to  any  possession  of 
the  United  States  is-  discussed  elsewhere  in  this  book.'^-  Where 
such  taxes  have  been  paid  by  a  partnership,  the  income  tax  of 
an  individual  member  thereof  will  be  credited  with  the  member's 
proportionate  share  of  such  taxes  of  the  partnership  paid  during 
the  taxable  year  to  a  foreign  country  or  to  any  possession  of  the 
United  States,  as  the  case  may  be.'^-'^  Under  the  1918  Law  a  part- 
ner, who  is  an  alien  resident  of  the  United  States  and  a  citizen 
or  subject  of  a  foreign  country,  is  entitled  to  such  credit  only 
for  taxes  paid  or  accrued  to  a  possession  of  the  United  States, 
or  to  the  foreign  country  of  which  he  is  a  citizen  or  subject,  and 
is  not  entitled  to  such  credit  for  taxes  paid  or  accrued  to  that 
country  unless  it  allows  a  similar  credit  to  a  citizen  of  the  United 

TOO.  D.  121,  T.  B.  3-19-182.  The  1921  Law  does  not  contain  the  $3,500 
exemption  granted  by  the  1918  Law  to  those  in  active  service. 

80  A.  R.  M.  25,  T.  B.  4-20-702. 

81  0.  D.  185,  T.  B.  8-19-322. 

82  See  Chapter  32. 

S3  Revenue  Act  of  1921,  §  222;  Revenue  Act  of  1918,  §  222. 


PARTNERSHIPS  185 

States  residing  therein.'*^  Under  the  Revenue  Act  of  1921  an 
alien  resident  is  entitled  to  a  credit  of  any  income,  war-profits 
and  excess-profits  taxes  paid  during  the  taxable  year  to  auy 
foreign  country  if  the  foreign  country  of  which  such  alien  resi- 
dent is  a  citizen  or  subject,  in  imposing  such  taxes,  allows  a 
similar  credit  to  citizens  of  the  United  States  residing  in  such 
country.'^'j 

Readjustment  of  Partnership  Interests.  When  a  partner 
retires  from  a  partnership  or  it  is  dissolved,  he  realizes  a  gain 
or  loss  measured  by  the  difference  between  the  price  received  for 
his  interest  and  the  cost  to  him  of  his  interest  in  the  partnership, 
including  in  such  cost  the  amount  of  his  share  in  any  undistrib- 
uted partnership  net  income  earned  since  he  became  a  partner 
on  which  the  income  tax  has  been  paid.  However,  if  such  inter- 
est in  the  partnership  was  acquired  prior  to  March  1,  1913,  both 
the  cost  as  hereinbefore  provided  and  the  value  of  such  interest 
as  of  such  date,  plus  the  amount  of  the  share  in  any  undistrib- 
uted partnership  net  income  earned  since  February  28,  1913, 
on  which  the  income  tax  has  been  paid,  must  be  ascertained  and 
the  taxable  gain  derived  or  the  deductible  loss  sustained  be 
computed  in  accordance  with  the  rules  relative  to  the  basis  for 
determining  gain  or  loss  from  sales  set  forth  elsewhere  in  this 
book.^"  If  the  partnership  distributes  its  assets  in  kind  and 
not  in  cash,  the  partner  realizes  no  gain  or  loss  until  he  disposes 
of  the  property  received  on  liquidation.  Whenever  a  new  part- 
ner is  admitted  to  a  partnership,  or  any  existing  partnership  is 
reorganized,  the  facts  as  to  such  change  or  reorganization  should 
be  fully  set  forth  in  the  next  return  of  income,  in  order  that  the 
commissioner  may  determine  whether  any  gain  or  loss  has  been 
realized  by  any  partner.''*"  The  effect  of  the  admission  to  a  part- 
nership of  a  new  partner  will  depend  upon  the  terms  of  his 
admission.  If,  under  the  terms  of  the  partnership  agreement  he 
contributes  property  or  cash  to  the  capital  of  the  partnership  he 
acquires  a  right,  upon  dissolution,  to  a  return  of  his  contribution 
together  with  his  proportionate  share  of  the  net  profits  of  the 
partnership  business,  and  in  the  meantime  to  a  corresponding 
share  in  the  net  earnings  of  the  partnership.  There  is  no 
realization  on  the  part  of  any  partner.  If,  on  the  other  hand, 
he  purchases,  for  cash,  an  interest  in  the  existing  partnership, 
it  is  clear  that  what  he  has  acquired  is  simply  a  right  to  share 

84  Revenue  Act  of  1918,  §  222   (a)  ;  Reg.  45,  Art.  323. 
8">  Revenue  Act  of  1921,  §222    (a)    (3). 

86  See  Chapter  17. 

87  Reg.  45,  Art.  1570,  as  amended  by  T.  D.  3206;  T.  B.  33-21-1767. 


186  FEDERAL  INCOME  TAX 

in  the  profits  of  the  partnership  during  its  continuance  and  in 
any  sum  remaining,  upon  the  dissolution  of  the  partnership, 
after  the  satisfaction  of  creditors  and  of  the  equities  as  between 
the  contributing  partners.  Since  this  would  represent  a  pur- 
chase, by  the  incoming  partner,  there  could  be  no  realization 
as  to  him,  and,  as  to  the  members  of  the  former  partnership, 
the  amount  paid  by  him  will  clearly  be  income  to  them  in  direct 
proportion  to  their  respective  interests  in  the  former  partner- 
ship and  should  be  returned  by  them  as  such.^^ 

Fiscal  Year.  The  net  income  of  a  partnership  is  computed 
generally  in  the  same  manner  and  on  the  same  basis  as  the  net 
income  of  individuals,*^''  Its  net  income  must  be  computed  upon 
the  basis  of  the  partnership's  annual  accounting  period  (fiscal 
year  or  calendar  year,  as  the  case  may  be)  in  accordance  with 
the  method  of  accounting  regularly  employed  in  keeping  the 
books  of  the  partnership.  If  no  such  method  of  accounting  has 
been  employed,  or  if  the  method  employed  does  not  clearly  reflect 
income,  the  computation  is  made  upon  such  basis  and  in  such 
manner  as  in  the  opinion  of  the  commissioner  does  clearly  reflect 
income.  If  the  partnership's  annual  accounting  period  is  other 
than  a  fiscal  year,  or  if  the  partnership  has  no  annual  accounting 
period  or  does  not  keep  books,  its  net  income  will  be  computed 
on  the  basis  of  the  calendar  year.'^o  If  the  net  income  of  a  part- 
ner is  computed  on  the  basis  of  a  period  different  from  that  upon 
the  basis  of  which  the  net  income  of  the  partnership  is  com- 
puted, then  the  partner's  distributive  share  of  the  net  income  of 

88  Sol.  Op.  42,  T.  B.  36-20-1182;  O.  816,  T,  B.  3-19-197. 

89  Revenue  Act  of  1921,  §  218  (c)  ;  Revenue  Act  of  1918,  §  218  (d). 

90  Revenue  Act  of  1921,  §212  (b)  ;  Revenue  Act  of  1918,  §212  (b). 
Prior  to  the  enactment  of  the  Revenue  Act  of  1918  reporting  on  the  basis 
of  a  fiscal  year  was  a  privilege;  now  it  is  a  requirement,  if  the  books  of 
the  partnership  are  kept  on  the  basis  of  a  fiscal  year.  (See  Chapter  34.) 
Under  the  1916  Law  a  partnership  had  the  same  privilege  of  fixing  and 
making  returns  upon  the  basis  of  its  own  fiscal  year  as  was  accorded  to 
corporations.  If  a  fiscal  year  ended  during  1916  or  during  a  subsequent 
calendar  year  for  which  there  was  a  rate  of  tax  different  from  the  rate  of 
the  preceding  calendar  year,  the  rate  for  the  preceding  calendar  year 
applied  to  an  amount  of  each  partner's  share  of  such  partnership  profits 
equal  to  the  proportion  which  the  part  of  such  fiscal  year  falling  within 
such  preceding  calendar  year  bore  to  the  full  fiscal  year  and  the  rate  for  the 
calendar  year  during  which  such  fiscal  year  ended  applied  to  the  rem.ainder 
of  such  profits.  (Revenue  Act  of  1916,  §  8  (e)  as  amended  by  the  Revenue 
Act  of  1917.)  Prior  to  this  amendment  of  the  statute  the  treasury  depart- 
ment held  that  where  the  fiscal  year  of  a  partnership  ended  at  any  time 
other  than  December  31st  the  total  profits  of  the  partnership  were  required 
to  be  reported  as  income  of  the  partners  for  the  calendar  year  in  which 
the  fiscal  year  of  the  partnership  ended. 


PARTNERSHIPS  ^^'^ 


the  partnership  for  any  accounting  period  of  the  partnership 
ending  within  the  fiscal  year  or  calendar  year  upon  the  basis 
of  which  the  partner's  net  income  is  computed,  is  included  in 
computing  the  net  income  of  each  partner.^^     Under  the  1918 
Law  if  the  fiscal  year  of  a  partnership  ends  during  a  calendar 
year  for  which  the  rates  of  tax  differ  from  those  for  the  preced- 
ing calendar  year,  then  (1)  the  rates  for  such  preceding  calendar 
year  applv  to  an  amount  of  each  partner's  share  of  such  partner- 
e,hip  net  income  equal  to  the  proportion  which  the  part  of  such 
fiscal  year  falling  within  such  calendar  year  bears  to  the  full 
fiscal  year  and  (2)  the  rates  for  the  calendar  year  during  which 
such  fiscal  year  ends  apply  to  the  remainder."-^     If  the  fiscal 
year  of  a  partnership  begins  in  1920  and  ends  in  1921,  or  begins 
in  1921  and  ends  in  1922,   (1)   the  rates  for  the  calendar  year 
during  which  such  fiscal  year  begins  will  apply  to  an  amount 
of  each  partner's  share  of  such  partnership  net  income   (deter- 
mined under  the  law  applicable  to  such  year)  equal  to  the  propor- 
tion which  the  part  of  such  fiscal  year  falling  within  such  calen- 
dar year  bears  to  the  full  fiscal  year,  and  (2)  the  rates  for  the 
calendar  year  during  which  such  fiscal  year  ends  will  apply  to 
an   amount   of   each   partner's   share   of   such   partnership   net 
income   (determined  under  the  law  applicable  to  such  calendar 
year)    equal  to  the  proportion   which  the   part  of   such   fisca 
year  falling  within  such  calendar  year  bears  to  the  full  fiscal 

vear  ^^ 

Net  Losses  of  Partnership.  Where  the  result  of  partnership 
operation  is  a  net  loss,  the  loss  will  be  divisible  between  the 
partners  in  the  same  proportion  as  a  profit  would  have  been 
divisible,  and  may  be  used  by  the  individual  partners  m  their 
returns  of  income,-  as  the  loss  of  a  partnership  is  considered 
to  be  a  loss  sustained  in  trade  by  the  individual  members.  The 
partner  may  deduct  the  loss  whether  he  is  compelled  to  make 

91  Revenue  Act  of  1921,  §218   (a);  Revenue  Act  of  l^l^'  ^;':|^^/^^^^     ,  ^^ 

02  Revenue  Act  of  1918,  §218   (b).    In  the  case  of  an  '-^-^  ^    -^"^^^  J 

of  a  partnership  making  return  for  a  fiscal  year  ^^^'""^"f/"  ^^'^'j^';^ 

Ldine    in  1918    his  proportionate  share  of  any  excess-profits  tax  imposed 

Reg.  45,  Arts.  324-5  and  Reg.  45,  Arts.  326-7. 
fl.H  Revenue  Act  of  1921,  ?;  205   (c). 
94  Reg.  33  Rev.,  Art.  30. 


188  FEDERAL  INCOME  TAX 

good  his  proportionate  share  by  payment  of  money  to  the  part- 
nership or  whether  the  loss  is  charged  against  profits  accrued 
to  his  account  in  preceding  years.^s  if  the  loss  occurs  in  a  fiscal 
year  covering  a  period  in  which  there  is  a  change  of  tax  rates 
it  does  not  seem  that  under  the  Revenue  Act  of  1918  the  loss 
should  be  prorated  although  the  income,  if  any,  would  be,  since 
a  loss  is  deductible  in  the  year  in  which  it  is  actually  sustained.^^ 
Under  the  Revenue  Act  of  1921,  however,  if,  in  order  to  clearly 
reflect  the  income,  the  loss  should,  in  the  opinion  of  the  commis- 
sioner, be  accounted  for  as  of  a  diff'erent  period  it  may  be  de- 
ducted in  a  year  other  than  the  one  in  which  sustained.^"^ 

Profits  Earned  Prior  to  March  1,  1913.  In  a  case  arising  under 
the  1913  law  it  was  contended  that  where  the  fiscal  year  of  a 
partnership  ended  between  March  1,  1913,  and  December  31st 
of  the  same  year,  the  equitable  method  would  be  to  apportion  the 
profits  for  the  fiscal  year  in  equal  monthly  installments  and  allot 
to  the  period  preceding  March  1st  its  proper  proportion,  making 
the  partners  taxable  only  on  their  respective  shares  in  the  re- 
mainder. The  court  held  that  the  plaintiff  in  this  case  failed 
to  show  that  profits  were  earned  by  the  partnership  prior  to 
March  1,  1913,  and  in  what  sum,  and  in  the  absence  of  such 
showing  the  court  assumed  that  the  tax  was  legally  collected.^^ 
The  treasury  department  held  under  the  1913  Law  that  the  entire 
amount  of  profits  accruing  to  a  partner  at  the  close  of  the  fiscal 
year  of  the  partnership  was  taxable  in  the  calendar  year  in 
which  the  fiscal  year  ended,^^  although  a  part  of  the  fiscal  year 
may  have  covered  a  period  prior  to  the  incidence  of  the  tax. 

Returns  by  Partnerships.  Every  partnership  must  make  a 
return  of  income,  regardless  of  the  amount  of  its  net  income. 
The  return  under  the  1918  Law  was  on  form  1065  (revised). 
The  return  should  be  sworn  to  by  one  of  the  partners.  Such 
return  should  be  made  for  the  taxable  year  of  the  partnership, 
that  is,  for  its  annual  accounting  period  (fiscal  year  or  calendar 
year  as  the  case  may  be),  irrespective  of  the  taxable  years  of 
the  partners. 1^0  A  receiver  in  charge  of  the  business  of  a  part- 
nership must  make  a  return  for  it  on  form  1065  (revised).  As 
the  death  or  withdrawal  of  a  partner  ordinarily  dissolves  the 

95  Letter  from  treasury  department  dated  February  12,  1915;  L  T.  S, 
1918,  11674. 

96  See  Chapter  25. 

97  Revenue  Act  of  1921,  §214   (a)    (6). 

98  Cohen  v.  Lowe,  234  Fed.  474. 

99  T.  D.  2090. 

100  Revenue  Act  of  1921,  §224;  Revenue  Act  of  1918,  §224;  Reg.  45, 
Arts.  411  and  412.     If  the  partnership  makes  any  change  in  its  accounting 


PARTNERSHIPS  189 

partnership,  a  return  would  be  required  covering  the  period 
from  the  beginning  of  the  partnership's  taxable  year  to  the 
date  of  its  dissolution.  If  the  business  of  the  partnership  is  con- 
tinued as  such,  a  new  accounting  period  would  be  established 
upon  the  necessary  reorganization  of  the  partnership,  and  its 
next  return  should  cover  the  period  from  the  date  of  reorganiza- 
tion until  the  end  of  the  taxable  yearJ'" 

Contents  of  Partnership  Return.  Under  the  1918  law  the 
return  of  a  partnership  was  required  to  state  specifically  (a)  the 
items  of  its  gross  income;  (b)  the  deductions  to  which  it  is  en- 
titled under  the  law;  (c)  the  amounts  of  dividends  from  taxable 
.corporations  and  from  personal  service  corporations  out  of 
earnings  and  profits  upon  which  income  tax  has  been  imposed, 
and  of  interest  upon  obligations  of  the  United  States  and  bonds 
of  the  War  Finance  Corporation  included  in  gross  income;  (d) 
the  amount  of  any  income,  war-profits  and  excess-profits  taxes  of 
the  partnership  paid  during  the  taxable  year  to  a  foreign  coun- 
try or  to  any  possession  of  the  United  States,  and  the  amount  of 
any  such  taxes  accrued  but  not  paid  during  the  taxable  year; 
(e)  the  names  and  addresses  of  the  individuals  who  would  be 
entitled  to  share  in  the  net  income  of  the  partnership  if  distrib- 
uted; (f)  the  amount  of  the  distributive  share  of  such  net 
income  of  each  such  individual;  and  (g)  such  other  facts  as  are 
required  by  form  1065   (revised)  .i"- 

Returns  of  Tax  Withheld  at  Source.  Partnerships  are  re- 
quired to  make  returns  on  or  before  March  first  of  each  year  of 
amounts  of  tax  required  to  be  withheld  at  the  source.^""' 

period,  it  should  make  its  return  in  accordance  with  the  provisions  of  §  22ti 
of  the  statute  and  Reg.  45,  Art.  431.  Prior  to  the  enactment  of  1918  Law, 
partnerships  as  such  were  not  required  to  render  annual  returns  of  in- 
come, but  when  requested  by  the  commissioner,  or  any  collector,  were  re- 
quired to  make  a  correct  return  of  earnings,  profits  and  income,  showincr 
their  gross  income  and  the  deductions  and  credits  allowed  by  the  law  and 
the  names  and  addresses  of  the  individuals  who  would  be  entitled  to  the 
net  earnings,  profits  and  income-  if  distributed.  It  was  not  required  in 
such  returns  that  the  partnership  report  income  exempt  under  §  4  of  the 
1916  Law.  (Revenue  Act  of  1916,  §8  (e);  Reg.  33  Rev..  Art.  30;  Reg.  33, 
Art.  12.)  Special  returns  from  partnerships  were  required  generally  in 
1913,  but  no  returns  were  required  for  the  year  1914  or  for  subsequent 
years,  except  in  instances  where  it  was  specially  required  by  the  commi.s- 
sioner  or  a  collector.  In  1917  partnerships  were  required  to  file  returns 
of  income  for  the  excess-profits  tax. 

ifi  O.  D.  228,  T.  B.  12-19-403. 

102  Reg.  45,  Art.  412. 

if>3  Revenue  Act  of  1921,  §§221  (c)  and  237;  Revenue  Act  of  1918,  §§221 
(c)    and  237;    Reg.  45,  Arts.  361-376;  see   Chapter  40. 


190  FEDERAL  INCOME  TAX 

Returns  of  Information.  Partnerships  are  required  to  file 
such  returns  as  are  required  under  the  provisions  of  law  relating 
to  information  at  the  source.^^i 

Reports  by  Brokers.  Every  partnership  doing  business  as  a 
broker  is  required,  when  called  upon  by  the  commissioner,  to 
make  a  return  showing  the  names  of  its  customers  with  such  de- 
tails as  to  the  profits,  losses  or  other  information  which  the  com- 
missioner may  require,  as  to  each  of  such  customers,  as  will  en- 
able the  commissioner  to  determine  whether  all  income  tax  due 
on  the  profits  or  gains  of  such  customers  has  been  paid.^o^  This 
report  is  for  the  purpose  of  information  at  the  source  and  is 
more  fully  discussed  in  another  chapter.^"''^ 

Penalties.  Partnerships  or  their  members  or  employes  are 
subject  in  certain  cases  to  penalties,  both  specific  and  ad  valorem, 
for  failing  or  refusing  to  make  returns,  to  supply  information, 
to  pay  or  collect  any  tax,  or  for  wilfully  attempting  in  any 
manner  to  defeat  or  evade  the  income  tax.  Such  penalties  are 
more  particularly  discussed  in  another  chapter.i^^ 

Examination  of  Partnership  Records.  All  partnership  books, 
papers,  records  or  memoranda  are  subject  to  examination  by  any 
revenue  agents  or  inspectors  designated  by  the  commissioner 
for  the  purpose  of  ascertaining  the  correctness  of  returns  which 
have  been  made,  or  making  a  return  where  none  has  been  made, 
in  accordance  with  and  subject  to  rules  which  are  discussed  at 
length  in  another  chapter.i^s 

Foreign  Partnerships.  The  distinction  between  domestic  and 
foreign  partnerships  is  given  above.i"^  The  Revenue  Acts  of 
1918  and  1921  do  not  use  the  word  "foreign"  in. connection  with 
partnerships  in  the  part  of  the  act  imposing  the  income  tax.^^^ 
The  acts,  however,  provide  that  individuals  carrying  on  business 
in  partnership  shall  be  liable  for  income  tax  in  their  individual 
capacity.  This  implies  that  the  income  of  a  foreign  partnership 
from  sources  within  the  United  States  is  taxable  in  the  hands 
of  the  nonresident  alien  partners,  to  the  extent  included  in  the 

104  Revenue  Act  of  1921,  §256;  Revenue  Act  of  1918,  §256;  Reg.  45, 
Arts.   1071-1080. 

105  Revenue  Act  of  1921,  §255;  Revenue  Act  of  1918,  §255;  Reg.  45, 
Art.  1061. 

106  See   Chapter   39. 

107  See  Chapter  36. 

108  See  Chapter  38. 

109  See  p.  166. 

110  The  term  "foreign"  is  applied  to  partnerships  in  the  title  imposing 
stamp  taxes.  (Revenue  Act  of  1921,  Title  XI,  Schedule  A-13;  Revenue  Act 
of  1918,  Title  XI,  Schedule  A-15.) 


PARTNERSHIPS  191 

distributive  share  of  each,  and  such  has  been  the  ruling  of  the 
treasury  department.'"  The  income  received  by  a  nonresident 
alien  partnership  from  sources  within  the  United  States  does 
not,  like  the  income  received  by  a  domestic  or  resident  alien 
partnership,  lose  its  identity  as  to  source  when  distributed  to  a 
nonresident  alien  member  of  a  firm."-  If  the  partner  is  a  citi- 
zen or  resident  of  this  country,  he  is  of  course  subject  to  tax  upon 
his  entire  distributive  share  of  the  profits  of  any  partnership  of 
which  he  may  be  a  member.  Foreign  partnerships  are  divided 
into  two  classes :  (1)  resident  foreign  partnerships,  and  (2)  non- 
resident foreign  partnerships.  A  foreign  partnership  which  is 
engaged  in  business  or  trade  within  the  United  States  and  has 
an  office  or  place  of  business  therein  is  a  resident  foreign  part- 
nership, and  a  foreign  partnership  which  is  not  engaged  in  busi- 
ness or  trade  within  the  United  States  and  has  no  office  or  place 
of  business  therein  is  a  nonresident  foreign  partnership. 

Extent  to  Which  Taxable.  Foreign  partnerships,  unless 
they  are  of  the  kind  taxable  as  corporations,""'  are  not  taxable, 
but  the  partners  are  required  to  pay  the  tax  in  all  cases  on  their 
distributive  shares  of  the  profits,  gains  or  income  of  the  partner- 
ship arising  from  sources  within  the  United  States.  A  complete 
discussion  of  the  term  "income  from  sources  within  the  United 
States"  is  contained  in  another  chapter."^  In  a  recent  case  un- 
der the  1918  law  it  appeared  that  two  members  of  a  British 
partnership,  engaged  in  the  cotton  business,  resided  in  England, 
and  the  third  resided  temporarily  in  the  United  States.  The 
partnership  maintained  an  office  in  this  country  for  the  purpose 
of  purchasing  cotton  to  be  shipped  abroad.  The  purchase  price 
was  paid  by  draft  drawn  on  England.  None  of  the  cotton  so 
purchased  was  sold  within  the  United  States,  nor  were  any  of  the 
profits  of  the  sale  received  in  this  country.  The  treasury  de- 
partment held  that  any  income  derived  from  the  sale  of  such 
cotton  was  not  taxable  as  income  from  sources  within  the  United 
States,  since  the  sale  was  consummated  in  a  foreign  country 
through  transactions  by  the  home  office.  The  third  member  of 
the  partnership  who  remained  within  the  United  States  seven 

111  Letter  from  treasury  department  dated  April  7,  1917;  I.  T.  S.  1918, 
11702;  Letter  from  treasury  department  dated  June  6,  1918;  I.  T.  S.  1918, 
113528;  Letter  from  treasury  department  dated  October  1,  1918;  I.  T.  S. 
1921,  TI1700;  Letter  from  treasury  department  dated  December  fi,  1916; 
I.  T.  S.  1921,  T11701. 

112  Letter  from  treasury  department  dated  October  1,  1918;  I.  T.  S.  1921, 
H 1700. 

ii'5  See  the  discussion  of  Limited  PartntM-ship?  on  p.  1(!7. 
n^  See   Chapter  4. 


192  FEDERAL  INCOME  TAX 

or  eight  months  of  the  year  for  the  purpose  of  transacting  the 
partnership  business,  and  who  returned  to  Europe  when  this 
purpose  was  accomplished,  was  held  to  be  a  nonresident  alien 
and  therefore  not  taxable  with  respect  to  his  share  of  the  part- 
nership profits  so  held  to  be  from  sources  without  the  United 
States. "5  A  foreign  partnership  is  liable  for  tax  under  thQ 
1917  act  on  the  entire  amount  of  profit  derived  from  the  sale  of 
goods  through  its  branch  office  or  through  its  agencies  in  the 
United  States.  The  basis  of  computation  of  profits  should  be 
the  difference  between  the  cost  of  the  goods  sold  through  its 
branch  office  or  agent  in  the  United  States  and  the  price  received 
therefor  and  not  merely  the  amount  disclosed  by  the  books  of  the 
branch  office  in  the  United  States.^i'^^ 

Collection  of  the  Tax  at  the  Source.  Under  the  Revenue 
Act  of  1918,  a  partnership,  resident  or  non-resident,  is  not 
subject  to  having  any  tax  withheld  at  the  source  on  income  from 
sources  in  this  country,  except  in  the  case  of  interest  upon  bonds 
of  corporations  containing  covenants  to  pay  the  tax.^i^  The 
treasury  department  under  the  1916  law  made  no  distinction 

115  0.   D.   593,   T.   B.  29-20-1072. 

11'^  O.  D.  311,  T.  B.  25-19-585. 

117  Revenue  Act  of  1918,  §  221  (b)  ;  Reg.  45,  Art.  361.  Withholding  was 
not  required  in  any  case  on  payments  to  a  resident  foreign  partnership 
under  the  1916  Law.  Nonresident  foreign  partnerships  were  also  not  sub- 
ject to  having  the  tax  withheld  on  interest  from  investments  in  the  bonds 
or  similar  obligations  of  domestic  or  resident  corporations  (telegram  from 
treasury  department  dated  May  17,  1918;  I.  T.  S.  1918,  113362)  or  on  divi- 
dends (Reg.  33  Rev.,  Art.  32;  letter  from  treasury  department  dated  June 
6,  1918;  I.  T.  S.  1918,  113528)  on  the  stock  of  corporations  or  other  income. 
The  language  of  the  Revenue  Act  of  1916,  §  13  (e),  as  amended,  was  am- 
biguous. It  provided  that  the  provisions  relating  to  withholding  of  the  tax 
should  be  made  applicable  "to  the  tax  imposed  by  subdivision  (a)  of  §  10 
upon  incomes  'derived  from  interest  upon  bonds  and  mortgages  or  deeds  of 
trust  or  similar  obligations  of  domestic  or  other  resident  corporations 
*  *  *  by  nonresident  alien  firms."  No  tax,  as  a  matter  of  fact,  was 
imposed  upon  firms  or  partnerships  by  subdivision  (a)  of  §  10,  and  conse- 
quently it  was  ruled  that  no  tax  need  be  withheld. 

ii'i  Telegram  from  treasury  department  dated  May  17,  1918;  I.  T.  S. 
1918,  H  3362.  It  is  interesting  to  note  in  this  connection  that  immediately 
after  the  1913  Law  was  enacted  and  before  it  was  held  that  partnerships 
were  not  subject  to  withholding  the  treasury  department  provided  for  the 
use  of  partnerships  an  ownership  certificate  which  required  a  statement 
of  the  names  and  addresses  of  each  of  the  partners.  No  such  disclosure  of 
the  names  of  the  partners  of  nonresident  foreign  partnerships  was  subse- 
quently required,  which  indicates  that  the  treasury  department  did  not  con- 
sider the  individual  status  of  the  partners  to  be  essential  in  determining 
whether  or  not  withholding  is  necessary. 


PARTNERSHIPS  193 

based  upon  the  status  of  the  individual  partners  and  no  such 
distinction  was  made  under  the  1918  law."^  Under  the  1921 
law,  however,  withholding  is  required  against  partnerships  com- 
posed in  whole  or  in  part  of  non-resident  aliens  to  the  same  ex- 
tent as  against  non-resident  alien  individuals."'-' 

Procedure  in  Collecting  Income.  Under  the  1918  law.  in 
collecting  income  from  interest  on  bonds  not  containing  a  "tax- 
free  covenant"  a  resident  or  non-resident  foreign  partnership 
made  use  of  a  form  certifying  that  it  was  not  subject  to  having 
the  income  tax  withheld  at  the  source.'-"  In  collecting  any  other 
form  of  income  no  prescribed  certificate  was  necessary,  but  the 
partnership  might  be  called  upon  to  disclose  its  name  and  loca- 
tion for  the  purpose  of  supplying  the  payor  of  the  income  with 
the  information  which  he  was  required  to  transmit  to  the  goven:- 
ment.^-' 

Duty  in  Paying  Out  Income.  Resident  foreign  partnerships 
are  under  the  same  duty  in  paying  out  income  to  others  as  are 
domestic  partnerships;  that  is,  they  are  required  to  withhold  on 
payments  made  from  the  office  in  this  country  under  the  same 
conditions  which  require  domestic  partnerships  to  withhold. 
They  are  also  required  to  report  the  names  of  those  to  whom 
they  pay  fixed  or  determinable  income,  in  the  manner  required  by 
law  of  corporations,  partnerships,  and  individuals  generally. '-- 

ii!»  Revenue  Act  of  1921,  §221    (a).    See  Chapter  40. 

'-"Reg.  45,  Art.  365.    Form  No.  1001   (revised)   is  used  for  this  purpose. 

'-1  For  the  1916  procedure  in  this  respect  see  Reg.  33  Rev.,  Art.  43. 
Telegram  from  treasury  department  dated  May  21,  1918;  I.  T.  S.  1918, 
113364.     See  I.  T.  S.  1918,  ^  3452a. 

1--  See  Chapters  39  and  40. 


CHAPTER  9 

PERSONAL  SERVICE  CORPORATIONS 

In  an  attempt  to  equalize  the  relative  tax  burdens  of  corpora- 
tions and  partnerships  the  Revenue  Act  of  1918  prescribed  a  new 
system  of  taxation  for  a  certain  type  of  corporation,  which  it 
called  a  personal  service  corporation.  Personal  service  corpora- 
tions are  corporations  whose  income  is  to  be  ascribed  primarily 
to  the  activities  of  the  principal  owners  or  stockholders  who  are 
themselves  regularly  engaged  in  the  active  conduct  of  the  affairs 
of  the  corporation  and  in  which  capital  (whether  invested  or  bor- 
rowed) is  not  a  material  income-producing  factor.  The  term 
"personal  service  corporation"  does  not  include,  however,  any 
foreign  corporation,  or  any  corporation  50  per  centum  or  more 
of  whose  gross  income  consists  either  (1)  of  gains,  profits,  or 
income  derived  from  trading  as  a  principal,  or  (2)  of  gains, 
profits,  commissions,  or  other  income,  derived  from  a  govern- 
ment contract  or  contracts  made  between  April  6,  1917,  and 
November  11,  1918,  both  dates  inclusive.^  Personal  service  cor- 
porations as  such  are  not  subject  to  the  income,  war-profits  or 
excess-profits  taxes  imposed  by  the  Revenue  Act  of  1918  and  the 
Revenue  Act  of  1921  for  the  year  1921,  the  individual  stock- 
holders thereof  being  taxed  in  the  same  manner  as  the  mem- 
bers of  partnerships.^  The  latter  statute,  however,  abolishes 
the  exemption  of  personal  service  corporations  as  of  December 
31,  1921.  Thereafter  personal  service  corporations  are  to  be 
treated  in  the  same  manner  as  all  other  corporations.  The  dis- 
cussion in  this  chapter  is,  therefore,  limited  to  the  years  1917 
to  1921,  inclusive.  The  Revenue  Act  of  1921  also  imposes  an 
alternative  retroactive  tax  on  personal  service  corporations  in 
the  event  that  the  scheme  of  taxation  of  such  corporations  is 
held  unconstitutional  and  invalid,  and  this  provision  will  be 
discussed  below. 

All  the  provisions  of  law  discussed  in  the  preceding  chapter 
relating  to  partnerships  and  the  members  thereof  apply,  so  far 

1  Revenue  Act  of  1921,  §  200  (5)  ;  Revenue  Act  of  1918,  §  200.  The  defini- 
tion is  the  same  in  the  two  law^s.  For  a  definition  of  the  term  "Government 
Contract,"  see  Reg.  45,  Art.  1510,  and  Revenue  Act  of  1921,  §2   (11). 

2  Revenue  Act  of  1921,  §§  231  (14),  218  (d)  ;  Revenue  Act  of  1918,  §§  231 
(14),  218  (e)  ;  Reg.  45,  Art.  328.  In  making  returns  for  fiscal  years  be- 
ginning in  1917,  personal  service  corporations  were  not  treated  wholly  as 
such 

194 


PERSONAL  SERVICE  CORPORATIONS  195 

as  practicable,  to  personal  service  corporations  and  the  stock- 
holders thereof,  provided  that  amounts  distributed  by  a  personal 
service  corporation  during  its  taxable  year  be  accounted  for  by 
the  distributees  (i.e.,  the  persons  who  actually  receive  the  divi- 
dends) ;  and  any  portion  of  the  net  income  remaining  undis- 
tributed at  the  close  of  its  taxable  year  must  be  accounted  for  by 
the  stockholders  of  such  corporation  at  the  close  of  its  taxable 
year  in  proportion  to  their  respective  shares.'^  Thus,  the  indi- 
vidual stockholders  of  personal  service  corporations  are  taxable 
upon  their  distributive  shares  in  the  same  manner  as  the  mem- 
bers of  partnerships,  and  the  corporation  is  subject  to  neither 
income  nor  excess-profits  taxes.^ 

Definition.  The  statutory  definition  of  personal  service  cor- 
porations has  been  given  above.  By  regulation  the  term  "per- 
sonal service  corporation"  is  defined  as  a  corporation,  not  ex- 
pressly excluded,  the  income  of  which  is  derived  from  a  profes- 
sion or  business  (a)  which  consists  principally  of  rendering 
personal  sei'vice,  (b)  the  earnings  of  which  are  to  be  ascribed 
primarily  to  the  activities  of  the  principal  owners  or  stockhold- 
ers, and  (c)  in  which  the  employment  of  capital  is  not  necessary 
or  is  only  incidental.  No  definite  and  conclusive  tests  can  be 
prescribed  by  which  it  can  be  finally  determined  in  advance  of  an 
examination  of  the  corporation's  return  whether  or  not  it  is 
a  personal  service  corporation.''  The  general  principles  under 
which  such  determination  will  be  made  are  stated  in  the  follow- 
ing paragraphs. 

Certain  Corporations  Excluded.  The  following  classes  of 
corporations  are  expressly  excluded  from  classification  as  per- 
sonal service  corporations:  (a)  foreign  corporations;  (b)  cor- 
porations 50  per  centum  or  more  of  whose  gross  income  consists 
of  gains,  profits  or  income  derived  from  trading  as  a  principal ; 
and  (c)  corporations  50  per  centum  or  more  of  whose  gross 
income  consists  of  gains,  profits,  commissions,  or  other  income 
derived  from  a  government  contract  or  contracts  made  between 
April  6,  1917,  and  November  11,  1918,  inclusive.  A  corporation 
is  not  a  personal  service  corporation  merely  because  less  than 
50  per  centum  of  its  gross  income  was  derived  from  trading  as 
a  principal  or  from  government  contracts.""'    A  corporation  can 

3  Revenue  Act  of  1921,  §218  (d)  ;  Revenue  Act  of  1918,  §218  (e). 

4  Reg.  45,  Art.  328. 

•"•  Reg.  45,  Art.  1523. 

C'  Reg.  45,  Art.  1524.  This  rule  was  applied  in  A.  R.  M.  120,  T.  B.  15-21- 
1558,  where  25 9r  of  the  earnings  of  the  corporation  were  derived  from  trad- 
ing as  a  principal.    No  other  reason  against  personal  service  classification 


196  FEDERAL  INCOME  TAX 

not  be  considered  a  personal  service  corporation  when  another 
corporation  owns  or  controls  substantially  all  of  its  stock,  or 
when  substantially  all  of  its  stock  and  of  the  stock  of  another 
corporation  (not  itself  a  personal  service  corporation)  forming 
part  of  the  same  business  enterprise  is  owned  or  controlled  by 
the  same  interests.^ 

In  a  case  in  which  this  ruling  was  applied,  the  recommendation 
has  been  made  that  the  ruling  be  modified  so  as  to  allow  both  the 
parent  corporation  and  its  subsidiaries  to  be  classed  as  personal 
service  corporations,  provided  they  fulfill  all  other  requirements 
for  such  qualification.'^ 

Personal  Services  Rendered.  In  order  that  a  corporation 
may  be  deemed  to  be  a  personal  service  corporation  its  earnings 
must  be  derived  principally  from  compensation  for  personal 
services  rendered  by  the  corporation  to  the  persons  with  whom 
it  does  business.  Merchandising  or  trading  either  directly  or 
indirectly  in  commodities  or  the  services  of  others  is  not  render- 
ing personal  service.  Conducting  an  auction,  agency,  brokerage, 
or  commission  business  strictly  on  the  basis  of  a  fee  or  commis- 
sion is  rendering  personal  service.  If,  however,  the  corporation 
assumes  any  such  risks  as  those  of  market  fluctuation,  bad  debts, 
failure  to  accept  shipments,  etc.,  or  if  it  guarantees  the  accounts 
of  the  purchaser  or  is  in  any  way  responsible  to  the  seller  for 
the  payment  of  the  purchase  price,  the  transaction  is  one  of 
merchandising  or  trading  and  this  is  true  even  though  the  goods 
are  shipped  directly  from  the  producer  to  the  consumer  and  are 
never  actually  in  the  possession  of  the  corporation.  The  fact 
that  earnings  of  the  corporation  are  termed  commissions  or  fees 
is  not  controlling.  The  fact  that  a  commission  or  fee  is  based 
on  a  difference  in  the  prices  at  which  the  seller  sells  and  the 
buyer  buys  raises  a  presumption  that  the  transaction  is  one  of 
merchandising  or  trading,  and  it  will  be  so  considered  in  the  ab- 
sence of  satisfactory  evidence  to  the  contrary.^ 

appeared.  The  statute  prescribes  50%  as  the  amount  of  trading  as  a 
principal  which  disqualifies  a  corporation  from  being  classed  as  a  personal 
service  corporation,  and  the  intent  of  the  1917  Act  was  similar.  Where  the 
statute  prescribes  50%  as  the  limit,  and  there  is  only  25%  of  such  trading, 
a  corporation  would  seem  to  be  a  personal  service  corporation  unless  some 
other  factor  required  a  different  conclusion.  The  validity  of  the  ruling 
upon  the  theory  that  capital  was  a  material  income-producing  factor  is 
doubtful. 

"Reg.  45,  Art.  1524;  O.  D.  1,  T.  B.  1-19-4. 

s  A.  R.  R.  46,  T.  B.  13-20-802. 

9  Reg.  45,  Art.  1525.  It  is  perhaps  the  most  fundamental  positive  essential 
to  personal  service  classification  that  the  earnings  of  a  corporation  be  de- 


personal  service  corporations  197 

Personal  Service  Rendered:  More  Than  One  Business. 
It  frequently  happens  that  corporations  are  engaged  in  two  or 
more  professions  or  businesses  which  are  more  or  less  related, 
one  of  which  does  not  consist  of  rendering  persona)  service. 
Thus  an  engineering  concern  may  also  engage  in  contracting, 
which  amounts  to  trading  in  materials  and  labor,  a  brokerage 
concern  may  guarantee  some  of  its  accounts,  a  photographer 
may  sell  pictures,  frames,  art  goods,  and  supplies,  or  a  dealer  in 
r.  commodity  may  furnish  expert  advice  or  services  with  respect 
to  its  installation,  use,  etc.  In  such  case  the  corporation  is  not 
a  personal  service  corporation  unless  the  non-personal  service 
element  is  negligible  or  merely  incidental  and  no  appreciable  part 
of  its  earnings  is  to  be  ascribed  to  such  sources. i" 

Activities  of  Stockholders.  In  determining  whether  a  cor- 
poration is  a  personal  service  corporation,  no  weight  can  be 
given  to  the  fact  that  it  renders  personal  services  unless  (a) 
the  principal  owners  or  stockholders  are  regularly  engaged  in 
the  active  conduct  of  its  affairs  and  are  engaged  in  such  a  man- 
ner that  the  earnings  are  to  be  ascribed  primarily  to  their  activ- 
ities, and  (b)  its  affairs  are  conducted  principally  by  such  owner? 
or  stockholders.^!  Where  the  principal  owners  or  stockholders 
do  not  render  the  principal  part  of  the  services,  but  merely  su- 
pervise or  direct  a  force  of  employees,  the  corporation  is  not  a 
personal  service  corporation.  If  employees  contribute  substan- 
tially to  the  services  rendered  by  a  corporation,  it  is  not  a  per- 
sonal service  corporation  unless  in  every  case  in  which  services 
are  so  rendered  the  value  of  and  the  compensation  charged 
for  such  services  are  to  be  attributed  primarily  to  the  experience 
or  skill  of  the  principal  owners  or  stockholders  and  such  fact 
is  evidenced  in  some  definite  manner  in  the  normal  course  of  the 
profession  or  business.  The  fact  that  the  principal  owners  or 
stockholders  give  personal  attention  or  render  valuable  services 
to  the  corporation  as  a  result  of  which  its  earnings  are  greater 
than  those  of  a  corporation  engaged  in  a  like  or  similar  business, 
the  principal  owners  or  stockholders  of  which  do  not  devote  per- 
sonal attention  to  the  management  or  supervision  of  its  affairs. 

rived  "principally  from  compensation  for  personal  services  rendered  by  the 
corporation  to  the  persons  with  whom  it  does  business."  The  force  of  the 
word  "principally,"  as  well  as  the  word  "primarily,"  as  used  in  the  statute 
is  discussed  in  A.  R.  R.  463,  T.  B.  41-21-1858. 

10  Reg.  45,  Art.  1526. 

n  Reg.  45,  Art.  1527. 


198  FEDERAL  INCOME  TAX 

does  not  of  itself  constitute  the  corporation  a  personal  service 
corporation.12 

Activities  of  Stockholders:  Stock  Interest  Required. 
No  definite  percentage  of  stock  or  interest  in  the  corporation 
which  must  be  held  by  those  engaged  in  the  active  conduct  of  its 
affairs  in  order  that  they  may  be  deemed  to  be  the  principal 
owners  or  stockholders  can  be  prescribed  as  a  conclusive  test,  as 
other  facts  may  affect  any  presumption  so  established.  No  cor- 
poration or  its  owners  or  stockholders  may,  however,  make  a 
return  in  the  first  instance  on  the  basis  of  its  being  a  personal 
service  corporation  unless  at  least  80  per  centum  of  its  stock 
is  held  by  those  regularly  engaged  in  the  active  conduct  of  its 
affairs.i^ 

12  Reg.  45,  Art.  1528;  A.  R.  R.  464,  T.  B.  17-21-1588.  The  statute  does 
not  require  that  the  "affairs"  of  a  personal  service  corporation  be  "con- 
ducted principally"  by  its  "owners  or  stockholders."  The  regulations  given 
in  the  text  above  are  in  this  respect  an  attempt  to  put  into  the  body  of  the 
statute  a  limitation  which  Congress  did  not  think  it  necessary  to  prescribe. 
The  statute  itself  simply  requires  that  the  principal  owners  or  stock- 
holders be  "regularly  engaged"  in  the  active  conduct  of  the  affairs  of  a 
personal  service  corporation  and  that  the  earnings  of  the  corporation  be 
such  as  may  be  ascribed  "primarily"  to  the  activities  of  such  owners  or 
stockholders.  It  does  not  require  that  the  affairs  of  the  corporation  be 
conducted  "principally"  by  its  owners  or  stockholders.  The  principal  owners 
of  a  corporation  might  be  "regularly  engaged"  in  the  conduct  of  its  affairs 
so  that  its  earnings  would  be  ascribed  "primarily  to  their  activities,"  and 
yet  the  activities  of  a  corporation  might  be  conducted,  at  least  on  a  quanti- 
tative basis,  "principally"  by  nonstockholding  employees.  Insofar  as  this 
regulation  extends  the  terms  of  the  statute  its  validity  is  to  be  questioned 
(See  Morrill  v.  Jones,  106  U.  S.  466,  and  cases  cited  upon  this  point  in 
Chapter  47).  There  is  no  requirement,  furthermore,  that  the  principal 
owners  or  stockholders  shall  attend  to  all  the  detail  of  a  business.  (See 
A.  R.  R.  463,  T.  B.  41-21-1858.) 

13  Reg.  45,  Art.  1529.  This  regulation  is  to  be  read  in  connection  with 
Reg.  45,  Art.  1524,  in  which  it  is  held  that  a  corporation  can  not  be  con- 
sidered a  personal  service  corporation  when  another  corporation  owns  or 
controls  substantially  all  of  its  stock.  The  basic  theory  underlying  these 
rulings  is  that  a  corporation  cannot  render  personal  services.  The  statute, 
however,  does  not  require  that  all  the  owners  and  stockholders  of  a  per- 
sonal service  corporation  must  be  regularly  engaged  in  the  active  conduct 
of  its  affairs  and  that  the  earnings  of  the  corporation  be  such  as  can  be 
ascribed  completely  to  the  activities  of  such  owners  and  stockholders. 
It  is  careful  to  avoid  any  such  absolute  requirement.  If  the  80% 
limitation  given  in  the  text  above  is  intended  to  be  anything  more 
than  prima  facie,  it  would  seem  to  be  a  perversion  of  the  statute.  For  ac- 
cording to  their  natural,  oi'dinary  and  familiar  meaning,  which  must  control 
in  ascertaining  the  legislative  intent  (DeGanay  v.  Lederer,  250  U.  S.  376, 
239  Fed.  568,  and  cases  cited  in  Chapter  47)  the  words  "principal"  and 
"primarily"  do  not  necessarily  imply  a  percentage  as  high  as  80 9o.     This 


PERSONAL  SERVICE  CORPORATIONS  199 

ACTIVITIES  OF  stockholders:    change  in  ownership.    The 
fact  that  the  owners  or  stockholders  of  the  corporation   may 
change  during  the  course  of  the  taxable  year  does  not  take  a 
corporation  which  is  normally  in  the  personal  service  class  out 
of  that  class.     Frequent  changes  in  the  ownership  of  anj  sub- 
stantial interest  or  number  of  shares  is,  however,  evidence  bear- 
ng    n  the  question  as  to  whether  the  principal  owners  or  s  ock- 
hoWers  are  actively  engaged  in  the  conduct  of  the  affairs  of  the 
cornoratlon     The  incapacity,  retirement  or  death  of  a  principal 
owne    o'-Ttockholder  who  has  been  actively  engaged  in  the  con- 
T  7„f  it=  affairs  will  not  be  deemed  to  make  any  change  in  the 
ft"atu    of  the  c  rporation  during  a  reasonable  time  thereafter. 

CAPITAL     In  determining  whether  a  corporation  is  a  personal 
sei^tr^'poration,  no  weight  can  be  given- to  the  fac    that   he 

to  carry  on  such  profession  or  business.-    If  the  use  of  capital 

conclusion  is  fortified  by  a  statemen.  of  Mr.  f^'f^-J^l^^ZTZlT. 
Ways  and  Means  Committee  f/^'  "^^^^^j^^/^^'^rue  Act  of  1918.  Mr. 
March  .8  and  f;  "^  J  "  .".^i^'  a  perTonaTservte  ^rporation)  may  have  a 
fh-rnHtl^rerrhutili^rLnm^^^^ 

N.  La  vnn  ran  attribute  the  profits  they  may  make,  or  substantially  an  oi 
it,  and  you  can  auiiuuLc  t       ^  „p,.<.nnal  service  corporation  under 

U.  S.  78,  and  cases  cited  in  Chapter  47). 

"-5'^-  ?.'  ^^\  \™'.   A    R    R    464,  T.  B.  17-21-1688.     This  ruling  is 
cletr^'un  otd."  In'leVermint/the  extent  to  which  capita,  is  rec,ui.d  to 

:'aTry'on  a  profession  or  ^^---^  .f "«  -"^tTp.  yed  in  a  P        ssTon 
dence  than  ^'^-'^^J-^^tf /^s      \  "det:rm™e'tre  ex.e„t^o  which 

:IpSTs- Ji  :d-:uh::^£.™-o  t.  acu..  .;----- 
i:-srji=^SS:nr:::drh^^^^^^^^ 

^r  pa,  olerTo"    st'ocKhoIders  .should  be  ta.en  into  consideration  .n  de^ 

te"mining  the  extent  to  .;hich   capita,    ».   -;■-•«',„'"„:  tTsdnt  of 
matter  of  fact,  it  is  so  taken  mto  cons.de.  at.on.    In 


200  FEDERAL  INCOME  TAX 

is  necessary  or  more  than  incidental,  capital  is  a  material 
income-producing  factor  and  the  corporation  is  not  a  personal 
service  corporation.  No  corporation  is  a  personal  service  cor- 
poration if  it  carries  on  business  of  a  kind  which  ordinarily 
requires  the  use  of  capital,  irrespective  of  whether  the  owners 
or  stockholders  have  actually  invested  a  substantial  amount  of 
capital.i'^ 

Capital:  Inference  from  Use.  The  term  "capital"  means 
not  only  capital  actually  invested  by  the  owners  or  stockholders, 
but  also  capital  secured  in  other  ways.  Thus,  if  capital  is  bor- 
rowed either  directly  as  shown  by  bonds,  debentures,  certificates 
of  indebtedness,  notes,  bills  payable  or  other  paper,  or  indirectly 
as  shown  by  accounts  payable  or  other  forms  of  credit,  or  if  the 
business  of  the  corporation  is  in  any  way  financed  by  or  through 
any  of  the  owners  or  stockholders,  these  facts  will  be  deemed 
evidence  that  the  use  of  capital  is  necessary.  If  a  substantial 
amount  of  capital  is  used  to  finance  or  carry  the  accounts  of 
clients  or  customers,  it  will  be  inferred  that  because  of  compe- 
tition or  other  reasons  such  practice  is  necessary  in  order  to 
secure  or  hold  business  which  otherwise  would  be  lost,  and  that 
the  corporation  is  not  a  personal  service  corporation.  If  a  cor- 
poration engaged  in  an  agency,  brokerage,  or  commission  busi- 
ness regularly  employs  a  substantial  amount  of  capital  to  lend 
to  principals,  to  buy  and  carry  goods  on  its  own  account,  or  to 
buy  and  carry  odd  lots  in  order  that  it  may  render  more  satisfac- 
tory service  to  its  principals  or  customers,  it  is  not  a  personal 
service  corporation.  In  general  the  larger  the  amount  of  the 
capital  actually  used  the  stronger  is  the  evidence  that  capital  is 
necessary  and  is  a  material  income-producing  factor  and  that  the 
corporation  is  not  a  personal  service  corporation.^" 

Article  1532  of  Regulations  45,  the  treasury  department  holds  that  the 
larger  the  amount  of  capital  actually  used,  the  stronger  is  the  evidence 
that  capital  is  necessary.  The  converse  of  this  proposition  is  equally  true. 
The  smaller  the  amount  of  capital  actually  used,  the  stronger  is  the  evidence 
that  capital  is  not  necessary. 

i(>  Reg.  45,  Art.  1531.  This  ruling  is  also  a  misinterpretation  of  the 
statute.  The  question  to  be  determined  in  regard  to  any  corporation  claim- 
ing personal  service  classification  is  not  whether  corporations  doing  a 
similar  business  ordinarily  require  the  use  of  capital,  but  whether  the 
particular  corporation  under  consideration  in  fact  requires  the  use  of  cap- 
ital. The  fact  that  similar  corporations  do  ordinarily  require  the  use  of 
capital  may  be  evidential,  but  it  should  certainly  not  conclusively  preclude 
personal  service  classification  if  a  corporation  in  fact  does  not  employ  cap- 
ital in  carrying  on  its  business. 

17  Reg.  45,  Art.  1532.  See  foot  note  13.  The  distinction  between  capital 
invested  and  held  in  a  corporation  and  capital  actually  used  should  not  be 


PERSONAL  SERVICE  CORPORATIONS  201 

Additional  Principles  Hearing  I'pon  Personal  Service  Classifi- 
cation: Examples.  The  Revenue  Act  of  1917  contained  a  pro- 
vision to  the  effect  that  in  the  case  of  a  trade  or  business  "having 
no  invested  capital  or  not  nnore  than  a  nominal  capital,"  there 
should  be  levied,  assessed,  collected,  and  paid  an  excess-profits 
tax  of  8'<'  of  the  net  income.'"^  The  regulations  interpreting  this 
provision  stated  that  it  applied  primarily  to  occupations,  pro- 
fessions, trades  and  businesses  engaged  principally  in  rendering 
personal  service  in  which  the  employment  of  capital  is  not  neces- 
sary and  the  earnings  of  which  are  to  be  ascribed  primarily  to 
the  activities  of  the  owners.  These  regulations  also  provided 
that  no  weight  would  be  given  to  the  fact  that  a  business  was 
carried  on  by  means  of  personal  services,  unless  the  principal 
owners  were  regularly  engaged  in  the  active  conduct  of  the  busi- 
ness.'" It  will  be  noted  that  this  provision  of  the  Revenue  Act 
of  1917,  as  construed  by  the  treasury  department,  is  closely 
analogous  to  the  personal  service  corporation  provision  of  the 
Revenue  Act  of  1918.  Several  cases  have  arisen  in  which  the 
applicability  of  the  above  provision  of  the  Revenue  Act  of  1917 
and  the  personal  service  corporation  provision  of  the  Revenue 
Act  of  1918,  or  both,  has  been  discussed  at  some  length  with 
reference  to  a  more  or  less  complicated  state  of  facts. 

The  question  whether  a  particular  business  is  one  having 
not  more  than  a  "nominal  capital"  or  is  such  as  to  render  a  cor- 
poration a  personal  service  corporation  within  the  meaning  of 

forgotten.  The  fact  that  a  corporation  has  a  substantial  capital  or  earned 
surplus  may  not  preclude  personal  service  classification,  if  this  capital  or 
earned  surplus  is  not  necessary  to  the  prosecution  of  the  business  of  the  cor- 
poration; and  the  fact  that  it  is  not  necessary  may  be  indicated  by  the  man- 
ner in  which  it  is  invested.  There  is  nothing  in  the  statute  preventing  the  ac- 
cumulation of  surplus  or  profits  by  a  personal  service  corporation.  This 
is  expressly  stated  by  Mr.  Kitchin,  the  chairman  of  the  Ways  and  Means 
Committee  of  the  House  of  Representatives  (hearings  before  the  committee 
on  Ways  and  Means,  House  of  Representatives,  March  18  and  19,  1920,  p.  S8) , 
and  this  statement  is  admissible  evidence  of  legislative  intent  (U.  S.  v.  St. 
Paul  M.  &  M.  R.  Co.,  247  U.  S.  310,  and  cases  cited  in  Chapter  47).  See 
also  Congressional  Record,  September  18,  1918,  pp.  11,  329.  In  Porter  v. 
Lederer,  267  Fed.  739,  in  construing  §  209  of  the  Revenue  Act  of  1917,  it  is 
said:  "The  mere  fact,  however,  that  the  profits  of  a  business  having  no  capital 
are  not  wholly  withdrawn  does  not  make  of  such  undrawn  profits  a  capital 
fund.  Congress  has  yiven  a  clear  definition  of  such  capital  or  capital  de- 
rived from  this  source.  When,  in  addition  to  profits  being  left  undrawn, 
the  fund  thus  accumulated  is  'used  or  employed  in  the  business,'  it  is  capital 
within  the  meaning  of  the  tax  law,  otherwise  it  is  not." 

i>^  Revenue  Act  of  1917,  §209. 

i!»Reg.  41,  Art.  71. 


202  FEDERAL  INCOME  TAX 

the  Revenue  Act  of  1918,  involves  in  each  case  an  extensive 
examination  of  such  business  and  the  manner  in  which  it  is 
conducted.  It  is  beyond  the  scope  of  this  work  to  describe  at 
length  and  in  detail  the  businesses  involved  in  the  rulings  of 
the  treasury  department  upon  this  question.  There  are  stated 
below,  however,  certain  general  principles  enunciated  by  such 
rulings  for  guidance  in  connection  with  the  determination  of 
the  question  in  respect  of  any  particular  business. 

1.  In  order  to  be  classed  as  a  concern  with  nominal  capital  or 
as  a  personal  service  corporation,  the  treasury  department  holds 
that  the  income  of  a  corporation  must  not  result  in  substantial 
degree  from  the  ownership  of  property,  such  as  patents.-^  But 
the  courts  have  assumed  a  rather  more  liberal  attitude  toward 
this  question  than  the  treasury  department.  In  a  recent  case 
a  corporation  originally  incorporated  with  a  capital  stock  of 
$100,000,  which  in  1911  had  ceased  conducting  any  other  busi- 
ness than  that  of  granting  licenses  under  patents  owned  by  it, 
its  capital  having  been  reduced  to  $10,000  and  its  surplus  in 
1917  amounting  to  $2,000,  this  capital  being  used  as  a  fund  from 
which  to  advance  salaries  and  wages  and  to  provide  oifice  furni- 
ture and  equipment,  was  held  to  be  a  concern  with  not  more 
than  a  nominal  capital  under  the  1917  Law.  The  court  held  in 
this  case  that  patents  were  not  capital  in  an  economic  sense  or 
in  the  sense  of  the  phrase  "nominal  capital." -i 

2.  In  order  to  be  classed  as  a  concern  with  nominal  capital 
or  as  a  personal  service  corporation,  an  agency  acting  as  selling 

20  T.  B.  M.  9,  T.  B.  1-10-135;  O.  D.  2,  T.  B.  1-19-5;  A.  R.  R.  363,  T.  B. 
3-21-1394. 

21  De  Laski  &  Thropp  Co.  v.  Iredell,  268  Fed.  377.  After  referring  to 
the  fact  that  Congress  included  patents  in  invested  capital  to  the  extent 
only  of  investment,  and  that  if  there  was  no  investment  in  them  they  re- 
mained in  the  same  class  as  that  intangible  something  which  makes  for  the 
wealth  of  the  professional  man  or  broker,  the  court  said :  "The  patents  which 
the  plaintiff  owned  were  the  concrete  embodiment  of  the  skill  which  the 
plaintiff  possessed  in  its  field  of  activity.  This  skill  or  service  it  bartered 
for  a  consideration.  Such  skill  or  service  is  like  the  service  a  lawyer  in 
large  practice  renders  for  an  annual  retainer,  and  is  very  nearly  akin  to  the 
service  which  a  commission  house  renders  to  those  who  buy  and  sell  through 
it,  or  the  service  of  a  concern  engaged  in  selling  or  leasing  real  estate,  and 
in  writing  insurance.  The  plaintiff's  source  of  income  was  that  which 
certain  persons  were  willing  to  pay  it  for  the  use  of  its  skill  and  knowledge. 
It  is  true  that  skill  and  knowledge  had  been  reduced  to  concrete  form;  but 
the  payment  was  for  the  use  of  the  skill  and  knowledge,  and  not  for  any 
part  or  parcel  of  the  form  to  which  the  skill  and  knowledge  had  been 
reduced." 


PERSONAL  SERVICE  CORPORATIONS  203 

agent  must  not  acquire  title  to  the  products  handled  or  be  re- 
sponsible to  the  manufacturer  for  the  products  sold.-- 

3.  In  order  to  be  classed  as  a  concern  with  nominal  capital 
or  as  a  personal  service  corporation,  a  company  in  the  brokerage 
commission  business  must  not  be  liable  to  the  consignor  for  the 
selling  price  of  the  product  sold.--' 

4.  In  order  to  be  classed  as  a  concern  with  nominal  capital 
or  as  a  personal  service  corporation,  a  commission  house  or 
agency  must  not  extend  substantial  credit  to  firms  for  which  it 
acts  as  agent. -^ 

5.  Where  the  income  of  a  concern  is  to  be  ascribed  to  a  com- 
bmation  of  the  activities  of  the  principal  owners  and  stockhold- 
ers and  the  activities  of  the  managers  and  various  agencies  who 
are  not  stockholders,  the  concern  will  not  be  entitled  to  be  classed 
as  one  with  a  nominal  capital  or  as  a  personal  service  corpo- 
ration.-"' 

The  following  businesses  have  been  held  not  to  fall  within  the 
definition  of  concerns  with  a  nominal  capital  or  personal  service 
corporations : 

1.  A  freight  forwarding  business  which  advances  various 
costs  of  carriage.-'"' 

2.  A  corporation  engaged  in  the  business  of  retailing  auto- 
mobiles, which  business  is  that  of  the  ordinary  commercial  en- 
terprise in  which  capital  is  a  material  factor  in  the  conduct  of 
the  business.-"^ 

3.  A  sanitarium  owned  and  operated  by  doctors  which  de- 
rives income  from  the  buildings  and  grounds  by  housing  pa- 
tients.-s 

4.  A  stevedoring  company,  financed  by  a  foreign  government, 
the  stockholders  of  which  are  practically  stevedoring  eflficiency 
engineers.'-"^ 

A  corporation  conducting  a  commercial  school,  having  both 
home  study  and  resident  instruction  departments,  which  does  not 
lodge  or  board  any  students,  and  to  which  the  principal  owners 
give  all  their  time  and  attention  in  the  preparation  of  courses, 

i-'2A.  R.  M.  42,  T.  B.  17-20-880;  A.  R.  R.  23,  T.  B.  6-20-724;  A.  R.  R.  364, 
T.  B.  3-21-1395.  The  nominal  capital  of  a  corporation  may  be  evidence  that 
no  responsibility  was  contemplated  (A.  R.  R.  500,  T.  B.  21-21-1645). 

23  A.  R.  R.  23,  T.  B.  6-20-724. 

24  A.  R.  R.  50,  T.  B.  20-20-929;  A.  R.  R.  4(5.  T.  B.  13-20-802. 

25  A.  R.  M.  59,  T.  B.  26-20-1023.     But  see  A.  R.  R.  463,  T.  B.  41-21-1858. 
20  A.  R.  R.  7,  T.  B.  29-19-622. 

27  T.  B.  R.  58,  T.  B.  19-19-492. 

28  0.  D.  2,  T.  B.   1-19-5. 

20  A.  R.  R.  463,  T.  B.  41-21-1858. 


204  FEDERAL  INCOME  TAX 

syllabus  of  work,  inspection  of  higher  lessons,  and  settling 
points  in  dispute,  has  been  held  to  be  a  concern  with  nominal 
capital  only  and  a  personal  service  corporation  under  the  Reve- 
nue Act  of  1918.''<' 

Dividends.  In  the  case  of  personal  service  corporations  the 
term  ''dividend"  means  any  distribution  made  by  a  personal 
service  corporation  to  its  shareholders  or  members,  whether  in 
cash  or  in  property  of  the  corporation  except  a  distribution  out 
of  its  earnings  or  profits  accumulated  since  December  31,  1917, 
and  prior  to  January  1,  1922.''^  Any  distribution  is  deemed  to 
have  been  made  from  earnings  or  profits,  and  from  the  most 
recently  accumulated  earnings  or  profits,  to  the  extent  of  such 
earnings  or  profits  accumulated  since  March  1,  1913 ;  but  any 
earnings  or  profits  accumulated,  or  increase  in  value  of  property 
accrued,  prior  to  March  1,  1913,  may  be  distributed  exempt  from 
tax,  after  the  earnings  and  profits  accumulated  since  February 
28,  1913,  have  been  distributed.^^ 

Returns.  Every  personal  service  corporation  must  make  a 
return  of  income,  regardless  of  the  amount  of  its  net  income. 
The  return  should  be  on  Form  1065  (Revised).  It  should  be 
made  for  the  taxable  year  of  the  personal  service  corporation ; 
that  is,  for  its  annual  accounting  period  (fiscal  year  or  calendar 
year,  as  the  case  may  be),  regardless  of  the  taxable  years  of  its 
stockholders.^^ 

Contents  of  Return.  The  return  of  a  personal  service  cor- 
poration should  state  specifically  (a)  the  items  of  its  gross  in- 
come; (b)  the  deductions  to  which  it  is  entitled;  (c)  the  amounts 
of  dividends  from  taxable  corporations  and  from  personal  serv- 
ice corporations  out  of  earnings  and  profits  upon  which  income 
tax  has  been  imposed,  and  from  interest  upon  obligations  of  the 
United  States  and  bonds  of  the  War  Finance  Corporation  in- 
cluded in  gross  income;  (d)  the  amount  of  any  income,  war- 
profits  and  excess-profits  taxes  of  the  personal  service  corpora- 
tion paid  during  the  taxable  year  to  a  foreign  country  or  to  any 

30  A.  R.  R.  24,  T.  B.  27-27-36. 

31  Cf.  Revenue  Act  of  1921,  §  201  (a)  and  Revenue  Act  of  1918,  §  201  (a). 
The  change  made  in  the  1921  Law  is,  of  course,  occasioned  by  the  abolition 
of  personal  service  corporations  as  of  December  31,  1921. 

32  Revenue  Act  of  1921,  §201  (b)  ;  Revenue  Act  of  1918,  §201  (b).  See 
Chapters  17  and  19  in  which  the  application  of  distributions  against  and 
their  reduction  of  the  basis  provided  in  §  202  for  determining  gain  or  loss 
is  discussed. 

33  Reg.  45,  Art.  624.  If  the  personal  service  corporation  makes  any 
change  in  its  accounting  period,  it  should  render  its  return  in  accordance 
with  the  provisions  of  §  226. 


PERSONAL  SERVICE  CORPORATIONS  205 

possession  of  the  United  States,  and  the  amount  of  any  such 
taxes  accrued  but  not  paid  during  the  taxable  year;  (e)  the 
amounts  distributed  by  the  corporation  during  its  taxable  year 
with  the  dates  of  distribution;  (f)  the  names  and  addresses  of 
the  stoctcholders  of  the  corporation  at  the  close  of  its  taxable 
year  and  their  respective  shares  in  such  corporation;  (g)  such 
facts  as  tend  to  show  whether  or  not  the  corporation  is  a  per- 
sonal service  corporation;  and  (h)  such  other  facts  as  are  re- 
cjuired  by  the  form.'" 

Distributive  Shares  of  Stockholders.  A  stockholder  of  a  per- 
sonal service  corporation  is  required  to  include  in  his  gross  in- 
come for  the  taxable  year  (a)  any  dividends  paid  by  the  corpo- 
ration in  such  year  out  of  earnings  or  profits  accumulated  since 
P'ebruary  28,  1913,  and  before  January  1,  1918;  (b)  his  share 
of  any  distribution  made  by  the  corporation  in  such  year  out  of 
earnings  or  profits  accumulated  since  December  31,  1917.  and 
since  the  close  of  its  taxable  year  ending  with  or  during  his  next 
preceding  taxable  year;  and  (c)  his  distributive  share  of  the 
undistributed  net  income  of  the  corporation  for  its  taxable  year 
ending  with  or  during  his  taxable  year,  provided  he  was  at  the 
close  of  its  taxable  year  a  stockholder  in  the  corporation,  not- 
withstanding he  might  since  have  ceased  to  be  a  stockholder. 
In  the  case  of  personal  service  corporations  with  taxable  years 
other  than  the  calendar  year,  however,  such  distributive  shares 
or  distributions  may  be  subject  to  different  rates  of  tax.-'"'  In 
view  of  the  fact  that  personal  service  corporations  are  not  re- 
quired to  file  consolidated  returns,  a  profit  realized  or  loss  sus- 

••^  Reff.  45,  Art.  624.  This  ruling  was  made  under  the  1918  l^w.  Point 
(c)  will  be  changed  under  the  1921  Law  to  dividends  from  domestic  corpo- 
rations (except  those  taxable  under  §2f)2)  and  foreign  corporations  with 
50',/  of  their  income  from  sources  within  the  United  States,  as  provided  in 
§216  (a).  In  connection  with  (d)  it  will  be  necessary  to  furnish  evidence 
as  to  the  amount  of  income  derived  from  sources  without  the  United  States 
and  any  information  necessary  for  the  verification  and  computation  of  the 
credit  for  taxes.    (See  §  222  (c).) 

:!-'>Reg.  45,  Art.  330.  This  ruling  was  made  under  the  1918  Law.  The  tax- 
ation of  stockholders  of  personal  service  corporations  with  fiscal  years 
ending  in  1918  and  1919,  is  discussed  in  Reg.  45,  Arts.  329,  3.*i2.  334;  O.  D. 
453,  T.  B.  15-20-850;  O.  D.  1101,  T.  B.  46-21-1922;  O.  D.  1127,  T.  B.  49-21-1963. 
The  application  of  different  tax  rates  in  the  case  of  fiscal  years  of  personal 
service  corporations  ending  in  1918  and  1919  respectively,  is  discussed  in 
Reg.  45,  Arts.  329,  333  and  335.  Point  (a)  will  now  probably  be  changed 
to  any  such  dividends  out  of  earnings  or  profits  accumulated  since  February 
28,  1913,  except  between  January  1,  1918,  and  December  31,  1921;  and 
Point  (b)  will  piobably  be  changed  to  any  such  dividends  out  of  earnings 
or   profits  accumulated   between  January    1,   1918,  and    December   31,    1921. 


206  FEDERAL  INCOME  TAX 

tained  by  a  personal  service  corporation,  attributable  to  its  own- 
ership of  stock  in  another  personal  service  corporation,  should 
be  accounted  for  in  the  same  manner  as  in  the  case  of  an  indi- 
vidual stockholder.  Where  the  business  of  a  personal  service 
corporation  results  in  an  operating  loss,  such  loss  will  be  divided 
among  the  stockholders  at  the  close  of  its  taxable  year  in  pro- 
portion to  their  respective  shares,  and  will  constitute  an  allow- 
able deduction  in  their  returns  of  annual  net  income.'*' 

Credits  Allowed  Stockholders.  A  stockholder  of  a  personal 
service  corporation  is  entitled  to  credit  for  the  purpose  of  the 
normal  tax  only  for  amounts  received  in  distribution  of  earnings 
or  profits  of  the  corporation  accumulated  since  February  28, 
1913,  and  prior  to  January  1,  1918.  He  will,  of  course,  also  be 
entitled  to  a  credit  for  amounts  received  in  distribution  of  earn- 
ings or  profits  accumulated  after  December  31,  1921,  because 
from  that  date  the  corporation  will  no  longer  be  taxed  as  a  per- 
sonal service  corporation.  In  addition  to  the  credits  ordinarily 
allowed  to  an  individual  a  stockholder  of  a  personal  service  cor- 
poration is  entitled  to  the  following  credits:  (a)  A  credit 
against  net  income  for  the  purpose  of  the  normal  tax  only  of 
his  proportionate  share  of  such  dividends  and  interest  as  are 
received  by  the  personal  service  corporation,  and  which  an  indi- 
vidual is  entitled  to  credit  against  net  income  for  the  purpose 
of  the  normal  tax  and  (b)  a  credit  against  income  tax  of  the 
stockholder's  proportionate  share  of  income,  war-profits  and 
excess-profits  taxes  of  the  personal  service  corporation  paid  or 
accrued  during  the  taxable  year  to  a  foreign  country  upon  in- 
come derived  from  sources  therein,  or  to  any  possession  of  the 
United  States.^^ 

Procedure  in  Claiming  Personal  Service  Status.  A  corpora- 
tion filing  returns  on  Form  1120  and  subsequently  desiring  to 
establish  its  status  as  a  personal  service  corporation  should 
adopt  the  following  method  of  procedure : 

It  should  file  amended  returns  on  Form  1065  accompanied  by 
a  claim  for  refund  on  Form  46  for  the  tax  or  installments  thereof 
paid.  The  individual  members  of  the  corporation  should  also 
file  amended  returns  accompanied  with  claims  in  abatement, 
Form  47,  covering  the  additional  assessment  shown  by  such  re- 
turns. In  the  event  that  the  corporation  is  found  to  be  taxable  as 
an  ordinary  corporation  the  claim  for  refund  will  be  disallowed. 

36  O.  D.  581,  T.  B.  28-20-1057. 

37  Reg.  45,  Art.  331.  See  Revenue  Act  of  1921,  §201,  216.  The  credit 
stated  in  (b)  is  of  course  subject  to  the  limitations  of  §  222  of  the  statute. 
See  foot  note  34. 


PERSONAL  SERVICE  CORPORATIONS  207 

In  case  the  corporation  establishes  a  personal  service  status,  the 
claim  for  refund  will  be  allowed  for  the  tax  paid  by  the  corpo- 
ration, and  the  claims  in  abatement  will  be  disallowed  and  as- 
sessment made  to  the  extent  of  the  additional  tax  shown  to  be 
due  on  the  amended  individual  returns.  Where  this  procedure 
is  adopted,  however,  the  installments  of  tax  which  become  due 
prior  to  determination  of  the  status  of  the  corporation  as  shown 
by  its  return,  as  originally  filed,  must  be  paid  on  or  before  the 
due  dates.  Such  installments  are  not  subject  to  either  abate- 
ment or  credit,  but  can  only  be  covered  by  supplemental  claim 
for  refund.-'"^ 

Corporations  Formed  to  Evade  the  Surtaxes.  If  any  corpora- 
tion, however  created  or  organized,  is  formed  or  availed  of  for 
the  purpose  of  preventing  the  imposition  of  the  surtax  upon  its 
stockholders  or  members  through  the  medium  of  permitting  its 
gains  and  profits  to  accumulate,  instead  of  being  divided  or  dis- 
tributed, the  stockholders  of  such  corporation  will  be  subject  to 
income  tax  of  2o'/c  or  they  will  be  subject  to  tax  in  the  same 
manner  as  the  stockholders  of  a  personal  service  corporation 
or  members  of  a  partnership."''' 

Alternative  Retroactive  Tax  on  Personal  Service  Corporations. 
It  has  been  contended  that  certain  expressions  of  the  Supreme 
Court  in  the  stock  dividend  decision'"'  indicate  the  invalidity  of 
the  provisions  of  the  Revenue  Act  of  1918  dealing  with  the  taxa- 
tion of  the  stockholders  of  personal  service  corporations  and 
taxing  such  stockholders  upon  their  distributive,  but  undistrib- 
uted, shares  of  the  net  income  of  such  corporations.  While  the 
treasury  department  has  officially  disagreed  with  this  view,-»i 
Congress  has  recognized  that  there  is  "doubt"  as  to  the  ''provi- 
sions of  the  Revenue  Act  which  treat  personal  service  corpora- 
tions substantially  as  partnerships,"  ^-^  and  has  provided  that  if 
such  provisions,  and  also  the  corresponding  provisions  (for 
1921)  of  the  Revenue  Act  of  1921  are  by  final  adjudication  de- 
clared invalid,  there  shall,  in  addition  to  all  other  taxes,  be  levied, 
collected,  and  paid  on  the  net  income  received  during  the  calendar 
years  1918,  1919,  1920,  and  1921,  by  every  personal  service  cor- 

38  0.  D.  614,  T.  B.  31-20-1103. 

39  Revenue  Act  of  1921,  §220;  Revenue  Act  of  1918,  §220.  For  a  full 
discussion  of  this  subject  see  Chapter  2. 

40  Eisner  v.  Macomber,  252  U.  S.  189.  Some  of  the  expressions  referred 
to  are  indicated  in  Chapter  2. 

41  0.  D.  679,  T.  B.  41-20-1232. 

42  See  Report  of  Finance  Committee  on  Internal  Revenue  Bill  of  1921, 
p.  34.  The  same  reasoning  occasioned  the  flat  25 Cf  tax  imposed  by  §  220 
of  the  Revenue  Act  of  1921.  (See  same  report,  p.  16.)  Some  of  the  ex- 
pressions referred  to  are  indicated  in  Chapter  2. 


208  FEDERAL  INCOME  TAX 

poration,  a  tax  equal  to  the  taxes  imposed  by  Titles  II  and  III 
of  the  Revenue  Act  of  1918  and,  in  the  case  of  income  received 
during  the  calendar  year  1921,  by  Titles  II  and  III  of  the  Reve- 
nue Act  of  1921.  In  such  event  every  such  personal  service  cor- 
poration is  required,  on  or  before  the  15th  day  of  the  6th 
month  following  the  date  of  entry  of  decree  upon  such  final  ad- 
judication, to  make  a  return  of  any  income  received  during  each 
of  the  calendar  years  1918,  1919,  1920,  and  1921  in  the  manner 
prescribed  by  the  Revenue  Act  of  1918  (or  in  the  manner  pre- 
scribed by  the  Revenue  Act  of  1921,  in  the  case  of  income  re- 
ceived during  the  calendar  year  1921).  Such  return  must  be 
made  and  the  net  income  computed  on  the  basis  of  the  taxpayer's 
annual  accounting  period  (fiscal  year  or  calendar  year,  as  the 
case  may  be)  in  the  manner  provided  for  other  corporations 
under  the  Revenue  Act  of  1918  and  the  Revenue  Act  of  1921. 
This  alternative  tax  will  be  assessed,  collected,  and  paid  upon 
the  same  basis,  in  the  same  manner,  and  subject  to  the  same 
provisions  of  law,  including  penalties,  as  the  ordinary  taxes  im- 
posed by  the  Revenue  Act  of  1918  (or  the  Revenue  Act  of  1921 
in  the  case  of  income  received  during  the  calendar  year  1921), 
but  no  interest  or  penalties  will  be  due  or  payable  thereon  for 
any  period  prior  to  the  date  upon  which  the  above  return  is  re- 
quired to  be  made  and  the  first  installment  paid.  The  tax  paid 
by  any  shareholder  or  member  of  a  personal  service  corporation 
will  be  credited  against  the  alternative  tax  due  from  such  corpo- 
ration upon  the  joint  written  application  of  such  corporation  and 
such  shareholder  or  member  or  his  representatives,  heirs,  or 
assigns,  if  such  application  is  filed  with  the  commissioner  within 
six  months  from  such  date  of  entry  of  decree. 

No  credit  or  refund  of  taxes  paid  by  any  shareholder  or  mem- 
ber of  a  personal  service  corporation  will  be  allowed  unless  claim 
therefor  is  filed  within  six  months  from  the  date  of  entry  of  the 
decree  declaring  the  provisions  taxing  personal  service  corpora- 
tions invalid.  If  the  claims  for  credit  or  refund,  filed  within  6 
months  from  such  date  of  entry  of  decree,  represent  less  than 
30%  of  the  outstanding  stock  or  shares  in  the  corporation,  the 
alternative  tax  upon  such  corporation  will  be  reduced  to  that 
proportion  thereof  which  the  number  of  stock  or  shares  owned 
by  the  shareholders  or  members  making  such  claims  bears  to 
the  total  number  of  stock  or  shares  outstanding.  A  personal 
service  corporation  of  which  no  shareholder  or  member  has  filed 
such  a  claim  for  credit  or  refund  within  such  period  of  six 
months,  will  not  be  subject  to  the  alternative  tax  discussed  in 
this  paragraph.^'- 

«  Revenue  Act  of  1921,  §  1332. 


CHAPTER  10 

CORPORATIONS 

Corporations  are  taxed  as  separate  entities  apart  from  their 
stockholders.  They  were  subject,  under  the  Revenue  Act  of  1918, 
to  a  tax  of  10' <  upon  their  net  income  for  the  years  1919  and 
1920.'  Under  the  Revenue  Act  of  1921,  in  lieu  of  the  tax  imposed 
by  the  1918  law,  they  are  subject  to  a  tax  of  10'  <  for  the  year 
1921,  and  12'/_>'r  for  the  year  1922  and  sub.sequent  years,  upon 
their  net  income.-  The  rate  is  increased  for  1922  and  subsequent 
years  because  of  the  repeal  of  the  excess-profits  tax,  as  of  Decem- 
ber 31,  1921.  Aside  from  this  increase  of  rate  the  most  important 
changes  made  in  the  present  law  applying  particularly  to  corpora- 
tions are  (a)  the  provision  that  for  any  taxable  year  beginning 
after  January  1,  1922.  the  filing  of  consolidated  returns  by  affil- 
iated corporations  shall  be  optional  with  the  taxpaying  corpora- 
tion, (b)  the  provision  for  the  taxation  of  certain  domestic  corpo- 
rations only  upon  income  from  "sources  within  the  United  States." 
and  (c)  the  provision  for  the  taxation  as  corporations  of  individ- 
ual or  partnership  businesses  incorporated  within  four  months  of 
the  passage  of  the  act.-'-  Corporations  are  not  subject  to  the  sur- 
taxes.^  They  are  entitled  to  deduct  from  their  gross  income, 
which  (except  in  the  case  of  insurance  companies)  is  computed 
in  the  same  manner  as  the  gross  income  of  individuals,"'  the  de- 
ductions and  credits  specified  in  the  law,''  which  differ  to  some 
extent  from  the  deductions  and  credits  allowed  to  individuals. 
Corporations,  like  individuals,  make  returns  for  the  calendar  or 
their  fiscal  year,  according  to  the  annual  accounting  period  em- 
ployed in  keeping  their  books.'  The  mere  existence  of  a  corpora- 
tion during  any  part  of  the  year  is  ordinarily  suflficient  to  require 

1  Revenue  Act  of  1918,  §  230.  This  rate  was  Vl'/t  for  the  calendar  year 
1918.  This  tax  was  in  lieu  of  the  taxes  imposed  by  the  191(5  Law,  as  amended 
by  the  1917  law.  (Revenue  Act  of  191(i,  §10.)  The  total  tax  to  which  corpo- 
rations were  subject  under  the  191<;  and  the  1917  Laws  was  H''<.  (Revenue 
Act  of  1917,  §4.) 

-Revenue  Act  of  1921,  §230. 

=5  Revenue  Act  of  1921,  §§  240,  262,  229.  The  filing?  of  consolidated  returns 
was  obligatory  under  the  1918  Law. 

•1  See  Reg.  33,  Art.  185.  The  excess-profits  tax  is  in  effect  a  corporate 
surtax. 

•*i  Revenue  Act  of  1921.  §  233;   Revenue  Act  of  1918,  §233. 

0  Revenue  Act  of  1921,  §§234,  23(;;  Revenue  Act  of  1918,  §§234,  236. 

7  Revenue  Act  of  1921.  §§200,  232;  Revenue  Act  of  1918,  §§200.  232. 

^  209 


210  FEDERAL  INCOME  TAX 

it  to  make  a  return.^  Prior  to  the  1918  law,  the  mere  receipt  of 
net  income  from  any  source  made  it  liable  for  the  tax,  but  it  may 
now  be  in  receipt  of  net  income  without  being  liable  for  the  in- 
come tax  if  the  credits  to  which  it  is  entitled  equal  or  exceed  such 
net  income.'^  Thus,  a  corporation  may  be  in  receipt  of  net  income 
not  in  excess  of  $2,000  and  be  entitled  to  a  credit  of  $2,000 
against  such  net  income  for  the  purpose  of  the  income  tax,  as  a 
result  of  which  it  will  be  in  receipt  of  net  income  without  being 
liable  for  the  income  tax.  Since  the  tax  is  an  income  tax  and  not 
an  excise  tax,io  doing  business  is  not  a  necessary  element  of  tax- 
ability.^^  The  special  provisions  of  the  law  applicable  only  to 
insurance  companies  are  discussed  in  another  chapter.^^ 

Definition.  The  tax  is  imposed  on  every  corporation,  domestic 
or  foreign.  The  word  "corporation"  is  used  in  this  chapter  as 
defined  in  both  the  1918  and  the  present  law,i^  and  includes  asso- 
ciations, joint-stock  companies,  and  insurance  companies.  The 
rulings  under  the  1918  law  in  definition  of  corporations  will, 
therefore,  be  applicable  under  the  present  law. 

Joint-Stock  Companies  and  Associations.^*  There  seems 
to  be  no  constitutional  or  legal  objection  to  including  joint-stock 

8  See  page  245. 

!>  Revenue  Act  of  1921,  §§234,  236;  Revenue  Act  of  1918,  §§234,  236. 

10  The  tax  assessed  on  corporations  for  the  months  of  January  and  Feb- 
ruary, 1913,  under  the  1913  Law,  was  an  excise  tax  and  not  an  income  tax 
and,  therefore,  applied  only  to  corporations  "doing  business,"  but  the  exemp- 
tions and  deductions  to  which  a  corporation  was  entitled  were  those  allowed 
by  the  1913  Law,  which  law  did  not  permit  the  deduction  of  dividends.  (But- 
terick  Company  v.  U.  S.,  240  Fed.  539.) 

11  The  numerous  cases  under  the  1909  Law  holding  certain  corporations 
not  to  be  taxable  on  the  ground  that  they  were  not  "doing  business"  have 
no  application  to  the  income  tax  laws. 

12  See  Chapter  11. 

13  Revenue  Act  of  1918,  §1;  Revenue  Act  of  1921,  §2.  As  used  in  the 
regulations  issued  under  the  1916  law,  the  term  "corporation"  was  construed 
to  include  all  corporations,  joint-stock  companies  and  associations,  and  all 
insurance  companies  coming  within  the  terms  of  the  law  as  well  as  all 
business  trusts  organized  or  created  for  the  purpose  of  engaging  in  com- 
mercial or  industrial  enterprises,  the  capital  of  which  was  evidenced  by 
certificates  or  shares  of  interest  issued  or  issuable  to  members  on  the  basis 
of  which  profits  were  distributed  or  distributable.    (Reg.  33  Rev.,  Art.  57.) 

11  The  1909  Law  taxed  "Every  corporation,  joint-stock  company  or  as- 
sociation, organized  for  profit  and  having  a  capital  stock  represented  by 
shares,  and  every  insurance  company,  now  or  hereafter  organized  under 
the  laws  of  the  United  States  or  of  any  state  or  territory  of  the  United 
States  or  under  the  acts  of  Congress  applicable  to  Alaska  or  the  District 
of  Columbia,  or  now  or  hereafter  organized  under  the  laws  of  any  foreign 
country  and  engaged  in  business  in  any  state  or  territory  of  the  United 
States  or  in  Alaska  or  in  the  District  of  Columbia."      (Act  of  August  5, 


CORPORATIONS  211 

companies  in  the  same  category  with  corporations.'^  A  joint- 
stock  company  organized  pursuant  to  the  New  York  Joint-Stock 
Association  Law  was  held,  under  the  1909  law,  to  be  practically  a 
"corporation,"  despite  the  absence  of  the  important  corporate 
attribute  of  limited  liability,  and  was  held  taxable  as  such.'''  By 
regulation  issued  under  the  1918  law,  it  is  provided  that  the  terms 
"joint-stock  companies"  and  "associations"  include  associations, 
common-law  trusts,  or  organizations  by  whatever  name  known 
which  act  or  do  business  in  an  organized  capacity,  whether 
created  under  and  pursuant  to  state  laws,  agreements,  declara- 
tions of  trust,  or  otherwise,  the  net  income  of  which,  if  any,  is 
distributed  or  distributable  among  the  members  or  shareholders 
on  the  basis  of  the  capital  stock  which  each  holds,  or  where  there 
is  no  capital  stock,  on  the  basis  of  the  proportionate  share  or 
capital  which  each  has,  or  has  invested,  in  the  business  or  prop- 

1909,  §  38.)  The  1913  Law  taxeil  "Every  corporation,  joint-stock  com- 
pany or  association,  and  every  insurance  company,  organized  in  the  United 
States,  no  matter  how  created  or  organized,  not  including  partnerships." 
(Act  of  October  3,  1913,  §  G  (a).)  The  1916  Law  taxed  "Every  corporation, 
joint-stock  company  or  association,  or  insurance  company  organized  in  the 
United  States,  no  matter  how  created  or  organizeci  but  not  including  part- 
nerships." (Revenue  Act  of  1916,  §  10  (a).)  The  present  law  and  the  1918 
Law  tax  every  corporation  and  define  the  term  "corporation"  to  include 
"associations,  joint-stock  companies,  and  insurance  companies."  (Revenue 
Act  of  1921,  §  2;  Revenue  Act  of  1918,  §  1,  230.)  It  will  be  noted  that  the 
phrase  "no  matter  how  created  or  organized"  used  in  both  the  1913  and 
1916  Laws  is  omitted  from  the  definition  of  corporation  contained  in  the 
1918  and  the  present  law.  On  the  other  hand,  the  phrase  "joint-stock  com- 
pany or  association"  (between  commas)  has  been  changed  to  "associations^ 
joint-stock  companies."  The  purpose  of  this  transposition  is  to  separate 
the  word  "associations"  from  any  limitation  imposed  by  conjunction  with 
the  word  "joint-stock"  and  to  use  it  to  cover  organizations  which  can  not 
be  included  within  the  terms  "corporations,"  "joint-stock  companies,"  or 
"insurance  companies."  The  phrase  "no  matter  how  created  or  organized" 
seems  to  have  been  aimed  to  include  organizations  not  "organized  under  the 
laws  of  the  United  States  or  of  any  state  *  *  *"  which  were  held  not 
liable  to  tax  under  the  1909  Law,  in  view  of  the  language  of  that  act.  They 
apply  not  only  to  insurance  companies,  but  relate  back  to  the  words  "every 
corporation,  joint-stock  company  or  association,"  so  that  what  is  meant 
is  that  all  such  concerns  (not  including  partnerships)  are  included  and 
are  taxable.  See  Crocker  v.  Malley,  249  U.  S.  223;  Eliot  v.  Freeman, 
220  U.  S.  178;  T.  D.  2418;  Chicago  T.  and  T.  Co.  v.  Smietanka.  275  Fed. 
60;  T.  D.  3193,  T.  B.  20-21-1741;  A.  R.  R.  i^'r2,  T.  B.  4r)-21-1902;  Reg.  38 
Rev.,  Art.  2,  General  Instructions  3. 

l:">See  Spreckels  Sugar  Refining  Co.  v.  McClain,  192  U.  S.  397;  Flint  v. 
Stone  Tracy  Co.,  220  U.  S.  107. 

IG  Roberts  v.  Anderson,  226  Fed.  7. 


212  FEDERAL  INCOME  TAX 

erty  of  the  organization.^"^  An  organization  the  membership  in- 
terests in  which  are  transferable  without  the  consent  of  all  the 
members,  however  the  transfer  may  be  otherwise  restricted,  and 
the  business  of  which  is  conducted  by  trustees  or  directors  and 
officers  without  the  active  participation  of  all  the  members  as 
such,  is  an  association  and  not  a  partnership. ^'^ 

It  has  been  held  under  the  1913  law  that  an  organization,  in 
form  a  trust,  created  by  an  agreement  of  the  stockholders  of 
several  street  railway  corporations  desiring  to  effect  a  unitary 
control  of  the  properties  of  such  corporations  is  an  association, 
where  the  agreement  uses  language  that  reads  much  like  the 
state  corporation  law,  and  superimposes  that  organization  upon 
ihe  several  corporations  by  placing  the  legal  title  to  the  capital 
stock  of  those  corporations  in  the  trustees  named,  who  are  to  do 
certain  specified  things  only,  and  by  providing  for  a  committee 
which  controls  even  the  power  of  the  trustees  to  vote  the  capital 
stock  of  the  corporations,  and  which  is  elected  and  controlled  by 
what  are  called  participating  shareholders,  who  hold  certificates 
of  common  and  preferred  participating  shares  issued  by  the 
trustees  in  lieu  of  the  capital  stocks  of  the  corporations.^*^  A  min- 
ing partnership,  within  the  meaning  of  the  laws  of  Colorado,  has 
no  delectus  personarum  and  is  not  dissolved  by  the  withdrawal, 
death,  or  bankruptcy  of  a  member ;  a  member's  interest  therein 
may  be  sold ;  a  majority  in  interest  may  bind  the  partnership. 
As  has  been  said  of  an  Idaho  mining  partnership,  it  is  "in  all 
essential  elements  *  *  *  precisely  like  a  corporation".-"  Such  a 
partnership  is,  therefore,  taxable  as  an  association,  even  though 
formed  independently  of  any  statute.-^  Where  after  the  expira- 
tion of  the  charter  of  a  corporation,  by  limitation,  its  business  .is 
continued  in  the  corporate  form,  the  organization  so  conducting 
the  business  is  an  "association".— 

Pooling  of  Corporate  Stock.  Where  the  holders  of  the 
entire  common  stock  of  a  corporation  agree  to  pool  their  stock 
interests  and  share  in  a  certain  portion  of  the  profits  accruing 
to  the  corporation  according  to  a  fixed  arbitrary  percentage 
rather  than   in  proportion   to  their   respective   stock   holdings, 

17  Reg.  45,  Art  1502;  Reg.  33  Rev.,  Art.  58;  Reg.  33,  Art,  79.  See  Chi- 
cago T.  &  T.  Co.  V.  Smietanka,  275  Fed.  60;  T.  D.  3193,  T.  B.  20-21-1741. 

18  Reg.  45,  Art.  1503. 

19  Chicago  T.  &  T.  Co.  v.  Smietanka,  275  Fed.  60;  T.  D.  3193,  T.  B. 
80-21-1741. 

20  Hawkins  v.  Spokane  Hydraulic  Co.,  3  Idaho  650,  33  Pac.  40. 
-'1  A.  R.  R.  652,  T.  B.  45-21-1902. 

-'-'  Sol.  Op.  93,  T.  B.  14-21-1552. 


CORPORATIONS  213 

the  corporation  is  still  taxable  as  such  and  is  not  to  be  treated 
as  a  partnership  for  purposes  of  the  income  tax.'--' 

"Syndicates."  Where  a  block  of  securities  is  purchased  in 
joint  account  by  several  corporations,  partnerships  or  individuals 
for  the  purpose  of  disposing  of  them  to  the  public  through  the 
syndicate  managers,  the  only  obligation  of  the  members  of  the 
syndicate  being  to  take  and  pay  for  the  portion  of  the  securities 
not  disposed  of,  such  temporary  combinations  of  business  inter- 
ests are  neither  corporations,  joint-stock  companies  or  associa- 
tions, nor  partnerships,  and  the  profits  of  the  syndicate  are  not 
taxable  in  the  hands  of  the  syndicate.  The  several  members  pay 
the  tax  on  their  respective  shares  of  the  profit  of  the  transac- 
tion.-^ Where  the  property  of  a  dissolved  corporation  is  trans- 
ferred to  trustees  for  the  benefit  of  a  newly  formed  syndicate 
consisting  of  the  trustees  and  two  other  persons,  and  all  the 
stockholders  of  the  dissolved  corporation  receive  transferable 
certificates  of  interest  in  the  syndicate  in  the  same  proportion 
that  they  had  held  stock  in  the  corporation,  the  purpose  of  the 
agreement  being  to  preserve  the  ownership  of  the  real  estate 
of  the  corporation  until  it  can  be  sold  on  reasonable  terms,  it  has 
been  held  that  the  organization  effected  constitutes  an  "associa- 
tion", and  not  a  "partnership",  "trust"  or  "joint  venture".  In 
this  case  a  majority  in  interest  controlled  the  management  and 
sale  of  the  property.  Distribution  to  the  shareholders  of  the 
profits  and  assets  upon  dissolution  was  provided  for.  At  the 
end  of  10  years,  an  undivided  interest  in  all  property  of  the 
syndicate  was  to  be  conveyed  to  the  members  as  their  interests 
appear  at  that  time.  The  death  of  any  one  or  more  of  the 
members  could  not  work  a  dissolution  of  the  syndicate.-"' 

Trusts  Not  Taxable  as  Associations.  In  a  case  arising 
under  the  1913  law  a  Maine  corporation  with  eight  shareholders 
had  its  mills  in  Massachusetts  and  owned  outlying  land.  The 
Maine  corporation  conveyed  to  a  Massachusetts  corporation 
formed  in  1912  seven  mills  and  let  to  it  an  eighth  that  was  in  the 
process  of  construction,  together  with  the  outlying  lands  and 
tenements,  on  a  long  lease,  receiving  the  stock  of  the  Massa- 
chusetts corporation  in  return.  The  Maine  corporation  then 
transferred  to  the  plaintiffs  as  trustees  the  fee  of  the  property 
subject  to  the  lease,  left  the  Massachusetts  stock  in  their  hands, 
and  was  dissolved.     By  the  declaration  of  trust  the  plaintiffs 

-••■•S.  1001,  T.  B.  4-19-227. 

--»  Letter  from  treasury  department  dated  Fehruaiy  2r.,  1914. 

•-'•"'0.  D.  89(),  T.  B.  18-21-1(503. 


214  FEDERAL  INCOME  TAX 

declared  that  they  held  the  real  estate  and  all  other  property  at 
any  time  received  by  them  thereunder,  subject  to  the  provisions 
thereof,  "for  the  benefit  of  the  cestui  que  t7nists  (who  shall  be 
trust  beneficiaries  only,  without  partnership,  associate,  or  other 
relations  whatever  inter  sese)"  upon  trust  to  convert  the  same 
into  money  and  distribute  the  net  proceeds  to  the  persons  then 
holding  the  trustees'  receipt  certificates — the  time  of  distribu- 
tion being  left  to  the  discretion  of  the  trustees,  but  not  to  be 
postponed  beyond  the  end  of  twenty  years  after  the  death  of  the 
specified  persons  then  living.  In  the  meantime  the  trustees  were 
to  have  the  powers  of  owners,  were  to  distribute  what  they  de- 
termined to  be  fairly  distributable  net  income  according  to  the 
interests  of  the  cestuis  que  trust,  but  could  apply  any  funds  in 
their  hands  for  the  repair  or  development  of  the  property  held 
by  them,  or  the  acquisition  of  other  property,  pending  conversion 
and  distribution.  A  consent  of  a  majority  in  interest  of  the 
cestuis  que  trust  was  required  for  the  filling  of  a  vacancy  among 
the  trustees,  for  a  modification  of  the  terms  of  the  trust,  or  for 
any  increase  over  the  stipulated  fee  of  the  trustees.  In  no  other 
matter  had  the  beneficiaries  any  control.  The  court  held  that  (1) 
the  declaration  of  trust  was  an  ordinary  real  estate  trust  of  the 
kind  familiar  in  Massachusetts  in  spite  of  the  fact  that  the 
trustees'  receipt  provided  that  the  holder  had  no  interest  in  any 
specific  property  and  that  it  purported  only  to  declare  the  holder 
entitled  to  a  certain  fraction  of  the  net  proceeds  of  the  property 
when  converted  into  cash  "and  meantime  to  income,"  and  in 
spite  of  the  fact  that  the  trustees  held  (although  not  pursuant 
to  the  declaration  of  trust)  stock  of  the  Massachusetts  corpo- 
ration and  collected  dividends  upon  it;  (2)  the  function  of  the 
trustees  was  not  to  manage  the  mills  but  simply  to  collect  the 
rents  and  income  from  such  property  as  might  be  in  their  hands, 
with  a  large  discretion  in  the  application  of  it,  but  with  a  recogni- 
tion that  the  receipt  holders  were  entitled  to  it,  subject  to  the 
exercise  of  the  powers  confided  to  the  trustees;  (3)  that  the 
trust  would  not  fall  under  any  familiar  conception  of  a  joint-stock 
association,  "whether  formed  under  a  statute  or  not";  (4)  the 
trustees  by  themselves  could  not  be  a  joint-stock  association,  and 
there  was  no  ground  for  grouping  the  trustees  and  beneficiaries 
together;  (5)  the  result  was  not  affected  by  any  technical  analy- 
sis of  the  individual  receipt  holder's  rights  in  the  income  received 
by  the  trustees ;  and  (6)  the  statute  failed  to  show  a  clear  intent 
to  subject  the  trust  to  tax  as  an  association  or  the  trustees  or 


CORPORATIONS  215 

receipt  holders  to  extra  tax  upon  the  dividends  of  the  Massa- 
chusetts corporation.-'^ 

The  treasury  department,  in  deciding  whether  a  given  organi- 
zation constitutes  a  "trust"  or  an  "association,"  now  treats  the 
question  whether  the  cestui  que  trust  or  beneficiaries  have  a 
voice  in  the  conduct  of  the  business  as  the  decisive  test.-"  If 
this  control  is  "substantial,"  an  association  is  held  to  exist ;  other- 
wise a  mere  trust.  In  the  former  event  the  so-called  trust  thus 
held  to  be  an  "association"  is  treated  as  a  distmct  entity  equiva- 
lent to  a  corporation.  Ordinary  distributions  of  income  by  the 
trustees  are  regarded  as  dividends  and  as  liable  only  to  the  sur- 
taxes, the  association  itself  being  liable  to  the  corporate  income 
and  excess-profits  taxes. -"^  If  the  organization  in  question  is  held 
to  be  a  "trust"  as  distinguished  from  an  "association",  its  in- 
come is  treated  in  the  manner  more  fully  described  in  another 

20  Crocker  v.  Malley,  249  U.  S.  223,  reversing  250  Fed.  817.  The  court 
&aid  in  part:  "We  do  not  see  either  that  the  result  is  affected  by  any 
technical  analysis  of  the  individual  receipt  holder's  rights  in  the  income 
received  by  the  trustees.  The  description  most  in  accord  with  what  has 
been  the  practice  M^ould  be  that,  as  the  receipts  declare,  the  holders,  until 
distribution  of  the  capital,  were  entitled  to  the  income  of  the  fund  subject  to 
an  unexercised  power  in  the  trustees  in  their  reasonable  discretition  to  divert 
it  to  the  improvement  of  the  capital.  But  even  if  it  were  said  that  the  receipt 
holders  were  not  entitled  to  the  income  as  such  until  they  got  it,  we  do  not 
discern  how  that  would  turn  them  into  a  joint-stock  company.  Moreover 
the  receipt  holders  did  get  it  and  the  question  is  what  portion  it  was  the 
duty  of  the  trustees  to  withhold.  We  presume  that  the  taxation  of  corpor- 
ations and  joint-stock  companies  upon  dividends  of  corporations  that  them- 
selves pay  the  income  tax  was  for  the  purpose  of  discouraging  combina- 
tions of  the  kind  now  in  disfavor,  by  which  a  corporation  holds  controlling 
interests  in  other  corporations  which  in  their  turn  may  control  others,  and  so 
on,  and  in  this  way  concentrates  a  power  that  is  disapproved.  There  is 
nothing  of  that  sort  here.  Upon  the  whole  case  we  are  of  opinion  that  the 
statute  fails  to  show  a  clear  intent  to  subject  the  dividends  on  the  Massa- 
chusetts corporation's  stock  to  the  extra  tax  imposed  by  G.  (a)."  (See 
also  Reg.  45,  Art.  1504.) 

27  Crocker  v.  Malley,  249  U.  S.  223;  Reg.  45,  Art.  1504;  S.  1337,  T.  B. 
9-20-762;  S.  1068,  T.  B.  10-19-351;  S.  1205,  T.  B.  27-19-600;  O.  D.  598,  T.  B. 
30-20-1083;  0.  D.  407,  T.  B.  9-20-763;  0.  D.  236,  T.  B.  13-19-414;  Sol.  Op. 
56,  T.  B.  36-20-1177;  O.  D.  654,  T.  B.  36-20-1178;  O.  D.  896,  T.  B.  18-21- 
1603;  0.  D.  868,  T.  B.  15-21-1557;  O.  D.  931,  T.  B.  22-21-1658;  O.  D.  886, 
T.  B.  17-21-1587. 

2S  As  an  association  the  organization  would  be  subject  also  to  the  capital 
stock  tax  imposed  by  Title  X  of  the  present  law  and  the  1918  Law.  This 
subject  is  treated  more  fully  in  Chapter  44.  Dealings  in  the  shares  or 
certificates  of  a  so-called  trust  are  subject  to  the  stamp  taxes  imposed  by 
Title  XI,  Schedule  A,  of  the  present  law  and  the  1918  Law.  This  subject  is 
also  treated  more  fully  in  Chapter  45. 


216  FEDERAL  INCOME  TAX 

chapter.-'  The  question  whether  a  particular  organization  is  to 
be  classed  as  a  "trust"  or  "association"  involves  in  each  case  a 
minute  examination  of  the  terms  of  the  instrument  creating  the 
so-called  trust  and  the  rights  of  the  parties  to  such  instrument. 
It  is  deemed  inadvisable  to  repeat  at  length  and  in  detail  the 
provisions  of  the  instruments  involved  in  numerous  rulings 
which  have  been  made  by  the  treasury  department  upon  this 
point,  but  there  are  stated  below  general  prmciples  enunciated 
by  such  rulings  for  guidance  in  connection  with  the  determina- 
tion of  the  question  in  respect  of  any  particular  instrument: 

1.  It  is  the  extent  of  the  control  vested  in  beneficiaries  under 
a  trust  agreement  rather  than  the  extent  to  which  such  control  is 
exercised  that  is  determinative  of  the  question  whether  the  trust 
is,  in  fact,  an  "association".-'" 

2.  If  the  beneficiaries  or  shareholders  have  the  right  under 
the  trust  agreement  to  elect  trustees  annually,  the  trust  con- 
stitutes an  "association" ;  on  the  other  hand,  if  the  trustees 
appointed  by  the  instrument  are  to  hold  office  during  the  entire 
period  of  the  trust,  the  right  of  the  beneficiaries  or  shareholders 
being  limited  to  filling  vacancies,  such  beneficiaries  or  share- 
holders not  retaining  any  substantial  control  over  the  aff'airs  of 
the  trust,  the  trust  instrument  creates  a  "trust"  and  not  an  asso- 
ciation.-'^ 

3.  The  power  to  increase  capital  stock,  advise  trustees  as 
to  the  management  of  the  business,  and  amend  or  terminate  the 
trust  may  likewise  cause  an  organization  to  be  treated  as  an 
association.-'^- 

4.  The  reservation  to  the  beneficiaries  or  shareholders  of  the 
right  to  direct  and  approve  the  terms  of  sale  of  the  trust  property 
will  constitute  the  trust  an  "association".-"'' 

5.  A  provision  authorizing  the  trustee  or  trustees  to  call 
upon  the  beneficiaries  or  shareholders  to  pay  certain  items,  such 
as  costs,  fees  and  expenses,  in  the  event  that  the  income  of  the 
trust  is  insufficient,  will  constitute  the  trust  an  "association".-'^ 

-!»  See  Chapter  6. 

•*5<»  O.  D.  407,  T.  B.  9-20-763. 

-IS.  1068,  T.  B.  10-19-351;  O.  D.  620,  T.  B.  32-20-1112;  S.  1337,  T.  B. 
9-20-762;  O.  D.  868,  T.  B.  15-21-1557;  O.  D.  931,  T.  B.  22-21-1658;  O.  D. 
790,  T.  B.  6-21-1425. 

32  0.  D.  868,  T.  B.  15-21-1557.  It  may  be  doubted  whether  the  power 
merely  to  "advise"  should  be  given  such  an  effect  unless  acceptance  of 
advice  given  be  imperative  upon  the  trustees. 

;«0.  D.  598,  T.  B.  30-20-1083;  Sol.  Op.  49,  T.  B.  39-20-1208. 

■>iO.  D.  598,  T.  B.  30-20-1083;  S.  1205,  T.  B.  27-19-600. 


CORPORATIONS  217 

6.  Where  an  agreement  between  a  reorganization  committee 
and  the  bondholders  of  a  company  gives  power  (a)  to  the  bond- 
holders to  terminate  the  trust  (this  alone  is  not  sufficient)  ;  (b) 
to  terminate  the  authority  of  the  committee  to  continue  business 
operations,  and  (c)  to  fill  vacancies  in  the  committee  if  dis- 
satisfied with  the  committee's  choice,  the  agreement  has  been 
held  to  create  an  "association"."-'' 

7.  If  the  trustee  is  given  absolute  control  over  the  affairs 
of  the  trust,  in  other  words,  if  the  trustee  is  given  all  the  rights 
and  powers  which  would  be  his  if  he  were  conducting  a  business 
of  which  he  was  the  sole  owner,  the  instrument  creates  a  mere 
"trust"  and  not  an  "association.""-'' 

8.  Where  a  majority  in  amount  of  the  shares  of  beneficial 
interest  in  the  trust  are  owned  by  the  trustees  as  beneficiaries 
so  that  to  the  extent  of  such  ownership  the  trustees  and  bene- 
ficiaries or  shareholders  are  identical,  the  beneficiaries  are  held 
in  fact  to  control  the  trustees,  even  though  no  control  is  vested 
in  such  beneficiaries  under  the  terms  of  the  trust  instrument."' 

9.  A  given  organization  may  be  a  "trust"  for  part  of  the 
year  and  an  association  for  part  of  the  year.  This  may  happen 
where  the  trustees  become  the  holders  of  a  majority  interest  or 
divest  themselves  of  such  majority  interest;  or  it  may  happen 
when  the  instrument  is  amended.  In  such  cases  separate  re- 
turns should  be  made  for  the  two  parts  of  the  year,  according 
to  the  character  of  the  organization.^^ 

Limited  Partnerships  and  Private  Banks.  This  subject  is 
discussed  in  another  chapter."-''  A  private  bank  owned  by  an  in- 
dividual is  not  an  "association." 

De  Facto  Corporations.  Where  articles  of  incorporation 
are  filed  under  the  laws  of  Kentucky  and  business  is  transacted 
in  the  corporate  name,  a  return  of  income  received  from  such 
business  should  be  rendered  for  the  corporation  although  its 
organization  as  a  corporation  has  not  been  perfected  in  the  man- 
ner required  by  law.  But  the  rule  would  be  diff"erent  if  no 
articles  of  incorporation  were  filed  and  the  corporation  had  no 
de  facto  existence.^" 

3-'  Sol.  Op.  49,  T.  B.  39-20-1208. 
•i^O.  D.  620,  T.  B.  32-20-1112. 

•■'TSol.  Op.  56,  T.  B.  36-20-1177;   O.  D.  654,  T.  B.  36-20-1178;  O.  D.  886, 
T.  B.  17-21-1587. 

38  0.  D.  886,  T.  B.  17-21-1587. 

39  See  Chapter  8. 

40  S.  972,  T.  B.  2-19-168;  O.  D.  1016,  T.  B.  35-21-1796;  0.  D.  1078,  T.  B. 
43-21-1887. 


218  FEDERAL  INCOME  TAX 

If  the  charter  board  of  a  state  declared  the  charter  of  a  cor- 
poration forfeited  but  the  corporation  had  no  notice  of  such 
action  and  continued  to  do  business  for  a  number  of  years  as  a 
corporation  and  made  returns  to  the  federal  government  ac- 
cordingly, the  corporation  can  not  now  set  up  the  action  of  the 
charter  board  to  negative  its  corporate  existence.  Until  the 
company  surrenders  its  charter  to  and  the  same  is  annulled  by 
the  state,  or  the  charter  is  annulled  in  some  other  manner  and 
the  company  ceases  to  operate  as  a  corporation,  it  must  be  held 
to  be  a  corporation  for  income  and  profits  tax  purposes.^i 

Where  a  single  stockholder  acquires  all  of  the  stock  in  a  cor- 
poration organized  and  existing  under  the  laws  of  Ohio,  and 
thereafter  carries  on  the  business  in  the  corporate  name  and 
with  corporate  property,  the  corporation  is  not  thereby  dissolved, 
even  though  under  the  statutes  of  Ohio  a  corporation  cannot  be 
organized  with  less  than  five  stockholders  and  directors,  and  the 
corporation  should  be  required  to  file  returns  as  a  de  facto  corpo- 
ration.-*2 

Incorporation   of    Individual   or   Partnership    Business.      The 

Revenue  Act  of  1921  contains  a  new  provision  that  in  the  case 
of  the  organization  as  a  corporation  within  four  months  after 
its  passage  of  any  trade  or  business  in  which  capital  is  a  material 
income-producing  factor,  and  which  was  previously  owned  by  a 
partnership  or  individual,  the  net  income  of  such  trade  or  bus- 
iness from  January  1,  1921,  to  the  date  of  such  organization  may 
at  the  option  of  the  individual  or  partnership  be  taxed  as  the  net 
income  of  a  corporation  is  taxed  under  Titles  II  and  III ;  in  which 
event  the  net  income  and  invested  capital  of  such  trade  or  busi- 
ness shall  be  computed  as  if  such  corporation  had  been  in  exist- 
ence on  and  after  January  1,  1921,  and  the  undistributed  profits 
or  earnings  of  such  trade  or  business  shall  not  be  subject  to  the 
surtaxes,  but  amounts  distributed  on  and  after  January  1,  1921, 
from  the  earnings  or  profits  of  such  trade  or  business  accumu- 
lated after  December  31,  1920,  shall  be  taxed  to  the  recipients  as 
dividends ;  and  all  the  provisions  of  Titles  II  and  III  relating  to 

41  O.  D.  365,  T.  B.  2-20-677. 

42  Sol.  Op.  91,  T.  B.  12-21-1524;  Society  v.  City  of  Cleveland,  43  O.  S. 
481,  3  N.  E.  357  (as  to  when  a  corporation  is  dissolved,  and  as  to  whether 
it  can  exercise  corporation  functions  when  it  was  not  legally  constituted)  ; 
Parker  v.  Bethel  Co.,  96  Tenn.  252;  34  S.  W.  209,  31  L.  R.  A.  706;  Main  v. 
Mills,  Fed.  Cas.  No.  8974;  Ulmer  v.  Luna  Rock  Co.  (Me.),  66  L.  R.  A.  387, 
98  Me.  579;  57  Atl.  1001.  This  is  another  application  of  the  frequently 
cited  principle  that  a  corporation  is  an  entity  irrespective  of  the  persons 
who  own  its  stock  (see  page  219)  a  view  consistently  adhered  to  by  the 
treasury  department. 


CORPORATIONS  219 

corporations  shall  so  far  as  practicable  apply  to  such  trade  or 
business.  This  provision  does  not  apply  to  any  trade  or  business, 
the  net  income  of  which  for  the  taxable  year  1921  was  less  than 
20%  of  its  invested  capital  for  such  year.  Any  taxpayer  who 
takes  advantage  of  this  provision  must  pay  the  capital  stock  tax 
imposed  by  the  Revenue  Act  of  1918  as  if  such  taxpayer  had 
been  a  corporation  on  and  after  January  1,  1921.^-^ 

Doctrine  of  Corporate  Entity.  Nothing  is  more  conclusively  es- 
tablished than  the  proposition  that  a  corporation  will  be  looked 
upon  as  a  legal  entity  entirely  distinct  from  those  who  own  and 
control  it.  This  general  rule  is  one  of  the  fundamental  theories 
of  corporation  law  and  has  been  firmly  embedded  in  the  common 
law  of  this  country  ever  since  the  celebrated  opinion  of  Chief 
Justice  Marshall  in  the  Dartmouth  College  case.^^  It  has  been 
consistently  recognized  by  both  state  and  federal  courts.^''  The 
same  position  has  been  uniformly  taken  by  the  bureau  of  inter- 
nal revenue  except  in  so  far  as  statutory  provisions  compel  other- 
wise.^'' The  doctrine  has  been  restated  in  emphatic  terms  by  the 
Supreme  Court  in  a  widely  discussed  case'*'^  as  follows:  "We  have 
no  doubt  of  the  power  or  duty  of  a  court  to  look  through  the  form 
of  the  corporation  and  determine  the  question  of  the  stock- 
holder's right,  in  order  to  ascertain  whether  he  has  received 
income  taxable  by  Congress  without  apportionment.  But,  look- 
ing through  the  form,  we  cannot  disregard  the  essential  truth 
disclosed;  ignore  the  substantial  difference  between  corporation 
and  stockholder;  treat  the  entire  organization  as  unreal;  look 
upon  stockholders  as  partners,  when  they  are  not  such;  treat 
them  as  having  in  equity  a  right  to  a  partition  of  the  corporate 
assets,  when  they  have  none;  and  indulge  the  fiction  that  they 
have  received  and  realized  a  share  of  the  profits  of  the  com- 
pany which  in  truth  they  have  neither  received  nor  realized.  We 
must  treat  the  corporation  as  a  substantial  entity  separate  from 

43  Revenue  Act  of  1921,  §229.  Compare  this  section  with  §330  of  the 
revenue  act  of  1918,  and  see  the  discussion  of  that  section  in  Chapter  43. 

44  Dartmouth  College  v.  Woodward,  4  Wheat.  518,  63(5. 

4-^  Peterson  v.  Chicago,  Rock  Island  &  Pac.  Ry.,  205  U.  S.  364;  Conley  v. 
Mathieson  Alkali  Works,  190  U.  S.  406,  409;  Pullman  Co.  v.  Missouri 
Pacific  Co.,  115  U.  S.  587,  597;  Oregon  Ry.  Co.  v.  Oregonian  Ry.  Co.,  130 
U.  S.  1;  U.  S.  v.  Nipissing  Mines  Co.,  206  Fed.  431,  appeal  dismissed  in 
234  U.  S.  765;  Peo.  v.  Amer.  Bell  Tel.  Co.,  117  N.  Y.  241.  22  N.  E.  1057. 

4«  See  L.  O.  1062,  T.  B.  14-21-1548.  For  instance,  the  provisions  for 
consolidated  returns  by  affiliated  corporations  (Revenue  Act  of  1918,  §240) 
constitute  a  statutory  exception  to  the  common  law  doctrine  of  corporate 
entity. 

47  Eisner  v.  Macomber,  2.52  U.  S.  189. 


220  FEDERAL  INCOME  TAX 

the  stockholder,  not  only  because  such  is  the  practical  fact,  but 
because  it  is  that  any  dividend — even  one  paid  in  money  or 
property — can  be  regarded  as  income  of  the  stockholder".  The 
same  reasoning  has  been  emphasized  very  recently  in  two  of  the 
latest  cases  decided  by  the  Supreme  Court. ^"^  In  spite  of  these 
decisions  the  "power  or  duty  of  a  court  to  look  through  the  form 
of  a  corporation",  clearly  recognized  by  the  Supreme  Court,  raises 
some  of  the  most  serious  questions  presented  by  the  income  tax. 
Many  questions  arising  under  the  law  turn  on  the  recognition  of 
the  separate  entity  of  a  corporation,  and  the  extent  to  which  the 
courts  will  respect  the  "substantial  difference  between  corpora- 
tion and  stockholder".  In  some  instances  the  distinction  between 
corporation  and  stockholder  has  been  ignored  in  favor  of  the 
"substance"  and  "practical  purposes"."'"  While  it  may  be  true 
that  cases  in  which  this  distinction  has  been  ignored  turn  on  their 
"very  peculiar  facts",  as  stated  by  the  court,  substantially  the 
same  peculiar  facts,  indeed,  facts  involving  the  same  controlling 
principle,  would  determine  the  decision  in  another  case.  It  will 
not  do  to  dismiss  the  cases  with  a  statement  that  they  "involve 
no  departure  from  the  doctrine  that  a  corporation  and  its  stock- 
holders are  to  be  regarded  as  separate  and  distinct  for  all  pur- 
poses including  taxation".''^ 

They  do  not  overrule  the  doctrine,  but  they  define  situations 
in  which  the  doctrine  will  not  be  applied.  They  establish  the 
point  that  the  doctrine  is  not  of  universal  application ;  they  are 
exceptions  to  it.  The  doctrine  is  too  well  established  for  any 
general     disaffirmance ;     the     important     consideration     is     its 

-ts  U.  S.  V.  Phellis,  42  Sup.  Ct.  Rep.  63;  Rockefeller  v.  U.  S.;  New  York 
Trust  Co.  V.  Edwards,  42  Sup.  Ct.  Rep.  68. 

"t^  For  instance,  the  deductibility  of  a  loss  has  depended  upon  the  answer 
to  this  question  (L.  0.  1062,  T.  B.  14-21-1548).  Many  questions  of  gain 
or  loss  in  connection  with  the  organization  and  reorganization  of  corpora- 
tions turn  upon  the  same  point  (See  Chapter  17).  Indeed,  in  these  cases 
the  very  definition  of  the  term  "income,"  as  used  in  the  Sixteenth  Amend- 
ment, is  involved,  as  it  was  also  in  the  stock  dividend  case  (Eisner  v. 
Macomber,  252  U.  S.  189).  The  residence  of  corporations  and  the  distinc- 
tion between  domestic  and  foreign  corporations  often  depends  upon  the 
same  doctrine  (see  paragraphs  supra  and  Chapter  12).  The  point  arises 
in  connection  with  the  requirement  that  all  corporations  must  file  returns, 
whether  or  not  they  receive  income  (See  paragraph  on  Returns,  Post).  It 
is  unnecessary  to  enumerate  the  many  viewpoints  from  which  the  point 
is  important;  it  arises  in  several  connections  throughout  this  volume. 

■'>0  Southern  Pacific  Co.  v.  Lowe,  247  U.  S.  330;  Gulf  Oil  Corp.  v.  Lewellyn, 
248  U.  S.  71;  distinguished  in  Walker  v.  Gulf  &  Interstate  Co.,  269  Fed.  885. 
See  Anderson  v.  Morris  &  Essex  Railroad  Co.,  216  Fed.  83. 

51  See  L.  O.  1062,  T.  B.  14-21-1548. 


CORPORATIONS  221 

scope  and  applicability.  If  it  is  not  to  be  applied  in  all  cases,  and 
this  must  be  admitted,  when  will  it  be  applied  and  when  will  it 
be  disregarded?  This  question  is  of  the  utmost  importance  in 
connection  with  the  income  tax,  and  for  this  reason  the  facts  of 
the  cases  in  which  separate  corporations  were  regarded  as 
"merged"  are  given  somewhat  at  length. 

Where  a  subsidiary  company  kept  no  bank  account,  but  its 
earnings  were  deposited  in  the  bank  account  of  the  parent  com- 
pany, which  advanced  the  necessary  funds  whenever  needed  by 
the  subsidiary  for  any  operating  expenses,  or  for  additions  or 
betterments,  it  was  held  that  dividends,  received  by  the  con- 
trolling company  and  declared  and  paid  during  the  first  six 
months  of  1914  out  of  surplus  of  the  subsidiary  company  accumu- 
lated prior  to  January  1,  1913,  and  on  such  date  consisting  princi- 
pally of  a  debit  on  the  books  of  the  subsidiary  company,  kept  in 
accordance  with  the  lease  under  which  the  controlling  company 
operated  the  subsidiary  company,  were  not  taxable  as  income 
received  in  1914  by  the  controlling  company.  It  was  also  held 
that  the  time  of  the  declaration  or  payment  of  the  dividends  was 
immaterial;  that  the  declaration  and  payment  thereof  was  a 
paper  transaction  to  bring  the  books  into  accord  with  the  ac- 
knowledged rights  of  the  controlling  company;  that  such  divi- 
dends bore  the  appearance  of  accruing  and  in  form  only  accrued 
to  the  controlling  company  after  January  1,  1913;  that,  prior  to 
such  date,  while  the  two  companies  were  separate  legal  entities, 
yet  in  fact  and  for  all  practical  purposes  they  were  merged  and 
identical,  the  subsidiary  company  being  but  a  part  of  the  control- 
ling company,  acting  merely  as  its  agent  and  subject  in  all  things 
to  its  direction  and  control,  the  funds  in  question  being  in  the 
actual  possession  and  control  of  the  holding  company  as  well  be- 
fore as  after  the  declaration."'- 

Where  a  holding  company,  owning  all  the  stock  in  several 
subsidiary  companies,  except  the  qualifying  shares  held  by  direc- 
tors, which  holding  company  and  subsidiary  companies  constituted 
and  were  related  as  parts  of  a  single  enterprise  of  buying,  trans- 
porting, refining  and  selling  oil  and  which  subsidiary  companies 
had  retained  their  earnings  although  making  some  loans  intei' 
^ese  and  had  invested  in  properties  all  their  funds  which  were 
not  actually  required  to  carry  on  the  business  so  that  the  debtor 
companies  had  no  money  to  pay  their  debts,  decided  in  January, 
1913,  to  take  over  the  previously  accumulated  earnings  and  sur- 

•">-  Southern  Pacific  Co.  v.  Lowe,  247  U.  S.  330,  distinguished  in  Walker 
V.  Gulf  &  Interstate  Co.,  2G9  Fed.  885. 


222  FEDERAL  INCOME  TAX 

plus  of  such  subsidiaries  and  actually  did  so  in  1913  by  votes  of 
the  subsidiaries,  the  court  disregarded  the  forms  gone  through 
and  the  distinct  corporate  entities,  and  considered  only  the  result, 
which  was  that  the  holding  company  became  the  holder  of  the 
debts  previously  due  from  one  subsidiary  to  another,  was  no 
richer  than  before,  but  its  property,  formerly  represented  only 
by  stock  in  the  subsidiaries,  was  thereafter  represented  by  stock 
in  and  debts  due  from  such  subsidiaries.  The  changes  having 
been  effected  by  entries  on  the  respective  companies'  books,  the 
transaction  was  held  to  be  a  bookkeeping  transaction  and  not  a 
declaration  and  payment  of  dividends  in  the  ordinary  course  by 
the  subsidiaries.  Although  the  holding  company  did  not  itself 
do  the  business  of  the  subsidiaries  and  have  possession  of  their 
property,  the  court  nevertheless  followed  the  principle  of  the 
case  last  discussed.^s 

The  above  cases,  arising  under  previous  income  tax  laws, 
establish  the  principle  that  corporate  form  may  be  disregarded 
under  unusual  circumstances.  The  courts  have  stated  that  this 
will  be  done  (1)  when  necessary  to  circumvent  fraud  and  (2) 
when  a  corporation  is  so  organized  and  controlled  as  to  make  it 
merely  an  instrumentality  or  adjunct  of  another  corporation  for 
a  sinister  or  wrongful  purpose  or  to  work  injustice.^^  This  defini- 
tion of  the  exceptions  to  the  rule  of  separate  corporate  entity, 
taken  in  connection  with  another  statement  quoted  below,  prob- 
ably furnishes  the  best  guide  possible  in  determining  the  applica- 
bility of  the  general  doctrine  that  a  corporation  is  separate  and 
distinct  from  those  who  own  and  control  it.  The  statement  re- 
ferred to  is  as  follows: 55 

53  Gulf  Oil  Corporation  v.  Lewellyn,  248  U.  S.  71,  distinguished  in  Wal- 
ker V.  Gulf  &  Interstate  Co.,  269  Fed.  885. 

54  Pittsburg-  &  Buffalo  Co.  v.  Duncan,  232  Fed.  584;  in  re  Watertown 
Paper  Co.,  169  Fed.  252. 

55  See  U.  S.  V.  Milwaukee  Co.,  142  Fed.  247.  While  most  of  the  excep- 
tions to  the  general  rule  of  separate  corporate  existence  involve  the  element 
of  fraud,  it  can  not  be  generally  asserted  that  the  existence  of  fraud  is 
necessary  to  constitute  an  exception.  The  cases  turn  on  their  peculiar  facts 
and  it  is  difficult  to  formulate  any  general  classification  of  the  exceptions. 

A  fevi^  of  the  many  cases  are  indicated  below  on  both  sides  of  the  question, 
viz.,  cases  wherein  corporate  entity  has  been  respected  and  cases  wherein  it 
has  been  ignored: 

(1)      Cases  tvherein  corporate  entity  has  been  ignored: 
(a)     Bankruptcy  Cases: 

In  re  Muncie  Pulp  Co.,  139  Fed.  546,  on  the  ground  that  the 
corporation  was  a  mere  agent  of  another  corporation; 
In  re  Rieger,  Kapner  &  Altmark,  157  Fed.  609,  on  the  ground 
that  the  corporation  was  merely  the  agency  of  a  partnership. 


CORPORATIONS  223 

In  re  Horgcni,  97  Fed.  319,  on  the  ground  that  the  corporation 
was  a  mere  fiction; 

(b)  Patent  Cases: 

Nat  Co.  V.  Connecticut  Co.,  73  Fed.  491,  on  the  ground  (a) 
that  the  corporation  was  a  mere  cover  for  the  transaction  of 
an  individual's  business,  (b)  the  relation  between  the  cor- 
poration and  an  individual  was  such  as  to  impute  estoppel 
against  the  individual  to  the  corporation,  or  (c)  that  the  cor- 
poration was  not  in  a  position  to  be  heard  in  a  court  of 
equity; 

(c)  Cases  of  vicarious  liability  imposed  upon  one  corporation  he- 
cause  of  stock  ownership  in  or  control  of  corporation  ■priirmrily 
liable : 

Chicago  Mill,  etc.,  Co.  v.  Boatman's  Bank,  234  Fed.  41,  on  the 
ground  (a)  that  the  corporation  was  a  department  of  the 
business  of  another  corporation  held  liable,  or  (b)  was  its 
alter  ego; 

Searchlight  Co.  v.  American  Co.,  240  Fed.  745,  on  the  ground 
that  the  separate  entity  of  the  corporation  was  being  made 
use  of  for  the  purpose  of  evading  responsibility,  as  a  means 
of  distorting  or  hiding  the  truth  or  covering  up  transactions; 
Interstate  Co.  v.  Baltimore  &  0.  Co.,  51  Fed.  49,  on  the  mixed 
ground  that  the  corporation  was  the  agent  of  another  corpo- 
ration and  was  a  mere  name  under  which  the  other  transacted 
its  business; 

Lehigh  Valley  R.  Co.  v.  Delachesa,  145  Fed.  617,  on  the  ground 
that  the  relationship  of  principal  and  agent  existed; 
O'Brien  v.  Champlain  Co.,  107  Fed.  338,  on  the  ground  that 
the  corporation  was  a  myth; 
(d)      Federal  Court  Jurisdiction  Cases: 

Miller  &  Lux  v.  East  Side  Co.,  211  U.  S.  293,  on  the  ground 
that  the  corporation  was  an  agent  of  another  corporation  es- 
tablished for  purpose  of  conferring  jurisdiction  on  federal 
courts,  through  diversity  of  citizenship; 

(e)  Criminal  Cases: 

Southern  Co.  v.  Interstate  Commerce  Commission,  219  U.  S. 
497,  on  the  ground  that  the  corporations  were  directed  by  the 
same  paramount  and  continuing  power  and  made  single  by  it; 
U.  S.  V.  Lehigh  Valley  Co.,  220  U.  S.  254,  on  the  ground  that 
the  corporation  was  but  an  agency,  dependency  or  department 
of  a  carrier; 

(f)  Miscellaneous: 

Amer.  Nat.  Bank  v.  Nat.  Co.,  77  Fed.  85,  on  the  ground  that 
the  corporation  was  being  used  by  another  corporation  as  a 
scapegoat  for  its  debts; 

Colonial  Trust  Co.  v.  MonteUo   Works,  172   Fed.  310,  on  the 
ground  that  the  corporation  was  especially  organized  agency 
of  another  corporation; 
(2)     Cases  wherein  corporate  entity  has  been  respected: 

Victor  Co.  V.  American  Co.,  189  Fed.  359  (patent  case)  ; 
Hall's   Safe   Co.   v.  Herring,   etc.,   Co.,   146    Fed.    37    (unfair 
trade  case) ; 


224  FEDERAL  INCOME  TAX 

"A  corporation,  from  one  point  of  view,  may  be  considered  an 
entity,  without  regard  to  its  shareholders,  yet  the  fact  remains 
self-evident  that  it  is  not  in  reality  a  person  or  thing  distinct 
from  its  consistent  parts.  The  word  corporation  is  but  a  collective 
name  for  the  members  who  compose  the  association.  (Citing 
cases.)  If  any  general  rule  can  be  laid  down,  in  the  present  state 
of  authority,  it  is  that  a  corporation  will  be  looked  upon  as  a  legal 
entity  as  a  general  rule,  and  until  sufficient  reason  to  the  con- 
trary appears ;  but,  when  the  notion  of  legal  entity  is  used  to 
defeat  public  convenience,  justify  wrong,  protect  fraud,  or  defend 
crime,  the  law  will  regard  the  corporation  as  an  association  of 
persons.  This  much  may  be  expressed  without  approving  the 
theory  that  the  legal  entity  is  a  fiction,  or  a  mere  mental  creation ; 
or  that  the  idea  of  invisibility  or  intangibility  is  a  sophism.  A 
corporation,  as  expressive  of  legal  rights  and  powers,  is  no  more 
fictitious  or  intangible  than  a  man's  right  to  his  own  home 
or  his  own  liberty." 

Residence.  A  domestic  corporation  is  one  organized  or  created 
in  the  United  States  including  only  the  states,  the  territories  of 
Alaska  and  Hawaii  and  the  District  of  Columbia.''^'  With  one 
exception  domestic  corporations  are  considered  to  be  residents  of 
this  country,  wherever  their  property  or  their  business  is  located 
and  whether  or  not  they  do  business  within  or  without  this  coun- 
try, and  are  taxable  regardless  of  the  fact  that  they  may  derive 
all  of  their  income  from  sources  outside  of  the  United  States,-" 

Richmond  Co.  v.  Richmond  Co.,  68  Fed.  105   (case  of  vicarious 

liability)  ; 

East  St.  Lonui  Ry.  Co.  v.  Jarvis,  92  Fed.  73.5  (case  of  vicarious 

liability)  ; 

Conley  v.  Mathieson  Works,  190  U.  S.  406,  205  U.  S.  392   (case 

of  "doing  business")  ; 

Federal  Mining  Co.  v.  Bunker  Hill  Co.,  187  Fed.  474   (federal 

court  jurisdiction  case)  ; 

Peterson  v.  Chicago,  etc.,  Co.,  205   U.  S.  362    (process  case)  ; 

United   Mines    Co.    v.   Hatcher,    79    Fed.    517    (statutory    lien 

case) ; 

Crane  &  Co.  v.  Fry,  126  Fed.  278; 

U.  S.  V.  Union  Stockyard  Co.,  192  Fed.  330  (criminal  case)  ; 

Jenks  V.  Brewster,  96  Fed.  625. 
•"»'j  Revenue  Act  of  1921,  §  2;  Revenue  Act  of  1918,  §  1.  A  corporation  re- 
ceiving a  charter  from  the  United  States  Court  for  China  and  holding 
itself  out  to  be  a  corporation  under  the  laws  of  the  United  States  will, 
under  the  Revenue  Act  of  1918,  be  considered  a  domestic  corporation.  (O. 
D.  661,  T.  B.  38-20-1199.) 

57  This  definition  follows  the  American  theory  that  a  corporation  can  not 
migrate  but  must  remain  a  resident  of  the  jurisdiction  in  which  it  is  created. 
See  Chapter  12.    In  a  case  under  the  1909  Law  payment  of  the   tax  was 


CORPORATIONS  225 

and  have  no  resident  stockholders.  They  are  a  distinct  artificial 
entity  domiciled  in  the  state  or  jurisdiction  pursuant  to  the  law 
of  which  they  are  organized  or  created. 

The  exception  referred  to  is  a  new  class  of  domestic  corpora- 
tion created  by  the  Revenue  Act  of  1921,  consisting  of  domestic 
corporations — (a)  80 'r  or  more  of  the  gross  income  of  which 
for  a  three-year  period  preceding  the  close  of  the  taxable  period 
was  derived  from  sources  within  a  possession  of  the  United 
States,  and  (b)  50%  or  more  of  the  gross  income  of  which  for 
such  three-year  period  was  derived  from  the  active  conduct  of  a 
trade  or  business  within  a  possession  of  the  United  States,  all  as 
is  more  fully  indicated  in  another  chapter.  Such  corporations  are 
treated  as  foreign  corporations ;  and  they  are  taxable  only  on  in- 
come from  sources  within  this  country."'^  Dividends  paid  by 
them  may  not  be  credited  for  purposes  of  the  normal  tax  and 
deducted  by  other  corporations.'"'"  Neither  are  dividends  paid 
by  them  income  from  sources  within  the  United  States  when 
received  by  nonresident  aliens  and  foreign  corporations. ''^ 

Although  domestic  corporations,  other  than  those  just  de- 
scribed, are  taxable  from  whatever  place  their  income  is  derived, 
and  in  whatever  jurisdiction  their  business  and  property  is  lo- 
cated and  stockholders  reside,  within  certain  limitations  they 
are  entitled  to  credit  against  the  tax  due  taxes  paid  to  any  foreign 
country  or  possession  of  the  United  States. ■'"^'^ 

Other  Corporations  Engaged  in  Business  in  Porto  Rico 
AND  the  Philippines.  The  1918  law  provided  that  in  Porto 
Rico  and  the  Philippines  the  income  tax  should  be  assessed  and 
collected  under  the  Revenue  Act  of  1916,  as  amended,  but  gave 
the  respective  legislatures  of  these  possessions  power  to  amend, 
alter,  modify,  or  repeal  the  income  tax  laws  in  force  therein.'"'- 
The  present  law  reserves  the  same  power  to  amend,  alter,  modify, 
or  repeal,  and  provides  that  the  income  tax  shall  be  assessed  and 
collected  in  Porto  Rico  and  the  Philippines  "as  provided  by  law 

refused,  the  corporation  claiming  that  because  its  business  was  transacted 
in  a  foreign  country  and  it  had  no  assets  in  this  country,  its  stockholders 
living  in  the  foreign  country  and  its  income  being  spent  and  invested  there 
it  was  not  liable  for  the  tax  assessed.  The  treasury  department  proposed 
to  test  the  question  but  after  the  institution  of  suit  the  company  abandoned 
its  position  and  made  payment  covering  the  tax  and  penalties,  the  action 
being  thereupon  discontinued.     (T.  D.  1863.) 

5S  Revenue  Act  of  1921,  §  238. 

•"iS  Revenue  Act  of  1921,  §  262. 

<iO  Revenue  Act  of  1921,  §§  216,  234  (a)  6. 

"1  Revenue  Act  of  1921,  §  217. 

«2  Revenue  Act  of  1918,  §  261. 


226  FEDERAL  INCOME  TAX 

prior  to  the  passage  of  this  act  (November  23,  1921)."''-"  The 
legislatures  of  Porto  Rico  and  the  Philippines  repealed  the  1916 
Law,  as  amended,  on  March  7,  1919,  and  July  26,  1919,  respec- 
tively, passing  other  acts  in  lieu  thereof/'^ 

A  United  States  corporation  which  derives  income  from 
sources  within  Porto  Rico,  a  Porto  Rican  corporation  which  de- 
rives income  from  sources  within  the  United  States,  and  a  corpo- 
ration of  a  foreign  country  which  derives  income  both  from 
sources  within  Porto  Rico  and  from  sources  within  the  United 
States,  are  all  taxed  in  both  places.  In  the  case  of  the  United 
States  corporation  the  income  and  excess-profits  taxes  in  the 
United  States  are  credited  with  the  amount  of  any  income  and 
excess-profits  taxes  paid  in  Porto  Rico.  In  the  case  of  the  Porto 
Rican  corporation  there  is  no  such  credit.  The  corporation  of  the 
foreign  country  deriving  income  from  both  places  is  subject  to 
no  double  taxation  so  far  as  the  United  States  and  Porto  Rico  are 
concerned.  The  same  principles  apply  in  the  case  of  the  Philip- 
pine Islands.''"' 

Gross  Income.  Corporations  are  subject  to  tax  on  income  re- 
ceived from  all  sources,  including  gains,  profits  and  income  de- 
rived from  trades,  businesses,  commerce  or  sales,  or  dealings  in 
property,  whether  real  or  personal,  growing  out  of  ownership  or 
use  of  or  interest  in  such  property ;  and  also  from  interest,  rent, 
dividends,  securities,  or  the  transaction  of  any  business  carried 
on  for  gain  or  profit,  or  gains  or  profits  and  income  from  any 
source  whatever,  except  exempt  income,  which  is  not  to  be  in- 
cluded in  gross  income,  as  provided  in  the  statute."*"' 

<i:^.  Revenue  Act  of  1921,  §  261. 

'■'^  See  The  Income  Tax  Law  of  Porto  Rico,  Laws  of  Porto  Rico,  ^^  77 ;  An 
Act  Establishing  the  Income  Tax,  Laws  of  the  Philippines,  §20;  Reg.  45, 
Art  1131,  as  revised  January  28,  1921. 

«5But,  under  the  1921  law,  a  United  States  corporation  which  derives 
income  from  sources  within  Porto  Rico  or  the  Philippines  may  be  taxed  in 
the  United  States  only  with  respect  to  income  from  sources  in  the  United 
States  (See  Revenue  Act  of  1921,  Sec.  262).  Reg.  45,  Art.  1133,  as  revised 
January  28,  1921;  O.  976,  T.  B.  1-20-663.  A  corporation  organized  in  the 
United  States  is  subject  to  the  4  per  cent,  war  income  tax  imposed  by  the 
Revenue  Act  of  1917,  even  though  it  has  its  principal  office,  keeps  its  ac- 
counts, and  does  all  of  its  business  in  Porto  Rico  and  derives  all  of  its  income 
from  sources  therein.  Such  a  corporation  should  file  its  return  in  the  district 
where  its  principal  office  in  the  United  States  is  located.  (L.  O.  1066,  T.  B. 
2.5-21-1694.) 

C«  Revenue  Act  of  1921,  §§213  (b),  233  (a);  Revenue  Act  of  1918, 
§§213  (b),  233  (a).  The  incom.e  so  exempted  from  tax  is  fully  discussed  in 
Ch.  14,  and  it  is  deemed  unnecessary  to  describe  this  income  at  this  point. 
Some  of  the  classes  of  exempt  income  obviously  have  no  application  to  cor- 


CORPORATIONS  227 

Gross  income  includes  items  subject  to  the  excess-profits  tax 
as  well  as  income  tax,  but  for  the  purpose  of  the  latter  these 
items  are  credited  against  the  net  income.""  Where  a  corporation 
is  engaged  in  carrying  on  more  than  one  class  of  business,  the 
gross  income  derived  from  the  different  classes  is  ascertained 
according  to  the  rules  applicable  thereto  and  the  gross  income 
of  all  the  classes  of  business  in  which  the  corporation  is  engaged 
is  taken  to  be  the  gross  income  of  the  corporation.  Thus,  the 
gross  income  of  manufacturing  companies  consists  of  the  total 
sales  of  manufactured  goods  during  the  year,  increased  or  de- 
creased by  the  gain  or  loss  as  shown  by  the  inventories  of  fin- 
ished and  unfinished  products,  raw  material,  etc.,  at  the  begin- 
ning and  end  of  the  year;  and  mercantile  companies  proceed 
similarly  in  determining  their  gross  income  by  inventory,  adding 
in  each  case  the  income  from  all  other  sources.'"'^  The  general 
provisions  as  to  income  applicable  both  to  corporations  and  indi- 
viduals are  discussed  in  the  succeeding  chapters  on  income'"''  and 
only  the  special  provisions  applicable  to  corporations  are  referred 
to  in  this  chapter.  Not  all  receipts  by  a  corporation  are  income, 
as  is  indicated  in  the  following  paragraphs.  Except  where  other- 
wise indicated  the  i-ulings  issued  under  the  1918  Law  with  regard 
to  income  in  the  case  of  corporations  are  believed  to  be  equally 
applicable  under  the  present  law. 

Sale  of  Capital  Stock.  The  proceeds  from  the  original  sale 
by  a  corporation  of  its  shares  of  capital  stock,  whether  such 
proceeds  are  in  excess  of  or  less  than  the  par  value  of  the  stock 
issued,  constitute  the  capital  of  the  company.  If  the  stock  is 
sold  at  a  premium,  the  premium  is  not  income.  Likewise,  if  the 
stock  is  sold  at  a  discount,  the  amount  of  the  discount  is  not  a  loss 
deductible  from  gross  income.     If,  for  the  purpose  of  enabling  a 

porations,  but  generally  the  exemption  of  income  applies  equally  to  indi- 
viduals and  corporations.  One  of  the  classes  of  exempt  income  is  gifts. 
Prior  to  the  enactment  of  the  1916  Law  it  was  not  clear  that  a  corporation 
was  exempt  from  tax  on  the  value  of  property  acquired  by  gift.  Under  the 
1909  Law  gifts  to  corporations  were  held  to  be  taxable  as  income,  although 
the  law  was  silent  in  this  respect.  Under  the  1913  Law  it  was  held  that  the 
statutory  exemption  of  gifts  did  not  apply  to  corporations,  since  the  1913 
Law  provided  for  such  exemption  under  a  provision  applicable  to  individuals 
only  and  made  no  mention  of  such  exemption  in  the  i)rovisions  applicable  to 
corporations.  The  1916  Law  provided  for  the  exemption  of  the  value  of  gifts 
in  a  section  applying  with  equal  force  to  corporations  and  individuals. 
(Compare  Revenue  Act  of  1916,  §4,  and  Revenue  Act  of  1913,  II  B.) 

•■>7  Revenue  Act  of  1921,  §236;  Revenue  Act  of  1918,  §236. 

<w  Reg.  33  Rev.,  Arts.  91  and  92.     See  also  Reg.  33.  Arts.  104  and  105. 

f>"  See  Chaps.  14  et  seq. 


228  FEDERAL  INCOME  TAX 

corporation  to  secure  working  capital  or  for  any  other  purpose, 
the  stockholders  donate  or  return  to  the  corporation  to  be  resold 
by  it  certain  shares  of  stock  of  the  company  previously  issued  to 
them,  or  if  the  corporation  purchases  any  of  its  stock  and  holds 
it  as  treasury  stock,  the  sale  of  such  stock  will  be  considered  a 
capital  transaction  and  the  proceeds  of  such  sale  will  be  treated 
as  capital  and  will  not  constitute  income  of  the  corporation.  A 
corporation  realizes  no  gain  or  loss  from  the  purchase  of  its  own 
stockjo 

Sale  of  Capital  Assets.  The  sale  by  a  corporation  of  its 
capital  assets  may  produce  a  gain  or  loss  in  the  same  manner  as 
the  sale  of  property  by  an  individual.  The  rules  for  determining 
this  gain  or  loss  are  discussed  elsewhere  in  this  book.  If  the 
purchaser  from  a  corporation  takes  over  all  the  assets  of  a  corpo- 
ration and  assumes  all  the  liabilities,  the  amount  of  liabilities  so 
assumed  is  part  of  the  purchase  price.^^ 

Sale  of  Assets  in  View  of  Liquidation.  Gains  derived  by 
a  corporation  from  the  sale  of  its  assets  with  a  view  of  liquidation 
are  taxable  income,  whether  or  not  the  corporation  is  in  process 
of  liquidation. '''2 

Creation  of  Sinking  Fund.  If  a  corporation,  in  order 
solely  to  secure  the  payment  of  its  bonds  or  other  indebtedness, 
places  property  in  trust,  or  sets  aside  certain  amounts  in  a 
sinking  fund  under  the  control  of  a  trustee,  who  may  be  author- 
ized to  invest  and  reinvest  such  sums  from  time  to  time,  the 
property  or  fund  thus  set  aside  by  the  corporation  and  held 
by  the  trustee  is  an  asset  of  the  corporation,  and  any  gain  arising 
therefrom  is  income  of  the  corporation.  The  trustee,  however, 
is  not  taxable  as  such  on  account  of  the  property  or  fund  so  held.'^^ 

Income  from  Leased  Property.  Where  a  corporation  has 
leased  its  property  in  consideration  that  the  lessee  shall  pay  in 
lieu  of  other  rental  an  amount  equivalent  to  a  certain  rate  of  divi- 
dend on  the  lessor's  capital  stock  or  the  interest  on  the  lessor's 
outstanding  indebtedness,  together  with  taxes,  insurance  or  other 
fixed  charges,  such  payments  are  to  be  considered  rental  pay- 

70  Reg.  45,  Art.  542;  Reg.  33  Rev.,  Arts.  98  and  99;  T.  D.  2090. 

71  Reg.  45,  Arts.  545,  563  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 
See  Ch.  17.  In  the  case  of  a  bank  the  term  "capital  assets"  includes  bonds 
and  other  securities  in  which  the  bank  has  invested  money  received  on  de- 
posit.    (0.  D.  832,  T.  B.  9-21-1485.) 

72  S.  1090,  Treasury  Bulletin  11-19-386.  The  distinction  betv^reen  the  cases 
of  Lynch  v.  Turrish,  247  U.  S.  221,  and  Lynch  v.  Hornby,  247  U.  S.  339, 
applies  only  for  purposes  of  the  tax  liability  of  the  shareholders  as  distin- 
guished from  the  corporation. 

73  T.  D.  3056,  T.  B.  35-20-1173. 


CORPORATIONS  229 

ments  and  are  to  be  returned  by  the  lessor  corporation  as  income, 
notwithstanding  the  fact  that  the  dividends  and  interest  are 
paid  by  the  lessee  directly  to  the  stockholders  and  bondholders 
of  the  lessor.  The  fact  that  a  corporation  has  conveyed  or  let  its 
property  and  has  parted  with  its  management  and  control,  or  has 
ceased  to  engage  in  the  business  for  which  it  was  originally  or- 
ganized, will  not  relieve  it  from  liability  to  the  tax.  While  the 
payments  made  by  the  lessee  directly  to  the  bondholders  or  stock- 
holders of  the  lessor  are  rentals  as  to  both  the  lessee  and  lessor 
(rentals  paid  in  one  case  and  rentals  received  in  the  other),  to 
the  bondholders  and  the  stockholders  such  amounts  are  interest 
and  dividend  payments  received  as  from  the  lessor  and  as  such 
must  be  accounted  for  in  their  returns.'"* 

Contributions  by  Stockholders.  Where  a  corporation  re- 
quires additional  funds  for  conducting  its  business  and  obtains 
such  needed  money  through  voluntary  pro  rata  payments  by  its 
stockholders,  the  amounts  so  received  being  credited  to  its  sur- 
plus account  or  to  a  special  capital  account,  such  amounts  will 
not  be  considered  income,  although  there  is  no  increase  in  the  out- 
standing shares  of  stock  of  the  corporation.  The  payments  in 
such  circumstances  are  in  the  nature  of  voluntary  assessments 
upon,  and  represent  an  additional  price  paid  for,  the  shares  of 
stock  held  by  the  individual  stockholders,  and  will  be  treated  as 
an  addition  to  and  as  a  part  of  the  operating  capital  of  the  com- 

74  Reg.  45,  Art.  546;  Reg.  33  Rev.,  Arts.  102,  104,  125,  208;  Reg.  33,  Art. 
82;  T.  D.  2090.  The  lessee,  in  rnaking  these  payments  direct  to  the  bond- 
holders and  the  stockholders,  does  so  as  the  agent  of  the  lessor.  Where 
under  the  terms  of  a  lease  a  lessee  agreed  to  pay  the  interest  upon  ani 
discharge  the  bonds  issued  by  the  lessor,  to  maintain  the  right  of  way  and 
buildings,  and  to  pay  direct  to  each  stockholder  of  the  lessor  dividends  at 
the  rate  of  eight  per  centum  per  annum,  it  was  held  that  the  amounts  paid 
to  the  creditors  and  stockholders  of  the  lessor  were  rents  or  compensation 
to  the  lessor  for  the  use  and  occupation  of  its  property  and  constituted  net 
income  to  it.  It  was  held  to  be  immaterial  that  the  lessor  was  not  possessed 
of  money  or  other  cash  revenues  with  which  to  pay  the  tax.  The  lessor 
could  not  exonerate  itself  from  liability  for  the  tax  subsequently  imposed 
under  a  law  thereafter  enacted  by  making  a  lease  of  its  property  which 
provided  for  the  payment  of  all  its  surplus  revenues  direct  to  its  stock- 
holders. (Rensselaer  &  Saratoga  Railroad  Co.  v.  Irwin,  249  Fed.  726,  writ 
of  certiorari  denied,  246  U.  S.  671.  See  Northern  Co.  v.  Lowe,  250  Fed.  856.) 
The  notion  that  a  corporation  is  an  artificial  entity  distinct  from  the  mem- 
bers who  compose  it  is  a  fiction  of  the  law  which  the  courts  recognize  for 
some  purposes  and  disregard  for  others.  Thus,  the  fact  that  a  lessee  cor- 
poration pays  the  rent  not  to  the  lessor  corporation,  but  to  its  stockholders 
and  bondholders,  cannot  prevent  the  lessor  corporation  from  being  taxable. 
(Anderson  v.  Morris  &  Essex  Railroad  Co.,  216  Fed.  83.) 


230  FEDERAL  INCOME  TAX 

pany.'"''  If  a  stockholder  in  a  corporation  which  is  indebted  to 
him  gratuitously  forgives  the  debt,  the  transaction  amounts  to  a 
contribution  to  the  capital  of  the  corporation."'"' 

Proceeds  of  Insurance.  The  1918  law  provided  that  "the 
proceeds  of  insurance  policies  paid  upon  the  death  of  the  insured 
to  individual  beneficiaries  or  the  estate  of  the  insured  shall 
be  exempt  from  tax".""  The  present  law  repeats  this  exemption, 
but  omits  the  words  in  italics  from  the  provision  granting  the 
exemption.  The  inference  is  clear  that  the  intention  of  Congress 
was  to  exempt  the  proceeds  of  insurance  policies  paid  upon  the 
death  of  the  insured  irrespective  of  the  status,  corporate  or  other- 
wise, of  the  beneficiary.  Under  the  1918  law  the  proceeds  of  life 
insurance  policies  paid  upon  the  death  of  the  insured  to  a  corpora- 
tion beneficiary,  less  any  premiums  paid  by  the  corporation  and 
not  deducted  from  gross  income,  were  required  to  be  included  in 
gross  income.'"*  The  option  exercised  by  a  corporation  beneficiary 
in  allowing  the  proceeds  of  an  insurance  policy  to  be  paid  in  in- 
stallments was  held  to  represent  an  investment  of  such  proceeds ; 
any  interest  or  profits  received  over  and  above  the  face  value 
of  each  installment  representing  taxable  income  to  the  corpora- 
tion for  the  year  in  which  received.'-' 

Where  an  individual  took  out  a  policy  of  insurance  in  favor  of 
his  estate  which  was  assigned  to  a  corporation  as  security  for 
money  advanced  without  interest  or  other  charge  to  pay  a  pre- 
mium thereon,  and  upon  the  death  of  the  insured  the  corporation 
deducted  the  amount  of  the  indebtedness  from  the  proceeds  of  the 
pohcy  paid  to  it  as  assignee,  and  turned  the  balance  over  to  the 
executor  of  the  estate,  the  corporation  was  not  required  to  include 
the  proceeds  of  the  policy  in  gross  income.  The  function  of  the 
corporation  was  merely  that  of  an  intermediary  in  the  collection 
of  the  proceeds  of  the  policy.-^o 

Interest  Upon  Liberty  Bonds.  Income  of  a  corporation  as 
such  is  taxable  to  the  corporation  and  not  to  the  stockholders. 
The  corporation,  and  not  the  stockholders,  is  regarded  as  the 
owner  of  Liberty  Bonds  held  by  the  corporation  and  is  entitled 
to  exemption  on  account  of  such  ownership.    Thus,  when  bonds 

"3  Reg.  45,  Art.  543;  letter  from  treasury  department  dated  February  21, 
1916;  I.  T.  S.,  1918,  TI1291. 

"'»  Reg.  45,  Art.  51.     See  Oregon-Washington  Co.  v.  U.  S.,  251  Fed.  211. 

"Revenue  Act  of  1918,  §§213  (b)l,  233;  Revenue  Act  of  1921, 
§§  213  (b)  1,  233. 

78  Reg.  45,  Art.  541. 

T9  0.  D.  66,  T.  B.  1-19-92. 

SO  O.  D.  804,  T.  B.  7-21-1445. 


CORPORATIONS  231 

of  the  Fourth  Liberty  Loan  are  subscribed  for  by  the  corporation, 
the  corporation,  as  distinguished  from  its  stockholders,  is  the 
original  subscriber  and  is  entitled  to  the  collateral  exemption  of 
interest  provided  for  years  prior  to  1921  on  bonds  of  previous  is- 
sues on  account  of  such  original  subscription."^' 

Where  a  partnership  vi^as  an  original  subscriber  to  liberty 
bonds  of  the  Fourth  Liberty  Loan  and  was  reorganized  as  a  cor- 
poration prior  to  July  1,  1919,  and  elected  to  be  taxed  as  a  corpo- 
ration from  January  1,  1918,  the  corporation  was  considered, 
under  the  1918  law,  "the  original  subscriber"  to  the  bonds."^- 
When  two  corporations  consolidate,  forming  a  new  corporation, 
the  former  corporations  ceasing  to  exist,  the  new  corporation 
could  not  be  considered  the  original  subscriber  to  bonds  of  the 
Fourth  Liberty  Loan  originally  subscribed  for  by  the  two  corpo- 
rations and  taken  over  by  it."^"' 

Deductions  in  Computing  Net  Income.  The  statute  specifies 
particularly  the  deductions  which  may  be  made  by  a  corporation 
from  its  gross  income  in  computing  its  net  income.  In  general, 
the  deductions  from  gross  income  allowed  corporations  are  the 
same  as  allowed  individuals,  except  that  corporations  may  de- 
duct dividends  received  from  other  corporations,  which  individ- 
uals use  as  a  credit  for  purposes  of  the  normal  tax  only,  and 
may  not  deduct  charitable  contributions.^-"  Certain  items  are 
also  expressly  declared  by  the  Revenue  Act  of  1918  not  to 
be  deductible  in  the  case  of  corporations  as  well  as  individuals. 
These  items  are  discussed  in  another  chapter.^'  These  deduc- 
tions are  discussed  generally  in  the  several  chapters  relating 
respectively  thereto."^''  In  this  chapter  reference  is  made  only 
to  those  provisions  having  special  application  to  corporations. 

Ordinary  and  Necessary  Expenses.  A  corporation  is  al- 
lowed to  deduct  all  the  ordinary  and  necessary  expenses  paid 
or  incurred •^'^  during  the  taxable  year  in  carrying  on  any  trade 

■'^i  T.  D.  2742.  See  Ch.  18  for  a  discussion  of  the  consolidated  exemption 
provided  for  1921  and  subsequent  years. 

«0.  D.  502,  T.  B.  20-20-932;  O.  D.  211,  T.  B.  11-19-373. 

«5  O.  D.  577,  T.  B.  28-20-1052. 

s^  Revenue  Act  of  1921,  §  234  (a)  ;  Revenue  Act  of  1918.  §  234  (a)  ;  Reg. 
45,  Art.  561. 

f<'' Revenue  Act  of  1921,  §§215,  235;  Revenue  Act  of  1918.  §§215,  235; 
Reg.  45,  Art.  581.     See  Ch.  21. 

«fi  See  Chaps.  21-30. 

'^^  The  terms  "paid  or  incurred"  or  "paid  or  accrued"  are  construed  ac- 
cording to  the  method  of  accounting  upon  which  net  income  is  computed 
under  §212  of  the  statute.  (Revenue  Act  of  1921.  §200;  Revenue  Act  of 
1918,  §  200.) 


232  FEDERAL  INCOME  TAX 

or  business,  including  a  reasonable  allowance  for  salaries  or 
other  compensation  for  personal  services  actually  rendered,  and 
including  rentals  or  other  payments  required  to  be  made  as  a 
condition  to  the  continued  use  or  possession  of  property  to 
which  the  corporation  has  not  taken  or  is  not  taking  title,  or  in 
which  it  has  no  equity.'^'*  It  will  be  noted  that  the  expenses  per- 
mitted by  this  provision  of  the  law  are  only  the  ordinary  and 
necessary  expenses.  Extraordinary  expenses  are  not  deductible 
under  this  head,  although  they  may  be  deductions  recognized  in 
accounting  practice  as  a  proper  charge  against  the  income  for 
the  year.  Payments  to  trustees  by  a  cemetery  company  of  a 
percentage  of  the  proceeds  of  sales  of  cemetery  lots  set  aside 
for  a  "maintenance  fund"  to  be  controlled  solely  by  the  trustees 
thereof  pursuant  to  a  provision  in  the  charter  of  a  corporation 
requiring  such  payments,  are  not  deductible  from  the  gross 
income  as  "ordinary  and  necessary  expenses." ^^ 

Organization  Expenses.  Organization  expenses  of  corpora- 
tions, such  as  attorneys'  and  accountants'  fees,  together  with 
fees  paid  to  state  authorities  prior  to  or  coincident  with  the 
securing  of  a  charter  and  the  incorporation  of  a  company, 
constitute  a  capital  investment,  such  assets  being  offset  by  the 
asset  value  of  the  corporate  franchise,  an  intangible  asset  of 
a  somewhat  permanent  character  and  in  many  instances  of 
substantial  value.  It  is  held  that  such  expenses  constitute  in- 
vestments of  capital  and  are  not  "ordinary  and  necessary  ex- 
penses," which  are  the  only  expenses  authorized  by  the  law  to 
be  deducted.^'^ 

Expenses  Incurred  in  Sale  of  Capital  Stock.  Expenses 
incidental  to  or  connected  with  the  selling  of  the  capital  stock 
(common  or  preferred)  of  a  corporation  for  the  purpose  of 
raising  capital  to  be  invested  by  it  in  property  to  be  employed 
in  the  business  of  the  corporation  are  not  an  allowable  deduc- 
tion from  gross  income,  for  the  reason  that  such  expenses  are 
incurred  in  a  capital  transaction ;  that  is,  the  raising  of  capital 
to  be  invested  or  employed  in  the  business.  Such  expense,  like 
the  discount  at  which  the  shares  of  stock  may  be  sold,  has  the 

S8  Revenue  Act  of  1921,  §234  (a)  1;  Revenue  Act  of  1918,  §234  (a)  1. 
In  the  case  of  corporations  the  statutory  provision  for  this  deduction  con- 
tained in  the  Revenue  Act  of  1921  is  identical  -with,  the  corresponding 
provision  of  the  1918  Lavi^.  The  rulings  under  the  1918  Law  should  therefore 
be  followed  under  the  present  law. 

89  S.  1145,  T.  B.  20-19-515. 

90  Reg.  45,  Art.  582;  T.  D.  2490.  This  ruling  is  not  in  accordance  with 
accounting  practice,  which  recognizes  the  propriety  of  charging  off  organiza- 
tion expenses  against  income  over  a  period  of  four  or  five  years. 


CORPORATIONS  233 

effect  only  of  reducing  the  available  capital  of  the  corporation 
and  cannot  be  used  to  reduce  the  income  from  operations;  that 
is  to  say,  any  expense  incident  to  the  bringing  of  capital  into 
the  company,  whether  it  be  a  new  or  a  going  concern,  cannot 
be  recouped  out  of  or  charged  against  the  operating  income. 
It  is  a  capital  loss  or  expense  properly  chargeable  against  the 
proceeds  of  the  sale  of  the  stock  and  reduces  the  capital  rather 
than  the  earnings  of  the  company.''^ 

Redemption  or  Retirement  of  Capital  Stock.  The  expenses 
exclusive  of  the  purchase  price,  incurred  by  a  company  in  pur- 
chasing its  own  stock  for  the  purpose  of  retirement  or  holding 
as  treasury  stock,  are  not  deductible  from  gross  income  as 
"ordinary  and  necessary  expenses."  These  expenses  are  to  be 
considered  part  of  the  purchase  price  of  the  stock  retired."- 
A  reserve  fund  created  out  of  the  earnings  of  a  corporation  for 
the  purpose  of  redeeming  its  preferred  stock  is  not  an  ordinary 
and  necessary  expense.""  Where  a  corporation  issued  preferred 
stock  at  par,  redeemable  at  110,  the  difference  appearing  on  the 
books  of  the  corporation  as  a  reduction  of  undivided  profits, 
the  transaction  has  been  held  to  be  a  capital  transaction  with 
the  result  that  the  difference  between  the  selling  price  of  the 
stock  and  the  price  at  which  it  was  redeemed  could  not  be 
deducted.^* 

Holding  Company  Financing  Subsidiary.  A  holding  com- 
pany which  guarantees  dividends  at  a  specified  rate  on  the 
stock  of  a  subsidiary  corporation  for  the  purpose  of  securing 
new  capital  for  the  subsidiary  and  increasing  the  value  of  its 
stock  holdings  in  the  subsidiary  may  not  deduct  amounts  paid 
in  carrying  out  this  guaranty  in  computing  its  net  income,  but 
such  payments  may  be  added  to  the  cost  of  its  stock  in  the 
subsidiary ."•>  Moneys  advanced  as  loans  to  a  subsidiary  to  cover 
an  annual  deficit  have  been  held  not  to  be  deductible  as  "ordinary 
and  necessary  expenses."-"'  Payments  by  a  holding  company 
under  a  guaranty  of  interest  on  the  bonds  of  an  insolvent  sub- 
sidiary are  a  legal  deduction  from  the  gross  income  of  the  corpo- 
ration making  the  payment,  either  as  an  operating  expense  or 

«i  Reg.  45,  Art.  563;  Reg.  33  Rev.,  Art.  145. 
"2  0.  D.  852,  T.  B.  12-21-1522. 

93  O.  D.  288,  T.  B.  22-19-537. 

94  Letter  from  treasury  department  dated  .A.pril  11,  1917;  I.  T.  S.  1921, 
51012. 

9"'  Res.  45,  Art.  582. 

9''' Walker  v.  Gulf  &  Interstate  Co.,  269  Fed.  885;  T.  D.  3133.  T.  B. 
13-21-1533. 


234  FEDERAL  INCOME  TAX 

as  interest,  or  as  a  bad  debt,  provided  it  is  charged  off  the  books 
of  account  of  the  guarantor.^'^ 

Interest.  Corporations,  like  individuals,  may  deduct  all  in- 
terest paid  v^ithin  the  taxable  year  on  their  indebtedness,  except 
on  indebtedness  incurred  or  continued  to  purchase  or  carry 
obligations  or  securities  (other  than  obligations  of  the  United 
States  issued  after  September  24,  1917,  and  originally  sub- 
scribed for  by  the  corporation)  the  interest  upon  which  is  wholly 
exempt  from  income  tax/'s  interest  paid  by  a  corporation  on 
scrip  dividends  is  an  allowable  deduction.  So-called  interest 
on  preferred  stock,  which  is  in  reality  a  dividend  thereon, 
can  not  be  deducted  in  computing  net  income.  Interest  paid 
by  a  corporation  on  so-called  debenture  stock,  a  kind  of  stock 
common  in  England,  but  more  or  less  unfamiliar  in  this  coun- 
try, has  been  held  deductible  from  gross  income  in  computing 
net  income.^^  In  the  case  of  banks  and  loan  or  trust  companies 
interest  paid  within  the  year  on  deposits  or  on  moneys  received 
for  investment  and  secured  by  interest-bearing  certificates  of 
indebtedness  issued  by  such  bank  or  loan  or  trust  company  may 
be  deducted  from  gross  income.^"*^ 

97  S.  1298,  T.  B.  8-20-753.  It  does  not  seem  that  the  amount  of  the  deduc- 
tion need  be  charged  off  unless  deducted  as  a  worthless  debt. 

9S  Revenue  Act  of  1921,  §234  (a)  2;  Revenue  Act  of  1918,  §234  (a)  2. 
The  1921  Law  contains  an  important  change  from  the  1918  Law  in  the  inser- 
tion of  the  words  "and  originally  subscribed  for  by  the  taxpayer"  in  the 
parenthetical  clause  of  subd.  (2)  of  ^  (a)  of  §234.  This  change  is  de- 
signed to  prevent  the  deduction  of  interest  paid  or  accrued  to  purchase  or 
carry  Victory  33  notes  and  is  fully  explained  in  Ch.  23.  The  1916  Law  con- 
tained a  substantial  limitation  upon  the  deduction  of  interest  by  corpora- 
tions. With  regard  to  this  limitation  see:  Revenue  Act  of  1916,  §12; 
T.  D.  2441;  T.  D.  2137;  T.  D.  2090;  T.  D.  1865;  T.  D.  1993;  T.  D.  1960; 
Reg.  33  Rev.,  Arts.  95,  188;  Reg.  33,  Art.  95,  Art.  148,  Art.  151.  Letter 
from  treasury  department  dated  April  29,  1918;  I.  T.  S.  1918,  If  3344;  letter 
from  treasury  department  dated  January  13,  1916;  I.  T.  S.  1918,  111767. 
Anderson  v.  42  Broadway  Co.,  239  U.  S.  69;  Associated  Pipe  Line  Co.  v. 
U.  S.,  258  Fed.  800;  Altheimer  Investment  Co.  v.  Allen,  246  Fed.  270,  peti- 
tion for  a  writ  of  certiorari  denied  November  18,  1918;  Middlesex  Banking 
Co.  V.  Eaton,  233  Fed.  87.  The  limitation  is  discussed  in  full  in  the  1920 
edition  of  this  book  at  p.  855.  Since  that  discussion  was  written  the  fol- 
lowing decisions  have  been  made  bearing  upon  the  subject-matter:  Boston  & 
M.  R.  R.  V.  U.  S.,  265  Fed.  578;  U.  S.  v.  N.  Y.,  N.  H.  &  H.  R.  R.  Co.,  265 
Fed.  331;  Sol.  Op.  23,  T.  B.  39-20-1217;  A.  R.  R.  559,  T.  B.  29-21-1733;  Sol. 
Op.  127,  T.  B.  47-21-1934. 

99  A.  R.  R.  237,  T.  B.  33-20-1142.  The  chaiacter  of  the  debenture  stock 
involved  in  this  ruling  is  thoroughly  described  in  the  chapter  herein  on  the 
excess-profits  tax  under  the  heading  of  borrowed  capital. 

1'"'  Reg.  45,  Art.  564. 


CORPORATIONS  235 

Taxes.  Corporations,  like  individuals,  may  deduct  taxes  paid 
or  accrued,!"^  within  the  taxable  year,  except  (a)  income,  war- 
profits,  and  excess-profits  taxes  imposed  by  the  authority  of 
the  United  States,  (b)  that  part  of  any  income,  war-profits  and 
excess-profits  taxes  imposed  by  the  authority  of  any  foreign 
country  or  possession  of  the  United  States  as  is  allowed  as  a 
credit,  and  (c)  taxes  assessed  against  local  benefits  of  a  kind 
tending  to  increase  the  value  of  the  property  assessed. i"-  Under 
a  new  provision  of  the  Revenue  Act  of  1921,  taxes  imposed  upon 
a  shareholder  or  member  of  a  corporation,  upon  his  interest 
as  shareholder  or  member,  which  are  paid  by  the  corporation 
without  reimbursement,  are  deductible  by  the  corporation.!""^ 
This  provision  applies  particularly  to  banks.  The  shareholder 
or  member  is,  of  course,  not  permitted  to  deduct  the  same  tax. 
Additional  taxes  assessed  against  a  corporation  under  the  1909 
law  and  paid  during  subsequent  years  are  allowable  deductions 
from  the  gross  income  of  the  corporation  for  the  year  when  paid, 
but  income  taxes  assessed  under  the  1913  law  and  the  1916  law 
are  deductible  only  if  paid  prior  to  January  1,  1917.i"^  Except 
as  stated  in  this  and  following  paragraphs  the  same  rules  apply 
to  the  deduction  of  taxes  by  corporations  and  individuals  and 
are  discussed  elsewhere.^"'' 

Interest  on  Tax-Free  Bonds.  Where  a  corporation  has  is- 
sued bonds  or  other  indebtedness  with  a  guarantee  that  the  in- 
terest thereon  shall  be  paid  without  deduction  for  any  tax 
which  the  corporation  may  be  called  upon  to  pay  or  withhold 
under  the  laws  of  the  United  States  or  of  any  state  or  jurisdic- 
tion, no  deduction  for  the  payment  of  the  income  tax  or  any 
other  federal  tax  paid  pursuant  to  the  contract  or  provision 
contained  in  such  bonds  is  permitted  to  the  coii^oration  under 
the  heading  of  taxes  or  interest  or  on  any  ground.  In  the  case, 
however,  of  corporate  bonds  or  obligations  containing  an  appro- 
priate "tax-free  covenant"  clause,  the  corporation  paying  a  state 

i"i  See  note  87. 

W2  Revenue  Act  of  1921,  §  234  (a)  3.  The  taxes  which  are  allowed  as  a 
credit  are  set  forth  in  §  238.  In  this  provision  for  the  deduction  of  taxes  the 
1918  Law  described  particularly  the  taxes  which  were  deductible  as  well  as 
some  exceptions;  the  present  law  describes  particularly  only  the  exceptions 
—that  is,  the  taxes  not  deductible.  The  two  sections  should  be  carefully 
compared;  thev  are  discussed  in  full  in  ch.  24. 

w.\  Revenue  Act  of  1921,  §  234  (a)  3.  Formerly  such  taxes  were  not  de- 
ductible by  the  shareholder,  but  only  by  the  member.  This  subject  is  fully 
discussed  in  ch.  24. 

1"^  O.  D.  240,  T.  B.  13-19-418.     See  ch.  24. 

1«>"'  Res.  45,  Art.  565.    See  ch.  24. 


236  FEDERAL  INCOME  TAX 

tax  or  any  other  than  a  federal  tax  for  some  one  else  pursuant 
to  its  agreement  may  deduct  such  payment  as  interest  paid 
on  indebtedness. 10*^  Under  the  1918  law  the  amount  of  tax  so 
paid  for  a  bondholder  by  an  obligor  pursuant  to  a  tax-free 
covenant  was  regarded  as  additional  interest  paid  to  the  bond- 
holder and  was  required  to  be  included  in  gross  income.^"^  The 
Revenue  Act  of  1921  expressly  provides  that  the  tax  so  paid  shall 
not  be  included  in  the  gross  income  of  the  obligee  (bond- 
holder) .los 

Losses.  Corporations  are  permitted  to  deduct  all  losses  sus- 
tained during  the  taxable  year  and  not  compensated  for  by  in- 
surance or  otherwise,  unless,  in  order  to  clearly  reflect  the  in- 
come, the  loss  should,  in  the  opinion  of  the  commissioner,  be 
accounted  for  as  of  a  different  period. ^"'^ 

Losses  in  Ultra  Vires  Transactions.  Where  a  corpora- 
tion suffers  a  loss  as  the  result  of  an  ultra  vires  act,  it  may 
not  deduct  such  loss  in  computing  its  net  income.  Where  a 
corporation  is  authorized  by  its  certificate  of  incorporation  to 
purchase  stocks  on  a  margin,  and  where  there  are  no  laws  in 
the  state  where  it  trades  in  stocks  making  marginal  stock 
transactions  by  corporations  illegal,  if  it  sustains  a  loss  as  a 
result  of  marginal  trading  in  stocks,  such  loss  may  be  deducted 
in  computing  its  net  income,  if  sustained  during  the  taxable 
year  and  not  compensated  for  by  insurance  or  otherwise,  unless 
it  appears  affirmatively  that  the  transaction  was  merely  color- 
able and  no  bona  fide  purchase  of  stock  was  made.^^*^ 

Dividends  on  Stock  of  Other  Corporations.  The  dividends 
which  may  be  deducted  by  corporations  in  computing  net  in- 
come are  the  same  as  those  which  individuals  may  use  as  a 
credit  for  purposes  of  the  normal  tax.  Under  the  Reveni'e  Act 
of  1921  corporations  may  deduct  amounts  received  as  divider^ds 
(a)  from  a  domestic  corporation  (other  than  a  corporation 
deriving  a  substantial  proportion  of  income  from  sources  within 
a  possession  of  the  United  States  and  entitled  to  be  treated 
as  a  foreign  corporation)   or   (b)   from  any  foreign  corporation 

100  Revenue  Act  of  1921,  §234  (a)  3;  Revenue  Act  of  1918,  §234  (a)  3; 
Reg.  45,  Art.  565. 

107  Reg.  45,  Art.  31. 

108  Revenue  Act  of  1921,  §  234   (a)    3. 

109  Revenue  Act  of  1921,  §234  (a)  4;  Revenue  Act  of  1918,  §234  (a)  4. 
The  provision  for  "net  losses"  and  the  new  "wash  sale"  provision  of  the 
Revenue  Act  of  1921  apply  similarly  to  individuals  and  corporations  and 
are  discussed  in  ch.  25.  The  provision  of  the  1918  Law  for  the  deduction  of 
losses  in  inventory  and  from  rebates  is  also  discussed  in  that  chapter. 

110  O.  968,  T.  B.  1-20-660. 


CORPORATIONS  237 

when  it  is  shown  to  the  satisfaction  of  the  commissioner  that 
more  than  50  per  centum  of  the  gross  income  of  such  foreign 
convocation  for  the  three-year  period  ending  with  the  close 
of  its  taxable  year  preceding  the  declaration  of  such  dividends 
(or  for  such  part  of  such  period  as  the  foreign  corporation  has 
been  in  existence)  was  derived  from  sources  within  the  United 
States. '11  Under  the  1918  law  corporations  might  deduct  all 
amounts  received  as  dividends  from  a  corporation  taxable  upon 
its  net  income  and  amounts  received  as  dividends  from  a  per- 
sonal service  corporation  out  of  earnings  or  profits  upon  which 
income  tax  had  been  imposed."-  Dividends  paid  by  foreign 
corporations  receiving  no  income  from  sources  within  the 
United  States  might  not  be  deducted.  An  American  corporation 
might  deduct  all  amounts  received  as  dividends  from  a  foreign 
holding  company  whose  income  was  derived  entirely  from  divi- 
dends on  the  stock  of  another  American  company. i^'^ 

Contributions  to  Charities.  Under  both  the  present  and 
the  1918  law  corporations  are  not  entitled  to  deduct  from  their 
gross  income  contributions  made  to  the  United  States,  any 
state,  territory,  or  the  District  of  Columbia,  for  public  pur- 
poses, or  to  religious,  charitable,  scientific  or  educational  cor- 
porations or  organizations,  including  the  American  Legion,  or 
to  the  fund  for  vocational  rehabilitation.  Contributions  made 
to  the  Red  Cross  or  other  war  activities  are  not  deductible  by 
corporations.!!^ 

m  Revenue  Act  of  1921,  §  234  (a)  6.     See  also  §§  216,  217,  262. 

112  Revenue  Act  of  1918,  §234  (a)  6.  Under  the  1913  Law  corporations 
were  not  permitted  to  deduct  the  amount  received  as  dividends  from  other 
corporations  subject  to  the  income  tax.  This  was  likewise  true  under  the 
1916  Law.  For  the  purpose  of  the  1917  Law,  dividends  on  the  stock  of  such 
other  corporations  as  were  taxable  thereunder  on  their  net  income  might  be 
deducted.  Thus,  in  1917  a  corporation  might  not  deduct  dividends  in  com- 
puting the  2%  tax  imposed  by  the  1916  Law,  but  might  do  so  in  computing 
the  4%  tax  imposed  by  the  1917  Law. 

113  0.  D.  130,  T.  B.  3-19-201. 

114  T.  D.  2847,  as  amended  May  24,  1919.  This  treasury  decision  was 
founded  on  an  opinion  of  the  attorney-general  dated  May  19,  1919,  which 
held  that  Red  Cross  donations  were  not  deductible  as  expense,  and  which 
was  also  founded  on  a  consideration  of  the  legislative  history  of  the  Revenue 
Act  of  1918.  (See  Congressional  Record  for  September  17.  1918,  in  which  it 
appears  that  an  amendment  to  the  effect  that  corporations  might  deduct 
charitable  and  other  contributions  and  gifts  in  the  same  manner  as  indi- 
viduals was  defeated.)     It  was  not  necessary  to  file  amended  returns  when 

■donations  had  been  erroneously  deducted  prior  to  the  promulgation  of  T.  D. 
2847.  It  was  simply  necessary  to  file  a  statement  showing  the  amount  of 
donations,  the  net  income  as  reported  and  corrected,  and  the  additional  tax 
which  was  required  to  be  paid,  together  with  interest  from  each  installment 


238  FEDERAL  INCOME  TAX 

Sale  and  Retirement  of  Corporate  Bonds.  The  rules  for  the 
computation  and  allocation  of  income  and  deductions  upon  a 
sale  and  retirement  of  corporate  bonds  stated  below  as  issued 
under  the  1918  law  should  remain  substantially  unchanged  under 
the  present  law.  If  bonds  are  issued  by  a  corporation  at  their 
face  value,  the  corporation  realizes  no  gain  or  loss.  If  there- 
after the  corporation  purchases  and  retires  any  of  such  bonds 
at  a  price  in  excess  of  the  issuing  price  or  face  value,  the  excess 
of  the  purchase  price  over  the  issuing  price  or  face  value  is 
a  deductible  expense  for  the  taxable  year.  If,  however,  the 
corporation  purchases  and  retires  any  of  such  bonds  at  a  price 
less  than  the  issuing  price  or  face  val.ue,  the  excess  of  the  issuing 
price  or  face  value  over  the  purchase  price  is  gain  or  income  for 
the  taxable  year. 

If  bonds  are  issued  by  a  corporation  at  a  premium,  the  net 
amount  of  such  premium  is  gain  or  income  which  should  be 
prorated  or  amortized  over  the  life  of  the  bonds.  If  thereafter 
the  corporation  purchases  and  retires  any  of  such  bonds  at  a 
price  m  excess  of  the  issuing  price  minus  any  amount  of  pre- 
mium already  returned  as  income,  the  excess  of  the  purchase 
price  over  the  issuing  price  minus  any  amount  of  premium 
already  returned  as  income  (or  over  the  face  value  plus  any 
amount  of  premium  not  yet  returned  as  income)  is  a  deductible 
expense  for  the  taxable  year.  If,  however,  the  corporation 
purchases  and  retires  any  of  such  bonds  at  a  price  less  than 
the  issuing  price  minus  any  amount  of  premium  already  returned 
as  income,  the  excess  of  the  issuing  price  minus  any  amount 
of  premium  already  returned  as  income  (or  of  the  face  value 
plus  any  amount  of  premium  not  yet  returned  as  income)  over 
the  purchase  price  is  gain  or  income  for  the  taxable  year. 

If  bonds  are  issued  by  a  corporation  at  a  discount,  the  net 
amount  of  such  discount  is  deductible  and  should  be  prorated 
or  amortized  over  the  life  of  the  bonds.  If  thereafter  the  cor- 
poration purchases  and  retires  any  of  such  bonds  at  a  price  in 
excess  of  the  issuing  price  plus  any  amount  of  discount  already 
deducted,  the  excess  of  the  purchase  price  over  the  issuing  price 
plus  any  amount  of  discount  already  deducted  (or  over  the 
face  value  minus  any  amount  of  discount  not  yet  deducted)  is 
a  deductible  expense  for  the  taxable  year.  If,  however,  the  cor- 
date. Failure  to  file  such  a  statement  resulted  in  the  5'/r  penalty  upon 
audit  of  the  return.  (T.  D.  3105,  T.  B.  1-21-1385;  M.  2207,  T.  B.  14-19-438.) 
Payment  of  the  additional  tax  was  required  within  30  days.  The  statement 
was  not  required  when  the  amount  of  donations  was  disclosed  upon  an  audit 
of  corporate  books  by  the  department  (T.  D.  3215). 


CORPORATIONS  239 

poration  purchases  and  retires  any  of  such  bonds  at  a  price 
less  than  the  issuing  price  plus  any  amount  of  discount  ah*eady 
deducted,  the  excess  of  the  issuing  price  plus  any  amount  of 
discount  already  deducted  (or  of  the  face  value  minus  any 
amount  of  discount  not  yet  deducted)  over  the  purchase  price  is 
gain  or  income  for  the  taxable  year.''"' 

It  was  claimed  in  one  case  that  the  excess  of  the  par  or  face 
value  of  a  corporation's  bonds,  issued  prior  to  March  1,  1913, 
over  the  price  paid  upon  the  purchase  and  retirement  of  the 
bonds  was  not  income,  the  bonds  having  depreciated  prior  to 
that  date,  by  reason  of  the  impaired  capital  of  the  corporation, 
to  a  value  equivalent  to  that  paid  for  the  bonds  in  1918.  This 
claim  was,  in  other  words,  that  the  corporation  received  the 
excess  in  question  when  the  bonds  were  sold  prior  to  March  1, 
1913,  so  that  such  excess  was  not  taxable  income;  and  that  the 
corporation  received  no  income  in  1918,  merely  because  in  that 
year  it  transpired  that  the  excess  received  prior  to  March  1, 
1913,  need  not  be  paid  back.  This  claim  was  not  allowed,  how- 
ever, the  committee  deciding  that  the  excess  in  question  was 
properly  taxable  in  1918.'"' 

A  corporation  which  issued  its  bonds  at  a  discount  and  im- 
properly charged  the  discount  to  profit  and  loss  may  correct 
its  books  to  show  the  discount  treated  as  interest  paid  in  advance, 
to  be  amortized  over  the  life  of  the  bonds.  Amended  returns 
reflecting  a  correction  in  the  books  may  be  filed.  If,  however, 
the  bonds  were  issued  prior  to  the  incidence  of  the  tax  and,  at 
that  time,  the  entire  amount  of  the  discount  was  charged  to 
profit  and  loss,  the  issuing  corporation  may  not  claim  a  pro  rata 
allowance  for  such  discount  for  the  years  subsequent  to  the 
incidence  of  the  taxV'  Charging  off  the  discount  prior  to  the 
incidence  of  the  tax  constitutes  a  closed  transaction  and  such 
transaction  cannot  be  reopened  for  the  purpose  of  reducing  the 
taxable  income  of  the  corporation."*^  Thus  where  a  railroad 
company  sold  bonds  and  equipment  notes  at  a  discount  in  1906 
and  its  books  show  that  the  loss  was  entirely  charged  off  under 

"•"'  Reg.  45,  Art.  544;  Baldwin  Locomotive  Works  v.  McCoach,  liJl  Keti.  5i». 
This  discount  was  formerly  treated  as  a  loss  prorated  over  the  life  of  the 
bonds  (Reji.  33  Rev.,  Art.  150).  The  1909  Law  which  authorized  the  deduc- 
tion only  of  "interest  actually  paid  within  the  year  on  its  bonded  or  other 
indebtedness"  did  not  permit  the  deduction  each  year  of  a  reserve  set  aside 
to  pay  a  discount  at  maturity  (vSouthcrn  Pacific  R.  R.  Co.  v.  Muenter,  260 
Fstl.  837). 

11'' A.  R.  R.  545,  T.  B.  27-21-1717. 

iiTO.  D.  Ill,  T.  B.  2-19-l(Ui. 

iiJ^T.  D.  21(il,  T.  D.  2137. 


240  FEDERAL  INCOME  TAX 

the  profit  and  loss  account  for  1906,  and  the  company  in  making 
returns  for  the  years  1911  and  1912  failed  to  deduct  the  propor- 
tionate amount  of  discount  sustained,  it  has  no  right  to  amend 
its  returns  and  claim  a  refund  of  such  amount.^i^ 

Where  bonds  mature  serially,  a  proper  proportion  of  the 
total  discount  and  expenses  should  be  allocated  to  each  series 
and  each  series  then  treated  as  a  separate  unit.  The  deduc- 
tion applicable  to  each  series  should  be  prorated  equally  over 
the  life  of  the  bonds  constituting  the  series,  provided,  however, 
that  if  the  corporation  retires  any  of  the  bonds  before  maturity, 
the  deduction  for  that  year  should  be  increased  by  an  amount 
equivalent  to  the  amount  which  would  ordinarily  be  deducted 
during  the  succeeding  years  on  account  of  those  particular  bonds 
if  they  had  not  been  prematurely  retired.i-o 

Where  a  sole  proprietor  of  an  unincorporated  business  issued 
mortgage  bonds,  some  of  which  were  traded  for  Liberty  bonds, 
which  had  a  market  value  of  less  than  par,  but  were  taken 
at  their  par  value,  there  being  trustee's  expenses  and  agent's 
commissions  incident  to  the  selling  of  the  bonds,  it  has  been 
held  that  when  he  exchanged  the  mortgage  bonds  for  Liberty 
bonds,  he,  in  effect,  disposed  of  the  bonds  at  a  discount,  the 
amount  of  which  is  represented  by  the  difference  between  the 
par  value  of  his  bonds  and  the  fair  market  value  of  the  Liberty 
bonds  when  taken  in  exchange  therefor.  Such  discount  is  de- 
ductible and  should  be  prorated  or  amortized  over  the  life  of 
the  bonds.  The  trustee's  expenses  and  agent's  commissions  in- 
cident to  the  floating  of  the  bonds  constitute  a  deductible  ex- 
pense which  should  be  prorated  over  the  life  of  the  bonds.^-^   " 

Amortization  of  premiums  or  discount  on  bonds  is  not  per- 
missible in  the  case  of  a  purchaser  of  bonds.  The  purchase 
price  of  the  bond,  even  though  different  from  par,  represents 
the  investment.^" 

Credits  Against  Net  Income.  In  addition  to  the  deductions 
which  corporations  are  permitted  in  computing  their  net  income, 
corporations  are  allowed  certain  credits  against  net  income. 
Credits  differ  from  deductions  in  the  case  of  corporations  in  that 
deductions  reduce  the  net  income  for  the  purpose  of  all  taxes, 
while  credits  reduce  the  net  income  for  the  purpose  of  the  in- 

119  Chicago  &  Alton  R.  R.  Co.  v.  U.  S.,  53  Ct.  Cls.  41. 

120  0.  D.  936,  T.  B.  22-21-1665. 

121  0.  D.  959,  T.  B.  26-21-1704. 

122  0.  D.  475,  T.  B.  17-20-887. 


CORPORATIONS  241 

come  tax  and  not  for  the  purpose  of  the  excess-profits  tax.^-'^ 
The  credits  are  discussed  in  the  following  paragraphs. 

Interest  Upon  Obligations  of  the  United  States.  The 
amount  of  interest  received  by  a  corporation  upon  obligations 
of  the  United  States  issued  prior  to  September  1,  1917,  is  exempt 
from  all  taxation,  and  is  excluded  from  the  gross  income  of  the 
corporation.  The  amount  of  interest  upon  obligations  of  the 
United  States  issued  after  September  1,  1917,  (other  than 
postal  savings  certificates  of  deposit)  and  upon  bonds  issued 
by  the  War  Finance  Corporation  is  exempt  from  taxation  only 
if  and  to  the  extent  provided  in  the  respective  acts  authorizing 
the  issue  thereof,  as  amended  and  supplemented,  and  is  excluded 
from  gross  income  only  if  and  to  the  extent  it  is  wholly  exempt 
from  income,  war-profits  and  excess-profits  taxes.  Corporations 
are  allowed  a  credit  against  net  income  for  the  purpose  of  the 
income  tax  of  any  amount  received  as  interest  upon  obligations 
of  the  United  States  and  bonds  issued  by  the  War  Finance  Cor- 
poration which  is  included  in  gross  income.^-^ 

Amount  of  War-Profits  and  Excess-Profits  Tax.  Corpora- 
tions are  also  allowed  a  credit  for  purposes  of  the  income  tax, 
of  the  amount  of  the  war-profits  and  excess-profits  tax  imposed 
for  the  same  taxable  year.i-''  j^  the  case  of  a  corporation  making 
return  for  a  fiscal  year  beginning  in  1920  and  ending  in  1921, 
or  beginning  in  1921  and  ending  in  1922,  certain  special  rules 
apply,  which  are  set  forth  elsewhere  in  this  book.^-*"'  An  addition 
to  excess-profits  tax,  on  a  delinquent  or  false  and  fraudulent 
return,  is  to  be  considered  a  penalty  and  not  a  tax,  except  for 
pui-poses  of  collection,  and  is  not  an  allowable  credit. i-" 

Specific  Exemption.  Under  the  1918  law  domestic  corpora- 
tions were  permitted  a  credit  for  purposes  of  the  income  tax 
of  the  sum  of  $2,000  as  a   specific  exemption.!-^     Where  for 

123  After  December  31,  1921,  when  the  excess-profits  tax  is  abolished,  these 
credits  (except  the  war-profits  and  excess-profits  tax)  would  seem  to  be  the 
equivalent  of  deductions.  This  means  that  the  specific  exemption  will 
amount  to  a  deduction,  but  with  respect  to  interest  upon  obligations  of  the 
United  States  it  seems  that  the  useless  formality  of  including  p:ross  income 
an  exact  amount  later  deducted  from  gross  income  must  be  observed. 

124  Revenue  Act  of  1921,  §§236  (a),  233,  213  (a)  4;  Revenue  Act  of  1918, 
§§236   (a),  233,  213   (a)   4;  Reg.  45,  Art.  591. 

125  Revenue  Act  of  1921,  §  236  (c)  ;  Revenue  Act  of  1918,  §  236  (b)  ;  Reg. 
45,  Art.  591. 

120  See  ch.  24. 
-     127  0.  926,  T.  B.  23-19-551. 

128  Revenue  Act  of  1918,  §  236  (c)  ;  Reg.  45,  Art.  591.  The  1916  Law  and 
the  1913  Law  contained  no  similar  provision. 


242  FEDERAL  INCOME  TAX 

any  cause,  a  corporation  filed  a  return  for  a  period  of  less  than 
12  months,  the  specific  exemption  was  such  proportion  of  $2,000 
as  the  number  of  months  in  the  period  bore  to  12  months.  If 
the  period  for  which  the  first  or  final  return  was  made  included 
a  fraction  of  a  month  there  was  added  to  the  number  of  com- 
plete months  as  many  thirtieths  of  a  month  as  there  were  days 
in  the  fractional  part  of  the  month. ^■-"  In  the  case  of  a  domes- 
tic corporation  the  net  income  of  which  is  $25,000  or 
less,  a  specific  credit  of  $2,000  is  allowed  under  the  present 
law ;  but  if  the  net  income  is  more  than  $25,000  the  income  tax 
must  not  exceed  the  tax  which  would  be  payable  if  the  $2,000 
credit  were  allowed,  plus  the  amount  of  the  net  income  in  excess 
of  $25,000,130 

Credits  Against  Tax.  Domestic  corporations  may  credit 
against  the  amount  of  tax  which  would  be  due  on  income  derived 
from  all  sources  the  amount  of  any  income,  war-profits  and  ex- 
cess-profits taxes  paid  during  the  taxable  year  to  any  foreign 
country  or  to  any  possession  of  the  United  States.  This  credit, 
and  the  limitation  applicable  thereto  is  discussed  in  another 
chapter.131 

Receivers  for  Corporations.  The  Revenue  Act  of  1921  provides 
that  in  cases  where  receivers,  trustees  in  bankruptcy,  or  as- 
signees are  operating  the  property  or  business  of  corporations, 
such  receivers,  trustees,  or  assignees  shall  make  returns  for 
such  corporations  in  the  same  manner  and  form  as  corporations 
are  required  to  make  returns.  This  is  true  notwithstanding  that 
the  powers  and  functions  of  a  corporation  are  suspended  and 
that  the  property  and  business  are  for  the  time  being  in  the 
custody  of  the  receiver,  trustee,  or  assignee,  subject  to  the  order 
of  the  court.  Any  tax  due  on  the  basis  of  such  returns  made 
by  receivers,  trustees  or  assignees  is  collected  in  the  same  manner 
as  if  collected  from  the  corporations  of  whose  business  or 
property  they  have  custody  or  control. ^'s  Receivers  of  corpora- 
tions are  not  fiduciaries  within  the  meaning  of  the  law  and  are 
not  governed  by  the  rules  applicable  to  receivers  for  individ- 
uals.133    The  receiver  of  a  corporation  stands  in  the  same  posi- 

12!J  0.  D.  756,  T.  B.  51-20-1356. 

131)  Revenue  Act  of  1921,  §  236  (b).  The  effect  of  this  limitation  is  to  pre- 
vent an  increase  of  $1  in  net  income  resulting:  in  an  increase  of  $250  in  tax. 

i:5l  Revenue  Act  of  1921,  §288;  Revenue  Act  of  1918,  §238.     See  eh.  32. 

i'5-i  Revenue  Act  of  1921,  §  239;  Revenue  Act  of  1918,  §  239. 

1-!  Reg.  45,  Art.  424;  O.  D.  821,  T.  B.  8-21-1468.  This  is  true  in  view  of 
the  express  provision  of  §  239,  notwithstanding  the  definition  of  "person"  and 
"fiduciary"  contained  in  §  200.     See  ch.  6. 


CORPORATIONS  243 

tion  as  the  officers  of  a  solvt'iii   e(»rj)«)ration  and  upon  him  de- 
volve all  the  duties  of  such  officers  as  to  the  making  of  returns 
and  payment  of  tax.     The  fact  that  the  business  and  property 
of  the  corporation  are  temporarily  in  the  hands  of  a  receiver 
does  not  alter  the  fact  that  the  corporation  is  the  beneficiary  of 
the   income  arising  and  accruing.     If  there   is  net   income   in 
excess  of  credits,  it  is  taxable,  and  the  custodian  of  such  income 
is  liable  for  the  tax  assessable  thereon. '-'^     Where  the  property 
of  a  corporation  is  placed  in  the  hands  of  trustees  to  dissolve 
the  corporation,  such  trustees  should  make  returns  in  the  same 
manner  and  form  as  corporations  are  required  to  make  returns, 
at  least,  unless  they  are  merely  engaged  in  marshalling,  selling 
and  distributing  the  assets  of  the  conjoration.^--"'     But   where 
trustees  have  taken  the  property  of  a  Minnesota  corporation  at 
the  expiration  of  its  charter  and  continue  the  business  until 
the  property  can  be  disposed  of  advantageously,  it  is  held  that 
they  are  not  trustees  in  dissolution,  but  are  acting  for  them- 
selves  as  trustees  of  a  trust  property.     The   full  power  and 
control  over  the  property  being  in  the  trustees,  they  are  trustees 
under  a  mere  trust,  and  do  not  constitute  an  "association."'""' 
A  receiver  whose  duties  extend  through  the  end  of  the  year 
should  prepare  and  file  a  corporate  return  for  the  entire  taxable 
year,  including  therein  the  gross  income  received  by  the  corpora- 
tion prior  to  the  time  of  his  appointment,  and  also  the  gross 

!-■*  Under  the  1913  Law,  as  well  as  under  the  1909  Law,  there  was  no 
express  provision  in  the  statute  taxing  corporations  in  the  hands  of  re- 
ceivers. Several  cases  under  the  1909  Law  held  that  that  act  did  not  impose 
a  tax  on  such  corporations  or  any  duties  on  the  receivers  thereof.  (See 
Pennsylvania  Steel  Co.  v.  New  York  City  Railways  Co.,  193  Fed.  286;  198 
Fed.  774,  affirmed  U.  S.  v.  Whitridge,  231  U.  S.  144;  O.  1009,  T.  B.  11-20-787. 
The  1909  Law  was  a  tax  on  corporations  doing  business  and  it  was  held  in 
several  cases  that  a  corporation  in  the  hands  of  receivers  was  not  one  doing 
business  within  the  meaning  of  those  words  as  used  in  that  act.  Only  one 
decision  seems  to  have  been  rendered  under  the  1913  Law,  and  in  that  cast- 
it  was  held  that  receivers  were  not  subject  to  the  income  tax  where  the  court 
took  possession  of  the  property  of  an  insolvent  railroad  company  and  oper- 
ated the  railroad.  The  funds  in  the  hands  of  the  receivers,  represented  by 
the  net  proceeds  in  conducting  the  operation  of  the  road,  over  and  above  the 
authorized  expenditure  paid  out  by  them,  were  held  not  to  be  subject  to  the 
tax  as  "net  earnings."  (Equitable  Trust  Co.  v.  Western  Pac.  Ry.  Co.,  236 
Fed.  814,  affirmed  Scott  v.  Western  Pac.  Ry.  Co..  246  Fed.  545.)  The  ques- 
tion was  no  longer  left  open  under  the  express  provisions  of  the  1916  Law. 

i:*"'  0  D  884,  T.  B.  16-21-1584.  The  trustees  of  an  Ohio  corporation  would 
be  required  to'  make  a  return  in  behalf  of  the  corporation.  They  wholly 
supersede  the  officers  of  the  corporation. 

i:'.«>0.  D.  931,  T.  B.  22-21-1658.  See  paragraph,  "Trusts  not  taxable  as 
associations,"  above. 


244  FEDERAL  INCOME  TAX 

income  received  under  his  supervision.i^'^  It  is  not  clear  whether 
a  receiver  is  obliged  to  render  a  return  for  the  period  extending 
from  the  end  of  a  taxable  year  to  the  date  when  he  concludes 
his  duties  or  is  discharged,  or  whether  such  a  return  must  be 
made  by  the  corporation.  It  would  seem  that  the  receiver  is 
responsible  for  a  return  covering  that  part  of  the  year  during 
which  he  acted  as  receiver,  but  it  has  been  held  that  a  return  may 
be  made  by  the  corporation  to  whom  the  receiver  returns  the 
corporate  property  for  the  full  period  including  the  part  of  the 
year  when  the  receiver  was  in  control  and  the  part  after  the 
property  is  returned  to  the  corporation. I'^s 

A  receiver  in  charge  of  only  part  of  the  property  of  a  corpora- 
tion, however,  as  a  receiver  in  mortgage  foreclosure  proceedings 
involving  merely  a  small  portion  of  its  property,  need  not  make 
a  return  of  income.^^^ 

The  receiver  liquidating  the  assets  of  an  insolvent  bank  is 
required  to  file  a  return  for  the  bank,  but  in  view  of  the  fact 
that  the  bank  is  insolvent  he  will  have  no  tax  to  pay.  The 
return  may  contain  a  statement  to  that  effect  in  lieu  of  the 
data  ordinarily  required.^^o 

Income  Taxable  in  Hands  of  Trustee  in  Bankruptcy.  It 
has  been  held  under  the  1916  law  that  the  only  income  taxable 
in  the  hands  of  a  trustee  in  bankruptcy  is  the  income  earned 
by  the  trustee  while  operating  the  business  of  a  bankrupt 
corporation.  Thus,  funds  representing  the  result  of  a  com- 
promise made  by  the  trustee  with  a  foreign  corporation  of  a 
claim  for  the  nonpayment  of  salaries  and  commissions  by  the 
foreign  corporation  to  the  bankrupt  corporation  as  its  agents 
between  the  years  1910  and  1914  have  been  held  to  be  exempt 
from  tax  in  the  hands  of  the  trustee  in  bankruptcy.^^i 

Income  Taxable  in  Hands  of  Assignee.  Income  received 
by  assignees  appointed  by  a  corporation  to  liquidate  its  prop- 

137  O.  D.  73,  T.  B.  1-19-102;  O.  D.  884,  T.  B.  16-21-1584. 

138  See  O.  D.  557,  T.  B.  25-20-1018;  O.  D.  873,  T.  B.  15-21-1565;  0.  D.  884, 
T.  B.  16-21-1584. 

139  Reg.  45,  Art.  622. 

140  0.  D.  114,  T.  B.  2-19-170.  Such  insolvent  bank  would  have  no  tax  to 
pay  because  of  §  22  of  the  Act  of  March  1,  1879,  v^^hich  provides  that  no  tax 
shall  be  assessed  or  collected  or  paid  into  the  United  States  treasury  on 
account  of  a  bank  which  has  ceased  to  do  business  by  reason  of  insolvency 
or  bankruptcy  which  shall  diminish  the  assets  thereof  necessary  for  the  full 
payment  of  all  depositors.  No  action  will  be  taken  against  the  receiver 
until  depositors'  claims  have  been  fully  satisfied  (O.  D.  990,  T.  B. 
32-21-1763). 

141  In  re  Heller  Hirsh  &  Co.,  258  Fed.  208. 


CORPORATIONS  245 

erty  and  business  over  a  period  of  years,  who  have  full  power 
of  control  and  management  thereof,  is  taxable.  This  is  true 
although  the  business  conducted  by  the  trustees  in  the  process 
of  liquidation  is  not  the  business  which  the  corporation  orig- 
inally started  to  conduct.  This  rule  applies  to  all  income 
received  by  the  trustees,  including  interest  on  bank  deposits, 
interest  upon  deferred  payments,  and  gains  upon  sales  of  real 

property.i-'- 

Fiscal  Year.  A  corporation  is  required  to  make  returns  and 
pay  the  tax  on  the  basis  of  its  annual  accounting  period  (fiscal 
year  or  calendar  year,  as  the  case  may  be)  in  accordance  with 
the  method  of  accounting  regularly  employed  in  keeping  its 
books,  unless  (a)  no  such  method  of  accounting  has  been  em- 
ployed, or  (b)  the  method  employed  does  not  clearly  reflect  in- 
come. '  In  case  of  (a)  and  (b)  the  computation  of  net  income  is 
made  on  such  basis  and  in  such  manner  as  in  the  opinion  of  the 
commissioner  does  clearly  reflect  income.  If  the  corporation's 
annual  accounting  period  is  other  than  a  fiscal  year,  or  if  the  cor- 
poration has  no  annual  accounting  period,  or  does  not  keep 
books,  its  net  income  is  computed  on  the  basis  of  the  calendar 
year.  In  the  event  of  any  change  of  accounting  period  from 
fiscal  year  to  calendar  year,  or  vice  versa,  or  from  one  fiscal 
year  to  another,  net  income  is  computed  on  the  basis  of  such 
new  accounting  period,  subject  to  the  rules  outlined  in  a  later 
chapter.i«  Reporting  upon  the  basis  of  a  fiscal  year  was  for- 
merly a  privilege  accorded  to  corporations  and  partnerships 
only.  It  is  now  a  requirement  if  the  annual  accounting  period 
of  the  corporation  is  a  fiscal  year.  This  subject  is  more  fully 
treated  in  another  chapter.^^^ 

Returns.  The  duty  to  make  a  return  depends  upon  corporate 
existence  and  not  upon  the  receipt  of  income.  Every  corporation 
not  expressly  exempt  is  required  to  make  a  return  regardless  of 
the  amount  of  its  net  income."--  Even  a  potential  corporate 
existence  which  may  be  called  into  action  by  the  proper  author- 
ity without  affecting  the  identity  of  the  corporate  body  will  be 
sufficient  to  necessitate  the  filing  of  a  return.  Thus,  where  a 
stockholder  purchased  the  name,  merchandise  and  business  of 
a  Michigan  corporation  and  as  sole  stockholder  operated  the 

141^0.  D.   853,   T.   B.  6-19-280;    O.    D.   931,  T.   B.  22-2l-ir,r>8.     See  foot- 

!°143  Revenue  Act  of  1921,  §§212,  232;  Revenue  Act  of   1918.  §§212,  232; 

Reg.  45,  Art.  25. 

144  See  ch.  34.  „.      ^     t^     n,n     t     d 

14.-^  Reg.   45,   Art.   621;    O.   D.   882,   T.    B.    16-21-1582;    0.   D.   919,   T.   B. 

20-21-1641. 


246  FEDERAL  INCOME  TAX 

enterprise  as  an  individual  instead  of  as  a  corporation  under 
a  "change  of  attitude"  filed  with  the  secretary  of  state,  a  cor- 
porate return  was  required,  because  the  corporation  was  not 
dissolved,  its  powers  being  only  suspended.^^"  Copies  of  the 
prescribed  return  forms  will  be  furnished  corporations  by  col- 
lectors. Failure  on  the  part  of  any  corporation  liable  to  tax 
to  receive  a  prescribed  blank  form  will  not,  however,  excuse 
it  from  making  the  return.  Corporations  not  supplied  with  the 
proper  forms  should  make  application  therefor  to  the  collector 
in  ample  time  to  have  their  returns  prepared,  verified  and  filed 
with  the  collector  on  or  before  the  due  date.  Each  corporation 
should  carefully  prepare  its  return  so  as  fully  and  clearly  to 
set  forth  the  data  therein  called  for.  Imperfect  or  incorrect 
returns  will  not  be  accepted  as  meeting  the  requirements  of  the 
statute.  In  lack  of  a  prescribed  form  a  statement  made  by  a 
corporation  disclosing  its  gross  income  and  the  deductions  there- 
from may  be  accepted  as  a  tentative  return,  and  if  filed  within 
the  prescribed  time  a  return  so  made  will  relieve  the  corporation 
from  liability  to  penalties,  provided  that  without  unnecessary 
delay  such  a  tentative  return  is  replaced  by  a  return  made  on 
the  proper  form,  or  an  extension  of  time  is  obtained.!^" 

When  Filed.  Returns  of  income  must  be  made  by  domestic 
corporations  (except  those  which  are  treated  as  foreign  cor- 
porations) on  or  before  March  15th  or  the  15th  day  of  the  third 
month  following  the  close  of  the  fiscal  year  for  which  the  return 
is  required  to  be  made.^^'^ 

Extension  of  Time.  A  corporation  desiring  an  extension  of 
time  within  which  to  file  its  return  should  submit  to  the  col- 
lector before  the  time  for  filing  the  return  a  tentative  return 
and  estimate,  accompanied  by  a  remittance  of  not  less  than 
one-fourth  of  the  estimated  amount  of  income  and  excess-profits 
taxes  for  the  taxable  year.  In  such  a  case  the  collector  may 
grant  a  reasonable  extension  of  time   for   filing  the   complete 

140  0.  D.  919,  T.  B.  20-21-1641;  0.  D.  1120,  T.  B.  48-21-1951.  See  para- 
graph, "De  Facto  Corporations,"  above. 

i4TReg.  45,  Arts.  621  and  407;  Reg.  33  Rev.,  Art.  203;  Reg.  33,  Art.  80. 
Under  the  1909  Law  it  was  held  that  corporations  of  all  kinds  specified  in 
the  act  as  subject  to  the  tax  were  bound  to  file  returns  though  their  net 
profits  were  not  sufficient  to  render  them  liable  to  the  tax  (U.  S.  v.  Military 
Construction  Co.,  204  Fed.  153),  and  that  the  duty  to  make  returns  was  not 
limited  to  those  the  net  profits  of  which  were  sufficient  to  render  them  liable 
to  the  payment  of  the  tax.     (U.  S.  v.  Acorn  Roofing  Co.,  204  Fed.  157.) 

14S  Revenue  Act  of  1921,  §§227  (a) ,  241  (a)  ;  Revenue  Act  of  1918,  §§  227 
(a),  241   (a). 


CORPORATIONS  2^7 

return,  not  to  exceed  30  clays  from  the  date  on  which  the  return 
was  originally   due.^''' 

Where  Filed,  Corporate  returns  are  filed  with  the  collector 
of  the  district  in  which  is  located  the  principal  place  of  business 
or  principal  office  or  agency  of  the  corporation.  If  a  domestic 
corporation  keeps  its  books  of  account  and  other  data  in  a  for- 
eign country  and  has  no  principal  place  of  business  or  principal 
office  in  this  country,  the  return  should  be  made  to  the  collector 
in  the  district  in  which  the  corporation  has  its  principal  agency 
in  this  country.^"-*'  If  it  has  no  such  agency  or  branch  office  in 
this  country,  the  return  should  be  made  to  the  collector  of  the 
district  in  which  is  located  its  statutory  office ;  that  is,  the  office 
required  to  be  maintained  in  the  state  of  incorporation  in  accord- 
ance with  the  statutes  of  that  state.^'i  It  is  to  be  noted  that  a 
corporate  return  is  not  ordinarily  to  be  filed  in  the  district  in 
which  is  located  the  statutory  office,  unless  the  corporation  has 
no  principal  place  of  business  or  principal  office  or  agency  from 
which  the  return  can  be  filed.  The  purpose  of  designating  the 
principal  business  office  is  for  the  convenience  of  the  treasury 
department  in  examining  the  books  of  the  corporation  and 
verifying  the  return.  Since  the  statute  now  expressly  designates 
the  principal  place  of  business  or  principal  office  or  agency,  the 
filing  of  a  return  from  another  office  may  not  be  considered  a 
proper  filing.^"'- 

By  Whom  Filed.  Responsibility  for  filing  corporate  return.-^ 
rests  upon  the  principal  officers  of  the  corporation,  although 
there  is  no  penalty  on  such  officers  personally  for  failure  to  file 
returns.  The  only  personal  penalty  on  officers  is  for  wilfully 
refusing  to  make  the  return,  pay  the  tax,  supply  information 
required,  or  in  any  manner  attempting  to  defeat  or  evade  the 

tax.^-''-^ 

How  Signed  and  Sworn  to.  The  return  is  required  to  be 
sworn  to  by  the  president,  vice  president  or  other  principal  officer 
of  the  corporation  and  by  the  treasurer  or  assistant  treasurer, 

uo  See  ch.  34.  ■     , ,     i  . 

io<i  Revenue  Act  of  1921,  §241  (b)  ;  Revenue  Act  of  1918.  ^  L41  (h). 

1-.1  T.  D.  2137.  ,  u         n     . 

IVJ  The  1916  Law  required  corporate  returns  to  be  made  "to  the  collector 
of  the  district  in  which  is  located  the  principal  office  of  the  corporation,  com- 
pany or  association,  where  are  kept  its  books  of  account  and  other  data 
from  which  the  return  is  prepared."  The  1913  Law  was  less  expl.c.t  and 
might  have  been  held  tc.  ju.stify  the  filin^r  of  corporate  returns  from  some 
other  office,  but  the  present  law  an.l  the  1918  Law.  as  well  as  the  l.H..  Law, 
are  open  to  no  such  construction. 

i->;5  Revenue  Act  of  1921,  §253;  Revenue  Act  of  1918.  §  Lo3. 


248  FEDERAL  INCOME  TAX 

and  must  be  verified  under  the  oath  of  such  officers,  except  in  the 
cases  where  the  return  is  filed  by  a  receiver,  trustee,  or  assignee, 
or  directors  in  the  case  of  insolvency,  in  which  cases  the  affidavit 
on  the  return  should  be  changed  in  accordance  with  the  facts.^^* 
When  the  treasurer  or  assistant  treasurer  of  a  corporation 
is  the  only  officer  available  to  swear  to  the  corporation  return, 
it  is  held  to  be  v^o  tanto  a  sufficient  compliance  with  the  statute 
if  he  signs  and  swears  to  the  return  as  such  treasurer  or  assist- 
ant treasurer  and  signs  also  for  the  president,  vice  president 
or  other  principal  officer.i^s 

Corporations  Formed  During  the  Year.  A  corporation  or- 
ganized during  the  year  is  required  to  make  a  return  covering 
that  portion  of  the  year  during  which  it  was  in  existence.^^^ 
But  the  return  must  cover  only  the  period  during  which  the 
corporation  was  legally  in  existence.^^^  Where  a  corporation 
was  organized  to  take  over  a  partnership  business  in  June  and 
the  transaction  is  consummated  as  of  the  past  January  1st, 
the  taxable  period  of  the  corporation  will  begin  as  of  June.^^^ 
The  fact  that  a  new  corporation  organized  in  the  year  has 
transacted  no  business  does  not  excuse  it  from  making  a  re- 
turn.159  Corporations  which  have  applied  for,  but  not  received, 
charters,  or  corporations  which  have  received  charters,  but  have 
not  perfected  their  organizations,  transacted  any  business  and 
had  any  income  whatever  from  any  source,  may,  upon  the  pre- 
sentation of  these  facts  to  the  local  collector  be  relieved  from 
the  necessity  of  making  returns  so  long  as  they  remain  in  this 
unorganized  condition.  In  the  absence  of  a  proper  showing 
to  the  collector,  such  a  corporation  will  be  required  to  make  a 
retum.i^o  When  a  distinct  new  corporation  is  organized  to  take 
over  the  property  of  an  old  corporation,  both  corporations  will 
be  required  to  make  returns  covering  the  periods  of  the  year 
during  which  they  were  each  respectively  in  charge  of  the  busi- 
ness, or  file  a  consolidated  return.!*^!  Where  a  contract  provided 
that  on  December  31,  1919,  a  new  corporation  should  take  over 
the  assets  and  liabilities  of  an  old  corporation  as  of  October  4, 
1919,  it  was  held  that  the  old  corporation  must  make  return  for 

154  Revenue  Act  of  1921,  §  239;  Revenue  Act  of  1918,  §  239.    See  eh.  34. 

155  0.  D.  911,  T.  B.  19-21-1628. 

156  Reg.  45,  Art.  621 ;  Reg.  33,  Art.  84. 

157  0.  D.  1016,  T.  B.  35-21-1796. 

158  0.  D.  1121,  T.  B.  48-21-1952. 

159  Reg.  45,  Art.  621;  O.  D.  574,  T.  B.  27-20-1044;  T.  D.  2090. 

160  Reg.  45,  Art.  621;  T.  D.  2152;  O.  D.  1120;  T.  B.  48-21-1951. 

161  Reg.  33  Rev.,  Art.  206;  T.  D.  2137.  But  if  there  is  a  mere  change  in 
domicile  this  will  not  be  true  (O.  D.  1119,  T.  B.  48-21-1950). 


CORPORATIONS  249 


the  full  year  1919,  including  the  profit,  if  any,  made  from  the 
sale  of  its  property  to  the  new  corporation.^'"'- 

Change  of  Name  or  Domicile.     A  mere  change  m  name 
does  not  constitute  a  new  corporation.    If  the  business  was  con- 
tinuous throughout  the   year,   no   change   in   management   or 
operation  other  than  the  change  in  name  having  occurred,  the 
return     should    be    made    covering    the    business    transacted 
throughout  the  year,  such  return  to  be  made  by  the  corporation 
in  the  name  which  it  bears  at  the  end  of  the  year,  with  a  nota- 
tion on  the  return  to  the  effect  that  the  name  had  been  changed, 
giving  both  the  old  and  the  new  names.^"^    Since  in  the  conver- 
sion of  a  state  bank  into  a  national  bank  there  is  not  a  dissolu- 
tion of  the  corporation,  but  merely  a  change  of  title  and  the 
extension  of  government  supervision  thereover,  a  bank  so  chang- 
ing during  the  taxable  year  must  file  one  return  for  the  entire 
year  i«^     Where  there  is  a  mere  change  of  domicile  during  the 
year' without  change  of  business  or  in  capital  and  surplus,  only 
one  return   is  necessary  for  the   operations   of  both   corpora- 

tions.""'"' 

Corporations  Liquidating  During  the  Year.  A  corpora- 
tion entirely  out  of  business,  maintaining  its  corporate  existence 
merely  for  the  purposes  of  liquidation,  and  still  holding  income- 
producing  investments  not  yet  due,  is  required  to  file  returns 
for  each  year  embracing  the  liquidating  period.^'-^  A  corpora- 
tion going  into  liquidation  during  any  taxable  year  may  upon 
the  completion  of  such  liquidation  prepare  a  "final  return 
covering  its  income  during  the  fractional  part  of  the  year  dur- 
ing which  it  was  engaged  in  business  and  may  immediately  file 
such  return  with  the  local  collector.i'-^    Where  a  corporation  is 

1C2  0   D.  1025,  T.  B.  36-21-1808. 

1C3  Reg.  33  Rev.,  Art.  206;  T.  D.  2137. 

m  0.  D.  476,  T.  B.  17-20-888;  see  also  A.  R.  R.  285,  T.  B.  42-20-1252. 

163  O.  D.  1119,  T.  B.  48-21-1950. 

iwi  O.  D.  231,  T.  B.  12-19-406.  oo     v   .    «r  .   t    n 

107  Reg  45,  Art.  651;  Reg.  33  Rev.,  Art.  205;  Reg.  33,  Art.  So,  T  D. 
2209;  T  D.  2090.  This  return  should  be  filed  by  t^^^f-^^^j;;^  °^^,;'^^.^; 
persons  in  charge  of  the  winding  up  of  the  corpox.U>on.  Under  the  C^p^^^^^^^^^ 
tion  Act  of  New  Jersey  (P.  L.  1896,  p.  295),  which  Provides  that  coipma 
tions,  however  dissolved,  are  "continued  bodies  ^^-^'P^-^^  ;;^^;^',^,.,^"tren 
of  prosecuting  and  defending  suits  by  or  against  them  ^"^  ^f^"^.^;;'  f  j^^^ 
to  settle  and  close  their  affairs,"  and  constitutes  ^^e  director  U  uee^^^ 
settle  the  business,  the  officers  of  a  corporation  which  had  been  dissohed 
r;  becoming  subject  to  the  tax  on  its  income  of  the  ^^^^J^  ^^ 

V.  General  Inspection  and  Loading  Co.,  192  hed.  223;  204  Fed.  657.) 


250  FEDERAL  INCOME  TAX 

completely  dissolved  before  the  close  of  its  taxable  year,  it  has 
the  same  time  in  which  to  file  its  final  return  as  if  it  had  con- 
tinued its  existence  during  its  entire  taxable  year,  and  in  case 
it  files  its  final  return  before  the  time  provided  by  law  it  can 
not  be  compelled  at  the  time  of  filing  such  return  to  pay  any 
tax  shown  to  be  due  thereon.  The  first  installment  of  tax  is  due 
on  the  date  the  return  would  have  been  due  if  it  had  covered  the 
full  taxable  year.^''^  f^ie  treasury  department  will  warve  the 
filing  of  evidence  of  the  completion  of  liquidation  required  by^ 
the  Illinois  statutes  and  will  accept  a  final  return  from  a  cor- 
poration, if  accompanied  by  a  certificate  of  the  court  showing 
that  all  requirements  of  the  law  with  regard  to  dissolution  of 
the  corporation  and  distribution  of  its  assets  have  been  satis- 
fied, except  as  to  evidence  of  payment  of  federal  income  taxes, 
and  that  actual  winding  up  of  the  corporation  merely  awaits 
formal  court  action.  Upon  payment  of  all  federal  income  tax 
shown  to  be  due  from  the  corporation,  the  collector  will  issue 
the  necessary  receipt.^"-'  It  seems  to  be  within  the  power  of  the 
commissioner  to  declare  the  taxable  period  of  a  corporation 
terminated  at  the  time  it  is  dissolved  and  to  demand  immediate 
payment  of  the  tax  for  such  taxable  period  and  the  tax  for  the 
preceding  year  or  to  require  security  for  the  payment  thereof.^''" 
This  remedy  is  more  fully  discussed  elsewhere  in  this  book.^'^^ 
Where  a  corporation,  by  affidavit  or  otherwise,  has  clearly  estab- 
lished the  fact  and  satisfied  the  collector  that  it  is  defunct, 
dissolved  or  obsolete  and  is  no  longer  carrying  on  business  and 
has  no  property  or  income,  returns  will  not  be  required  after 
such  condition  has  been  clearly  established.  Only  one  showing 
of  this  character  is  required,  unless  it  appears  later  that  the 
corporation  has  income. ^~- 

CORPORATiONS     IN     HANDS    OF    ALIEN     PROPERTY     CUSTODIAN. 

The  proper  officers  of  a  corporation  that  has  been  taken  over 
by  the  Alien  Property  Custodian  should  file  a  return  for  the 
corporation  up  to  the  time  the  property  was  taken  over  by 
the  Alien  Property  Custodian.  The  board  of  directors  ap- 
pointed by  the  Alien  Property  Custodian  is  not  required  to 
render  a  return  for  the  corporation  while  in  control  of  the 
Alien  Property  Custodian.^'^'^ 

I'W  0.  D.  692,  T.  B.  42-20-1253. 
109  O.  D.  672,  T.  B.  39-20-1214. 

1"0  Revenue  Act  of  1921,  §250  (g)  ;   Revenue  Act  of  1918,  §250  (g)  ;   0. 
D.  692,  T.  B.  4-20-1253. 

171  See  Chapter  35. 

172  T.  D.  2137. 

IT?.  O.  D.  148,  T.  B.  4-19-231. 


CORPORATIONS  251 

Returns  for  Fractional  Part  of  Year.  In  the  case  of  a 
corporation  making  its  first  return  of  income  on  the  basis  of  a 
fiscal  year  and  in  the  case  of  a  corporation  changing  its  account- 
ing period,  whether  from  calendar  year  to  fiscal  year,  from  fiscal 
year  to  calendar  year,  or  from  one  fiscal  year  to  another  fiscal 
year,  a  separate  return  for  a  fractional  part  of  a  year  is  required. 
Such  a  return  for  a  period  of  less  than  twelve  months  should  be 
made  according  to  the  rules  discussed  in  another  chapter. '"^ 

Amended  Returns  Where  Capital  Charges  Have  Been 
Made  to  Income.  A  corporation  may  submit  amended  returns 
for  previous  year.^,  when  through  wrang  accounting  prac- 
tice, capital  charges  have  been  made  to  income.  An  affidavit 
should  be  attached,  explaining  the  changes  made  by  such 
amended  returns  and  explaining  why  the  original  returns  were 
not  properly  prepared  and  the  object  of  the  company  in  pre- 
paring amended  returns.  Such  amended  returns  will  be  accepted 
only  when  the  erroneous  charge  can  be  specifically  pointed  out 
and  the  facts  proved.  The  treasury  department  reserves  the 
right  to  penalize  for  the  making  of  false  returns  in  the  past.^"' 

Distribution  of  Earnings.  There  must  be  included  in  eve  ex- 
corporate  return,  or  appended  thereto,  a  statement  of  such  facts 
as  will  enable  the  commissioner  to  determine  the  portion  of  the 
earnings  or  profits  of  the  corporation  (including  gains,  profits 
and  income  not  taxed)  accumulated  during  the  taxable  year  for 
which  the  return  is  made,  which  have  been  distributed  or  or- 
dered to  be  distributed,  respectively,  to  its  stockholders  or  mem- 
bers during  such  year.^'*' 

Consolidated  Returns.  The  Revenue  Act  of  1921  gives  afiil- 
iated  corporations,  for  any  taxable  year  beginning  on  or  after 
January  1,  1922,  the  option  of  making  separate  or  consolidated 
returns.  If  return  is  made  on  either  of  these  bases,  returns 
made  thereafter  must  be  upon  the  same  basis  unless  permission 
to  change  is  granted  by  the  commissioner.^""  The  purpose  of 
and  reason  for  this  change  may  best  be  gathered  from  the  report 
of  the  chairman  of  the  senate  finance  committee,  in  which  the 
following  is  stated:'"'-  "Under  existing  law  affiliated  corpora- 
tions are  required  to  make  consolidated  returns.  Owing  to  the 
complexity  of  the  consolidated  return  in  certain  instances,  the 

174  See  Chapter  34;  see  Reg.  45,  Art.  (52(i;  O.  D.  852.  T.  B.  31-19-650. 

17.-.  O.  D.  113.  T.  B.  4-19-231. 

I7'i  Revenue  Act  of  1921,  §  239  (c).     This  is  a  new  provision. 
.    1"  Revenue  Act  of  1921,  §  240a. 

i7SSee  Report  of  Senate  Finani-e  Cominittce  on  Internal  Revenue  Bill  of 
1921,  p.  20. 


252  ,      FEDERAL  INCOME  TAX 

corporations  affected  would  prefer  not  to  make  such  consoli- 
dated return,  although  it  benefits  aflfiliated  corporations  when 
one  or  more  of  them  sustain  a  loss.  The  consolidated  return  is 
necessary  to  prevent  evasion  under  the  excess-profits  tax,  but 
this  necessity  will  disappear  when  the  excess-profits  tax  is 
repealed."  The  Revenue  Act  of  1921  makes  no  change  in  its 
definition  of  affiliated  corporations,  except  that  the  accounts  of 
closely  related  trades  or  business  may  be  consolidated,  as  is  more 
fully  indicated  below. i'^^  Like  the  1918  law,  the  Revenue  Act 
of  1921  provides  that  "in  any  case  in  which  a  tax  is  assessed 
upon  the  basis  of  a  consolidated  return,  the  total  tax  shall  be 
computed  in  the  first  instance  as  a  unit  and  shall  then  be  assessed 
upon  the  respective  affiliated  corporations  in  such  proportions 
as  may  be  agreed  upon  among  them,  or,  in  the  absence  of  any 
such  agreement,  then  on  the  basis  of  the  net  income  properly 
assignable  to  each,"  and  that  there  shall  be  allowed  in  computing 
the  income  tax  only  one  specific  credit.^'^^  Since  corporations 
which  are  affiliated  may  file  consolidated  returns  after  January, 
1922,  and  must  file  such  returns  for  the  years  1917,  1918,  1919, 
1920  and  1921,  it  is  important  to  consider  the  rulings  and  deci- 
sions bearing  upon  the  filing  of  consolidated  returns  under  the 
1918  and  1917  law.^^i  The  rulings  discussed  below  were  made 
under  the  1918  law,  except  as  otherwise  indicated. 

Consolidated  Returns  Under  1918  Law.  Under  the  1918 
law  affiliated  corporations  were  required  to  file  consolidated  re- 
turns on  Form  1120.  The  consolidated  return  was  filed  by  the 
parent  or  principal  reporting  corporation  in  the  office  of  the 
collector  of  the  district  in  which  it  had  its  principal  office.  Each 
of  the  other  affiliated  corporations  filed  in  the  office  of  the  col- 
lector of  its  district  Form  1122,  along  with  the  several  schedules 
indicated  thereon.  The  parent  or  principal  corporation  filing 
a  consolidated  return  included  in  such  return  a  statement  spe- 
cifically setting  forth  (a)  the  name  and  address  of  each  of  the 
subsidiary  or  affiliated  corporations  included  in  such  return, 
(b)  the  par  value  of  the  total  outstanding  capital  stock  of  each 
of  such  corporations  at  the  beginning  of  the  taxable  year,  (c) 
the  par  value  of  such  capital  stock  held  by  the  parent  corpora- 
tion or  by  the  same  interests  at  the  beginning  of  the  taxable 

iTOCf.  Revenue  Act  of  1921,  §240  (c)  ;  Revenue  Act  of  1918,  §240  (b). 
See  also  Revenue  Act  of  1921,  §  240  (d)  and  p.  258. 

ISO  Cf.  Revenue  Act  of  1921,  §  240  (b)  ;  Revenue  Act  of  1918,  §  240  (a). 

181  The  treasury  department's  practice  of  requiring  consolidated  excess- 
profits  tax  returns  for  1917  has  now^  been  validated  (Revenue  Act  of  1921, 
§1331).     See  footnote  209. 


CORPORATIONS  253 

year,  (d)  in  the  case  of  affiliated  corporations  owned  by  the 
same  interests,  a  list  of  the  individuals  or  partnerships  consti- 
tuting such  interests,  with  the  percentage  of  the  total  outstand- 
ing stock  of  each  affiliated  corporation  held  by  each  of  such  in- 
dividuals or  partnerships  during  all  of  the  taxable  year,  and 
(e)  a  schedule  showing  the  proportionate  amount  of  the  total 
tax  which  it  is  agreed  among  them  is  to  be  assessed  upon  each 
affiliated  corporation.!'*-  The  treasury  department  greatly  pre- 
ferred that  the  parent  or  principal  reporting  corporation  take 
up  and  pay  the  entire  tax,  making  any  desired  adjustments 
thereof  by  charging  the  affiliated  corporations  through  their 
own  records.  The  amount  reported  by  the  subsidiary  on  Form 
1122  as  apportioned  to  it  was  used  as  the  basis  of  assessment 
and  payment.  If  the  subsidiaries  reported  an  apportionment 
in  this  manner,  but  the  parent  corporation  had  paid  the  tax 
installments  on  account  of  such  subsidiaries,  an  amended  Form 
1122  was  required  to  be  filed  showing  "none"  in  answer  to  the 
question  as  to  the  amount  of  tax  apportioned  to  it.  If  the  last 
condition  obtained,  but  the  taxpayer  insisted  upon  apportion- 
ment the  collector  of  the  subsidiary's  district  would  request 
abatement  of  such  portion  of  the  subsidiary's  tax  as  might  have 
been  previously  paid  by  the  parent  corporation  in  another  dis- 
trict. As  a  basis  for  such  advice,  the  latter  collector  secured 
from  the  parent  corporation  a  schedule  showing  apportionment 
of  the  total  tax  and  installments  to  the  respective  affiliated  cor- 
porations. If  a  subsidiary  filed  a  tentative  return  and  paid  an 
installment  of  the  tax,  it  was  assessed  the  amount  shown  on 
Form  1122,  and  paid  future  installments  as  they  fall  due.^^ 
Foreign  corporations  and  personal  service  corporations  were 
not  permitted  to  file  consolidated  returns.!'*^ 

182  Reg.  45,  Art.  632. 

I'^'S  Mimeograph  letter  to  collectors,  I.  T. — Mim.  2221  dated  August  8, 
1919;  I.  T.  S.  1919,  ^3570. 

is-i  Revenue  Act  of  1918,  §240.  The  English  Finance  Act  of  1915  pro- 
vided for  the  consolidated  assessment  of  the  excess  profits  duty  in  the  case 
of  affiliated  companies  carrying  on  the  same  trade  or  business.  Before  the 
regulations  under  the  1917  American  Law  vv^ere  issued  the  American  Insti- 
tute of  Accountants  advocated  the  assessment  of  federal  corporate  taxes 
upon  the  basis  of  consolidated  returns  in  a  brief,  of  which  the  following  is 
an  extract:  "If  the  rule  which  we  advocate  (consolidated  returns)  be 
adopted  the  tax  will  be  based  on  the  real  facts  and  determined  by  the  rela- 
tion between  true  income  and  the  true  investment  of  the  group  of  com- 
panies as  a  whole;  and  the  latter  course  (consolidated  returns)  would  im- 
pose no  additional  burdens  on  anyone,  since  it  is  the  course  followed  for  all 
practical    purposes    by    the    corporations    themselves    and    recognized    by 


254  FEDERAL  INCOME  TAX 

Affiliated  Corporations.  The  provision  I'^'J  of  the  Revenue  Act 
of  1918  (and  the  Revenue  Act  of  1921)  requiring  affiliated  cor- 
porations to  file  consolidated  returns  is  based  upon  the  principle 
of  levjnng  the  tax  according  to  the  true  net  income  and  invested 
capital  of  a  single  business  enterprise,  even  though  the  business 
is  operated  through  more  than  one  corporation.  Where  one  cor- 
poration owns  the  capital  stock  of  another  corporation  or  other 
corporations,  or  where  the  stock  of  two  or  more  corporations 
is  owned  by  the  same  interests,  a  situation  results  which  is  closely 
analogous  to  that  of  a  business  maintaining  one  or  more  branch 
establishments.  In  the  latter  case,  because  of  the  direct  owner- 
ship of  the  property,  the  invested  capital  and  net  income  of  the 
branch  form  a  part  of  the  invested  capital  and  net  income  of  the 
entire  organization.  Where  such  branches  or  units  of  a  business 
are  owned  and  controlled  through  the  medium  of  separate  cor- 
porations, a  consolidated  return  is  necessary  in  order  that  the 
invested  capital  and  net  income  of  the  entire  group  may  be 
accurately  determined.  Otherwise  taxation  may  be  evaded  by 
the  shifting  of  income  through  price  fixing,  charges  for  services 
and  other  means  by  which  income  could  be  arbitrarily  assigned 
to  one  or  another  unit  of  the  group.  In  other  cases  without  a 
consolidated  return  excessive  taxation  may  be  imposed  as  a 
result  of  purely  artificial  conditions  existing  between  corpora- 
tions within  a  controlled  group.^'^''' 

When  Corporations  Are  Affiliated.^'^'  Corporations  will 
be  deemed  to  be  affiliated  (a)  when  one  domestic  corporation 
owns  directly  or  controls  through  closely  affiliated  interests  or 
by  a  nominee  or  nominees  substantially  all  the  stock  of  the  other 
or  others,  or  (b)  when  substantially  all  the  stock  of  two  or  more 
domestic  corporations  is  owned  or  controlled  by  the  same  inter- 
ests. The  words  "substantially  all  the  stock"  cannot  be  inter- 
preted as  meaning  any  particular  percentage,  but  must  be  con- 
strued according  to  the  facts  of  the  particular  case.  The  owning 
or  controlling  of  95  S'  or  more  of  the  outstanding  voting  capital 
stock  (not  including  stock  in  the  treasury)  at  the  beginning  of 
and  during  the  taxable  year  will  be  deemed  to  constitute  an 
affiliation  within  the  meaning  of  the  statute.  Consolidated  re- 
bankers,  economists  and  accountants  as  the  only  course  which  reveals  the 
true  situation."     (Journal  of  Accountancy,  January,  1919.) 

IS-^  Revenue  Act  of  1921,  §240;  Revenue  Act  of  1918,  §240. 

ISC  Reg.  45,  Art.  631. 

IS"  The  same  corporations  affiliated  within  the  meaning-  of  the  rulings  dis- 
cussed in  this  paragraph  will  be  affiliated  within  the  meaning  of  the  Reve- 
nue Act  of  1921. 


CORPORATIONS  255 

turns  may,  however,  be  required  even  though  the  stock  owner- 
ship is  less  than  95''  .  When  the  stock  ownership  is  less  than 
95'  <  ,  but  in  excess  of  50'  <  ,  a  full  disclosure  of  affiliations  should 
be  made,  showing  all  pertinent  facts,  including  the  stock  owned 
in  each  subsidiary  or  affiliated  corporation  and  the  percentage  of 
such  stock  owned  to  the  total  stock  outstanding.  Such  statement 
should  preferably  be  made  in  advance  of  filing  the  return,  with 
a  request  for  instructions  as  to  whether  a  consolidated  return 
should  be  made.  In  any  event  such  a  statement  should  be  filed 
as  a  part  of  the  return. ^"^"^  If  the  stock  ownership  is  less  than 
95V( ,  corporations  will  not  be  deemed  to  be  affiliated  unless  there 
are  revealed  inter-company  operating  transactions  or  an  arti- 
ficial inter-corporate  relationship.  A  SI'*  stock  control  will  not 
infrequently  present  such  conditions;  a  69' r  control  will  be  in- 
sufficient, without  such  conditions,  to  authorize  a  consolidated 
return. i"""  Where  practically  all  the  stock  of  one  corporation  is 
owned  by  another  corporation,  but  the  latter  corporation  has 
deposited  the  same  with  an  independent  trust  company  under 
an  escrow  agreement  as  collateral  security  to  secure  its  preferred 
stockholders  in  the  redemption  of  their  stock,  and  the  independ- 
ent trust  company  has  legal  title  to  the  stock  for  the  benefit  of 
such  preferred  stockholders  with  full  and  irrevocable  right, 
power  and  authority  during  the  existence  of  such  preferred  stock 
to  vote  the  stock  held  by  it,  the  two  corporations  are  not  affiliated. 
The  mere  equity  of  the  corporation  formerly  owning  the  stock 
is  not  a  direct  ownership  and  the  irrevocable  voting  power  of 
the  trust  company  obviates  any  control. ^^" 

The  words  "the  same  interests"  will  be  deemed  to  mean  the 
same  individual  or  partnership  or  the  same  individuals  or  part- 
nerships, but  when  the  stock  of  two  or  more  corporations  is 
owned  by  two  or  more  individuals  or  by  two  or  more  partner- 
ships, a  consolidated  return  is  not  required  unless  the  percentage 
of  stock  held  by  each  individual  or  each  partnership  is  substan- 
tially the  same  in  each  of  the  afl^liated  corporations. ^-'^     On  ac- 

i'^'^  Reg.  45,  Art.  633. 

iw»  A.  R.  R.  448,  T.  B.  14-21-1553.  This  was  held  in  spite  of  the  cumula- 
tive voting  provisions  of  the  Ohio  statutes  and  other  provisions  that  a 
majority  of  the  board  of  directors  which  could  be  elected  by  the  69';'r  inter- 
est might  select  officers,  and  that  a  60''<  interest  might  exercise  practically 
all  important  corporate  powers. 

i'»"  A.  R.  R.  641,  T.  B.  43-21-1883. 

i-'i  Reg.  45,  Art.  633,  The  ruling  on  this  point  should  be  the  same  under 
the  1921  Law.  In  the  case  of  two  corporations,  one  owning  and  operating 
property  in  the  Hawaiian  Islands,  the  other  owning  and  leasing  various 
pieces  of  property  in  California,  the  stock  of  the  California  corporation  was 


256  FEDERAL  INCOME  TAX 

count  of  the  disparity  of  holdings  of  the  stockholders  in  the 
corporations  the  treasury  department  would  be  unable  in  such 
cases  to  compel  the  corporations  to  pay  a  tax  based  upon  a  con- 
solidated return,  provided  the  corporations  failed  to  pay  such 
tax  voluntarily.  Corporations  will  not  be  permitted  to  do  what 
they  could  not  be  required  to  do.  Thus,  an  application  to  make 
a  consolidated  return  has  been  denied  in  the  case  of  two  com- 
panies when  24.26%  of  the  stock  of  the  first  company  was  owned 
by  individuals  who  held  no  stock  whatever  in  the  second  com- 
pany, and  more  than  6%  of  the  stock  of  the  second  company  was 
held  by  individuals  who  held  no  stock  whatever  in  the  first  com- 
pany.1^2  "Where  19%  of  the  stock  of  a  corporation  is  owned  by 
minority  interests,  13%  of  which  is  owned  unconditionally  by 
one  of  the  officers  and  where  39%  of  the  stock  of  another  cor- 
poration is  held  by  minority  interests,  10%  of  which  is  held 
unconditionally  by  a  different  officer,  and  in  each  instance  the 
officer  has  no  other  interest  in  the  otherwise  controlled  corpo- 
rations, there  should  be  no  consolidation.^'^s    j^  ^  recent  case  a 

held  by  the  members  of  one  family — four  male  members  of  the  family,  each 
owning  five-twenty-fourths,  and  a  sister  one-sixth  of  the  entire  stock;  and 
the  stock  of  the  Hawaiian  Corporation  was  held  by  the  same  family  prin- 
cipally, with  the  exception  that  one-sixth  of  the  stock  was  held  by  each  of 
the  four  male  members  aforementioned,  one-sixth  by  the  sister  aforemen- 
tioned, and  one-sixth  by  the  husband  of  a  deceased  sister  to  the  other  stock- 
holders. Although  the  affairs  and  operations  of  the  two  corporations  were 
always  actively  conducted  by  and  in  the  control  of  the  male  members  of  the 
family,  and  although  the  two  corporations  were  in  purpose  and  effect  only 
one  enterprise,  the  treasury  department  has  ruled  that  the  holdings  of  the 
two  companies  were  not  so  substantially  in  the  same  proportions  as  to  re- 
quire a  consolidated  return,  and  that  these  two  corporations  should  file  sepa- 
rate returns.  (Letter  from  treasury  department  dated  April  11,  1919,  I.  T. 
S.  1921,  TI2051.) 

192  T.  B.  M.  32,  T.  B.  7-19-304;  T.  B.  R.  521,  T.  B.  16-19-465.  It  is  ques- 
tionable whether  this  ruling  is  correct.  Sec.  240  (b)  provides  as  follows: 
"For  the  purpose  of  this  section,  two  or  more  domestic  corporations  shall 
be  deemed  to  be  affiliated  *  *  *  (2)  if  substantially  all  the  stock 
of  two  or  more  corporations  is  owned  or  controlled  by  the  same  interests." 
The  substantial  effect  of  the  ruling  is  to  add  the  following  words  to  the 
statute:  "provided  that  the  percentage  of  stock  held  by  each  individual  or 
partnership  is  sribstantiaUy  the  same  in  each  of  the  corporatioTis.^' 

193  A.  R.  R.  378,  T.  B.  5-21-1421.  Neither  of  the  two  above  officers  were 
related  by  blood  or  marriage,  a  relationship  which  may  be  an  important 
consideration.  Inter-company  loans  upon  which  6%  interest  was  charged 
and  the  fact  that  one  of  the  companies  sold  to  the  other  two  on  the  basis 
of  cost  plus  handling  charges  were  held  not  to  affect  the  conclusion  stated  in 
the  text  above,  the  other  two  corporations  selling  to  the  first  at  market 
prices.  A  contract  by  which  certain  stockholders  of  the  three  companies, 
including  the  officers  above  mentioned,  agreed  to  assume  liability  in  propor- 


CORPORATIONS  257 

corporation,  the  majority  of  whose  stock  was  owned  by  its  presi- 
dent and  manager,  turned  over  a  branch  of  its  business  to  a 
new  company  not  incorporated,  the  president  and  manager  of 
the  corporation  retaining  control  of  the  new  company.  There 
was  no  transfer  of  corporate  assets.  The  new  company  simply 
used  the  assets  of  the  corporation  without  consideration  of  any 
kind,  but  was  operated  as  a  separate  enterprise.  The  treasury 
department  held  the  new  company  to  be  merely  a  branch  of  the 
corporation  and  not  a  separate  entity,  with  the  result  that  its 
income  was  required  to  be  included  in  the  return  of  the  coi-po- 
ration.^'-'^ 

Change  in  Ownership  During  Taxable  Year.  When  one 
corporation  owns  substantially  all  the  stock  of  another  corpora- 
tion at  the  beginning  of  any  taxable  year,  but  during  the  taxable 
year  sells  all  or  a  majority  of  such  stock  to  outside  interests  not 
aflfiliated  with  it,  or  when  one  corporation  during  any  taxable 
years  acquires  substantially  all  the  capital  stock  of  another  cor- 
poration with  which  it  was  not  previously  affiliated,  a  full  dis- 
closure of  the  circumstances  of  such  changes  in  ownership  must 
be  submitted  to  the  commissioner.  In  accordance  with  the  pecu- 
liar circumstances  in  each  case  the  commissioner  may  require 
separate  or  consolidated  returns  to  be  filed,  to  the  end  that  the 
tax  may  be  equitably  assessed.^""' 

Corporation  Deriving  Chief  Income  from  Government 
Contracts.  In  the  case  of  any  affiliated  corporation  organized 
after  August  1,  1914,  and  not  a  successor  to  a  then  existing  busi- 
ness, 50  per  cent,  or  more  of  whose  gross  income  consists  of 
gains,  profits,  commissions,  or  other  income  derived  from  a  gov- 
ernment contract  or  contracts  made  between  April  6,  1917,  and 
November  11,  1918,  both  dates  inclusive,  the  net  income  and 
invested  capital  of  such  corporation  will  be  taken  out  of  the 
consolidated  net  income  and  invested  capital  of  the  group  of 
affiliated  corporations  and  the  corporation  so  segregated  will  be 
separately  assessed  on  the  basis  of  its  own  invested  capital  and 
net  income,  the  remainder  of  such  affiliated  group  being  assessed 
on  the  basis  of  the  remaining  consolidated  invested  capital  and 
net  income.i'^''     The  income  of  affiliated  corporations  which  is 

tion  to  stockholdings  to  protect  certain  endorsements  {riven  on  notes  the 
proceeds  of  which  had  been  received  by  the  corporations  was  also  held  im- 
material, particularly  in  view  of  the  fact  the  stockholdings  had  changed 
since  the  making  of  the  agreement. 

ISH  0.  D.  467,  T.  B.  16-20-866. 

195  Reg.  45,  Art.  634. 

100  Reg.  45,  Art.  635. 


258  FEDERAL  INCOME  TAX 

derived  from  government  contracts  is  taxable  upon  the  basis  of 
the  total  sum  received  from  that  source  by  the  group  and  not 
upon  the  basis  of  the  separate  amount  received  by  each  corpo- 
ration.19^ 

Domestic  Corporation  Affiliated  With  Foreign  Corpora- 
tion Under  1918  Law.  A  domestic  corporation  which  owns 
a  majority  of  the  stock  of  a  foreign  corporation  will  not  be  per- 
mitted or  required,  under  the  1918  law,  to  include  the  net  in- 
come or  invested  capital  of  such  foreign  corporation  in  a  con- 
solidated return,!'^^  but  a  domestic  corporation  which  owns  a 
majority  of  the  voting  stock  of  a  foreign  corporation  is  entitled 
under  that  law  to  credit  its  income,  war-profits  and  excess- 
profits  taxes  with  any  income,  war-profits  or  excess-profits  taxes 
paid  (but  not  including  taxes  accrued)  by  such  foreign  corpo- 
ration during  the  taxable  year  to  any  foreign  country  or  to  any 
possession  of  the  United  States  upon  income  derived  from 
sources  without  the  United  States  in  an  amount  equal  to  the 
proportion  which  the  amount  of  any  dividends  received  by  such 
domestic  corporation  from  such  foreign  corporation  during  the 
taxable  year  bears  to  the  total  taxable  income  of  such  foreign 
corporation  upon  or  with  respect  to  which  such  taxes  were  paid. 
But  in  no  such  case  may  the  amount  of  the  credit  for  such  taxes 
exceed  the  amount  of  such  dividends  received  by  such  domestic 
corporation  during  the  taxable  year.^^^  The  rule  with  regard  to 
the  affiliation  of  domestic  and  foreign  businesses  under  the  pres- 
ent law  is  stated  in  the  next  paragraph. 

Affiliation  of  Related  Trades  or  Businesses.  A  new  sub- 
division is  added  to  the  provision  for  the  filing  of  consolidated 
returns  by  affiliated  corporations  giving  the  commissioner  power 
to  consolidate  the  accounts  of  two  or  more  closely  related  trades 
or  businesses  (whether  unincorporated  or  incorporated  and 
whether  organized  in  the  United  States  or  not)  for  the  purpose 
of  making  an  accurate  distribution  or  apportionment  of  gains, 

197  0.  D.  415,  T.  B.  12-20-799. 

198  Where  a  New  Jersey  corporation  owned  all  of  the  outstanding  stock 
in  a  foreign  corporation  which  in  turn  owned  all  of  the  outstanding  stock 
in  a  New  York  corporation,  the  treasury  department  required  the  two 
domestic  corporations  to  file  a  consolidated  return,  excluding  the  foreign 
corporation.  (Letter  from  treasury  department  dated  April  23,  1919;  I.  T. 
S.  1921,  112056.) 

199  Reg.  45,  Art.  636;  T.  B.  R.  36,  T.  B.  11-19-388.  A  domestic  corpora- 
tion seeking  such  credit  must  comply  with  those  provisions  of  subdivision 
(a)  of  Reg.  45,  Art.  383,  which  are  applicable  to  credits  for  taxes  already 
paid,  except  that  in  accordance  with  Article  611  the  form  to  be  used  is 
Form  1118  instead  of  Form  1116, 


CORPORATIONS  259 

profits,  income,  deductions,  or  capital  between  or  among  such 
related  trades  or  businesses.-""  The  official  explanation  of  this 
provision  is  that  it  "is  necessary  to  prevent  the  arbitrary  shift- 
ing of  profits  among  related  businesses,  particularly  in  the  case 
of  subsidiary  corporations  organized  as  foreign  trade  corpora- 
tions."-'"i 

Consolidated  Net  Income  of  Affiliated  Corporations. 
Subject  to  the  provisions  governing  the  determination  of  taxable 
net  income  of  separate  corporations,  and  subject  further  to  the 
elimination  of  intercompany  transactions,  the  consolidated  tax- 
able net  income  will  be  the  combined  net  income  of  the  several 
corporations  consolidated,  except  that  the  net  income  of  corpo- 
rations deriving  their  chief  income  from  government  contracts 
will  be  taken  out.  In  respect  of  the  statement  of  gross  income 
and  deductions  and  the  several  schedules  required  under  Form 
1120,  a  corporation  filing  a  consolidated  return  is  required  to 
prepare  and  file  such  statements  and  schedules  in  columnar  form 
to  the  end  that  the  details  of  the  items  of  gross  income  and  de- 
ductions for  each  corporation  included  in  the  consolidation  may 
be  readily  audited.-"- 

DlFFERENT   FISCAL   YEARS   OF   AFFILIATED   CORPORATIONS.      In 

the  case  of  all  consolidated  returns,  consolidated  invested  capital 
must  be  computed  as  of  the  beginning  of  the  taxable  year  of  the 

200  Revenue  Act  of  1921,  §  240  (d).  It  is  a  question  whether  this  provision 
takes  effect  as  of  January  1,  1921  (see  §  263)  or  January  1,  1922,  when 
the  remainder  of  the  consolidated  returns  provision  takes  effect. 

-'•1  See  Report  of  Senate  P'inance  Committee  on  Internal  Revenue  Bill  of 
1921,  p.  20.  See  also  Report  of  Committee  on  Ways  and  Means,  p.  14,  in 
which  it  is  said  of  §  249,  (240  (d) )  :  "Subsidiary  corporations,  particularly 
foreign  subsidiaries,  are  sometimes  employed  to  'milk'  the  parent  corpo- 
ration, or  otherwise  improperly  manipulate  the  financial  accounts  of  the 
parent  company.  To  prevent  this  abuse,  §249  (240),  would  give  the  Com- 
missioner of  Internal  Revenue  power  to  consolidate  the  accounts  of  two 
or  more  related  trades  or  businesses  solely  for  the  purposes  of  making 
an  accurate  distribution  of  gains,  profits,  income,  deductions,  or  capital 
and  not  for  the  purpose  of  computing  the  tax  on  the  basis  of  the  con- 
solidated return." 

^••^  Reg.  45,  Art.  637.  A  consolidated  return  for  federal  tax  purposes  is  to 
be  distinguished  from  a  consolidated  statement  for  submission  to  stock- 
holders. This  is  because,  among  other  things,  a  foreign  corporation  will 
not  be  deemed  to  be  affiliated  with  a  domestic  corporation  (Reg.  45,  Art. 
636),  nor  will  a  corporation  bO'A  or  more  of  whose  gross  income  was  derived 
from  government  contracts  made  between  April  6,  1917,  and  November  11, 
1918,  be  deemed  to  be  an  affiliated  corporation  (Reg.  45,  Art.  635).  More- 
over, in  the  case  of  two  companies,  one  of  which  holds  between  50', c  and  95% 
of  the  stock  of  the  other,  a  consolidated  return  might  not  be  required  by 
the  treasury   department. 


260  FEDERAL  INCOME  TAX 

parent  or  principal  reporting  company  and  consolidated  income 
must  be  computed  on  the  basis  of  its  taxable  year.-*'^  Whenever 
the  fiscal  year  of  one  or  more  subsidiary  or  other  affiliated  cor- 
porations differs  from  the  fiscal  year  of  the  parent  or  principal 
corporation,  the  commissioner  should  be  fully  advised  by  the  tax- 
payer in  order  that  provision  may  be  made  for  assessing  the  tax 
in  respect  of  the  period  prior  to  the  beginning  of  the  fiscal  year 
of  the  parent  or  principal  company.-"-*  In  any  case  where  an 
affiliated  corporation  has  made  its  income  tax  return  on  the  basis 
of  a  taxable  year  different  from  that  on  the  basis  of  which  a 
consolidated  excess-profits  tax  return  in  which  it  is  included  has 
been  made,  an  amended  income  tax  return  may  be  made  on  the 
basis  of  the  same  taxable  year  as  the  consolidated  return,  even 
though  notice  was  not  given  within  the  time  prescribed.-"-''  In 
such  case  an  amended  income  tax  return  should  also  be  made  for 
any  unaccounted  for  portion  of  the  corporation's  taxable  year.-"'' 

Liberty  Bond  Exemption  in  Case  of  Affiliated  Corpora- 
tions. In  case  of  consolidated  returns,  affiliated  corporations 
are  treated  as  if  they  were  not  affiliated  and  each  corporation  is 
entitled  to  the  same  full  benefits  under  the  exemption  provisions 
of  the  several  Liberty  Bond  Acts  to  which  it  would  be  entitled  if 
separate  returns  were  made.^*^^ 

Claims  for  Credit  or  Refund.  A  claim  for  credit  or  refund 
of  excess  tax  paid  by  one  of  affiliated  corporations  can  be  made 
only  by  the  corporation  entitled  to  receive  such  credit  or  refund. 
With  respect  to  refunds,  credits,  and  additional  assessments 
each  affiliated  corporation  occupies  a  status  similar  to  that  of 
an  independent  and  unaffiliated  corporation.  An  additional  tax 
assessed  for  the  year  1918,  on  the  basis  of  the  consolidated  re- 
turn for  that  year,  must  be  apportioned  among  affiliated  corpo- 

203  Letter  from  treasury  department  dated  May  20,  1919;  I.  T.  S.  1921, 
§  2044.  Under  the  Act  of  October  3,  1917,  it  was  held  that  the  consolidated 
return  should  be  made  on  the  basis  of  the  fiscal  year  of  the  parent  company. 
As  to  past  periods,  the  income  of  subsidiaries  was  to  be  computed  to  the 
date  of  the  fiscal  year  of  the  parent  company,  and  where  the  accounts 
did  not  disclose  the  profits  earned  as  of  such  dates,  estimates  were  accepted 
subject  to  a  correct  accounting  at  the  close  of  the  succeeding  year.  (Letter 
from  treasury  department  dated  March  23,  1918;  W.  T.  S.  1918,  TI913.) 

204  Reg.  45,  Art.  638. 

205  Reg.  33  Rev.,  Arts.  211-215;  Reg.  45,  Art.  26;  See  Reg.  41,  Arts.  77 
and  78;  T.  D.  2662. 

206  T.  D.  2805. 

207  Letter  from  treasury  department  dated  May  21,  1919;  W.  T.  S.  1921, 
11736,  1[1046;  revising  letter  from  treasury  department  dated  April  5, 
1919;  W.  T.  S.  1919,  TI1038;  letter  from  treasury  department  dated  April 
16,  1919,  U  1039;  T.  B.  R.  7,  T.  B.  2-19-171.     See  Chapter  18. 


CORPORATIONS  261 

rations,  and  to  the  extent  that  each  debtor  corporation  is  entitled 
to  receive  back  a  part  of  taxes  paid  in  prior  years,  a  claim  for 
credit  may  be  filed  and  the  amount  of  additional  tax  each  sub- 
sidiary is  required  to  pay  may  be  reduced  thereby  by  the  amount 
it  is  entitled  to  receive.  In  case  the  amount  payable  to  the  sub- 
sidiary exceeds  its  proportionate  part  of  the  additional  tax  as- 
sessed under  the  consolidated  return,  it  may  file  a  claim  for 
refund  for  the  difference.-"^^ 

Preparation  of  Consolidated  Balance  Sheets.  In  the 
preparation  of  consolidated  balance  sheets,  it  is  extremely  im- 
portant (1)  to  reconcile  inter-company  current  accounts,  allo- 
cating any  differences  to  the  proper  asset  or  liability  account, 
which  includes  the  surplus  or  undivided  profits  account  in  case 
of  the  adjustment  of  income  or  expense  items,  (2)  to  eliminate 
inter-company  holdings  of  capital  stock,  (3)  to  eliminate  the 
surplus  of  the  subsidiary  companies  when  the  capital  stock 
thereof  was  purchased  by  the  parent  or  holding  company,  for 
an  amount  equal  to,  or  greater  than,  the  par  value  of  the  capital 
stock  plus  the  surplus  of  the  subsidiary  companies  at  the  date 
of  such  purchase.  When  the  book  value  of  a  subsidiary  company 
in  the  balance  sheet  of  the  holding  or  parent  company  is  greater 
than  the  par  value  of  the  stock  plus  the  surplus  of  the  subsidiary 
at  the  time  of  acquisition,  the  excess  should  be  charged  to  good 
will.  When  it  is  less,  the  difference  should  be  credited  to  surplus, 
unless  there  is  good  will  of  a  greater  amount  either  (1)  on  the 
accounts  of  the  holding  or  parent  company  or  of  the  subsidiary 
company,  or  (2)  arising  from  purchases  of  stocks  of  other  sub- 
sidiary companies.  If  good  will  is  not  shown  separately,  the 
debits  and  credits  should  be  made  to  the  account  in  which  good 
will  is  included,  instead  of  to  good  will  or  surplus.  Where  one 
company  does  not  own  the  entire  capital  stock  of  a  subsidiary 
company,  it  is  customary  to  show  the  capital  stock  of  the  subsid- 
iary company  plus  the  surplus  attributable  thereto,  owned  by 
other  stockholders  on  the  consolidated  balance  sheet  as  a  distinct 
obligation  to  such  stockholders.  Inventories  in  consolidated  ac- 
counts should  be  carefully  scrutinized  and  adjustments  made 
eliminating  any  inter-company  profits  reflected  therein. 

Consolidated  Returns  Under  the  1917  Law.  For  the  year  1917 
affiliated  corporations  and  partnerships  were  permitted  or  re- 
quired to  file  consolidated  returns  for  the  purpose  of  the  excess- 
profits  tax.  Some  doubt  exists  concerning  the  legality  of  this 
procedure  and  in  order  to  set  all  doubts  at  rest  provision  is  made 
in  the  Revenue  Act  of  1921  validating  the  practice  of  the  treas- 

20S0.  D.  (i83,  T.  B.  41-20-1237. 


262  FEDERAL  INCOME  TAX 

ury  department  in  this  respect  under  that  law.^"^  The  present 
law  provides  that  a  corporation,  or  partnership,  was  affiliated 
within  the  meaning  of  the  1917  law  "with  one  or  more  corpora- 
tions or  partnerships  (1)  when  such  corporation  or  partnership 
owned  directly  or  controlled  through  closely  affiliated  interests 
or  by  a  nominee  or  nominees  all  or  substantially  all  the  stock 
of  the  other  or  others,  or  (2)  when  substantially  all  the  stock 
of  two  or  more  corporations  or  the  business  of  two  or  more  part- 
nerships was  owned  by  the  same  interests :  Provided,  That  such 
corporations  or  partnerships  were  engaged  in  the  same  or  a 
closely  related  business,  or  one  corporation  or  partnership  bought 
from  or  sold  to  another  corporation  or  partnership  products  or 
services  at  prices  above  or  below  the  current  market,  thus  ef- 
fecting an  artificial  distribution  of  profits,  or  one  corporation 
or  partnership  in  any  way  so  arranged  its  financial  relationships 
with  another  corporation  or  partnership  as  to  assign  to  it  a  dis- 
proportionate share  of  net  income  or  invested  capital,"  Public 
service  corporations  which  (1)  were  operated  independently, 
('2)  were  not  physically  connected  or  merged  and  (3)  did  not 
receive  special  permission  to  make  a  consolidated  return,  are 
not  affiliated ;  but  a  railroad  or  other  public  utility  which  was 

200  Revenue  Act  of  1921,  §  1331.  See  Report  of  Committee  on  Ways  and 
Means  on  Revenue  Bill  of  1921,  p.  16;  Report  of  Finance  Committee,  p.  34. 
The  fact  that  one  corporation  held  the  entire  capital  stock  of  another 
and  that  the  two  were  component  parts  of  one  business  unit  or  system  did 
not  ordinarily,  under  the  1916  Law,  destroy  the  separate  entities  of  the 
two  corporations.  As  a  general  rule  corporations  as  such  were  subject  to 
the  tax,  not  the  business  organizations  of  which  the  corporations  might  be 
a  part.  Every  corporation  was  considered  to  be  a  distinct  entity  regard- 
less of  its  relation  to  any  other  corporartion.  Where  a  parent  corpora- 
tion owned  all  or  practically  all  of  the  stock  of  subsidiary  companies,  each 
was  required  to  make  a  return  accounting  in  detail  for  their  separate  gross 
incomes  and  deductions,  and  each  was  generally  required  to  pay  the  tax  on 
the  net  earnings  shown  by  such  return.  The  parent  company  was  not 
permitted  to  report  the  gross  income  of  all  subsidiaries  and  deduct  there- 
from the  gross  expenses.  (T.  D.  2137;  T.  D.  2090.)  The  net  earnings  of  the 
subsidiary  companies  turned  over  to  the  parent  company  were  to  be 
treated  as  dividends,  notwithstanding  the  earnings  out  of  which  the 
dividends  were  paid  were  also  subject  to  tax,  as  against  the  subsidiary 
companies.  In  U.  S.  v.  Nipissing  Mines  Co.,  206  Fed.  431,  234  U.  S.  765, 
decided  under  the  1909  Law,  it  was  held  that  although  the  affairs  of  the 
holding  and  operating  company  were  closely  connected  and  they  had  officers 
in  common,  the  distinct  corporate  existence  of  each  should  not  be  ignored 
and  the  holding  company  should  not  be  treated  as  being  engaged  in  the 
business  of  the  operating  company.  It  was  held  in  an  early  ruling  that  the 
fact  that  a  corporation  had  a  number  of  subsidiaries  only  for  the  purpose 
of  protecting  trade  brands,  trade  marks  and  trade  names  was  immate- 
rial;  that  the  liability  to  make  separate  returns  attached  to  each   subsi- 


CORPORATIONS  263 

owned  by  an  industrial  corporation  and  was  operated  as  a  plant 
facility  or  as  an  integral  part  of  a  group  organization  of  affili- 
ated corporations  which  were  recjuired  to  file  a  consolidated  re- 
turn, are  affiliated.-'"' 

Special  Returns  of  Corporations.  In  addition  to  the  above 
mentioned  returns  required  to  be  filed  by  every  corporation  not 
exempt  from  tax,  several  special  returns  are  required  annually 
or  at  such  times  as  the  commissioner  may  request  of  every  cor- 
poration. 

Report  of  Dividend  Payments.  Every  corporation,  including 
a  personal  service  corporation,  when  requested  by  the  commis- 
sioner, is  required  to  render  a  correct  return  of  its  payments  of 
dividends,  stating  the  name  and  address  of  each  stockholder, 
the  number  of  shares  owned  by  him,  and  the  amount  of  dividends 

diary  company  by  reason  of  the  fact  that  it  was  a  separate  and  distinct 
entity.  If  such  subsidiary  had  no  net  income  or  earnings  and  no  expense 
of  operations,  and  if  the  earnings  accrued  direct  to  the  parent  company, 
which  also  paid  direct  the  operating  expenses  of  the  subsidiaries,  those 
facts  should  be  set  out  in  the  return  of  the  subsidiary,  but  they  did 
not  operate  to  release  the  subsidiary  from  liability  to  make  a  return. 
(T.  D.  2161.)  If  subsidiary  corporations  existed  in  name  only,  or  were 
mere  agents  or  integral  parts  of  the  parent  corporation  and  as  such, 
transacted  no  business  and  had  no  income  of  and  for  their  own  account, 
and  incurred  no  expenses,  all  business  being  transacted,  all  income  being 
received  and  all  expenses  being  paid  directly  by  the  parent  company,  no 
separate  accounts  being  kept  by  or  for  such  subsidiaries,  it  was  considered 
that  such  subsidiary  concerns  had  no  taxable  income.  In  such  cases,  how- 
ever, such  subsidiary  corporations  were  required  to  make  returns  and 
indorse  thereon  a  statement  to  the  effect  that  the  corporation  making  the 
return  was  a  subsidiary  or  integral  part  of  the  parent  company  (naming 
it)  and  that,  for  its  own  account,  it  had  no  income  from  any  source  what- 
ever, that  it  made  no  disbursements,  and  that  all  the  business  done  in  its 
name  was  done  for  the  account  of  and  was  the  business  of  the  parent  corpo- 
ration, and  would  be  accounted  for  in  the  return  of  such  parent  corpo- 
ration. This  ruling  (Reg.  33  Rev.,  Art.  208)  was  not  intended  to  cover 
those  subsidiary  corporations  which  actually  transacted  business  in  their 
own  names,  received  income  for  their  own  account,  which  incurred  and  paid 
expenses  incident  to  the  production  of  such  income,  which  kept  separate 
books  of  account,  and  which,  as  separate  entities,  exercised  all  the  powers 
and  functions  authorized  by  their  charters.  Corporations  of  this  character 
were  required  to  pay  the  income  tax  on  the  net  income  received  by  them 
from  all  sources,  regardless  of  the  fact  that  such  net  income  was  paid 
or  turned  over  to  a  parent  or  holding  company,  by  whom  it  was  also  re- 
turned for  the  purpose  of  the  tax. 

-'10  Revenue  Act  of  1921,  §  1331;  T.  D.  2662;  Reg.  41,  Arts  77,  78;  Letter 
from  treasury  department  dated  April  17,  1919;  I.  T.  S.  1921,  112049;  A. 
R.  R.  123,  T.  B.  22-20-976;  A.  R.  R.  624,  T.  B.  38-21-1834;  A.  R.  R.  641, 
T.  B.  43-21-1888. 


264  FEDERAL  INCOME  TAX 

paid  to  him.-^i  This  return  is  for  the  purpose  of  supplying  the 
government  with  information  with  which  the  returns  of  stock- 
holders may  be  compared,  and  is  more  fully  discussed  in  another 
chapter. 

Report  of  Income  Payments.  All  corporations,  in  whatever 
capacity  acting,  including  lessees  or  mortgagors  of  real  or  per- 
sonal property,  fiduciaries -i-  and  employers,  making  payment 
to  any  individual,  corporation  or  partnership  of  interest,  rent, 
salaries,  wages,  premiums,  annuities,  compensations,  remunera- 
tions, emoluments,  or  other  fixed  or  determinable  gains,  profits 
and  income  (other  than  dividends  and  the  payments  described 
in  the  following  paragraph)  of  $1,000  or  more  in  any  taxable 
year,  are  required  to  make  returns  in  regard  thereto  to  the 
commissioner,  setting  forth  the  amount  of  such  payments  and 
the  names  and  addresses  of  the  recipients.  In  the  case  of  pay- 
ments of  interest  upon  its  bonds,  mortgages  or  deeds  of  trust  or 
other  similar  obligations,  such  return  is  required  from  a  corpo- 
ration regardless  of  the  amount  paid.-^^  This  return  is  for  the 
purpose  of  supplying  the  treasury  department  with  information 
to  be  used  in  auditing  the  returns  of  the  taxpayers  to  whom  the 
income  is  paid,  and  is  more  fully  discussed  in  a  later  chapter.^i* 

Reports  by  Brokers.  Every  corporation  doing  business  as  a 
broker-12  is  required,  when  called  upon  by  the  commissioner,  to 
make  a  return  showing  the  names  of  its  customers  with  such 
details  as  to  the  profits,  losses  or  other  information  which  the 
commissioner  may  require,  as  to  each  of  such  customers,  as  will 
enable  the  commissioner  to  determine  whether  all  income  tax 
due  on  the  profits  or  gains  of  such  customer  has  been  paid.-^**' 
This  report  is  for  the  purpose  of  information  at  the  source  and 
is  more  fully  discussed  in  a  later  chapter.^i" 

Payment  of  the  Tax.  Ordinarily  the  tax  of  corporations  is  paid 
in  the  same  manner  and  subject  to  the  same  rules  as  the  tax  of 

211  Revenue  Act  of  1921,  §254;  Revenue  Act  of  1918,  §254.  See  the 
definition  of  the  term  "dividend"  in  §  201. 

212  See  Chapter  39.  It  will  be  noted  in  this  provision  the  Commissioner 
is  given  discretion  to  require  or  not  to  require  such  returns. 

213  Revenue  Act  of  1921,  §256;   Revenue  Act  of  1918,  §256. 

214  See  Chapter  39. 

215  The  Revenue  Act  of  1921  and  the  Revenue  Act  of  1918  omit  the 
clause  defining  brokers,  "on  any  exchange  or  board  of  trade  or  other  sim- 
ilar place  of  business,"  which  appeared  in  the  1916  Law. 

21C  Revenue  Act  of  1921,  §255;   Revenue  Act  of  1918,  §255. 
217  See  Chapter  39.    It  will  be  noted  that  under  this  provision  the  Com- 
missioner is  given  discretion  to  require  or  not  to  require  such  returns. 


CORPORATIONS  265 

individuals.-^''  Certain  special  rules  applicable  to  the  payment  of 
the  tax  by  corporations  are  set  forth  in  the  following  paragraphs. 
Liability  for  Tax  After  Dissolution.  When  a  corporation 
is  dissolved  its  affairs  are  usually  wound  up  by  a  receiver  or 
trustees  in  dissolution.  The  corporate  existence  is  continued  for 
the  purpose  of  liquidating  the  assets  and  paying  the  debts,  and 
such  receiver  or  trustees  stand  in  the  stead  of  the  corporation 
for  such  purposes.  Any  sales  of  property  by  them  are  to  be 
treated  as  if  made  by  the  corporation,  for  the  purpose  of  ascer- 
taining the  gain  or  loss.  Any  profit  or  loss  resulting  from  the 
sale  of  capital  assets  by  the  trustees  or  receiver  during  the 
process  of  liquidation  is  to  be  merged  with  the  profit  or  loss 
resulting  from  the  regular  business  of  the  corporation  during 
the  same  taxable  year  prior  to  the  taking  over  of  the  aflfairs  of 
the  corporation  by  the  trustees  or  by  the  receiver.^is  No  gain 
or  loss  is  realized  by  a  corporation  from  the  mere  distribution 
of  its  assets  in  kind  upon  dissolution,  however  they  may  have 
appreciated  or  depreciated  in  value  since  their  acquisition.-o 

218  See  Chapter  35. 

2in  Letter  from  treasury  department  dated  October  24,  1919;  I.  T.  S.  1921, 
TI1031.  ^! 

220  Reg:.  45,  Art.  547;  In  re  Heller  Hirsh  &  Co.,  258  Fed.  208.  See  also 
Reg.  33  Rev.,  Art.  205;  Reg.  33,  Art.  85;  T.  D.  2209;  T.  D.  2090.  Where 
the  officers  and  directors  (being  all  the  stockholders)  of  a  manufacturing 
company  had  for  many  years  fraudulently  converted  to  their  own  use  as  divi- 
dends sums  which  should  have  been  paid  to  the  government  as  taxes,  and 
where  the  company  had  become  insolvent  and  a  sale  of  the  company's  prop- 
erty did  not  satisfy  the  government's  lien,  it  was  held  that  there  is  jurisdic- 
tion in  equity,  on  the  ground  of  inadequacy  of  remedy  at  law,  for  the  appoint- 
ment of  a  receiver  and  for  impounding  the  company's  tangible  and  intangible 
assets,  wrongfully  in  the  hands  of  the  stockholders,  and  applying  them  to 
the  payment  of  the  company's  obligations  to  the  government.  It  was  not 
necessary  that  the  government  first  obtain  a  judgment.  (United  States  v. 
Capital  City  Dairy  Co.,  252  Fed.  900.)  It  was  held  on  demurrer  under  the 
Corporation  Excise  Tax  Law  of  1909  that  a  corporation  could  not  evade  lia- 
bility for  the  tax  by  dissolving  before  the  time  when  it  was  required  to 
make  a  return.  (U.  S.  v.  General  Inspection  &  Loading  Co.,  192  Fed.  223.) 
When  the  same  case  came  before  the  court  for  trial,  it  was  held  that  notice 
addressed  to  the  defendant  at  the  place  of  its  principal  office  at  the  time 
of  its  dissolution,  presumptively  received,  was  sufficient  to  warrant  the  col- 
lection of  penalties  (204  Fed.  657).  Corporations  which  were  dissolved  in 
1917,  prior  to  the  passage  of  the  1917  law,  were  held  subject  to  tax  under 
the  1916  law,  as  amended,  and  also  under  the  1917  law.  A  corporation  so 
situated  was  required  to  make  a  return  covering  the  period  in  1917  during 
wh-ich  it  was  in  business  prior  to  its  dissolution.  If  it  should  previously 
have  made  a  return  covering  this  period  and  paid  any  excess-profits  tax 
under  the  act  of  March  3,  1917,  it  credited  the  amount  of  such  tax  against 
any   excess-profits  tax   assessable   against   it  under  Title  II  of  the   act  of 


266  "  FEDERAL  INCOME  TAX 

Collection  of  Tax  From  Assets.  The  Revised  Statutes,"^ 
as  amended,  provide  generally  with  reference  to  internal  reve- 
nue taxes  that:  "If  any  person  liable  to  pay  any  tax  neglects 
or  refuses  to  pay  the  same  after  demand,  the  amount  shall  be  a 
lien  in  favor  of  the  United  States  from  the  time  when  the  assess- 
ment list  was  received  by  the  collector,  except  when  otherwise 
provided,  until  paid,  with  the  interest,  penalties  and  costs  that 
may  accrue  in  addition  thereto,  upon  all  property  and  rights 
belonging  to  such  person."  The  present  law  and  the  Revenue 
Act  of  1918  provide-"  that  "all  administrative,  special,  or  stamp 
provisions  of  law,  including  the  law  relating  to  the  assessment 
of  taxes,  so  far  as  applicable,  are  hereby  extended  to  and  made 
a  part  of  this  act."  The  condition  to  the  above  lien,  which  gives 
the  government  a  preference  over  general  creditors,  is  a  receipt 
of  an  assessment  list  by  the  collector.  When  returns  under  the 
]  918  law  were  received  at  the  collector's  offices,  they  were  exam- 
ined and  listed  before  being  forwarded  to  the  commissioner.  If 
it  appeared  that  the  tax  was  greater  or  less  than  shown  in  the 
return,  the  tax  was  recomputed.  After  checking  the  figures  the 
commissioner  assessed  the  tax  on  the  basis  of  the  collectors'  lists. 
The  collectors  then  sent  out  bills  for  the  taxes,  either  as  com- 
puted by  the  taxpayer  or  as  recomputed.—'''  This  procedure  is 
different  from  the  procedure  under  the  1916  law.  Under  that 
law  it  was  the  duty  of  the  commissioner  to  send  to  each  col- 
lector a  list  of  the  companies  liable  for  tax  in  his  district,  show- 
ing the  amounts  for  which  they  were  liable  within  such  time 
that  the  collector  might  give  the  required  notice  of  assessment 
on  or  before  June  1  and  upon  such  lists  the  collections  were 
made.  The  present  law,  except  with  regard  to  a  "tax  or  defi- 
ciency" discovered  upon  examination  of  a  return,  does  not  seem 
to  require  any  different  procedure  from  that  adopted  under  the 
1918  law. 

Under  the  provision  of  the  Revised  Statutes  above  quoted  thq 
lien  was  fixed  upon  the  assets  of  the  corporation  when  this  list 
came  into  the  collector's  hands.  It  is  doubtful  whether  the  com- 
missioner's assessment  under  the  Revenue  Act  of  1918  "upon 
the  basis"  of  the  collectors'  lists  constituted  a  technical  compli- 

October  3,  1917.  (Reg.  33  Rev.,  Art.  61.)  This  ruling  was  made  on 
authority  of  Brady  v.  Anderson,  240  Fed.  665,  writ  of  certiorari  denied, 
244  U.  S.  654.  (See  letter  from  treasury  department  dated  November  17, 
1917;  I.  T.  S.  1918,  ^1085). 

221  R.    S.,    §3186. 

222  Revenue  Act  of  1921,  §  1300;  Revenue  Act  of  1918,  §  1305. 

223  Reg.  45,  Art.  1012. 


CORPORATIONS  267 

ance  with  the  above  provision  of  the  Revised  Statutes  giving  a 
lien,  unless  the  commissioner  after  his  assessment  forwarded 
lists  to  the  collectors  which  were  "received"  by  them.  When 
additional  taxes  were  assessed  under  the  Revenue  Act  of  1918, 
lists  containing  the  names  of  taxpayers  liable  to  such  additional 
taxes  and  the  amounts  thereof  were  forwarded  to  the  collectors 
from  time  to  time.  The  government's  lien,  with  respect  to 
these  additional  taxes,  commenced  when  these  lists  were  received 
by  the  collectors.  Under  the  present  law  this  practice  in  regard 
to  additional  taxes — "a  tax  or  a  deficiency  in  tax" — will  probably 
be  continued.  If  a  corporation  has  distributed  all  of  its  assets 
and  become  dissolved  prior  to  the  time  when  the  list  carrying 
an  assessment  against  it  is  received  by  the  collector,  the  tax  is 
not  collectible  upon  notice  and  demand  followed  by  distraint.--^ 
The  corporation  is  not  in  existence;  it  has  distributed  its  assets 
before  any  lien  attached  to  them.  No  personal  liability  for  addi- 
tional taxes  will  ordinarily  be  incurred  by  the  officers  of  a  cor- 
poration or  liquidating  agents  in  charge  thereof  on  the  distri- 
bution of  the  assets  of  the  corporation,  provided  they  have  paid 
all  taxes  theretofore  assessed.--"' 

Notice  of  Lien.  The  government's  lien  is  not  valid  as  against 
any  mortgagee,  purchaser  or  judgment  creditor  unless  perfected 
as  outlined  in  another  chapter.--'' 

Recovery  Against  Stockholders.  Although  the  statutes 
provide  for  a  lien,  this  particular  remedy  for  collecting  the  tax 
is  not  exclusive,  and  the  government  may  resort  to  the  common- 
law  method  of  collecting  the  same.--''  The  dissolution  of  a  cor- 
poration does  not  extinguish  its  liabilities  and  through  the  courts 
of  equity  creditors  may  pursue  its  assets  into  the  hands  of  any 
person  who  is  not  a  bona  fide  purchaser.  The  sale  of  the  entire 
capital  stock  of  a  corporation  and  the  distribution  of  the  pro- 
ceeds of  the  sale  among  the  stockholders  will  not  defeat  or  im- 
pair the  remedy  of  creditors,  if  any  debts  remain  unpaid,  as  the 
creditors  in  that  event  may  pursue  the  proceeds  of  the  sale  in 
the  hands  of  the  respective  stockholders  and  compel  each  one  to 
contribute  pro  rata  toward  the  payment  of  the  debts  to  the  ex- 
tent of  the  moneys  received  on  the  distribution.--'^  This  remedy 
is  open  to  the  government  in  the  same  manner  as  it  is  to  any 

2-^0.  D.  769,  T.  B.  1-21-1378. 
--•■>  O.  D.  863,  T.  B.  16-21-1583. 
.  --•!  See  Chapter  35. 
2-'T  Dollar  Savings  Bank  v.  U.  S.,  19  Wall.  227. 
2-><  Railroad  Co.  v.  Howard,  7  Wall.  392. 


268  FEDERAL  INCOME  TAX 

other  creditor  for  the  collection  of  the  tax,"9  but  not  for  collec- 
tion of  the  penalty  for  failure  to  file  returns.-^o  Where  a  Mon- 
tana corporation  sold  all  its  property  and  distributed  the  pro- 
ceeds to  the  stockholders  and  became  dissolved,  the  additional 
tax  imposed  by  the  Revenue  Act  of  1916  retroactively  from 
January  1,  1916,  to  the  date  of  dissolution  may  be  collected  from 
the  stockholders  to  whom  the  corporate  assets  have  been  dis- 
tributed.-'^i  If  certain  of  the  stockholders  are  without  assets 
and  fail  to  pay  their  pro  rata  share,  the  remaining  stockholders 
are  responsible  for  the  payment  of  the  tax  to  the  extent  of  the 
value  of  the  assets  of  the  corporation  received  by  them  regard- 
less of  their  pro  rata  share  under  the  principle  known  as  the 
"trust  fund"  doctrine  in  respect  of  corporations.-^^ 

Reorganization  Prior  to  Attachment  of  Lien.  In  cases 
where  corporations  liable  for  additional  taxes,  not  yet  assessed 
and  paid,  dispose  of  their  assets  as  an  incident  of  a  reorganiza- 
tion, the  liability  of  the  new  corporation  may  depend  largely  on 
the  form  of  the  transaction.  Upon  such  a  reorganization  the  new 
corporation  may  acquire  the  stock  of  the  old  corporation  in  ex- 
change for  its  own  stock  and  then  dissolve  the  old  corporation, 
taking  over  all  its  assets.  In  that  case  the  new  corporation  is 
the  stockholding  distributee  of  the  corporate  assets  of  the  old 
corporation,  and  is  liable  to  the  extent  of  the  value  of  the  assets 
so  received.  On  the  other  hand,  the  new  corporation  may  pur- 
chase the  assets  of  the  old,  paying  therefor  in  its  own  stock,  in 
which  event  it  does  not  stand  in  the  position  of  a  stockholder 
receiving  a  dividend  in  liquidation.  If  there  is  an  agreement  to 
assume  the  liabilities  of  the  old  corporation,  it  may  be  that  the 
new  corporation  is  liable  to  a  greater  extent  than  the  value  of 

229  0.  D.  769,  T.  B.  1-21-1378;  0.  D.  883,  T.  B.  16-21-1583;  28  Op.  Atty. 
Gen.  241.     See  U.  S.  v.  Capital  City  Dairy  Co.,  252  Fed.  900  and  Note  220. 

230  T.  D.  1852.  In  the  case  of  U.  S.  v.  General  Inspection  and  Loading 
Co.,  192  Fed.  223,  204  Fed.  657,  judgment  was  entered  for  tax,  penalty 
for  delay  in  the  payment  of  the  tax,  and  interest,  under  the  1909  Law, 
notwithstanding  the  fact  that  the  corporation  had  been  previously  dis- 
solved.  But  in  this  case  the  assets  had  not  been  distributed, 

231  U.  S.  V.  McHatton,  266  Fed.  602;  T.  D.  3043,  T.  B.  29-20-1078;  0.  D. 
597,  T.  B.  29-20-1079;  A.  R.  R.  43,  T.  B.  12-20-794.  In  the  McHatton  case 
the  court  said :  "Although  taxes  are  not  debts,  and  in  respect  to  them  the 
government  is  not  a  creditor,  both  being  of  higher  nature,  no  reason  is 
perceived  why  they  are  not  within  the  principle  that  those  who  gratuitously 
take  all  a  debtor's  property,  to  the  extent  thereof,  may  be  held  to  respond 
for  his  present  debts  and  obligations,  inchoate  or  vested,  or  for  the  damages 
thereby  inflicted^ — the  sometime  'trust  fund'  doctrine,  so  far  as  corporations 
are  concerned."    See  also  O.  D.  75,  T.  B.  1-19-107. 

232  0.  D.  707,  T.  B.  43-20-1269. 


CORPORATIONS  269 

the  property  or  assets  received.  But  in  the  absence  of  such  an 
assumption  it  would  seem  that  the  Hability  of  the  new  company 
would  be  limited  to  the  value  of  the  assets  received.  It  is  doubt- 
ful whether  there  can  be  any  liability  in  excess  of  the  assets  re- 
ceived, on  the  theory  of  novation.  Whether  or  not  the  govern- 
ment has  a  prior  claim  on  the  assets  of  the  new  corporation  for 
the  satisfaction  of  a  contractual  liability  arising  from  an  agree- 
ment to  assume  the  liabilities  of  the  old  company  or  otherwise 
is  not  clear,  although  some  federal  cases  seem  to  point  to  such 
priority. 

Abatement  and  Refund.  The  principles  controlling  abatement 
and  refund  of  taxes  claimed  from  or  paid  by  corporations  are 
generally  the  same  as  those  applying  to  individuals  and  are 
treated  in  another  chapter.-"'--  It  has  been  held  with  regard  to 
claims  for  credit  in  the  case  of  corporations  that  under  the 
statutes  of  New  Jersey  providing  for  a  merger  or  consolidation 
of  corporations  resulting  in  the  formation  of  another  corpora- 
tion, which  in  effect  shall  represent  predecessor  corporations  in 
the  enforcement  of  their  rights,  the  successor  corporation  is 
entitled  to  file  a  claim  for  credit  on  account  of  overpayment  of 
taxes  by  the  predecessor  corporation.-"^^ 

Withholding  the  Tax  at  the  Source.  No  withholding  takes 
place  on  payment  of  income  to  domestic  corporations.  Such 
corporations  are  required  to  withhold  the  tax  on  payments  of 
fixed  or  determinable  and  annual  or  periodical  gains,  profits  and 
income  to  nonresident  aliens,  and  nonresident  foreign  corpora- 
tions and  on  payment  of  bond  interest  as  indicated  in  another 
chapter.-'"^'' 

Foreign  Items.  Corporations  undertaking  as  a  matter  of  busi- 
ness and  for  profit  the  collection  of  foreign  items  are  required 
to  obtain  a  license  in  the  manner  more  particularly  set  forth  in 
another  chapter.-'""' 

Examination  of  Corporate  Records.  All  corporate  books,  pa- 
pers, records  or  memoranda  are  subject  to  examination  by  any 
revenue  agents  or  inspectors  designated  by  the  commissioner  for 
the  purpose  of  ascertaining  the  correctness  of  returns  which  have 
been  made,  or  making  a  return  where  none  has  been  made,  in 

-'33  See  Chapter  37. 

234  0.  D.  950,  T.  B.  24-21-1690. 

23".  See  Chapter  40.  Under  the  191(5  Law,  as  amended,  corporations  were 
required  to  withhold  the  tax  on  dividend  payments  to  non-resident  foreign 
corporations,  but  this  is  no  longer  required. 

23t!  Revenue  Act  of  1921,  §259;  Revenue  Act  of  1918,  §259.  See  Chapter 
40. 


270  FEDERAL  INCOME  TAX 

accordance  with  and  subject  to  certain  rules  which  are  discussed 
at  length  in  another  chapter.-"''' 

Penalties.  Corporations  or  their  officers  or  employees  are  sub- 
ject in  certain  cases  to  penalties,  both  specific  and  ad  valorem, 
for  failing  or  refusing  to  make  returns,  supply  information,  pay 
or  collect  any  tax  or  for  willfully  attempting  in  any  manner  to 
defeat  or  evade  the  tax.  Such  penalties  are  more  particularly 
discussed  in  another  chapter.-"'^ 

Personal  Service  Corporations.  Personal  service  corpora- 
tions,-^^  as  such,  were  not  subject  to  the  tax  imposed  by  the 
Revenue  Act  of  1918,  and  the  tax  imposed  by  the  present  law 
for  the  year  1921,  their  individual  stockholders  being  taxed  in 
the  same  manner  as  the  members  of  partnerships.  After  De- 
cember 31,  1921,  they  are  taxable  in  the  same  manner  as  other 
corporations.240 

Transportation  Systems.  For  the  purpose  of  the  act-^^  provid- 
ing for  the  operation  of  transportation  systems  while  under 
federal  control  four-fifths  of  the  tax — or  a  tax  of  S%: — on  the 
net  income  of  corporations  in  excess  of  credits  for  the  calendar 
year  1919  and  each  calendar  year  thereafter,  is  treated  as  levied 
by  an  act  in  amendment  of  Title  I  of  the  Revenue  Act  of  1917.^42 
The  act  providing  for  the  operation  of  transportation  systems 
while  under  federal  control  and  for  the  just  compensation  of 
their  owners  provided  that  every  agreement  entered  into  pur- 
suant thereto  between  the  President  and  the  transportation  sys- 
tems covering  the  operation  thereof  while  under  federal  control 
and  the  just  compensation  of  the  owners  thereof  should  provide 
that  any  federal  taxes  "under  the  act  of  October  third,  nineteen 
hundred  and  seventeen,  or  acts  in  addition  thereto  or  in  amend- 
ment thereof,  commonly  called  war  taxes,"  assessed  for  the 
period  of  federal  control  beginning  January  1,  1918,  or  any  part 
of  such  period,  should  be  paid  by  the  carrier  out  of  its  own 
funds  or  charged  against  or  deducted  from  the  just  compensation 
stipulated  in  the  agreement.  Other  taxes  assessed  under  federal 
or  any  other  governmental  authority  for  the  period  of  federal 
control  or  any  part  thereof  either  on  the  property  used  or  on 

237  See  Chapter  38.  This  chapter  also  discusses  the  new  provision  of  the 
Revenue  Act  of  1921  against  unnecessary  examinations  or  investigations. 

238  See  Chapter  36. 

239  The  subject  of  personal  service  corporations  is  treated  in  full  in  Chap- 
ter 9. 

240  Revenue  Act  of  1921,  §218;  Revenue  Act  of  1918,  §218. 

241  Act  of  March  21,  1918. 

242  Revenue  Act  of  1918,  §230  (b).  For  the  calendar  year  1918  five-sixths 
of  the  tax — or  a  tax  of  10% — vi^as  so  treated. 


CORPORATIONS  271 

the  right  to  operate  as  a  carrier  or  on  the  revenues  or  any  part 
thereof  derived  from  operation  (not  including,  however,  assess- 
ments for  public  improvements  or  taxes  assessed  on  property 
under  construction  and  chargeable  under  the  classification  of  the 
interstate  commerce  commission  to  investment  in  road  and 
equipment)  were  provided  to  be  paid  out  of  revenues  derived 
from  railway  operations  while  under  federal  control.  All  taxes 
assessed  under  federal  or  any  other  governmental  authority  for 
the  period  prior  to  January  1,  1918,  whenever  levied  or  payable 
were  provided  to  be  paid  by  the  carrier  out  of  its  own  funds  or 
charged  against  or  deducted  from  the  just  compensation.  The 
4%  tax  levied  under  the  1917  law  was  paid  by  the  carrier  out  of 
its  own  funds  or  charged  against  or  deducted  from  the  compen- 
sation payable  to  the  carrier,  whereas  the  29''  tax  imposed  by  the 
1916  law  was  paid  out  of  revenues  derived  from  railway  opera- 
tions while  under  federal  control.  The  tax  on  all  income  pay- 
able by  the  carrier  on  its  income  taxable  under  the  Revenue  Act 
of  1918  in  excess  of  the  2%  levied  under  the  1916  law  was  ac- 
cordingly to  be  paid  by  the  carrier  out  of  its  own  funds  or 
charged  against  or  deducted  from  any  compensation  it  may 
receive  by  reason  of  government  operation  since  such  excess  is 
treated  as  levied  by  the  act  in  amendment  of  "the  act  of  October 
third,  nineteen  hundred  and  seventeen  or  acts  in  addition  thereto 
or  in  amendment  thereof,  commonly  called  war  taxes". --'^ 

243  Act  of  March  21,  1918;  Reg.  45,  Art.  504.  This  act  also  provides: 
"That  moneys  and  other  property  derived  from  the  operation  of  the  car- 
riers during  federal  control  are  hereby  declared  to  be  the  property  of  the 
United  States.  Unless  otherwise  directed  by  the  President,  such  moneys 
shall  not  be  covered  into  the  treasury,  but  such  moneys  and  property  shall 
remain  in  the  custody  of  the  same  officers,  and  the  account  thereof  shall 
be  in  the  same  manner  and  form  as  before  the  federal  control.  Disburse- 
ments therefrom  shall,  without  further  appropriation,  be  made  in  the  same 
manner  as  before  federal  control  and  for  such  purposes  as  under  the 
Interstate  Commerce  Commission  classification  of  accounts  in  force  on  De- 
cember 27,  1917,  are  chargeable  to  operating  expenses  or  to  railway  tax 
accruals  and  for  such  other  purposes  in  connection  with  federal  control 
as  the  President  may  direct,  except  that  taxes  under  Titles  I  and  II  of  the 
act  entitled  'An  act  to  provide  revenue  to  defray  war  expenses,  and  for 
other  purposes,'  approved  October  1,  1917,  or  any  act  in  addition  thereto 
or  in  amendment  thereof,  shall  be  paid  by  the  carrier  out  of  its  own  funds. 
If  federal  control  begins  or  ends  during  the  tax  year  for  which  any  taxes 
so  chargeable  to  railway  tax  accruals  are  assessed,  the  taxes  for  such 
year  shall  be  apportioned  to  the  date  of  the  beginning  or  ending  of  such 
federal  control,  and  disbursements  shall  be  made  only  for  that  portion 
of  such  taxes  as  is  due  for  the  part  of  such  tax  year  vvhich  falls  within 
the  period  of  federal  control." 


272  FEDERAL  INCOME  TAX 

Standard  Return,  In  the  case  of  railroads  which  elected  to 
have  their  claims  for  compensation  adjusted  by  a  board  of  ref- 
erees, or  the  court  of  claims,  the  government  does  not  deny  the 
right  to  compensation,  but  the  amount  of  compensation  is  placed 
in  dispute.  In  the  case  of  such  roads  an  accrual  should  be  made. 
The  estimated  amount  that  must  be  accrued  in  such  cases  is  the 
so-called  standard  return,-^^ 

Expenses  of  Railroads.  The  following  expenditures  of  rail- 
roads constitute  an  allowable  deduction  from  gross  income: 

1.  Payments  for  labor  and  materials  going  into  the  actual 
operation  of  the  road  and  property. 

2.  Expenses  of  maintenance:  The  upkeep  or  preserving  of 
the  condition  of  the  property  to  be  operated. 

3.  Expenditures  for  replacement  of  old  rails  with  new  and 
heavier  rails,  wooden  bridges  and  culverts  with  concrete  and 
steel  bridges  and  culverts,  except  the  excess  cost,  the  deduction 
being  limited  to  the  cost  of  renewals  with  like  kind  and  quality. 

The  following  are  not  deductible : 

1.  Expenditures  for  additions  and  betterments,  such  as  ex- 
penditures for  sidings  or  spur  tracks. 

2.  Expenditures  for  improving  and  adding  to  the  property, 
such  as  building  new  stations  and  shops,  installing  new  ma- 
chinery, and  making  additions  to  equipment.^^s 

Under  the  provisions  of  Section  15a  of  the  Interstate  Com- 
merce Act,  as  amended  by  the  Transportation  Act  approved  Feb- 
ruary 29,  1920,  railroad  corporations  are  required  to  pay  to  the 
Interstate  Commerce  Commission  one-half  of  their  net  railway 
operating  income  in  excess  of  6  per  cent,  on  their  invested  capital. 
It  is  understood  that  such  payments  are  absolute,  the  railroad 
company  having  no  present  or  future  rights  therein.  It  has  been 
held  that  any  sum  so  paid  may  be  deducted  in  the  taxable  year 
in  which  paid  or  accrued,  dependent  upon  whether  the  books  of 
the  corporation  are  kept  upon  a  cash  receipts  and  disbursements 
or  accrual  basis.^^e 

Telephone  Companies.  Telephone  companies  taken  over  by 
the  government,  whose  compensation  was  fixed  by  the  govern- 
ment, were  required  to  include  such  compensation  in  gross  in- 
come, in  addition  to  the  income  accruing  from  other  sources. 
Companies  whose  compensation  had  not  been  fixed  were  re- 
quired to  include  in  gross  income,  in  addition  to  other  income 
reported,  operating  income  received,  and  when,  later  on,  tl;ie 

244  0.  D.  642,  T.  B.  34-20-1151. 

245  Grand  Rapids  Ry.  Co.  v.  Doyle,  245  Fed.  792;  T.  D.  2210. 

246  o.  D.  989,  T.  B.  32-21-1762. 


CORPORATIONS  273 

President  fixed  the  compensation  for  the  use  of  their  properties 
during  the  taxable  year,  such  companies  filed  amended  returns 
showing  the  total  income  received  and  recomputed  the  tax  on 
that  basis.-^'  A  telephone  company  was  required  to  make  a 
1918  return  for  its  accounting  period,  either  calendar  or  fiscal 
year,  and  all  income  applicable  to  such  period  was  required  to 
be  included  in  the  corporation's  return,  irrespective  of  the  por- 
tion of  the  year  during  which  it  might  have  been  operated  under 
government  control.-^^ 

247  o.  D.  229,  T.  B.  13-19-404. 

248  0.  D.  255,  T.  B.  15-19-449. 


CHAPTER  11 

SPECIAL  PROVISIONS  APPLYING  TO  INSURANCE  COMPANIES 

The  provisions  of  the  Revenue  Act  of  1918  applicable  to  in- 
surance companies  (except  mutual  insurance  companies)  are 
completely  revised  by  the  Revenue  Act  of  1921  which  provides 
an  entirely  new  and  distinctive  scheme  of  taxation  for  such 
companies.  This  revision  was  made  because  the  provisions  of  the 
1918  law  were  regarded  as  "imperfect  and  productive  of  constant 
litigation",  and  because  it  was  regarded  that  the  taxes  paid  by 
such  companies  under  that  law  were  inadequate.  The  plan 
adopted  is  somewhat  similar  to  the  plan  embodied  in  the  Revenue 
Act  of  1918,  as  first  adopted  by  the  senate.^  It  takes  the  place, 
in  the  case  of  life  insurance  companies,  of  the  income  tax  im- 
posed on  other  corporations  for  the  calendar  year  1921,  and 
also  the  capital  stock  tax  for  that  year,  and  applies  for  1921  and 
each  calendar  year  thereafter,  in  lieu  of  such  taxes.  In  the 
case  of  insurance  companies  other  than  life  and  mutual  insurance 
companies,  the  new  tax  takes  the  place  of  the  income  tax  imposed 
on  other  corporations  for  the  calendar  year  1922,  and  also  the 
capital  stock  tax  for  that  year,  and  applies  for  1922  and  each 
calendar  year  thereafter.  Life  insurance  companies  are  relieved 
from  the  excess-profits  tax  for  the  year  1921,  while  other  in- 
surance companies,  including  life  insurance  companies,  will  share 
with  all  other  corporations  in  the  repeal  of  the  excess-profits  tax 
as  of  December  31,  1921.  Insurance  companies  other  than  life 
insuraftce  companies  are,  therefore,  liable  for  the  excess-profits 
tax  for  the  year  1921.-  The  effect  of  the  new  taxes  upon  insur- 
ance companies  with  respect  to  the  capital  stock  tax  is  discussed 
in  another  chapter.-^ 

The  taxes  above  referred  to  are  so  radically  different  from 
the  taxes  formerly  imposed  upon  such  companies  that  it  is 
thought  best  to  discuss  them  separately  in  this  chapter.  The 
discussion  of  the  taxes  imposed  upon  insurance  companies  by 
the  Revenue  Act  of  1918  will  still  be  applicable  and  of  value  for 
years  prior  to  1921  in  the  case  of  life  insurance  companies,  and 
for  years  prior  to  1922  in  the  case  of  other  insurance  companies 

1  See  Reports  of  Finance  Committee  and  Ways  and  Means  Committee, 
respectively,  on  Revenue  Bill  of  1921,  p.  20,  p.  14. 

2  See  Revenue  Act  of  1921,  §§  243,  246  (a). 

3  See  Chapter  44. 

274 


INSURANCE  COMPANIES  275 

(except  mutual  insurance  companies),  and  for  all  years  in  the 
case  of  mutual  insurance  companies. 

Domestic  Life  Insurance  Companies  Under  the  1921  Law.    The 

new  tax  imposed  by  the  present  law  upon  life  insurance  com- 
panies applies  only  to  an  insurance  company  engaged  in  the 
business  of  issuing  life  insurance  and  annuity  contracts  (includ- 
ing contracts  of  combined  life,  health,  and  accident  insurance), 
the  reserve  funds  of  which  held  for  the  fulfillment  of  such  con- 
tracts comprise  more  than  50  per  centum  of  its  total  reserve 
funds.* 

Rate  of  Tax.  The  rate  of  tax  imposed  upon  life  insurance 
companies  under  the  Revenue  Act  of  1921  is  the  same  as  that 
imposed  upon  other  corporations — 10  "^r  upon  the  net  income 
(as  defined  below)  for  the  calendar  year  1921  and  121/2^^  upon 
such  net  income  for  the  calendar  year  1922  and  subsequent 
years. ^ 

Gross  Income.  The  gross  income  of  a  life  insurance  com- 
pany includes  only  the  gross  amount  of  income  received  during 
the  taxable  year  "from  interest,  dividends,  and  rents."'' 

Deductions  in  Computing  Net  Income.  The  Revenue  Act  of 
1921  specifies  a  number  of  deductions  which  are  to  be  applied  in 
reduction  of  gross  income  (as  above  defined)  in  the  calculation 
of  the  net  income  which  is  taxable  in  the  case  of  a  life  insurance 
company.  These  deductions  are  set  forth  in  the  following  para- 
graphs. Many  of  these  deductions  are  the  same  deductions 
which  are  allowed  to  ordinary  corporations." 

Interest  Received  Upon  State  and  Federal  Obligations. 
The  following  may  be  deducted  by  a  life  insurance  company  in 
computing  net  income: 

(1)  Interest  upon  (a)  the  obligations  of  a  state,  territory,  or 
any  political  subdivision  thereof,  or  the  District  of  Columbia ;  or 
(b)  securities  issued  under  the  provisions  of  the  Federal  Farm 
Loan  Act  of  July  17,  1916;  or  (c)  the  obligations  of  the  United 
States  or  its  possessions ;  or  (d)  bonds  issued  by  the  War  Finance 
Corporation;  and 

(2)  An  amount  equal  to  the  excess,  if  any,  over  the  deduction 
specified  in  (1)  of  4'r  of  the  mean  of  the  reserve  funds  required 
by  law  and  held  at  the  beginning  and  end  of  the  taxable  year, 
plus  (in  case  of  life  insurance  companies  issuing  policies  covering 

4  Revenue  Act  of  1921,  §  242. 
'5  Revenue  Act  of  1921,  §  243. 
c  Revenue  Act  of  1921,  §  244  (a). 

7  See  Chapter   10  for  a  discussion  of  these  deductions   and   the   several 
chapters  on  the  particular  deductions. 


276  FEDERAL  INCOME  TAX 

life,  health,  and  accident  insurance  combined  in  one  policy  issued 
on  the  weekly  premium  payment  plan,  continuing  for  life  and 
not  subject  to  cancellation)  4%  of  the  mean  of  such  reserve 
funds  (not  required  by  law)  held  at  the  beginning  and  end  of  the 
taxable  year,  as  the  commissioner  finds  to  be  necessary  for  the 
protection  of  the  holders  of  such  policies  only.s 

The  term  "reserve  funds  required  by  law"  includes,  "in  the 
case  of  assessment  insurance,  sums  actually  deposited  by  any 
company  or  association  with  state  or  territorial  officers  pursuant 
to  law  as  guaranty  or  reserve  funds,  and  any  funds  maintained 
under  the  charter  or  articles  of  incorporation  of  the  company 
or  association  exclusively  for  the  payment  of  claims  arising  under 
certificates  of  membership  or  policies  issued  upon  the  assessment 
plan  and  not  subject  to  any  other  use."^ 

Interest  Paid.  A  life  insurance  company,  in  computing  net 
income,  may  deduct  from  gross  income  all  interest  paid  or  accrued 
within  the  taxable  year  on  its  indebtedness,  except  on  indebted- 
ness incurred  or  continued  to  purchase  or  carry  obligations  or 
securities  (other  than  obligations  of  the  United  States  issued 
after  September  24,  1917,  and  originally  subscribed  for  by  the 
company)  the  interest  upon  which  is  wholly  exempt  from  income 
taxation. 10 

Dividends  Received.  The  following  dividends  may  be  de- 
ducted by  a  life  insurance  company  in  computing  net  income : 

(1)  Dividends  from  a  domestic  corporation  other  than  a  cor- 
poration entitled  to  the  benefit  of  being  taxable  only  with  re- 
spect to  income  from  sources  within  the  United  States,  and 

(2)  Dividends  from  any  foreign  corporation  when  it  is  shown 
to  the  satisfaction  of  the  commissioner  that  more  than  50%  of 
the  gross  income  of  such  foreign  corporation  for  the  three-year 
period  ending  with  the  close  of  its  taxable  year  preceding  the 
declaration  of  such  dividends  (or  for  such  part  of  such  period 
as  the  foreign  corporation  has  been  in  existence)  was  derived 
from  sources  within  the  United  States.^i 

Reserve  for  Dividends.  An  amount  equal  to  2%  of  any 
sums  held  at  .the  end  of  the  taxable  year  as  a  reserve  for  divi- 

8  Revenue  Act  of  1921,  §§245  (a)  12,  213  (b)  4.  Interest  upon  obliga- 
tions of  the  United  States  issued  after  September  1,  1917,  is  exempt  from 
the  income  tax,  which  is  the  only  one  payable  after  January  1,  1921,  by 
life  insurance  companies;  therefore,  such  interest  is  a  deduction  (See 
Chapter  18). 

9  Revenue  Act  of  1921,  §244  (b). 

10  Revenue  Act  of  1921,  §  245  (a)  8.     See  Chapter  23. 

11  Revenue  Act  of  1921,  §  245  (a)  3.    See  Chapters  10  and  32. 


INSURANCE  COMPANIES  277 

dends  (other  than  dividends  payable  during  the  year  following 
the  taxable  year)  the  payment  of  which  is  deferred  for  a  period 
of  not  less  than  five  years  from  the  date  of  the  policy  contract, 
is  deductible  from  the  gross  income  of  a  life  insurance  company 
in  computing  net  income.^'- 

INVESTMENT  EXPENSES.  The  investment  expenses  of  a  life 
insurance  company  are  deductible  from  gross  income  in  com- 
puting net  income.  If  any  general  expenses  are  in  part  as- 
signed to  or  included  in  the  investment  expenses,  the  total  de- 
duction for  investment  expenses  can  not  exceed  V^.  of  IV^  of 
the  book  value  of  the  mean  of  the  invested  assets  held  at  the 
beginning  and  end  of  the  taxable  year.i=^ 

Taxes.  In  computing  the  net  income  of  a  life  insurance 
company  there  may  be  deducted  from  gross  income  taxes  and 
other  expenses  paid  during  the  taxable  year  exclusively  upon  or 
with  respect  to  the  real  estate  owned  by  the  company,  not 
including  taxes  assessed  against  local  benefits  of  a  kind  tending 
to  increase  the  value  of  the  property  assessed,  and  not  including 
any  amount  paid  out  for  new  buildings,  or  for  permanent  im- 
provements or  betterments  made  to  increase  the  value  of  any 
property.  This  deduction  is  allowed  in  the  case  of  taxes  imposed 
upon  a  shareholder  or  member  of  a  company  upon  his  interest 
as  shareholder  or  member,  which  are  paid  by  the  company  with- 
out reimbursement  from  the  shareholder  or  member,  but  in  such 
cases  no  deduction  will  be  allowed  the  shareholder  or  member  for 
the  amount  of  such  taxes.i^ 

No  deduction  for  taxes  will  be  allowed  on  account  of  any  real 
estate  owned  and  occupied  in  whole  or  in  part  by  a  life  insurance 
company  unless  there  is  included  in  the  return  of  gross  income 
the  rental  value  of  the  space  so  occupied.  Such  rental  value  must 
be  not  less  than  a  sum  which  in  addition  to  any  rents  received 
from  other  tenants  will  provide  a  net  income  (after  deducting 
taxes,  depreciation,  and  all  other  expenses)  at  the  rate  of  4'  -  per 
annum  of  the  book  value  at  the  end  of  the  taxable  year  ot  the 
real  estate  so  owned  or  occupied.^-^ 

DEPRECIATION.  In  computing  the  net  income  of  a  hie  insur- 
ance company  there  may  be  deducted  from  gross  income  a  rea- 
sonable allowance  for  the  exhaustion,  wear  and  tear  of  property, 
including  a  reasonable  allowance  for  obsolescence.     In  the  case 

12  Revenue  Act  of  1021,  §  245  (a)  4. 
'  13  Revenue  Act  of  1921,  §245  (a)  5.  ,„        ,  o, 

14  Revenue  Act  of  1921,  §  245  (a)  (5.     See  Chapters  10  ami  .4. 

15  Revenue  Act  of  1921,  §  245  (b). 


278  FEDERAL  INCOME  TAX 

of  property  acquired  before  March  1,  1913,  this  deduction  may 
be  computed  upon  the  basis  of  its  fair  market  price  or  value  as  of 
March  1,  1913.16 

No  deduction  for  depreciation  will  be  allowed  on  account  of 
real  estate  owned  and  occupied  by  a  life  insurance  company  un- 
less the  rental  value  (computed  as  indicated  in  the  preceding 
paragraph)  of  the  space  so  occupied  is  included  in  gross  in- 
come.i^ 

Specific  Exemption.  In  computing  the  net  income  of  a 
(domestic)  life  insurance  company  with  a  net  income  of  $25,000 
(without  the  benefit  of  this  deduction)  there  may  be  deducted 
the  sum  of  $2,000;  but  if  the  net  income  is  more  than  $25,000 
the  tax  imposed  upon  the  company  must  not  exceed  the  tax  which 
would  be  payable  if  the  $2,000  credit  were  allowed,  plus  the 
amount  of  the  net  income  in  excess  of  $25, 000. ^^ 

Foreign  Life  Insurance  Companies  Under  the  1921  Law.  For- 
eign life  insurance  companies  are  taxable  under  the  Revenue  Act 
of  1921  in  the  same  manner  as  domestic  life  insurance  companies, 
except  that  (1)  the  tax  applies  only  to  their  net  income  from 
"sources  within  the  United  States",  and  (2)  they  are  entitled  to 
no  deduction  or  exemption  of  $2,000  (or  any  exemption  in  lieu 
thereof  if  their  net  income  is  more  than  $25,000). ^^  In  the  case 
of  a  foreign  life  insurance  company  the  amount  of  its  net  income 
for  any  taxable  year  from  sources  within  the  United  States  will 
be  the  same  proportion  of  its  net  income  for  the  taxable  year 
from  sources  within  and  without  the  United  States,  which  the 
reserve  funds  required  by  law  and  held  by  it  at  the  end  of  the 
taxable  year  upon  business  transacted  within  the  United  States 
is  of  the  reserve  funds  held  by  it  at  the  end  of  the  taxable  year 
upon  all  business  transacted.-*^ 

Insurance  Companies  (Other  Than  Life  and  Mutual  Compa- 
nies) Under  the  1921  Law.  The  new  tax  imposed  by  the  present 
law  upon  insurance  companies  (other  than  life  and  mutual  in- 
surance companies)  is  at  the  same  rate  as  that  imposed  upon 
other  corporations — 121^%  upon  the  net  income  (as  defined  be- 
low) for  the  calendar  year  1922  and  subsequent  years.  The  new 
tax  does  not  affect  the  calendar  year  1921.21 

16  Revenue  Act  of  1921,  §245   (a)   7.     See  Chapters  10  and  26. 

17  Revenue  Act  of  1921,  §245   (b). 

18  Revenue  Act  of  1921,  §245   (a)  9.     See  Chapter  10. 

19  Revenue  Act  of  1921,  §§  243,  245  (a)  9.     See  Chapters  4  and  12. 

20  Revenue  Act  of  1921,  §245  (c). 

21  Revenue  Act  of  1921,  §246   (a). 


INSURANCE  COMPANIES  279 

Gross  Income.  The  gross  income  of  insurance  companies 
(other  than  life  and  mutual  insurance  companies)  means  the 
combined  gross  amount,  earned  during  the  taxable  year,  from 
investment  income  and  from  underwriting  income  as  defined  in 
this  paragraph,  computed  on  the  basis  of  the  underwriting  and 
investment  exhibit  of  the  annual  statement  approved  by  the  Na- 
tional Convention  of  Insurance  Commissioners.-- 

The  "investment  income"  means  the  gross  amount  of  income 
earned  during  the  taxable  year  from  interest,  dividends  and 
rents,  computed  as  follows : 

To  all  interest,  dividends  and  rents  received  during  the  taxable 
year,  add  interest,  dividends  and  rents  due  and  accrued  at  the 
end  of  the  taxable  year,  and  deduct  all  interest,  dividends  and 
rents  due  and  accrued  at  the  end  of  the  preceding  taxable  year. 

The  "underwriting  income"  means  the  premiums  earned  on  in- 
surance contracts  during  the  taxable  year  less  losses  incurred  and 
expenses  incurred. 

The  term  "premiums  earned  on  insurance  contracts  during  the 
taxable  year"  means  an  amount  computed  as  follows : 

From  the  amount  of  gross  premiums  written  on  insurance 
contracts  during  the  taxable  year,  deduct  return  premiums  and 
premiums  paid  for  reinsurance.  To  the  result  so  obtained  add 
unearned  premiums  on  outstanding  business  at  the  end  of  the 
preceding  taxable  year  and  deduct  unearned  premiums  on  out- 
standing business  at  the  end  of  the  taxable  year. 

The  term  "losses  incurred"  means  losses  incurred  during  the 
taxable  year  on  insurance  contracts,  computed  as  follows: 

To  losses  paid  during  the  taxable  year  add  salvage  and  rein- 
surance recoverable  outstanding  at  the  end  of  the  preceding  tax- 
able year,  and  deduct  salvage  and  reinsurance  recoverable  out- 
standing at  the  end  of  the  taxable  year.  To  the  results  so  obtained 
add  all  unpaid  losses  outstanding  at  the  end  of  the  taxable  year 
and  deduct  unpaid  losses  outstanding  at  the  end  of  the  preceding 
taxable  year. 

The  term  "expenses  incurred"  means  all  expenses  shown  on 
the  annual  statement  approved  by  the  National  Convention  of 
Insurance  Commissioners,  and  is  computed  as  follows : 

To  all  expenses  paid  during  the  taxable  year  add  expenses  un- 
paid at  the  end  of  the  taxable  year  and  deduct  expenses  unpaid 
at  the  end  of  the  preceding  taxable  year.  For  the  purpose  of 
computing  the  net  income  there  must  be  deducted  from  such 

22  Revenue  Act  of  1921,  §246  (b)  1. 


280  FEDERAL  INCOME  TAX 

expenses  incurred  all  expenses  incurred  which  are  not  otherwise 
allowed  as  deductions.^^ 

Deductions  in  Computing  Net  Income.  The  Revenue  Act 
of  1921  allows  insurance  companies  (other  than  life  and  mutual 
insurance  companies)  deductions  for  the  most  part  the  same  as 
the  deductions  which  are  permitted  to  corporations  in  general. 
This  is  true  of  (1)  ordinary  and  necessary  expenses  paid  or  in- 
curred, (2)  taxes  paid  or  accrued,  (3)  dividends  received,  and 
(4)  depreciation  sustained.  The  law  permits  the  deduction  of 
"losses  incurred",  seemingly  without  the  limitations  applicable 
in  the  case  of  other  corporations.  It  permits  the  deduction  of  bad 
debts  in  the  nature  of  agency  balances  and  bills  receivable,  ascer- 
tained to  be  worthless  and  charged  off  within  the  taxable  year. 
All  interest  received  upon  state  and  federal  obligations  which  is 
exempt  from  tax  in  the  case  of  ordinary  corporations,  and  interest 
received  which  may  be  used  as  a  credit  for  purposes  of  the  in- 
come tax  may  also  be  deducted,  as  well  as  the  interest  qmid  or 
accrued  which  may  be  deducted  by  the  ordinary  corporation. 
The  specific  exemption  granted  to  ordinary  corporations  with  a 
net  income  (computed  without  the  benefit  of  the  deduction)  of 
$25,000,  or  less,  as  a  credit,  is  allowed  as  a  deduction  to  this 
class  of  insurance  companies  with  a  net  income  so  computed  of 
$25,000  or  less ;  and  if  the  net  income  so  computed  is  more  than 
$25,000,  the  tax  on  this  class  of  insurance  companies  may  not 
exceed  the  tax  which  would  be  payable  if  the  credit  of  $2,000  were 
allowed,  plus  the  amount  of  the  net  income  in  excess  of  $25,000. 
As  in  the  case  of  all  taxpayers  there  can  be  no  duplication  of  the 
above  deductions;  that  is,  the  same  item  may  not  be  twice  de- 
ducted.24 

Foreign  Insurance  Companies  (Other  Than  Life  and  Mutual 
Companies)  Under  the  1921  Law.  Foreign  insurance  companies 
(other  than  life  and  mutual  insurance  companies)  are  taxable 
under  the  Revenue  Act  of  1921  in  the  same  manner  as  domestic 
insurance  companies  of  the  same  class,  except  that  (1)  the  tax 
applies  only  to  their  net  income  from  "sources  within  the 
United  States",  and  (2)  they  are  entitled  to  no  deduction  or 
ekemption  of  $2,000  (or  any  exemption  in  lieu  thereof  if  their 
net  income  is  more  than  $25,000).  The  deductions  provided  are 
allowable  to  such  foreign  companies  only  if  and  to  the  extent 
that  they  are  connected  with  income  from  "sources  within  the 

23  Eevenue  Act  of  1921,  §  246  (b)  3.  These  methods  are  comparable  to 
the  calculation  of  income  by  the  method  of  inventories.     See  Chapter  16. 

24  Revenue  Act  of  1921,  §247  (a).  See  Chapters  10,  21,  22,  23,  24,  25, 
26,  and  31. 


INSURANCE  COMPANIES  281 

United  States";  and  the  proper  apportionment  and  allocation  of 
the  deductions  with  respect  to  sources  within  and  sources  without 
the  United  States  is  to  be  determined  as  provided  in  the  case 
of  foreign  corporations  and  under  rules  and  regulations  pre- 
scribed by  the  commissioner  with  the  approval  of  the  secretary.-^ 
Comparison  of  1921  and  1918  Laws.  Mutual  insurance  com- 
panies (other  than  mutual  life  insurance  companies)  are,  in 
general,  taxable  under  the  law  in  the  same  manner  as  ordinary 
corporations.  This  applies,  for  instance,  to  mutual  marine  in- 
surance companies.  All  insurance  companies  not  taxed  as  indi- 
cated in  the  previous  paragraphs,  and  so  taxable  as  ordinary 
corporations,'-"  are  allowed  certain  deductions  under  the  1921  law, 
the  necessity  for  which  arises  from  the  peculiar  nature  of  their 
business.-^  These  deductions  are  substantially  the  same  as  the 
corresponding  deductions  allowed  by  the  1918  law.  The  provision 
discussed  below-''  for  a  special  deduction  of  the  net  addition  to 
reserve  funds,  and  sums  other  than  dividends  paid  on  policy  and 
annuity  contracts,  is  applicable  only  to  mutual  insurance  com- 
panies other  than  life  insurance  companies,  after  December  31, 
1921,  and  is  of  course  made  inapplicable  to  life  insurance  compa- 
nies for  1921.-'  Otherwise,  it  is  substantially  the  same  as  the 
corresponding  provision  of  the  1918  law.  The  provision  of  the 
1918  law  for  a  special  deduction,  in  the  case  of  corporations  issu- 
ing policies  covering  life,  health  and  accident  insurance  combined 
in  one  policy  issued  on  the  weekly  premium  payment  plan,  of 
such  portion  of  the  net  addition  to  reserve  funds  as  is  required 
for  the  protection  of  policyholders  is,  of  course,  made  inappli- 
cable to  life  insurance  companies  (as  defined  above)  for  1921,  and 
is  not  applicable  at  all  after  December  31,  1921.-^"  The  provision 
for  a  special  deduction  to  mutual  marine  insurance  companies 
remains  the  same  as  under  the  1918  law.'"'^  The  provision  for  a 
special  deduction  in  the  case  of  mutual  insurance  companies 
(other  than  mutual  life  or  mutual  marine  insurance  companies) 
of  the  amount  of  premium  deposits  returned  to  policyholders 
or  retained  for  the  payment  of  losses,  expenses,  and  reinsurance 

•-!•■>  Revenue  Act  of  1918,  §§  234  (b),  246  (a)  2,  247.     See  Chapters  4  and  12. 

-•'  This  includes  all  insurance  companies  except  life  insurance  companies 
for  the  year  1921. 

^7  See  Revenue  Act  of  1921,  §§234  (a),  10,  11,  12,  13. 

•-*«  See  p.  291. 

-It  Revenue  Act  of  1921,  §  234  (a)  10. 
-   -"Revenue  Act  of  1921,  §234  (a)    11.     See  p.  294  for  a  discussion  of  this 
deduction. 

aiCf.  Revenue  Act  of  1921,  §234  (a)   12.  Revenue  Act  of  1918,  §234  (a) 
12.     See  p.  294  for  a  discussion  of  this  deduction. 


282  FEDERAL  INCOME  TAX 

reserves,  is  retained  in  practically  the  same  form  in  the  present 
law,  but  is  extended  in  its  application  to  "interinsurers  and  recip- 
rocal underwriters"."'-  A  further  provision  of  the  1918  law 
that  mutual  marine  insurance  companies  shall  include  in  gross 
income  "gross  premiums  collected  and  received  by  them  less 
amounts  paid  for  reinsurance"  is  retained  in  the  1921  law.-"-^  The 
provision  of  the  1918  law  that  life  insurance  companies  need  not 
include  in  gross  income  "such  portion  of  any  actual  premium  re- 
ceived from  any  individual  policyholder  as  is  paid  back  or 
credited  to  or  treated  as  an  abatement  of  premiums  of  such 
policyholder  within  the  taxable  year"  is  necessarily  omitted  from 
the  Revenue  Act  of  1921. 

Insurance  Companies  Under  the  1918  Law.  While  the  re- 
maining discussion  contained  in  this  chapter  is  limited  to  the 
1918  law,  it  must  be  remembered  that  the  present  law  substan- 
tially re-enacts  the  1918  law  as  to  mutual  insurance  companies 
(other  than  life  insurance  companies).  For  that  reason  this 
discussion  will  be  important  in  connection  with  such  companies 
for  the  future  as  well  as  the  past.  It  will  also  have  a  bearing 
upon  the  taxation  of  all  insurance  companies  (other  than  life 
insurance  companies)  for  the  year  1921.  In  general,  domestic 
insurance  companies  were  subject,  under  the  Revenue  Act  of 
1918,  to  the  same  provisions  as  other  domestic  corporations,  and 
foreign  insurance  companies  were  subject  to  the  same  provisions 
as  other  foreign  corporations.  In  the  case  of  insurance  compa- 
nies, both  domestic  and  foreign,  certain  special  provisions  govern 
the  calculation  of  gross  income  and  the  allowance  of  deductions.^^ 
These  special  provisions  are  the  subject  of  this  chapter. 

Definition.  Insurance  companies  included  both  stock  and 
mutual  companies  as  well  as  mutual  benefit  insurance  companies. 
A  voluntary  unincorporated  association  of  employees  formed  for 
the  purpose  of  relieving  sick  and  aged  members  and  the  depend- 
ents of  deceased  members  was  an  insurance  company,  whether 
the  fund  for  such  purpose  was  created  wholly  by  membership 
dues  or  partly  by  contributions  from  the  employer.  But  a  corpo- 
ration which  merely  set  aside  a  fund  for  the  insurance  of  its 
employees  was  not  required  to  file  a  separate  return  for  such 

32  Cf.  Revenue  Act  of  1921,  §  234  (a)   13,  Revenue  Act  of  1918,  §  234  (a) 
13.     This  deduction  is  discussed  on  p.  294  below^. 

33  Cf.  Revenue  Act  of  1921,  §233   (a),  Revenue  Act  of  1918,  §233  (a)  2. 
See  p.  294. 

34  Revenue  Act  of  1918,  §§233   (a)   1  and  2,  234    (a)   10,  11,  12  and  13. 


INSURANCE  COMPANIES  283 

fund,  if  the  income  and  disbursements  therefrom  were  included  in 
the  corporation's  own  return.^^ 

An  organization  doing  business  on  the  "interindemnity"  or 
"reciprocal  insurance"  plan  through  an  attorney-in-fact,  subject 
to  direction  by  an  advisory  board  of  policyholders,  which  require 
advance  deposits  to  cover  the  cost  of  the  insurance  and  main- 
tained investments  or  deposits  from  which  substantial  income  is 
derived,  was  held  to  be  a  mutual  insurance  company .^^ 

Gross  Income  of  Insurance  Companies.  The  gross  income 
of  insurance  companies  was  determined  in  the  same  manner  as 
in  the  case  of  other  corporations  except  that  (a)  in  the  case  of 
life  insurance  companies  it  did  not  include  such  portion  of  any 
annual  premium  received  from  any  individual  policyholder  as 
was  paid  back  or  credited  to  or  treated  as  an  abatement  of  pre- 
mium of  such  policyholder  within  the  taxable  year'''  and  (b)  in 
the  case  of  mutual  marine  insurance  companies  it  included  the 
gross  premiums  collected  and  received  by  such  companies  less 
amounts  paid  for  reinsurance.  The  gross  income  of  insurance 
companies  consisted  of  their  total  revenue  from  the  operation  of 
the  business  and  of  their  income  from  all  other  sources  within  the 
taxable  year,  except  as  otherwise  provided  by  the  statute.  Gross 
income  included  net  premiums  (that  is,  gross  premiums  less  re- 
turned premiums  on  policies  cancelled  and  premiums  on  policies 
not  taken),  investment  income,-'*^  profits  from  the  sale  of  assets, 

35  Reg.  45,  Art.  1508. 

^''^  L.  0.  1063,  T.  B.  19-21-1626.  This  decision  was  made  under  the  Capital 
Stock  Tax  imposed  by  §  1000  of  the  Revenue  Act  of  1918  and  the  tax  im- 
posed by  §  503  of  the  Revenue  Act  of  1918.  It  seems  equally  applicable  for 
purposes  of  the  income  tax.  The  cases  chiefly  relied  upon  by  the  solicitor 
were  State  v.  Alley,  96  Miss.  720,  51  So.  467;  and  Imperial  Fire  Ins.  Co.  v. 
Coos  Co.,  151  U.  S.  452,  462.  The  solicitor  appears  to  have  regarded  these 
cases  as  superior  in  authority  to  Blanchard  v.  Hamblin,  162  Mo.  App.  242, 
144  S.  W.  880.  It  was  held  that  no  individual  legal  title  remained  in  the 
sums  deposited  under  the  arrangement  indicated  in  the  text.  (See  Young 
V.  Teutonia  Bank,  134  La.  879,  64  So.  806;  Commercial  Bank  v.  Armstrong. 
148  U.  S.  50;  Sergeant  v.  Goldsmith  Co.,  110  Tex.  482;  159  S.  W.  1036;  221 
S.  W.  259.)  The  amounts  deposited  were  held  to  be  premiums.  North- 
western Life  Assn.  v.  Stout,  32  111.  App.  31,  38;  Union  Ins.  Co.  v.  Hoge, 
21  How.  35;  U.  S.  Life  Ins.  Co.  v.  Spinks  (Ky.),  96  S.  W.  889.  (See,  how- 
ever, Jewelers  Safety  Fund  Society  v.  Lowe,  274  Fed.  93,  note  38  below.) 
In  holding  that  the  association  involved  constituted  a  mutual  insurance 
company,  the  solicitor  relied  upon  Mutual  Ins.  Co.  v.  Hcrold,  198  Fed.  199, 
209. 
-  "5"  This  provision  has  no  application  after  December  31,  1920.     See  p.  285. 

3S  It  was  held,  however,  under  the  1913  Law  in  the  case  of  Jewelers 
Safety  Fund  Society  v.  Lowe,  same  v.  Anderson,  274  Fed.  93  (reversing  a 
lower  court  whose  decision  will  be  found  in  T.   D.  3078,  T.  B.  44-20-1279) 


284  FEDERAL  INCOME  TAX 

and  all  gains,  profits  and  income  reported  to  the  state  insurance 
departments,  except  income  specifically  exempt  from  tax.  Pre- 
miums received  by  mutual  marine  insurance  companies  paid  out 
for  reinsurance  were  required  to  be  eliminated  from  gross  income 
and  the  payments  for  reinsurance  from  disbursements.  Deposit 
premiums  on  perpetual  risks  received  and  returned  by  fire  insur- 
ance companies  were  required  to  be  treated  in  the  same  manner, 
as  no  reserve  was  recognized  covering  liability  for  such  de- 
posits. The  earnings  on  such  deposits  should  be  included  in  the 
investment  income.  A  net  decrease  in  reserve  funds  required  by 
law  within  the  taxable  year  should  be  included  in  the  gross  in- 
come,"-'* But  a  decrease  in  reserve  funds  was  only  taxable  if  it  re- 
sulted in  the  release  to  the  general  uses  of  the  company  of  the 
reserves  set  up  with  the  result  that  the  company's  "free  assets" 
were  increased.  Although  the  reserves  of  an  insurance  company, 
other  than  a  life  insurance  company,  are  generally  speaking  only 
a  percentage  of  its  surplus  which  may  not  be  distributed  in  divi- 
dends, the  efi'ect  is  the  same  as  if  they  were  separate  and  distinct 
funds.  The  "unearned  premium  reserve"  is  not  only  a  guarantee 
of  payment  of  the  policies  against  which  it  is  held  but  also  a  fund 
to  which  resort  may,  in  case  of  necessity,  be  made  for  payment  of 
losses  thereunder.  If  a  loss  occurs  during  the  life  of  any  policy 
the  reserve  established  for  the  protection  of  such  policy  is  re- 
leased, and  to  that  extent  the  reserve  fund  is  reduced.  If  the 
reserve  exceeds  the  amount  of  the  loss  and  the  policy  is  not  con- 
tinued in  force,  the  excess  becomes  part  of  the  general  surplus 

where  the  so-called  premiums  I'eceived  by  the  company  were  simply  de- 
posited with  it  for  convenience  and  could  not  be  used  by  it  or  drawn  upon 
until  a  loss  was  ascertained,  that  in  such  case  the  full  amount  of  such 
deposits  is  not  to  be  included  in  gross  income,  but  only  the  sums  actually 
taken  by  the  society  from  these  deposits  for  the  purpose  of  paying  operating 
expenses  and  losses.  It  was  the  practice  of  the  society  to  deposit  these 
premiums  in  a  bank  which  paid  interest  thereon.  The  court  held  that  this 
interest  was  not  to  be  included  in  gross  income  because  it  belonged  to  the 
depositors  and  not  the  society.  The  society  was  incorporated  in  New  York 
state  by  special  act,  without  capital  stock,  for  mutual  protection  of  its 
members  from  loss  by  fire,  burglary,  etc.,  with  power  only  to  levy  assess- 
ments after  a  loss  occurred. 

39  Revenue  Act  of  1918,  §  233  (a)  1  and  2;  Reg.  45,  Art.  548;  Reg.  33  Rev., 
Art.  239.  A  decrease  in  reserve  funds  is  commonly  called  released  reserve, 
and  was  to  be  treated  as  income  for  the  year  in  which  the  reserve  is 
released.  (Reg.  33  Rev.,  Art.  240).  Released  reserves  though  not  men- 
tioned in  express  terms  in  the  law  have  been  held  to  be  taxable  income  for 
the  year  in  which  released.  (Maryland  Casualty  Co.  v.  U.  S.,  251  U.  S.  342; 
T.  D.  2451).  Under  the  1909  Law  premiums  were  income  of  the  year  of  the 
receipt  (Lumber  Mut.  Fire  Ins.  Co.  v.  Malley,  256  Fed.  380). 


INSURANCE  COMPANIES  285 

of  the  company ;  it  is  "released  to  the  general  uses  of  the 
company."  If,  on  the  other  hand,  no  loss  is  incurred  by  the 
policyholder,  upon  the  expiration  of  the  policy,  the  whole  amount 
of  the  reserve  held  against  it  is  released  to  the  "general  uses 
of  the  company"  and  increases  its  "free  assets."  In  any  case, 
therefore,  in  which  there  was  a  net  decrease  in  the  reserve  funds 
of  an  insurance  company  it  was  necessary  first  to  determine  to 
what  extent  the  reserves  thus  released  had  been  applied  in  the 
payment  of  the  losses  against  which  they  were  held,  and  to  what 
extent  they  exceeded  the  actual  losses  paid,  and  were,  therefore, 
released  to  the  "general  uses  of  the  company."  So  much  of  the 
released  reserve  as  was  applied  to  the  payment  of  losses  never 
became  "free  assets"  of  the  company,  and  was  not  income  of  the 
company ;  but  any  excess  which  was  released  to  general  surplus 
thus  becoming  "free  assets"  available  for  any  purposes  of  the 
company  was  income  to  the  company  in  the  year  in  which  re- 
leased.^*' 

Gross  Income  of  Life  Insurance  Companies.  A  life  insur- 
ance company  was  not  required,  under  the  1918  Law,  to  include 
in  gross  income  such  portion  of  any  actual  premium  received 
from  any  individual  policyholder  as  was  paid  back  or  credited  to 
or  treated  as  an  abatement  of  premium  of  such  policyholder 
within  the  taxable  year. 

"Paid  back"  meant  paid  in  cash. 

"Credited  to"  meant  applied  by  the  way  of  credit  so  as  to  re- 
duce the  premium  received  on  the  policy  for  the  taxable  year.  It 
included  dividends  applied  (a)  directly  to  the  payment  of  the 
premium  for  the  taxable  year;  (b)  to  purchase  additional  paid-up 
insurance  or  annuities ;  or  (c)  to  shorten  the  endowment  or  pre- 
lum paying  period;  or  (d)  left  with  the  company  to  accumulate 
at  interest.  It  did  not  include  the  amount  of  divisible  surplus 
annually  ascertained  and  apportioned  to  deferred  dividend  pol- 
icies.'*^ 

40  L.  0.  1032,  T.  B.  23-20-991;  Maryland  Casualty  Co.  v.  U.  S.,  251  U.  S. 
342. 

41  Revenue  Act  of  1918,  §  233  (a)  1;  Reg.  45,  Art.  549,  as  amended  by  T.  D. 
3153,  T.  B.  17-21-1600,  in  part  reversing:  T.  D.  3053,  T.  B.  34-20-1153  and 
Sol.  Op.  40,  T.  B.  37-20-1195.  T.  D.  3153  was  approved  April  11,  1021.  It 
w^as  held  under  the  1916  Law  that  insofar  as  "deferred  dividends"  payable 
at  a  stated  period  represented  "a  portion  of  any  actual  premium  received," 
they  might  be  omitted  from  gross  income  for  the  year  in  which  they  were 
actually  paid  back,  except  that  so  much  of  any  deferred  dividends  paid 
during  the  tax  year  to  the  individual  policyholder  as  exceeded  the  amount 
of  premiums  paid  during  the  same  year  might  not  be  omitted;  that  only 
the  actual  amount  of  dividends  actually  credited  or  apportioned  to  a  policy- 


286  FEDERAL  INCOME  TAX 

"Treated  as  an  abatement  of  premium"  meant  of  the  premium 
for  the  taxable  year. 

Where  the  dividend  paid  back  or  credited  to  a  policyholder  was 
in  excess  of  the  premium  received  from  such  policyholder  within 
the  taxable  year  there  might  be  excluded  from  gross  income  only 
the  amount  of  the  premium  received,  and  where  no  premium  was 
received  from  the  policyholder  within  the  taxable  year  the  com- 
pany was  not  entitled  to  exclude  from  its  premiums  received 
from  other  policyholders  any  amount  on  account  of  such  divi- 
dend payment.'^- 

It  was  proper  for  a  life  insurance  company  to  exclude  from 
gross  income  of  the  current  year  so  much  of  the  premiums  paid 
during  that  year  as  did  not  exceed  dividends  applied  by  policy- 
holders during  the  year  to  purchase  additional  paid-up  insur- 
ance.4^ 

The  exact  language  of  the  Revenue  Act  of  1918  in  regard  to  the 
gross  income  of  life  insurance  companies  was  as  follows :  "In  the 
case  of  life  insurance  companies  there  shall  not  be  included  in 
gross  income  such  portion  of  any  actual  premium  received  from 
any  individual  policyholder  as  is  paid  back  or  credited  to  or 
treated  as  an  abatement  of  premium  of  such  policyholder  within 
the  taxable  year."^^  This  language  is  substantially  equivalent 
to  the  provision  contained  in  the  1913  law  with  regard  to  the 
gross  income  of  life  insurance  companies.^^     It  has  been  held 

holder  during  the  premium-paying  period,  and  not  any  accretions  thereto, 
could  be  excluded  from  gross  income.  In  the  case  of  whole  life  or  five-year 
distribution  policies,  deferred  dividends  could  be  excluded  from  gross 
income  to  the  extent  that  they  were  paid  back  or  credited  to  the  insured 
or  used  as  an  abatement  of  annual  premiums.     (Reg.  33,  Art.  100.) 

42  Revenue  Act  of  1918,  §233  (a)  1;  Reg.  45,  Art.  549,  as  amended  by 
T.  D.  3153,  T.  B.  17-21-1600,  in  part  reversing  T.  D.  3053,  T.  B.  34-20-1153 
and  Sol.  Op.  40,  T.  B.  37-20-1195.  T.  B.  3153  was  approved  April  11,  1921. 
Reg.  33  Rev.,  Art.  241.  This  provision  has  been  dropped  from  the  1921 
Law  (See  p.  275).  Under  the  1909  Law  there  was  much  litigation  as  to 
whether  so-called  dividends  paid  by  insurance  companies  to  policyholders 
as  a  return  of  a  part  of  the  premium  were  properly  deductible.  The  courts 
held  that  the  so-called  dividends  awarded  annually  to  policyholders  did  not 
constitute  income  (Herold  v.  Mutual  Benefit  Insurance  Co.,  201  Fed.  918, 
affirming  198  Fed.  199)  and  at  the  time  of  the  enactment  of  the  1913  and 
1916  Laws  the  point  was  expressly  covered  by  substantially  the  same  lan- 
guage as  in  the  present  law. 

43  0.  D.  994,  T.  B.  33-21-1770. 

44  Revenue  Act  of  1918,  §233   (a)  1. 

45  The  provision  of  the  1913  Law  was  that  life  insurance  companies — both 
stock  and  strictly  mutual — "shall  not  include  as  income  in  any  year  such 
portion  of  any  actual  premium  received  from  any  individual  policyholder 
as  shall  have  been  paid  back  or  credited  to  such  individual  policyholder,  or 


INSURANCE  COMPANIES  287 

by  the  United  States  Supreme  Court ^''  that  such  provision  of  the 
1913  law  requires  that  purely  mutual  legal  reserve  companies 
issuing  level-premium  insurance  shall  include  in  gross  income 
dividends  paid  by  such  companies  to  any  policyholder  and  not 
applied  in  payment  of  a  premium.  The  insurance  company  in 
this  case  contended  that  the  non-inclusion  clause  of  the  1913 
law  excluded  from  gross  income  the  aggregate  of  all  dividends 
paid  to  any  policyholder  by  credit  upon  a  premium  or  by  abate- 
ment of  a  premium,  and  also  all  dividends  whatsoever  paid  to 
any  policyholder  in  cash,  ivhether  applied  In  payment  of  a  pre- 
mium or  not.  This  contention  was  overruled  by  the  Supreme 
Court  for  the  following  reasons : 

1.  Consulting  the  history  of  the  Act  of  October  3,  1913,  the 
Supreme  Court  found  that  the  non-inclusion  clause  in  question 
was  framed  to  define  what  amounts  involved  in  dividends  should 
be  "non-included"  or  deductible  and  thus  prevent  controversies 
over  questions  which  had  been  raised  by  the  Act  of  August  5, 

1909.^' 

2. '  The  contention  was  made  by  the  insurance  company  that 
the'nature  of  all  life  insurance  dividends  is  the  same,  whatever 
the  disposition  made  of  them;  that  Congress  could  not  have  in- 
tended to  relieve  life  insurance  companies  from  taxation  to  the 
extent  that  dividends  are  applied  in  payment  of  premiums  and 
to  tax  them  to  the  extent  that  dividends  are  not  so  applied ;  that 
Congress  must  be  assumed  to  have  intended,  in  obedience  to  the 
demands  of  consistency,  that  all   dividends   should  be  treated 
alike.     Disposing  of  this  contention,  the   Supreme  Court  held 
that  the  differentiation  between  dividends  applied  in  payment 
of  a  premium  and  those  not  so  applied  was  entirely  consistent, 
the  principle  being  that  of  imposing  taxation  upon  net  premiums 
instead  of  gross  premiums.    The  Supreme  Court  held  that  "there 
is  a  striking  difference  between  an  aggregate  of  individual  pre- 
miums, each  reduced  by  means  of  dividends,  and  an  aggregate  of 
full  premiums  from  which  it  is  sought  to  deduct  amounts  paid 
out  by  the  company  which  have  no  relation  whatever  to  premiums 

treated  as  an  abatement  of  premium  of  such  individual  policyholder,  within 
such  year."     (Act  of  October  3,  1913,  §  II  G  (b).) 

4r.Penn  Mutual  Life  Insurance  Co.  v.  Lederer,  2o2  U.  S.  523,  T.  D.  3U4b, 
T.  B.  33-20-1138.    See  Sol.  Op.  70,  T.  B.  44-20-1280^ 

47  See   Mutual   Benefit   Life   Insurance   Co.   v.   Herold,   198    Fed.    199,   m 
which   the  court  stated  that  dividends  applied  as  a  reduction  on  renewa 
premiums  "should  not  be  confused  with  dividends  ^ec  ared  m  th     case  o 
a  full-paid   participating   holder  wherein   the   policyholder  has   no   further 
premium  payment     to  make.    Such   pay.,ent.  havings  been  duly   made,  th 
loZ^ZrLo.ne   at   once  a  contract   of   iu.urance  and  an  rnvestment. 


288  FEDERAL  INCOME  TAX 

received  within  the  tax  year,  but  which  relate  to  some  other 
premium  which  may  have  been  received  many  years  earlier." 
This  second  contention  of  the  insurance  company  was  also 
answered  by  the  argument  that  the  motive  for  taking  level-pre- 
mium life  insurance  may  be  mainly  protection,  but  the  motive 
of  such  insurance  is  largely  that  of  ''savings  investment."  When 
the  dividend  is  applied  in  reduction  of  the  renewal  premium. 
Congress  might  well  regard  the  element  of  protection  as  pre- 
dominant, and  treat  the  reduction  of  the  premium  paid  by  means 
of  the  dividend  as  merely  a  lessening  of  the  expense  of  protection, 
but  after  the  policy  is  paid  up  the  element  of  investment  pre- 
dominates and  Congress  might  reasonably  regard  dividends  not 
applied  in  reduction  of  the  renewal  premium  as  profit  on  the  in- 
vestment. 

3.  The  contention  was  made  by  the  insurance  company  that 
the  juxtaposition  of  the  clauses  covering  the  income  of  mutual 
fire  and  mutual  life  insurance  companies  and  the  provision  cover- 
ing mutual  life  insurance  companies  required  the  application 
of  the  same  rule  to  all  in  regard  to  returned  premiums.  The 
Supreme  Court  answered  this  contention  with  the  argument  that 
the  three  different  rules  prescribed  in  three  separate  clauses 
for  three  classes  of  insurance  was  conclusive  evidence  that  Con- 
gress deliberately  intended  to  differentiate.  The  purpose  of 
this  differentiation  was  then  explained  by  a  consideration  of  the 
distinction  between  mutual  fire  and  mutual  marine  insurance 
companies  on  the  one  hand,  and  mutual  life  insurance  companies 
on  the  other.  The  thing  for  which  a  fire  or  marine  insurance 
premium  is  paid  is  protection,  which  ceases  at  the  end  of  the 
term.  If  after  the  end  of  the  term  part  of  the  premium  is  re- 
turned, it  is  not  returned  as  something  purchased  with  the  pre- 
mium, but  as  a  part  of  the  premium  which  was  not  required  to 
pay  for  the  protection,  that  is,  the  expense  was  less  than  esti- 
mated. On  the  other  hand,  the  service  performed  in  level-pre- 
mium life  insurance  is  both  protection  and  investment.  Premiums 
paid  have  earned  so  much  for  the  co-operators  that  the  company 
is  able  to  pay  to  each  not  only  the  agreed  amount  but  also  addi- 
tional sums  called  dividends,  which  additional  sums  have  been 
earned  in  part,  at  least,  by  transactions  not  among  the  members 
but  with  others,  as  by  lending  the  money  of  the  co-operators  to 
third  persons.  The  fact  that  the  investment  resulting  in  the 
accumulation  or  dividend  is  made  by  a  co-operative,  as  distin- 
guished from  a  capitalistic,  concern  does  not  prevent  the  amount 
thereof  from  being  deemed  a  profit  on  the  investment  or  from 
being  taxable.     The  failure  to  differentiate  between  stock  and 


INSURANCE  COMPANIES  289 

mutual  life  insurance  companies  was  not  inadvertent.  There  is 
a  legal  difference  between  stock  fire  and  marine  companies  and 
mutual  fire  and  marine  companies,  but  the  participating  policy 
commonly  issued  by  a  stock  life  insurance  company  is  both  in 
rights  conferred  and  in  financial  results  substantially  the  same 
as  a  policy  issued  by  a  purely  mutual  life  insurance  company. 
The  real  difference  between  the  two  classes  of  life  companies  as 
now  conducted  lies  in  the  legal  right  of  electing  the  directors  and 
officers. 

4.  Answering  the  contention  of  the  company  that  the  decision 
of  the  court  below  required  the  interpolation  of  the  words 
"within  such  year"  in  the  statute  after  the  words  "any  indi- 
vidual policyholder,"  the  Supreme  Court  held  that  what  the 
insurance  company  was  seeking  was  not  to  have  "non-included" 
a  part  of  the  premiums  which  were  actually  received  within  the 
year  or  which  appeared  as  a  matter  of  bookkeeping  to  have  been 
received,  but  actually  were  not,  but  that  the  company  was  seek- 
ing to  have  the  aggregate  of  premiums  actually  received  in  a 
year  reduced  "by  an  amount  which  the  company  paid  out  within 
the  year,  mainly  on  account  of  premiums  received  long  before 
the  tax  year" ;  that  what  the  company  really  sought  was  "not  a 
non-inclusion  of  amounts  paid  in — but  the  deduction  of  amounts 
paid  out".  The  Supreme  Court  then  referred  to  another  pro- 
vision of  the  statute  prescribing  that  there  might  be  deducted 
"the  sums  other  than  dividends  paid  within  the  year  on  policy 
and  annuity  contracts".  This  clause  was  held  to  be  tantamount 
to  a  direction  that  dividends  should  not  be  deducted. 

In  support  of  the  company's  contention-  it  was  urged  that  the 
court  should  consider  the  history  of  the  Revenue  Act  of  1918  and 
specifically  that  in  that  bill,  as  introduced  and  passed  by  the 
House,  the  corresponding  section^^  contained  the  words  "within 
the  taxable  year",  and  that  these  words  were  stricken  out  by 
the  conference  committee.'"  The  court  held  that  no  aid  could  be 
derived  from  the  legislative  history  of  an  act  passed  nearly  six 
years  after  the  one  in  question.  It  may  be  argued  that  this 
legislative  history  of  the  present  statute  indicates  an  intention 
on  the  part  of  Congress  to  permit  dividends  of  a  mutual  life  in- 
surance company  not  applied  in  payment  of  premiums  to  be 
"non-included"  in  gross  income.  This  contention  would  seem, 
however,  to  be  unsound  in  view  of  the  fact  that  the  Revenue  Act 
of  1918  contains  a  provision  substantially  the  same  as  that  con- 

48  Revenue  Act  of  1918,  §  233  (a). 

49  Report  No.  1037,  65th  Congress. 


290  FEDERAL  INCOME  TAX 

tained  in  the  1913  law  referred  to  by  the  Supreme  Court;  that 
is,  it  provides  that  insurance  companies  may  deduct  ''the  sums 
other  than  dividends  paid  w^ithin  the  taxable  year  on  policy  and 
annuity  contracts"."'*'  This  is  apparently  the  view  of  the  treas- 
ury department,  and  it  has  been  held  that  a  life  insurance  com- 
pany is  not  entitled  to  exclude  from  its  total  income  during  the 
taxable  year,  for  the  purpose  of  ascertaining  its  gross  income, 
any  dividends  paid  or  credited  to  policyholders  from  whom  it 
did  not  receive  any  premium  during  that  year ;  and  as  to  policy- 
holders from  whom  as  it  did  receive  premiums  that  year  it  is 
entitled  to  exclude  only  such  part  of  the  dividends  paid  to  those 
policyholders  as  did  not  exceed  the  amounts  received  from  them, 
respectively,  by  way  of  premiums  during  that  year.^i 

Deductions  Allowed  Insurance  Companies.  Insurance 
companies  were  entitled,  under  the  Revenue  Act  of  1918,  to  the 
same  deductions  from  gross  income  as  other  corporations,  and 
also  to  the  deduction  of  the  net  addition  required  by  law  to  be 
made  within  the  taxable  year  to  reserve  funds  and  of  the  sums 
other  than  dividends  paid  within  the  taxable  year  on  policy  and 
annuity  contracts.^^ 

*Taid"  included  "accrued"  or  "incurred"  (construed  according 
to  the  method  of  accounting  upon  the  basis  of  which  the  net  in- 
come was  computed  during  the  taxable  year),  but  did  not  include 
any  estimate  for  losses  incurred  but  not  reported  during  the 
taxable  year.  As  payments  on  policies  there  were  required  to 
be  reported  all  death,  disability  and  other  policy  claims  (other 
than  dividends  as  above  specified)  paid  within  the  year,  including 
fire,  accident  and  liability  losses,  matured  endowments,  annui- 
ties, payments  on  installment  policies  and  surrender  values 
actually  paid.^^ 

50  Revenue  Act  of  1918,  §  234  (a)  10. 

51  T.  D.  2899,  T.  B.  20-19-514.  For  the  rule  under  the  1909  Law  see  Fink 
V.  Northwestern  Mutual  Life  Ins.  Co.,  267  Fed.  968;  T.  D.  3057,  T.  B.  36- 
20-1187. 

52  So-called  cash  bonuses  and  other  sums  paid  as  a  gratuity  by  an  insur- 
ance company  to  nonparticipating  policyholders  or  beneficiaries  have  been 
held  under  the  1909  Law  which  permitted  the  deduction  of  "sums  other 
than  dividends  paid  within  the  year  on  policy  and  annuity  contracts"  (§  38, 
Second)  not  to  be  deductible  from  gross  income  in  corporation  excise  tax 
returns  as  sums  other  than  dividends  paid  within  the  year  on  policy  and  an- 
nuity contracts.     (Sol.  Op.  100,  T.  B.  18-21-1612). 

53  Revenue  Act  of  1918,  §  234  (a)  10;  Reg.  45,  Art.  568.  Surrender  values 
applied  in  any  manner,  consideration  for  supplementary  contracts,  involving 
and  not  involving  life  contingencies,  should  be  included  in  the  gross  income 
of  life  insurance  companies.  Applied  surrender  values  and  consideration  for 
supplementary  contracts  not  involving  life  contingencies  included  in  income 


insurance  companies  291 

Deduction  of  Required  Addition  to  Reserve  Funds  by  In- 
surance Companies.  Insurance  companies  were  permitted 
under  the  1918  law,  to  deduct  from  gross  income  the  net  addi- 
tion required  by  law  to  be  made  within  the  taxable  year  to  re- 
serve funds,  including  in  the  case  of  assessment  insurance  com- 
panies the  actual  deposit  of  sums  with  state  or  territorial  officers 
pursuant  to  law  as  additions  to  guarantee  or  reserve  funds.-'^ 
This  was  first  considered  to  mean  the  net  addition  required  by 
the  specific  statutes  of  the  states  within  which  the  taxpayer 
transacted  business.  It  was  later  held  that  a  requirement  by  a 
state  insurance  commissioner  that  a  net  addition  shall  be  made 
to  certain  amounts  retained  to  meet  specified  liabilities  was  a 
net  addition  required  by  law  to  be  made  to  reserve  funds  within 
the  meaning  of  the  statute,  if  required  by  rules  and  regulations 
promulgated  in  the  exercise  of  an  appropriate  power  conferred 
by  statute.-"'  Only  reserves  commonly  recognized  as  reserve 
funds  in  insurance  accounting  were  to  be  taken  into  considera- 
tion in  computing  the  net  addition  to  reserve  funds  required  by 
law.  Assets  required  to  be  held  for  the  ordinary  running  expenses 
of  the  business,  such  as  taxes,  salaries,  reinsurance  and  unpaid 
brokerage  were  not  reserves  the  additions  to  which  might  be  de- 
ducted.^" 

are  deductible  as  payments  under  policy  contracts,  but  for  convenience  in 
verifying:  the  returns  these  items  should  appear  in  the  return  in  gross 
income  and  deductions.     (Reg.  33  Rev.,  Art.  241.) 

•"'^Reg.  45,  Art.  569. 

•"•  Maryland  Casualty  Co.  v.  U.  S.,  251  U.  S.  342,  modifying  52  St.  Cls.  201, 
T.  D.  2451.  In  McCcach  v.  Insurance  Co.  of  North  America,  244  U.  S.  585,  37 
Sup.  Ct.  709,  it  was  held  that  a  reserve  required  in  Pennsylvania  to  be 
maintained  by  a  fire  and  marine  insurance  company  against  unpaid  losses 
was  not  a  reserve  required  by  law  since  it  was  not  required  by  express 
statutory  provision.  There  is  nothing  in  this  case  inconsistent  with  the 
rule  recently  laid  down  in  Maryland  Casualty  Co.  v.  U.  S.,  251  U.  S.  342. 
There  was  no  question  in  the  McCoach  case  but  that  under  an  administrative 
interpretation  of  the  Pennsylvania  statute  the  reserve  was  required  to  be 
set  up;  the  case  turned  upon  the  question  whether  the  reserve  was  the 
kind  of  reserve  referred  to  in  the  1909  Law.  In  other  words,  the  case 
involved  a  definition  of  the  word  "reserve".  Under  the  1909  Law  it  has 
been  held  that  reserve  funds,  the  net  addition  to  which  is  to  be  deducted 
from  the  gross  income  of  a  life  insurance  company  in  computing  its  net 
income,  are  those  funds  which  are  built  up  to  mature  the  policy,  and  do  not 
include  funds  reserved  because  of  liabilities  on  supplementary  contracts 
not  involving  life  contingencies  and  canceled  policies  upon  which  a  cash- 
sucrender  value  may  be  demanded.  (Fink  v.  Northwestern  Mutual  Life 
Ins.  Co.,  267  Fed.  968;  T.  D.  3057,  T.  B.  36-20-1187.) 

■"■'fiReg.  45,  Art.  569;  Maryland  Casualty  Co.  v.  U.  S.,  251  U.  S.  342.  A  re- 
serve for  the  expense  of  investigating  loss  claims  of  an  insurance  company 


292  FEDERAL  INCOME  TAX 

In  the  case  of  a  casualty,  liability,  fidelity,  guaranty  and 
surety  insurance  company  recently  decided  by  the  United  States 
Supreme  Court''''  the  term  "reserve"  has  been  defined  as  follows : 
"*  *  *  A  sum  of  money,  variously  computed  or  estimated, 
which,  with  accretions  from  interest,  is  set  aside,  'reserved',  as 
a  fund  with  which  to  mature  or  liquidate,  either  by  payment  or 
reinsurance  with  other  companies  future  unaccrued  and  con- 
tingent claims,  and  claims  accrued,  but  contingent  and  indefinite 
as  to  amount  or  time  of  payment."  In  the  case  of  the  company 
under  consideration  a  "reserve  for  unearned  premiums",  a 
"special  reserve  for  unpaid  liability  losses"  and  a  "loss  claims 
reserve"  were  held  to  fall  within  this  definition.  On  the  other 
hand,  a  reserve  maintained  by  the  insurance  company  for  "un- 
paid taxes,  salaries,  brokerage  and  reinsurance  due  other  com- 
panies" was  held  not  to  fall  within  such  definition.  The  require- 
ments of  various  states  referring  to  such  reserves  use  the  term 
"reserve"  in  a  nontechnical  sense  and  not  necessarily  in  the 
sense  of  the  1909  law.  It  has  been  held  by  the  treasury  de- 
partment that  the  amount  deductible  as  an  addition  to  reserve 
funds  is  the  excess  of  the  total  reserve  fund  as  required  by  law 
at  the  end  of  the  taxable  year  over  the  total  of  such  reserve 
funds  at  the  beginning  of  the  year,  regardless  of  the  fact  that 
during  the  year  the  reserve  funds  are  increased  on  account  of 
new  business,  and  decreases  in  such  funds  are  inevitable  when 
policies  mature,  lapse,  or  are  surrendered.'^'^ 

In  the  case  of  a  fire  insurance  company  the  only  reserve  fund 
commonly  recognized  is  the  "unearned  premium"  fund.  A  re- 
serve set  up  by  a  fire  insurance  company  against  unpaid  losses 
has  been  held  not  to  be  deductible.-^^ 

Casualty  companies  might  deduct  losses  incurred  within  the 
taxable  year;  but  unless  the  net  addition  to  the  unpaid  loss  re- 
serve required  by  law  exceeded  such  losses  incurred,  no  deduc- 
tion for  the  net  addition  to  the  unpaid  loss  reserve  might  be 
taken.  In  any  event  only  the  excess  of  such  net  addition  over 
such  losses  might  be  deducted.^*' 

has  been  held  not  to  be  a  "reserve"  within  the  meaning  of  the  1913  Law  and 
any  net  addition  thereto  may  not  be  deducted  in  determining  net  income. 
(SoL  Op.  76,  T.  B.  47-20-1315.) 

57  Maryland  Casualty  Co.  v.  U.  S.,  251  U.  S.  342.  See  the  definitions  of 
"reserve"  in  Fink  v.  Northwestern  Mutual  Life  Ins.  Co.,  267  Fed.  968;  T.  D. 
3057,  T.  B.  36-20-1187. 

58  0.  D.  427,  T.  B.   13-20-876. 

59  L.  O.  1056,  T.  B.  2-21-1391.  This  ruling  applies  under  the  1916  Law, 
the  1913  Law,  and  the  1909  Law  (0.  D.  1094,  T.  B.  45-21-1912). 

60  Reg.  45,  Art.  569. 


INSURANCE  COMPANIES  293 

In  the  case  of  life  insurance  companies  the  net  addition  to  the 
"reinsurance  reserve"  and  the  "reserve  for  supplementary  con- 
tracts'"'^ not  involving  life  contingencies,"  and  the  net  addition 
to  any  other  reserve  funds  necessarily  maintained  for  the  pur- 
pose of  liquidating  policies  at  maturity,  were  legally  deductible. 
An  increase  in  the  reserve  maintained  by  a  life  insurance  com- 
pany to  pay  dividends  on  deferred  dividend  policies  was  not  per- 
mitted to  be  deducted  from  gross  income.'"'- 

A  life  insurance  company  which  maintained  a  reserve  to 
liquidate  coupons  left  with  the  company  to  accumulate  at  in- 
terest and  accrued  interest  thereon  was  held  entitled  to  deduct 
from  gross  income  the  net  addition  made  each  year  to  such 
fund/^  The  reserves  annually  set  aside  by  life  insurance  com- 
panies in  the  state  of  Nebraska  for  the  protection  of  deferred 
dividend  policies  have  been  held  to  be  reserves  required  by  law 
in  ascertaining  whether  there  has  been  a  net  addition  to  reserve 
funds  deductible  in  computing  the  net  income/'^ 

Mutual  hail  and  mutual  cyclone  insurance  companies  were  en- 
titled to  deduct  from  gross  income  the  net  addition  which  they 
were  required  to  make  to  the  "guaranty  surplus"  fund  or  similar 
fund.*^'^ 

«i  Where  a  life  insurance  company's  policies  contain  an  option  to  have 
proceeds  paid  in  annual  installments  for  a  given  term  of  years,  or  during 
the  lifetime  of  the  beneficiary,  instead  of  in  one  sum,  such  policies,  if  the 
option  is  exercised,  are  styled  "supplementary  policy  contracts."  These 
obligations  are  protected  by  reserves,  the  net  additions  to  which  are  deduct- 
ible if  such  reserves  are  "required  by  law."  The  Commissioners  of  Insurance 
of  all  the  states  require  the  establishment  of  a  reserve  to  cover  the  obliga- 
tions of  the  company  on  such  supplementary  policy  contracts.  This  fact  of 
itself  tends  strongly  to  show  that  they  are  required  by  law  (Mutual  Benefit 
Ins.  Co.  V.  Herold,  198  Fed.  199,  affirmed  201  Fed.  918). 

«2  Reg.  45,  Art.  569. 

63  0.  D.  799,  T.  B.  1-19-96. 

64  Sol.  Op.  40,  T.  B.  37-20-1195. 

65  Revenue  Act  of  1918,  §234  (a)  10;  Reg.  45,  Art.  569.  Under  the  laws 
of  Pennsylvania  reserves  against  unpaid  losses  are  required  by  law  of 
casualty  companies,  but  not  of  fire  and  marine  insurance  companies.  Hence, 
the  latter  can  not  deduct  reserves  against  losses,  although  the  Insurance 
Commissioner  of  Pennsylvania  may  require  such  reserves  under  a  practice 
of  his  office  established  for  many  years  and  relied  upon  as  an  administra- 
tive interpretation  of  the  law  of  that  state.  (See  Insurance  Company  of 
North  America  v.  McCoach,  218  Fed.  905,  reversed  224  Fed.  657,  661,  writ  of 
certiorari  granted,  241  U.  S.  694,  reversed  244  U.  S.  585;  T.  D.  2501.)  It 
has  been  held  that  the  act  addition  may  be  based  upon  the  highest  authorized 
reserve  required  by  the  statutes  of  any  state  in  which  the  company  does 
business,  but  that,  having  adopted  the  requirements  of  one  state,  a  company 
can  not  base  its  reserve  upon  the  requirements  of  another  state  for  subse- 
quent years  (T.  D.  1727;  Reg.  33  Rev.,  Art.  240). 


294  federal  income  tax 

Special  Deductions  Allowed  in  the  Case  of  Combined 
Life,  Health  and  Accident  Policies.  Corporations  issuing 
combination  policies  of  life,  health  and  accident  insurance  on  the 
weekly  premium  payment  plan,  continuing  for  life  and  not  sub- 
ject to  cancellation,  were  permitted,  under  the  1918  law,  to  de- 
duct from  gross  income  only  such  portion  of  the  net  addition 
not  required  by  law  made  within  the  taxable  year  to  reserve 
funds  as  was  needed  for  the  protection  of  the  holders  of  such 
combination  policies.  In  general,  the  net  addition  to  any  fund 
especially  maintained  for  the  protection  of  such  policyholders 
might  be  deducted.  The  determination  by  the  company  of  the 
need  for  such  addition  was  subject  to  review  by  the  commis- 
sioner, and  the  return  of  income  was  required  to  be  accom- 
panied by  a  full  explanation  of  the  basis  upon  which  such  fund 
and  the  additions  to  it  were  determined.^'' 

Special  Deductions  Allowed  Mutual  Marine  Insurance 
Companies.  Mutual  marine  insurance  companies  should  in- 
clude in  gross  income  the  gross  premiums  collected  and  received 
by  them  less  amounts  paid  for  reinsurance.  They  may  deduct 
from  gross  income  amounts  repaid  to  policyholders  on  ac- 
count of  premiums  previously  paid  by  them,  together  with  the 
interest  actually  paid  upon  such  amounts  between  the  date  of 
ascertainment  and  the  date  of  payment  thereof.  The  remainder 
of  the  premiums  accordingly  forms  part  of  the  net  income  of  the 
company,  except  to  the  extent  that  they  are  subject  to  the  de- 
ductions allowed  insurance  companies  in  general  and  other  cor- 
porations.'^'^ 

Special  Deductions  Allowed  Mutual  Insurance  Compa- 
nies. Mutual  insurance  companies  (other  than  mutual  life  and 
mutual  marine  insurance  companies),  which  require  their  mem- 
bers to  make  premium  deposits  to  provide  for  losses  and  ex- 
penses, are  allowed  to  deduct  from  gross  income  the  aggregate 
amount  of  premium  deposits  returned  to  their  policyholders  or 
retained  for  the  payment  of  losses,  expenses  and  reinsurance  re- 
serves.'''^ In  determining  the  amount  of  premium  deposits  re- 
tained by  a  mutual  fire  or  mutual  casualty  insurance  company 

66  Reg.  45,  Art.  570;  Sol.  Op.  83,  T.  B.  3-21-1402.  This  provision  is  not 
applicable  to  life  insurance  companies  after  December  31,  1920,  nor  to 
any  companies  after  December  31,  1921.     See  p.  281. 

67  Reg.  45,  Art.  571;  Revenue  Act  of  1918,  §§  233  (a)  2,  234  (a)  12.  This 
provision  is  substantially  the  same  in  the  Revenue  Act  of  1921. 

68  Revenue  Act  of  1918,  §234  (a)  13;  Reg.  45,  Art.  372.  This  provision 
is  extended  in  the  1921  Law  to  interinsurers  and  reciprocal  underwriters; 
otherwise  it  is  substantially  the  same. 


INSURANCE  COMPANIES  295 

for  the  payment  of  losses,  expenses  and  reinsurance  reserves,  it 
is  to  be  presumed  that  losses  and  expenses  have  been  paid  out  of 
earnings  and  profits,  other  than  premiums,  to  the  extent  of  such 
earnings  and  profits.'"'  If,  however,  any  portion  of  such  amount 
is  applied  during  the  taxable  year  to  the  payment  of  losses,  ex- 
penses or  reinsurance  reserves,  for  which  a  separate  allowance 
is  taken,  then  such  portion  is  not  deductible,  and  if  any  portion 
of  such  amount  for  which  an  allowance  is  taken  is  subsequently 
applied  to  the  payment  of  expenses,  losses  or  reinsurance  re- 
serves, then  such  payment  can  not  be  separately  deducted.  ,An 
amount  of  premium  deposits  retained  for  the  payment  of  ex- 
penses and  losses,  and  the  amount  of  such  expenses  and  losses, 
may  not  both  be  deducted.  A  company  which  invests  part  of 
the  premium  deposits  so  retained  by  it  in  interest-bearing  se- 
curities may  nevertheless  deduct  such  part,  but  not  the  interest 
received  on  such  securities.  A  mutual  fire  insurance  company 
which  has  a  guaranty  capital  is  taxed  like  other  mutual  fire  in- 
surance companies.  A  stock  fire  insurance  company,  operated 
on  the  mutual  plan  to  the  extent  of  paying  dividends  to  certain 
classes  of  policyholders,  may  make  a  return  on  the  same  basis 
as  a  mutual  fire  insurance  company  with  respect  to  its  business 
conducted  on  the  mutual  plan.™ 

Returns  of  Insurance  Companies.  Insurance  companies  trans- 
acting business  in  the  United  States  or  deriving  income  from 
sources  therein  are  required  to  file  returns  of  income.  As  an  aid 
in  auditing  the  returns  it  was  suggested  under  the  1918  law  that 
wherever  possible  a  copy  of  the  report  to  the  state  insurance 
department  be  submitted  with  the  return.  Otherwise  it  was 
suggested  that  a  copy  of  Schedule  D,  parts  1,  3  and  4,  of  the 
report  be  attached  to  the  return,  showing  the  federal,  state  and 

•«•  L.  O.  1050,  T.  B.  40-20-1226,  overruling  O.  D.  403,  T.  B.  7-20-744. 

™  Revenue  Act  of  1918,  §  234  (a)  13;  Reg.  45,  Art.  572.  Under  the  1916 
Law  it  was  provided  that  "mutual  fire  and  mutual  employers'  liability  and 
mutual  workmen's  compensation  and  mutual  casualty  insurance  companies 
requiring  their  members  to  make  premium  deposits  to  provide  for  losses  and 
expenses  shall  not  return  as  income  any  portion  of  the  premium  deposits 
returned  to  their  policyholders,  but  shall  return  as  taxable  income  all  income 
received  by  them  from  all  other  sources  plus  portions  of  their  premium  de- 
posits as  are  retained  by  the  companies  for  purposes  other  than  the  payment 
of  losses  and  expenses  and  reinsurance  reserves."  (Revenue  Act  of  1916, 
§12  (a).)  It  will  thus  be  noted  that  in  the  case  of  such  companies  the 
amount  of  premium  deposits  returned  to  policyholders  was  excluded  from 
gross  income,  under  the  1916  Law,  but  under  the  present  law  the  amount 
of  such  deposits  will  be  included  therein,  and  taken  as  a  deduction;  and 
this  will  also  be  true  of  such  portions  of  their  premium  deposits  as  are 
retained  for  the  payment  of  losses,  expenses  and  reinsurance  reserves. 


296  FEDERAL  INCOME  TAX 

municipal  obligations  from  which  the  interest  omitted  from 
gross  income  was  derived,  and  a  copy  of  the  complete  report 
was  required  to  be  furnished  as  soon  as  ready  for  filing."^ 

Foreign  Insurance  Companies.  Foreign  insurance  companies 
were  required,  under  the  1918  law,  to  report  as  gross  income 
only  the  gross  income  from  sources  within  the  United  States, 
Income  from  business  transacted  by  a  United  States  branch  or 
agency  of  a  foreign  insurance  company  which  related  to  a  for- 
eign country  was  required  to  be  returned  as  gross  incomes- 
Foreign  insurance  companies  with  agents  or  brokers  in  this 
country  soliciting  insurance  and  collecting  premiums  for  them 
were  held  to  be  doing  business  in  the  United  States,  so  that  any 
income  received  from  such  sources  was  income  from  "sources 
within  the  United  States" J^ 

Expenses  Under  the  1916  Law.  The  same  allowance  for  ex- 
penses was  permitted  to  insurance  companies  as  in  the  case  of 
other  corporations.  Insurance  companies  were  permitted  to  add 
to  expenses,  in  lieu  of  depreciation  of  furniture  and  fixtures,  the 
actual  cost  of  repairs,  replacements  and  renewals  of  such  furni- 
ture, as  reported  to  the  state  insurance  department,  provided 
that  in  the  case  of  an  original  investment,  the  cost  thereof  was 
charged  to  capital  accountJ-* 

71  Reg.  45,  Art.  623. 

72  Revenue  Act  of  1918,  §233  (b);  Reg.  33  Rev.,  Art.  244. 

73  0.  D.  586,  T.  B.  28-20-1062. 

74  Reg.  33  Rev.,  Art.  240. 


CHAPTER  12 

FOREIGN  CORPORATIONS 

Foreign  corporations,  like  domestic  corporations,  are  taxed  as 
separate  entities  apart  from  their  stockholders.  They  were 
subject,  under  the  Revenue  Act  of  1918,  to  a  tax  of  10'*  upon 
their  net  income  from  "sources  within  the  United  States"  for 
the  years  1919  and  1920.^  Under  the  present  law,  in  lieu  of 
that  tax,  they  are  subject  to  a  tax  of  lOS'  upon  their  net  income 
from  "sources  within  the  United  States"  for  the  year  1921,  and 
121/2%  foi'  the  year  1922  and  subsequent  years.  This  increase 
of  rate  is  in  lieu  of  the  excess-profits  tax  which  is  repealed  as 
of  December  31,  1921.  The  most  important  changes  made  by 
the  Revenue  Act  of  1921,  bearing  upon  the  taxation  of  foreign 
corporations  relate  to  the  definition  of  the  term  "sources  within 
the  United  States."  The  definition  of  this  term  has  been  con- 
siderably amplified  and  in  some  respects  modified,  as  is  more 
fully  indicated  in  a  preceding  chapter.-  Another  important  new 
provision  of  the  Revenue  Act  of  1921,  treated  in  this  chapter, 
is  the  provision  that  domestic  corporations  fulfilling  certain 
qualifications  shall  be  taxable  only  with  respect  to  income  from 
"sources  within  the  United  States."-' 

Definition.  As  used  in  this  chapter,  the  term  "foreign  corpo- 
ration" means  a  corporation,  association,  joint-stock  company 
or  insurance  company  created  or  organized  outside  the  United 
States^  including  only  the  states,  the  territories  of  Alaska  and 

1  Revenue  Act  of  1918,  §  230.     This  rate  was  V2':'(   for  the  year  1918. 

2  See   Chapter   4. 

:•  Revenue  Act  of  1921,  §  262.     See  p.  308. 

■»  See  Revenue  Act  of  1921.  §2;  Revenue  Act  of  1918,  §1;  Reg.  45,  Art. 
1508.  It  IS  interesting  to  note  in  this  connection  the  difference  between  the 
American  and  British  theories  of  residence  in  regard  to  corporations.  The 
definition  given  in  the  text  and  the  definition  of  the  term  "domestic"  when 
applied  to  corporations  is  founded  upon  the  American  conception  that  a 
corporation  cannot  migrate  but  must  be  and  remain  always  a  resident  of 
the  state  or  jurisdiction  in  which  it  is  created.  (See  Paul  v.  Virginia,  8 
Wall.  168.)  This  theory  contemplates  strictly  the  artificial  entity  of  the 
corporation.  The  British  statute  provides:  "For  and  in  respect  of  the 
annual  profits  or  gains  arising  or  accruing  to  any  person  residing  in  the 
United  Kingdom  from  any  kind  of  property  whatever,  whether  situated  in 
the  United  Kingdom  or  elsewhere,  and  for  and  in  respect  of  the  annual 
profits  or  gains  arising  or  accruing  to  any  person  residing  in  the  United 
Kingdom  from  any  profession,  trade,  employment,  or  vocation,  whether 
the  same  shall  be  respectively  carried  on   in   the   United   Kingdom  or  else- 

297 


298  FEDERAL  INCOME  TAX 

Hawaii,  and  the  District  of  Columbia.  Foreign  corporations  are 
in  fact  divisible  into  four  classes,  as  follows:  (1)  "nonresident 
foreign  corporations,"  which  have  no  office  or  place  of  business 
in  the  United  States;  (2)  "nonresident  foreign  corporations 
with  a  branch  in  the  United  States,"  which  have  their  principal 
or  head  business  office  in  a  foreign  country,  but  incidentally  have 
branch  offices  or  places  of  business  in  the  United  States;  (3) 
"resident  foreign  corporations"  which  have  their  principal  or 
head  business  office  in  the  United  States  and  do  business  solely 
in  this  country,  and  (4)  "resident  foreign  corporations  having 
branches  outside  the  United  States"  which  have  their  principal 
or  head  business  office  in  the  United  States,  but  incidentally 
have  branch   offices   or  places   of  business   outside   the   United 

where,  and  to  be  charged  for  every  twenty  shillings  of  the  annual  amount 
of  such  profits  and  gains:  And  for  and  in  respect  of  the  annual  profits  or 
gains  arising  or  accruing  to  any  person  whatever,  whether  a  subject  of  her 
Majesty,  or  not,  although  not  resident  within  the  United  Kingdom,  from 
any  property  whatever  in  the  United  Kingdom,  or  any  profession,  trade, 
employment,  or  vocation  exercised  within  the  United  Kingdom,  and  to  be 
charged  for  every  twenty  shillings  of  the  annual  amount  of  such  profits 
and  gains."  While  the  cases  decided  under  this  statute  upon  this  point  are 
in  some  confusion,  coming  to  different  conclusions  upon  substantially  the 
same  facts  and  the  same  conclusions  upon  diff'erent  theories,  and  while  in 
many  of  them  the  appellate  court  was  constrained  to  its  conclusions  by 
cases  stated  unfavorably  to  the  taxpayer  and  the  rule  that  the  judgment  of 
the  Commissioners  on  questions  of  fact  could  not  be  disturbed,  the  courts 
definitely  renounce  the  place  of  incorporation,  as  a  test  of  residence.  In 
De  Beers  Consolidated  Mines  v.  Howe  (1906)  App.  Cas.  455,  95  L.  T.  221; 
22  T.  L.  R.  756,  5  Tax  Cas.  198,  Lord  Loreburn,  L.  C,  said:  "In  apply- 
ing the  conception  of  residence  to  a  company,  we  ought,  I  think,  to  pro- 
ceed as  nearly  as  we  can  upon  the  analogy  of  an  individual.  A  company 
cannot  eat  or  sleep,  but  it  can  keep  house  and  do  business.  We  ought,  there- 
fore, to  see  where  it  really  keeps  house  and  does  business.  An  individual 
may  be  of  foreign  nationality,  and  yet  reside  in  the  United  Kingdom.  So 
may  a  company.  Otherwise  it  might  have  its  chief  seat  of  management 
and  its  centre  of  trading  in  England  under  the  protection  of  English  law, 
and  yet  escape  the  appropriate  taxation  by  the  simple  expedient  of  being 
registered  abroad  and  distributing  its  dividends  abroad."  Again  in  San 
Paulo  Ry.  Co.  v.  Carter  (1896)  App.  Cas.  31,  73  L.  T.  538;  Lord  Hals- 
bury  said :  "It  seems  to  me  that,  as  was  said  by  Cockburn,  C.  J.  in  the  case 
of  Sulley  V.  Attorney-General  (1),  *it  is  probably  a  question  of  fact  where 
the  trade  is  carried  on,'  and  it  is  probably  true  to  say  that  that  phrase 
may  be  understood  in  two  different  senses.  It  may  mean  where  the  goods 
in  respect  of  which  trading  is  carried  on  are  conveyed,  made,  bought,  or 
sold;  or,  speaking  of  land,  where  it  is  cultivated  or  used  for  any  other 
purpose  of  profit.  That  makes  the  locality  of  the  goods  or  the  land  which 
are  the  subjects  of  the  trade  to  be  in  a  certain  sense  the  place  where  the 
trade  is  carried  on,  because  it  is  the  place  where  the  things  corporeally 
exist,  or  are  dealt  with.     But  there  is  another  sense,  in  which  the  conduct 


FOREIGN    CORPORATIONS  299 

and   management,  the  head   and  brain  of  the  trading  adventure,  are  sit- 
uated  in   a   place  different   from   that   in    which   the   corporeal   subjects  of 
trading  are   to   be  found.    It  becomes,  therefore,  a  question   of   fact,  and 
according  to  the  answer  to  be  given  to  the  question  where  is  the  trade  in  a 
strict  sense  carried  on,  will  the  assessment  be."     (See  also  New  Zealand  Co. 
V    Stephens,  24  T.  L.  R.  172;  American  Thread  Co.  v.  Joyce,  i04  L.  T.  R. 
217    affirmed  106  L.  T.  R.  171,  28  T.  L.  R.  233,  6  Tax  Cas.  1;  approved  by 
House  of  Lords,  108  L.  T.  R.  353,  6  Tax  Cas.  163,  29  L.  T.  R.  266.)     In 
addition,  the  British  courts  have  taxed  many  foreign  corporations  on  the 
theory  that  they  were  a  mere  sham,  fiction,  or  dummy,  having  no  real  exist- 
ence apart  from  some  English  corporation  which  owned  and  controlled  them, 
and   also   on  the  theory  that  they   stood   in   the   relationship   of   principal 
and  agent  toward  an  English  company,  so  that  their  profits  were  in  con- 
templation of  law  the  profits  of  the  principal.     (See  Colquhoun  v.  Brooks, 
L.  R.  14  App.  Cas.  493,  61  L.  T.  518;  Frank  Jones  Brewing  Co.  v.  Apthorpe, 
15  T.  L.  R.   113,  4  Tax  Cas.  6;   United   States  Brewing  Co.  v.  Apthorpe, 
4  Tax  Cas.  17;  St.  Louis  Breweries  v.  Apthorpe,  79  L.  T.  R.  551,  15  T.  L.  R. 
112;  4  Tax  Cas.  Ill;  Apthorpe  v.  Peter  Schoenhofen  Brewing  Co.,  80  L.  T. 
R.  395,  15  T.  L.  R.  245,  4  Tax  Cas.  41.)    It  has  not  been  held  invariably  under 
the  British  statute  that  foreign  corporations  were  taxable  when  their  stock 
was  owned  by  British  corporations.     (Bartholomay  Brewing  Co.  v.  Wyatt 
(1893)  2  Q.  B.  499,  69  L.  T.  561;  Kodak  Ltd.  v.  Clark  (1902)  2  K.  B.  450, 
affirmed   (1903)    1  K.  B.  505,  88  L.  T.  R.  155;  Gramophone  &  Typewriter. 
Ltd.  v.  Stanley    (1906)   2  K.  B.  856,  affirmed    (1908)   2  K.  B.  89,  99  L.  T. 
R.  39).  In  the  last  mentioned  case  the  court  said:  "The  fact  that  an  mdividu- 
al  by  himself  or  by  his  nominee  holds  practically  all  the  shares  in  a  com- 
pany may  give  him  the  control  of  the  company  in  the  sense  that  it  may 
enable  him  by  exercising  his  voting  powers  to  turn  out  the  directors  and 
to  enforce  his  own  views  as  to  policy,  but  it  does  not  in  any  way  diminish 
the  rights  or  powers  of  the  directors,  or  make  the  property  or  assets  of  the 
company  his  as  distinct  from  the  corporation's.     Nor  does  it  make  any  dif- 
ference if  he  acquires  not  practically  the  whole,  but  absolutely  the  whole 
of  the  shares.     The  business  of  the  company  does  not  thereby  become  his 
business.   He  is  still  entitled  to  receive  dividends    on  his  shares,  but  no  more 
*     *     *.      The   profits   of   a   corporation   are   not   profits   of   any   business 
carried  on  by  him  in  a  foreign  country,  because  the  individual  corporator 
does  not  carry  on  the  business  of  the  corporation.     He  is  only  entitled  to  the 
profits  of  that  business  to  a  certain  extent  freed  and  ascertained  in  a  certain 
way  depending  on  the  constitution  of  the  corporation  and  his  holding  in  it. 
This  legal  proposition  that  the  legal  corporator  cannot  be  held  to  be  wholly 
or  partly  carrying  on  the  business  of  the  corporation  is  not  weakened  by 
the   fact   that   the   extent   of   his   interest   in   it  entitles   him   to   exercise   a 
greater  or  less  control  over  the  manner  in  which  that  business  is  carried 
on      Such  control  is  inseparable  from  his  position  as  a  corporator  and  is 
a   wholly   different  thing   both    in   fact    and    in   law   from   carrying  on   the 
business  himself.     The   directors   and   employees   are   not   his   agents,   and 
he  has  no  power  of  giving  directions  to  them  which  they  must  obey      This 
shows  that  the  control  of  individual  corporators  is  somethmg^  wholly  dif- 
ferent from  the  management  of  the  business  itself.       *       *  .     *     J\  "'I'tI 
to  succeed  the  Attorney-General  must,  I  think,  make  out  either  hrst.  that 
the    German    company    is    a    fiction,    a    sham,   a    simulacrum,    and    that    in 
reality  the  English  company  and  not  the  German  company  is  carrying  on  the 
business;  or  secondly,  that  the  German  company,  if  it  is  a   real  thing,  is 


300  FEDERAL  INCOME  TAX 

States.^  In  this  chapter,  however,  a  foreign  corporation  engaged 
in  trade  or  business  within  the  United  States  or  having  an 
office  or  place  of  business  therein  will  be  referred  to  as  a  "resi- 
deiit  foreign  corporation"  and  a  foreign  corporation  not  having 
any  office  or  place  of  business  therein  will  be  referred  to  as  a 
"nonresident  foreign  corporation.""  The  Revenue  Act  of  1921 
contains  a  new  provision  substantially  classifying  certain 
domestic  corporations  as  foi'eign  corporations,  which  provision 
is  discussed  below." 

Corporations  Exempt  from  the  Tax.  The  corporations  enumer- 
ated in  the  law  as  exempt  include  foreign  corporations  as  well 
as  domestic  corporations,  except  as  stated  in  the  chapter  on 
exempt  organizations.^ 

Corporations  Subject  to  the  Tax.  All  foreign  corporations  re- 
ceiving income  from  sources  within  this  country  and  not  specific- 
ally exempt  are  subject  to  the  tax.  It  is  not  necessary  that 
foreign  corporations  should  be  engaged  in  business  in  this  coun- 
try or  that  they  have  an  office,  branch  or  agency  in  the  United 
States.  Liability  to  the  income  tax  attaches  with  respect  to 
any  income,  the  "source"  of  which  is  in  the  United  States.'"* 

the  agent  of  the  English  company.  In  Kodak  Limited  v.  Clark  (ubi  sup.)  by 
way  of  contrast  the  English  company  owned  98  per  cent,  of  the  shares.  It 
is  true  that  they  did  not  own  them  all,  but  that  was  not  the  ground  of  the 
decision.  The  ground  was  that,  while  the  English  company  as  holding  98 
per  cent,  of  the  shares  no  doubt  had  the  control,  they  had  it  only  as  share- 
holders, and  it  was  the  corporation  and  not  the  shareholders  who  were 
carrying  on  the  business."  The  1918  ruling  of  the  treasury  department 
that  dividends  on  stock  and  interest  on  notes  of  corporations  organized 
in  the  United  States  (viz.,  "domestic"  corporations.  Revenue  Act  of  1918, 
§  1)  but  doing  no  business  and  owning  no  property  therein  paid  to  non- 
resident alien  individuals  and  corporations  are  not  subject  to  tax  (Reg.  45, 
Art.  92)  is  more  consistent  with  the  British  than  the  American  theory. 
The  doctrine  of  corporate  entity,  as  applied  by  the  American  courts,  is 
discussed  in  Chapter   10. 

5  See  T.  D.  2401;  Reg.  33  Rev.,  Art.  200. 

6  See  Reg.  45,  Art.  1508.    See  O.  D.  517,  T.  B.  21-20-955. 

7  See  p.  308. 

s  Revenue  Act  of  1921,  §231;  Revenue  Act  of  1918,  §231.  See  Chapter 
13. 

9  Reg.  33  Rev.,  Art.  66.  See  p.  301  on  which  the  word  "source"  is  dis- 
cussed and  where  it  is  shown  that  the  receipt  of  income  from  "sources  within 
the  United  States,"  rather  than  the  doing  of  business  within  the  United 
States,  is  the  test  as  to  the  taxability  of  foreign  corporations;  in  other 
words,  that  the  Revenue  Act  of  1921  and  the  Revenue  Act  of  1918  as  to 
foreign  as  well  as  domestic  corporations  impose  an  income,  not  an  excise  tax. 
The  act  of  August  5,  1909,  was  an  excise  tax  law,  both  with  respect  to 
domestic  and  foreign  corporations,  measured  with  reference  to  net  income. 


FOREIGN    CORPORATIONS  301 

Income  Subject  to  Tax.  The  gross  income  of  a  foreign  corpo- 
ration includes  only  the  gross  income  from  "sources  within  the 
United  States."'"  From  the  amount  of  such  gross  income  may 
be  subtracted  the  sum  of  the  deductions  and  credits  enumerated 
in  the  law,  with  the  exceptions  and  subject  to  the  limitations 
indicated  in  a  preceding  chapter.' ' 

Rate  of  Tax.  The  rate  of  tax  imposed  upon  foreign  corpo- 
rations by  the  present  law  is  the  same  as  that  imposed  upon 
domestic  corporations — 10%  for  the  calendar  year  1921,  and 
121/2 '/t^  foi'  the  calendar  year  1922,  and  subsequent  years. '- 

Income  from  Sources  Within  the  United  States.  While  the 
United  States  has  power  to  tax  a  foreign  corporation  for  the 
privilege  of  doing  business  in  the  United  States,'-'  the  Revenue 
Act  of  1921  and  the  1918  law  both  levy  a  tax  not  upon  such 
privilege,  but  upon  income  "from  sources  within  the  United 
States."  1^  The  subject  of  what  constitutes  income  from  such 
sources  is  thoroughly  discussed  in  another  chapter,  as  that  term 
is  to  be  defined  in  the  case  of  nonresident  alien  individuals  and 
foreign  corporations.'"'  It  is  sufficient  to  note  at  this  point  that 
the  term  "sources  within  the  United  States"  is  more  definitely 
defined  in  the  Revenue  Act  of  1921  than  in  the  Revenue  Act 
of  1918,  or  any  preceding  income  tax  law."'  A  few  rulings  and 
regulations,  having  special  application  to  foreign  corporations, 
rather  than  nonresident  alien  individuals,  are  discussed  in  the 
following  paragraphs,  as  well  as  an  important  exemption  pro- 
vision which  applies  in  the  case  of  a  certain  class  of  foreign 
corporation — foreign  steamship  companies. 

Domestic  Corporation  Owning  Stock  of  Foreign  Corpo- 
ration. A  foreign  corporation,  99  7o  of  whose  stock  was  owned 
by  a  domestic  corporation,  the  balance  being  held  by  foreign 
officers  as  qualifying  shares,  entered,  in  1918,  into  certain  agree- 
ments with  the  domestic  corporation  under  which  the  latter 
agreed  to  give  the  former  the  benefit  of  its  experience  and 
special  knowledge  and  the  use  of  equipment  for  the  manu- 
facture of  the  particular  products,  to  loan  to  the  former  plans, 

(Flint  V.   Stone-Tracy  Co.,  220   U.   S.   107;   Bryant  &  May,  Ltd.  v.   Scott, 
226  Fed.  875.) 

10  Revenue  Act  of   1921,  §233    (b)  ;   Revenue  Act  of  1918,   §233    (b). 

11  See  Chapter  4. 

12  Revenue  Act  of  1921,  §  230. 

13  See  Footnote  9. 

i-t  Revenue  Act  of  1921,  §§  230  (a),  233  (b)  ;  Revenue  Act  of  1918,  §§  230 
'(a),  233  (b). 

15  See  Chapter  4. 

i«  See  Revenue  Act  of  1921.  §  217. 


302  FEDERAL  INCOME  TAX 

specifications,  drawings,  patterns,  etc.,  and  to  furnish  the 
services  of  experienced  engineers,  draughtsmen  and  experts,  in 
consideration  of  which  assistance  the  domestic  corporation  was 
to  receive  a  fixed  percentage  of  the  net  profits  of  the  foreign 
corporation.  It  was  held  that  the  ownership  by  the  American 
corporation  of  stock  in  the  foreign  corporation  and  the  con- 
tractual relationship  between  the  two  corporations  had  no  bear- 
ing on  the  determination  of  whether  the  income  of  the  foreign 
corporation  from  the  sale  of  its  products  to  the  United  States 
government  was  income  from  "sources  within  the  United 
States."  The  two  corporations  were  separate  and  distinct  tax- 
able entities.  They  were  not  required  under  the  1918  law  and 
would  not  be  permitted,  to  file  a  consolidated  return  and  the 
contractual  relationship  did  not  constitute  the  American  corpora- 
tion the  agent  of  the  foreign  company.  The  American  corpora- 
tion merely  received  compensation  for  assistance  rendered  and 
dividends  on  its  stock  holdings.  The  foreign  corporation  main- 
tained no  oflfice  or  place  of  business  in  the  United  States  during 
the  period  in  question  and  the  sole  question  was  held  to  be 
where  the  goods  contracted  for  were  purchased  and  sold.  As 
it  appeared  that  the  foreign  corporation  executed  the  contract 
for  sale  outside  the  United  States,  manufactured  and  made 
delivery  of  the  goods  to  the  United  States  government,  f.  o.  b. 
at  a  point  outside  the  United  States,  and  received  payment  there- 
for outside  the  United  States,  it  was  held  that  the  profits  from 
such  sales  were  not  derived  from  "sources  within  the  United 
States."!' 

Foreign  Corporations  Having  No  Office  or  Agent  in  This 
Country,  Collecting  Commissions.  It  was  ruled  under  the 
1916  law  that  a  foreign  corporation  located  at  Singapore,  having 
no  office  or  agent  in  the  United  States,  which  was  engaged  in 
the  commission  business,  and  which  during  the  year  1917  sold 
at  Singapore  and  in  nearby  countries  certain  products  of  manu- 
facturing establishments  in  the  United  States — the  purchase 
price  of  the  goods  being  transmitted  by  the  purchasers  to  the 
manufacturers  and  American  houses  direct,  and  when  the  money 
was  received  in  the  United  States  a  commission  being  paid  out 
of  the  proceeds  of  sale  to  the  Singapore  corporation — was  not 
in  receipt  of  income  derived  from  sources  within  the  United 
States;  also  that  should  an  American  corporation  receive  these 
commissions  from  the  manufacturer  and  transmit  them  to  the 
Singapore  corporation,  where  it  simply  acted  as  agent  for  the 
Singapore  corporation  in  receiving  and  transmitting  such  com- 

17  A.   R.   M.   133,   T.   B.   26-21-1703. 


FOREIGN    CORPORATIONS  303 

missions  and  retained  no  part  thereof  for  its  own  use,  it  need 
not  report  them  as  its  own  income.^"*  Amounts  paid  to  a  non- 
resident foreign  corporation  as  compensation  for  orders  secured 
by  it  from  foreign  customers  for  exports  booked  through  such 
nonresident  foreign  corporation  are  held  not  to  be  income  from 
sources  within  the  United  States. ^^ 

Foreign  Steamship  Companies.  The  present  law  specifically 
exempts  the  income  of  a  nonresident  alien  or  foreign  corpora- 
tion, consisting  exclusively  of  earnings  derived  from  the  opera- 
tion of  a  ship  or  ships  documented  under  the  laws  of  a  foreign 
country,  which  grants  an  equivalent  exemption  to  citizens  of 
the  United  States  and  domestic  corporations.-'*  This  is  a  new 
exemption  created  by  the  Revenue  Act  of  1921,  designed  to 
"encourage  the  international  adoption  of  uniform  tax  laws  affect- 
ing shipping  companies,  for  the  purpose  of  eliminating  double 
taxation."-'  Under  the  1918  law  the  tax  did  not  apply  to  charter 
money  or  freight  payments  received  by  a  foreign  owner  in  re- 
gard to  a  vessel  operated  between  the  United  States  and  for- 
eign ports,  if  the  person  receiving  the  income  maintained  no 
regular  agency  in  the  United  States  and  was  not  doing  busi- 
ness in  the  United  States.--  Foreign  steamship  companies  en- 
gaged in  the  business  of  transporting  passengers,  goods  and 
merchandise  between  ports  in  this  country  and  foreign  ports 
and  maintaining  passenger  and  freight  agencies  in  this  country, 
were  subject  to  the  income  tax  imposed  by  the  1918  and  previous 
laws  and  will  be  subject  to  the  tax  imposed  by  the  present  law  if 
the  laws  of  the  country  under  which  their  ships  are  documented 
do  not  grant  the  "equivalent  exemption"  referred  to  above.  There 
seems  to  be  no  constitutional  objection  involved  in  such  tax 
being  a  tax  on  exports.-^     Foreign  steamship  companies  were 

18  Letter  from  treasury  department  dated  April  20,  1918;  I.  T.  S.  1921 
H  1087. 

i!>0.  D.  112,  T.  B.  2-19-167. 

20  Revenue  Act  of  1921,  §  213   (b)   8. 

-1  See  Report  of  Finance  Committee  on  Revenue  Bill  of  1921.  p.  14. 

"Reg.  45,  Art.  92. 

-3  28  Op.  Atty.  Gen.  211;  Aguirre  v.  Maxwell,  3  Blatch.  140;  Peck  v. 
Lowe,  247  U.  S.  165.  For  the  method  of  computing  the  income  of  such 
companies  from  sources  within  the  United  States  see  letter  from  treasury 
department  dated  July  18,  1916;  I.  T.  S.  1921,  111082.  But  this  is  a  highly 
unsatisfactory  method  and  its  legality  is  extremely  doubtful.  In  effect,  it 
holds  that  receipts  from  outgoing  freight  and  passenger  traffic  is  income 
from  sources  within  the  United  States.  It  would  seem  that  the  going  and 
'coming  voyage  of  a  steamship  should  be  treated  as  a  unit,  and  not  more 
than  50 ^/f  at  most  of  the  ship's  gross  receipts  treated  as  coming  from 
United  States  sources.     In  general  the  factors  producing  the  income  are  (1) 


804  FEDERAL  INCOME  TAX 

held  not  to  derive  income  from  "sources  within  the  United 
States"  by  reason  of  the  fact  that  they  received,  at  a  port  within 
the  United  States,  freight  originating  in  a  foreign  country  to 
be  shipped  to  another  foreign  country.  Income  from  "sources 
within  the  United  States"  was  held  to  be  that  derived  from 
frjeight  charges  paid  to  the  companies  within  the  United  States 
in  respect  of  shipments  originatmg  therein.^^  When  freight 
shipments,  originating  in  Canada,  were  brought  to  a  United 
States  port  by  railroad  and  received  at  that  port  by  a  foreign 
steamship  company  (which  did  business  and  maintained  a  regu- 
lar agency  in  the  United  States)  for  transportation  abroad,  and 
the  freight  charges  of  the  steamship  company  were  prepaid 
by  the  railroad  company,  and  the  company's  vessels,  upon  their 
return  voyage  to  the  United  States,  used  coal  purchased  abroad 
as  ballast,  which  was  sold  upon  arrival  in  the  United  States,  the 
freight  charges  on  the  goods  transported  abroad  were  held, 
under  the  1918  law,  to  represent  income  from  "sources  in  the 
United  States."  The  amount  received  for  the  ballast  coal  dis- 
posed of  in  the  United  States  was  held  to  be  gross  income  from 
sources  within  the  United  States,  and  the  cost  of  such  coal  a 
deduction.25 

Deductions  in  Computing  Net  Income  from  Sources  Within  the 
United  States.  The  deductions  of  a  foreign  corporation,  like 
those  of  a  nonresident  alien  individual,  are  in  general  the  same 
as  those  allowed  to  domestic  corporations,  except  that  such  de- 
ductions will  be  allowed  "only  if  and  to  the  extent  that  they 
are  connected  with  income  from  sources  within  the  United 
States" ;  and  the  proper  apportionment  and  allocation  of  such 
deductions  with  respect  to  income  from  sources  within  and 
sources  without  the  United  States  is  to  be  determined  as  out- 
lined in  another  chapter.-*^ 

Items  Not  Deductible.  No  deduction  will  be  allowed  to  foreign 
corporations  in  respect  of  certain  items  which  are  expressly 
specified  by  the  statute  not  to  be  deductible.    These  items  are  the 

the  loading  (or  discharging)  in  this  country,  (2)  the  navigation,  and  (3) 
the  discharging  (or  loading)  in  a  foreign  country.  It  is  difficult  to  measure 
the  navigation  factor  which  occurs  chiefly  without  the  jurisdiction  of  this 
country,  but  the  other  two  factors  are  certainly  equally  important,  and 
neglecting  navigation  entirely  as  a  factor,  there  would  seem  to  be  no  greater 
gross  income  from  sources  within  the  United  States  than  50%  of  the  gross 
receipts  on  both  sides  of  the  ocean.  In  the  case  of  trades  other  than  trans- 
Atlantic  trades,  the  problem  is  even  more  complicated. 

24  O.  D.  1024,  T.  B.  36-21-1806. 

25  0.  D.  596,  T.  B.  29-20-1077. 

26  See  Revenue  Act  of  1921,  §§234    (b),  217.     See   Chapter  4. 


FOREIGN    CORPORATIONS  305 

same  in  the  case  of  individuals,  resident  or  nonresident,  and 
corporations,  domestic  or  foreijrn,  and  arc  cniimei-attMl  and  dis- 
cussed in  another  chapter.-' 

Credits  Allowed  to  Foreisn  Corporations.  In  addition  to  the 
above  mentioned  deductions  foreign  corporations  are  allowed 
the  same  credits  as  are  allowed  to  domestic  corporations,  except 
the  specific  exemption  which  is  allowed  only  to  domestic  corpo- 
rations. These  credits  are  more  fully  discussed  in  another 
chapter.-^ 

Collection  of  the  Tax  at  the  Source.  The  withholding  pro- 
visions of  the  Revenue  Act  of  1921  applying  to  foreign  corpora- 
tions are  similar  to  the  corresponding  provisions  of  the  1918 
law,  except  that  withholding  is  no  longer  required  on  interest 
on  deposits  with  persons  carrying  on  the  banking  business  paid 
to  nonresident  foreign  corporations.  In  the  case  of  nonresident 
foreign  corporations,  a  tax  equal  to  10 "^r  in  1921,  and  12y-//o 
in  1922  and  subsequent  years,  is  withheld  at  the  source  on  pay- 
ment of  interest,  rent,  salaries,  wages,  premiums,  annuities, 
compensations,  remunerations,  emoluments,  or  other  fixed  or 
determinable  annual  or  periodical  gains,  profits  and  income, 
except  that  the  law  requires  a  tax  equal  only  to  2^1  to  be 
withheld  at  the  source  on  all  interest  on  bonds,  mortgages,  or 
deeds  of  trust  or  other  similar  obligations  of  a  corporation  con- 
taining a  so-called  "tax-free  covenant."-'^  A  nonresident  foreign 
corporation  cannot,  by  filing  any  certificate  or  claim  for  exemp- 
tion, prevent  the  withholding  of  such  tax,  but  if  there  is  in- 
cluded in  such  corporation's  return  of  all  income  received  from 
sources  within  the  United  States,  any  income  upon  which  tax 
has  been  withheld  at  the  source,  the  corporation  may  take  credit 
against  the  amount  of  tax  due  for  the  amount  of  the  tax  so 
withheld  at  the  source,  provided  a  statement  is  attached  to  the 
return  setting  forth  the  source  and  the  amount  of  the  income 
upon  which  the  tax  w^as  so  withheld.     If  a  return  discloses  the 

27  See  Revenue  Act  of  1921,  §§  235,  214;  Revenue  Act  of  1918.  §§  235,  215. 

2S  Revenue  Act  of  1921,  ^5  23(5;  Revenue  Act  of  1918,  ^  23(;.  See  Chapter 
31. 

20  Revenue  Act  of  1921,  §§221,  237;  Revenue  Act  of  1918,  §§221,  237. 
The  tax  on  corporation  bonds  containing  "tax-free  covenants"  is  required 
by  law  to  be  withheld  only  at  the  rate  of  2'',  in  order  to  limit  the  obliga- 
tion of  debtor  corporations  under  those  covenants.  It  seems,  therefore,  on 
such  bonds  the  remainder  of  the  income  may  be  paid  over  without  with- 
holding by  the  debtor  corporation.  The  collection  of  the  remaining  tax  on 
the,interest  paid  has  no  doubt  been  considered  l)y  the  treasury  department, 
but  it  is  difficult  to  find  a  method  by  which  this  can  be  done  without  in- 
creasing the  liability  of  the  debtor  corpnrnti.ins  under  their  covenants, 
which  liability  the  law  expressly  limits. 


306  FEDERAL  INCOME  TAX 

fact  that  the  tax  withheld  exceeds  the  liability  of  the  corporation, 
the  treasury  department  then  orders  a  refund  of  the  excess 
amount  withheld.  For  this  purpose  the  return  of  the  foreign 
corporation  should  have  attached  thereto  a  statement  giving 
the  names  of  the  withholding  agents  and  the  amounts  withheld 
respectively."^'  There  is  no  collection  of  the  tax  at  the  source 
on  payments  of  any  kind  to  resident  foreign  corporations.^^ 

Procedure  in  Collecting  Income  Subject  to  Withholding. 
To  enable  debtors  in  the  United  States  to  distinguish  between 
resident  and  nonresident  foreign  corporations  (foreign  corpora- 
tions which  have,  and  those  which  have  not  any  office  or  place  of 
business  in  the  United  States)  and  also  to  enable  resident  for- 
eign corporations  to  claim  exemption  from  withholding  on  bond 
interest  or  other  income,  a  certificate  stating  that  any  such 
corporation  has  an  office  or  place  of  business  in  the  United 
States  should  be  filed  by  it  with  the  debtor.^^ 

Resident  Agents  for  Foreign  Corporations.  In  addition 
to  the  provisions  prescribed  by  law  for  the  collection  of  the 
tax  at  the  source  on  income  paid  to  nonresident  foreign  corpo- 
rations the  treasury  department  has  evolved  a  method  of  col- 
lecting the  tax  by  impressing  upon  residents  of  this  country 
under  certain  circumstances  the  duty  of  filing  returns  and  ac- 
counting for  any  taxes  which  may  be  due  from  nonresident 
foreign  corporations  on  the  income  which  passes  through  the 
hands  of  such  residents.  This  duty  is  discussed  fully  in  another 
chapter.33 

Returns  of  Foreign  Corporations.  Every  foreign  corporation 
receiving  income  from  sources  within  this  country  is  required 
to  make  a  return  of  income,  stating  specifically  the  items  of  its 
gross  income  and  the  deductions  and  credits  to  which  it  may 
be  entitled.^^  It  is  not  necessary,  however,  in  order  to  be  re- 
quired* to  make  a  return,  that  a  foreign  corporation  shall  be 
engaged  in  business  in  this  country  or  that  it  have  any  office, 
branch  or  agency  in  the  United  States.^^ 

When  Filed.  The  return  of  a  nonresident  foreign  corpora- 
tion is  filed  on  or  before  June  15th,  or  the  15th  day  of  the  6th 

30  Revenue  Act  of  1921,  §§221  (d),  237;  Revenue  Act  of  1918,  §221  (d) ; 
Reg.  45,  Art.  376;  Reg.  33  Rev.,  Art.  201.  (See  also  Reg.  33  Rev.,  Art. 
43;  Reg.  33,  Art.  46,  and  Chapter  40.) 

31  Revenue  Act  of  1921,  §237;  Reg.  45,  Art.  361. 

32  Reg.  45,  Art.  601. 

33  Reg.  45,  Art.  404.    See  Revenue  Act  of  1916,  §  9  (g)  and  Chapter  5 

34  Revenue  Act  of  1918,  §  239;  Reg.  45,  Art.  625. 
33  Reg.   45,  Art.   625. 


FOREIGN    CORPORATIONS  307 

month  following  the  close  of  the  fiscal  year  of  the  corporation, 
accordingly  as  the  corporation  reports  on  the  basis  of  the  calen- 
dar or  a  fiscal  year.  The  return  of  a  resident  foreign  corpo- 
ration is  filed  on  or  before  March  15th,  or  the  15th  day  of  the 
3rd  month  following  the  close  of  the  fiscal  year  of  the  corpo- 
ration,^'' 

Where  Filed.  The  return  of  a  foreign  corporation  should  be 
made  to  the  collector  of  the  district  in  which  is  located  the 
principal  place  of  business  or  principal  office  or  agency  of  the 
corporation,  or  if  it  has  no  principal  place  of  business  or  prin- 
cipal office  or  agency  in  the  United  States,  then  to  the  collector 
at  Baltimore,  Maryland."'' 

By  Whom  Filed.  The  responsibility  for  filing  the  return  of 
a  foreign  corporation  rests  in  some  cases  on  the  agent  of  the 
foreign  corporation  in  the  United  States,  as  indicated  in  another 
chapter.-^^  When  the  return  is  filed  by  the  officers  of  the  foreign 
corporation,  the  agent  of  the  corporation  in  this  country  is 
relieved  of  the  responsibility. 

How  Prepared.  The  return  of  a  foreign  corporation  is  pre- 
pared in  the  same  manner  as  the  return  of  a  domestic  corpora- 
tion, except  that  the  statements  contained  therein  should  relate 
to  income  from  "sources"  within  this  country  and  the  deduc- 
tions should  be  limited  as  above  indicated."'^ 

How  Signed  and  Sworn  To.  If  the  return  of  a  foreign  corpo- 
ration is  filed  by  the  home  office,  it  should  be  sworn  to  by 
the  president,  vice  president  or  other  principal  officer  of  the 
corporation  and  by  the  treasurer  or  assistant  treasurer,  and 
be  verified  in  the  same  manner  as  is  required  in  the  case  of 
domestic  corporations.^"  In  case  the  return  is  signed  by  the 
agent  for  the  corporation  resident  in  this  country,  the  affidavit 
on  the  form  should  be  changed  to  show  that  report  is  made  by 
such  agent,  and  covers  all  the  income  coming  into  his  hands,  or  all 
the  income  of  the  corporation  from  "sources  within  the  United 
States,"  as  the  case  may  be. 

•i'l  Revenue  Act  of  1921,  §§241  (a),  227  (a).  Under  the  1918  Law,  such 
corporations  filed  returns  at  the  same  time  as  other  corporations.  See 
Chapter  34. 

37  Revenue  Act  of  1921,  §241  (b)  ;  Revenue  Act  of  1918,  §241  (b)  ;  Reg. 
45,  Art.  651. 

•^^  Reg:.  45,  Art.  625.  See  Chapter  5.  A  foreign  corporation  having 
several  branch  offices  in  the  United  States  was  required,  under  the  1916 
Law,  to  designate  one  of  such  branches  as  the  principal  office  and  to  desig- 
nate the  proper  officer  to  make  the  required  return.     (Reg.  3,S,  .\rt.  83.) 

:?!'  See  p.  304. 

w  Revenue  Act  of  1921,  §  239;  Revenue  Act  of  1918,  §  239. 


308  FEDERAL  INCOME  TAX 

Consolidated  Returns.  The  Revenue  Act  of  1921  modifies  the 
former  provision  for  the  filing  of  consolidated  returns  by  affiliated 
corporations,  but  this  provision  does  not  apply  to  foreign  corpo- 
rations, except  that  the  Commissioner  may,  as  indicated  in  an- 
other chapter,  consolidate  the  accounts  of  related  trades  or  busi- 
nesses, including  foreign  trades  or  businesses,  whether  incorpo- 
rated or  not.^i 

Special  Returns.  Resident  foreign  corporations  are  required  to 
make  the  same  special  returns  for  the  purpose  of  information 
at  the  source  as  are  required  of  domestic  corporations."^-  Non- 
resident alien  corporations  are  not  required  to  make  special 
returns  by  any  express  provision  of  the  law,  but  may  be  called 
upon  under  general  provisions  of  the  law  for  information  re- 
specting their  income  from  sources  in  this  country. 

Duty  of  Foreign  Corporations  in  Paying  Out  Income.  In  pay- 
ing out  income  to  others  subject  to  the  tax,  a  resident  foreign 
corporation  is  subject  to  all  the  duties  and  responsibilities  im- 
posed upon  domestic  corporations  as  to  withholding  the  tax  at 
the  source  or  reporting  the  names  of  the  persons  to  whom  such 
income  is  paid.^^  Nonresident  foreign  corporations  are  under 
no  duty  in  paying  out  income  to  others,  whether  or  not  such 
payees  are  citizens  or  residents  of  this  country. 

Collection  of  Foreign  Items.  Resident  foreign  corporations 
undertaking  as  a  matter  of  business  or  for  profit  the  collection 
of  foreign  items  are  required  to  obtain  a  license  in  the  same 
manner  as  domestic  corporations. ^"^ 

Penalties.  Foreign  corporations,  or  their  officers  or  employees, 
are  subject  in  certain  cases  to  penalties,  both  specific  and  ad 
valorem,  for  failing  or  refusing  to  make  returns,  supply  informa- 
tion, pay  or  collect  any  tax  or  for  wilfully  attempting  in  any 
manner  to  defeat  or  evade  the  tax.  Such  penalties  are  more 
particularly  discussed  in  another  chapter.^"^ 

Domestic  Corporations  Which  Are  Taxable  Only  on  Income 
From  Sources  Within  the  United  States.  Domestic  corporations 
which  satisfy  the  two  conditions  stated  below  are  taxable  only 
with  respect  to  income  from  "sources  within  the- United  States." 
This  constitutes  an  exception  to  the  general  rule  which  has  been 
invariably  applied  hitherto  in  taxing  domestic  corporations  that 

41  See  Chapter  10. 

42  Revenue  Acts  of  1918  and   1921,  §§254,  255  and  256. 

43  Revenue  Acts  of  1918  and  1921,  §§221,  237  and  256.  For  a  further 
discussion  of  this  subject  see  Chapters  40  and  39. 

44  Revenue  Acts  of  1918  and  1921,  §  259.     See  Chapter  10. 

45  See  Chapter  36. 


FOREIGN    CORPORATIONS  309 

Lhey  are  residents  of  this  country  if  organized  under  the  laws 
of  any  state,  or  political  subdivision  of  the  United  States  and 
as  such  residents  are  taxable  upon  their  income  from  all  sources, 
even  though  their  business  may  be  done  or  their  property 
located  entirely  abroad.    The  conditions  referred  to  are : 

(1)  80S;  or  more  of  the  gross  income  of  such  domestic 
corporation  (computed  without  the  benefit  of  this  provision)  for 
the  three-year  period  immediately  preceding  the  close  of  the 
taxable  year  (or  for  such  part  of  such  period  immediately  pre- 
ceding the  close  of  such  taxable  year  as  may  be  applicable) 
must  have  been  derived  from  sources  within  a  possession  of  the 
United  States;  and  (2)  50 Ve  or  more  of  its  gross  income  (com- 
puted without  the  benefit  of  this  provision)  for  such  period  or 
such  part  thereof  must  have  been  derived  from  the  active  con- 
duct of  a  trade  or  business  within  a  possession  of  the  United 
States.  Notwithstanding  the  rule  stated  above  there  must  be 
included  in  the  gross  income  of  such  domestic  corporations  all 
amounts  received  within  the  United  States,  whether  derived 
from  sources  within  or  without  the  United  States.^'' 

Foreign  Governments.  Any  income  received  by  foreign  gov- 
ernments from  investments  in  the  United  States  in  stocks,  bonds, 
or  other  domestic  securities  owned  by  such  foreign  governments, 
or  from  interest  or  deposits  in  banks  in  the  United  States  of 
moneys  belonging  to  such  foreign  governments,  or  from  any 
other  source  within  the  United  States,  is  exempt  from  the  in- 
come tax.  The  regulations  and  rulings  issued  under  the  1918 
law,  which  contained  precisely  the  same  exemption,  should 
control  under  the  present  law.  But  this  exemption  does  not 
apply  to  income  from  investments  in  the  United  States  in  stocks, 
bonds,  or  other  domestic  securities  which  are  not  actually  owned, 
but  are  loaned  to  such  foreign  governments.^"  Income  derived 
by  a  foreign  corporation  from  sources  within  the  United  States 
is  subject  to  federal  tax,  regardless  of  the  fact  that  51'.'    of  its 

40  Revenue  Act  of  1921,  §262.     It  was  first  intended  to  make  this  sec- 
tion retroactive,  but  this  intention  was  abandoned.     It  now  operates  as  of 

""  -TT  Revenue  Act  of  1921,  §213  (b)  5;  Revenue  Act  of  1918,  §213  (b)  5; 
Reg  45  Art.  83;  0.  D.  710,  T.  B.  24-20-1275.  Under  the  1916  Law,  prior 
to  the  amendment  of  October  3,  1917,  it  was  held  by  the  treasury  depart- 
ment that  the  income  accruing  to  a  foreign  government  from  sources  with- 
in the  United  States  arising  from  interest  on  bonds  or  dividends  on  stock 
of  domestic  corporations  was  subject  to  tax.  The  1917  Law  provided  that 
the  income  of  foreign  governments  received  from  investments  in  the  United 
States  in  stocks,  bonds,  or  other  domestic  securities  owned  by  them,  or 
from  interest  or>.  deposits  in  banks  in  the  United  States  of  money  belonging 


310  FEDERAL  INCOME  TAX 

stock  is  owned  by  a  foreign  government."''^  Interest  credited 
by  a  domestic  bank  to  the  account  of  a  foreign  bank,  part  of 
whose  stock  is  owned  by  a  foreign  government,  is  not  exempt 
from  income  tax."^-'  A  foreign  government  is  not  subject  to  tax 
on  income  derived  from  the  operation  of  vessels  owned  by  such 
government  through  its  agents  in  the  United  States.  Neither 
is  the  foreign  government  liable  to  tax  upon  the  income  arising 
from  the  operation  for  its  benefit  of  vessels  chartered  by  it.-™ 

Political  Subdivisions  of  Foreign  Governments.  The 
exemption  discussed  in  the  previous  paragraph  applies  to  the 
political  subdivisions  of  foreign  governments."'''^  The  Common- 
wealth Bank  of  Australia  was  established  by  an  act  of  the  legis- 
lature of  Australia,  which  provided  that  the  appointment  of 
the  governor  of  the  bank  and  the  control  of  its  affairs  should 
be  vested  in  officials  of  the  government;  that  the  capital  neces- 
sary for  its  operations  should  be  supplied  solely  by  the  sale  of 
interest-bearing  obligations,  not  entitling  the  purchaser  thereof 
to  any  interest  in  the  bank  or  to  any  share  in  its  profits,  the 
issuance  and  sale  of  which  are  to  be  controlled  by  the  governor- 
general  of  the  commonwealth;  that  the  securities  so  issued  are 
guaranteed  by  the  commonwealth;  that  the  commonwealth  is 
exclusively  entitled  to  any  profits  of  the  bank  and  is  the  guar- 
antor of  its  debts.  The  bank  is,  therefore,  a  governmental 
agency  of  the  commonwealth  of  Australia  and  as  such  is  exempt 
from  income  tax.^''^ 

Foreign  Ambassadors  and  Ministers.  The  income  of  foreign 
ambassadors  and  ministers  from  investments  in  bonds  and 
stocks  and  from  interest  on  bank  balances,  and  the  fees  of  for- 

to  such  foreign  governments  was  exempt.  This  did  not,  however,  exempt 
from  the  tax  any  income  collected  by  foreign  governments  from  investments 
in  the  United  States  in  stocks,  bonds  or  other  domestic  securities,  which 
were  not  bona  fide  owned  by  but  were  loaned  to  such  foreign  governments. 
The  exemption  was  and  still  is  predicated  upon  the  fact  that  the  securities 
or  moneys  from  which  income  was  deiived  were  actually  owned  by  such 
foreign  governments.  (Reg.  33  Rev.,  Art.  87;  T.  D.  2425;  Revenue  Act  of 
1916,  as  amended  by  Revenue  Act  of  1917,  §30;  O.  D.  483,  T.  B.  18-20-895; 
O.  D.  20,  T.  B.  1-19-32.) 

48  0.  D.  958,  T.  B.  26-21-1702. 

49  O.  D.  448,  T.  B.  15-20-844.  Such  interest  is  not  income  from  "Sources 
within  the  United  States"  under  the  present  law,  if  paid  to  a  nonresident 
foreign  corporation  not  engaged  in  business  in  the  United  States  (Revenue 
Act  of  1921,  §217  (a)  1). 

50  0.  D.  515,  T.  B.  21-20-951. 

51  Reg.  45,  Art.  83. 

52  0.  D.  628,  T.  B.  33-20-1129. 


FOREIGN    CORPORATIONS  311 

eign  consuls,  are  exempt  from  tax,  but  income  of  such  foreign 
officials  from  any  business  carried  on  by  them  in  the  United 
States  would  be  taxable."''  Only  foreign  diplomats,  ambassadors, 
and  other  diplomatic  representatives  in  charge  who  are  ac- 
credited to  the  United  States  to  represent  their  sovereign  or 
country  and  who  reside  in  the  United  States,  and  the  members 
of  their  staff,  are  entitled  to  this  exemption.  Foreign  consuls 
resident  in  the  United  States  are  not  entitled  to  the  exemption, 
except  as  to  fees."'^  Delegates  to  the  United  States  representing 
a  foreign  country  in  connection  with  an  agreement  with  the 
United  States  food  administration,  whereby  flour  is  furnished 
to  that  country,  and  raw  materials  are  brought  to  this  country 
and  sold,  are  not  subject  to  tax  with  respect  to  any  profits  derived 
from  the  sale  of  such  products.''"*  The  compensation  of  citizens 
of  the  United  States  who  are  officers  or  employees  of  a  foreign 
government  is  not  exempt  from  tax.""  A  subject  of  a  foreign 
country,  who  at  the  time  of  his  appointment  to  a  legation  in 
the  United  States  is  a  resident  of  the  United  States,  would  be 
subject  to  tax  on  the  same  basis  as  a  citizen  of  the  United 
States."''  The  provision  which  exempts  income  of  foreign  am- 
bassadors, ministers,  and  their  subordinates  who  were  non- 
resident aliens  at  the  time  of  appointment  extends  to  income 
received  by  their  wives  from  sources  within  the  United  States.''^ 

•■■'■■'>  Reg.  45,  Art.  83. 

•"'-to.  D.  336,  T.   B.  29-19-624. 

33  O.  D.  182,  T.  B.  8-19-315. 

3«!  Reg.  45,  Art.  83. 

37  O.  D.  196,  T.  B.  9-19-339. 

3^0.  D.  1115,  T.  B.  48-21-1945,  overruling  O.   D.  153,  T.  B.  5-19-248. 


CHAPTER  13 

EXEMPT   ORGANIZATIONS 

The  Revenue  Act  of  1918,  with  the  exceptions  noted  below, 
exempted  the  same  classes  of  corporations  as  the  1916  Law.  The 
Revenue  Act  of  1921  continues  the  exemption  to  the  same  classes 
of  corporations,  in  certain  cases  limiting  or  describing  such 
corporations  in  somewhat  greater  detail  than  the  1918  Law. 
These  additional  limitations  will  be  discussed  in  the  paragraphs 
in  this  chapter  dealing  with  the  classes  of  corporations  affected. 
There  are  fourteen  classes  of  exempt  organizations.^  Exempt 
corporations  are  required  to  withhold  the  tax  at  the  source, 
and  to  report  payments  of  income  to  others,  in  the  same  manner 
as  is  required  of  taxable  corporations.- 

Foreign  Corporations.  The  exemptions  of  the  law  apply  to 
foreign  corporations  as  well  as  to  domestic  corporations,  except 
in  the  case' of  building  and  loan  associations  and  co-operative 
banks.3  In  case  a  foreign  corporation  desires  to  be  held  exempt 
from  the  law  and  doubt  exists  as  to  whether  or  not  it  comes 
within  the  classes  of  organizations  enumerated  in  the  law,  it 
is  required  to  file  a  copy  of  its  charter  or  articles  of  incorpora- 
tion and  by-laws  and  an  affidavit  executed  by  its  principal  officer 
showing  the  sources  of  its  income  and  its  disposition,  whether 
or  not  any  of  its  income  is  credited  to  surplus  or  may  inure 
to  the  benefit  of  any  private  stockholder,  or  individual,  and  in 
general  all  facts  relating  to  its  operations  which  relate  to  its 

1  Revenue  Act  of  1921,  §  231;  Revenue  Act  of  1918,  §  231.  The  first  eight 
of  these  classes  were  exempt  under  the  1913  Law;  the  next  five  classes  were 
added  by  the  1916  Law.  The  1918  Law  and  the  1921  Law  discontinue  the 
exemption  granted  by  the  1916  Law  to  joint-stock  land  banks  and  add  an 
exemption,  in  favor  of  personal  service  corporations.  Corporations  exempt 
under  the  1916  Law  were  also  exempt  to  the  same  extent  under  the  1917 
Law.  (Reg.  33  Rev.,  Art.  68.) 

2  T.  D.  2693;  T.  D.  2407;  Reg.  33  Rev.,  Art.  81.  Exempt  corporations  under 
the  1913  Law  were  exempt  from  all  provisions  of  the  law,  and  it  was  held 
that  this  included  exemption  from  the  duty  of  acting  as  withholding  agent, 
but  under  the  1916  Law  and  the  present  law  the  rule  is  as  stated  in  the  text. 
The  1913  Law  provided  that  "nothing  in  this  section"  should  apply  to  the 
corporations  enumerated  as  exempt;  the  1916  Law:  "there  shall  not  be  taxed 
under  this  title  any  income  received  by"  such  exempt  corporations;  the  1918 
and  the  1921  Laws:  "the  following  organizations  shall  be  exempt  from 
taxation  under  this  title." 

3  The  provisions  of  §11  of  the  1916  Law  were  so  held.  (Letter  from  treas- 
ury department  dated  December  6,  1916;  I.  T.  S.  1921,  111073.) 

/ 

312 


EXEMPT   ORGANIZATIONS  313 

rights  to  exemption.  The  question  whether  or  not  the  organiza- 
tion will  be  held  exempt  is  determined  by  the  treasury  depart- 
ment upon  the  facts  so  shown.' 

Exemption  Limited  to  Classes  Specifically  Enumerated.     Any 

corporation,  no  matter  how  created  or  organized,  or  what  the 
purpose  of  its  organization  may  be,  is  taxable  unless  it  comes 
within  the  classes  of  organizations  specifically  enumerated  as 
exempt.    A  corporation  is  not  exempt  simply  and  only  because 
it  is  primarily  not  organized  and  operated  for  profit.     If  income 
within  the  meaning  of  the  law  arises  and  accrues  to  a  corpora- 
tion, such  income  will  be  subject  to  the  tax  unless  the  corpora- 
tion' is  one  of  the  exempt  organizations  expressly  enumerated 
in  the  law.     Thus,  commercial  men's  associations,  and  like  or- 
ganizations are  not  exempt,  as  they  are  not  expressly  enumer- 
ated,   although   they   may   be   corporations   not   organized   for 
profit."'     Where  a  corporation  is  organized  for  the  purpose  of 
owning  and  operating  an  apartment  house,   its  income  being 
derived  from  co-operatively  collecting  the  expense  of  operating 
the  apartments  each  month  from  its  members,  each  of  whom 
is  entitled  to  occupy  an  apartment  in  the  building,  it  has  been 
held  that  inasmuch  as  there  is  no  provision  in  the  law  expressly 
exempting  co-operative  home-owning  corporations  from  taxa- 
tion such  a  corporation  is  precluded  from  exemption."     An  or- 
ganization which  would  otherwise  be  exempt,  but  which  operates 
in  a  nonexempt  manner  is  not  entitled  to  exemption;  and  an 
organization  which  is  ordinarily  exempt,  but  which  owns  prop- 
erty in  excess  of  its  needs  and  carries  on  industrial  pursuits 
distinct  from  its  exempt  activities  is  not  exempt.' 

Where  Question  as  to  Right  of  Exemption  Exists.  In  order  to 
establish  exemption,  and  thus  be  relieved  from  the  duty  of  filing 
returns  of  income  and  paying  the  tax,  it  is  necessary  that  every 
organization  claiming  exemption,  except  personal  service  corpo- 
rations, file  an  affidavit  with  the  collector  of  the  district  in  which 
it  is  located,  showing  (1)  the  character  and  purpose  of  the  or- 
ganization; (2)  the  source  from  which  all  its  income  is  derived; 
(3)  what  disposition  is  made  of  such  income;  and  (4)  whether 

4  Reg.  45,  Art.  511;  Letter  from  treasury  department  dated  December  5, 
1916;  I.  T.S.  1919,  112284.  „    o^r  Vpd 

r.T    D    2152.     See  Commercial  Travelers  etc.  Ass  n  v.  Rod\Nay,  23o  Fed. 
370     T    D    2152  also  held  farmers'  mutual  fire  insurance  companies  to  be 
taxable,'  but  the  191G  Law  subsequently  expressly  exempted  such  organiza- 
tions.   The  1918  Law  and  the  1921  Law  expressly  exempt  them. 
,  »i  O.  D.  1042,  T.  B.  38-21-1832. 
'  7  0.  D.  953,  T.  B.  25-21-1695. 


314  FEDERAL  INCOME  TAX 

or  not  any  of  it  is  credited  to  surplus  or  inures  or  may  inure 
to  the  benefit  of  any  private  stockholder  or  individual,"^  To 
such  affidavit  should  be  attached  a  copy  of  the  charter  or  articles 
of  incorporation  and  by-laws  of  the  organization.  Upon  receipt 
by  the  collector  of  the  affidavit  accompanied  by  the  copy  of  the 
charter,  or  articles  of  incorporation  and  copy  of  the  by-laws,  he 
will  inform  the  organization  whether  or  not  it  is  exempt.  If, 
however,  the  collector  is  in  doubt  as  to  the  taxable  status  of 
the  organization,  he  will  refer  the  affidavit  and  accompanying 
papers  to  the  commissioner  for  decision.'*  The  character  of  a 
corporation  must  be  judged  by  its  articles  of  incorporation, 
constitution,  and  by-laws  rather  than  by  the  declarations  of  its 
officers  or  the  method  by  which  it  conducts  or  has  conducted 
its  business. 1*'  Where  there  is  any  doubt  as  to  the  status  of  a 
corporation  under  the  provisions  of  the  law,  and  its  exempt 
status  has  not  been  established  by  the  treasury  department,  the 
annual  return  should  be  filed  (in  blank  if  desired)  and  an 
affidavit  attached  thereto  setting  out  fully  the  same  information. 
If  the  collector  is  in  doubt,  he  will  refer  the  statement  and 
return  to  the  commissioner  for  decision  and  withhold  listing  for 
assessment  until  a  decision  is  reached.^! 

Right  of  Exemption  Must  Be  Proved  on  Request.  In  the  ab- 
sence of  the  showing  indicated  in  the  preceding  paragraph,  or- 
ganizations enumerated  as  exempt  may  at  any  time  be  required 
to  make  returns  of  income  or  disclose  their  books  of  account  to 
a  revenue  officer  for  examination  in  order  that  the  status  of 
the  company  may  be  determined.^-  Having  once  satisfied  the 
collector  as  to  its  right  to  exemption,  a  corporation  is  not  re- 
quired to  make  a  return  of  income  or  any  further  showing  with 
respect  to  its  status  under  the  law  unless  it  changes  the  character 
of  its  organization  or  operations  or  the  purpose  for  which  it 
was  originally  created.^^  Collectors  keep  a  list  of  all  exempt 
corporations  to  the  end  that  they  may  occasionally  inquire  into 

8  Reg.  45,  Art.  511;  Reg.  33  Rev.,  Art.  78. 

9  Reg.  45,  Art.  511;  T.  D.  2693. 

10  0.  D.  190,  T.  B.  8-19-328.  But  see  A.  R.  R.  218,  T.  B.  32-20-1121.  A 
distinction  is  made  as  to  religious,  charitable,  scientific  and  educational 
corporations.     See  A.  R.  R.  219,  T.  B.  32-20-1121,  as  to  such  corporations. 

1^  Reg.  33  Rev.,  Art.  79.  Letter  from  treasury  department  dated  November 
1,  1916;  I.  T.  S.  1919,  Tj  2282. 

12  Reg.  33,  Art.  88. 

13  Reg.  45,  Art.  511;  Mimeograph  ktter  to  collectors  No.  1148;  I.  T.  S. 
1918,  ^1201.    T.  D.  2137. 


EXEMPT   ORGANIZATIONS  315 

their  status  and  ascertain  whether  or  not  they  are  observing  the 
conditions  upon  which  their  exemption  is  predicated.'^ 

Labor,  Agricultural  and  Horticultural  Organizations  (first 
class).  The  exemption  of  this  class  is  unconditional.  Although 
the  language  of  the  statute  is  very  broad,  the  law  undoubtedly 
refers  only  to  such  organizations  as  are  not  organized  for  profit, 
have  no  income  inuring  to  the  benefit  of  their  members,  and 
are  educational  or  instructive  in  character,  having  for  their 
purpose  the  betterment  of  the  condition  of  their  members,  the 
improvement  of  the  grade  of  their  products,  and  the  encourage- 
ment and  promotion  of  the  industries  named  to  a  higher  degree 
of  efficiency.'"'  The  following  kinds  of  organization  have  been 
held  not  to  fall  within  this  class  of  exempt  organizations : 

1.  An  activity  organized  for  the  purpose  of  affording  em- 
ployment to  members  of  a  labor  union,  which,  although  owned 
and  controlled  by  the  union,  is  not  a  part  of  the  union  as  such, 
wages  being  paid  to  members  employed  and  profits  after  pay- 
ing expenses  being  turned  into  the  treasury  of  the  union. i'' 

2.  Organizations  for  the  publication  of  a  breed  register  the 
purpose  of  which  is  to  render  a  service  to  the  breeders  of  pure 
bred  live  stock. ^^ 

3.  A  corporation  engaged  in  the  business  of  raising  stock 
or  poultry,  or  growing  grain,  fruits,  or  other  products  of  this 
character  as  a  means  of  livelihood  and  for  the  purpose  of  gain.^^ 

4.  Agricultural  corporations  owning  sugar  plantations  and 
disposing  of  the  product  thereof.^" 

5.  Societies  or  associations  which  have  for  their  purpose  the 
holding  of  annual  or  periodical  race  meets  and  from  which 
profits  inure,  or  may  inure,  to  the  benefit  of  the  members  or 
stockholders.-'^ 

County  fairs  or  like  organizations  of  a  quasi-public  char- 
acter, not  themselves  engaged  in  agricultural  or  horticultural 

11  Reg.  45,  Art.  511;  Reg.  33  Rev.,  Art.  80. 

i-^'Reg.  45,  Art.  512;  Reg.  33  Rev.,  Art.  73. 

16  0.  D.  523,  T.  B.  21-20-961. 

l"A.  R.  M.  79,  T.  B.  33-20-1137.  Many  of  these  organization?  are  very 
profitable,  and  while  they  utilize  a  portion  of  their  profits  for  the  advance- 
ment of  the  breeds  which  they  register,  through  prizes  and  premiums  offered 
for  such  breeds  at  the  various  agricultural  fairs,  thereby  advancing  their 
own  interests  as  well  as  those  of  the  breeders,  they  do  pay  dividends  out  of 
what  remains.  Such  organizations  might  be  so  organized  and  operated  as 
to  fall  under  the  sixth  or  seventh  class  described  below. 
'  i«Reg.  45,  Art.  512;  Reg.  33  Rev.,  Art.  74. 

in  T.  D.  2090. 

2«Reg.  45,  Art.  512;  Reg.  33  Rev.,  Art.  73. 


316  FEDERAL  INCOME  TAX 

pursuits,  and  which,  by  means  of  awards,  prizes  or  premiums, 
etc.,  are  designed  to  encourage  better  production,  and  no  part 
of  whose  income,  derived  from  gate  receipts,  entry  fees,  dona- 
tions, etc.,  inures  to  the  benefit  of  any  private  stockholder  or 
individual,  but  is  used  exclusively  to  meet  the  necessary  ex- 
penses of  upkeep  and  operation,  are  held  to  be  exempt.-^ 

Mutual  Savings  Banks  (second  class).  The  mutual-  savings 
banks  which  are  exempt  are  those  not  having  a  capital  stock 
represented  by  shares.-^  A  savings  bank  within  the  accepted 
meaning  of  the  term  contemplates  the  ordinary  institution  of 
that  kind  as  organized  and  conducted  in  accordance  with  the 
statutes  of  the  various  states.  Its  manner  of  investing  the 
savings  of  depositors  is  restricted.  Furthermore,  the  funds  are 
received  by  deposits  ordinarily  made,  rather  than  by  a  contract 
under  which  there  arises  a  binding  duty  to  make  future  deposits. 
Therefore,  an  organization  which  receives  deposits  from  its 
members  by  contract  under  which  there  arises  a  binding  duty 
to  make  future  deposits,  and  which  is  operated  for  the  purpose 
of  speculation  rather  than  for  savings,  is  not  a  mutual  savings 
bank.2^  A  savings  fund  association  having  no  capital  stock  rep- 
resented by  shares  and  deriving  its  entire  income  from  invest- 
ments of  deposits,  such  income  being  divided  pro  rata  among 
all  members  after  deducting  operating  expenses,  the  members 
(who  are  required  to  be  depositors)  electing  the  board  of 
trustees  from  their  number  and  these  trustees  electing  officers, 
is  exempt.-^  An  association  of  employees  of  a  company  formed 
for  the  purpose  of  enabling  its  members  to  save  and  borrow 
money,  the  members  of  which  are  limited  to  the  employees  of  the 
company  who  elect  annually  a  board  of  trustees,  has  been  held 
exempt  under  this  heading.  Each  member  of  this  association 
might  subscribe  to  from  1  to  25  shares  of  stock  which  is  rep- 
resented by  certificates  of  deposit,  and  at  the  end  of  the  year 
the  money  paid  in,  together  with  the  earnings  thereon,  was 
returnable  to  the  members  proportionately,  but  each  member 
had  the  option  of  allowing  the  money  to  remain  on  deposit  to 
accumulate  further  earnings.  Any  member  might  borrow 
from  the  association  on  his  promissory  note,  but  in  no  greater 
amount  than  remained  to  his  credit,  plus  a  sum  equal  to  one 

21  Reg.  45,  Art.  512. 

22  As  to  what  constitutes  a  mutual  purpose  see  notes  41  and  95  below. 

23  Revenue  Act  of  1921,  231   (2)  ;  Revenue  Act  of  1918,  231   (2). 

24  O.  D.  780,  T.  B.  4-21-1410. 

25  0.  D.  528,  T.  B.  22-20-974. 
2fi  0.  D.  703,  T.  B.  43-20-1265. 


EXEMPT   ORGANIZATIONS  317 

month's  salary,  unless  the  note  was  secured  by  satisfactory 
collateral.-"  A  Massachusetts  savings  bank,  otherwise  exempt, 
which  establishes  an  insurance  department  under  the  statutes  of 
that  state,  does  not  thereby  become  subject  to  tax  upon  the  in- 
come received  by  such  department.-" 

Fraternal  Beneficiary  Societies  (third  class).  Fraternal  bene- 
ficiary societies,  orders  or  associations  are  exempt  (a)  if  they 
operate  under  the  lodge  system,  or  if  they  are  for  the  exclusive 
benefit  of  the  members  of  a  fraternity  itself  operating  under 
the  lodge  system,  and  (b)  if  they  provide  for  the  payment  of 
life,  sick,  accident,  or  other  benefits  to  the  members  of  such 
society,  order  or  association  or  their  dependents.  One  important 
characteristic  of  this  class  of  exempt  corporations  is  that  they 
must  operate  under  the  lodge  system,  or  be  for  the  exclusive 
benefit  of  a  society  operating  under  such  system.  "Operating 
under  the  lodge  system"  means  carrying  on  its  activities  under 
a  form  of  organization  that  comprises  local  branches,  chartered 
by  a  parent  organization  and  largely  self-governing,  called 
lodges,  chapters,  or  the  like.-^  Mutual  protective  associations 
not  operating  under  a  lodge  system  are  not  exempt  under  this 
provision  since  they  lack  one  of  the  characteristics  of  this  class.-^ 
A  fraternal  beneficiary  society  is  a  society  whose  members  have 
adopted  the  same  or  a  very  similar  calling,  avocation,  or  profes- 
sion, or  who  are  working  in  unison  to  accomplish  some  worthy 
object,  and  who  for  that  reason  have  bound  themselves  together 
as  an  association  or  society  to  aid  and  assist  one  another  and  to 
promote  the  common  cause.  The  term  "fraternal"  can  prop- 
erly be  applied  to  such  an  association  for  the  reason  that  the 
pursuit  of  a  common  object  usually  has  a  tendency  to  create  a 
brotherly  feeling  among  those  who  are  thus  engaged.  The 
absence  of  profit  in  the  operation  of  such  an  association  is  not 
the  criterion  as  to  whether  it  is  within  the  exemption  as  a  fra- 
ternal beneficiary  society,  but  the  want  of  a  fraternal  side  or 
object  which  it  is  in  some  manner  organized  to  promote.  A 
fraternal  beneficiary  association  may  be  a  mutual  insurance 
company,  but  must  be  something  more.  It  must  be  primarily 
fraternal  and  must  be  operated  under  the  lodge  system  or  for 
the  exclusive  benefit  of  the  members  of  a  fraternity  itself 
operating  under  the  lodge  system.  A  society  whose  single 
purpose  was  to  write  insurance  only  for  members  of  a  certain 
religious  sect  who  might  pass  a  satisfactory  medical  examina- 

27  Reg:.  45,  Art.  513. 

2«Rep:.  45,  Art.  514;  Reg.  33  Rev.,  Arts.  77  and  239. 

-9  Commercial  Travelers  etc.  Ass'n  v.  Rodway,  235  Fed.  370.     This  case 


318  FEDERAL  INCOME  TAX 

tion,  and  which  extended  the  privilege  of  insurance  to  mem- 
bers living  apart  from  their  fellows,  has  been  held  not  to  be  a 
fraternity  of  communicants  of  a  certain  sect,  but  a  mutual 
insurance  company  writing  only  such  communicants.^o  An  in- 
corporated society  operating  under  the  lodge  system  throughout 
the  United  States,  its  charter  providing  for  the  union  of  eligi- 
ble members  into  a  grand  fraternal,  beneficiary,  educational  and 
patriotic  society,  assessments  being  levied  upon  its  members  to 
provide  for  the  payment  of  sick  and  death  benefits,  for  dis- 
ability relief  in  case  of  accident  and  for  promoting  their  social, 
moral,  educational  and  patriotic  advancement,  the  society  deriv- 
ing income  from  subscriptions  to  a  daily  and  a  weekly  newspaper 
as  well  as  from  job  printing  and  other  sources,  none  of  the 
income  inuring  to  the  benefit  of  any  private  stockholder  or 
individual,  has  fraternal  and  benevolent  features,  but  it  is 
chieflj''  a  patriotic  organization  interested  in  the  general  welfare 
of  its  members  and  its  powers  are  so  extensive  as  to  preclude 
its  classification  as  a  fraternal  beneficiary  society .^i  A  travelers' 
association  providing  for  fixed  death  benefits  to  the  beneficiaries 
of  the  members  is  held  to  be  a  mutual  life  insurance  association 
rather  than  a  fraternal  beneficial  society.  The  law  provides  no 
exemption  for  mutual  associations  of  this  character.^^ 

Domestic  Building  and  Loan  Associations  and  Co-operative 
Banks  (fourth  class).  The  Revenue  Act  of  1918  exempted 
"domestic  building  and  loan  associations  and  co-operative  banks 
without  capital  stock,  organized  and  operated  for  mutual  pur- 
poses and  without  profit."  The  1921  law  exempts  "domestic 
building  and  loan  associations  substantially  all  the  business  of 
which  is  confined  to  making  loans  to  members ;  and  co-operative 
banks  without  capital  stock  organized  and  operated  for  mutual 
purposes  and  without  profit."  The  Revenue  Bill  of  1921,  as 
introduced  into  the  House,  required,  in  the  case  of  building  and 
loan  associations,  that  they  should  be  operated  exclusively  for 
the  purpose  of  making  loans  to  members.  As  finally  passed  the 
bill  requires  that  substantially  all  the  business  be  confined  to 
making  loans  to  members.  The  purpose  of  the  change  in  the 
language  of  the  House  bill  was  stated  in  the  report  of  the  com- 
mittee on  ways  and  means  as  follows :  "Under  the  present  law 
some  mortgage  and  investment  companies  have  been  able  to 

contains  an  extended  discvission  on  the  distinction  between  a  mutual  asso- 
ciation and  a  fraternal  association. 

30  O.  D.  690,  T.  B.  42-20-1250. 

31  O.  D.  508,  T.  B.  20-20-940. 

32  O.  D.  63,  T.  B.  1-19-88. 


EXEMPT   ORGANIZATIONS  319 

obtain  this  exemption  by  operating  in  the  guise  of  building  and 
loan  associations.  By  limiting  the  exemption  to  'domestic  build- 
ing and  loan  associations,  operated  exclusively  for  the  purpose 
of  making  loans  to  members,'  this  abuse  will  be  prevented." 
The  regulations  issued  under  the  1918  Law  required  that  to  be 
exempt,  building  and  loan  associations  should  accumulate  their 
funds  for  the  primary  business  of  making  loans  to  its  members 
for  the  purpose  of  building  or  acquiring  homes.  It  will  be  seen 
that  the  present  law  is,  in  etfect,  largely  an  enactment  of  such 
regulations.  Under  the  1918  Law  the  following  rulings  and 
regulations  were  made: 

In  general,  a  building  and  loan  association  entitled  to  exemp- 
tion is  one  organized  pursuant  to  the  laws  of  the  United  States, 
of  some  state  or  territory  thereof,  which  accumulates  funds  for 
the  primary  business  of  making  loans  to  its  members  for  the 
purpose  of  building  or  acquiring  homes,  and  in  which  the 
members  of  the  association  share  in  the  profits  on  substantially 
the  same  footing.  It  is  essential  that  the  association  should  be 
(a)  mutual;  (b)  organized  and  operated  for  the  accumulation 
of  funds  to  be  loaned  primarily  to  members  for  home  building.^^' 
When  a  building  and  loan  association  has  no  other  features 
which  render  it  liable  to  income  tax,  it  will  ordinarily  not  be 
subject  to  tax  merely  because:  (1)  It  has  paid-up  shares  which 
are  (a)  preferred  as  to  earnings  and  (b)  have  a  definite  rate 
of  interest  which  may  be  higher  than  the  rates  of  dividends  paid 
on  other  stock.'^  (2)  It  borrows  large  sums  of  money  (accept- 
ing deposits  is  considered  as  borrowing) ,  which  it  uses  pri- 
marily for  loans  to  members,  the  dues  paid  by  members  being 
entirely  inadequate  for  this  purpose.'^'^  (3)  In  times  of  small 
demand  it  loans  considerable  sums  to  nonmembers  from  or 
invests  association  funds  which  would  otherwise  lie  idle  and  un- 
productive.-"'    (4)   The  amount  of  prepaid  or  full-paid  stock  is 

•■5"5Rep:.  4'),  Art.  515,  as  amended  by  T.  D.  3179,  T.  B.  27-21-171tx  The 
essential  features  of  a  building  and  loan  association  are  stated  in  F'olk  v. 
State  Capital  Ass'n,  214  Pa.  529,  63  Atl.  1013.  Conducting  an  insurance 
atrency  by  a  building  and  loan  association  will  defeat  its  exemption.  (O.  D. 
1129,  T.  B.  49-21-1965.) 

•■J^Reg.  45.  Art.  515,  as  amended  by  T.  D.  3179,  T.  B.  27-21-1716.  Park 
View  Bui'ding  &  Loan  Ass'n  v.  Hcrold,  203  Fed.  876,  210  Fed.  577;  T.  P. 
1941.    This  was  not  true  under  the  1909  Law.     (See  footnote  41.) 

•'J-'Reg.  45.  Art.  515,  as  amended  by  T.  D.  3179,  T.  B.  27-21-1716;  Belle- 
fontaine  Building  &  Loan  Co.  v.  McMaken.  216  Fed.  526. 

:«'Reg.  45,  Art.  515,  as  amended  by  T.  D.  3179,  T.  B.  27-21-1716;  Central 
Building,  Loan  &  Savings  Co.  v.  Bowland  and  Bellefontaine  Building  & 
Loan  Co.  v.  McMaken,  216  Fed.  526.  This  also  was  not  true  under  the  1909 
Law    (see   footnote  41).      A   building  and   loan  association   which   loans   its 


320  FEDERAL  INCOME  TAX 

disproportionate  to  running  or  installment  stock,  provided  the 
issuance  of  such  prepaid  or  full-paid  stock  is  incidental  to  the 
furtherance  of  the  main  business  of  the  association ;  that  is, 
that  it  is  intended  to  provide  a  fund  from  which  loans  may  be 
made  primarily  to  persons  subscribing  to  the  running  or  install- 
ment stock  to  enable  them  to  acquire  or  build  homes.-"'^  Where, 
however,  the  facts  show  that  a  building  and  loan  association  is 
borrowing  large  sums  of  money  from  nonmembers,  with  no 
reference  to  the  borrowing  needs  of  its  members,  and  is  in  turn 
loaning  these  sums  to  nonmembers,  the  number  of  depositors  be- 
ing disproportionate  to  the  number  of  members,  and  the  amounts 
loaned  to  nonmembers  being  disproportionate  to  the  amount 
loaned  to  members,  such  association  will  be  deemed  to  be  tax- 
able and  will  be  granted  exemption  only  upon  a  satisfactory 
showing  to  the  commissioner  that  it  is,  in  fact,  a  bona  fide 
building  and  loan  association  within  the  meaning  of  this  article.^^ 
When  a  building  and  loan  association  charges  a  commission  on 
all  money  loaned,  in  lieu  of  a  membership  fee,  and  does  not 
charge  a  membership  fee  to  nonborrowing  members,  such  com- 
mission or  membership  fee  is  held  to  be  in  the  nature  of  addi- 
tional interest  for  the  use  of  the  money  loaned  and  is  insufficient 
to  deny  the  association  the  exemption  to  which  it  is  otherwise 
entitled.-"^  Where  a  large  proportion  of  the  loans  of  an  associa- 
tion are  made  upon  such  securities  as  stocks,  automobile  notes 
and  personal  endorsements  and  only  a  small  proportion  upon 
real  estate,  it  is  held  that  such  an  association  is  not  a  domestic 
building  and  loan  association  within  the  meaning  of  the  law 
and  must  file  returns  of  annual  net  income  and  pay  any  tax 
shown  to  be  due  thereon.'^o  jf  ^  corporation  by  any  other  name 
is  carrying  on  an  exclusive  building  and  loan  business,  before 
it  is  entitled  to  exemption  it  will  be  incumbent  upon  it  to  show 
to  the  satisfaction  of  the  commissioner  that   it  is   in  fact   a 

funds  to  nonmembers,  on  indorsed  notes,  a  very  small  amount  only  being 
secured  by  real  estate,  and  divides  the  profits  among  the  holders  of  the 
paid-up  certificates,  these  being  the  only  members  of  the  association  partici- 
pating in  the  management  and  in  the  profits,  is  held  to  be  engaged  in 
business  in  the  nature  of  a  banking  business,  and  does  not  come  within  this 
exemption.     (O.  D.  768,  T.  B.  1-21-1375.) 

a7Reg.  45,  Art.  515,  as  amended  by  T.  D.  3179,  T.  B.  27-21-1716;  see  S. 
1140,  T.  B.  19-19-449,  O.  D.  573,  T.  B.  27-20-1043;  Sol.  Op.  78,  T.  B.  48-20- 
1325. 

38  Reg.  45,  Art.  515,  as  amended  by  T.  D.  3179,  T.  B.  27-21-1716. 

30  0.  D.  744,  T.  B.  49-20-1336. 

40  O.  D.  1088,  T.  B.  44-21-1900. 


EXEMPT   ORGANIZATIONS  321 

building  and  loan  association.^'  Co-operative  banks  without 
capital  stock  organized  and  operated  for  mutual  purposes  and 
without  profit  are  exempt.  Credit  unions,  such  as  those  or- 
ganized under  the  laws  of  Massachusetts,  are  in  substance  the 

41  Reg.  33  Rev.,  Art.  70.  The  1909  and  1913  Laws  provided  that  "domestic 
buildinj?  and  loan  associations,  organized  and  operated  exclusively  for  the 
mutual  benefit  of  their  members"  should  be  exempt.  The  1916  Law  contained 
the  following  exemption:  "Domestic  building  and  loan  associations  and  co- 
operative banks  without  capital  stock  organized  and  operated  for  mutual 
purposes  and  without  profit."  Under  the  1916  Law  it  was  ruled  that  mu- 
tuality in  operation  and  in  the  distribution  of  profits  and  benefits  was  essen- 
tial to  exemption;  that  in  order  to  come  within  the  exempted  class  such 
associations  must  not  only  be  domestic,  but  they  must  be  organized  and  op- 
erated exclusively  for  mutual  purposes  and  without  profit,  that  is,  all  profits 
and  benefits  provided  for  in  the  articles  of  association  and  by-laws  must  be 
ratably  distributed  among  all  the  members  regardless  of  the  kind  of 
stock  held,  according  to  the  amount  of  money  they  had  on  deposit; 
and  that  an  association  issuing  different  classes  of  stock  upon  which 
different  rates  of  interest  or  dividends  were  guaranteed  or  paid,  was 
not  in  the  exempt  class.  (Reg.  33,  Art.  87.)  Under  the  1909  Law 
it  was  ruled  that  building  and  loan  associations  were  not  exempt  if 
they  loaned  money  to  others  than  their  members,  thus  doing  a  business 
similar  to  that  engaged  in  by  banks  or  trust  companies;  and  that 
building  and  loan  associations  which  received  sums  of  money  on  deposit  not 
in  payment  of  stock,  and  on  which  the  depositor  received  a  fixed  rate  of  in- 
terest, regardless  of  the  earnings  of  the  association,  were  conducting  a  bus- 
iness similar  to  a  banking  business  and  were  therefore  subject  to  tax  unless 
they  fell  within  the  class  of  co-operative  banks.  (T.  D.  1655.)  Under  the 
1909  Law  it  was  decided  that  a  building  and  loan  association  was  exempt 
although  it  issued  both  prepaid  and  installment  stock,  but  that  one  issuing 
preferred  stock  was  not  exempt.  (Pacific  Bldg.  &  Loan  Ass'n  v.  Hartson, 
201  Fed.  1011.)  In  Herold  v.  Parkview  Bldg.  &  Loan  Ass'n,  203  Fed.  876, 
the  association  issued  two  varieties  of  stock,  one  known  as  prepaid  stock  on 
which  the  full  par  value  of  $200  per  share  was  paid  by  the  holder  at  the 
time  of  the  issuance  of  the  stock,  and  upon  which  the  company  paid  to  the 
holder  out  of  the  profits  of  the  association  the  sum  of  59c  per  annum  in  lieu 
of  participation  by  said  stockholder  in  the  general  profits  of  the  association, 
and  a  second  stock  known  as  installment  stock  whereon  the  holder  paid  one 
dollar  per  share  per  month  and  to  which  was  added  the  proportionate  share 
of  the  profits  of  the  association  after  deducting  expenses  until  the  aggregate 
of  payments  and  profits  equaled  the  sum  of  $200,  when  the  said  sum  was 
paid  to  the  holder  and  the  shares  retired.  The  prepaid  stock  could  be  can- 
celled by  the  corporation  at  any  time  upon  thirty  days'  notice  and  payment 
of  the  value  thereof  together  with  interest  at  the  rate  of  5?f  from  the  date 
of  last  payment  of  interest,  and  each  holder  of  such  stock  could  likewise 
upon  thirty  days'  notice  tender  his  certificate  and  require  payment  from 
the  association.  The  association  borrowed  no  money  from  individuals 
whether  members  or  nonmembers,  loaned  no  money  to  persons  other  than 
members  of  the  association,  but  borrowed  according  to  its  business  demands 
from  a  local  bank.     The  association  was  organized  under  the  Act  of  April 


322  FEDERAL  INCOME  TAX 

same  as  co-operative  banks,  and  when  organized  and  operated 
without  capital  stock,  for  mutual  purposes,  and  without  profit 
are  likewise  exempt.*^ 

Cemetery  Companies  (fifth  class).  Under  the  1918  Law  ''ceme- 
tery companies  owned  and  operated  exclusively  for  the  benefit 
of  their  members"  were  exempt.  The  present  law  adds  the 
words :  "or  which  are  not  operated  for  profit ;  and  any  corpora- 
tion chartered  solely  for  burial  purposes  as  a  cemetery  corpora- 
tion and  not  permitted  by  its  charter  to  engage  in  any  busi- 
ness not  necessarily  incident  to  that  purpose,  no  part  of  the 
net  earnings  of  which  inures  to  the  benefit  of  any  private  stock- 
holder or  individual.-t-^  Under  the  1918  Law  the  following  rulings 
were  made:  A  cemetery  company  having  a  capital  stock  rep- 
resented by  shares,  or  which  is  operated  for  profit  or  for  the 
benefit  of  others  than  its  members,  does  not  come  within  the 
exempted  class.  A  cemetery  company  of  which  all  lot  owners 
are  members,  issuing  preferred  stock  entitling  the  holder  to  a 
semi-annual  dividend  of  4  per  cent.,  and  whose  articles  of  incor- 
poration provide  that  the  preferred  stock  shall  be  retired  at  par 
as  soon  as  sufficient  funds  are  realized  from  sales  and  that  all 
funds  realized  in  addition  thereto  shall  be  used  by  the  company 
for  the  care  and  improvement  of  the  cemetery  property,  is  within 
the  exemption.'^^  The  word  "members"  as  used  by  the  law, 
means  "lot  owners".^^ 

Religious,  Charitable,  Scientific,  Literary,  and  Educational 
Corporations  (sixth  class).  This  exemption  applies  under  the 
1918  Law  only  to  a  corporation  or  association.  Under  the  present 
law  it  applies,  as  well,  to  "any  community  chest,  fund,  or  founda- 
tion" subject  to  the  same  limitations  applying  to  corporations. 
The  Revenue  Act  of  1921  adds  the  term  "literary"  to  the  pur- 
poses for  which  such  organizations  must  be  organized  and  oper- 
ated. It  does  not  include  the  case  of  a  trust,  under  which  the 
trustee  is  authorized  to  use  the  trust  property  for  religious  pur- 
poses.    In  order  to  be  exempt  the  corporation  or  association 

8,  1903  (Public  Laws,  p.  457),  of  New  Jersey.  It  was  held  that  mutual 
benefit  does  not  necessarily  mean  equal  benefit;  that  a  building  and  loan 
association  is  organized  and  operated  for  the  mutual  benefit  of  its  members 
when  they  share  in  the  profits  on  substantially  the  same  footing;  and  that 
exact  equality  is  probably  not  possible  where  part  of  the  stock  is  prepaid 
and  part  is  installment,  but  an  approximate  equality  sufficiently  close  for  all 
purposes  is  certainly  not  beyond  the  reach  of  calculation. 

42  Reg.  45,  Art.  515,  as  amended  by  T.  D.  3179,  T.  B.  27-21-1716. 

43  Revenue  Act  of  1918,  §    231  (5);  Revenue  Act  of  1921,  §231  (5).     ' 

44  Reg.  45,  Art.  516;  Reg.  33  Rev.,  Art.  71. 

45  Sol.  Op.  120,  T.  B.  39-21-1846. 


EXEMPT  ORGANIZATIONS  323 

must  meet  three  tests:  (a)  it  must  be  organized  and  operated 
for  one  or  more  of  the  specified  purposes;  (b)  it  must  be  or- 
ganized and  operated  exclusively  for  such  purposes;  and  (c) 
no  part  of  its  income  must  inure  to  the  benefit  of  private  stock- 
holders or  individuals."'  The  courts  favor  tax  exemptions  which 
pertain  to  charitable,  religious,  or  educational  institutions  upon 
the  theory  that  such  institutions  relieve  burdens  of  the  gov- 
ernment.^" The  term  "organized,"  as  used  in  the  provision 
granting  exemption  to  this  class  of  corporations,  refers  to  the 
real  substance  and  intent  of  the  organization,  and  not  to  its 
mere  form,  the  charter  and  by-laws  merely  giving  rise  to  pre- 
sumptions which  may  be  affirmed  or  rebutted  by  extraneous 
evidence."*^  The  word  "private"  refers  to  a  stockholder  or  indi- 
vidual in  his  private  capacity  as  distinguished  from  a  public 
capacity.  Dividends  inure  to  a  stockholder  in  his  private  ca- 
pacity when  they  inure  to  him  separate  from  the  public  and 
not  as  an  official  or  representative  of  the  public.^"  The  term 
"charitable"  has  been  given  a  very  broad  meaning  by  the 
courts,  but  it  is  noticeable  that  the  decisions  applying  the 
broadest  meaning  are  in  cases  involving  "charitable  uses,"  that 
is,  where  there  is  a  trust  for  a  charitable  purpose.  It  is,  of 
course,  expedient  to  uphold  such  trusts  where  a  construction 
of  the  law  will  possibly  admit  it."'"  Education,  in  a  broad  sense 
and  with  reference  to  man,  comprehends  all  that  disciplines 
and  enlightens  the  understanding,  corrects  the  temper,  cultivates 
the  taste,  and  forms  the  manners  and  habits.''!  It  is  the  process 
of  developing  and  training  the  powers  and  capabilities  of  human 
individuals.''-  The  prime  purpose  of  education  is  to  benefit  the 
individual."'^'  On  the  other  hand,  the  primary  purpose  of  propa- 
ganda is  much  more  narrow.  Propaganda  is  that  which 
propagates  the  tenets  or  principles  of  a  particular  doctrine  by 
zealous  dissemination."'^  It  is  a  matter  of  common  knowledge 
that  propaganda  in  the  popular  sense  is  disseminated  not  pri- 
marily to  benefit  the  individual  at  whom  it  is  directed,  but  to  ac- 
complish the  purpose  or  purposes  of  the  person  instigating  it. 

46  Reg.  45,  Art.  517;  Reg.  33  Rev.,  Art.  67. 

47  0.  D.  510,  T.  B.  20-20-942;  Congregational  Church  Society  v.  Board,  290 
111.  108,  125  N.  E.  7. 

•I'^A.  R.  R.  219,  T.  B.  32-20-1121. 

40  T.  B.  R.  33,  T.  B.  8-19-329. 

50  S.  1246,  T.  B.  8-20-755. 

*ii  Century  Dictionary,  p.  1845. 

r>2  Mt.  Herman  Boys'  School  v.  Gill,  145  Mass.  139,  13  N.  E.  354,  357. 

•'^s  Century  Dictionary,  p.  1845. 

54  Century  Dictionary,  p.  4774. 


324  FEDERAL  INCOME  TAX 

This  is  a  very  material  difference.  The  solicitor  of  the  treasury 
department  is  of  the  opinion  that  it  was  Congress'  intention, 
when  providing  for  the  deduction  of  contributions  to  educational 
corporations,  not  to  benefit  and  assist  the  aims  of  one  class 
against  another,  not  to  encourage  the  dissemination  of  ideas  in 
support  of  one  doctrine  as  opposed  to  another,  to  the  profit  of  one 
class  and  to  the  detriment  perhaps  of  another,  but  to  foster  edu- 
cation in  its  true  and  broadest  sense,  thereby  advancing  the  in- 
terest of  all,  over  the  objection  of  none.'''' 

The  following  types  of  organization  are  exempt  under  this 
class : 

1.  A  branch  of  the  Y.  W.  C.  A.,  established  for  the  purpose 
of  marketing  the  needlework  of  self-supporting  women,  which 
pays  to  the  producers  the  full  selling  price  of  the  goods  sold,  less 
a  certain  commission  which  only  partially  defrays  the  running 
expenses  of  the  enterprise,  the  deficit  being  derived  from  income 
of  the  Y.  W.  C.  A.  and  from  voluntary  contributions.^*^ 

2.  An  organization  incorporated  for  the  purpose  of  estab- 
lishing and  maintaining  a  day  nursery  for  young  children  whose 
parents  are  obliged  to  work  and  have  no  means  to  provide  care 
for  their  children  during  the  day,  and  deriving  its  income  from 
subscriptions  and  donations,  and  a  small  amount  from  securities, 
all  of  which  is  used  in  promoting  the  activities  of  the  nursery .^^ 

3.  An  incorporated  publishing  house,  without  capital  stock, 
owned  and  controlled  by  a  religious  denomination,  its  business 
consisting  strictly  of  printing  religious  publications  in  the  form 
of  books,  tracts,  Sunday  school  lessons,  catalogues,  periodicals, 
etc.,  and  distributing  them  to  the  various  branches  of  the  church 
and  members  of  congregations,  no  business  being  done  for  the 
general  public.'^s 

4.  An  organization  such  as  the  Teachers'  Insurance  and 
Annuity  Association  of  America,  which  though  in  form  a  busi- 
ness insurance  company  was  required  to  adopt  this  form  in  order 
to  issue  non-participating  policies  under  the  laws  of  New  York.^'^ 

53  S.  1362,  T.  B.  22-20-971. 
5<5  O.  D.  509,  T.  B.  20-20-941. 

57  O.  D.  340,  T.  B.  29-19-630. 

58  O.  D.  510,  T.  B.  20-20-942.  It  was  clear  that  the  predominant  purpose 
of  the  publishing  house  involved  in  this  decision  was  to  advance  the  cause 
of  Christianity.  It  was  conducted  at  a  profit,  none  of  the  income  inured  to 
the  benefit  of  any  private  individual,  being  paid  over  in  its  entirety  to  the 
treasurer  of  the  church  for  the  exclusive  benefit  of  the  church. 

59  A.  R.  R.  218,  T.  B.  32-20-1121. 


EXEMPT   ORGANIZATIONS  325 

5.  A  corporation  organized  and  operated  for  the  purpose  of 
preventing  the  employment  of  children  in  injurious  occupa- 
tions.^ 

6.  An  association  for  the  relief  of  the  families  of  clergymen, 
even  though  the  latter  make  a  contribution  to  the  fund  estab- 
lished for  this  purpose ;  or  for  furnishing  the  services  of  trained 
nurses  to  persons  unable  to  pay  for  them ;  or  for  aiding  the  gen- 
eral body  of  litigants  by  improving  the  efficient  administration 
of  justice/'i 

7.  An  association  to  promote  acquaintance  with  the  Spanish 
language  and  literature,  although  it  has  incidental  amusement 
features ;  an  association  to  increase  knowledge  of  the  civilization 
of  another  country ;  and  a  chautauqua  association  whose  primary 
purpose  is  to  give  lectures  on  subjects  useful  to  the  individual 
and  beneficial  to  the  community  and  whose  amusement  features 
are  incidental  to  this  purpose.^- 

8.  An  association  for  the  scientific  study  of  law,  to  the  end 
of  improvement  in  its  administration/'^ 

9.  A  private  corporation  without  capital  stock  organized  and 
operated  under  state  laws  and  managed  by  a  board  of  trustees 
for  the  purpose  of  conducting  a  school  to  educate  and  train  men 
and  women  in  those  subjects  that  will  prepare  them  for  practical 
business  and  commercial  and  industrial  occupations,  deriving  its 
income  from  tuition  fees  paid  by  students  attending  its  courses, 
the  balance  remaining  after  payment  of  expenses  being  placed 
in  an  operating  fund  to  meet  operating  expenses  in  the  future, 
any  amount  in  excess  of  25  per  cent,  of  the  current  year's  in- 
come being  placed  in  a  students'  loan  fund  from  which  deserving 
students  may  borrow  money  for  the  purpose  of  pursuing  a  course 
of  study  in  the  school,  and  no  part  of  the  earnings  of  the  school 
inuring  to  the  benefit  of  any  individual  or  individuals  connected 
with  the  corporation  in  any  manner  whatever,  the  by-laws  pro- 
viding that  no  remuneration  of  any  kind  shall  be  paid  to  the 
board  of  trustees  for  their  services  as  such.^^ 

The  following  types  of  organizations  are  not  exempt  under 
this  class: 

1.  An  actively  operating  railroad  which  turns  over  all  of  its 
income  to  a  charitable  institution  as  a  dividend.''^ 

60  O.  D.  705,  T.  B.  43-20-1267. 

61  Reg.  45,  Art.  517. 

62  Reg.  45,  Art.  517. 

63  Reg.  45,  Art.  517. 

64  0.  D.  1102,  T.  B.  46-21-1923. 

65  0.  D.  60,  T.  B.   1-19-85. 


326  FEDERAL  INCOME  TAX 

2.  A  corporation  conducting  an  educational  institution  all  of 
whose  stockholders  are  directors  in  the  company,  and  which 
pays  dividends  to  its  stockholders,  the  surplus  earnings  over  a 
fixed  rate  paid  as  dividends  being  invested  as  they  accrue  in 
grounds,  buildings,  and  equipment  needed  in  the  business/'*^ 

3.  An  incorporated  educational  institution  whose  only  source 
of  income  is  from  tuition  and  sale  of  uniforms  and  supplies  to  its 
students,  and  no  part  of  the  net  income  of  which  is  distributed 
as  dividends,  but  is  expended  in  acquiring  additional  buildings 
and  equipment,  is  not  entitled  to  exemption,  the  corporation 
being  considered  as  capitalizing  its  earnings  by  acquiring  new 
buildings  and  equipment.*^^ 

4.  A  corporation  organized  for  the  purpose  of  acquiring  and 
holding  title  to  land  and  erecting  thereon  suitable  buildings  for 
conducting  an  assembly  or  chautauqua,  religious,  educational, 
and  recreational  in  character,  deriving  income  from  ground 
rentals,  sales  of  tickets,  advertising  space,  hotel  accommoda- 
tions, etc.,  all  expenditures  being  made  in  connection  with  hiring 
talent  and  entertainment  and  the  upkeep  of  buildings  and 
grounds,  none  of  the  income  of  which  is  paid  to  any  stockholder 
or  individual,  although  the  charter  and  by-laws  do  not  prohibit 
such  payment.*^'^ 

5.  A  corporation  organized  and  operated  exclusively  for  the 
purpose  of  erecting  and  maintaining  monuments  or  other  like 
memorials  no  part  of  the  earnings  of  which  inures  to  the  benefit 
of  any  private  stockholder  or  individual.''^ 

6.  An  association  organized  and  operated  for  the  purpose  of 
furthering  the  enactment  of  prohibition  laws,  the  selection  of 
prohibition  officials,  and  the  nomination  and  election  of  political 
candidates  favorable  to  its  work.™ 

7.  The  pension  fund  organization  of  a  corporation  the  object 
of  which  is  the  payment  of  annuities  to  member  employes  in  the 
event  that  they  are  incapacitated  by  infirmity  from  performing 
their  duties  to  the  corporation,  or  in  the  event  of  their  death, 
and  the  payment  of  annuities  to  the  widows  or  dependents  of 

6fiT.  B.  R.  33,  T.  B.  8-19-329. 

67  0.  D.  293,  T.  B.  23-19-548. 

C8A.  R.  M.  36,  T.  B.  11-20-786.  If  the  corporation  involved  in  this  de- 
cision should  have  gone  out  of  existence,  the  stockholders  would  have  bene- 
fited directly  through  the  distribution  of  the  assets,  as  w^ell  as  through  any 
appreciation  of  such  assets. 

69  S.  1246,  T.  B.  8-20-755.  The  status  of  such  corporations  as  have  addi- 
tional purposes  involving  a  positive  dissemination  of  knowledge  will  be 
determined  on  proper  facts  submitted  in  each  case. 

70  0.  D.  703,  T.  B.  43-20-1266. 


EXEMPT   ORGANIZATIONS  327 

members  who  had  been  in  the  uninterrupted  service  of  the  cor- 
poration for  ten  years  or  more  and  have  attained  the  age  of  sixty- 
four  years ;  the  funds  out  of  which  annuities  are  paid  consisting 
of  the  contributions  of  members. "^ 

8.  A  society  designed  to  encourage  the  performance  of  first 
class  orchestral  music,  the  purpose  of  which  is  to  encourage  a 
high  grade  of  entertainment. "- 

9.  A  school  which,  though  devoted  solely  to  educational  pur- 
poses, is  operated  for  the  pecuniary  profit  of  certain  stock- 
holders, even  though  all  such  stockholders  are  oflEicers,  directors 
and  teachers  in  the  institution. "=• 

10.  An  ordinary  common-law  trust  created  by  a  will  for  the 
purpose  of  erecting  schools  which  does  not  amount  to  an  "asso- 
ciation".'^ 

11.  A  lyceum  and  chautauqua  association  organized  to  take 
over  the  assets  of  a  partnership  for  the  purpose  of  promoting 
the  intellectual,  social,  physical,  moral  and  nonsectarian  religious 
welfare  of  the  people  in  the  places  where  it  operates  and  espe- 
cially in  the  United  States,  its  income  being  received  from  admis- 
sion charges  to  its  entertainments  and  being  used  first  to  defray 
expenses  of  operating;  second  to  the  payment  of  the  members 
of  the  partnership  for  assets  purchased,  and,  third,  to  build  up 
a  surplus,  the  members  of  the  partnership  whose  assets  were 
taken  having  been  made  life  members  of  the  board  of  trustees.""' 

12.  A  hospital  association  incorporated  under  the  laws  of 
a  state  to  build,  own,  lease,  acquire,  and  operate  a  hospital  to 
furnish  and  provide  medical,  surgical  and  hospital  services  and 
care  to  all  employes  of  other  corporations,  persons,  or  partner- 
ships with  whom  contracts  may  be  made;  said  services  being 
intended  to  take  care  of  the  needs  of  sick  and  injured  employes 
requiring  and  entitled  to  such  care  by  virtue  of  membership  in 
said  corporations  and  in  conformity  to  the  provisions  of  the  by- 

"J  A.  R.  R.  477,  T.  B.  18-21-1610.  The  solicitor  founded  this  decision  upon 
the  consideration  that  the  pension  fund  was  not  for  the  benefit  of  an  in- 
definite number  of  persons.  (See  St.  Clement  v.  L'Institut  Jacques  Cartier, 
95  Maine  493,  50  Atl.  376;  Young  Men's  Society  v.  City  of  Fall  River,  160 
Mass.  409,  36  N.  E.  57;  Franta  v.  Bohemian  Union,  164  Mo.  304,  63  S.  W. 
1100). 

'-  Reg.  45,  Art.  517. 

"•"5  Kemper  Military  School  v.  Crutchley,  274  Fed.  125. 

'I  A.  R.  M.  104,  T.  B.  1-21-1376.  Neither  were  the  expenses  of  operating 
the  schools  permitted  to  be  deducted  from  the  gross  income  of  the  trust  as 
ordinary  and  necessary  expenses;  they  constituted  the  expenditure  of  the 
trust  moneys  for  the  very  purpose  for  which  the  trust  was  created. 

"'  O.  D.  1077,  T.  B.  43-21-1886. 


328  FEDERAL  INCOME  TAX 

laws  of  the  corporation  and  the  care  of  injured  employes  as  con- 
templated and  provided  for  in  the  laws  of  the  state  and  the  rules, 
regulations,  and  practices  now  or  hereafter  promulgated  by  the 
state  medical  aid  board;  the  corporation  also  contemplating 
hospital  services  and  care  for  the  families  of  employees  and  for 
other  persons ;  the  income  of  the  association  being  received  from 
the  corporations  with  which  it  has  contractual  relations,  from 
the  medical  aid  department  of  the  state  for  services  to  injured 
employees  who  do  not  have  contract  arrangements,  and  from 
direct  payments  by  patients  and  no  patients  being  treated  free, 
but  where  destitute  patients  have  been  admitted  as  objects  of 
public  charge  the  services  being  rendered  at  cost  to  the  municipal 
corporation  paying  for  such  services.^" 

13.  A  religious  corporation  owning  a  large  quantity  of  farm 
land  and  working  it,  and  also  manufacturing  and  selling  clothing 
and  other  articles  for  profit,  even  though  its  property  is  held  in 
common  and  its  profits  do  not  inure  to  the  benefit  of  individual 
members  of  the  society.  It  does  not  prevent  exemption  that  pri- 
vate individuals,  for  whose  benefit  a  charity  is  organized,  receive 
the  income  of  the  corporation  or  association.  The  statute  refers 
to  individuals  having  a  personal  and  private  interest  in  the  activi- 
ties of  the  corporation,  such  as  stockholders.  If,  however,  a  cor- 
poration issues  "voting  shares,"  which  entitle  the  holders  upon 
the  dissolution  of  the  corporation  to  receive  the  proceeds  of  its 
property,  including  accumulated  income,  the  right  to  exemption 
does  not  exist,  even  though  the  by-laws  provide  that  the  share- 
holders shall  not  receive  any  dividend  or  other  return  upon  their 
shares."^^ 

Business  Associations  (seventh  class).  Business  leagues, 
chambers  of  commerce  and  boards  of  trade  are  conditionally  ex- 
empt; that  is,  those  not  organized  for  profit  and  no  part  of  the 
net  income  of  which  inures  to  the  benefit  of  any  private  stock- 
holder or  individual  are  exempt.  A  business  league  is  an  asso- 
ciation of  persons  having  some  common  business  interest,  which 
limits  its  activities  to  work  for  such  common  interest  and  does 
not  engage  in  a  regular  business  of  a  kind  ordinarily  carried  on 
for  profit.  Its  work  need  not  be  similar  to  that  of  a  chamber  of 
commerce  or  board  of  trade.'^^ 

The  following  types  of  organizations  are  business  leagues 
within  the  purview  of  the  statute: 

76  O.  D.  993,  T.  B.  33-21-1769. 

77  Reg.  45,  Art  517;  Reg.  33  Rev.,  Art.  67. 

78  Reg.  45,  Art.  518. 


EXEMPT  ORGANIZATIONS  329 

1.  A  clearing  house  association  not  organized  for  profit,  no 
part  of  the  net  income  of  which  inures  to  any  private  stock- 
holder or  individual,  provided  its  activities  are  limited  to  the 
exchange  of  checks  and  similar  work  for  the  common  benefit  of 
its  members.'^ 

2.  An  association  of  persons  engaged  in  the  business  of 
carrying  freight  and  passengers  by  boats  propelled  by  steam, 
which  is  designed  to  promote  the  legitimate  objects  of  such 
business,  all  the  income  of  which  is  derived  from  membership 
dues  and  is  expended  for  office  expenses  and  the  salary  of  the 
secretary-treasurer.'^" 

3.  A  corporation  organized  for  the  purpose  of  fostering,  de- 
veloping and  promoting  scientifically  a  certain  industry,  with 
no  capital  stock  represented  by  shares  and  not  authorized  to  in- 
vest funds  for  profit  or  to  make  any  distribution  thereof  by  way 
of  dividends,  the  funds  for  maintaining  the  association  being 
derived  solely  from  assessments  against  individual  member 
firms  and  dues  with  the  exception  of  interest  on  bank  deposits 
and  Liberty  bonds  purchased  from  excess  surplus  funds,  which 
in  accordance  with  the  by-laws  are  required  to  be  refunded  pro- 
portionately to  those  contributing  the  funds,  no  other  securities 
being  owned  by  the  association,  and  the  interest  on  the  Liberty 
bonds  not  being  credited  or  distributed  to  any  member.^^ 

4.  An  unincorporated  association  formed  for  the  purpose  of 
ascertaining  the  causes  of  losses  sustained  through  navigation 
of  vessels  belonging  to  its  members,  thereby  reducing  such 
losses,  any  excess  of  fees,  assessments,  and  interest  received  over 
current  expenses  and  losses  sustained  by  members  being  returned 
to  members  on  a  pro  rata  basis.^- 

The  following  types  of  organizations  are  not  entitled  to  ex- 
emption under  this  heading: 

1.  An  association  engaged  in  furnishing  information  to  pros- 
pective investors  to  enable  them  to  make  sound  investments, 
since  its  members  have  no  common  business  interest."^-- 

2.  An  incorporated  cotton  exchange  whose  shares  carry  the 
right  to  dividends.'^^ 

3.  An  association  of  credit  men  acting  through  its  credit  in- 
terchange bureau  and  its  adjustment  bureau   as  receiver  and 

TOReK.  45,  Art.  518. 

80  Reg.  45,  Art.   518. 

f«i  O.  D.  522,  T.  B.  21-20-960. 

^^2  0.  D.  (il,  T.  B.  1-19-86. 

^^•■5  Reg.  45,  Art.  518. 

S4  Reg.  45,  Art.  518. 


330  FEDERAL  INCOME  TAX 

trustee  for  insolvent  or  embarrassed  businesses  and  otherwise 
protecting  the  interests  of  its  members  in  excess  of  insolvency 
and  producing  for  its  members  larger  dividends  from  bankrupt 
or  embarrassed  estates  than  they  would  otherwise  receive ;  for 
these  services  charging  a  fee  covering  the  cost  thereof,  the  asso- 
ciation's fees  and  disbursements  in  connection  with  these  ac- 
tivities amounting  to  about  45  per  cent,  of  its  total  budget.s^ 

Civic  Organizations  (eighth  class).  Civic  leagues  or  organi- 
zations not  organized  for  profit  but  operated  exclusively  for  the 
promotion  of  social  welfare  are  exempt.*^'"'  A  corporation  having 
capital  stock  and  possessing  a  charter  which  authorizes  it  to  buy, 
improve  and  sell  real  estate  is  organized  for  profit  within  the 
meaning  of  the  statute  and  is  not  exempt  from  tax  as  a  civic 
league  or  organization,  even  though  it  no  longer  exercises  such 
powers  for  profit  and  is  operated  exclusively  for  the  promotion 
of  social  welfare.'*" 

Clubs  (ninth  class).  Clubs  organized  and  operated  exclusively 
for  pleasure,  recreation  and  other  non-profitable  purposes  are 
exempt  if  no  part  of  the  net  income  inures  to  the  benefit  of  any 
private  stockholder  or  member.ss  This  exemption  applies  to 
practically  all  social  and  recreation  clubs  which  are  supported  by 
membership  fees,  dues  and  assessments.  If  a  club,  by  reason  of 
the  comprehensive  powers  granted  in  its  charter,  engages  in 
traffic,  in  agriculture,  or  horticulture,  in  the  sale  of  real  estate, 
timber,  etc.,  for  profit,  such  club  is  not  organized  and  operated 
exclusively  for  pleasure,  recreation,  or  social  purposes.  It  thus 
becomes  a  business  or  commercial  enterprise,  and  any  profit  re- 
alized from  such  activities  is  subject  to  the  tax,  and  the  club  so 
operated  must  make  returns  of  income.^^  A  provision  in  the  by- 
laws of  a  country  club,  that,  in  the  event  of  dissolution,  the 
holder  of  a  life  membership  shall  participate  in  the  distribution 
of  the  assets  of  the  club  after  its  other  debts  are  paid  and  be- 
fore any  sums  are  paid  to  either  regular  members  or  share- 
holders, is  not  alone  sufficient  to  make  the  club  liable  to  tax.^o 

85  0.  D.  786,  T.  B.  5-21-1419. 

8«  Reg.  33  Rev.,  Art.  67. 

87  Reg.  45,  Art.  519. 

ss  Reg.  33  Rev.,  Arts.  67  and  72.  T.  D.  2090.  Letter  from  treasury  de- 
partment dated  February  12,  1916;  L  T.  S.  1918,  111194.  Such  clubs  were 
held  to  be  exempt  under  the  1913  Law,  although  that  law  did  not  contain 
the  express  exemption  which  appears  in  the  1916  and  1918  Laws.  (Letter 
from  treasury  department  dated  May  4,  1914;  I.  T.  S.  1918,  ^  1192.) 

89  Reg.  33  Rev.,  Art.  72;  Reg.  45,  Art.  520. 

90  S.  958,  T.  B.  1-19-81. 


EXEMPT  ORGANIZATIONS  331 

The  following  clubs  are  exempt: 

1.  A  club  formed  for  the  purpose  of  providing  for  the  mem- 
bers thereof  a  suitable  meeting  place,  a  library,  and  a  dining 
room  where  meals  will  be  furnished  to  the  members,  the  income 
being  derived  from  membership  dues  and  the  receipts  for  food, 
wine  and  cigars  purchased  by  members,  and  no  part  of  the  net 
earnings  inuring  to  the  private  benefit  of  any  member.'-^^ 

2.  A  club  organized  for  the  purpose  of  promoting  the  princi- 
ples and  interests  of  a  certain  political  party,  deriving  its  in- 
come from  membership  dues  and  donations  which  are  used  for 
the  purpose  of  defraying  expenses  necessary  to  the  operation 
and  upkeep  of  its  rooms,  no  part  of  which  inures  to  the  benefit 
of  any  of  its  members."-' 

3.  An  automobile  club  organized  for  the  purpose  of  promot- 
ing the  improvement  of  roads  and  boulevards,  and  other  matters 
of  benefit  to  automobile  owners  and  drivers,  such  as  signposting 
roads  and  securing  legislation  of  benefit  to  automobile  owners 
and  drivers,  its  income  being  derived  from  membership  fees  and 
subscriptions,  no  part  of  which  inures  to  the  benefit  of  any  pri- 
vate stockholder  or  individual.''^ 

4.  An  incorporated  club,  composed  of  employees  of  a  corpora- 
tion, organized  for  social  purposes,  its  only  source  of  income 
being  the  initiation  fee  and  this  being  expended  solely  for  en- 
tertainments; in  which  certain  members,  called  participating 
members,  made  contributions  to  a  Christmas  fund  which  was 
invested  by  the  executive  committee  and  distributed  just  before 
Christmas  each  year. 

Mutual  or  Co-operative  Organizations  of  a  Local  Character 
(tenth  class).  Farmers'  or  other  mutual  hail,  cyclone  or  fire  in- 
surance companies,  mutual  ditch  or  irrigation  companies,  mutual 
or  co-operative  telephone  companies,  and  like  organizations  of  a 
purely  local  character,  the  income  of  which  consists  solely  of  as- 
sessments, dues  and  fees  collected  from  members  for  the  sole 
purpose  of  meeting  expenses  incurred  in  pursuance  of  the  purpose 
for  which  the  company  is  organized,  are  specifically  exempt.  It 
should  be  noted  that  the  essential  features  of  this  class  are  as 
follows:  (a)  They  must  be  mutual  or  co-operative;  (b)  they 
must  be  of  a  purely  local  character;  (c)  the  income  must  be 
solely  from  assessments,  dues  and  fees  collected  from  members, 
and  such  assessments,  dues  and  fees  must  be  used  for  the  sole 

91  0.  D.  108,  T.  B.  2-19-162. 

92  0.  D.  280,  T.  B.  20-19-513. 

93  0.  D.  643,  T.  B.  34-20-1152. 


332  FEDERAL  INCOME  TAX 

purpose  of  meeting  expenses,''^  incurred  in  pursuance  of  the  pur- 
poses for  which  the  companies  are  organized.  It  is  necessary 
to  exemption  that  the  income  of  the  company  be  derived  solely 
from  assessments,  dues  and  fees  collected  from  members.  If 
income  is  received  from  other  sources,  the  corporation  is  not 
exempt,  even  though  its  additional  income  is  tax  exempt.  In- 
come, however,  from  sources  other  than  those  specified  does  not 
prevent  exemption  where  its  receipt  is  a  mere  incident  of  the  busi- 
ness of  the  company.  Thus  the  receipt  of  interest  upon  a  work- 
ing bank  balance,  or  of  the  proceeds  of  a  sale  of  badges,  office 
supplies  or  equipment,  will  not  defeat  the  exemption.  The  same 
is  true  of  the  receipt  of  interest  upon  Liberty  bonds,  where  they 
were  purchased  as  a  patriotic  duty  and  were  afterwards  sold. 
Where,  however,  such  bonds  are  bought  as  a  permanent  invest- 
ment, the  receipt  of  the  interest  destroys  the  exemption.  The 
receipt  of  what  is  in  substance  an  entrance  fee,  charged  by  a 
mutual  fire  insurance  company  as  a  condition  of  membership, 
does  not  render  the  company  taxable,  although  this  fee  is  called 
a  "premium."  But  the  issuance  of  policies  for  stipulated  cash 
premiums  prevents  exemption.'-^"'    The  phrase  "of  a  purely  local 

9^  Reg.  33  Rev.,  Arts.  69  and  239. 

95  Reg.  45,  Art.  521.  In  connection  with  this  class  of  exempt  corporations 
the  decision  in  the  case  of  Niles  v.  Central  etc.  Ins.  Co.,  252  Fed.  564,  is  inter- 
esting. The  case  arose  under  the  Act  of  Oct.  22,  1914  (38  Stat.  762,  c.  331) 
imposing  a  stamp  tax  on  insurance  policies,  and  contained  an  exemption 
reading,  "provided  that  purely  co-operative  or  mutual  fire  insurance  com- 
panies or  associations  carried  on  by  the  members  thereof  for  the  protection 
of  their  own  property  and  not  for  profit,  shall  be  exempted  from  the  tax 
herein  provided."  A  mutual  fire  insurance  company  was  organized  under 
the  laws  of  Ohio,  which  required  the  company  to  (1)  charge  a  cash  premium 
payable  at  the  time  of  delivery  of  policies,  and  (2)  maintain  an  un- 
earned premium  reserve  of  a  definite  percentage  of  the  cash  premiums  on 
unexpired  risks,  and  which  permi-tted  the  company  to  (1)  maintain  a  surplus 
in  excess  of  the  above  reserve,  as  an  additional  security  to  policyholders, 
and  (2)  earn  interest  on  both  the  above  reserve  and  surplus  by  investing 
them;  the  cash  premium  in  excess  of  the  amount  estimated  as  sufficient  for 
the  protection  and  payment  of  losses  at  the  expiration  of  each  policy  being 
returnable  to  the  policyholder.  The  company  was  held  to  fall  within  the 
exemption  above  quoted,  because  its  primary  purpose  was  not  to  derive  inci- 
dental profit  from  interest  on  its  reserve  and  surplus,  or  to  undertake  in- 
vestments on  behalf  of  its  members,  but  solely  to  protect  more  effectively 
the  property  of  its  members.  The  court  said:  "The  distinction  drawn  in  the 
act  is  between  those  mixed  mutuals,  which,  though  commonly  called  mutuals, 
are  in  fact  also  doing  a  non-mutual  business  for  profit,  and  the  strictly 
mutual  companies;  not  between  the  mutuals  which  carry  a  reserve  and 
surplus,  and  those  which  levy  assessments  only  after  each  loss.  A  mere 
incidental  profit  earned  by  way  of  interest  on  its  invested  safety  funds,  or 


EXEMPT   ORGANIZATIONS  333 

character"  qualifies  only  "like  organizations".  An  association 
is  not  "of  a  purely  local  character"  when  its  business  activities 
are  not  confined  to  a  particular  community,  place,  or  district.  The 
business  operations  of  such  a  "like  organization"  might  be  con- 
fined to  a  particular  community,  place,  or  district,  thus  bringing 
it  within  the  meaning  of  the  words  "purely  local  character,"  and 
yet  cover  portions  of  more  than  one  state.  The  words  "purely 
local  character"  imply  a  single  locality,  irrespective  of  political 
subdivisions.  But  when  its  activities  cover  half  the  counties  of 
two  states,  and  part  of  two  other  states,  such  districts  being  two 
or  three  hundred  miles  apart;  or  when  its  activities  cover  a  whole 
state  and  part  of  another  state,  they  are  of  "general"  rather 
than  of  "local"  character  and  the  associations  are  not  exempt 

from  taxation."^  ..,..11  f 

The  following  kinds  of  organization  fall  within  this  class  of 

exemption:  .       ^      ^1  ^  ^-p 

1  An  incorporated  insurance  association  for  the  purpose  ot 
permitting  automobile  owners  to  exchange  contracts  of  insur- 
ance and  indemnity  without  becoming  jointly  liable  as  sub- 
scribers on  any  risks,  confining  its  activities  within  the  state  of 
incorporation  and  its  only  source  of  income  being  from  assess- 
ments, dues  and  fees  collected  from  members  for  the  sole  pur- 
pose of  meeting  expenses."" 

2  A  reciprocal  indemnity  exchange  incorporated  by  a  num- 
ber of  manufacturers  to  insure  their  businesses  agamst  fire  loss 
on  the  reciprocal  and  inter-insurance  plan  through  an  attorney 
in  fact,  having  the  power  to  issue  policies,  collect  Premiums, 
and  adjust  losses,  the  business  of  which  is  not  conducted  for 
profit,  and  the  contract  of  insurance  or  power  of  attorney  signed 
by  each  member  providing  that  there  shall  be  no  capital  stock 
or  joint  funds,  but  that  each  subscriber  shall  act  individually 
and  shall  deposit  a  fixed  amount  to  meet  losses,  any  balance 
being  returnable  at  the  end  of  the  period  of  insurance.- 

3  A  farmers'  mutual  fire  and  lightning  insurance  company 
making  assessments  on  its  members  for  the  sole  Vuvv^^ejyf 
meeting  estimated  future  losses  and  expenses,  and  which  has 
an   unexpended  balance  of  the  assessment  or  assessments   so 

on  its  bank  balances,  does  not  change  the  purely  mutual  character  of  the 
company,  or  indicate  that  its  business,  though  thus  earnmg  a  profit,  is 
'carried  on  for  profit.'  " 

90  0.  792,  T.  B.  1-19-82. 

9T  0.  D.  312,  T.  B.  25-19-586. 

98  O.  D.  538,  T.  B.  23-20-989. 


334  FEDERAL  INCOME  TAX 

made  on  hand  at  the  end  of  the  year,  which  balance  is  retained 
by  the  company  to  meet  losses  and  expenses  in  the  ensuing 
year.99 

4.  A  local  exchange  or  association  to  insure  the  owners  of 
automobiles  against  fire,  theft,  collision,  public  liability  and 
property  damage,  is  exempt,  since  it  performs  functions  of  the 
same  character  as  a  mutual  fire  insurance  company.ioo 

5.  A  local  reservoir  and  ditch  company.^^^ 

The  following  kinds  of  organization  do  not  fall  within  this 
class : 

1.  A  casualty  insurance  association  organized  for  the  purpose 
of  insuring  its  members  throughout  the  state,  and  not  wuthin  a 
geographical  subdivision  thereof,  and  issuing  policies  of  insur- 
ance for  stipulated  cash  premiums  instead  of  depending  upon 
assessments  solely  for  the  payment  of  its  insurance  liabilities, 
and  its  annual  surplus  over  all  expenditures,  losses,  etc.,  being 
returnable  to  the  members  in  the  shape  of  annual  dividends,  and 
the  fund  for  the  payment  of  salaries  and  other  operating  expenses 
being  a  large  percentage  of  cash  received  by  it,  and  which  makes 
permanent  investments  of  large  amounts  in  Liberty  bonds  of  the 
United  States.i"2 

2.  A  mutual  irrigating  ditch  company  providing  for  its  ex- 
penses by  assessment  against  its  stockholders  and  receiving  no 
other  income  except  certain  rents  derived  from  the  use  of  its 
surplus  water,  since  its  income  does  not  consist  solely  of  assess- 
ments, dues,  and  fees  collected  from  members.i'^^ 

3.  A  mutual  liability  insurance  company  deriving  its  income 
from  premiums  and  assessm.ents  of  its  members  which  are  used 
to  defray  operating  expenses  and  to  indemnify  its  policyholders 
against  amounts  which  they  are  required  to  pay  under  a  work- 
men's compensation  law.^"^ 

4.  An  association  of  manufacturers  incorporated  as  a  recip- 
rocal indemnity  exchange  to  insure  their  business  against  fire 
loss  on  the  reciprocal  and  inter-insurance  plan  through  an  at- 
torney in  fact  having  the  power  to  issue  policies,  collect  pre- 
miums, and  adjust  losses;  the  subscriber's  contract  providing 
that  there  shall  be  no  joint  funds  but  this  provision  not  being 
carried  out  in  letter  or  spirit;  advance  payments  being  made 

99  Sol.  Op.  99,  T.  B.  15-21-1564. 

100  Reg.  45,  Art.  521. 

101  Reg.  45,  Art.  521. 

102  O.  790,  T.  B.  1-19-83. 

103  0.  D.  318,  T.  B.  26-19-594. 

104  0.  D.  252,  T.  B.  14-19-437. 


EXEMPT  ORGANIZATIONS  335 

direct  to  the  exchange  and  charged  in  the  nature  of  advance 
premium  deposits;  policies  being  subject  to  cancellation  on  a 
short  rate  basis. ^"■' 

5.  A  telephone  clearing  association,  whose  business  is  to  ap- 
portion toll  rates  between  independent  telephone  companies 
handling  the  same  calls  and  whose  income  consists  of  compen- 
sation paid  by  such  companies  and  receipts  from  the  sale  of 
form  blanks.^'"^ 

Associations  for  Marketing  Produce  and  Purchasing  Supplies 
(eleventh  class).  Farmers',  fruit  growers',  or  like  associations, 
organized  and  operated  as  sales  agents  for  the  purpose  of  mar- 
keting the  products  of  members  and  turning  back  to  them  the 
proceeds  of  sales,  less  the  necessary  selling  expense,  on  the  basis 
of  quantity  of  produce  furnished  by  them,  are  exempt.^"^ 

The  1921  law  adds  a  new  provision  exempting  such  associa- 
tions organized  and  operated  as  purchasing  agents  for  the 
purpose  of  purchasing  supplies  and  equipment  for  the  use  of 
members  and  turning  over  such  supplies  and  equipment  to  such 
members  at  actual  cost,  less  necessary  expenses.i»s  The  following 
rulings  were  made  under  the  1918  law.  Co-operative  associa- 
tions, in  order  to  come  within  this  exemption,  must  establish  to 
the  satisfaction  of  the  collector  or  commissioner  the  fact  that, 
for  their  own  account,  they  have  no  net  income,  their  business 
being  to  market  the  products  of  their  members,  and  that  the 
entire  proceeds  of  such  marketing,  less  necessary  selling  ex- 
penses, are  turned  back  or  paid  to  the  members  on  the  basis  of 
the  quantity  of  produce  furnished  by  them— quality  and  grade 
being  considered — as  the  purchase  price  of  such  produce.  If  in 
the  course  of  their  business  such  associations  purchase  for  cash 
at  a  stipulated  price  articles  or  produce  with  a  view  to  selling 
them  for  gain,  it  will  be  held  that  such  associations  are  organ- 
ized for  profit  and  such  associations  will  be  required  to  make 
returns  of  annual  income  and  include  therein,  for  the  purpose 
of  the  tax,  all  income  derived  from  such  transactions.  If 
amounts  paid  to  members  are  based  solely  upon  the  quantity  of 
produce  furnished,  such  amounts  may  be  deducted  from  the  gross 
proceeds  of  sales,  and  the  taxable  net  income  will  be  the  amount 
of  earnings  passed  to  surplus,  or  distributed  or  distributable 
among  members  on  the  basis  of  their  stock  holdings.^'^'^ 

105  0.  D.  8GG,  T.  B.  14-21-1551;  see  also  L.  0.  UH?3,  T.  B.  19-21-1626. 

i"«  Reg.  45,  Art.  521. 

107  Revenue  Act  of  1921,  §  231  (11) ;  Revenue  Act  of  1918,  §  231  (11). 

los  Revenue  Act  of  1921,  §231   (11). 

100  Reg.  33  Rev.,  Art.  75;  S.  952,  T.  B.  1-19-84. 


336  FEDERAL  INCOME  TAX 

The  following-  types  of  organization  have  been  held  exempt 
under  this  class : 

1.  A  co-operative  dairy  company  engaged  in  collecting  milk 
and  disposing  of  it  or  the  products  thereof  and  distributing 
the  proceeds,  less  necessary  operating  expenses,  among  mem- 
bers, upon  the  basis  of  the  quantity  of  milk  or  butter  fat  fur- 
nished by  members;  but  not  if  the  proceeds  of  the  business  are 
distributed  in  any  other  way  than  on  such  a  proportionate 
basis.iio 

2.  A  corporation  organized  to  act  as  sales  agent  for  farmers 
and  having  a  capital  stock  on  which  it  pays  a  fixed  dividend 
amounting  to  legal  rate  of  interest  and  all  of  the  capital  stock 
of  which  is  owned  by  such  farmers. ^ 

The  following  types  of  organization  are  not  exempt : 

1.  A  farmers'  association  which  in  accounting  to  farmers 
furnishing  products  for  the  proceeds  of  sales  deducts  more  than 
the  necessary  selling  expenses  incurred.^i- 

2.  A  co-operative  association  acting  as  purchasing  agent,  but 
such  an  association  may  exclude  from  gross  income  rebates  made 
to  purchasers  whether  or  not  members  of  the  association ;  any 
profits  made  from  nonmembers  and  distributed  to  members  in 
the  guise  of  rebates  being,  of  course,  subject  to  tax.^i^ 

3.  An  incorporated  fruit  growers'  association  conducting  its 
business  at  a  profit,  thereby  accumulating  a  fund  out  of  which 
dividends  are  paid  which  allows  persons  who  are  not  fruit 
growers  to  acquire  stock  and  thus  share  in  the  proceeds ;  but 
such  a  union  may  deduct  from  gross  income  amounts  periodically 
returned  to  members  as  a  refund  of  profits  on  business  trans- 
acted with  them  and  proportionate  to  the  amount  of  such  busi- 
ness.ii'^ 

Corporations  Owned  by  Exempt  Corporations  (twelfth  class). 
Corporations  organized  for  the  exclusive  purpose  of  holding  title 

110  Reg.  45,  Art.  522;  O.  D.  191,  T.  B.  8-19-330.  Under  the  1913  Law, 
which  did  not  contain  the  foregoing  exemption,  it  was  held  that  co-operative 
dairy  associations,  whether  issuing  capital  stock  or  not,  were  not  exempt 
as  agricultural  organizations.  In  the  preparation,  of  their  returns  such 
associations  were  permitted  to  deduct  from  gross  income  the  amount  actually 
paid  to  members  and  patrons  for  milk,  but  any  amount  retained  at  the  end 
of  the  year  over  and  above  expenditures  was  taxable  as  income.  (T.  D. 
1996;  see  also  Reg.  33  Rev.,  Art.  76.) 

111  Sol.  Op.  57,  T.  B.  35-20-1172. 

112  Reg.  45,  Art.  522. 

113  Reg.  45,  Art.  522.  Purchasing  associations  are  exempt  under  the 
present  law. 

114  0.  D.  64,  T.  B.  1-19-89. 


EXEMPT  ORGANIZATIONS  337 

to  property,  collecting  income  therefrom,  and  turning  over  the 
entire  amount  thereof,  less  expenses,  to  organizations  which  are 
themselves  exempt  from  the  income  tax  are  also  exempt.^ ^■''  A 
coi-poration  managed  by  five  trustees,  operating  a  theater  build- 
ing erected  as  a  memorial,  the  net  income  from  which  is  to  be 
turned  over  to  a  city,  for  its  use  and  benefit,  is  not  one  organ- 
ized for  the  "exclusive  purpose  of  holding  title  to  property,  col- 
lecting income  therefrom,  and  turning  over  the  entire  amount 
thereof  less  expenses  to  an  organization  which  itself  is  exempt 
from  income  tax."^^"  A  co-operative  store  managed  by  a  uni- 
versity for  the  purpose  of  selling  to  its  students  supplies  of 
every  kind,  and  in  case  of  dissolution  its  property  reverting  to 
the  trustees  of  the  school,  does  not  come  within  the  class  of 
corporations  organized  for  the  exclusive  purpose  of  holding  title 
of  property,  collecting  income  therefrom,  and  turning  over  the 
entire  amount  thereof.  It  is  actively  engaged  in  the  operation 
of  a  business  in  which  profits  are  realized.^i" 

Federal  Land  Banks  and  National  Farm-Loan  Associations 
(thirteenth  class).  Federal  land  banks  and  National  Farm-Loan 
Associations  as  provided  in  §  26  of  the  act  of  July  17,  1916, 
entitled  "An  act  to  provide  capital  for  agricultural  development, 
to  create  standard  forms  of  investment  based  upon  farm  mort- 
gage, to  equalize  rates  of  interest  upon  farm  loans,  to  furnish  a 
market  for  United  States  bonds,  to  create  government  deposi- 
taries and  financial  agents  for  the  United  States,  and  for  other 
purposes,"  are  exempt.^^^ 

Personal  Service  Corporations  (fourteenth  class).  Since  the 
stockholders  of  personal  service  corporations  are  taxable  in  the 
same  manner  as  the  members  of  a  partnership,!^^  personal  service 
corporations  as  such  are  exempt  from  tax.^-*^  Since  'personal 
service  corporations  are  taxed  as  other  corporations  after  De- 
cember 31,  1921,  this  exemption  is  not  effective  after  that  date.^-^ 

Joint-Stock  Land  Banks.  Joint-stock  land  banks  were  uncon- 
ditionally exempt  under  the  1916  law,  as  amended,  as  to  income 
derived  from  bonds  or  debentures  of  other  joint-stock  land  banks 
or  any  federal  land  bank  belonging  to  such  joint-stock  land  bank. 

^i"»  Such  corporations  were  held  to  be  taxable  under  the  1913  Law  in  the 
absence  of  express  provisions  in  that  law  for  their  exemption.    (T.  D.  2137.) 

iiti  O.  D.  177,  T.  B.  7-19-300. 

iiT  o.  D.  65,  T.  B.  1-19-90. 

lis  Revenue  Act  of  1921,  §231  (13);  Revenue  Act  of  1918,  §231  (13); 
ReK.  45,  Art.  74;  Reg.  33  Rev.,  Art.  68. 

119  Revenue  Act  of  1921,  §218  (d);  Revenue  Act  of  1918.  §218  (e). 

120  Revenue  Act  of  1921,  §231  (14);  Revenue  Act  of  1918,  §231  (14). 

121  Revenue  Act  of  1921,  §231   (14). 


338  FEDERAL  INCOME  TAX 

They  were  taxable,  however,  as  to  income  from  other  sources  and 
consequently  it  would  seem  they  were  not  exempt  from  the  re- 
quirement of  making  a  return  of  annual  income,  since  the  ex- 
emption from  making  returns  applied  only  to  corporations  not 
subject  to  the  tax.     Neither  the  1918  law  nor  the  present  law 

includes  joint-stock  land  banks  in  the  list  of  exempt  organiza- 
tions.122 

122  Cf.  Revenue  Act  of  1916,  §11;  Revenue  Act  of  1918,  §231,  and  Re- 
venue Act  of  1921,  §  231.     See  Sol.  Op.  68,  T.  B.  41-20-1235. 


CHAPTER  14 

INCOME — IN  GENERAL 

The  term   "gross  income"  is  defined  by  the  law  to  include 
"gains,  profits,  and  income  derived  from  salaries,  wages,  or  com- 
pensation for  personal  service    (including  in  the  case  of  the 
President  of  the  United  States,  the  judges  of  the  Supreme  and 
inferior  courts  of  the  United  States,  and  all  other  officers  and 
employees,  whether  elected  or  appointed,  of  the  United  States, 
Alaska,  Hawaii,  or  any  political  subdivision  thereof,  or  the  Dis- 
trict of  Columbia,  the  compensation  received  as  such) ,  of  what- 
ever kind  and  in  whatever   form   paid,   or   from   professions, 
vocations,  trades,  businesses,  commerce,  or  sales,  or  dealings  in 
property,  whether  real  or  personal,  growing  out  of  the  owner- 
ship or  use  of  or  interest  in  such  property ;  also  from  interest, 
rent,  dividends,  securities,  or  the  transaction  of  any  business 
carried  on  for  gain  or  profit,  or  gains  or  profits  and  income 
derived  from  any  source  whatever."    This  definition  of  the  term 
"gross  income"  contained  in  the  1918  law  has  not  been  changed 
in  any  respect  by  the  Revenue  Act  of  1921.^     The  general  rules 
and  principles  applicable  to  income  from  all  sources  will  be  dis- 
cussed in  this  chapter,  and  thereafter  the  special  rules  applicable 
to  income  from    (1)   personal  services,    (2)    business,  trade  or 
commerce,  (3)  sales  or  dealings  in  property,  (4)  interest,  rent, 
and  royalties,    (5)    dividends,   (6)   miscellaneous  sources.     The 
special  rules  relating  to  income  from  partnerships  and  fiduciaries 
are  treated  in  the  chapters  on  those  respective  subjects.-^ 

What  Constitutes  Income.  A  discussion  of  the  various  con- 
ceptions of  "income"  would  be  interesting  but  out  of  place  in 
a  work  of  this  character.  "Income,"  like  most  other  words,  has 
different  meanings,  dependent  upon  the  connection  in  which 
it  is  used  and  the  result  intended  to  be  accomplished  by  its  use.-"^ 

■  I  Revenue  Act  of  1921,  §  213  (a)  ;  Revenue  Act  of  1918,  §213  (a).  The 
clause  "all  other  gains  and  profits  derived  from  any  source  whatever" 
contained  in  the  Virginia  Income  Tax  (Acts  1902-04,  Chapter  148,  as 
amended  by  Acts  1912,  Chapter  279)  has  been  held  not  to  be  limited  by  the 
rule  of  ejusdem  genervi  to  the  specific  kinds  of  income  enumerated  there- 
tofore (Commonwealth  v.  Werth,  116  Va.  604,  82  S.  E.  695.) 

-  See  Chapters  8  and  6. 

■■iTrefry  v.  Putnam,  227  Mass.  522,  116  N.  E.  904,  L.  R.  A.  1917,  F.  806. 
One  interesting  definition  is  that  contained  in  Waring  v.  The  Mayor,  60 
Ga.  93,  which  is  as  follows:  "The  fact  is,  property  is  a  tree;  income  is  the 
fruit:  labor  is  a  tree;  income  the  fruit:  capital  the  tree;  income,  the  fruit. 

339 


340  FEDERAL  INCOME  TAX 

The  subject  of  what  constitutes  income  in  the  technical  or  true 
economic  sense  is  one  upon  which  few  economists  and  courts 
agree.  As  used,  however,  in  the  Sixteenth  Amendment  and  in 
the  statutes  enacted  in  pursuance  thereof,  the  word  must  be 
held  to  have  been  used  in  its  common,  ordinary  meaning,  and 
not  in  its  technical  or  true  economic  sense,  for  it  is  a  familiar 
rule  of  construction  that  ordinary  words  used  in  constitutions 
and  statutes  must  be  given  their  usual  and  common  significance, 
if  such  meaning  harmonizes  with  the  evident  intent  of  the  lan- 
guage employed  and  with  the  purpose  to  be  accomplished.^  In 
its  ordinary  and  popular  meaning  "income"  is  the  amount  of 
actual  wealth  which  comes  to  a  person  during  a  given  period  of 
time.  At  any  single  moment  a  person  scarcely  can  be  said  to 
have  income.  The  word  in  most,  if  not  all,  connections,  involves 
time  as  an  essential  element  in  its  measurement  or  definition. 
It  thus  is  differentiated  from  capital  or  investment,  which  com- 
monly means  the  amount  of  wealth  which  a  person  has  on  a  fixed 
date.  Income  may  be  derived  from  capital  invested  or  in  use, 
from  labor,  from  the  exercise  of  skill,  ingenuity,  or  sound  judg- 
ment, or  from  a  combination  of  any  or  all  of  these  factors.-"'  One 
of  the  most  recent  of  its  definitions  and  the  one  most  commonly 
accepted  by  the  courts,  is  "the  gain  derived  from  capital,  from 
labor,  or  from  both  combined."'"'  It  would  be  difficult  to  give 
a  comprehensive  definition  which  can  be  treated  as  universal  and 
final  but  the  word's  usual  synonyms  are  "gain,"  "profit,"  "reve- 
nue." It  is  used  in  this  sense  also  by  writers  upon  taxation  and 
economics.'  An  able  English  jurist  has  held  in  effect  that 
annual  income  is  either  a  conventional  figure  or  a  mere  approxi-. 
mation.  Income  must  be  a  thing  sufficiently  real  to  be  capable 
of  being  taken  out  of  a  business  by  its  owners  without  impair- 
ment of  capital.  The  exact  point  at  which  an  impairment  of 
capital  begins  is  one  that  cannot  easily  be  determined  with  pre- 

The  fruit,  if  not  consumed  as  fast  as  it  ripens,  will  germinate  from  the  seed 
which  it  encloses,  and  will  produce  other  trees  and  grow  into  more  property; 
but  so  long  as  it  is  fruit  merely,  and  plucked  to  eat  and  consumed  in  the 
eating,  it  is  no  tree,  and  will  produce  itself  no  fruit." 

4  Van  Dyke  v.  City  of  Milwaukee,  159  Wis.  460,  146  N.  W.  812,  150  N. 
W.  509. 

5Trefry  v.  Putnam,  227  Mass.  522,  116  N.  E.  904,  L.  R.  A.  1917,  F.  806. 

GStratton's  Independence  v.  Howbert,  231  U.  S.  399;  Doyle  v.  Mitchell 
Brothers,  247  U.  S.  179;  Eisner  v.  Macomber,  252  U.  S.  189.  In  U.  S.  v. 
Oregon,  Washington,  etc.  Co.,  251  Fed.  211,  the  court  held  that  the  term 
is  not  limited  to  earnings  from  economic  capital,  i.  e.,  wealth  industrially 
employed  in  permanent  form.  See  Eliasberg  Bros.  Mercantile  Co.  v.  Grimes, 
204  Ala.  492,  86  So.  56. 

7  Trefry  v.  Putnam,  227  Mass.  522,  116  N.  E.  904,  L.  R.  A.  1917,  F.  806. 


INCOME — IN   GENERAL  341 

cision,  and  questions  of  doubt  as  between  income  and  capital 
must  be  resolved  in  favor  of  capital.  In  a  very  real  sense  losses 
may  be  admitted,  while  profits  must  be  proved.  Capital  once 
impaired  is  gone,  but  the  admission  of  a  loss  not  fully  realized 
by  a  complete  transaction  results  in  nothing  more  serious  than 
a  postponement  of  profit  to  a  subsequent  period.  The  imposition 
of  an  income  tax  in  effect  compels  a  withdrawal  of  a  portion  of 
the  income  from  the  business,  and  the  tax  is  imposed  ratably 
upon  all  net  income,  so  that  if  through  an  error  in  computation 
a  stated  figure  of  income  includes  any  amount  of  capital  the  tax 
is  imposed  not  upon  income  but  upon  capital.^  One  conception 
of  income  excludes  gains  or  increment  in  the  value  of  capital 
assets,  but  this  conception  was  not  that  of  Congress  in  enacting 
the  recent  income  tax  laws,  since  the  tax  is  not  only  upon  income 
conceived  as  production  of  capital  but  also  upon  gains  and  profits 
derived  from  sales  or  dealings  in  capital  itself.''  Property  held 
by  the  taxpayer  on  March  1,  1913,  the  date  of  incidence  of  the 
first  income  tax  law  passed  pursuant  to  authority  given  to  Con- 
gress by  the  Sixteenth  Amendment,  is  capital.  Any  liquidated 
claim  existing  unconditionally  on  March  1,  1913,  and  then  assign- 
able, whether  presently  payable  or  not  and  held  by  a  taxpayer 
prior  to  March  1,  1913,  whether  evidenced  by  writing  or  not; 
and  all  interest  which  had  accrued  thereon  before  that  date,  do 
not  constitute  taxable  income  although  actually  recovered  or 
received  subsequent  to  such  date.^" 

Bookkeeping  Entries.  Real  facts  and  not  bookkeeping  en- 
tries constitute  income.  Books  of  account  are  no  more  than  evi- 
dential; they  are  neither  indispensable  nor  conclusive.^'  A  book 
value  increase  in  the  value  of  capital  assets  due  to  a  reappraisal 
of  property  is  not  income  within  the  meaning  of  the  law.'-  A 
book  entry  reflecting  only  an  enhanced  value  of  assets  during  the 
year  evidences  an  increase  in  the  net  worth  of  the  corporation 
or  individual  for  that  year,  an  increase  which,  under  adverse 
conditions,  may  disappear  the  next  year.  An  increase  in  value 
thus  evidenced  is  intangible,  unstable  and  is  not  such  income  as 
the  law  contemplates  shall  be  taxed.' ^'     Taxable  income  is  that 

ST.  B.  R.  48,  T.  B.  1(5-19-457. 

y  The    constitutionality    of    taxing    such    gains    and    profits    has    recently 
been  upheld  by  the  Supreme  Court  of  the  United  States.    See  Chapter  42. 
T'Reg.  45,  Art.  87,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 

11  Doyle  V.  Mitchell,  247  U.  S.  179;  Southern  Pacific  R.  R.  Co.  v.  Muenter, 
260  Fed.  837. 

12  T.  D.  2005;  Baldwin  Locomotive  Works  v.  McCoach,  221  Fed.  59. 

13  Industrial  Trust  Co.  v.  Walsh,  222  Fed.  437;  Letter  from  treasury 
department  dated  August  14,  1914;  I.  T.  S.  1917,  ^200.   See  Reg.  45,  Art.  23. 


342  FEDERAL  INCOME  TAX 

actually  realized  during  the  year,  evidenced  by  the  receipt  of  cash 
or  its  equivalent.  Hence  mere  book  entries  of  an  appreciation  in 
the  value  of  capital  assets  will  be  disregarded. ^^  Neither  the 
government  nor  the  taxpayer  is  bound  by  valuations  entered  on 
the  books  of  the  taxpayer.^-''  This  does  not  mean  that  the  return 
of  income  should  not  be  made  in  accordance  with  the  taxpayer's 
books,  for  ordinarily  the  books  reflect  the  real  or  actual  facts. 
It  means,  for  instance,  that  the  government  is  not  precluded 
from  going  behind  the  taxpayer's  books  and  assessing  the  tax 
on  the  basis  of  the  actual  facts.  Where  property  is  carried  at 
a  nominal  value  on  the  books  of  the  taxpayer,  and  the  govern- 
ment seeks  to  assess  a  tax  on  the  basis  of  that  value,  the  tax- 
payer may  prove,  by  other  evidence,  the  true  value  of  such  prop- 
erty .^^  As  a  general  rule,  the  method  of  accounting  employed 
by  a  taxpayer  determines  his  income.  No  system  of  bookkeep- 
ing or  accounting  is  prescribed  for  all  taxpayers,  but  the  business 
transacted  by  the  taxpayer  should  be  so  recorded  that  he  may 
make  a  return  of  his  true  income  and  that  each  and  every  item 
set  forth  in  the  return  of  income  may  be  readily  verified  by  an 
examination  of  the  books  of  account.^^  The  books  of  a  corpora- 
tion are  assumed  to  reflect  facts  as  to  its  earnings,  etc.,  hence 
they  will  be  taken  as  the  best  guide  in  determining  the  net  in- 
come, and,  except  as  the  same  may  be  modified  by  provisions  of 
the  law  wherein  certain  deductions  are  limited,  the  net  income 
disclosed  by  the  books  and  verified  by  the  annual  balance  sheet, 
or  the  annual  report  to  stockholders,  should  be  the  same  as  that 
returned  for  taxation. ^'^^     It  has  been  held  that  no  taxable  income 

14  Reg.  45,  Art.  23;  Fink  v.  N.  W.  Mutual  Life  Ins.  Co.,  267  Fed.  968; 
T.  D.  3057,  T.  B.  36-23-1187;  Letter  from  treasury  department  dated 
August  14,  1914;   L  T.  S.  1917,  Tf  260. 

15  Doyle  V.  Mitchell  Brothers,  235  Fed.  686,  affirmed  247  U.  S.  179.  In 
some  instances  the  law  places  a  further  determining  importance  on  the 
bookkeeping  entries,  as  in  the  case  of  worthless  debts.  The  latter  seems  to 
be  the  only  deduction  expressly  required  by  the  law  to  be  evidenced  by 
book  entries  in  the  case  of  individuals.  Under  the  1916  Law  this  was 
true  also  of  cases  of  losses,  which  were  required  to  be  sustained  and 
"charged  off"  in  order  to  be  deducted  by  corporations.  (Revenue  Act 
of  1916,  §12    (a).) 

1*>  U.  S.  v.  Guggenheim  Exploration  Co.,  238  Fed.  231.  In  this  case  the 
value  at  which  the  property  was  acquired,  the  declaration  of  the  board  of 
directors  as  to  such  value,  at  the  time  of  acquisition,  and  statements  in  the 
annual  reports,  were  held  to  overcome  in  weight  the  alleged  admission 
against  interest  in  placing  the  valuation  of  the  property  on  the  books  at  a 
nominal  amount. 

17  Reg.  45,  Art.  24;  Reg.  33,  Art.  182;  T.  D.  2161. 

IS  Reg.  33,  Art.  183. 


INCOME — IN  GENERAL  343 

accrues  to  a  public  utility  corporation  from  a  mere  book  entry 
charging  construction  account  and  crediting  income  account  due 
to  charging  interest  on  the  company's  own  funds  used  tempo- 
rarily for  construction  purposes,  as  permitted  under  the  classi- 
fication of  the  interstate  commerce  commission.^'' 

Income  Actually  Received.  The  courts  have  uniformly  con- 
strued the  word  "income"  to  include  only  the  receipt  of  actual 
cash  as  opposed  to  contemplated  revenue  due  but  unpaid,  unless 
a  contrary  purpose  is  manifest  from  the  language  of  the  statute; 
that  is,  the  courts  in  the  absence  of  a  clear  direction  to  the  con- 
trary construe  a  revenue  law  in  accord  with  an  intention  to  reach 
actual  and  not  potential  income.-^    One  cannot  be  said  to  reach 

19  0.  D.  246,  T.  B.  13-19-425;  O.  D.  811,  T.  B.  7-21-1453.  Neither  will  the 
company  be  allowed  to  include  in  its  assets  such  amount  of  interest  charged 
to  capital  account  for  the  purpose  of  determining  invested  capital.  The 
principles  contained  in  the  above  ruling  are  applicable  under  the  Revenue 
Acts  of  1916  and  1917   (0.  D.  1061,  T.  B.  41-21-1862). 

20  U.  S.  V.  Schillinger,  14  Blatch.  71,  27  Fed.  Cas.  No.  16,228.  The  language 
of  the  1909  Law,  Act  of  August  5,  1909,  §38  (36  Stats.  112),  was  held  to 
indicate  that  the  net  income,  which  was  the  measure  of  taxation,  meant 
what  had  actually  been  received  and  not  that  which,  although  due,  had  not 
been  received,  its  payment  for  any  reason  having  been  deferred  or  post- 
poned. (Mutual  Benefit  Life  Ins.  Co.  v.  Herold,  198  Fed.  199,  affirmed 
201  Fed.  918;  Connecticut  Mutual  Life  Ins.  Co.  v.  Eaton,  218  Fed.  206;  Fink 
V.  N.  W.  Mutual  Life  Ins.  Co.,  267  Fed.  968.  See  also  Lumber  Mut.  Fire 
Ins.  Co.  V.  Malley,  256  Fed.  380.)  In  Connecticut  General  Life  Ins.  Co.  v. 
Eaton,  218  Fed.  188,  it  was  held  under  that  law  that  items  of  "non-ledger 
assets"  shown  in  the  annual  report  of  a  life  insurance  company,  made  in 
pursuance  to  a  state  statute  as  "uncollected  and  deferred  premiums"  and 
"interest  due  and  accrued,"  but  no  part  of  which  had  been  received,  were 
not  a  part  of  the  company's  "income  received  during  such  year."  Speaking 
of  the  1909  Law,  Justice  Pitney  said  in  Hays  v.  Gauley  Mountain  Coal  Co., 
247  U.  S.  189:  "The  expression  'income  received  during  such  year'  employed 
in  the  Act  of  1909,  looks  to  the  time  of  realization  rather  than  to  the  period 
of  accruement."  Accrued  but  unpaid  interest  on  investments  has  been  held 
not  to  be  income.  (Ins.  Co.  of  North  America  v.  McCoach,  218  Fed.  905.) 
In  the  1913  Law  the  phrase  "arising  and  accruing"  was  used.  Doubtless  it 
was  the  intention  of  Congress  to  employ  terms  of  sufficient  comprehension 
to  reach  actual  income  by  foreclosing  any  possible  avenue  of  escape,  but 
it  can  hardly  be  said  that  in  so  doing  an  intention  prevailed  to  tax  that 
which  did  not  actually  exist,  except  on  paper,  as  income  accrued  during  the 
taxing  period.  (Maryland  Casualty  Co.  v.  U.  S.,  52  Ct.  Cls.  201,  modified  by 
the  Supreme  Court  (251  U.  S.  342)  on  another  point.)  An  early  ruling  of 
the  treasury  department,  under  the  1913  Law,  holding  that  a  person  re- 
ceiving fees  or  emoluments  for  professional  services  must  report  all  actual 
receipts  for  services  rendered  in  the  year  for  which  the  return  was  made, 
together  with  all  unpaid  accounts,  charges  for  services  or  contingent  in- 
come due  for  that  year,  was  discussed  in  Edwards  v.  Keith,  231  Fed.  110, 
in  which  the  court  said :  "No  such  construction  of  the  treasury  department 


344  FEDERAL  INCOME  TAX 

an  income  of  defined  proportions  until  he  balances  receipts  and 
disbursements  at  the  end  of  a  stated  period  and  ascertains,  not 
what  is  due,  but  what  has  been  actually  received.  The  assets 
and  liabilities  may  be  measured  by  a  diff'erent  rule  of  account- 
ing, but  as  said  in  one  case,-i  "in  the  absence  of  any  special 
law  to  the  contrary,  income  must  be  taken  to  mean  money,  and 
not  the  expectation  of  receiving  it  or  the  right  to  receive  it  at  a 
future  time."  Under  the  Revenue  Act  of  1918  all  items  of  gross 
income  were  required  to  be  reported  in  the  year  in  which  re- 
ceived by  the  taxpayer,  unless  in  order  clearly  to  reflect  income 
such  amounts  were  to  be  accounted  for  as  of  a  different  period.-- 
The  same  is  true  under  the  1921  Law.--^  The  law  intends,  there- 
fore, primarily  to  tax  income  received,  and  not  income  which 
has  arisen  or  accrued,  but  has  not  been  received.-^  This  basis 
of  actual  receipts  is  not  exclusively  prescribed ;  for  the  statute 
recognizes  as  income-determining  factors  other  items,  among 
which  are  inventories,  accounts  receivable,  property  exhaustion, 
and  accounts  payable  for  expenses  incurred.  Net  income  is  com- 
puted in  accordance  with  the  method  of  accounting  regularly 
employed  in  keeping  the  books  of  the  taxpayer  unless  no  such 
method  of  accounting  has  been  employed  or  the  method  em- 
ployed does  not  clearly  reflect  the  income,  in  which  case  the  com- 
putation is  made  on  such  basis  and  in  such  manner  as  in  the 

can  enlarge  the  scope  of  the  statute  so  as  to  impose  the  tax  upon  unpaid 
charges  for  professional  services  rendered,  which  for  aught  any  one  can  tell 
may  never  be  paid.  The  statute  alone  determines  what  is  income  to  be 
taxed.  It  taxes  only  income  derived  from  many  specified  sources,  and 
one  does  not  derive  income  by  rendering  services  and  charging  for  them." 
In  State  ex  rel.  Moon  Company  v.  Wisconsin  Tax  Commission,  166  Wis.  287, 
163  N.  W.  639,  the  court  distinguishes  between  the  case  at  bar  and  the  case 
of  Lynch  v.  Turrish,  247  U.  S.  221,  on  the  ground  that  the  1913  Federal  Law 
taxed  net  income  "arising  or  accruinii"  from  all  sources  in  the  preceding 
calendar  year,  while  the  Wisconsin  Law  (§  1087  (M)  1,  Stat.  1911)  taxed 
income  received.  The  court  said:  "Unlike  the  federal  act  there  is  no  need 
(under  the  Wisconsin  Act)  to  ascertain  whether  the  income  arose  or  ac- 
crued in  order  to  determine  when  it  is  taxable.  The  fact  that  it  was  re- 
ceived during  1911  makes  it  taxable  irrespective  of  when  it  arose  or  ac- 
crued." In  the  1916  Law  the  phrase  "income  received"  was  used  with  re- 
spect to  both  individuals  and  corporations.  (Revenue  Act  of  1916,  §§  1  (a) 
and  10  (a).) 

21  Maryland  Casualty  Co.  v.  U.  S.,  52  Ct.  Cls.  201,  251  U.  S.  342;  T.  D. 
2451. 

22  Revenue  Act  of  1918,  §213  (a).  Reg.  45,  Art.  23.  Stock  dividends 
were  an  exception  to  this  rule,  but  they  have  been  held  exempt  (Eisner  v. 
Macomber,  252  U.  S.  189). 

2o  Revenue  Act  of  1921,  §  213   (a). 

2-t  Revenue  Act  of  1921,  §§213  (a)  and  233  (a);  Revenue  Act  of  1918, 
§§   213  (a)  and  233  (a). 


INCOME — IN   GENERAL  345 

opinion  of  the  commissioner  does  clearly  reflect  the  income.--^ 
Thus,  individuals  and  corporations  may  report  their  income  upon 
the  basis  of  accruals  instead  of  actual  receipts.    In  other  words, 
under  the  Revenue  Acts  of  1918  and  1921,  the  time  as  of  which 
any  item  of  income  is  to  be  accounted  for  is  to  be  determined 
in  the  light  of  the  fundamental  rule  that  the  computation  of  net 
income  shall  clearly  reflect  the  taxpayer's  income.-''     Unless  the 
taxpayer  keeps  his  books  on  a  basis  other  than  that  of  actual 
receipts,  and  reports  accordingly,  he  should  report  as  income  all 
amounts   received   in   the   year   in   which   payment   is   actually 
made.-"    The  rules  under  the  preceding  laws  are  applicable  under 
the  1918  and  1921  Laws  if  the  taypayer  keeps  his  books  on  the 
basis  of  actual  receipts.-^     Thus,  dividends  and  interest,  pro- 
fessional fees  of  lawyers,  physicians,  and  the  like,  need  not  be 
returned  as  income  in  the  year  in  which  they  become  due  or  are 
earned,  but  should  be  returned  as  income  in  the  year  in  w^hich 
the  payments  are  received  or  made  available.-''    Where  the  serv- 
ice and  payment  period  is  divided  by  the  end  of  the  taxable  year, 
the  compensation  for  the  period  so  divided  at  the  end  of  the  year 
will  be  accounted  for  as  income  for  the  year  in  which  payment 
is  actually  received.    Where  the  service  is  compensated  by  fee, 
or  is  of  such  nature  that  no  part  of  the  fee  or  compensation  be- 
comes due  until  the  completion  of  the  service,  the  entire  amount 
received  should  be  income  to  be  accounted  for  as  of  the  year  of 
receipt.3'^    It  is  immaterial  that  the  services  for  which  payment 
may  be  made  have  been  performed  for  a  period  extending  over 
several  years,  the  entire  payment  is  taxable  in  the  year  in  which 
received,  and  may  not  be  pro-rated. ^'-i     A  more  extended  discus- 

li"- Revenue  Act  of  1921,  §§212  (b)  and  232;  Revenue  Act  of  1918. 
§§  212  (b)  and  232. 

-'•!  Reg.  45,  Art.  22. 

27  Reg.  45,  Art.  23. 

-SSee  one  exception  to  this  rule  (Reg.  45,  Art.  52). 

20  Letters  from  treasury  department  dated  February  18,  1915,  and  March 
1,  1915;  I.  T.  S.  1919,  M  855  and  853. 

;«»  Reg.  33  Rev.,  Art.  4. 

■■51  Jackson  v.  Smietanka,  267  Fed.  932,  affirmed  272  Fed.  970.  T.  D. 
2135.  In  Edwards  v.  Keith,  231  Fed.  110,  it  was  argued  on  behalf  of  an 
agent  of  a  foreign  insurance  company,  under  a  contract  by  the  terms  of 
which  he  should  receive  compensation  on  premiums  of  policies  to  the  extent 
of  certain  specified  percentages  for  a  term  aggregating  twenty  years  from 
the  date  of  each  policy,  that  all  of  the  labor  creating  such  income  had 
been  performed  prior  to  the  incidence  of  the  tax,  but  the  court  held  that 
fact  to  be  immaterial  and  sustained  an  assessment  on  the  entire  income  for 
the  year  in  which  it  was  received.  See  also  Holbrook  v.  Moore,  U.  S.  Dist. 
Ct.,  E.  Dist.  Mo.,  decided  February  8,  1921;  Ct.  D.  10.  T.  B.  17-21-1592. 


346  FEDERAL  INCOME   TAX 

sion  of  the  subject  of  when  items  of  income  should  be  included 
in  gross  income  will  be  found  elsewhere  in  this  book.''- 

Income  Constructively  Received.  The  rule  that  the  law  ordi- 
narily taxes  income  "received"  and  not  that  which  has  "arisen 
or  accrued"  is  subject  to  the  qualification  that  income  may  be 
constructively  as  well  as  actually  received.  This  is  not  in  truth 
a  qualification ;  it  is  a  matter  of  defining  the  term  "received." 
Income  which  is  credited  to  the  account  of,  or  set  apart  for,  a 
taxpayer  and  which  may  be  drawn  upon  by  him  at  any  time  is 
subject  to  tax  for  the  year  during  which  so  credited  or  set  apart, 
although  not  then  actually  reduced  to  possession.-^^  ^o  consti- 
tute receipt  in  such  a  case  the  income  must  be  credited  to  the 
taxpayer  without  any  substantial  limitation  or  restriction  as  to 
the  time  or  manner  of  payment  or  condition  upon  which  pay- 
ment is  to  be  made.  A  book  entry,  if  made,  should  indicate  an 
absolute  transfer  from  one  account  to  another.  If  the  income  is 
not  credited,  but  is  set  apart,  such  income  must  be  unqualifiedly 
subject  to  the  demand  of  the  taxpayer.  Where  a  corporation 
contingently  credits  its  employees  with  bonus  stock,  but  the  stock 
is  not  available  to  such  employees  until  the  termination  of  five 
years  of  employment,  the  mere  crediting  on  the  books  of  the 
corporation  does  not  constitute  receipt.  The  distinction  between 
receipt  and  accrual  must  be  kept  in  mind.  Income  may  accrue 
to  the  taxpayer  and  yet  not  be  subject  to  his  demand  or  capable 
of  being  drawn  on  or  against  by  him."^  Appreciation  in  the  value 
of  property  is  not  even  an  accrual  of  income  to  the  taxpayer 
prior  to  the  realization  of  such  appreciation  through  conversion 
of  the  property. 

A  corporation  owning  stock  in  four  other  companies  decided 
to  distribute  its  assets  as  a  liquidating  dividend,  an  option  being 
given  to  the  stockholders  in  the  case  of  the  stock  of  one  of  the 
companies,  to  take  either  stock  or  cash.  The  board  of  directors 
in  December,  1915,  authorized  the  distribution  and  at  the  same 
time  authorized  the  mailing  of  a  circular  letter  to  the  stock-' 
holders  giving  them  until  January,  1916,  to  elect  whether  to 
take  stock  or  cash.  This  circular  letter  advised  the  stockholders 
that  the  distribution  was  "to  be  made  as  of  December  — ,  1915." 

32  See  Chapter  33. 

33  The  1921  Law  is  specific  in  this  respect  with  regard  to  taxable  dis- 
tributions of  corporations.     (Revenue  Act  of  1921,  §213   (a).) 

34  Reg.  45,  Art.  53,  Reg.  33  Rev.,  Art  4;  letter  from  treasury  depart- 
ment dated  May  31,  1919;  L  T.  S.  1921,  ^696.  See  Chapter  33  for  a  fur- 
ther discussion  of  this  subject. 


INCOME — IN  GENERAL  347 

In  the  case  of  a  stockholder  making  no  election,  it  was  assumed 
that  he  desired  cash.  The  resolution  provided  that  for  the  pur- 
pose of  this  distribution  the  transfer  books  of  the  company 
were  to  be  closed  December  — ,  1915,  and  reopened  January  — , 
1916.  The  circular  letter  stated  that  the  stock  or  cash  would 
be  distributed  "as  soon  ?fter  January  — ,  1916,  as  practicable." 
The  distribution  was  actually  made  in  January,  1916.  One  of 
ihe  stockholders  participating  in  the  distribution  claimed  that 
the  amount  distributed  should  be  treated  as  constructively  re- 
ceived in  1915.  This  claim  was  denied,  it  being  held  that  while 
rights  vested  in  the  stockholders  in  1915,  they  constituted  a  mere 
chose  in  action,  a  right  to  receive  property  at  a  future  date. 
The  theory  of  constructive  receipt  by  its  very  nature  does  not 
apply  to  the  receipt  of  an  indefinite  thing.  There  can  be  no 
receipt,  constructive  or  otherwise,  when  the  thing  to  be  received 
is  not  yet  determined.  Until  the  exercise  of  their  option  by  the 
stockholders  and  communication  thereof  to  the  corporation,  no 
payment  could  be  made  under  the  terms  of  the  resolution  de- 
claring the  distribution.  Election  was  a  condition  precedent  to 
the  right  to  demand  payment.''"' 

Examples  of  Constructive  Receipt.  Where  interest  cou- 
pons have  matured,  but  have  not  been  cashed,  such  interest  pay- 
ment, though  not  collected  when  due  and  payable,  is  nevertheless 
available  to  the  taxpayer  and  should  therefore  be  included  in  his 
gross  income  for  the  year  during  which  the  coupons  matured. 
This  is  so  if  the  coupons  are  exchanged  for  other  property  in- 
stead of  eventually  being  cashed.  Dividends  on  corporate  stock 
are  subject  to  tax  when  set  apart  for  the  stockholder  and  made 
unqualifiedly  subject  to  his  demand,  although  not  yet  collected 
by  him.'^*'  The  distributive  share  of  the  profits  of  a  partner  in 
a  partnership  or  of  a  stockholder  in  a  personal  service  corpora- 
tion is  regarded  as  received.  Interest  credited  on  savings  bank 
deposits,  even  though  the  bank  nominally  have  a  rule,  seldom 
or  never  enforced,  that  it  may  require  so  many  days'  notice  in 
advance  of  cashing  depositors'  checks,  is  income  to  the  depositor 
when  credited.*''"  Where  under  the  by-laws  of  a  co-operative 
bank  the  profits  credited  to  a  shareholder  may  not  be  withdrawn 
in  their  entirety  until  five  years  have  elapsed,  but  three-fourths 
of  such  profits  may  be  withdrawn  at  any  time  upon  thirty  days' 
notice,  in  which  case  the  other  fourth  is  forfeited  it  has  been 
held  that  three-fourths  of  the  profits  credited  to  the  shareholder 

3n  A.  R.  R.  375,  T.  B.  15-21-1560. 

30  Reg.  45,  Art.  54;  Revenue  Act  of  1921,  §213   (a). 

37  Reg.  45,  Art.  54. 


348  FEDERAL  INCOME  TAX 

are  credited  to  or  set  apart  for  him  without  restriction,  and  as 
such  should  be  included  in  gross  income  for  the  year  in  which 
so  credited  or  set  apart.  The  remaining  one-fourth  becomes 
income,  constructively  received,  at  the  end  of  the  five-year 
period,  provided  he  has  not  previously  withdrawn  his  shares.^'^ 

In  1891  A  purchased  an  interest  in  a  corporation  and  was 
elected  treasurer.  At  the  time  of  this  purchase  the  company 
had  large  indebtedness,  a  small  and  inadequate  plant,  and  com- 
paratively little  business.  A  placed  behind  the  company  all  his 
personal  credit,  endorsing  its  notes  and  contracts  freely,  and 
after  some  years  of  eflfort  on  his  part  the  business  became  one 
of  the  leading  businesses  of  its  kind  and  regularly  paid  divi- 
dends. In  1906  it  was  agreed  that  A  should  receive  as  his  an- 
nual compensation,  in  lieu  of  salary,  a  commission  upon  the 
increase  of  business  of  the  company  under  his  management. 
It  was  arranged  that  he  should  be  paid  a  weekly  allowance  and 
that  any  excess  of  his  commission  beyond  such  allowance  should 
be  credited  to  him  monthly  upon  the  books  of  the  company,  but 
not  actually  paid  except  at  the  convenience  of  the  company. 
In  1916  his  weekly  drawings  were  in  excess  of  his  commissions 
for  that  year,  while  in  1917  and  1918  his  commissions  exceeded 
the  amount  of  his  actual  drawings.  In  his  return  he  included 
as  income  for  those  years  the  amounts  actually  withdrawn.  It 
was  held  that  the  amounts  credited  during  these  years  as  dis- 
tinguished from  the  amounts  actually  withdrawn  constituted 
taxable  income  to  A.^^ 

Receipt  by  Agent  Is  Receipt  by  Principal.  A  system  of 
accounting  adopted  by  an  insurance  company,  which  allowed  a 
period  of  two  months  to  local  agencies  in  which  to  report  their 
cash  premium  receipts  to  the  home  office,  has  been  held,  in  view 
of  the  rules  and  regulations  of  the  commissioner,  not  to  ''clearly 
reflect"  the  company's  income.  A  payment  to  the  agent  was  held 
to  be  payment  to  the  principal,  and  the  company  was  required  to 
include  such  payments  in  the  return  for  the  year  in  which  they 
were  received  by  the  agent.  The  provision  of  the  1916  law,  per- 
mitting a  corporation  to  report  according  to  its  books,  was  held 
not  to  justify  the  system  followed  by  the  corporation  in  this 
case,  as  the  system  adopted  was  required  to  be  such  as  to  "clearly 
reflect  its  income," ^"^  and  the  provisional  of  the  law  that  if  the 
method  of  accounting  regularly  employed  does  not  clearly  re- 

38  O.  D.  1081,  T.  B.  44-21-1892. 

39  A.  R.  R.  366,  T.  B.  4-21-1404. 

40  Maryland  Casualty  Co.  v.  U.  S.,  52  Ct.  Cls.  201,  modified  by  the  Su- 
preme Court  on  another  point  (251  U.  S.  342). 

41  Revenue  Act  of  1921,  §212   (b)  ;  Revenue  Act  of  1918,  §212   (b). 


INCOME — IN   GENERAL  349 

fleet  the  income,  the  computation  of  net  income  shall  be  made 
upon  such  basis  and  in  such  manner  as  in  the  opinion  of  the 
commissioner  does  "clearly  reflect"  income  would  seem  to  justify 
the  same  conclusion  under  the  present  law.  The  basis  of  this 
decision  is  undoubtedly  that  the  cash  premium  receipts  of*  the 
local  agencies  were  constructively  received  by  the  home  office 
when  they  were  received  by  the  local  agencies.  When  the  offi- 
cers of  a  corporation  upon  the  sale  of  their  capital  stock  in  the 
corporation  to  another  corporation  agree  not  to  engage  in  a 
similar  business  for  a  certain  period  within  the  United  States, 
any  part  of  such  consideration  in  fact  payable  to  the  other  em- 
ployees of  the  corporation  for  the  purpose  of  securing  their  good 
will  is  not  income  to  the  officers  even  though  the  agreement  of 
sale  of  the  stock  makes  no  mention  of  this  collateral  arrange- 
ment. It  must,  however,  be  satisfactorily  established  that  by 
written  or  oral  understanding  such  part  of  the  consideration 
was  not  for  the  benefit  of  the  officers.^-  Since  an  unrecorded 
assignment  of  an  oil  and  gas  lease  under  the  laws  of  Oklahoma, 
executed  in  good  faith  and  actually  delivered,  passes  title,  funds 
coming  into  the  hands  of  the  assignor  thereafter  are  held  by 
him  in  trust  for  the  benefit  of  the  assignee.^^ 

Income  Accrued.  The  Revenue  Act  of  1918  changed  the  privi- 
lege of  reporting  income  upon  the  basis  of  book  entries  to  a 
requirement  that  income  be  so  reported.  It  is  expressly  pro- 
vided that  net  income  shall  be  computed  in  accordance  with  the 
method  of  accounting  regularly  employed  in  keeping  the  books 
of  a  taxpayer;  if  no  such  method  of  accounting  has  been  so 
employed  or  if  the  method  employed  does  not  clearly  reflect 
income  the  computation  is  to  be  made  upon  such  basis  and  in 
such  manner  as  in  the  opinion  of  the  commissioner  does  clearly 
reflect  the  income.'^  Approved  standard  methods  of  accounting 
will  ordinarily  be  regarded  as  clearly  reflecting  income.  The 
method  of  accounting  will  not,  however,  be  regarded  as  clearly 
reflecting  income,  unless  all  items  of  gross  income  and  all  de- 
ductions are  treated  with  reasonable  consistency.  The  two  sys- 
tems can  not  overlap ;  a  taxpayer  may  not  report  in  part  on  the 
accrual  and  in  part  on  the  basis  of  actual  receipts.^-^ 

42  A.  R.  M.  56,  T.  B.  23-20-984. 

43  Sol.  Op.  59,  T.  B.  38-20-1201. 

44  Revenue  Act  of  1918,  §  212  (b)  ;  Revenue  Act  of  1921,  §  212  (b)  ;  Reg. 
45,  Art.  22.    See  Chapter  33  for  a  full  discussion  of  this  subject. 

4rjReg.  45,  Art.  23;  Maryland  Casualty  Co.  v.  U.  S.,  52  Ct.  Cls.  201.  This 
case  was  modified  by  the  Supreme  Court  (251  U.  S.  342)  but  the  principle 
here  involved  was  upheld. 


350  FEDERAL  INCOME  TAX 

Income  Received  in  Kind.  When  income  is  received  in  kind, 
as  for  instance,  in  produce,  crops,  or  other  property  having  no 
definite  market  value,  no  tax  is  assessable  until  the  produce, 
crops  or  other  property  is  disposed  of,  in  which  year  such  income 
is  first  reduced  to  money  or  a  money  equivalent.^*"' 

Income  Received  in  the  Equivalent  of  Cash.  Items  of  income, 
as  well  as  expenditures,  need  not  be  in  the  form  of  cash.  It 
is  sufficient  that  such  items,  if  otherwise  properly  included  in 
the  computation  of  net  income,  can  be  readily  valued  in  terms  of 
money.*'^     The  Revenue  Act  of  1918  expressly  provided  that 

46  Revenue  Act  of  1921,  §  202  (c)  ;  Revenue  Act  of  1918,  §  202  (b)  ;  T.  D. 
2153. 

47  Id.  Reg.  45,  Art.  22.  It  is  held  by  the  treasui'y  department  in  a  variety 
of  cases  that  income  (other  than  from  dividends  and  from  personal  services) 
may  be  received  in  a  form  other  than  cash.  Thus,  w^here  farm  produce  is 
exchanged  for  merchandise,  groceries  or  mill  products,  the  market  value  of 
the  article  or  product  received  in  exchange  is  to  be  returned  as  income. 
(Reg.  45,  Art.  38).  Rents  received  in  crop  shares  should  be  returned  as 
income  of  the  year  in  vi^hich  the  crop  shares  are  reduced  to  money  or  a 
money  equivalent.  (Reg.  45,  Art.  38).  When  improvements  made  by  a 
lessee  become  part  of  the  real  estate,  the  value  of  such  improvements  to  the 
extent  of  their  fair  market  value  is  income  to  the  lessor  at  the  time  such 
improvements  are  made  (Reg.  45,  Art.  48,  as  amended  by  T.  D.  3206,  T.  B. 
33-21-1767).  Warrants  received  by  contractors  pursuant  to  state  con- 
tracts are  considered  income.  (Reg.  45,  Art.  37).  Promissory  notes  are 
held  to  be  income  to  the  extent  of  their  discount  or  fair  market  value.  (Reg. 
45,  Art.  34;  letter  from  treasury  department  dated  March  1,  1915).  As 
stated  broadly  in  Article  21  of  Regulations  45,  the  term  income  "is  not 
limited  to  cash  alone,  for  the  statute  recognizes  as  income-determining 
factors  other  items,  among  which  are  inventories,  accounts  receivable,  prop- 
erty exhaustion  and  accounts  payable  for  expenses  incurred."  Again  in 
Regulations  45,  Art.  31,  it  is  stated  that  "income  may  be  received  in  the 
form  of  cash  or  of  property."  The  case  of  Peabody  v.  Eisner,  247  U,  S. 
347,  M^hich  recognized  the  doctrine  that  dividends  received  in  the  form  of 
property  (stock  of  corporations  other  than  the  distributing  corporation) 
were  taxable  under  the  1913  Law,  which  did  not  contain  any  express  pro- 
vision that  "property"  dividends  should  be  taxable,  settles  the  point  that 
taxable  income  may  be  received  in  the  form  of  property.  (See  also  U.  S.  v. 
Phellis,  42  Sup.  Ct.  Rep.  63 ;  Rockefeller  v.  U.  S.,  N.  Y.  Trust  Co.  v.  Edwards, 
42  Sup.  Ct.  Rep.  68.  The  question  still  remains,  however,  how  far  the  statute 
reaches  out  to  tax  "property"  income;  in  other  words,  what  is  to  be  con- 
sidered the  "equivalent  of  cash."  For  purposes  of  "property"  income,  a 
line  must  be  drawn  somewhere  between  such  readily  convertible  property 
as  Liberty  bonds  and  such  extremely  unconvertible  property,  as,  for  ex- 
ample, works  of  art.  The  question  occurs  in  each  case;  Can  the  property 
received  be  turned  to  pecuniary  account  ?  The  provision  of  the  Revenue  Act 
of  1921  (§  202  (c)  )  that  when  property  is  exchanged  for  other  property  no 
gain  or  loss  shall  be  recognized  unless  the  property  received  in  exchange 
has  a  readily  realizable  market  value  is  an  indication  that  Congress  had  in 
mind  the  difficulties  inherent  in  such  transactions  and  marks  a  step  in  ad- 


INCOME — IN   GENERAL  351 

amounts  distributed  in  the  liquidation  of  a  corporation  shall  be 
treated  as  payments  in  exchange  for  stock  or  shares,  and  any 
gain  or  profit  realized  thereby  shall  be  taxed  to  the  distributee 
as  other  gains  or  profits.^"*  It  also  expressly  provided  that  "prop- 
erty" dividends  should  be  taxable.-*"  The  Revenue  Act  of  1921 
provides  that  any  distribution  (whether  in  cash  or  other  prop- 
erty) made  by  a  corporation  to  its  shareholders  or  members 
otherwise  than  out  of  (1)  earnings  or  profits  accumulated  since 
February  28,  1913,  or  (2)  earnings  or  profits  accumulated  or 
increase  in  value  of  property  accrued  prior  to  March  1,  1913, 
shall  be  applied  against  and  reduce  the  cost  for  the  purpose  of 
ascertaining  the  gain  derived  or  the  loss  sustained  from  the  sale 
or  other  disposition  of  the  stock  or  shares  by  the  distributee.''" 
Inventories  and  accounts  receivable  may  also  be  income-produc- 
ing factors.^''^  Salaries,  wages  or  compensation  for  personal  serv- 
ices of  whatever  kind  "and  in  whatever  form  paid"  are  taxable 
income."-  Under  the  1918  Law  any  property  having  a  market 
value  was  the  equivalent  of  cash  when  received  in  exchange  for 
other  property.''^  Under  the  present  law,  on  an  exchange  of 
property,  no  gain  or  loss  is  recognized  unless  the  property  re- 
ceived in  exchange  has  a  readily  realizable  market  value.^^  A 
dealer  in  automobiles  who  takes  used  machines  as  part  payment 
on  sales  of  new  cars  is  required  to  report  the  entire  profits  real- 

vance  of  all  past  legislation  on  this  subject.  Even  now,  each  case  will  have 
to  be  decided  upon  its  peculiar  facts  and  the  character  of  the  property 
received.  It  is  not  easy  to  determine  whether  property  has  a  readily  re- 
alizable market  value;  the  definition  of  this  term  involves  much  of  the 
same  difficulty  which  was  involved  in  the  term  "fair  market  value,  if  any", 
and  it  is  well  to  guard  against  the  impression  that  the  present  law  has 
finally  solved  the  problem  of  what  is  and  what  is  not  property  income. 
(Tennant  v.  Smith,  (1892)  A.  C.  150,  66  L.  T.  327,  3  Tax  Cas.  158;  U.  S. 
V.  Schillinger,  14  Blatch.  71,  27  Fed.  Cas.  No.  16,228;  U.  S.  v.  Smith,  27 
Fed.  Cas.  No.  16,341;  State  v.  Frear,  148  Wis.  456,  134  N.  W.  673,  135  N. 
W.  164.)     This  subject  is  more  fully  discussed  in  Chapter  17. 

4S  Revenue  Act  of  1918,  §201  (c).  This  section  also  provided  that  stock 
dividends  should  be  considered  income  to  the  amount  of  earnings  or  profits 
distributed  but  stock  dividends  were  held  not  to  be  taxable.    See  Chapter  19. 

•4!' Revenue  Act  of  1918,  §201   (a). 

•"'"Revenue  Act  of  1921,  §201   (c). 

"•i  Revenue  Act  of  1921,  §§202  (a)  and  203;  Revenue  Act  of  1918,  §§202 
(a)  and  203;  Reg.  45,  Art.  21. 

:'>2  Revenue  Act  of  1921,  §213   (a)  ;  Revenue  Act  of  1918,  §213   (a). 

">^  Revenue  Act  of  1918,  §  202. 

"»•*  Revenue  Act  of  1921,  §  202  (c).  Even  where  the  property  received  has 
a  readily  realizable  market  value  no  gain  or  loss  is  recognized  in  certain 
cases  specified  by  the  statute.  (Revenue  Act  of  1921,  §202  (c).)  This 
subject  is  fully  treated  in  Chapter  17. 


352  FEDERAL  INCOME  TAX 

ized  on  the  new  cars  for  the  year  in  which  received  regardless  of 
the  fact  that  part  of  the  payments  received  are  in  the  form  of 
used  machines.  The  fair  market  value  of  the  used  cars  taken 
as  part  payment  is  deemed  to  be  the  value  at  which  they  were 
taken  in  on  the  sales."' 

Income  Received  in  the  Form  of  Notes.  Payments  received  in 
the  form  of  promissory  notes,  not  merely  security  for  such  pay- 
ments, constitute  income  to  the  amount  of  their  readily  realizable 
market  value.  A  taxpayer  receiving  as  compensation  a  note 
regarded  as  good  for  its  face  value  at  maturity,  but  not  bearing 
interest,  may  properly  treat  as  income  as  of  the  time  of  receipt 
the  fair  discounted  value  of  the  note  at  such  time.  Thus,  if  it 
appears  that  such  a  note  is  or  could  be  discounted  on  a  six  or 
seven  per  cent,  basis,  the  recipient  may  include  such  note  in  his 
gross  income  to  the  amount  of  its  face  value  less  discount  com- 
puted at  the  prevailing  rate  of  such  transactions.  If  the  pay- 
ments due  on  a  note  so  accounted  for  are  met  as  they  become 
due,  there  should  be  included  as  income  in  respect  of  each  such 
payment  so  much  thereof  as  represents  recovery  for  the  discount 
originally  deducted."''  If  notes  can  not  be  so  discounted  or  are 
not  readily  marketable,  they  need  not  be  reported  as  income 
until  paid.  Thus,  when  a  corporation  keeping  its  accounts  on 
the  basis  of  actual  receipts  and  disbursements,  loans  money 
secured  by  first  mortgage  bonds  and  receives  as  commission 
second  mortgages  on  the  property  of  the  borrower  payable  with- 
out interest  in  5  or  10  annual  installments,  such  second  mort- 
gage notes  were  held  under  the  1918  Law  to  be  income  at  their 
fair  discounted  value  as  of  the  date  of  receipt.  They  had  a  dis- 
ss O.  D.  782,  T.  B.  5-21-1413. 

56  Reg.  45,  Art.  34.  This  regulation  used  the  term  "fair  market  value", 
as  required  by  the  1918  Law.  With  the  substitution  of  the  words  "readily 
realizable"  for  the  word  "fair"  it  would  seem  to  state  the  present  law.  In 
U.  S.  V.  Schillinger,  14  Blatch.  71,  27  Fed.  Cas.  No.  16,  228,  arising  under 
the  Civil  War  Income  Tax  Laws,  it  was  held  that  promissory  notes  taken 
in  payment  of  a  patent  right  were  not  income  until  the  notes  became  due. 
The  court  said:  "In  this  case  the  defendant  changes  his  patent  rights  for 
promissory  notes  payable  in  the  future.  Their  value  was  uncertain;  they 
might  or  might  not  be  paid ;  but,  until  they  were  paid,  they  were  not  income, 
but  only  the  ground  of  expecting  income.  The  notes  were  no  more  taxable 
as  income  than  would  have  been  other  patent  rights,  if  the  defendant  had 
received  them  in  payment  of  those  he  sold."  On  the  other  hand,  in  U.  S. 
V.  Smith,  27  Fed.  Cas.  No.  16,341,  also  arising  under  the  Civil  War  Income 
Tax  Laws,  it  was  held  that  a  transfer  of  stocks  for  a  promissory  note, 
which  is  collectible,  or  an  exchange  thereof  for  land,  followed  by  a  sale  of 
such  land  within  the  year,  for  collectible  promissory  notes,  is  to  be  considered 
a  sale  of  such  stock  for  so  much  cash. 


INCOME — IN   GENERAL  353 

count  or  market  value  at  that  time.  If  the  notes  were  not  mar- 
ketable at  a  fair  discount,  each  installment  payment  was  held 
to  be  gross  income  in  its  entirety  in  the  year  in  which  received.^^ 
A  taxpayer  in  computing  his  net  income  will  not  be  obliged  or 
allowed  to  value  his  notes  receivable  at  their  fair  market  value 
in  cases  where  the  time  for  the  payment  of  such  notes  has  been 
extended  by  the  taxpayer  and  the  notes  can  not  be  discounted 
or  sold  without  material  loss.  If  this  were  not  the  case,  a  mer- 
chant who  had  notes  receivable  for  goods  sold  and  who  granted 
the  purchaser  an  extension  of  time  within  which  to  pay  the 
notes  would  be  permitted  to  treat  the  fair  market  value  of  the 
notes  as  the  price  for  which  the  goods  were  sold  or  to  deduct 
from  gross  income  as  a  loss  the  difference  between  the  face 
value  of  the  notes  and  their  fair  market  value  at  the  time  they 
originally  became  due.  The  effect  of  such  a  procedure  would  be 
to  allow  taxpayers  to  take  a  deduction  for  bad  debts  prior  to 
the  year  in  which  they  were  determined  worthless  and  charged 
off  contrary  to  the  plain  wording  of  the  statute.^^ 

Gross  Receipts  and  Gross  Income.  It  is  important  to  note 
that  the  term  "gross  receipts"  as  ordinarily  used  is  not  synony- 
mous with  the  term  "gross  income"  for  tax  purposes.  A  tax- 
payer's gross  income  consists  of  his  gross  receipts  less  (a) 
receipts  fundamentally  free  from  tax,  such  as  receipts  constitut- 
ing a  return  of  capital,  and  (b)  receipts  representing  the  kind 
of  income  specifically  exempted  by  the  law.-^»  The  Revenue  Act 
of  1918  was  the  first  income  tax  law  to  use  the  term  ".?ross 
income,"  defining  what  is  and  what  is  not  included  therein,  the 
latter  being  exempt  income.^^o 

Exempt  Income.  In  addition  to  receipts  fundamentally  free 
from  tax  (such  as  a  return  of  capital)  the  present  law,  as  well 
as  the  Revenue  Act  of  1918,  specifically  prescribe  that  certain 
receipts  shall  not  be   included   in   gross   income  and  shall  be 

57  O.  D.  728,  T.  B.  46-20-1302. 

.'WO.  D.  979,  T.  B.  30-21-1742.  But  see  the  new  provision  in  the  1921 
Law  for  the  deduction  of  a  proportionate  amount  of  worthless  debts,  dis- 
cussed in  Chapter  25. 

59  Reg.  45,  Arts.  21,  71. 

CO  Revenue  Act  of  1918,  §§213  and  235;  Revenue  Act  of  1921,  §§213 
and  235.  Prior  to  the  enactment  of  the  Revenue  Act  of  1918  the  treasury 
regulations  and  rulings  referred  to  "gross  income"  generally  as  the  income 
of  the  taxpayer  before  making  the  deductions  and  allowances  permitted 
by  law.  The  1916  Law  did  not  use  the  phrase  "gross  income,"  but  in  pre- 
scribing the  deductions  allowed  to  corporations  made  use  of  the  phrase 
"gross  amount"  of  its  income.     (Revenue  Act  of  1916,  §  12  (a).) 


354  FEDERAL  INCOME   TAX 

exempt  from  the  tax."^  The  exemption  of  these  receipts  de- 
pends in  certain  instances  on  the  status  or  character  of  the 
recipient,  and  in  other  instances  there  is  no  such  limitation, 
the  exemption  being  applicable  whether  the  recipient  is  an  in- 
dividual or  a  corporation.  The  classes  so  exempted  by  the 
present  law  are  given  below;  unless  otherwise  stated  the  same 
exemption  was  allowed  under  the  1918  Law : 

(1)  The  proceeds  of  life  insurance  policies  paid  upon  the 
death  of  the  insured  ;"- 

(2)  The  amount  received  by  the  insured  as  a  return  of  pre- 
mium or  premiums  paid  by  him  under  life  insurance,  endow- 
ment, or  annuity  contracts,  either  during  the  term  or  at  the 
maturity  of  the  term  mentioned  in  the  contract  or  upon  sur- 
render of  the  contract; 

(3)  The  value  of  property  acquired  by  gift,  bequest,  devise, 
or  descent  (but  the  income  from  such  property  must  be  included 
in  gross  income)  ; 

(4)  Interest  upon  (a)  the  obligations  of  a  state,  territory, 
or  any  political  subdivision  thereof,  or  the  District  of  Columbia ; 
or  (b)  securities  issued  under  the  provisions  of  the  Federal 
Farm  Loan  Act  of  July  17,  1916;  or  (c)  the  obligations  of  the 
United  States  or  its  possessions;  or  (d)  bonds  issued  by  the  War 
Finance  Corporation,  In  the  case  of  obligations  of  the  United 
States  issued  after  September  1,  1917  (other  than  postal  savings 
certificates  of  deposit) ,  and  in  the  case  of  bonds  issued  by  the 
War  Finance  Corporation,  the  interest  is  exempt  only  if  and 
to  the  extent  provided  in  the  respective  acts  authorizing  the 
issue  thereof,  as  amended  and  supplemented,  and  may  be  ex- 
cluded from  gross  income  only  if  and  to  the  extent  it  is  wholly 
exempt  to  the  taxpayer  from  income,  war-profits  and  excess- 
profits  taxes ; '■'•"• 

(5)  The  income  of  foreign  governments  received  from  invest- 
ments in  the  United  States  in  stocks,  bonds,  or  other  domestic 
securities,  owned  by  such  foreign  governments,  or  from  interest 

«!  Revenue  Act  of  1921,  §§  213  (b),  233  (a)  ;  Revenue  Act  of  1918,  §§  213 
(b),  233  (a). 

^>-  Under  the  1918  Law  only  the  proceeds  of  such  policies  paid  to  individual 
beneficiaries  or  to  the  estate  of  the  insured  were  exempt.  The  treasury 
department  ruled  that  the  term  "industrial  beneficiaries"  includes  partner- 
ships (T.  B.  R.  32,  T.  B.  16-19-270;  letter  from  treasury  department  dated 
November  18,  1919;  L  T.  S.  1921,  111208). 

•J'^  Under  the  1918  Law  interest  credited  to  postal  savings  accounts  upon 
money  deposited  subsequent  to  September  1,  1917,  was  taxable.  (Reg.  45, 
Art.  77). 


INCOME — IN   GENERAL  355 

on  deposits  in  banks  in  the  United  States  of  moneys  belonging 
to  such  foreign  governments,  or  from  any  other  sources  within 
the  United  States; 

(6)  Amounts  received  through  accident  or  health  insurance 
or  under  workmen's  compensation  acts,  as  compensation  for 
personal  injuries  or  sickness,  plus  the  amount  of  any  damages 
received  whether  by  suit  or  agreement  on  account  of  such  in- 
juries or  sickness; 

(7)  Income  derived  from  any  public  utility  or  the  exercise  of 
any  essential  governmental  function  and  accruing  to  any  state, 
territory,  or  the  District  of  Columbia,  or  any  political  subdivision 
of  a  state  or  territory,  or  income  accruing  to  the  government  of 
any  possession  of  the  United  States,  or  any  political  subdivision 
thereof,  as  is  more  fully  indicated  elsewhere  in  this  book.*'^ 

(8)  The  income  of  a  nonresident  alien  or  foreign  corporation 
which  consists  exclusively  of  earnings  derived  from  the  opera- 
tion of  a  ship  or  ships,  documented  under  the  laws  of  a  foreign 
country  which  grants  an  equivalent  exemption  to  citizens  of  the 
United  States  and  to  corporations  organized  in  the  United 
States ; '"' 

(9)  Amounts  received  as  compensation,  family  allotments  and 
allowances  under  the  provisions  of  the  War  Risk  Insurance  and 
the  Vocational  Rehabilitation  Acts,  or  as  pensions  from  the 
United  States  for  service  of  the  beneficiary  or  another  in  the 
military  or  naval  forces  of  the  United  States  in  time  of  war;"'' 

(10)  So  much  of  the  amount  received  by  an  individual  after 
December  31,  1921,  and  before  January  1,  1927,  as  dividends  or 
interest  from  domestic  building  and  loan  associations,  operated 
exclusively  for  th-e  purpose  of  making  loans  to  members,  as 
does  not  exceed  $300;'"'" 

(11)  The  rental  value  of  a  dwelling  house  and  appurtenances 
thereof  furnished  to  a  minister  of  the  gospel  as  part  of  his  com- 
pensation ;"'^ 

(12)  The  receipts  of  shipowners'  mutual  protection  and  in- 
demnity associations,  not  organized  for  profit,  and  no  part  of 
the  net  earnings  of  which  inures  to  the  benefit  of  any  private 

M  See  p.  357. 

'■'■"'  This  exemption  was  not  contained  in  the  1918  Law. 

'■'•■'  This  exemption  was  not  contained  in  the  1918  Law.  See  Chapter  12 
for  a  discussion  of  the  purpose  of  this  exemption.  It  takes  the  place  of  the 
exemption  granted  by  the  1918  Law  of  so  much  of  the  amount  received 
durinj;  the  recent  war  by  a  person  in  the  military  or  naval  forces  of  the 
United  States  for  active  service  in  such  forces,  as  did  not  exceed  $3,500. 

""  This  exemption  was  not  granted  by  the  1918  Law. 

'^"^  This  exemption  was  not  granted  by  the  1918  Law. 


356  FEDERAL  INCOME  TAX 

stockholder  or  member,  but  such  corporations  shall  be  subject  as 
other  persons  to  the  tax  upon  their  net  income  from  interest, 
dividends,  and  rents.^^ 

Federal  Reserve  Banks.  The  income  of  federal  reserve 
banks  is  exempt  from  income  tax™  by  express  provision  in  the 
Federal  Reserve  Act J^  The  dividends  on  the  stock  of  such  banks 
are  exempt  from  tax  in  the  hands  of  member  banksJ-  Divi- 
dends paid  by  member  banks  are  treated  like  dividends  of  ordi- 
nary corporations  and  are  not  exempt  from  taxJ^ 

Net  Income.  "Net  income"  is  defined  by  the  Revenue  Acts 
of  1918  and  1921  to  be  gross  income  as  defined  by  the  law  less 
the  statutory  deductionsJ^  Thus,  taxable  net  income  is  whollj^ 
a  statutory  conception,  although  it  follows,  subject  to  certain 
modifications  as  to  exemptions  and  as  to  some  of  the  deductions, 
the  lines  of  commercial  usage.  Statutory  net  income  is,  subject 
to  these  modifications,  commercial  "net  income."  This  appears 
from  the  fact  that  ordinarily  it  is  to  be  computed  in  accordance 
with  the  method  regularly  employed  in  keeping  the  books  of  a 
taxpayer.'^^  Net  income  must  be  computed  with  respect  to  a 
fixed  period.  Usually  that  period  is  twelve  months  and  is  known 
as  the  taxable  year.^*^ 

Net  Income  Subject  to  Normal  Tax.  The  entire  net  income, 
as  defined  in  the  preceding  paragraph,  is  subject  to  the  surtax 
in  the  case  of  individuals  and  the  excess-profits  tax  in  the  case 
of  corporations.  For  the  purpose  of  the  normal  tax  in  the  case 
of  individuals  and  the  income  tax  in  the  case  of  corporations, 
certain  additional  deductions  called  "credits"  are  allowed.''''' 
These  credits  in  the  case  of  individuals  are,  (a)  amounts  re- 
ceived as  dividends  from  domestic  corporations  (with  certain 
exceptions  specified  by  the  statute)  and  from  certain  foreign 
corporations;  (b)  the  amount  received  as  interest  upon  obliga- 
tions of  the  United  States  and  bonds  issued  by  the  war  finance 
corporation,  which  is  included  in  gross  income;  (c)  the  personal 

69  This  exemption  was  not  granted  by  the  1918  Law. 

70  Also  from  the  excess-profits  tax. 

71  Federal  Reserve  Act,  38  Stat.  251,  Ch.  6,  §  7. 

72  Reg.  45,  Art.  75.     Federal  Reserve  Bulletin,  April  1,  1916. 

73  Reg.  45,  Art.  75,  Reg.  33  Rev.,  Art.  86. 

74  Revenue  Act  of  1921,  §§212  (a)  and  232;  Revenue  Act  of  1918,  §§212 
(a)  and  232;  Reg.  45,  Art.  21. 

75  Reg.  45,  Art.  21. 
70  Reg.  45,  Art.  22. 
77  Reg.  45,  Art.  21. 


INCOME — IN   GENERAL  357 

exemption;  (d)  the  credit  for  dependents."^  In  the  case  of  cor- 
porations the  credits  allowed  are,  (a)  the  amount  received  as  in- 
terest upon  obhgations  of  the  United  States  and  bonds  issued  by 
the  war  finance  corporation,  which  is  included  in  gross  income; 
(b)  the  amount  of  any  war-profits  and  excess-profits  taxes  im- 
posed for  the  same  taxable  year;  (c)  in  the  case  of  a  domestic 
corporation,  $2,000."''  This  specific  credit  of  $2,000  is  allowed 
under  the  present  law  only  to  corporations  with  net  incomes  of 
less  than  $25.000.»^ 

Income  of  States  and  Political  Subdivisions  Thereof.  In  gen- 
eral, income  accruing  to  any  state,  territory  or  possession  of  the 
United  States,  or  to  any  political  subdivision  thereof,  is  exempt 
from  tax.^^  Both  the  Revenue  Act  of  1918  and  the  Revenue  Act 
of  1921  exempt  the  income  derived  from  any  public  utility,  or 
the  exercise  of  any  essential  governmental  function  and  accru- 
ing to  any  state,  territory  or  the  District  of  Columbia,  or  any 
political  subdivision  of  a  state  or  territory  or  income  accruing  to 
the  government  of  any  possession  of  the  United  States,  or  any 
political  subdivision  thereof.  In  addition  to  the  above,  both 
acts  provide  that  whenever  any  state,  territory,  or  the  District 
of  Columbia,  or  any  political  subdivision  of  a  state  or  territo^', 
prior  to  September  8,  1916,  entered  in  good  faith  into  a  contract 
with  any  person,  the  object  and  purpose  of  which  is  to  acquire, 
construct,  operate,  or  maintain  a  public  utility,  no  income  tax 
shall  be  levied  upon  the  income  derived  from  the  operation  of 
such  public  utility,  so  far  as  the  payment  thereof  will  impose 
a  loss  or  burden  upon  such  state,  territory,  District  of  Columbia, 
or  political  subdivision;  but  this  provision  is  not  intended  and 
will  not  be  construed  to  confer  upon  such  person  any  financial 
gain  or  exemption  or  to  relieve  such  person  from  the  payment  of 
a  tax  as  provided  for  in  the  law  upon  the  part  or  portion  of 
such  income  to  which  such  person  is  entitled  under  such  con- 
tract.^-    Rentals  derived  from  the  leasing  of  a  railroad  con- 

7S  Revenue  Act  of  1921,  §216;  Revenue  Act  of  1918,  §216.  Such  divi- 
dends are  a  deduction  in  the  case  of  corporations.  (Revenue  Act  of  1921, 
§234  (a)    (6);  Revenue  Act  of  1918,  §234  (a)    (6). 

79  Revenue  Act  of  1921,  §236;  Revenue  Act  of  1918,  §236. 

80  Revenue  Act  of  1921,  §  236  (b).     See  Chapter  10. 

81  Reg.  45,  Art.  84;  Cooley  on  Taxation,  Vol.  I.,  p.  153;  Ward  v.  Maryland. 
12  Wall.  418;  Collector  v.  Day,  11  Wall.  113;  U.  S.  v.  Railroad  Co.,  17  Wall 
322;  S.  1374,  T.  B.  18-20-896.  See  the  discussion  of  this  subject  in  the  para- 
graph "Interest  on  the  Obligations  of  States"  in  Chapter  18.  See  also  the 
discussion  of  this  subject  in  Chapter  15. 

82  Revenue  Act  of  1921,  §213   (b)  ;  Revenue  Act  of  1918,  §213   (b). 


358  FEDERAL   INCOME   TAX 

structed  and  owned  in  common  by  certain  townships  and  a 
county  are  income  derived  from  a  public  utility  and  are  exempt 
from  income  tax.  The  leased  railroad  must,  however,  file  a 
return  of  income."^''  When  a  corporation  is  organized  to  furnish 
water,  light,  power  and  heat  to  a  town,  the  town  owning  prac- 
tically all  the  common  stock,  which  is  not  dividend  bearing,  the 
preferred  stock  to  be  redeemed  as  soon  as  possible  out  of  earn- 
ings, after  which  the  plant  becomes  the  property  of  the  town, 
the  income  of  the  corporation  from  the  operation  of  its  plant  is 
exempt  from  income  tax,  since  the  imposition  of  a  tax  would 
delay  the  redemption  of  the  preferred  stock,  thereby  imposing 
"a  loss  or  burden"  on  the  town.  The  corporation  must,  however, 
file  a  return  of  income.*^^  The  income  of  state  workmen's  com- 
pensation insurance  funds  established  by  state  statutes  is  not 
taxable.'^s  -pj^e  funds  contemplated  are  only  those  managed  and 
controlled  directly  by  the  state  through  state  officers,  that  is  to 
say,  those  funds  the  management  and  control  of  which  con- 
stitute an  activity  of  the  state.  A  mutual  liability  insurance 
company  created  by  an  act  of  the  state  legislature  to  provide 
insurance  for  employers  to  cover  their  liability  under  the  state 
employers'  liability  act  and  workmen's  compensation  law,  which 
is  not  so  managed  and  controlled,  is  not  exempt."^"  Where 
property  is  willed  to  a  municipality  in  trust  that  the  income 
of  the  property  shall  be  used  for  a  public  charity  the  income 
is  not  liable  to  tax  and  the  trustees  of  the  fund  are  not  required 
to  file  annual  returns."^"  This  is  true  even  where  the  incom.e  is 
to  be  paid  to  an  individual  during  his  life.'^"* 

Income  from  Foreign  Countries.  Where  income  has  accrued 
in  a  foreign  country  on  foreign  investments,  but  has  not  been 
remitted  to  the  owner  in  this  country,  being  placed  to  his  credit 
in  the  foreign  country,  it  has  nevertheless  been  constructively 
received  by  the  owner  and  he  should  report  the  same  as  income 
for  the  year  in  which  it  is  placed  to  his  credit,  computing  the 
amount  in  United  States  money  by  using  the  rate  of  exchange 
prevailing  at  the  time  the  amounts  were  credited  to  him  abroad.'^^ 
Where  a  citizen  of  the  United  States  purchases  German  securi- 
ties in  Germany,  the  interest  being  collected  by  a  German  bank, 

S3  O.  D.  250,  T.  B.  14-19-434. 

84  0.  D.  328,  T.  B.  28-19-612. 

S5  Reg.  45,  Art.  84. 

»'  0.  D.  1074,  T.  B.  43-21-1883. 

S7  O.  D.  895,  T.  B.  14-19-433. 

«8  0.  D.  972,  T.  B.  28-21-1724. 

89  0.   D.  419,   T.   B.   13-20-805.      Letter  from   treasury   department  dated 


INCOME — IN  GENERAL 


359 


January  11,  lOlO;  I.  T.  S.  1921,  *1  792.  The  following  rates  have  been 
accepted  as  the  current  or  market  rates  of  exchange  prevailing  as  of 
December  31,  1920: 

London    3.535  (dollars  to  £  sterling) . 

Australia 3.55  (dollars  to  £  sterling) . 

New   Zealand 3.55  (dollars  to  £  sterling) . 

Paris 0595  ( cents  to  franc ) . 

Belgium     0622  (cents  to  franc) . 

Milan 0347  (cents  to  lira) . 

Zurich   1528  (cents  to  franc) . 

Madrid    1355  (cents  to  peseta) . 

Stockholm     20  (cents  to  krone) . 

Christiania 1535  (cents  to  krone  . 

Copenhagen    1535  (cents  to  krone) . 

Amsterdam 3145  (cents  to  guilder ) . 

Buenos    Aires    7510  (cents  to  peso) ;  .33375  =  1  paper 

peso). 

Montevideo 7462  (cents  to  centavo) . 

Colombia : 

Bogota    8620  (Colombian  cents  to  dollars). 

Barranquilla    8474  (Colombian  cents  to  dollars) . 

Cartagena    8474  (Colombian  cents  to  dollars) . 

Medellin     8474  (Colombian  cents  to  dollars) . 

Lima    4.42  (dollars  to  Peruvian  £) . 

Bolivia 277  (cents  to  bolivianos) . 

Mexico  City 4925  (cents  to  pesa) . 

Yokohama 48  (cents  to  yen) . 

Calcutta    265  (cents  to  rupee ) . 

Singapore 42  (cents  to  Singapore  dollars) . 

Dutch  E.  Indies 3145  (cents  to  florin) . 

Germany 01365  (cents  to  mark) . 

Poland     0016  (cents  to  mark) . 

Austria   0024  (cents  to  krone) . 

Czecho-Slovakia     0115  (cents  to  krone) . 

Jugo-Slavia    007  (cents  to  krone) . 

Greece   074  (cents  to  drachma) . 

Roumania 0126  (cents  to  leu) . 

Bulgaria    0115  (cents  to  lev) . 

Serbia    0274  (cents  to  dinar) . 

Finland 032  (cents  to  markka) . 

Canada    86  (cents  to  Canadian  dollar) . 

Shanghai,  China 7725  (cents  to  tael) . 

Rio  dt'  Janeiro,  Brazil 1333  (cents  to  government  paper 

milreis). 

Manila,  P.  1 46  (cents  to  peso) . 

(O.  D.  803,  T.  B.  7-21-1444;  O.  D.  898,  T.  B.  18-21-1605;  0.  D.  876,  T.  B. 
16-21-1575;  0.  D.  913,  T.  B.  20-21-1632;  O.  D.  1027,  T.  B.  37-21-1811.  For 
the  rates  prevailing  as  of  December  31,  1919,  see  O.  D.  551,  T.  B.  25-20- 
1010;  O.  D.  772,  T.  B.  2-21-1386;  O.  D.  1027,  T.  B.  37-21-1811,  and  0.  D. 
1036,  T.  B.  38-21-1826.  For  rates  as  of  December  31,  1916,  December  31, 
1917,  and  December  31,  1918,  see  O.  D.  1065,  T.  B.  42-21-1869;  O.  D.  1027, 
T.  B.  37-21-1811;  O.  D.  1036,  T.  B.  38-21-1826. 


360  FEDERAL  INCOME  TAX 

and,  after  tax  at  the  rate  of  10 -{  has  been  paid  to  the  German 
government,  the  balance  of  the  interest  is  credited  to  the  account 
of  the  citizen,  the  income  in  question  is  taxable  in  the  hands  of 
the  citizen.  The  interest  should  be  converted  into  United  States 
money  values  at  the  rate  of  exchange  prevailing  at  the  time  the 
interest  is  credited  to  the  citizen's  account  by  the  German  bank. 
In  the  event  the  interest  is  not  deposited,  but  is  paid  'by  check 
or  draft  drawn  by  the  German  bank  in  German  marks,  the  inter- 
est should  be  converted  into  United  States  money  values  at  the 
rate  of  exchange  prevailing  at  the  time  the  check  or  draft  is 
received.'"' 

Gains  or  Losses  Relating  to  Foreign  Dealings.  If  the 
owner  mentioned  in  the  previous  paragraph  receives  a  greater 
or  less  amount  when  the  income  is  actually  transmitted  to  him, 
owing  to  a  fluctuation  in  exchange  rates  between  the  time  when 
the  income  has  been  constructively  received  and  the  time  when  it 
is  actually  transmitted,  it  would  seem  that  he  should  report  the 
difference  as  income  or  claim  it  as  a  loss,  as  the  case  may  be. 
Where  in  1917  a  domestic  corporation  purchased  tangible 
property  in  a  foreign  country  for  a  stated  sum  in  the  currency  of 
that  country  at  an  exchange  rate  of  $0.20,  and  later  in  the  same 
year  the  property  was  transferred  to  a  newly  organized  corpo- 
ration of  the  same  foreign  country  in  exchange  for  its  capital 
stock  of  a  total  par  value  equal  to  the  same  amount  as  the  cost 
of  the  tangible  property,  the  rate  of  exchange  at  the  time  of 
the  transfer  being  $0.30,  it  was  held  that  gain  or  loss  was 
realized  by  the  domestic  corporation  through  the  exchange  of 
the  property  for  stock  of  the  new  foreign  corporation  in  the 
amount  that  the  fair  market  value  of  such  stock  in  American 
money  at  the  time  of  such  exchange  was  greater  or  less  than 
the  cost  of  the  property  in  American  money.-'^  It  has  been  held 
that  no  deductible  loss  was  sustained  where  a  corporation  at 
the  time  of  closing  its  books  for  the  taxable  year  had  an  asset 
of  pounds  sterling  represented  by  advances  made  in  cash  to  its 
London  representative  for  the  purchase  of  raw  material  in  the 
London  market,  the  purchases  not  having  been  made  at  the  time 
of  the  closing  of  the  books  by  reason  of  the  fact  that  the  rate 
of  exchange  at  the  time  of  closing  the  books  was  lower  than  at 
the  date  the  exchange  was  purchased.^-  Where  shares  of  German 
securities  were  bought  in  Germany  at  300,000  marks,  or  $9,000, 

f)0  0.  D.  809,  T.  B.  7-21-1450. 

91  0.  D.  938,  T.  B.  23-21-1670. 

92  O.  D.  940,  T.  B.  23-21-1672. 


INCOME — IN   GENERAL  361 

and  sold  for  500,000  marks,  or  $5,000,  the  taxpayer  may  deduct 
a  loss  of  $4,000.-'=' 

Taxpayers  Manufacturing  or  Trading  in  Foreign  Coun- 
tries. The  rulings  on  the  subject  of  computing  the  income  of 
taxpayers  trading  or  manufacturing  in  foreign  countries  are 
in  some  confusion.  In  the  case  of  such  taxpayers  the  committee 
has  held  that  under  the  abnormal  conditions  characterizing  for- 
eign exchange  during  the  European  war,  current  assets  less 
current  liabilities  payable  in  the  foreign  currency  may  be  con- 
verted at  the  current  rate  of  exchange  or  at  any  rate  less  favor- 
able to  the  taxpayer.  The  commissioner  will  consider  applica- 
tions to  adopt  a  rate  more  favorable  to  the  taxpayer  or  may  on 
his  own  motion  apply  such  a  rate  where  the  facts  in  the  par- 
ticular case  warrant  such  departure.  This  ruling  has  no  reference 
to  isolated  or  collateral  investments  in  foreign  credits  or  securi- 
ties.''^ A  domestic  corporation  which  bought  its  raw  material 
from  foreign  stockholders,  making  credit  and  debit  entries  first 
in  francs  and  then  in  dollars  at  the  rate  of  exchange  prevailing 
at  the  date  of  each  transaction,  which  corporation  on  closing  its 
books  converted  the  entire  balance  due  into  dollars  at  the  rate  as 
of  the  closing  of  the  taxable  year,  has  been  held  to  have  incor- 
rectly reported  income,  since  the  method  used  resulted  in  the 
returning  of  unrealized  gain  or  loss  due  to  changes  in  the  rate  of 
exchange — a  gain  or  loss  which  could  never  be  realized  (except 
upon  liquidation)  until  the  debit  due  the  foreign  interests  was 
repaid.  It  was  held  that  in  order  to  reflect  true  net  income,  all 
amounts  either  debited  or  credited  to  the  account  of  the  foreign 
interests  should  be  entered  on  the  books  in  dollars  at  the  rate  of 
exchange  prevailing  at  the  date  of  the  transaction ; 
that  any  net  debit  at  the  end  of  a  taxable  year  should 
be  applied  to  the  portion  of  the  debt  to  the  foreign  interest 
longest  outstanding;  that  any  gain  or  loss  arising  from  the 
difference  in  the  rate  of  exchange  prevailing  at  the  time  the 
obligation  was  incurred  and  the  rate  prevailing  at  the  time  the 
obligation  is  retired  should  be  accounted  for,  the  rate  prevail- 
ing at  the  time  the  obligation  is  retired  to  be  the  average  rate 
of  exchange  per  dollar  as  ascertained  by  applying  to  each  debit 
item  against  the  foreign  interests  during  such  succeeding  year 
the  rate  of  exchange  prevailing  at  the  time  each  such  debit 
item    was    created.      The    franc    value    might    thereafter    be 

"3  O.  D.  809,  T.  B.  7-21-1450. 
f»4  .A..  R.  R.  15.  T.  B.  3-20-682. 


362  FEDERAL  INCOME  TAX 

disregarded.^^''  The  net  profits  of  a  foreign  branch  of  a 
domestic  corporation,  which  keeps  a  separate  set  of  books  in 
foreign  currency  and  renders  a  report  at  the  end  of  the  year  as 
to  the  profits,  and  which  remits  amounts  to  the  home  office  from 
time  to  time  when  it  has  more  money  on  hand  than  it  needs, 
should  be  computed  in  foreign  currency.  From  the  total  profits 
for  the  year  should  be  subtracted  the  total  amount  remitted  to 
the  home  office  during  the  year,  all  expressed  in  foreign  cur- 
rency. To  determine  the  equivalent  of  the  profits  in  terms  of 
United  States  money,  the  amounts  remitted  should  be  converted 
at  the  rate  of  exchange  in  effect  at  the  date  such  remittances 
were  made.  The  balance  of  the  net  profits,  expressed  in  foreign 
currency,  should  be  converted  at  the  rate  as  of  the  end  of  the 
taxable  year,  regardless  of  the  fact  that  the  profits  may  not  have 
been  remitted  to  the  home  office.""  A  taxpayer  purchasing 
goods  from  a  foreign  country,  the  value  of  such  goods  being 
quoted  in  terms  of  the  foreign  currency,  should  enter  the  cost 
thereof  at  the  current  or  market  rate  of  exchange  prevailing 
at  the  time  payment  for  the  goods  is  actually  made.-'' 

Dealer  in  Foreign  Exchange.  A  dealer  in  foreign  exchange 
— that  is,  one  who  regularly  engages  in  the  purchase  and  resale 
to  customers  of  foreign  money  with  a  view  to  the  gains  and 
profits  that  may  be  derived  therefrom — who,  in  his  books  of 
account  regularly  inventories  unconverted  foreign  money  on 
hand  either  (a)  at  cost  or  (b)  at  cost  or  market  value  whichever 
is  lower,  may  make  his  return  upon  the  basis  upon  which  his 
accounts  are  kept.  A  taxpayer  who  is  not  a  dealer  in  foreign 
exchange,  but  merely  purchases  foreign  money  on  his  own  ac- 

y5  0.  D.  590,  T.  B.  29-20-1069.  This  ruling  criticises  the  method  em- 
ployed by  the  company  as  pi'oductive  of  artificial  and  unrealized  gain  or  loss 
arising  from  changes  in  the  rate  of  exchange,  yet  the  method  proposed  seems 
open  to  the  same  criticism.  The  ruling  ignores  the  well  established  accounting 
practice  that  current  assets  and  liabilities  should  be  converted  at  the  rate 
of  exchange  current  on  the  date  of  the  balance  sheet.  (See  Kester — "Ac- 
counting Theory  and  Practice" — 1918,  Vol.  II,  page  547;  Dickinson — "Ac- 
counting Practice  and  Procedure,"  pages  125-6;  Dawson — "The  Accountant's 
'Compendium'",  pages  529-530;  Cutworth — "Treatment  of  Fluctuating  Cur- 
rency in  Accounts",  page  10). 

»C0.  D.  550,  T.  B.  25-20-1009;  O.  D.  489,  T.  B.  19-20-909;  O.  D.  618,  T.  B- 
31-20-1109.  This  ruling  leaves  unsettled  the  question  of  gain  or  loss  arising 
from  a  difference,  if  any,  between  the  rate  of  exchange  at  the  end  of  the 
year  and  the  date  or  dates  when  the  balance  at  the  end  of  the  year  is  re- 
mitted. 

97  0.  D.  489,  T.  B.  19-20-909. 


INCOME — IN   GENERAL  363 

count  or  as  an  incident  of  his  principal  business  may  not  inven- 
tory such  unconverted  foreign  money  at  the  close  of  his  taxable 
year.  The  realization  of  the  gain  or  loss  is  postponed  until  the 
foreign  money  is  disposed  of  or  converted/'"* 

'••>*  O.  D.  834,  T.  B.  10-21-1491. 


CHAPTER  15 

INCOME  FROM  PERSONAL  SERVICES 

The  law  expressly  provides  that  the  gross  income  of  a  tax- 
able person  shall  include  gains,  profits,  and  income  derived  from 
salaries,  wages,  or  compensation  for  personal  services  of  what- 
ever kind  and  in  ivhatever  form  paid,  or  from  professions  or 
vocations.  The  provisions  of  the  1921  Law  and  the  1918  Law  are 
identical  in  this  connection.^  It  is  to  be  noted  that  salaries, 
wages,  or  compensation  for  personal  services  are  taxable  income 
"in  whatever  form  paid."  Where  services  are  paid  for  in  some- 
thing other  than  money,  the  fair  market  value  of  the  thing  taken 
in  payment  is  income.-  This  is  one  of  the  three  cases  in  which 
the  law  expressly  specifies  that  the  tax  shall  be  based  upon  pay- 
ments other  than  in  cash,  the  others  being  the  provision  relating 
to  dividends"''  and  the  provision  relating  to  exchanges  of  prop- 
erty.^ 

Salaries.  Salaries  and  compensation  for  services  are  ordinarily 
income  of  the  year  in  which  they  are  actually  received  rather 
than  the  year  in  which  earned.-^  They  will  be  income 
of  the  year  in  which  actually  earned,  if  the  recipient  keeps 
his  accounts  upon  an  accrued  basis  and  reports  accordingly. 
A  salary  paid  by  a  corporation  which  is  itself  exempt  is 
nevertheless  subject  to  tax  in  the  hands  of  the  employee." 
In  the  case  of  corporations,  so-called  "salaries"  of  stock- 
holders, if  they  are  unreasonable  in  amount  and  if  they  bear 
a  close  relationship  to  the  amount  of  stock  held,  are  treated  as  a 
distribution  of  the  net  profits  of  the  corporation,  are  not  deduct- 

1  Revenue  Act  of  1921,  §  213  (a)  ;  Revenue  Act  of  1918,  §  213  (a).  It  is 
to  be  noted  that  the  Revenue  Act  of  1921,  in  the  provision  relating  to  ex- 
changes of  property,  treats  as  the  equivalent  of  cash  only  property  with 
a  readily  realizable  market  value  (§202  (c)).  While  the  provision,  stated 
in  the  text  above,  that  amounts  received  as  compensation  for  personal 
services  shall  be  included  as  income  in  "whatever  form  paid"  (§213  (a)) 
§  202  (c)  is  indicative  of  the  more  liberal  intent  of  Congress  in  this  respect 
in  enacting  the  1921  Law. 

2  Reg.  45,  Art  33. 

3  Revenue  let  of  1921,  §  201 ;  Revenue  Act  of  1918,  §  201. 

4  Revenue  Act  of  1921,  §202  (c)  ;  Revenue  Act  of  1918,  §202  (b). 

5T.  D.  2135;  T.  D.  2090;  A.  R.  R.  182,  T.  B.  29-20-1070;  O.  D.  717,  T.  B. 
45-20-1289;  O.  D.  432,  T.  B.  14-20-824;  O.  D.  19,  T.  B.  1-19-31;  O.  D.  512, 
T.  B.  21-20-948;  0.  D.  997,  T.  B.  34-21-1776.  See  Chapter  33. 

6T.  D.  2135;  T.  D.  2090. 

364 


INCOME   FROM   PERSONAL   SERVICE  365 

ible  as  a  business  expense  of  the  corporation,  and  are,  therefore, 
not  subject  to  the  normal  tax  in  the  hands  of  the  recipient.'     So- 
called  salaries  representing  an  appropriation  of  assets  of  the  cor- 
poration by  officers  who  control  it  and  fix  their  compensation  in 
violation  of  the  rights  of  the  corporation  are  not  deductible  by 
the  corporation  insofar  as  they  exceed  a  reasonable  amount; 
such  excessive  payments  are  to  be  treated  by  their  recipients, 
however,  as  compensation  subject  to  the  normal  tax,  smce  com- 
pensation illegally  secured  is  none  the  less  subject  to  tax  in  all 
respects^     So-called  salaries  constituting  in  part  payment  tor 
property,  should,  insofar  as  they  exceed  a  reasonable  amount,  be 
treated  by  the  corporation  as  a  capital  expenditure  and  by  the 
recipient  as  part  of  the  purchase  price.    In  the  case  of  excessive 
payments  by  individuals  or  partnerships,  the  amounts  of  osten- 
sible salaries  disallowed  as  deductions  should  ordmarily  be  treated 
as  shares  of  the  profits  of  a  partnership,  except  that  salaries 
constituting  in  part  payment  for  property  should  be  treated  by 
the  paying  individual  or  partnership  as  a  capital  expenditure 
and  by  the  recipient  as  part  of  the  purchase  pnce.^ 

Bonuses  and  Profit  Sharing.    Where  employees  receive  bonuses, 
or  are  entitled  to  a  share  of  the  profits  of  the  employer    he 
amount  so  received  should  be  included  as  income,  provided  (a) 
it  is  clearly  made  as  compensation  for  services  rendered  and 
(b)  it  is  paid  under  a  contract,  express  or  implied,  or  a  long-time 
practice    (practically  an  implied  contract)    regularly  employed, 
which  constitutes  a  condition,  if  not  a  contract,  under  which  the 
employees  may  reasonably  expect  additional  pay  for  the  greater 
or  better  services  which  they  render,  or   (c)   the  total  amount 
of  salary  and  bonus  is  not  greater  than  a  reasonable  compensa- 
tion for  the  services  rendered  by  the  employee.-    Such  payments 
are  income  to  the  employee  if  they  are  of  such  character  that 
the  employer  is  entitled  to  deduct  them  as  an  expense  of  domg 
business.  "  If  a  bonus  is  a  mere  gift,  the  employee  should  not 
treat  it  as  income,  since  gifts  or  gratuities  are  not  taxable,  and 
the  employer  is  not  entitled  to  deduct  it  from  his  income  as  an 
expense  of  doing  business.     The  rules  governing  the  deduction 
of  bonuses  and  profit  sharing  payments  are  more  fully  tieated 

TFxceDt  in  the  case  of  certain  corporations  specified  in  §216   (a)   of  the 
Revenue  let  of  1921.  the  dividends  of  which  are  not  allowed  as  a  cred.t 

^^?kt  twrv^^Rlu^.  U.  S.,  260  Fed.  131.  136.  wherein  it  is  stated  that 
embezzled  moneys  are  not  income. 

9  Reg   45,  Art.  106;  T.  D.  2696.     See  Chapter  22. 

10  Reg.  45,  Art.  107 ;  T.  B.  2696.    See  Chapter  22. 


366  FEDERAL  INCOME   TAX 

elsewhere  in  this  book."  The  rule  to  be  followed  by  the  em- 
ployee is  that  if  the  employer  is  entitled  to  deduct  the  payments 
in  question  as  an  expense  of  doing  business,  the  employee  should 
return  them  as  income ;  while  if  the  employer  is  not  entitled 
to  deduct  the  payments  in  question  as  an  expense,  the  employee 
should  not  return  them  as  income,  otherwise  the  same  item  of 
income  would  be  taxed  twice.  If  so-called  bonuses  or  shares  of 
profits  paid  to  officers  or  stockholders  of  corporations,  are  in 
fact  distributions  of  net  profits  bearing  a  close  relationship 
to  stock  holding,  or  a  waste  or  appropriation  of  the  corporation's 
assets,  or  in  part  payment  for  property,  they  will  be  treated  as 
indicated  in  the  preceding  paragraph.  The  same  considerations 
apply  when  excessive  bonuses  are  paid  by  individuals  or  part- 
nerships.i-  When  extra  compensation  in  the  form  of  bonuses,  or 
otherwise,  is  paid  to  employees  by  affording  them  an  opportunity 
to  purchase  stock  of  a  corporation  and  title  to  the  stock  remains 
in  the  corporation  until  it  is  fully  paid  for,  any  so-called  dividends 
credited  to  the  employee  purchasing  the  stock  as  part  payment 
are  not  in  fact  dividends,  since  dividends  cannot  legally  be  de- 
clared on  unissued  or  treasury  stock.  Such  dividends  constitute 
additional  compensation  to  the  employees.  Where  special  allow- 
ances are  credited  to  the  account  of  such  employee  as  part 
payment  upon  the  fulfillment  of  certain  conditions,  provision 
being  made  for  the  payment  of  a  certain  amount  if  the  employee 
does  not  default,  such  special  allowances  are  held  to  constitute 
additional  compensation.  But  neither  the  so-called  dividends 
or  such  special  allowances  constitute  income  until  the  terms  of 
the  agreement  have  been  completed.^-' 

Any  lump  sum  received  by  an  employee  from  a  former  employer 
upon  the  termination  of  his  employment  has  in  it  a  large  element 
of  compensation  for  services  previously  rendered  and  must  be 
returned  as  income  for  the  year  in  which  it  was  received. ^^ 

Commissions.     Commissions  paid  salesmen,  compensation  for 

11  See  Chapter  22. 

12  Reg.  45,  Art.  106;  T.  D.  2696. 

13  See  Chapter  33  for  the  reason  for  this  rule.  O.  D.  763,  T.  B.  1-21-1370. 
The  same  rule  was  applied  in  a  case  with  similar  facts  and  where,  in  ad- 
dition, in  case  of  resignation  or  discharge  of  an  employee  prior  to  the  time 
of  receiving  title  to  the  stock,  he  was  to  receive  the  dividends  paid  to  the 
trustee  on  account  of  the  stock  issued  in  his  name,  and  in  case  of  his  death 
they  were  to  be  paid  to  his  next  of  kin.     (O.  D.  791,  T.  B.  6-21-1426). 

14  O.  D.  1029,  T.  B.  37-21-1814. 


INCOME  FROM    PERSONAL   SERVICE  367 

services  on  the  basis  of  a  percentage  of  profits,  and  commissions 
on  insurance  premiums  are  income  to  the  recipients. i"' 

Traveling  Expenses.  The  Revenue  Act  of  1921  provides  that 
"traveling  expenses  (including  the  entire  amount  expended  for 
meals  and  lodging)  while  away  from  home  in  the  pursuit  of  a 
trade  or  business"  i''  may  be  deducted.  This  provision  was  not  con- 
tained in  the  1918  Law  and  under  that  law  the  department  made 
many  and  conflicting  regulations  and  rulings  as  to  the  deductibili- 
ty of,  or  income  from,  traveling  expenses.  The  latest  rulings 
under  the  1918  Law  (which  seem  to  be  too  complicated  to  be 
practicable)  insofar  as  they  relate  to  income  are  as  follows :  If 
an  individual  receives  a  salary  and  is  also  repaid  his  actual  travel- 
ing expenses,  he  is  required  to  include  in  gross  income  an  amount 
thereof  equal  to  the  ordinary  expenditures  required  for  meals 
and  lodging  when  at  home,  as  such  amount  is  held  to  be  addition- 
al compensation  to  the  taxpayer.  If  he  receives  a  salary  and  also 
an  allowance  for  meals  and  lodging,  as,  for  example,  a  per  diem 
allowance  in  lieu  of  subsistence,  any  excess  of  the  cost  of  such 
meals  and  lodging  over  the  sum  of  the  allowance  and  the  ordinary 
expenditures  required  for  such  purposes  when  at  home,  is  de- 
ductible, but  any  excess  of  the  allowance  over  the  difference  be- 
tween such  expenses  and  such  ordinary  expenditures  is  taxable 
income.  Congressmen  and  others  who  receive  a  mileage  allow- 
ance for  railroad  fares  should  return  as  income  any  excess  of 
such  allowance  over  their  actual  expenses  for  such  fares.^^ 

Insurance  Premiums  Paid  for  Employees.  Premiums  paid  by 
an  employer  on  life,  accident  or  health  policies  in  favor  of  his 
employees  as  additional  compensation  of  such  employees  have 
been  held  to  be  income  to  the  employees. ^^  Premiums  paid  by  an 
employer  on  policies  of  group  life  insurance  covering  the  lives  of 
employees,  the  beneficiaries  of  which  are  not  designated  by  the 
employees,  are  not  income  to  such  employees.  The  financial 
benefits  under  such  policies  do  not  move  to  the  employees  per- 
sonally but  only  to  their  heirs  or  dependents  after  their  deaths, 
and  the  payment  of  the  policies  is  in  any  case  contingent  upon  the 
employee's  continuance  until  death  in  the  employment  of  his 
present  employer,  which  employment  may  be  terminated  at  any 
time  by  himself  or  his  employer.     The  payment  is  also  contin- 

15  Reg.  45,  Alt.  32;  S.  1312,  T.  B.  7-20-738;  T.  D.  2090;  letter  from  treas- 
ury department  dated  April  30,  1918;  I.  T.  S.  1919,  11858. 

I'i  Revenue  Act  of  1921,  §214   (a)    (1). 

1"  Reg.  45,  Art.  292.  See  Chapter  21  for  a  discussion  of  the  deductibility 
of  traveling  expenses. 

1R  O.  D.  627,  T.  B.  33-20-1039. 


368  FEDERAL  INCOME  TAX 

gent  upon  continued  payment  of  premiums  by  the  employer. 
The  employee  has  no  option  to  take  the  amount  of  the  premiums 
paid  for  the  policy  covering  his  life  instead  of  the  insurance.  The 
policies  have  no  paid-up  value  either  to  the  employer  or  to  the 
employee.  Such  insurance  creates  no  debt  on  the  part  of  the 
employer,  pays  no  debt  to  the  employee,  and  discharges  no  legal 
obligations  resting  upon  the  employee.  The  only  benefit  obtained 
by  the  employee  himself  is  a  feeling  of  contentment  that  provi- 
sion has  been  made  for  his  dependents,  and  the  payment  consti- 
tutes an  investment  on  the  part  of  the  employer  in  increased 
efficiency.  The  same  considerations  apply  to  cases  in  which  a 
portion  of  the  premiums  for  group  life  insurance  is  paid  by  asso- 
ciations of  employees,  provided  no  contract  covering  such  pay- 
ment exists  between  the  employer  and  the  employees. i'^ 

Services  in  Cancellation  of  Indebtedness.  If  an  individual  per- 
forms services  for  a  creditor,  who  in  consideration  thereof  can- 
cels the  debt,  income  to  that  amount  is  realized  by  the  debtor  as 
compensation  for  his  services.  If,  however,  a  creditor  merelj' 
desires  to  benefit  a  debtor  and  without  any  consideration  there- 
for cancels  the  debt,  the  amount  of  the  debt  is  a  gift  from  the 
creditor  to  the  debtor  and  need  not  be  included  in  the  letter's 
gross  income.20 

Voluntary  Offerings  Received  by  Clergymen.  Although  as  a 
general  rule  gifts  and  gratuities  are  not  income,  yet  Easter  oflier- 
ingS;  and  fees  received  by  clergymen  for  funerals,  masses,  mar- 
riages, baptisms,  and  sums  paid  for  saying  masses  for  the  dead, 
are  considered  income,  because,  though  in  the  form  of  gifts,  they 
are  in  fact  payment  to  the  clergymen,  evangelists,  and  religious 
workers  for  services  rendered.^i  Christmas  gifts  to  clergymen 
do  not  come  within  this  category.—  The  question  is  whether  ov 
not  the  money  is  actually  a  gift  or  merely  in  the  form  of  a  gift,  A 
clergyman  is  not  liable  to  tax  on  amounts  received  by  him  during 
the  year  from  his  parish,  if  he  turns  over  to  the  religious  order 
of  which  he  is  a  member  all  moneys  received  in  excess  of  his 
actual  living  expenses  on  account  of  the  vow  of  poverty  which 
he  has  taken.^s 

Rental  Value  of  Dwelling  House  Furnished  to  Clergy- 
man.   Under  the  1918  Law  it  was  held  that  where  in  addition  to 

19  T.  D.  2992,  amending  Reg.  45,  Art.  33;  T.  B.  13-28-19;  0.  1014,  T.  B. 
12-20-793. 

20  Reg.  45,  Art.  51. 

21  Reg.  45,  Art.  32. 

22  T.  D.  2090. 

23  O.  D.  119,  T.  B.  3-19-180. 


INCOME   FROM   PERSONAL   SERVICE  369 

the  salary  paid  a  clergyman  he  was  permitted  to  use  the  parson- 
age for  living  quarters  free  of  charge  the  fair  rental  value  of  the 
parsonage  was  considered  a  part  of  his  compensation  for  services 
rendered  and  as  such  was  required  to  be  reported  as  income.-^ 
The  Revenue  Act  of  1921  expressly  provides  that  the  rental  value 
of  a  dwelling  house  and  appurtenances  thereof  furnished  to  a 
minister  of  the  gospel  as  part  of  his  compensation  shall  be  ex- 
empt.-'' 

Rewards.  A  reward  for  the  performance  of  a  special  service, 
such  as  prevention  of  a  bank  robbery,  constitutes  taxable  in- 
come.-" 

Tips.  Tips,  though  in  the  form  of  gifts,  are  in  fact  payment 
for  services  rendered  and  constitute  income  to  the  recipient.-" 

Supper  Money.  "Supper  money"  paid  to  an  employee  for  vol- 
untary performance  of  extra  labor  after  regular  business  hours, 
such  payment  not  being  regarded  as  additional  compensation  nor 
charged  to  the  salary  account,  is  paid  for  the  convenience  of  the 
employer  and  is  not  taxable  income  to  the  employee.-^ 

Compensation  Paid  Other  Than  in  Cash.  Salaries,  wages,  or 
compensation  for  personal  services  are  income  "in  whatever  form 
paid."  Where  services  are  paid  for  with  something  other  than 
money,  the  fair  market  value  of  the  thing  taken  in  payment 
is  the  amount  to  be  included  as  income.  If  the  services  were 
rendered  at  a  stipulated  price,  in  the  absence  of  evidence  to 
the  contrary  such  price  will  be  presumed  to  be  the  fair  value  of 
the  compensation  received.-^  Where  there  is  no  stipulation  as 
to  the  value  of  service,  and  payment  for  service  is  made  with 
something  other  than  money,  the  market  or  reasonable  value  of 
the  thing  taken  in  payment  is  the  amount  to  be  included  as  in- 
come."*'^ 

Use  of  Property  of  Employer.  Where  an  employee  uses  his 
employer's  property,  horses,  automobile,  etc.,  by  permission,  and 
not  by  legal  right  as  a  part  of  his  compensation  for  services, 
such  use  is  in  the  nature  of  a  gift  from  which  no  taxable  income 
arises  to  the  employee. 

Living  Quarters,  Board  or  Lodging.  When  living  quarters, 
such  as  camps,  are  furnished  to  employees  for  the  convenience 

-'■»  O.  D.  8<32,  T.  B.  14-21-1544. 

25  Revenue  Act  of  1921,  §  213  (b)  11. 

20  O.  D.  602,  T.  B.  30-20-1088. 

27  Re^.  45,  Art.  32. 

28  0.  D.  514,  T.  B.  21-20-950. 

20  Reg.  45,  Art.  33.     See  footnote  1. 
30  Reg.  33  Rev.,  Art.  4. 


370  FEDERAL  INCOME  TAX 

of  the  employer,  the  value  need  not  be  added  to  the  cash  com- 
pensation of  the  employee,  but  where  a  person  receives  as 
compensation  for  services  rendered  a  salary  and  in  addition  there- 
to living  quarters,  the  value  to  such  person  of  the  quarters  fur- 
nished constitutes  income  subject  to  tax.''i  Where,  from  the 
location  and  nature  of  the  work,  it  is  necessary  that  employees 
engaged  in  fishing  and  canning  be  furnished  with  lodging  and 
sustenance,  the  value  of  such  lodging  and  sustenance  may  be 
considered  as  being  furnished  for  the  convenience  of  the  em- 
ployer and  need  not  be  included  in  the  income  of  the  employees.^s 
Where  the  employees  of  a  hospital  are  subject  to  immediate 
service  on  demand  at  any  time  during  the  day  and  night  and  on 
that  account  are  required  to  accept  quarters  and  meals  at  the 
hospital,  the  value  of  such  quarters  and  meals  may  be  considered 
as  being  furnished  for  the  convenience  of  the  hospital  and  does 
not  represent  additional  compensation.  On  the  other  hand,  where 
the  employees  are  on  duty  a  certain  specified  number  of  hours 
each  day  and  could,  if  they  so  desired,  obtain  meals  and  lodging 

31  Reg.  33  Rev.,  Art.  34;  Reg.  45,  Arts.  33,  292;  T.  D.  2090.  In  this  con- 
nection the  case  of  Tennant  v.  Smith  (1892)  A.  C.  150,  66  L.  T.  327,  3  Tax 
Cas.  158,  is  interesting.  It  appeared  in  this  case  that  the  appellant  Ten- 
nant was  agent  for  a  bank,  and  was  bound  as  part  of  his  duty  to  occupy 
the  bank  house  as  custodier,  of  the  whole  premises  belonging  to  the  bank, 
and  also  for  the  transaction  of  any  special  bank  business  after  bank  hours. 
He  was  not  entitled  to  sublet  the  bank  house  or  use  it  for  other  than  bank 
business,  and  in  the  event  of  his  ceasing  to  hold  his  office  he  was  under 
obligation  to  quit  the  premises  forthwith.  In  holding  that  Tennant  was  not 
in  receipt  of  any  taxable  income  by  reason  of  the  use  as  living  quarters  of 
the  bank  house,  the  various  lords  writing  opinions  freely  conceded  that 
such  use  might  be  a  substantial  benefit  to  Tennant.  Lord  Watson  said: 
*  *  *  "I  do  not  think  it  comes  within  the  category  of  profits,  because  that 
word,  in  its  ordinary  acceptation,  appears  to  me  to  denote  something  ac- 
quired which  the  acquirer  becomes  possessed  of  and  can  dispose  of  to  his 
advantage — in  other  words,  money — or  that  tvhich  can  be  turned  to  pecuni- 
ary account."  Lord  Macnaghten  said:  *  *  *  »j^  jg  ^  tax  on  what 
'comes  in' — on  actual  receipts."  *  *  *  "No  doubt  if  the  appellant  had 
to  find  lodgings  for  himself  he  might  have  to  pay  for  them.  His  income 
goes  further  because  he  is  relieved  from  that  expense.  But  a  person  is 
chargeable  for  income  tax  under  Schedule  D,  as  well  as  under  Schedule  E, 
not  on  what  saves  his  pocket,  but  on  what  goes  into  his  pocket.  And  the 
benefit  which  the  appellant  derives  from  having  a  rent-free  house  provided 
for  him  by  the  bank,  brings  in  nothing  which  can  be  reckoned  up  as  a  re- 
ceipt or  properly  described  as  income."  This  case  might,  of  course,  be  decided 
differently  under  the  American  law  because  compensation  for  personal 
services  was  involved  and  such  compensation  is  taxable  under  the  Revenue 
Acts  of  1918  and  1921  "in  whatever  form  paid."     (§-213  (a).) 

32  O.  D.  814,  T.  B.  8-21-1459. 


INCOME   FROM    PERSONAL   SERVICE  371 

elsewhere,  the  value  of  the  l)()ar(l  and  lodKiii^  furnished  is  addi- 
tional compensation.'-' 

Stock  Received  in  Exchange  for  Services.  Compensation 
paid  an  employee  of  a  corporation  in  its  stock  is,  if  the  stock 
has  a  market  value,  to  be  treated  as  if  the  corporation  sold  the 
stock  for  its  market  value  and  paid  the  employee  in  cash.-'^ 

Promissory  Notes  Received  in  Exchange  for  Services. 
Promissory  notes  received  in  payment  for  services,  and  not 
merely  as  security  for  such  payment,  constitute  income  to  the 
amount  of  their  fair  market  value.-'' 

Services  Rendered  Prior  to  March  1,  1913.  Where  services 
were  rendered  prior  to  March  1,  1913,  but  paid  for  thereafter, 
the  amount  received  is  taxable  income  to  the  extent  of  the  excess 
of  such  amount  over  the  fair  market  value  on  March  1,  1913,  of 
the  principal  of  the  claim  for  compensation  for  such  services  and 
any  interest  which  had  then  accrued.  A  claim  for  this  purpose 
is  a  right  existing  unconditionally  on  March  1,  1913,  and  then  as- 
signable, whether  presently  payable  or  not.  Interest  does  not. 
of  course,  include  dividends  on  corporate  stock."'"  In  a  recent 
case  an  individual  was  president  and  active  manager  of  a  corpo- 
ration for  a  number  of  years  prior  to  March  1,  1913.  It  was 
deemed  that  his  services  for  the  years  1909,  1910,  1911,  and 
1912,  were  such  as  reasonably  to  entitle  him  to  additional  com- 
pensation. No  agreement  as  to  the  amount  of  the  additional 
compensation  was  ever  arrived  at  until  December,  1913.  The 
president,  relying  upon  the  promise  of  the  two  directors,  became 
indebted  to  the  company,  this  indebtedness  being  carried  on  the 
company's  books  as  overdrafts.  These  overdrafts  amounted  in 
December,  1913,  to  $70,000.  In  that  month,  with  the  concurrence 
of  himself  and  two  of  the  other  four  directors  he  was  given  a 
credit  on  the  corporate  books  for  $50,000,  leaving  a  balance  of 
$20,000  owing  to  the  company  on  his  overdrafts.  The  court  held 
that  the  president  of  the'  company  was  taxable  in  1913  on  the 
$50,000  allowed  to  him  in  that  year  as  additional  compensation 

.<;'  0.  D.  915,  T.  B.  20-21-1634. 

^^  Reg.  45,  Art.  83  as  amended  by  T.  D.  2992,  Treasury  Bulletin  13-20-819; 
O.  D.  570,  T.  B.  27-20-1039.  Conversely,  in  an  early  ruling  of  the  treasury 
department  under  the  1913  Law  it  was  held  that  commissions  allowed  sales- 
men paid  in  stock  miuht  be  deducted  as  expense  if  so  charged  on  the  books 
of  the  corporation,  at  the  actual  value  of  such  stock.     (Reg.  33,  Art.  117). 

3ri  Reg.  45,  Art.  34.  See  Chapter  14  for  discussion  of  the  manner  of  com- 
puting the  value  of  income  received  in  the  form  of  promissory  notes. 

•■5'i  Reg.  45,  Art.  87  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767.  See  O.  D. 
956,  T.  B.  26-21-1700;  0.  D.  1116,  T.  B.  48-21-1946.  See  also  Chapter  33  for 
a  full  discussion  of  this  subject. 


372  FEDERAL  INCOME   TAX 

for  the  four  prior  years.^^  An  executor  is  entitled,  under  the 
laws  of  New  York,  to  one-half  of  his  commission  for  receiving 
the  estate  of  the  deceased,  and  one-half  for  paying  it  out.  In 
the  case  of  commissions  received  subsequent  to  March  1,  1913, 
in  an  estate  received  prior  to  that  date,  one-half  is  in  satisfaction 
of  a  claim  which  vested  prior  to  March  1,  1913,  and  is  a  return 
of  capital  to  the  extent  of  its  market  value  on  that  date."'^ 

Compensation  for  Services  Extending  Over  a  Year.  Where  no 
determination  of  compensation  is  had  until  the  completion  of 
services,  the  amount  received  is  income  for  the  calendar  year  of 
its  determination,  if  the  return  is  rendered  on  the  accrual  basis ; 
or  for  the  taxable  year  in  which  received,  if  the  return  is  rendered 
on  the  basis  of  receipts  and  disbursements.-'-^  A  taxpayer  who 
keeps  no  books  of  account,  and  to  whom  is  paid  upon  the  termina- 
tion of  services  extending  over  a  period  of  years,  a  lump  sum 
in  amount  not  previously  agreed  upon,  as  compensation  for  such 
ser\ices,  must  return  as  income  in  the  year  in  which  received  the 
entire  amount  so  paid  him,  even  when  such  payment  is  accom- 
panied by  a  statement  proportioning  the  compensation  over  the 
years  in  which  the  services  were  rendered.^^  Where  the  com- 
pensation of  a  receiver,  trustee,  or  similar  fiduciary  is  awarded 
or  paid  at  the  conclusion  of  the  trust,  it  is  presumed,  in  the  ab- 
sence of  satisfactory  evidence  to  the  contrary,  that  it  did  not 
accrue  during  the  course  of  the  trust,  and  it  is  accordingly  tax- 
able as  income  of  the  year  when  awarded  or  paid.  Where  it  is 
understood  at  the  beginning  of  the  trust  that  the  amount  of  the 
compensation  is  not  to  be  determined  until  its  conclusion,  and 
this  understanding  is  adhered  to  during  the  course  of  the  trust 
and  no  payments  are  made  on  account  of  such  compensation,  this 
presumption  becomes  conclusive.^! 

3'Holbrook  v.  Moore,  U.  S.  Dist.  Ct.,  East.  Dist.  of  Missouri,  Ct.  10, 
T.  B.  17-21-1592.  This  was  held  even  though  the  taxpayer  had  received  and 
spent  the  money  before  March  1,  1913.  But  it  was  not  certain  that  he 
would  become  entitled  to  any  of  the  compensation  in  question  until  after 
that  date. 

3-S  A.  R.  R.  321,  T.  B.  47-20-1311. 

3a  Reg.  4.5,  Art.  32 ;  T.  D.  2090 ;  .Jackson  v.  Smietanka,  272  Fed.  970 ; 
letter  from  treasury  department,  dated  April  30,  1918;  I.  T.  S.  1919,  ''858. 
This  point  is  more  fully  discussed  in  Chapters  14  and  33.  The  latter  chap- 
ter contains  a  full  discussion  of  when  items  of  income  should  be  reported. 

-tf' Jackson  v.  Smietanka,  272  Fed.  970;  T.  D.  2960,  T.  B.  .3-20-683;  State 
ex  rel.  Houghton  v.  Phelps,  (Wis.)  176  N.  W.  217.  See  also  O.  D.  956,  T.  B. 
26-21-1700. 

*1  T.  B.  R.  12,  T.  B.  3-19-178.  This  was  also  the  rule  under  the  1916  Law 
(T.  D.  21.35). 


INCOME  FROM    PERSONAL   SERVICE  373 

Compensation  to  Federal  Government  Officers  and  Employees. 

Compensation  received  as  such  by  officers  and  employees,  whether 
elected  or  appointed,  of  the  United  States,  or  of  Alaska.  Hawaii, 
or  any  political  subdivision  thereof,  or  the  District  of  Columbia 
is  subject  to  tax  whether  paid  in  cash  or  in  other  forms.-^-  Com- 
pensation received  by  federal  reserve  agents  and  their  assistants, 
as  well  as  other  employees  of  federal  reserve  banks,  is  subject 
to  t&xS-^  The  entire  sum  received  by  federal  officers  and  em- 
ployees, however,  is  not  necessarily  taxable  as  will  be  indicated 
in  the  following  paragraphs.-*^ 

AMOUNTS  Withheld  to  Provide  Annuities.  The  amounts  de- 
ducted and  withheld  from  the  basic  salary,  pay  or  compensation 
of  employees  in  the  civil  service  of  the  United  States  in  accord- 
ance with  the  provisions  of  the  act  approved  May  22,  1920,  is 
taxable  income.  The  total  compensation  of  the  employees  should 
be  reported  in  gross  income  and  no  corresponding  deduction  may 
be  taken  for  the  amounts  withheld,  as  such  amounts  are  pay- 
ments made  toward  the  purchase  of  annuities  provided  for  in  the 
act.  The  annuities  paid  to  retired  employees  are  subject  to  tax 
to  the  extent  that  the  aggregate  amount  of  the  payments  exceeds 
the  amounts  withheld  from  the  compensation  of  the  employees.^  ■ 
If  an  employee  leaves  the  civil  service  before  he  is  eligible  to 
retirement  and  receives  the  amount  of  salary  withheld,  together 
with  interest,  he  should  report  only  the  amount  of  interest  re- 
ceived by  him  as  income  for  the  year  in  which  received.-"' 

Living  Quarters.  Commutation  of  quarters  and  the  money 
equivalent  of  quarters  furnished  in  kind  should  be  returned  as 
income.  When  quarters  are  furnished  in  kind  of  a  less  number 
of  rooms  than  the  number  allowed  by  law,  the  money  equivalent 
only  of  the  number  of  rooms  actually  assigned  should  be  returned 
as  income.  When  quarters  are  furnished  of  a  greater  number  of 
rooms  than  the  number  allowed  by  law,  it  is  to  be  assumed  that 
the  excess  number  is  assigned  for  the  convenience  of  the  govern- 
ment, and  the  money  equivalent  only  of  the  number  of  rooms 
allowed  by  law  should  be  returned  as  income.^"  The  value  of 
living  quarters,  subsistence,  laundry,  heat  and  light  furnished  to 
officers  and  employees  of  the  public  health  service  is  taxable 
income.^^ 

42  Revenue  Act  of  1921,  §  213  (a)  ;  Revenue  Act  of  1918,  §  213  (a)- 

43  0.  D.  15,  T.  B.  1-19-27. 

44  T.  D.  2079. 

45  T.  D.  3112,  T.  B.  3-21-1403. 

46  O.  D.  823,  T.  B.  9-21-1475. 

47  T.  D.  2079;  O.  D.  921,  T.  B.  21-21-1647. 

48  0.  D.  1098,  T.  B.  46-21-1917. 


374  FEDERAL  INCOME  TAX 

Heat  and  Light.  Amounts  received  by,  or  paid  for,  an  officer 
for  heat  and  light  should  be  returned  as  income.  This  includes 
the  money  equivalent,  as  fixed  by  the  government,  of  heat  and 
light  furnished  to  an  officer  occupying  public  quarters.^''  Amounts 
expended  for  heat  and  light  are  in  the  nature  of  personal  living 
expenses  and  differ  in  this  respect  from  amounts  furnished  for 
mileage,  the  latter  being  in  the  nature  of  a  business  expense  or 
an  expense  of  the  employer  rather  than  that  of  the  employee. 

Mileage.  Officers  and  employees  of  the  government  were  re- 
quired under  the  1918  Law  to  return  as  income  any  excess  of  the 
mileage  allowance  received  by  them  over  their  actual  expenses 
for  railroad  fares,''"  The  Revenue  Act  of  1921  permits  the  de- 
duction of  traveling  expenses  (including  the  entire  amount  ex- 
pended for  meals  and  lodging)  while  away  from  home  in  the 
pursuit  of  a  trade  or  business."^!  No  reason  appears  why  this 
provision  should  not  be  applicable  to  federal  officers  and  em- 
ployees. 

Reimbursement  for  Actual  Expenses.  Amounts  paid  by  the 
government  in  the  nature  of  reimbursement  for  subsistence  and 
other  items  of  actual  expense  incurred  while  absent  on  business 
for  the  government  are  not  required  to  be  returned  as  income.^'- 
If  expended  solely  in  connection  with  their  official  duties  and  if  no 
part  of  the  same  is  diverted  for  personal  use,  any  expense  money 
received  by  naval  attaches  to  be  expended  for  entertaining  and 
exceptional  purposes  in  connection  with  their  duties,  is  not  sub- 
ject to  tax.^^ 

Per  Diem  Allowances.  The  total  per  diem  allowance  is  in- 
come and  it  has  been  ruled  that  there  may  be  taken  as  a  deduc- 
tion for  expense,  the  amount  actually  expended  from  such  allow- 
ance for  actual  necessary  traveling  expenses.-"^^ 

Compensation  of  Soldiers  and  Sailors.  Under  the  1918  Law  a 
person  of  either  sex  in  active  service  in  the  military  or  naval 
forces  might  exclude  from  gross  income  his  or  her  compensation 
received  during  the  recent  war  from  the  United  States  up  to  the 
amount  of  $3,500  in  any  taxable  year."'     A  bonus  paid  by  a 

49  T.  D.  2079. 

•'if'  Reg.  45,  Art.  292.     See  the  paragraph  "Traveling   Expenses",   supra. 
See  T.  D.  2079  and  O.  D.  921,  T.  B.  21-21-1647;  Galm  v.  U.  S.,  39  Ct.  Cls.  55. 
Ri  Revenue  Act  of  1921,  §  214  (a)    (1). 

52  T.  D.  2079. 

53  O.  D.  36,  T.  B.  1-19-48. 

54  Reg.  33  Rev.,  Art.  8;  T.  D.  2079;  T.  D.  2124.  See,  however,  the  para- 
graph "Traveling  Expenses",  supra. 

55  Revenue  Act  of  1918,  §  213  (b).     See  Chapter  3,  footnote  11. 


INCOME  FROM   PERSONAL   SERVICE  375 

state  to  its  residents  who  served  in  the  military  or  naval  forces 
during  the  war  with  Germany  does  not  constitute  taxable  income 
to  the  recipient.'"'  By  joint  resolution  of  Congress  approved  by 
the  President,  March  3,  1921.  that  date  was  fixed  as  the  date  of 
the  termination  of  the  war  for  certain  purposes.  In  order  to 
entitle  a  person  in  the  military  or  naval  forces  of  the  United 
States  to  the  $3,500  exemption,  the  salary  or  compensation  must 
have  been  received  during  the  period  January  1,  1918,  to  and  in- 
cluding March  3,  1921.-''  A  person  is  in  active  service  if  he  is 
actually  serving  in  such  forces,  not  necessarily  in  the  field  or  in 
the  theatre  of  war,  and  is  not  merely  on  the  retired  or  reserve 
list  Accordingly,  if  such  a  person  received  compensation  from 
the  United  States  of  $3,500  or  less  and  had  no  other  income  of 
an  amount  sufficient  in  itself  to  require  him  to  render  a  return  of 
income,  he  was  not  required  to  make  a  return.-  The  following 
compensation  was  held  not  to  be  within  the  exemption  of  $3,500: 

1.  Compensation  received  by  persons  serving  m  the  American 
Merchant  Marine  Sea  Training  Bureau  ;  •'•' 

2.  Retainer  pay  received  by  naval  reservists  while  on  inactive 

duty  •  '"'^ 

3.  '  Compensation  received  by  persons  in  the  army  transport 

service  ;''^ 

4.  Compensation  received  by  persons  in  the  military  service 
from  the  Spruce  division; '^2 

5.  Compensation   received   from   the   war   department   by   a 
civihan  flying  instructor  ;'■'•'• 

6.  Compensation  of  the  employees  of  the  commission  on  train- 
ing camp  activities;''^ 

7.  Compensation  received  by  an  officer  of  the  national  guard 
detailed  to  the  general  staff  college;'*^  ^^   •  uf       f 

8.  Compensation  received  by  employees  of  the  Knights  ot 
Columbus  war  activities;'"'" 

.-.<•.  O.  D.  286,  T.  B.  22-19-533. 

r.T  0.  D.  900,  T.  B.  18-21-1608. 

•■>>^  Reg.  45,  Art  86. 

■-.'.»  0.  D.  329,  T.  B.  28-19-613. 

tin  o.  D.  463,  T.  B.  16-20-860. 

tn  O.  D.  462,  T.  B.  16-28-59.  ,-^.,110^9 

«-.0.  D.  214,  T.  B.  11-19-376;   (Op.  A.  G.  3)  ;  T.  D.  3242,  1.  B.  4<-21-1932. 

<«  O.  D.  122,  T.  B.  3-19-183. 

M  o.  D.  27,  T.  B.  1-19-39. 

••..-■0.  D.  435;  T.  B.  14-20-828. 

<«•-  O.  D.  485,  T.  B.  18-20-898. 


376  FEDERAL  INCOME  TAX 

9.  Compensation  received  by  persons  in  the  military  or  naval 
forces  for  services  between  April  6,  1917,  and  December  31, 
1917  ;C' 

10.  Compensation  received  by  the  personnel  of  the  United 
States  Merchant  Marine  enrolled  in  accordance  with  rules  and 
regulations  of  the  shipping  board  ;^'''^ 

11.  Compensation  received  by  members  of  draft  boards i^^ 

12.  Compensation  of  employees  of  the  public  health  service 
whether  officers  or  civilians;'™ 

13.  Compensation  of  teachers  on  duty  in  the  medical  depart- 
ment at  large.'^i 

The  following  compensation  was  held  to  be  within  the  exemp- 
tion of  $3,500  according  to  persons  in  active  service  in  the  mili- 
tary or  naval  forces  of  the  United  States  by  the  1918  Law : 

1.  Compensation  of  army  contract  surgeons;"-  and 

2.  Compensation  of  army  field  clerks."^ 

The  following  items  were  to  be  included  in  the  $3,500  exemp- 
tion: 

(a)  Bonus  payable  upon  discharge ; 

(b)  Mileage  from  point  of  discharge  to  point  of  enlistment, 
and 

(c)  Ration  money  covering  the  periods  of  absence  from  camp 
on  furlough."* 

The  personal  exemption  allowed  married  men  and  the  exemp- 
tion for  dependents  were  not  included  in  the  $3,500  exemption.'''^ 

Under  the  1918  Law  it  was  held  that  compensation  paid  to  or  in 
behalf  of  discharged  soldiers,  sailors,  or  members  of  the  army 
and  navy  nurse  corps,  provided  for  in  the  Vocational  Rehabilita- 
tion Act  and  amendments  thereto,  is  income  subject  to  tax.  Such 
income  included,  besides  money  payments,  the  value  of  courses 

67  O.  D.  337,  T.  B.  29-19-625. 

68  O.  D.  663,  T.  B.  38-20-1202. 

69  Reg.  45,  Art.  86. 

70  O.  D.  904,  T.  B.  19-21-1618,  reversing  0.  D.  495,  T.  B.  19-20-915. 

71  O.  D.  752,  T.  B.  51-20-1351. 

72  Reg.  45,  Art.  86. 

73  O.  D.  435,  T.  B.  14-20-827.  The  right  to  the  $3,500  exemption  in  the 
case  of  "reconstruction  aids"  in  the  army  is  dependent  upon  their  status, 
whether  military  or  civil,  while  engaged  in  such  work.  The  exemption 
would  not  be  allowed  in  the  case  of  a  civilian  so  engaged,  whereas  it  would 
be  allowed  in  the  case  of  a  member  of  the  military  forces  under  similar  as- 
signment without  change  of  status.      (O.  D.  435,  T.  B.  14-20-827). 

74  O.  D.  370,  T.  B.  3-20-686. 

75  0.  D.  123,  T.  B.  3-19-184. 


INCOME  FROM   PERSONAL  SERVICE  377 

pursued  also  books,  material,  etc.,  which  were  furnished  without 
charge  lo  and  became  the  property  of  the  recipients,  and  were 
not  included  in  the  cost  of  such  courses.  •'■ 

The  Revenue  Act  of  1921  exempts  amounts  received  as  com- 

tinn   frmUv  allotments  and  allowances  under  the  provisions 

^ttwa^^Ris^  insurance  and  the  Vocational  Rehabilitation 

Actror  as  pensions  from  the  United  States  for  service  of  the 

benekcTary  or  another  in  the  military  or  naval  forces  of  the 

United  States  *"  "-"^^  j;-,  ^he  salaries  of  .judges  of  the 

Compensation  of  bederaijuages.    x  .    .  o^-^t^^   in  office 

Supreme  Court  and  inferior  courts  of  the  ""«»  states  in  oftce 
»t  the  time  the  law  was  passed,  were  exempt  from  the  tax,  unaer 
^he  191  Law  but  this  did  not  include  the  salaries  of  such  .,udg 
L  were  appointed  subsequent  ^  the  passage  of  he  'aw^  or  o 
retired  Judges.  The  R---^f;^^f  J,  ^  but  i  a  -cent  case 
fha'sir remh™  tti:   — n^islnconstitutional.^'..    It  has 

L"\r by  the  --7 -prrUs::Le*oVrR:re 

heM  not  ti  bl  ex"em^!^'    Members  of  the  Board  of  United  States 

7.-.  Sol.  Op.  97,  T.  B.  14-21-1543. 

77  Revenue  Act  of  1921,  §  213  (b)    (9). 

\   4.  ^r  1Q91    S213  (a):  Revenue  Act  of  lylo,  S -^^-^  ^'^i- 

Rev::rLr:;t9fe  ^ : f"  t]  2090.  r..  ^^^^^-^.^-x^- 

Z  o,  *e  provision  ^{^^  ^^:^^'-^Z^i  ;  ^^i: S.f  dunn, 
tees  that  the  compensation  of  '<=<'"  ".'J^^r^,,":,.  pield  in  Pollock  v.  Farm- 
their  continuance  in  office.  See  op.n.on  °t  '-  -^ J^-^"  ™  e^„.  ,,,,  On 
ers  Loan  and  Trust  Company,  157  U.  S.  ^ti:,..,,'i\t.tJsmr<:m<,  Court 
February  16,  1863,  Chief  Justice  Taney  of  the  United  f^'^^  ^"P"  .. 

wrote  a'ett;r  ,o  Hon.  S.  P.  Chase,  then  -cret-y  f  ^^^'.^X^' J/^^,, 
ously  protesting  against  the  --'""'■""t  >^  °' Xies  rte  judges  of 
income  tax  *-JV°-;:;rta:rorthrtr:asrr' hiving  ignored  this 
;e^^ThrwreSa?e;  r^cured^ts  entry  on  the  records  o,^ 

Court  on  March  10,  1863  (Tylers  Life  o  Taney  PP'  «f'_,^^i„'  ^e  war. 
deemed  unpatriotic  to  resist  the  ™'  ^'^''°7' *;  ,9  whi  he  opinL  of  the 
and  it  was  collected  until  toward  the  end  "* /«? '.,  ^'J  '""^  Ji„„  ,he  con- 
attorney.general  referred  to  above  was  '-"^jf '  "'^  ^^  ^,J„f„t  jh^  United 
stitutionality  of  any  tax  upon  the  salary  of  the  P.es.dent 
States  and  upon  ^e  iu<iges  of  the  Supreme  Cour,__^^_^^^_^  ^^^  ^^,^_,  ,^^^ 

79  Evans  v.  Gore,  253  U.  b.  ^4iy.     ine  tre^       j'       i 
this  case  is  not  applicable  to  referees  m  bankruptcy  and  that  the  f_e 
ceived  by  such  referees  are  subject  to  tax.     (O.  D.  678,   1.  «. 

SOT.  D.  3049,  T.  B.  33-20-1127. 

81  O.  D.  899,  T.  B.  18-21-1606. 


378  FEDERAL  INCOME  TAX 

General  Appraisers  are  not  exempt,  since  the  board  is  not  a  court 
nor  are  its  members  federal  judges.^- 

Compensation  of  the  President  of  the  United  States.  Under 
the  1916  Law,  the  compensation  of  the  President  of  the  United 
States  in  office  at  the  time  the  law  was  passed  was^exempt  from 
the  tax  during  the  term  for  which  he  was  elected.'^^  Compensa- 
tion received  as  such  by  the  President  of  the  United  States  is 
expressly  taxable  under  the  1918  and  1921  Laws.'^^  In  a  recent 
decision  of  the  United  States  Supreme  Court,  which  in  reality 
presented  the  question  whether  the  provision  of  the  Revenue  Act 
of  1918  taxing  the  salaries  of  federal  judges  was  constitutional 
it  has  been  clearly  indicated  that  the  provision  taxing  the  salary 
of  the  President  of  the  United  States  is  unconstitutional.'^^  The 
salaries  of  Presidents  elected  after  the  passage  of  the  Revenue 
Act  of  1918  will  be  held  taxable.^'' 

Compensation  of  Officers  and  Employees  of  a  State  or  Political 
Subdivision  Thereof.  Neither  the  Revenue  Act  of  1918  nor  the 
Revenue  Act  of  1921  expressly  exempt  ''the  compensation  of  all 
officers  and  employees  of  a  state,  or  any  political  subdivision 
thereof,  except  when  such  compensation  is  paid  by  the  United 
States  government,"  as  did  the  1916  Law.'^''  It  would  seem,  there- 
fore, that  such  compensation  is  intended  to  be  made  taxable,^^ 
but  the  treasury  department  has  ruled  that  compensation  paid  its 
officers  and  employees  by  a  state  or  political  subdivision  thereof, 
including  fees  received  by  notaries  public  commissioned  by  states 
and  the  commissions  of  receivers  appointed  by  state  courts,  are 

82  O.  D.  902,  T.  B.  19-21-1616. 

83  Revenue  Act  of  1916,  §  4.  In  an  opinion  of  the  attorney-general  in 
1869  it  was  held  that  a  specific  tax  by  the  United  States  upon  the  salary  of 
the  President  in  office  at  the  time  the  act  was  passed,  to  be  deducted  from  the 
salary  which  otherwise  would  be  paid  to  him,  would  be  a  diminution  of  his 
compensation  in  contravention  of  Article  2,  §  1,  Clause  7,  of  the  Federal 
Constitution,  which  provides  that  the  compensation  of  the  President  shall 
neither  be  increased  nor  diminished  during  the  period  for  which  he  shall 
have  been  elected.  13  Op.  Atty.  Gen.  162.  This  consideration  no  doubt  moved 
Congress  to  grant  the  exemption  in  the  1916  Law. 

84  Revenue  Act  of  1921,  §213   (b)  ;  Revenue  Act  of  1918,  §213    (a). 

85  Evans  v.  Gore,  253  U.  S.  245. 

86  T.  D.  3049,  T.  B.  33-20-1127. 

87  Revenue  Act  of  1916,  §  4.  For  the  exemption  provided  by  the  1916  Law, 
see  Revenue  Act  of  1916,  §23;  Reg.  33  Rev.,  Art.  4;  Reg.  33,  Art.  5;  T.  D. 
2152. 

88  The  general  opinion  that  a  federal  tax  on  the  salaries  of  officers  or  em- 
ployees of  a  state  is  unconstitutional,  is  based  on  the  cases,  among  others,  of 
Collector  v.  Day,  11  Wall.  113;  Freedman  v.  Sigel,  9  Fed.  Cas.  No.  5,080; 
U.  S.  V.  Ritchie,  27  Fed.  Cas.  No.  16,168.    In  the  Day  case,  Day,  who  was 


INCOME  FROM  PERSONAL  SERVICE  379 

not  taxable.  Employees  ol'  universities  receiving  salaries  paid  in 
part  or  in  whole  from  funds  available  under  the  Smith-Lever  Act 
of  May  8,  1914,  who  are  officers  or  employees  of  a  state,  are  not 
required  to  return  as  taxable  income  the  salaries  so  received.  This 
is  also  true  with  respect  to  the  Act  of  August  30,  1890,  relating 
to  colleges  for  the  benefit  of  agriculture  and  the  mechanic  arts, 
and  to  the  act  of  March  2,  1887,  relating  to  agricultural  experi- 
ment stations  in  such  colleges.^-'  An  industrial  commission  was 
established  by  a  slate  and  certain  amounts  were  paid  into  the 
commission's  fund  by  manufacturers  and  others,  based  on  their 
pay  rolls.  Such  funds  are  under  the  supervision  and  sole  control 
of  the  state  and  are  deposited  in  the  state  treasury.     The  law 

Judge  of  the  Court  of  Probate  and  Insolvency  for  a  county  in  Massachusetts, 
was  taxed  on  his  salary  in  186G  and  1867  as  such  officer.  The  question  was 
presented  "whether  or  not  it  is  competent  for  Congress,  under  the  Constitu- 
tion of  the  United  States,  to  impose  a  tax  upon  the  salary  of  a  judicial  officer 
of  a  state."  The  court  considers  at  some  length  the  case  of  Dobbins  v.  Erie 
Co.,  16  Pet.  435,  in  which  it  was  decided  that  a  state  could  not  levy  a  tax 
on  the  salary  of  an  officer  of  the  United  States,  because  (1)  such  officer  was 
a  means  or  instrumentality  employed  for  carrying  into  effect  some  of  the 
legitimate  powers  of  the  federal  government  which  could  not  be  interfered 
with  by  the  states,  (2)  the  salary  or  compensation  for  the  service  of  the 
officer  was  inseparably  connected  with  the  office,  and  (3)  if  the  officer  was 
exempt,  his  salary  was  equally  exempt.  The  court  also  considered  at  some 
length  the  leading  case  of  McCullough  v.  Maryland,  4  Wheat.  316,  and  dis- 
cussed the  relationship  between  the  federal  government  and  the  separate 
states.  Conceding  that  the  exemption  of  the  salaries  in  question  from  income 
tax  rested  upon  "necessary  implication,"  the  court  placed  its  decision  on  the 
grounds  that  (1)  in  respect  to  the  powers  reserved  to  them,  one  of  which 
was  the  power  to  maintain  a  judicial  department,  the  separate  states  are  as 
sovereign  and  independent  as  the  federal  government,  (2)  that  the  unim- 
paired existence  of  such  reserved  powers  is  as  essential  in  one  case  as  in  the 
other,  and  (3)  the  means  and  instrumentalities  employed  by  the  states  for 
carrying  on  the  operations  of  their  governments,  for  preserving  their  ex- 
istence and  for  fulfilling  the  duties  assigned  to  them  by  the  Constitution, 
must  be  left  free  and  unimpaired  and  must  not  be  crippled  or  defeated  by 
another  taxing  power.  Opinion  to  the  contrary  is  founded  largely  upon 
the  recent  cases  of  Peck  v.  Lowe,  247  U.  S.  165,  and  U.  S.  Glue  Co.  v.  Oak 
Creek,  247  U.  S.  321.  The  1918  Revenue  Bill  as  introduced  into  Congress 
expressly  taxed  such  salaries,  but  the  provision  was  stricken  out  in  the 
senate,  and  not  restored  by  the  conference  committee,  although  that  com- 
mittee restored  the  provision  taxing  the  salary  of  the  President  and  salaries 
of  federal  judges.  Under  the  Canadian  form  of  government,  it  has  been 
held  that  a  provincial  legislature  has  power  to  tax  the  official  income  of  an 
officer  of  the  Dominion  government.  (Abbott  v.  St.  John,  40  Can.  Sup.  Ct. 
597;  Webb  v.  Outrin,  (1907)  App.  Cas.  81,  95  L.  T.  850;  23  T.  L.  R.  147; 
contra  the  discredited  case  of  Leprohon  v.  Ottawa.  2  Ont.  App.  522). 

■'*^  Reg.   45,   Art.   85.      Letter   from    treasury   department    dated    May    17, 
1919;  I.  T.  S.  1919,  113335;  31  Op.  Atty.  Gen.  441. 


380  FEDERAL  INCOME  TAX 

provides  for  the  payment  out  of  such  fund  of  the  compensation 
of  a  secretary,  physicians  and  other  persons  performing  services 
for  the  commission.  It  has  been  held  that  a  surgeon  who  per- 
forms surgical  operations  on  individuals  sustaining  injuries  while 
in  the  employ  of  the  manufacturers,  such  surgeon  not  being 
under  contract  with  the  state  but  being  paid  out  of  the  com- 
mission fund  on  a  fee  basis  and  devoting  only  a  portion  of  his 
time  to  the  treatment  of  such  employees,  is  not  an  employee  of 
the  state.  Compensation,  therefore,  received  for  the  above  serv- 
ices, is  income  subject  to  tax.^"  In  order  to  be  exempt,  the  re- 
cipient of  income  from  a  state  or  political  subdivision  thereof 
must  be  an  officer  or  employee  of  such  state  or  political  sub- 
division. 

Who  Are  Officers  and  Employees  of  a  State  or  Politi- 
cal Subdivision  Thereof.  An  officer  is  a  person  who  occupies 
a  position  in  the  service  of  the  government,  the  tenure  of  which 
is  continuous  and  not  temporary  and  the  duties  of  which  are 
established  by  law  or  regulations  and  not  by  agreement.  An 
emploj^ee  is  one  whose  duties  consist  in  the  rendition  of  pre- 
scribed services  and  not  the  accomplishment  of  specific  objects, 
and  whose  services  are  continuous,  not  occasional,  temporary  or 
specific  in  character  or  object.'^i  Compensation  paid  by  a  state  or 
political  subdivision  thereof  to  its  officers  and  employees  is  ex- 
empt even  though  the  recipient  be  a  nonresident  alien.^^ 

In  addition  to  the  above,  the  following  are  officers  or  employees 
of  a  state  or  political  subdivision  thereof  within  the  meaning  of 
exemption  granted  to  the  compensation  of  such  officers  and  em- 
ployees by  the  treasury  department  (but  not  by  the  Revenue  Acts 
of  1918  or  1921)  : 

1.  Persons  serving  on  the  jury  of  a  state,  county,  or  munici- 
pal court ;  03 

2.  A  chief  engineer  appointed  by  a  sewerage  commission 
created  by  the  common  council  of  a  state  under  authority  of  a 
state  statute  ;0* 

3.  A  referee  in  drainage  appointed  by  the  district  judge  of  a 
state  judicial  district  in  which  the  drainage  project  is  located, 
such  judge  being  vested  with  authority  to  provide  for  the  pay- 
so  O.  D.  1038,  T.  B.  38-21-1828. 

91  A.  R.  R.  664  (Sol.  Op.  122),  T.  B.  45-21-1906. 

92  0.  D.  274,  T.  B.  19-19-497. 

93  O.  D.  434,  T.  B.  14-20-826. 

94  0.  D.  309,  T.  B.  25-19-582. 


INCOME   FROM    PERSONAL   SERVICE  381 

ment  of  the  referee's  salary,  to  regulate  his  duties,  and  to  dis- 
charge him  at  pleasure;'*"' 

4.  A  county  surveyor  who  is  paid  from  county  funds  even 
though  on  a  per  diem  basis  ;^" 

5.  Members  of  the  Virginia  Debt  Commission  ;^^ 

6.  The  attorney  for  the  state  comptroller  appointed  under  the 
New  York  Transfer  (Inheritance)  Tax  Law  to  look  after  the 
state's  interests  in  the  collection  of  inheritance  taxes ;  such  at- 
torney receiving  as  compensation  a  commission  on  the  transfer  of 
most  of  the  estates  and  in  some  cases  such  fees  and  allowances'  as 
the  state  comptroller  deems  reasonable  and  proper;-'*^ 

7.  Officers  of  the  national  guard ; 

8.  A  deputy  sheriff  of  New  Hampshire;^''"  and 

9.  An  attorney-at-law,  employed  by  the  collector  of  revenues 
in  a  county,  under  an  agreement  to  render  personal  services  as 
directed  by  the  collector.'"" 

The  following  are  not  officers  or  employees  of  a  state  or  politi- 
cal subdivision  thereof  within  the  meaning  of  exemption  granted 
to  the  compensation  of  such  officers  and  employees: 

1.  Trustees  of  a  corporation  who  have  filed  an  application 
for  winding  up  the  affairs  of  the  corporation  in  accordance 
with  the  laws  of  Connecticut,  such  trustees  not  being  receivers 
in  fact  and  not  exercising  a  public  function  under  an  appoint- 
ment of  the  court;'"' 

2.  Administrators  and  executors ;  '"- 

3.  An  individual  who  exercises  a  public  function  under  an 
appointment  issued  by  a  court  officer  for  a  particular  transaction 
or  purpose  for  a  limited  time  and  who  in  the  exercise  of  such 
function  is  not  vested  with  the  character  of  either  an  officer  or 
employee  of  the  state  or  political  subdivision  thereof  ;^"2 

4.  Witnesses  summoned  by  a  state  attorney  (as  to  fees)  ;^'^"* 

0"'  O.  D.  525,  T.  B.  22-20-968. 
9fiO.  D.  33,  T.  B.  1-19-45. 
07  O.  D.  257,  T.  B.  16-19-460. 
9S  0.  D.  494,  T.  B.  19-20-14. 

99  O.  D.  1053,  T.  B.  40-21-1853. 

100  O.  D.  1099,  T.  B.  46-21-1919. 

101  0.  D.  369,  T.  B.  3-20-685.  The  compensation  of  such  trustees  is  fixed 
by  the  court. 

loii  O.  D.  256,  T.  B.  16-19-459. 
103  O.  D.  256,  T.  B.  16-19-459. 
1(M  O.  D.  195,  T.  B.  9-19-338. 


382  FEDERAL  INCOME  TAX 

5.  Clerical  assistants  employed  by  the  clerks  of  state  courts 
in  connection  with  the  administration  of  the  federal  naturaliza- 
tion laws  and  paid  out  of  fees  collected  by  the  state  court 
clerks;  105 

6.  Individuals  employed  in  constructing  a  causeway  and  paid 
from  the  funds  of  three  railway  companies  and  a  county  which  is 
part  owner  of  the  project;^"" 

7.  A  "special  counsel"  of  a  municipality ;  i"" 

8.  Individuals  holding  the  positions  of  ''State  Agent  of  Nor- 
mal Schools  for  Whites,"  "State  Agent  of  Normal  Schools  for 
Negroes,"  and  "High  School  Inspector,"  which  positions  are 
created  by  the  Superintendent  of  Public  Instruction  of  a  state 
without  statutory  authority ;  i""*  and 

9.  A  partnership  of  civil  engineers  employed  by  a  state  irri- 
gation district  to  serve  as  consulting  and  supervisory  engineers 
in  connection  with  the  development  of  the  irrigation  district 
under  a  contract  prescribing  a  stipulated  payment  per  annum 
in  addition  to  expenses  and  for  all  time  in  excess  of  60  days  in 
any  one  year,  a  certain  sum  per  day  in  addition  to  expenses,  and 
under  which  contract  the  engineering  work  in  connection  with 
the  irrigation  district  is  to  be  performed  under  the  general  direc- 
tion of  the  partnership ;  '^^^ 

10.  A  bank,  designated  a  depositary  for  state  and  county 
funds  and  receiving  for  its  services  a  fixed  sum  of  money  per 
year;  110 

11.  Building  and  real  estate  experts  employed  by  the  board 
of  local  improvements  of  a  city,  not  appointed  to  any  position, 
the  tenure  and  duties  of  which  were  established  by  law  and  re- 
ceiving a  percentage  of  the  value  of  the  buildings  and  real  estate 
appraised.iii 

When  a  receiver  is  appointed  by  a  state  court  for  the  assets 
of  a  corporation,  part  of  which  are  located  in  the  state  appointing 

if>5  O.  D.  484,  T.  B.  18-20-897. 
100  O.  D.  553,  T.  B.  25-20-1013. 

107  Letter  from  treasury  department  dated  April  15,  1919;  L  T.  S.  1919, 
1l  3313. 

108  O.  D.  449,  T.  B.  15-20-845. 

109  0.  D.  545,  T.  B.  24-20-1001.  The  partnership  in  this  case  had  similar 
contracts  with  other  districts  and  counties  and  accepted  business  from  the 
public  in  general.  The  work  was  not  subject  to  the  direction  and  control 
of  the  directors  of  the  irrigation  district,  but  its  relation  to  the  directors 
was  similar  to  the  relation  between  an  attorney  and  a  client  who  pays  an 
annual  retainer  for  any  legal  services  the  client  may  require. 

110  0.  D.  1090,  T.  B.  45-21-1907. 

111  O.  D.  1075,  T.  B.  43-21-1884. 


INCOME   FROM    PERSONAL   SERVICE  383 

the  receiver  and  the  remainder  in  another  state,  the  federal 
district  court  for  the  latter  state  appointing  the  same  person  as 
receiver  for  the  assets  located  in  that  state,  and  the  fees  from 
the  receivership  are  allowed  in  a  lump  sum,  the  exemption  ac- 
corded to  compensation  received  by  an  officer  of  a  state  or  political 
subdivision  thereof  applies  only  to  that  portion  of  the  fee  of  such 
receiver  attributable  to  his  appointment  by  the  state  court. ^'■- 

Salaries  Paid  to  Teachers.  Salaries  paid  to  teachers  are 
exempt  only  where  the  educational  institution  is  maintained 
wholly  by  the  state  and  the  relation  of  employer  and  employee 
exists  between  the  state  and  the  teacher.  They  are  not  exempt 
merely  because  the  teachers  are  engaged  in  educational  work,  nor 
because  they  are  pensioned  by  the  state.' ^■''  Where  the 
laws  of  a  certain  state  require  that  all  children  under 
16  years  of  age,  who  are  employed,  shall  attend  a  regular  school 
for  eight  hours  a  week  and  a  certain  corporation,  instead  of  send- 
ing its  employees  to  an  outside  school,  conducts  one  in  its  place 
of  business,  placing  it  in  charge  of  a  teacher  who  is  certified  by 
the  supervisor  of  schools  of  another  state  but  subject  to  the 
authority  of  a  city  in  the  former  state,  the  salary  of  the  teacher 
being  paid  and  the  school  maintained  not  by  the  state  or  political 
subdivision  thereof,  but  by  and  for  the  convenience  of  the  corpo- 
ration, it  has  been  held  that  the  teacher  is  not  exempt  as  an 
officer  or  employee  of  a  state  or  political  subdivision  thereof. ^'^ 
The  compensation  of  teachers  of  the  territory  of  Hawaii  is  sub- 
ject to  tax.ii'' 

Pensions.  Pensions  received  from  a  state  or  political  sub- 
division thereof  by  retired  employees  are  exempt.' '''  but  pensions 
paid  by  the  state  of  Kentucky  to  Confederate  Civil  War  veterans 
are  not  exempt.^'^ 

Pilot  Fees.  It  has  been  held  that  the  compensation  of  a 
pilot  for  a  port  in  Florida,  where  such  pilot  was  appointed  by  the 
board  of  pilot  commissioners  appointed  by  the  governor  of  the 
state,  is  not  exempt  because  the  pilot  receives  his  compensation 
from  fees  paid  by  the  steamship  companies  to  the  board  of  pilot 
commissioners,  rather  than  from  funds  of  the  state.' '"" 

11-' O.  D.  503,  T.  B.  20-20-933. 
ii-t  O.  D.  82G,  T.  B.  4-19-214. 
114  0.  D.  963.  T.  B.  27-21-1711. 
ii">0.  D.  12,  T.  B.  1-19-24. 
11'- O.  D.  434,  T.  B.  14-20-826. 
117  0.  D.  903,  T.  B.  19-21-1617. 
ii'^  0.  D.  916,  T.  B.  20-21-1636. 


384  FEDERAL  INCOME  TAX 

Compensation  of  Public  Library  Employees.  The  em- 
ployees of  a  public  library  incorporated  by  special  act  of  the  legis- 
lature of  a  state  are  not  exempt  from  tax  where  the  control  and 
management  of  the  corporation  and  of  all  moneys  appropriated 
by  the  city  for  the  care  and  maintenance  of  the  library  are  vested 
in  the  board  of  directors  consisting  of  the  president,  vice  presi- 
dent, the  three  managers  of  the  corporation,  two  citizens  of  the 
city  appointed  by  the  mayor,  and  three  officials  of  the  city,  the 
expenses  of  the  corporation  being  chiefly  provided  for  by  an  ap- 
propriation by  the  state  and  the  city,  and  the  power  of  appoint- 
ment and  removal  of  employees  being  exercised  by  the  board  of 
directors.  In  such  case  the  relationship  of  employer  and  em- 
ployees does  not  exist  between  the  state  or  the  city  and  the  em- 
ployees of  the  library.  The  moneys  appropriated  by  the  state 
and  city  are  turned  over  to  the  corporation  to  be  used  as  the 
board  of  directors  may  direct.  The  fact  that  the  compensation 
of  employees  may  be  paid  out  of  moneys  appropriated  by  the 
state  or  the  city  does  not  change  their  status  as  employees  of  the 
corporation.ii^ 

119  0.  D.  973,  T.  B.  28-21-1725. 


CHAPTER  16 

INCOME  FROM  BUSINESS,  TRADE  OR  COMMERCE 

The  Revenue  Act  of  1921,  like  the  Revenue  Act  of  1918,  pro- 
vides that  gains,  profits  and  income  derived  from  trades,  busi- 
nesses or  commerce,  or  the  transaction  of  any  business  carried 
on  for  gain  or  profit,'  shall  be  taxable.  The  general  rules  re- 
specting income  from  such  sources  are  discussed  in  this  chapter, 
and  the  refiection  of  income  by  means  of  inventories.-  The 
subjects  of  income  derived  from  sales  or  dealings  in  property, 
and  income  from  interest,  rent  and  royalties  are  discussed  in 
other  chapters."' 

Gross  Income  from  Business.  In  the  case  of  a  manufacturing, 
merchandising  or  mining  business  "gross  income"  means  the 
total  sales,  less  the  cost  of  goods  sold,  plus  any  income  from 
investments  and  from  incidental  or  outside  operations  or  sources. 
In  determining  the  gross  income  subtractions  should  not  be  made 
for  depreciation,  depletion,  selling  expenses  or  losses,  or  for 
items  not  .ordinarily  used  in  computing  the  cost  of  goods  sold. 
Gross  income  includes  all  amounts  received  by  the  taxpayer  as 
allowances  for  amortization,  from  whatever  source  and  by  what- 
ever name  called.  The  allowance  for  amortization  authorized 
by  the  statute  must  be  taken  by  way  of  explicit  deduction  from 
gross  income.^  It  is  not  permissible  for  an  individual,  whose 
business  is  that  of  a  sole  proprietor,  to  compute  his  income  from 
his  business  on  one  basis  and  his  income  from  other  sources  on 
another  basis,  either  with  respect  to  the  method  of  accounting 
or  the  taxable  period.''  A  taxpayer  engaged  as  a  sole  proprietor 
of  a  business  selling  provisions  must  subtract  from  his  total 
purchases  for  the  year,  or  add  to  his  total  sales  for  the  year,  the 
cost  of  provisions  withdrawn  for  personal  or  family  use." 

Income  of  Contractors.  Persons  engaged  in  contracting  opera- 
tions, who  have  uncompleted  contracts,  in  some  cases  perhaps 
running  for  periods  of  several  years,  will  be  allowed  to  prepare 
their  returns  so  that  the  gross  income  will  be  arrived  at  on  the 
basis  of  completed  work;  that  is,  on  jobs  which  have  been  finally 

1  Revenue  Act  of  1921,  §  213  (a)  ;  Revenue  Act  of  1918,  §  213  (a). 

2  See  Chapter  25  for  discussion  of  the  subject  of  losses  in  inventories. 
^  See  Chapters  17  and  18. 

4  Reg.  45,  Art.  35;  Reg.  33  Rev.,  Art.  93;  Reg.  33,  Arts.  106  and  107. 

5  0.  D.  941,  T.  B.  23-21-1673.     See  Chapter  33. 

6  0.  D.  998,  T.  B.  34-21-1777. 

385 


386  FEDERAL  INCOME  TAX 

completed  any  and  all  moneys  received  in  payment  will  be  re- 
turned as  income  for  the  year  in  which  the  work  was  completed. 
If  the  gross  income  is  arrived  at  by  this  method,  the  deduction 
from  such  gross  income  should  include  and  be  limited  to  the  ex- 
penditures made  on  account  of  such  completed  contracts.  Or  the 
percentage  of  profit  from  the  contract  may  be  estimated  on  the 
basis  of  percentage  of  completion,  in  which  case  the  income  to 
be  returned  each  year  during  the  performance  of  the  contract 
will  be  computed  upon  the  basis  of  the  expenses  incurred  on 
such  contract  during  the  year;  that  is  to  say,  if  one-half  of  the 
estimated  expenses  necessary  to  the  full  performance  of  the 
contract  are  incurred  during  one  year,  one-half  of  the  gross 
contract  price  should  be  returned  as  income  for  that  year.  Upon 
the  completion  of  a  contract  if  it  is  found  that  as  a  result  of 
such  estimate  or  apportionment  the  income  of  any  year  or  years 
has  been  overstated  or  understated,  the  taxpayer  should  file 
amended  returns  for  such  year  or  years.'^  A  taxpayer,  having 
once  made  his  election  to  prepare  his  return  so  that  the  gross 
income  will  be  arrived  at  on  the  basis  of  completed  work,  will 
not  later  be  permitted  to  file  amended  returns  for  the  purpose 
of  reporting  income  computed  upon  the  basis  of  the  expenses 
incurred  on  such  contract  each  year  during  the  performance  of 
the  contract.  However,  he  may,  without  permission,  report  his 
income  from  contracts  thereafter  entered  into  by  him  computed 
upon  the  basis  of  expenses  incurred  on  such  contracts  during 
the  year.^ 

Income  from  Export  Business.  Under  the  1916  Law  income 
from  the  business  of  exporting  goods  was  held  by  the  treasury 
department  to  be  taxable.  It  has  also  been  held  that  a  tax  on 
such  income  is  not  a  tax  on  the  articles  exported,  and  therefore 
not  unconstitutional  in  that  regard,  since  if  Congress  has  power 
to  lay  a  tax  up  to  the  time  when  articles  are  put  in  course  of 
exportation,  the  conclusion  is  unavoidable  that  the  net  income 
arising  from  exportation  when  it  has  been  completed  or  after 
the  exportation  and  sale  are  fully  consummated,  is  likewise  sub- 
ject to  taxation  under  general  laws.^ 

Discounts.  The  discount  allowed  to  a  corporation  purchasing 
new  equipment  need  not  be  reported  as  income,  but  the  cost  of 
the  equipment  as  charged  to  capital  must  represent  only  the  net 
cost  after  making  allowance  for  the  discount  in  question.^o 

7  Reg.  45,  Art.  36;  Reg.  33  Rev.,  Art.  121;  T.  D.  2161. 

8  0.  D.  933,  T.  B.  22-21-1661. 

9  Peck  V.  Lowe,  247  U.  S.  165. 

10  Letter  from  Treasury  Department  dated  November  26,  1918;  I.  T.  S., 
1921,11951. 


INCOME  FROM  BUSINESS,  TRADE  OR  COMMERCE  387 

Bank  Discounts.  In  cases  wherein  banks  or  other  corporations 
loan  money  by  discounting  bills  or  notes,  one  of  two  methods  is 
used  in  determining  the  amount  of  discount  to  be  reported  as 
income,  namely:  (1)  if  the  bank  or  corporation  makes  a  prac- 
tice of  crediting  such  discount  directly  to  a  "discount  account" 
or  to  profit  and  loss,  the  total  amount  thus  credited  during  the 
year  should  be  considered  income  and  should  be  so  reported,  re- 
gardless of  the  fact  that  a  portion  of  this  amount  may  represent 
discount  paid  in  advance  and  not  then  earned;  (2)  if  the  bank 
or  corporation  follows  the  practice  of  crediting  such  discount 
to  an  "unearned  discount  account,"  and  later,  as  the  discount 
becomes  earned,  debits  the  unearned  account  and  credits  an 
"earned  discount  account"  with  the  amount  so  earned,  the  total 
amount  credited  to  the  "earned  discount  account"  during  the 
year  should  be  considered  income  and  should  be  so  reported.  The 
corporation  reporting  income  of  this  character  should  state  in 
a  memorandum  attached  to  its  return  which  of  the  two  methods 
was  used  in  determining  the  amount  of  discount  returned.!^  The 
latter  of  the  two  above  methods  has  been  generally  recognized 
as  the  correct  method  of  computing  such  income  and  the  comp- 
troller of  the  currency  has  suggested  the  adoption  of  this  method 
by  all  national  banks.  Banks  which  in  the  past  have  treated 
discount  as  income  before  it  was  actually  earned  and  during 
the  taxable  year  1918  have  placed  the  discount  account  upon  an 
accrual  basis  will  be  required  to  submit  all  necessary  infonna- 
tion  and  an  amended  return  for  the  taxable  year  1917,  and  will 
be  permitted  to  submit  (or  the  Commissioner  may  require) 
amended  returns  for  all  prior  years  during  which  the  taxpayer 
was  subject  to  tax.  Additional  taxes  for  prior  years  found  to 
t  be  due  upon  such  re-examinations  will  be  paid  upon  the  basis  of 
the  amended  returns  in  the  ordinary  way.  Where  it  appears  that 
prior  taxes  have  been  paid  in  excess  of  the  amount  properly 
due  such  excess  will  to  the  extent  possible  be  credited  against 
future  income  and  profits  taxes. i- 

Manufacturers  Selling  on  the  Coupon  System.  Where  a  manu- 
facturing corporation  sells  a  large  part  of  its  product  on  the 
coupon  system,  this  system  being  a  mutually  advantageous  ar- 
rangement between  purchaser  and  manufacturer  whereby  the 
purchaser  orders  and  pays  for  a  quantity  of  the  product  in 
excess  of  his  immediate  needs,  thereby  securing  quantity  dis- 
count, the  balance  of  the  order  to  be  delivered  as  needed  upon 

11  Reg.  33  Rev.,  Art.  114. 

12  Reg.  45,  Art.  23.  Letter  from  Treasury  Department  dated  February  11, 
1919;  I.  T.  S.  1919,  113248. 


388  FEDERAL  INCOME  TAX 

presentation  of  coupons  issued  by  the  manufacturer  at  the  time 
of  the  sale,  the  full  purchase  price  of  the  coupon  being  refunded 
to  the  purchaser  if  any  coupons  are  not  used  or  if  the  company 
is  unable  to  make  delivery  of  goods  upon  demand,  may  treat 
the  sales  value  of  the  coupons  issued  and  outstanding  at  the  close 
of  the  taxable  year  as  a  liability  and  base  the  amount  of  gross 
profits  from  sales  upon  the  coupons  redeemed  in  merchandise 
during  the  year.i^ 

Inventories.  The  Revenue  Act  of  1921  is  identical  with  the 
Revenue  Act  of  1918  in  regard  to  the  use  of  inventories.  Tax- 
payers engaged  in  manufacturing  or  mercantile  business  usually 
determine  their  net  income  by  inventory,  purchases  during  the 
year  plus  the  stock  on  hand  at  the  beginning  of  the  year  being 
subtracted  from  sales  during  the  year  plus  stock  on  hand  at  the 
close  of  the  year,  or  vice  versa,  to  ascertain  the  gain  or  loss. 
The  treasury  department's  first  recognition  of  this  system  re- 
quired that  in  every  case  where  the  annual  gain  or  loss  was 
determined  by  inventory,  the  merchandise  must  be  inventoried 
at  cost  price,  as  any  loss  in  salable  value  would  ultimately 
be  reflected  in  the  sales  during  the  year  when  the  goods  were 
disposed  of.  This  rule  permitting  inventories  on  the  basis  of 
cost  only  was  later  altered  and  new  rules  established  for  the 
purpose  of  income  and  excess-profits  tax  returns,  permitting 
inventories  at  cost  or  market  value,  whichever  is  lower.^* 
Except  where  inventories  are  allowed  at  cost  or  market,  gain 
or  loss  must  in  all  cases  be  determined  on  the  basis  of  cost.^-''' 
In  no  cases  should  overhead  charges  be  included  in  inventory .^^ 
It  is  provided  by  the  Revenue  Acts  of  1921  and  1918  that  when- 
ever, in  the  opinion  of  the  Commissioner,  the  use  of  inventories 
is  necessary  in  order  clearly  to  determine  the  income  of  any 
taxpayer,  inventories  shall  be  taken  by  such  taxpayer  upon  such 
basis  as  the  Commissioner  with  the  approval  of  the  secretary  may 
prescribe  as  conforming  as  nearly  as  may  be  to  the  best  account- 
ing practice  in  the  trade  or  business  and  as  most  clearly  reflecting 
the  income,  ^'^  and  gain  or  loss  is  determined  in  the  case  of  prop- 
is  0.  D.  827,  T.  B.  9-21-1479. 

14  T.  D.  2609.  The  attorney-general  has  advised  on  the  authority  of  Doyle 
V.  Mitchell  Brothers,  247  U.  S.  179,  that  the  methods  of  taking  inventories 
authorized  by  T.  D.  2609  are  permissible.  (T.  D.  2744;  T.  D.  2649.)  See 
Chapter  14  as  to  "Inventories  of  Foreign  Exchange." 

15  T.  D.  2609.  For  the  rule  where  goods  were  purchased  prior  to  March  1, 
1913,  see  Chapter  17. 

16  See  instructions  on  back  of  Form  1031  for  1916. 

17  Revenue  Act  of  1921,  §203.  The  Revenue  Act  of  1918  contained  the 
same  provision  (Revenue  Act  of  1918,  §  203). 


INCOME  FROM  BUSINESS,  TRADE  OR  COMMERCE  389 

erty  acquired  on  or  after  March  1,  1913,  on  the  basis  of  the  cost 
thereof  or  inventory  value,  if  the  inventory  is  made  in  accordance 
with  the  above  provision. ^^  Where  a  taxpayer  manufactures 
property  and  keeps  it  on  hand  for  a  number  of  years,  until  it 
is  sold  in  the  taxable  year  1918,  the  gain  derived  is  the  difference 
between  the  selling  price  and  the  cost;  or  the  difference  be- 
tween the  selling  price  and  the  inventory  value  of  the  goods  at 
the  beginning  of  the  taxable  year,  on  the  inventory  basis  regu- 
larly followed  by  the  taxpayer ;  that  is,  either  an  inventory  basis 
of  cost  or  an  inventory  basis  of  cost  or  market  value,  whichever 
is  lower.  It  is  not  permissible  to  use  market  value  except  when 
it  becomes  material  in  taking  inventoiy  on  the  basis  of  cost  or 
market  value,  whichever  is  lower.i''  where  a  taxpayer  takes 
inventories  on  the  basis  of  cost  or  market  price,  whichever 
is  lower,  goods  which  were  acquired  before  March  1,  1913,  will 
be  inventoried  at  the  market  value  on  March  1,  1913,  or  at  the 
market  price  at  the  time  of  the  inventory,  whichever  is  lower.^o 
Where  a  taxpayer  in  rendering  his  returns  for  years  prior  to 
1918  exercised  his  option  to  include  excise  taxes  in  the  cost  of 
merchandise  in  calculating  inventories  it  has  been  ruled  that  he 
is  not  entitled  to  change  his  method  and  treat  such  taxes  paid 
during  1918  as  business  expenses.-^ 

Need  of  Inventories.  In  order  to  reflect  the  net  income  cor- 
rectly, inventories  at  the  beginning  and  ending  of  each  year  are 
necessary  in  every  case  in  which  the  production,  purchase  or  sale 
of  merchandise  is  an  income-producing  factor.  The  inventory 
should  include  raw  materials  and  supplies  on  hand  that  have  been 
acquired  for  sale,  consumption  or  use  in  productive  processes,  to- 

18  Revenue  Act  of  1921,  §202  (a)  1;  Revenue  Act  of  1918,  §202  (a)  2. 
Copies  of  inventory  need  not  be  filed  with  the  return,  but  it  is  recommended 
that  the  taxpayer  attach  to  his  return  a  summarized  analysis  of  his  inven- 
tories.   (I.  T.  S.  1919,  ^3958.) 

in  S.  926,  T.  B.  1-19-10.  In  this  case  the  taxpayer  was  taxed  in  1918  on  an 
appreciation  in  value  occurring  gradually  over  several  years  merely  because 
the  sale  occurred  in  1918.  The  case  illustrates  the  effect  of  the  limitation  of 
inventories  to  (a)  cost,  or  (b)  cost  or  market,  whichever  is  lower,  to  be  as 
follows:  1  A  gradual  appreciation  in  value  may  not  be  prorated  over  the 
years  of  appreciation  because  inventories  may  not  be  taken  at  market  if 
market  is  higher  than  cost;  2  A  gradual  depreciation  in  value  may  be  pro- 
rated over  the  years  of  depreciation  because  inventories  may  be  taken  at 
market  if  market  is  lower  than  cost.  See  Chapter  17  as  to  property  acquired 
before  March  1,  1913. 

20  8.  1003,  T.  B.  5-19-245.  This  ruling  was  made  before  the  decisions  in 
Goodrich  v.  Edwards,  65  L.  Ed.  450,  and  Walsh  v.  Brewster.  65  L.  Ed.  451 
U.  S.  Sup.  Ct.     For  the  effect  of  these  decisions,  see  Chapter  17. 

21  A.  R.  M.  121,  T.  B.  16-21-1574. 


390  FEDERAL  INCOME  TAX 

gether  with  all  finished  or  partly  finished  goods.  Title  to  the  mer- 
chandise included  in. the  inventory  should  be  vested  in  the  tax- 
payer and  goods  merely  ordered  for  future  delivery  ana  for 
which  no  transfer  of  title  has  been  effected  should  be  excluded. 
The  inventory  should  include  merchandise  sold  but  not  shipped 
to  the  customer  at  the  date  of  the  inventory,  together  with  any 
merchandise  out  upon  consignment,  but  if  such  goods  have  been 
included  in  the  sales  of  the  taxable  year  they  should  not  be  taken 
in  the  inventory.  It  should  also  include  merchandise  purchased, 
although  not  actually  received,  title  to  which  has  passed  to  the 
purchaser.  In  this  regard  care  should  be  exercised  to  take  into 
the  accounts  all  invoices  or  other  charges  in  respect  of  mer- 
chandise properly  included  in  the  inventory,  but  which  is  in 
transit  or  for  other  reasons  has  not  been  reduced  to  physical 
possession." 

The  delivery  of  copper  bullion  to  a  smelting  and  refining  com- 
pany where  it  is  mixed  with  other  bullion  and  concentrates  of 
different  metallic  contents  under  a  contract  by  which  the  smelt- 
ing and  refining  company  is  to  return  the  equivalent  of  the 
metallic  contents  of  such  ore  previously  determined  by  assay, 
less  commissions  and  other  allowable  charges,  constitutes  a 
sale  and  not  a  bailment.  Only  so  much  of  the  metals  as  had 
been  redelivered  by  the  refining  company  at  the  close  of  the 
taxable  year  belonged  to  and  should  have  been  included  in  the 
inventory  of  the  taxpayer  as  of  that  date.^^ 

Where  in  1919  an  American  corporation  advanced  a  sum  of 
money  to  an  English  corporation  for  the  purpose  of  enabling 
the  English  corporation  to  purchase  raw  material  to  manu- 
facture certain  articles  which  the  American  corporation  had 
contracted  to  sell  for  the  English  corporation  and  at  the  time 
the  American  corporation  took  its  inventory,  December  1,  1919, 
the  articles  had  not  been  received  by  it,  such  advance  to  the 
English  corporation  was  considered  a  loan,  and  the  value  of  the 

22  Reg.  45,  Arts.  24,  1581;  T.  D.  2609. 

23  S.  1373,  T.  B.  20-20-930.  The  general  rule  is  that  when  by  the  terms  of 
the  contract  under  which  property  is  delivered  by  an  owner  to  another,  the 
latter  is  under  no  obligation  to  return  the  specific  property  either  in  its 
identical  form  or  in  some  other  form  in  which  its  identity  may  be  traced,  but 
is  authorized  to  substitute  something  else  in  its  place,  either  money  or  some 
other  equivalent,  the  transaction  is  not  a  bailment,  but  is  a  sale  or  exchange. 
(Austin  V.  Seligman,  18  Fed.  519;  Powder  Co.  v.  Burkhardt,  97  U.  S.  110; 
Woodward  v.  Semans,  125  Ind.  330,  25  N.  E.  444;  BuflFum  v.  Merry,  4  Fed. 
Cas.  2112.) 


INCOME  FROM   BUSINESS.  TRADE  OR  COMMERCE  391 

claim  could  not  be  inventoried  at  its  depreciated  value  owing  to 
the  decline  in  exchange.-' 

The  net  income  of  a  person  engaged  in  the  business  of  propa- 
gation and  culture  of  oysters  can  not  be  properly  computed  upon 
the  basis  of  inventories.-^ 

A  taxpayer,  engaged  in  the  real  estate  business,  is  not  per- 
mitted to  inventory  real  estate  which  is  held  for  sale  for  the 
puiT)ose  of  calculating  net  income  subject  to  income  tax.-*^ 

In  1918  the  United  States  army  commandeered  certain  quanti- 
ties of  canned  goods  subject  to  price  fixing  and  allotment  by  the 
United  States  food  administration.  In  one  of  these  cases  a  tenta- 
tive price  (subsequently  increased)  was  fixed  by  the  food  ad- 
ministration, shipments  were  to  be  made  subject  to  an  initial 
inspection  and  the  government  had  until  July  1,  1919,  to  make 
final  inspection  as  to  quantity.  The  taxpayer  guaranteed  the 
goods  against  "spoils"  and  "swells"  until  July  1,  1919.  Spoiled  or 
swelled  goods  were  to  be  held  subject  to  the  seller's  order.  The 
taxpayer  made  all  the  shipments  in  1918  and  the  goods  were 
paid  for  subject  to  the  above  guarantee.  In  May,  1919,  a  certain 
portion  of  the  goods,  on  inspection,  was  found  to  be  spoiled, 
and  in  order  to  finally  dispose  of  the  matter  without  great  ex- 
pense and  loss,  it  was  agreed  in  a  bill  of  re-sale,  executed  by 
the  representatives  of  the  army  and  the  taxpayer,  that  the  tax- 
payer should  take  back  the  goods  which  it  had  delivered  and  pay 
to  the  United  States  the  provisional  price  for  each  case,  less 
certain  deductions  by  way  of  allowance  to  cover  the  cost  of  new 
cases,  recasing,  relabeling,  etc.  The  taxpayer  claimed  an  ad- 
justment of  1918  taxes  based  upon  the  rejection  of  canned  goods 
sold  to  the  army  in  1918,  by  reducing  the  rejected  goods  to  a 
valuation  of  cost  as  at  December  31,  1918.  It  was  held,  however, 
that  the  resale  to  the  taxpayer  at  the  original  price,  less  certain 
definite  concessions,  was  in  substance  a  compromise  sale  and 
a  new  transaction.  As  of  December  31,  1918,  the  goods  in  ques- 
tion were  not  the  property  of  the  taxpayer,  they  had  been  shipped 
out  by  him  and  he  was  eventually  paid  in  accordance  with  the 
terms  of  the  purchase.  This  stock,  therefore,  could  not  be  con- 
sidered as  a  part  of  the  inventory  of  the  taxpayer  as  of  December 
31,  1918,  particularly  since  it  was  shown  that  all  of  the  goods 
purchased  by  the  governmeit  under  these  contracts  had  not  been 
returned  to  the  taxpayer  or  accounted  for.  The  taxpayer  had 
an  opportunity  in  the  taxable  year  1919  to  determine  his  loss  by 

24  O.  D.  541,  T.  B.  24-20-994. 
2-")0.  D.  684,  T.  B.  42-20-1240. 
2«iO.  D.  848,  T.  B.  12-21-1517. 


392  FEDERAL  INCOME  TAX 

a  subsequent  sale  or  other  disposition  of  the  goods  so  bought 
back  from  the  government.^^ 

Cotton  Merchants  and  Dealers  in  Grain.  Cotton  mer- 
chants and  dealers  in  grains  and  its  products  have  contended 
for  such  a  modification  in  the  regulations  with  regard  to  in- 
ventories as  v^ill  permit  them  to  include  in,  or  make  a  part  of, 
their  inventories  "hedges",  or  transactions  in  "futures"  which 
are  recognized  practices  in  their  businesses  and  which  transac- 
tions are  entered  into,  it  is  claimed,  for  the  purpose  of  stabiliz- 
ing the  cost  of  the  commodities  in  which  they  deal  and  to  remove 
their  operations  from  the  realm  of  speculation.  These  "hedges" 
are  transactions  in  which  contracts  are  made  for  the  purchase 
or  sale  of  these  commodities  for  delivery  at  some  time  in  the 
future,  a  profit  or  loss  being  realized  at  the  time  the  delivery  is 
made,  either  actually  or  constructively,  but  not  before  then.  In 
the  case  of  cotton  merchants,  these  "hedges"  are  always  sales 
contracts  for  the  future  delivery  of  cotton  made  at  the  time  and 
to  the  same  extent  that  "spot  cotton"  is  actually  purchased.  But 
in  the  case  of  merchants  dealing  in  grain  and  its  products,  these 
"hedges"  consist  of  contracts  for  purchases  to  be  received  at 
some  future  time  as  well  as  for  sales  for  future  delivery. 

The  modifications  of  the  existing  regulations  for  which  the 
various  taxpayers  have  contended  are  reducible  to  the  following 
general  propositions : 

1.  To  add  to  the  value  of  the  physical  inventory : 

(a)  The  value,  at  "cost"  or  "cost  or  market,  whichever  is 
lower,"  of  all  commodities  purchased  to  be  received  at  some 
future  date,  the  title  to  which  does  not  pass  to  the  taxpayer  until 
the  commodities  have  been  reduced  to  physical  possession ; 

(b)  Potential  losses,  not  realized  within  the  taxable  year,  on 
transactions  in  futures. 

2.  To  deduct  from  the  value  of  the  physical  inventory: 

(c)  The  value,  at  "cost"  or  "cost  or  market,  whichever  is 
lower,"  of  all  commodities  sold  to  be  delivered  at  some  future 
date,  the  title  to  which  does  not  pass  to  the  purchaser  until 
the  date  of  delivery,  irrespective  of  whether  or  not  such  com- 
modities are  in  the  possession  of  the  taxpayer  at  the  date  of  the 
contract  for  sale; 

(d)   Potential  gains,  not  realized  within  the  taxable  year,  on 
transactions  in  futures. 

In  the  case  of  (a)  above,  the  department  holds  that  since  the 
taxpayers  do  not  own  the  commodities  in  question,  but  have 
only  a  contract  for  their  purchase,  they  cannot  properly  include 

27  A.  R.  M.  129,  T.  B.  24-21-1683. 


INCOME  FROM  BUSINESS,  TRADE  OR  COMMERCE  393 

such  property  in  an  inventory  as  of  that  date.     This  also  dis- 
poses by  analogy  of  (c),  for  if  commodities  purchased,  but  not 
received,  cannot  be  included  in  an  inventory  where  title  has  not 
passed,  it  is  clear  that  under  the  same  circumstances  and  condi- 
tions, commodities  sold  but  not  delivered  cannot  be  deducted 
therefrom.    With  regard  to  (b)  and  (d)  above,  potential  gams 
or  losses  on  transactions  in  "futures"  cannot  form  an  integral 
part  of  the  co,^t  of  the  commodity  in  which  the  taxpayer  deals. 
The  actual  purchase  of  a  commodity,  and  the  simultaneous  sale 
of  the  same  quantity  of  the  commodity  for  future  delivery,  do 
not  constitute  one  transaction.     They  are.  two  entirely  separate 
and  distinct  transactions,  neither  one  of  which  can  have  any 
effect  upon  the  other.     If  the  commodity  purchased  is  on  hand 
at  the  end  of  the  taxable  year  it  forms  a  part  of  the  physical  in- 
ventory in  which  it  should  be  included  at  "cost"  or  "cost  or  mar- 
ket, whichever  is  lower,"  and  whatever  potential  loss  or  gain  may 
be  shown  at  the  time  of  the  inventory  in  the  "futures"  transac- 
tion does  not  affect  that  cost  in  the  slightest  degree.     The  fact 
that  these  transactions  may   be   simultaneous   does   not   make 
them  identical,  since  the  commodity  may  be  retained  and  the 
"future"  contract  "covered"   or  closed   out  or  the   commodity 
may  be  disposed  of  and  the  "future"  contract  still  remain  open 
without  any  effect  whatever  upon  the  other  transaction  of  each 
pair.    There  is,  in  fact,  no  profit  or  loss  in  the  purchase  of  a  com- 
modity until  the  transaction  has  been  completed  by  the  sale  of 
that  particular  commodity,  nor  is  there  any  profit  or  loss  in  a 
transaction  in  "futures"  until  the  transaction  has  actually  been 
closed. 

The  department,  therefore,  holds: 

(1)  That  transactions  in  "futures"  unclosed  at  the  end  of  the 
taxable  year  form  no  integral  part  of  the  cost  of  the  com- 
modity included  in  the  taxpayer's  physical  inventory;  and 

(2)  That  the  basis  of  (a)  cost,  or  (b)  cost  or  market,  which- 
ever is  lower,  is  the  only  admissible  basis  for  the  valuation  .of 
a  physical  inventory  in  the  computation  of  statutoiy  net  income 
for  income  tax  purposes.-^ 

2s  A.  R.  M.  100,  T.  B.  49-20-1331.  It  has  been  held,  however,  that  dealers 
in  cotton  and  grain  and  in  such  other  commodities  as  are  dealt  in  in  similar 
manner  may,  for  the  purpose  of  determining  taxable  income,  incorporate  in 
their  balance  sheets  at  the  close  of  any  taxable  year  such  open  "future"  con- 
tracts to  which  they  are  parties  as  are  "hedges"  against  actual  "spot"  or 
cash  transactions,  provided  that  no  particularly  speculative  transactions  m 
"futures"  not  offset  by  actual  "spot"  or  cash  transactions  may  be  so  included 
or  taken  into  the  taxpayer's  account  in  any  manner  until  such  transactions 
are  actually  closed  by  liquidation  (A.  R.  M.  135,  T.  B.  31-21-1750). 


394  FEDERAL  INCOME  TAX 

Valuation  of  Inventories.  Inventories  must  be  valued  at 
(a)  cost  or  (b)  cost  or  market,  whichever  is  lower.  Whichever 
basis  is  adopted  must  be  applied  consistently  to  the  entire  in- 
ventory. A  taxpayer  may,  regardless  of  his  past  practice,  adopt 
the  basis  of  cost  or  market,  whichever  is  lower,  for  his  1920 
inventory,  provided  a  disclosure  of  the  fact  and  that  it  rep- 
resents a  change  is  made  in  the  return.  Thereafter  changes  can 
be  made  only  after  permission  is  secured  from  the  commissioner. 
Inventories  should  be  recorded  in  a  legible  manner,  properly 
computed  and  summarized,  and  should  be  preserved  as  a  part  of 
the  accounting  records  of  the  taxpayer.  Goods  taken  in  the  in- 
ventory which  have  been  so  intermingled  that  they  can  not  be 
identified  with  specific  invoices  will  be  deemed  to  be  the  goods 
most  recently  purchased.-*^ 

The  rule  applicable  to  all  industries  is  that  inventories  should 
be  taken  on  the  basis  *'(a)  cost,  or  (b)  cost  or  market,  which- 
ever is  lower."  It  is  recognized  that  in  some  industries  the 
actual  cost  of  production  can  not  be  ascertained  accurately,  and 
it  is  therefore  necessary  to  approximate  a  cost  value  by  using 
selling  market  prices  as  a  starting  point  and  reducing  such 
selling  market  prices  in  each  case  by  an  amount  sufficient  to 
eliminate  the  element  of  profit.  This  rule  is  applicable  to  the 
inventories  of  farmers  and  stockmen,  and  is  widely  used  in  many 
lines  of  industry,  notably  in  those  types  of  mining  and  manu- 
facturing in  which  a  product  of  more  than  one  grade  or  more 
than  one  kind  is  obtained  by  a  common  operation.^o 

If  the  actual  accrued  charges  which  must  eventually  be  paid 
by  a  taxpayer,  either  directly  or  indirectly  through  credits  to 
customers,  can  be  accurately  determined  and  applied  to  the 
goods  actually  in  stock  at  any  specified  date,  such  charges  if 
set  on  the  books  as  an  existing  liability,  form  proper  additions 
to  the  cost  price  of  the  goods  then  on  hand ;  but  this  additional 
value  must  be  determined  by  charges  actually  paid  or  to  be  paid 
and  cannot  be  arrived  at  by  the  application  of  any  empirical 
formula  and  cannot  include  interest,  except  on  money  actually 
borrowed  for  the  purpose  of  carrying  the  goods,  nor  any  ap- 
preciation in  value  of  the  goods.^^ 

A  taxpayer  who  for  many  years  has  elected  to  take  inventory 
only  every  two  years,  and  used  an  estimated  inventory  in  the 
return  for  the  intermediate  year,  making  any  necessary  adjust- 

29  Reg-.  45,  Art.  1582,  as  amended  by  T.  D.  3108,  T.  B.  1-21-1382;  A.  R.  R. 
517,  T.  B.  22-21-1667. 

30  O.  844,  T.  B.  6-19-268. 

31  A.  R.  R.  140,  T.  B.  23-20-982. 


INCOME  FROM   BUSINESS,  TRADE  OR  COMMERCE  395 

ments  in  the  return  for  the  following  year  when  an  actual 
inventory  was  taken,  may  not  apportion  his  total  earnings  for 
the  two  years  1917  and  1918  equally  between  such  years  for 
income  tax  purposes."'-  After  the  year  1918  taxpayers  will  not 
be  permitted  to  adopt  one  period  for  inventorying  and  closing 
their  books  applicable  to  one  part  of  their  business  and  a  differ- 
ent period  applicable  to  another  part  thereof."^ 

Liquor  dealers  were  not  permitted  to  omit  from  inventory  as 
at  December  31,  1919,  stocks  of  liquor  then  on  hand  with  the 
understanding  that  if  the  liquor  was  subsequently  disposed  of 
for  value  the  total  value  received  would  be  returned  as  income 
of  the  year  in  which  the  disposition  was  made.^^ 

A  dealer  may  value  used  or  secondhand  automobiles  included  in 
a  closing  inventory  on  the  basis  of  cost  or  market,  whichever  is 
lower,  if  he  can  furnish  satisfactory  evidence  of  the  market 
value  of  such  secondhand  automobiles  at  the  date  of  the  in- 
ventory; otherwise  they  must  be  valued  at  cost.^-'' 

Change  from  Cost  or  Market  to  Cost.  When  request  is 
made  for  permission  to  change  from  cost  or  market,  whichever 
is  lower,  to  cost  for  pricing  inventories  at  the  close  of  1919,  the 
permission  will  be  granted  since  it  will  have  no  effect  on  the  tax 
if  market  was  above  cost  at  the  close  of  1918,  and  will  increase 
the  tax  if  market  was  lower  than  cost  at  that  date.  The  permis- 
sion will,  of  course,  be  upon  the  condition  that  the  new  method  be 
followed  consistently  thereafter.  Under  the  tax  laws  prior  to  the 
Revenue  Act  of  1918,  no  specific  reference  was  made  to  inven- 
tories, but  under  the  regulations  inventories  were  required  to  be 
taken  at  cost  for  every  year  until  December  19,  1917.^''  As 
this  date  was  only  a  few  days  prior  to  the  end  of  the  calendar 
year  1917,  probably  few  taxpayers  took  advantage  of  the  option 
to  inventory  at  cost  or  market,  whichever  was  lower,  in  making 
their  1917  return.  The  Revenue  Act  of  1918  specifically  granted 
authority  to  provide  for  the  taking  of  inventories  on  any  basis 
consistent  with  sound  commercial  practices  and  which  would 
reflect  true  income,  and  the  regulations  issued  under  that  law 
authorized  a  change  to  cost  or  market,  whichever  was  lower. 
In  many  lines  of  industry,  however,  market  was  above  cost  and 
inventories  were  consequently  priced  at  cost.  Where  it  can  be 
shown  that  the  market  at  the  close  of  1918  or  1919  was  above 

32  0.  D.  133,  T.  B.  4-19-211. 

33  O.  D.  289,  T.  B.  23-19-541. 
31  A.  R.  M.  33,  T.  B.  9-20-765. 
3r.  O.  D.  888,  T.  B.  17-21-1590. 
30  See  T.  D.  2609. 


396  FEDERAL  INCOME  TAX 

cost  the  taxpayer  may,  for  the  succeeding  year,  elect  to  take 
his  inventory  upon  a  cost  or  market  basis,  whichever  is  lower, 
provided  that  such  practice  is  consistently  adhered  to  in  the 
future.  But  where  market  at  the  close  of  1918  or  1919  was 
below  cost  and  the  taxpayer  thus  had  an  opportunity  to  take 
inventories  at  a  figure  lower  than  cost,  he  will  not  be  permitted 
to  change  from  cost  to  cost  or  market,  whichever  is  lower,  where 
it  appears  that  the  principal  reason  for  the  change  is  the  re- 
duced tax  payable.  If,  however,  permission  is  granted  in  any 
of  the  above  cases  to  change  the  method  of  pricing  inventory, 
it  is  unnecessary  to  file  any  amended  returns  for  the  past  years 
or  make  any  change  in  the  inventory  by  reason  of  the  changed 
method  of  pricing.  Where  a  change  is  necessitated  because  in 
the  past  a  basis  has  been  used  not  permitted  by  the  regulations 
now  nor  then,  amended  returns  on  one  or  the  other  of  the  two 
bases  now  authorized  from  1915  to  date  should  be  filed.  If 
the  adjustments  due  to  the  amendment  of  returns  so  affect  the 
taxpayer  as  to  occasion  an  inequality  in  the  tax  prior  to  the 
year  1915,  such  inequality  may  be  remedied  in  the  1915  return 
by  the  deduction  from  or  addition  to  the  tax  accruing  in  that 
year  of  an  amount  equal  to  the  net  amount  overpaid  or  under- 
paid in  prior  years,  such  amount  to  be  determined  by  filing 
with  the  return  for  1915  a  composite  return  for  all  prior  years 
accompanied  by  a  statement  showing  the  total  adjustment  for 
each  of  the  years  and  the  net  for  the  entire  period.^'^ 

Valuation  of  Inventories  on  Basis  of  Average  Cost  or 
Average  of  Market  Prices.  The  valuation  of  inventories  on 
the  basis  of  average  cost'^*^  or  average  of  market  prices  extending 
over  a  period  of  years •'''  is  not  permitted  by  statute.  The  aver- 
age cost  method  may  be  briefly  described  as  follows :  Materials 
purchased  during  the  month  are  added  both  as  to  quantity  and 
cost  to  the  quantity  and  cost  balance  brought  forward  from  the 
previous  month,  and  an  average  cost  at  the  close  of  the  month 
is  computed  by  dividing  the  total  quantity  into  the  total  money 
figures.  This  average  is  then  applied  to  the  quantity  of  material 
used  for  manufacture  during  the  month,  and  the  amount  so 
computed  is  credited  to  the  material  account. 

The  starting  point  in  the  computation  of  annual  income  must 
be  the  sales  made  during  the  year.  It  is  the  profits  or  losses 
upon  these  sales  that  are  to  be  computed  if  any  actuality  is  to 

37  A.  R.  M.  38,  T.  B.  13-20-804,  as  modified  by  A.  R.  M.  85,  T.  B.  43-20- 
1273;  A.  R.  R.  506,  T.  B.  20-21-1631. 

38  T.  B.  R.  48,  T.  B.  16-19-457. 

39  T.  B.  M.  31,  T.  B.  6-19-269. 


INCOME  FROM  BUSINESS,  TRADE  OR  COMMERCE  397 

be  attained.  To  do  otherwise  is  to  invite  speculation  and  con- 
fusion. To  give  annual  profits  and  losses  meaning  and  integrity 
they  must  be  arrived  at  by  a  logical  computation  which  rec- 
ognizes that  each  year  acquires  from  its  predecessor  certain 
potentialities  and  turns  over  to  the  successor  the  property  as  it 
exists  at  the  end  of  the  year,  and  the  basis  of  valuation  at  the 
beginning  and  end  of  the  year  must  be  reasonably  uniform. 
If  the  starting  point  in  the  computation  of  annual  profit  or  loss 
is  the  sales  made  during  the  period,  the  next  step  is  the  computa- 
tion of  the  amount  that  is  to  be  charged  against  such  sales  in 
respect  of  the  cost  of  the  goods  that  have  gone  into  the  sales. 
This  must  include  (1)  the  cost  of  the  goods  included  in  the 
sales,  less  any  portion  of  such  cost  which  may  have  in  effect, 
through  a  previous  inventory  based  upon  a  market  lower  than 
cost,  been  charged  against  the  sales  of  a  previous  year,  and  (2) 
where  as  a  consistent  policy  inventories  are  taken  upon  the  basis 
of  market  when  it  is  less  than  cost,  such  further  amount,  if 
any,  as  may  be  required  to  reduce  the  goods  in  the  inventory  to 
the  level  of  a  lower  present  market.  To  charge  against  the  sales 
of  a  year  a  sum  less  than  the  total  found  under  (1)  and  (2) 
above  will  show  as  profits  an  amount  larger  than  the  profits 
actually  realized  upon  the  sales  of  the  period.  In  a  business 
requiring  goods  to  be  carried  for  lengthy  periods  and  where  an 
average  method  of  inventory  valuation  is  used,  this  overstate- 
ment of  profits  will  occur  whenever  the  current  market  is  declin- 
ing, while  on  an  advancing  market  the  profits  on  the  actual  sales 
of  the  year  will  be  understated.  When  the  market  is  stable  the 
average  method  will  reflect  with  approximate  accuracy  the  true 
profits,  and  in  a  business  in  which  the  turnover  is  rapid,  the 
eflFect  of  such  a  method  upon  the  computation  of  annual  income 
is  small  as  compared  with  a  business  in  which  it  is  necessary 
to  carry  goods,  such  as  raw  materials,  for  long  periods.  In  such 
cases,  so  long  as  the  annual  profits  are  stated  with  substantial 
accuracy,  taxpayers  should  not  be  required  to  make  inventory 
changes  which  are  annoying  to  them  and  which  are  without 
commensurate  importance  to  the  government.  The  average  cost 
method  of  inventorying  may,  however,  have  an  important  effect 
upon  taxation.  The  computation  of  net  income  upon  such  a  basis 
results  in  an  assignment  of  income  to  a  year,  not  upon  the  basis  of 
the  transactions  of  the  year,  but  upon  the  basis  of  transactions 
part  of  which  spread  over  more  than  a  year.  To  be  strictly  logi- 
cal, such  a  method  should,  moreover,  include  a  similar  averaging 
of  sales.  This  would  tend  toward  uniformity  of  annual  profits 
and  might,  in  fact,  reflect  the  profits  as  accurately  as  the  partial 


398  FEDERAL  INCOME  TAX 

average  method,  but  it  would  be  a  far  departure  from  an  actual 
computation.  An  annual  accounting  period  is  a  fundamental  re- 
quirement, and  every  computation  of  taxable  net  income  must  be 
made  in  conformity  therewith.  This  the  average  cost  inventory 
method  fails  to  do,  and  its  use  cannot  be  approved  as  meeting  the 
statutory  requirement.^^ 

Base  Stock,  Minimum  and  Cushion  Methods.  The  "base 
stock,"  "minimum"  or  "cushion"  methods  of  taking  inventory 
are  not  permitted  by  the  statute.  According  to  the  base  stock 
method  of  taking  inventories  a  manufacturer  or  dealer  values  at 
the  same  price  year  after  year  the  minimum  quantity  of  goods 
which  he  must  have  on  hand  at  all  times.  This  base  stock  method 
has  not  been  sanctioned  as  an  established  accounting  practice  by 
the  test  of  general  acceptation  or  the  test  of  time.  The  present  in- 
come tax  system  is  based  upon  an  annual  accounting  period.  The 
object  of  an  inventory  is  to  assign  to  an  annual  accounting  period 
its  profits  and  losses.  The  effect  of  the  base  stock  inventory 
method  is  to  assign  all  profits  and  losses  in  respect  of  the  mini- 
mum inventory  to  the  year  in  which  such  inventory  is  liquidated. 
This  result  is  accomplished  through  ignoring  sales  and  exchanges 
of  individual  items  of  the  inventory  and  treating  the  minimum 
inventory  as  a  unit.  Each  sale  or  exchange  of  property  for  other 
property  having  a  market  value  is,  however,  in  fact  a  realization 
of  taxable  profit  or  deductible  loss  in  the  year  in  which  it  occurs 
and  a  method  of  accounting  which  disregards  such  realization 
does  not  truly  reflect  income. 

The  usual  practice  and  general  object  of  the  basic  method  is  to 
get  the  base  or  constant  stock  at  a  figure  below  cost  and  hold  it 
there.  It  arises  not  from  a  desire  to  measure  capital  and  net 
income  accurately,  but  to  play  safe,  stabilize  profits,  and  provide 
reserves  against  possible  future  losses.  It  is  a  result  of  essential- 
ly the  same  policy  and  theory  which  leads  bankers  to  write  down 
their  buildings  to  a  nominal  figure  and  to  accumulate  hidden  re- 
serves. 

In  substance,  the  base  stock  inventory  results  in  offsetting  an 
inventory  gain  of  one  year  against  an  inventory  loss  of  another 
rather  than  in  assigning  to  each  year  its  true  gain  or  loss.  The 
fact  that  the  Revenue  Acts  of  1918  and  1921  in  their  provisions 
with  respect  to  inventory  loss  and  net  loss  authorize  in  some 
cases  the  carrying  of  a  loss  realized  in  one  year  into  accounts 

40  T.  B.  R.  48,  T.  B.  16-19-457.  A  monthly  average  cost  method  has  been 
permitted  in  the  case  of  tobacco  companies  taking  inventories  by  that 
method,  no  other  method  approaching  theoretical  accuracy  being  practicably 
possible.    (A.  R.  R.  18,  T.  B.  3-20-680.) 


INCOME  FROM  BUSINESS,  TRADE  OR  COMMERCE  399 

of  another  year  is  some  indication  that  Congress  did  not  intend 
that  the  ordinary  inventory  provisions  should  be  construed  to 
authorize  such  a  transfer.  Furthermore,  the  argument  that  the 
application  of  the  ordinary  rules  as  to  inventories  results  in  hard- 
ship is  met  by  the  fact  that  Congress  has  authorized  relief  against 
hardship  through  the  medium  of  these  inventory  and  net  loss 
provisions  in  cases  which  are  within  the  terms  thereof.^' 

The  general  conclusion  that  the  base  stock  method  does  not 
conform  to  the  requirements  of  the  law,  applies  to  "goods  taken  in 
the  inventory  which  have  been  so  intermingled  that  they  can  not 
be  identified  with  specific  invoices."  Such  goods  will  be  deemed  to 
be  the  goods  most  recently  purchased.  This  presumption  or  in- 
ference is  warranted  because  in  the  absence  of  evidence  as  to  the 
actual  fact  it  is  more  nearly  true  than  any  other.  Goods  taken 
in  the  inventory  which  have  been  so  intermingled  that  they  can- 
not be  identified  with  specific  invoices  will  not  be  deemed  to  be 
the  goods  included  in  the  minimum  inventory. 

In  lieu  of  the  base  stock  method,  it  was  suggested  that  inven- 
tories be  valued  on  a  moving  average  basis  for  a  period  of  five 
years,  more  or  less.  According  to  this  method  one-fifth,  for  ex- 
ample, of  the  inventory  would  be  deemed  to  be  the  goods  most 
recently  purchased  and  the  balance  the  goods  on  hand  at  the 
beginning  of  the  year.  Another  method  proposed  was  that  the 
goods  in  the  inventory  be  deemed  to  be  the  earliest  rather  than 
the  latest  purchases.  These  methods  have  been  held  open  to  the 
same  objections  as  the  base  stock  method.-*- 

INVENTORIES  AT  Cost.  Cost  means:  (1)  In  the  case  of  mer- 
chandise purchased,  the  invoice  price  less  trade  or  other  discounts 
except  strictly  cash  discounts  approximating  a  fair  interest  rate, 
which  may  be  deducted  or  not  at  the  option  of  the  taxpayer  pro- 
vided a  consistent  course  is  followed.  To  this  net  invoice  price 
should  be  added  transportation  or  other  necessary  charges  in- 
curred in  acquiring  possession  of  the  goods ;  (2)  in  the  case  of 
merchandise  produced  by  the  taxpayer,  (a)  the  cost  of  raw  ma- 
terials and  supplies  entering  into  or  consumed  in  connection  with 
the  product,  (b)  expenditures  for  direct  labor,  (c)  indirect  ex- 
penses incident  to  and  necessary  for  the  production  of  the  par- 
ticular article,  including  in  such  indirect  expenses  a  reasonable 
proportion  of  management  expenses,  but  not  including  any  cost 

41  T.  B.  R.  65.  T.  B.  22-19-531.  The  British  Committee  on  Financial  Risks 
attaching  to  the  holding  of  trading  stock?,  after  an  investigation  and  analy- 
sis of  this  subject,  decided  against  the  base  stock  method  in  a  report  submit- 
ted December  5,  1918. 

42  T.  B.  R.  65.  T.  B.  22-19-531. 


400  FEDERAL  INCOME  TAX 

of  selling  or  return  on  capital  whether  by  way  of  interest  or 
profit.  In  any  industry  in  which  the  usual  rules  for  computation 
of  cost  of  production  are  inapplicable,  costs  may  be  approximated 
upon  such  basis  as  may  be  reasonable  and  in  conformity  with  es- 
tablished trade  practice  in  the  particular  industry.^^ 

Taxpayers  who  as  a  matter  of  settled  practice  do  not  deduct 
cash  discounts  from  purchases,  but  who  take  the  merchandise 
purchased  into  their  inventories  at  invoice  price  (less  trade  or 
other  discounts  other  than  strictly  cash  discounts),  carrying  the 
discounts  in  a  discount  account,  may  not,  in  valuing  their  closing 
inventories,  deduct  from  the  invoice  price  of  the  merchandise 
on  hand  at  the  close  of  the  taxable  year  the  average  amount  of 
cash  discount  received  on  such  merchandise;  neither  may  the 
amount  of  cash  discount  earned,  to  be  reported  as  income,  be 
decreased  by  an  amount  representing  the  estimated  cash  dis- 
count received  on  merchandise  on  hand  at  the  close  of  the  year.^* 

Inventories  at  Market.  Under  ordinary  circumstances, 
"market"  means  the  current  bid  price  prevailing  at  the  date  of 
the  inventory  for  the  particular  merchandise  in  the  volume  in 
which  ordinarily  purchased  by  the  taxpayer.  This  method  of 
valuation  is  applicable  in  the  cases  (a)  of  goods  purchased  and 
on  hand,  (b)  of  basic  elements  of  cost  (materials,  labor,  and  bur- 
den) in  goods  in  process  of  manufacture,  and  (c)  of  finished 
goods  on  hand ;  exclusive,  however,  of  goods  on  hand  or  in  process 
of  manufacture  for  delivery  upon  firm  sales  contracts  at  fixed 
prices  entered  into  before  the  date  of  the  inventory,  which 
goods  must  be  inventoried  at  cost.  Where  no  open  market  quo- 
tations are  available,  the  taxpayer  must  use  such  evidence  of  a 
fair  market  price  at  the  date  or  dates  nearest  the  inventory  as 
may  be  available,  such  as  specific  transactions  in  reasonable  vol- 
ume entered  into  in  good  faith,  or  compensation  paid  for  can- 
cellation of  contracts  for  purchase  commitments.  Where,  owing 
to  abnormal  conditions,  the  taxpayer  has  regularly  sold  such 
merchandise  at  prices  lower  than  the  current  bid  price  as  above 
defined,  the  inventory  may  be  valued  at  such  prices,  and  the 
correctness  of  such  prices  will  be  determined  by  reference  to  the 
actual  sales  of  the  taxpayer  for  a  reasonable  period  before  and 
after  the  date  of  the  inventory.  Prices  which  vary  materially 
from  the  actual  prices  so  ascertained  will  not  be  accepted  as 
reflecting  the  market  and  the  penalties  prescribed  for  filmg 
false  and  fraudulent  returns  may  be  asserted.     Goods  in  process 

43  Reg.  45,  Art.  1583. 

44  0.  D.  326,  T.  B.  28-19-610. 


INCOME  FROM  BUSINESS,  TRADE  OR  COMMERCE  401 

of  manufacture  may  be  valued  for  purposes  of  the  inventory 
on  the  lowest  of  the  following  bases:  (1)  The  replacement  or 
reproduction  cost  prevailing-  at  the  date  of  the  inventory;  or  (2) 
the  proper  proportionate  part  of  the  actual  finished  cost;  or, 
under  abnormal  conditions,  (3)  the  proper  proportionate  part 
of  the  sales  price  of  the  finished  product,  account  being  taken 
in  all  cases  of  the  proportionate  part  of  the  total  cost  of  basic 
elements  (materials,  labor,  and  burden)  represented  in  such 
goods  in  process  of  manufacture  at  the  stages  at  which  they 
are  found  on  the  date  of  the  inventory.  The  inventories  of  tax- 
payers on  whatever  basis  taken  will  be  subject  to  investigation 
by  the  Commissioner,  and  the  taxpayer  must  satisfy  the  Com- 
missioner of  the  correctness  of  the  prices  adopted.  He  must 
be  prepared  to  show  both  the  cost  and  the  market  price  of  each 
article  included  in  the  inventory.  It  is  recognized  that  in  the 
latter  part  of  1918,  by  reason  among  other  things  of  govern- 
mental control  not  having  been  relinquished,  conditions  were  ab- 
normal and  in  many  commodities  there  was  no  such  scale  of  trad- 
ing as  to  establish  a  free  market.  In  such  a  case,  when  a  market 
was  established  during  the  succeeding  year,  a  claim  may  be  filed 
for  any  loss  sustained.-*"' 

Where  a  corporation,  in  taking  its  inventory  on  December  31, 
1918,  on  the  basis  of  cost  or  market,  whichever  was  lower,  used 
as  the  basis  for  such  inventory  the  "asking  prices"  as  of  the 
date  of  the  inventory,  the  department  has  held  that  the  com- 
pany may  amend  its  inventory  by  using  instead  of  "asking 
prices",  the  "fair  bid  prices."  If  at  the  end  of  1918  abnormal 
conditions  existed  and  there  was,  in  fact,  no  market  for  such 
goods,  the  taxpayer  may  use  as  the  basis  for  his  inventory  his 
actual  sales  for  a  reasonable  period  before  and  after  the  date 
of  the  inventory.  It  is  not  permissible,  where  no  actual  market 
exists,  to  value  the  inventory  by  prices  fixed  subsequent  to  the 
close  of  the  taxable  year.'*" 

INVENTORIES  BY  DEALERS  IN  SECURITIES.  A  dealer  in  secu- 
rities, who  in  his  books  of  account  regularly  inventories  unsold 
securities  on  hand  either  (a)  at  cost  or  (b)  at  cost  or  market, 
whichever  is  lower,  may  make  his  return  upon  the  basis  upon 
which  his  accounts  are  kept;  provided  that  a  description  of  the 
method  employed  shall  be  included  in  or  attached  to  the  return, 
that  all  the  securities  imist  be  inventoried  by  the  same  method, 
and  that  such  method  must  be  adhered  to  in  subsequent  years, 

45  T.  D.  3109,  T.  B.   1-21-1383,  amending  ReR.  45,  Art.  1584,  previou.sly 
amended  by  T.  D.  3047,  T.  B.  32-20-1114. 
4RA.  R.  R.  487,  T.  B.  18-21-1609. 


402  FEDERAL  INCOME  TAX 

unless  another  be  authorized  by  the  Commissioner.-*'*'  For  the 
purpose  of  this  rule,  a  dealer  in  securities  is  a  merchant  of  securi- 
ties, whether  an  individual,  partnership  or  corporation,  with  an 
established  place  of  business,  regularly  engaged  in  the  purchase 
of  securities  and  their  resale  to  customers,  that  is,  one  who  as 
a  merchant  buys  securities  and  sells  them  to  customers  with  a 
view  to  the  gains  and  profits  that  may  be  derived  therefrom. 
If  such  business  is  simply  a  branch  of  the  activities  carried 
on  by  such  person,  the  securities  inventoried  as  here  provided 
may  include  only  those  held  for  purposes  of  resale  and  not  for 
investment.^^  A  bank  or  other  institution  having  a  regularly 
established  department  for  the  merchandising  of  securities,  even 
though  that  department  is  subordinate  in  importance  to  other 
departments,  is  entitled  to  the  same  benefit  of  using  the  basis 
above  provided  of  inventorying  securities  acquired  and  held  for 
resale,  as  one  who  is  solely  a  dealer  in  securities.  Insofar  as 
the  bank  or  other  institution  carries  on,  with  an  established 
place  of  business,  a  department  for  the  merchandising  of  securi- 
ties, it  is  in  respect  of  such  department  treated  in  the  same 
way  as  any  other  security  merchant.^'-*  Taxpayers  who  buy  and 
sell  or  hold  securities  for  investment  or  speculation,  and  not  in 
the  course  of  an  established  business,  and  officers  of  corporations 
and  members  of  partnerships,  who  in  their  individual  capacities 
buy  and  sell  securities,  are  not  dealers  in  securities  within  the 
meaning  of  this  rule.^^ 

An  inventory  method  of  accounts  may  be  availed  of  by  a 
dealer  in  securities  only  as  to  stocks  owned  by  the  dealer  at  the 
end  of  the  year.  In  the  process  of  a  "short"  sale  legal  title  to 
stock  is  transferred  from  the  lender  to  the  borrower  and  from 
the  borrower  to  the  buyer,  and  then  later  from  the  borrower 
to  the  lender.  The  "short"  sale  dealer  having  no  stock  in  his 
possession  to  which  he  has  title,  consequently  has  no  stock 
which  he  can  inventory  at  the  end  of  the  year;  as  soon  as  title 
was  secured  from  the  lender,  it  was  passed  on  to  the  buyer. 
Since  the  statute  does  not  authorize  the  inventorying  of  liabili- 
ties even  though  the  liability  is  one  to  return  specific  property 
in  kind  on  demand  and  inasmuch  as  the  word  "inventory"  in  its 
commonly  accepted  commercial  meaning  refers  to  the  inventory- 

^7  The  rules  as  to  valuation  of  inventories  s^ted  in  an  earlier  paragraph, 
are  applicable  to  dealers  in  securities.     (M.  2703,  T.  B.  7-21-1442). 

48  Reg.  45,  Art.  1585. 

49  Letter  from  treasury  department  dated  June  28,  1919;  I.  T.  S.  1921, 
112717. 

50  Reg.  45,  Art.  1585. 


INCOME  FROM  BUSINESS,  TRADE  OR  COMMERCE  403 

ing  of  assets  only,  a  dealer  in  securities  may  not  inventory 
stock  sold  "short"  as  of  the  end  of  the  taxable  year.  Conse- 
quently, where  a  taxpayer  has  "borrowed"  stock  in  order  to 
make  a  "short"  sale  the  gain  or  loss  arising  from  the  transaction 
cannot  be  accrued  upon  the  books  of  the  taxpayer  at  the  close 
of  his  taxable  year  by  treating  as  an  offsetting  obligation  the 
market  value  of  the  stock  sold  "short"  as  of  that  date ;  the  gain 
or  loss  is  determined  when  the  amount  of  stock  sold  "short"  is 
repurchased  for  return  to  the  lender  and  the  transaction  closed.^"*! 
INVENTORIES  OF  LUMBER  MANUFACTURERS.  Because  of.  the 
impracticability  of  determining  accurately  the  costs  properly 
assignable  to  each  species,  grade,  and  dimension  of  lumber 
making  up  the  product  of  the  mill,  lumber  manufacturers  may 
use  as  a  basis  for  pricing  inventories  the  average  cost  to  the 
manufacturer  of  producing  the  inventoried  products  during 
the  taxable  year  for  which  the  return  of  net  income  is  made. 
If  the  quantity  of  lumber  on  hand  at  the  time  of  inventory  is 
greater  than  the  total  quantity  of  lumber  produced  during  the 
current  taxable  year,  it  is  evident  that  the  excess  stock  has 
been  carried  over  from  the  previous  year's  production,  and 
such  excess  shall  be  valued  at  the  average  cost  of  production 
for  the  preceding  taxable  year.  A  taxpayer  who  regularly 
allocates  in  his  books  of  account  such  average  cost  to  the 
different  kinds  and  grades  of  lumber  in  proportion  to  the  sell- 
ing value  of  such  kinds  and  grades  may,  subject  in  each  case 
to  the  approval  of  the  Commissioner  upon  audit  of  the  returii, 
make  his  returns  of  net  income  on  that  basis.  The  term  lum- 
ber manufacturer,  as  thus  used,  means  a  person  who  manufac- 
tures lumber  from  logs,  as  distinguished  from  a  remanufac- 
turer  of  lumber."'- 

INVENTORIES  OF  RETAIL  DRY  GOODS  MERCHANTS.      Retail  dry 

goods  dealers  who  employ  the  "retail  method,"  will  be  permitted 
to  make  their  returns  upon  that  basis,  provided  (a)  that  the  use 
of  such  method  is  designated  upon  the  return,  (b)  that  accurate 
accounts  are  kept,  and  (c)  that  such  method  be  adhered  to  in 
subsequent  years,  unless  a  change  is  authorized  by  the  Com- 
missioner.-"'-^'  Other  organizations  and  individual  stores  who  con- 
duct retail  establishments  and  follow  essentially  the  retail  method 
of  dry  goods  stores,  may  be  allowed  this  method  upon  applica- 
tion to  the  Commissioner.     While  in  its  original  ruling  on  this 

51  S.  1179,  T.  B.  24-19-558. 

52  T.  D.  3024,  T.  B.  24-20-995. 

53  T.  D.  3058,  T.  B.  35-20-1162. 


404  FEDERAL   INCOME   TAX 

subject  54  the  treasury  department  designated  the  "retail 
method"  a  "cost"  method  of  valuing  inventories,  it  is  recognized 
that  while  on  a  constant  or  rising  market  such  method  is  approxi- 
mately a  "cost"  basis,  on  a  falling  market  it  results  in  a  reduc- 
tion to  "cost  or  market,  whichever  is  lower," ^s  The  "retail 
method"  consists  in  computing  the  "cost"  of  goods  on  hand  from 
the  "percentage  of  purchase  mark-up"  and  the  "retail  value" 
of  goods  on  hand.  A  taxpayer  employing  the  "retail  method" 
of  valuing  inventories  should  maintain  and  preserve  in  perma- 
nent form,  for  the  inspection  of  internal  revenue  officers,  the 
accounts  and  records  of  each  year,  together  with  a  schedule  of 
all-  mark-downs  in  each  department,  and  such  mark-downs  should 
not  be  included  in  the  computation  of  the  retail  value  of  goods 
on  hand  unless  the  goods  so  marked  down  have  been  actually 
sold.-"'^'  There  must  be  a  permanent  form  of  recording  by  de- 
partments, purchases  showing  the  firm  name,  date  of  invoice, 
invoice  cost  and  retail  sales,  stock,  etc.  It  must  be  borne  in  mind 
that  under  no  circumstances  will  arbitrary  standard  percentages 
of  purchase  mark-up  be  allowed  in  the  determination  of  the 
"cost"  or  "cost  or  market"  value  of  retail  inventories,  but  that 
such  percentages  must  be  the  purchase  mark-up  percentage  dis- 
closed by  the  department  records  of  the  fiscal  period  for  which 
the  return  is  made,"'''  The  following  general  plan  of  taking  an 
inventory  by  the  "retail  method"  will,  it  is  believed,  be  found 
readily  adaptable  to  the  requirements  of  most  retail  dry  goods 
dealers : 

(A)  The  'percentage  of  purchase  mark-up  is  computed  as 
follows:  The  value  of  all  merchandise,  as  received,  is  recorded 
by  departments  at  two  prices,  (a)  invoice  cost  plus  transpor- 
tation, and  (b)  original  retail  sale  price.  These  cost  and  retail 
values  are  accumulated  as  recorded  during  the  year.  The  total 
retail  value  minus  the  total  cost  value  equals  the  total  purchase 
mark-up,  which  divided  by  the  total  retail  value  gives  the  per- 
centage of  purchase  mark-up.^^  The  words,  "the  value  of  all 
merchandise  as  received,"  is  inclusive  of  inventory  at  the  be- 
ginning of  the  period.  The  purchase  mark-up  must  be  computed 
as  follows: 

54  Id. 

55  Letter  from  treasury  department  dated  January  21,  1921;  I.  T.  S.  1921, 
:i  2681. 

56  T.  D.  3058,  T.  B.  35-20-1162. 

57  Letter  from  the  treasury  department  dated  January  21,  1921;  I.  T.  S., 
1921,  112681. 

5S  T.  D.  3058,  T.  B.  35-20-1162. 


INCOME  FROM  BUSINESS,  TRADE  OR  COMMERCE  405 

Cost:  Inventory  at  cost  at  beginning:  purchases  at  cost; 
transportation.  Retail:  Inventory  at  sales  price:  purchases  at 
sales  price.  Within  the  meaning  of  this  ruling,  it  is  proper  to 
include  as  a  part  of  "original  retail  sales  price"  the  actual  in- 
crease in  the  original  sales  price  which  has  been  brought  about 
by  market  conditions  or  by  incorrect  pricing  when  the  goods  were 
put  into  stock.  For  the  convenience  of  the  examining  officer, 
a  special  form  should  be  provided ;  complete  information  by  items 
of  the  increase  from  the  original  retail  must  be  shown;  refer- 
ence, if  possible,  must  be  made  to  the  original  invoice ;  entry  and 
the  reason  for  the  increase  freely  explained.  All  such  amended 
retail  increases  must  be  approved  by  the  buyer  of  the  depart- 
ment and  merchandise  manager  or  other  responsible  official  and 
they  should  be  so  ffied  that  quick  reference  to  them  may  be  made. 
Entry  of  such  increased  retail  properly  belongs  in  department 
purchase  books,  although  it  may  be  set  up  as  a  separate  item 
in  the  accumulated  records  of  the  department.  The  same  forms 
that  are  used  to  record  such  price  increases  should  not  be  used 
for  mark-downs  and  in  no  instances  will  a  store  be  allowed  to 
include  as  retail  increases  a  mark-up  which  has  been  taken  as  a 
correction  or  cancellation  of  a  mark-down;  such  mark-up  must 
be  regarded  and  treated  in  all  cases  as  opposite  to  mark-down."'" 

(B)  The  retail  value  of  goods  on  hand  is  computed  as  fol- 
lows: A  record  is  kept  of  (a)  the  amounts  of  all  sales  at 
retail,  (b)  any  variations  from  the  inventory  prices  of  the 
preceding  year  of  goods  carried  over  from  that  year,  and  (c)  any 
variations  from  the  original  sale  prices,  such  as  subsequent 
mark-ups  or  mark-downs.  The  retail  value  of  the  opening  in- 
ventories plus  the  retail  value  of  the  purchases  (plus  or  minus 
the  algebraic  sum  of  all  subsequent  mark-ups,  and  mark-downs 
in  the  case  of  goods  actually  sold)  minus  the  retail  value  of  the 
sales  equals  the  retail  value  of  the  book  inventory  of  goods  on 
hand.  Physical  inventories  by  departments  are  taken  of  goods 
on  hand  at  retail  at  the  close  of  the  taxable  year,  and  the  retail 
value  of  the  book  inventory  of  goods  on  hand  is  adjusted  accord- 
ingly. 

(C)  The  cost  of  goods  on  hand  is  computed  by  subtracting 
from  100%  the  percentage  of  purchase  mark-up,  which  gives 
the  percentage  of  cost,  and  multiplying  the  retail  value  of 
goods  on  hand  by  such  percentage  of  cost.^'"     The  above  deci- 

59  Letter  from  treasury  department  dated  January  21,  1921;  I.  T.  S.  1921, 
<i  2681. 

60  T.  D.  3058,  T.  B.  35-20-1162. 


406  FEDERAL  INCOME  TAX 

sion  is  not  intended  to  disturb  the  procedure  in  stores  which 
have  properly  handled  mark-downs,  but  instances  where  arbitary 
reductions  from  retail  values  have  been  made  because  of  the 
desire  to  provide  for  depreciation  and  obsolescence  with  no  actual 
offering  to  the  public  of  the  goods  on  which  the  mark-downs 
were  claimed,  cannot  be  recognized.  Under  no  circumstances 
will  a  store  be  allowed  to  depreciate  its  stock  in  any  way  except 
by  the  offering  of  it  to  its  customers  at  such  reduced  prices. 
The  procedure  of  stores  in  regard  to  mark-downs  will  be  deemed 
proper  if  in  any  fiscal  year  or  period  of  that  year  the  goods  so 
marked  down  are  in  proportion  to  current  sales,  stock  on  hand, 
to  mark-downs  of  preceding  months  of  preceding  year,  or  if 
evidence  can  be  submitted  as  to  market  changes  which  have 
forced  a  reduction  in  retail  prices  necessary  to  bring  about  a 
parity  with  the  selling  price  of  the  same  goods  which  have  been 
purchased  or  could  be  purchased  at  a  reduced  cost.  A  store 
which  has  employed  this  retail  method  in  the  past,  may  now 
specify  in  the  return  that  such  method  is  used,  as  a  basis  of 
valuing  inventories,  regardless  of  the  fact  that  in  past  years  it 
reported  on  a  "cost"  or  "cost  or  market,  whichever  is  lower" 
basis.  However,  the  use  of  the  retail  method  will  not  be  recog- 
nized unless  it  has  been  correctly  followed  throughout  the  entire 
fiscal  or  calendar  year  period  for  which  the  return  is  made.^i 

61  Letter  from  treasury  department  dated  January  21,  1921 ;  L  T.  S.  1921, 
^2681. 


CHAPTER  17 

INCOME    FROM    SALES   OR  DEALINGS   IN   PROPERTY;    QUASI   CAPITAL 

TRANSACTIONS 

Both  the  present  law  and  the  Revenue  Act  of  1918  expressly 
provide  that  gains,  profits  and  income  derived  from  sales  or  deal- 
ings in  property,  whether  real  or  personal,  growing  out  of  the 
ownership  or  use  of  or  interest  in  such  property  shall  be  tax- 
able.^  For  some  time  after  the  enactment  of  the  Sixteenth 
Amendment  there  were  many  who  argued  that  gains  resulting 
from  an  increase  in  capital  or  appreciation  of  capital  assets 
could  not  be  taxed,  at  least  where  the  owner  was  not  engaged  in 
the  business  of  dealing  in  such  property,  basing  this  contention 
on  a  leading  case  construing  the  Income  Tax  Act  of  1864.-  This 
argument  has  been  definitely  set  at  rest  by  several  recent  deci- 
sions of  the  United  States  Supreme  Court,  which  held  that  such 
gains  were  intended  to  be  taxed  by  the  Revenue  Act  of  1916 
and  could  constitutionally  be  taxed.-"*  It  was  conceded  by  the 
solicitor-general  in  these  cases  that  gain  or  loss  upon  any 
exchange  of  property  was  to  be  determined  upon  the  basis 
of  cost  or  acquisition  value  and  not  value  on  March  1,  1913,  the 
gain  or  loss  accruing  before  that  date  being  excluded,  however, 
for  the  purpose  of  computing  net  income.  This  concession, 
which  became  in  effect  a  part  of  the  decision  of  the  Supreme 
Court,  necessitated  the  modification  of  all  the  regulations  there- 
tofore issued  involving  the  consideration  that  gains,  profits  and 
income  accruing  prior  to  March  1,  1913,  were  capital  and  so 
exempt.^  The  regulations,  as  so  modified  under  the  1918  Law, 
establishing  the  basis  for  determining  gain  or  loss  upon  an 
exchange  of  property  for  property  are  discussed  later  in  this 

1  Revenue  Act  of  1921,  §  213  (a)  ;  Revenue  Act  of  1918,  §  213  (a). 

2  Gray  v.  Darlington,  15  Wall.  63. 

■5  Walsh  v.  Brewster,  41  Sup.  Ct.  Rep.  392,  T.  B.  16-21-1573;  Goodrich  v. 
Edwards,  41  Sup.  Ct.  Rep.  390,  T.  B.  16-21-1572;  Eldorado  Coal  Co.  v. 
Mager,  65  L.  Ed.  449,  T.  B.  16-21-1571;  Merchants  Loan  &  Trust  Co.  v. 
Smietanka,  41  Sup.  Ct.  Rep.  386,  T.  B.  16-21-1570;  Darlington  v.  Mayer, 
U.  S.  Dist.  Ct.,  N.  Dist.  111.,  affirmed  by  U.  S.  Supreme  Court  April  18,  1921, 
see  I  T.  S.  1921,  ^  2988.  Taxpayers  who  omitted  from  gross  income  for  1920 
or  failed  to  make  a  disclosure  of  gains  from  the  sale  of  capital  assets  have 
been  held  guilty  of  negligence  or  fraud,  but  if  a  full  disclosure  was  made  no 
negligence  was  imputed  to  the  taxpayers.  (M.  2791,  T.  B.  23-21-1674; 
M.  2739,  T.  B.  14-21-1542.) 

4  This  amendment  was  accomplished  in  large  part  by  T.  D.  3206,  T.  B. 
33-21-1767. 

407 


408  FEDERAL  INCOME  TAX 

chapter.  The  basis  so  estabhshed  by  the  treasury  department 
has  now  been  written  into  the  Revenue  Act  of  1921  as  the  gen- 
eral rule  for  determining  gain  or  loss  upon  an  exchange  of 
property  for  property.  The  special  rules  embodied  in  the  1918 
Law,  with  respect  to  property  included  in  inventory  and  property 
acquired  by  bequest,  devise,  or  inheritance  are  in  substance 
preserved  in  the  present  law.  One  important  change  made  by 
the  present  law  relates  to  the  basis  for  determining  gain  or  loss 
when  the  property  exchanged  was  acquired  by  gift.  This  change 
is  discussed  below."' 

While  the  general  basis  for  determining  gain  or  loss  upon 
an  exchange  of  property  for  property  thus  remains  largely  the 
same  under  the  present  law  as  it  was  under  the  Revenue  Act  of 
1918,  the  present  law,  in  many  important  respects,  modifies  the 
provisions  of  the  1918  Law  upon  this  point.  The  general  rule 
under  the  1918  Law  as  to  when  a  gain  or  loss  could  be  said  to 
occur  indicates  the  first  congressional  recognition  of  the  in- 
congruities, hardships  and  absurdities  involved  in  the  taxation 
of  gains  said  to  be  realized  and  the  deduction  of  losses  claimed 
to  be  sustained  upon  exchanges  of  property  for  property.*'  The 
most  general  of  the  modifications  contained  in  the  present  law 
is  the  provision  that  no  gain  or  loss  shall  be  recognized  upon  an 
exchange  of  property  for  property  unless  the  property  received 
in  exchange  has  a  "readily  realizable  market  value."  ^  Other 
provisions  involving  substantial  departures  from  the  previous 
law  are :  ( 1 )  The  provision  with  regard  to  the  exchange  of  prop- 
erty held  for  investment,  or  productive  use  in  trade  or  busi- 
ness, for  property  of  a  like  kind  or  use;  and  (2)  the  provisions 
practically  eliminating  the  element  of  taxable  profit  or  deduct- 
ible loss  upon  the  organization,  reorganization,  merger,  and  con- 
solidation of  corporations.  The  new  statute  also  provides  for 
cases  in  which  property  of  readily  realizable  market  value  and 
property  without  such  value  are  received  upon  an  exchange, 
and  cases  in  which  property  of  such  value  is  received  upon  the 
organization  or  reorganization,  in  addition  to  stock  or  securi- 
ties, of  a  corporation.     The  method  adopted  by  the  treasury 

5  See  p.  458. 

6  It  is  stated  by  the  Senate  Finance  Committee  (see  Report  of  that  Com- 
mittee on  Internal  Revenue  Bill  of  1921,  p.  11)  :  "Probably  no  part  of  the 
present  income  tax  law  has  been  productive  of  so  much  uncertainty  or  has 
more  seriously  interfered  with  necessary  business  adjustments."  (See  also 
Report  of  Ways  and  Means  Committee  on  Internal  Revenue  Bill  of  1921, 
p.  10.) 

■7  Revenue  Act  of  1921,  §202  (c). 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      409 

department  under  the  1918  Law  for  taxing  gains  or  profits  upon 
installment  transactions,  discussed  in  the  latter  part  of  this 
chapter,  is  expressly  sanctioned  by  the  present  law.*^  A  further 
distinctive  feature  of  the  Revenue  Act  of  1921  is  the  so-called 
"capital  gain"  provision  the  effect  of  which  is  to  limit  the  tax  on 
gains  derived  from  the  sale  or  disposition  of  capital  assets  to 
121/2  %.» 

Taxation  of  Capital  Gains.  Many  sales  of  farms,  mineral 
properties  and  other  capital  assets  have  been  prevented  in  the 
last  years  by  the  prohibitive  taxes  which  would  have  been  pre- 
cipitated thereby.  Under  the  Revenue  Act  of  1918  and  previous 
laws,  the  profits  derived  on  such  sales  were  taxed  at  high  surtax 
rates,  like  other  income,  and  were  taxed  in  the  year  of  disposi- 
tion though  the  profits  represented  the  realization  of  a  gradual 
appreciation  extending  over  several  years.  Thus,  income  was 
unduly  concentrated  and  higher  surtax  rates  made  to  apply. 
Corporations  were  perhaps  more  fortunate  than  individuals  in 
this  respect  because  such  undue  concentration  of  income  in  one 
taxable  year  might  be  held  to  be  an  abnormality  of  income  which 
would  permit  the  excess-profits  tax  of  the  corporation  to  be 
calculated  by  reference  to  representative  corporations,  but  this 
was  an  uncertain  and  inadequate  remedy. i" 

The  "capital  gain"  provision  of  the  Revenue  Act  of  1921  is 
a  recognition  of  these  considerations. ^^  The  provision  applies 
after  December  31,  1921.  Since  the  excess-profits  tax  is  repealed 
as  of  that  date  there  is  no  need  for  the  provision  to  apply  to 
corporations  the  income  tax  of  which  then  is  at  the  same  rate 
(121/^/c)  as  the  capital  gain  rate,  and  it  is  expressly  made 
inapplicable  to  corporations.  Any  taxpayer  (not  a  corporation) 
who  for  any  taxable  year  (after  1921)  derives  a  capital  net  gain, 
as  defined  below,  may  at  his  election,  in  lieu  of  the  ordinary 
normal  tax  and  surtax,  pay  thereon  a  tax  computed  as  follows: 

A  partial  tax  is  first  computed  upon  the  basis  of  the  ordinary 
net  income  at  the  rates  and  in  the  ordinary  manner  (that  is, 
the  normal  tax  and  the  surtaxes  are  computed  on  such  ordinary 
net  income)  and  the  total  tax  will  be  this  amount  plus  121/2't' 
of  the  capital  net  gain;  but  if  the  taxpayer  elects  to  be  taxed 
under  this  provision  the  total  tax  must  in  no  such  case  be  less 
than  121/2  7o  of  the  total  net  income.     The  total  tax  thus  de- 

s  See  Revenue  Act  of  1921,  §  202. 
!'  See  Revenue  Act  of  1921,  §  206. 

10  See  Chapter  43. 

11  In  Great  Britain  capital  gain  or  loss  is  ignored  in  computing  net  in- 
come. The  1921  Law  takes  an  intermediate  position  between  the  extreme 
views  embodied  in  the  1918  Law  and  the  British  law. 


410  FEDERAL  INCOME  TAX 

termined  is  to  be  computed,  collected  and  paid  in  the  same 
manner,  at  the  same  time  and  subject  to  the  same  provisions 
of  law,  including  penalties,  as  other  taxes  under  Title  II  of  the 
Revenue  Act  of  1921  (the  income  tax  title)  .i- 

Definition.  For  the  purpose  of  the  provision  indicated  in 
the  previous  paragraph,  the  Revenue  Act  of  1921  has  adopted 
the  following  definitions: 

(1)  The  term  "capital  gain"  means  taxable  gain  from  the 
sale  or  exchange  of  capital  assets  consummated  after  December 
31,  1921; 

(2)  The  term  "capital  loss"  means  deductible  loss  resulting 
from  the  sale  or  exchange  of  capital  assets  consummated  after 
December  31,  1921 ; 

(3)  The  term  "capital  deductions"  means  such  deductions  as 
are  allowed  for  the  purpose  of  computing  net  income  and  are 
properly  allocable  to  or  chargeable  against  items  of  capital  gain; 

(4)  The  term  "capital  net  gain"  means  the  excess  of  the  total 
amount  of  capital  gain  over  the  sum  of  the  capital  deductions 
and  capital  losses; 

(5)  The  term  "ordinary  net  income"  means  the  net  income, 
computed  in  accordance  with  the  provisions  of  Title  II,  after 
excluding  all  items  of  capital  gain,  capital  loss,  and  capital  de- 
ductions ;  and 

(6)  The  term  "capital  assets"  means  property  acquired  and 
held  by  the  taxpayer  for  profit  or  investment  for  more  than 
two  years  (whether  or  not  connected  with  his  trade  or  business) , 
but  does  not  include  property  held  for  the  personal  use  or 
consumption  of  the  taxpayer  or  his  family,  or  stock  in  trade  of 
the  taxpayer  or  other  property  of  a  kind  which  would  properly 
be  included  in  the  inventory  of  the  taxpayer  if  on  hand  at  the 
close  of  the  taxable  year.^'^ 

Partnerships  and  Estates  and  Trusts.  In  the  case  of  a 
partnership  or  of  an  estate  or  trust,  the  proper  part  of  each 
share  of  the  net  income  which  consists,  respectively,  of  ordinary 
net  income  and  capital  net  gain,  will  be  determined  under  rules 
and  regulations  to  be  prescribed  by  the  Commissioner  with  the 
approval  of  the  secretary,  and  will  be  separately  shown  in  the 
return  of  the  partnership  or  estate  or  trust,  and  will  be  taxed 
to  the  member  or  beneficiary  or  to  the  estate  or  trust,  but  at 
the  rates  and  in  the  manner  indicated  above.^* 

12  Revenue  Act  of  1921,  §  206  (b). 

13  Revenue  Act  of  1921,  §  206  (a). 

14  Revenue  Act  of  1921,  §  206  (c). 


income  from  sales  or  dealings  in  property         411 

Illustration  of  Computation  of  Tax  of  Taxpayer  Elect- 
ing TO  Be  Taxed  at  121/2''  Upon  Capital  Net  Gains.  The 
computation  of  tax  by  a  taxpayer  electing  in  1922  to  be  taxed 
under  the  capital  gain  provision  may  be  illustrated  as  follows: 

Capital  gains   $100,000 

Capital  losses    $20,000 

Capital  deductions   10,000         30,000 


Capital  net  gain $  70,000 

Gross  income   (excluding  capital  gains)    $150,000 
Deductions      (excluding     capital      losses 
and  deductions)   70,000 


Ordinary  net  income $  80,000 

Partial  Tax  oyi  Ordinary  Net  Income 

Normal  Tax 

$80,000  minus  $2,000  (personal 

exemption)  equals  $78,000 

First  $4,000  @  4% $      160 

Remaining  $74,000  @  8% 5,920 

Surtax   13,660 

Partial  tax  on  ordinary  net  income $19,740 

Tax  on  capital  net  gain  ($70,000)  @12i/2^f^     8,750 

Total  tax $28,490 

The  tax  of  this  taxpayer,  without  the  benefit  of  the  "capital 
gain"  provision,  would  be  $57,840 ;  the  provision  will  save  him 
$29,350. 

Exchange  of  Property  Held  for  Investment  or  for  Productive 
Use.  One  of  the  most  essential  changes  made  by  the  Revenue 
Act  of  1921  is  the  provision  that  "when  any  such  property  (viz., 
real,  personal  or  mixed  property)  held  for  investment,  or  for 
productive  use  in  trade  or  business  (not  including  stock-in-trade 
or  other  property  held  primarily  for  sale),  is  exchanged  for 
property  of  a  like  kind  or  use,"  no  gain  or  loss  will  be  recognized 
even  if  the  property  received  in  exchange  has  a  "readily  realiz- 
able market  value."  Upon  such  an  exchange  the  property  re- 
ceived is  to  be  treated  as  taking  the  place  of  the  property  ex- 


412  FEDERAL  INCOME  TAX 

changed.  If  money,  or  other  property  of  a  "readily  realizable 
market  value"  is  received  upon  such  an  exchange,  in  addition 
to  the  property  of  "like  kind  or  use,"  such  money  or  the  fair 
market  value  of  such  other  property  received  in  exchange  is  to 
be  applied  against  and  reduce  the  basis  (for  ascertaining  gain  or 
loss)  of  the  property  exchanged,  and  if  such  money  or  the  fair 
market  value  of  such  other  property  is  in  excess  of  such  basis, 
the  excess  is  taxable.^''  These  provisions  have  no  counterpart  in 
the  Revenue  Act  of  1918.  Their  effect  is  apt  to  be  far-reaching. 
The  language  used  is  broad.  The  provision  may  be  separated 
into  two  parts:  (1)  where  property  held  for  investment  is  ex- 
changed for  property  of  a  like  kind  or  use  i^*^  and  (2)  when  prop- 
erty held  for  productive  use  in  trade  or  business  (not  including 
stock  in  trade  or  other  property  held  primarily  for  sale)  is 
exchanged  for  property  of  a  like  kind  or  use.  There  is  no  limita- 
tion upon  the  phrase  "property  held  for  investment."  The 
statute  does  not  even  say  property  held  "only"  or  "primarily" 
for  investment.  In  a  degree  the  element  of  investment  enters 
into  the  holding  of  almost  all  property.  Apparently  the  phrase 
includes  all  forms  of  property.  An  individual  will  apparently 
incur  no  tax  upon  the  exchange  of  real  estate  held  for  investment 
for  other  similar  real  estate.  Nor  would  an  individual  seem  to 
be  taxable  upon  an  exchange  of  stocks  held  for  investment  for 
other  stocks,  or  of  bonds  for  bonds  in  like  manner.  These  con- 
siderations are  apt  to  have  a  revolutionary  effect  upon  the  real 
estate  and  brokerage  business,  and  indeed  on  all  sales  and  deal- 
ings in  property.  A  change  of  investments  produces  no  taxable 
income ;  and  the  selling  of  securities  and  other  property  for  cash 
followed  by  a  repurchase  of  other  securities  with  the  proceeds 
will  be  largely  abandoned  in  favor  of  a  trading  or  exchanging  of 
the  old  securities  directly  for  new  securities,  any  discrepancy  in 
value  being  adjusted  by  a  cash  payment  which  will  be  less  than 
the  basis  provided  for  ascertaining  gain  or  loss.  It  seems  that 
the  stock  of  one  company  is  property  of  a  "like  kind"  to  the 
stock  of  another  company ;  it  may  be  held  that  common  stock  and 
preferred  stock  are  not  property  of  a  "like  kind."  Again  the 
parenthetical  expression  "stock-in-trade  or  other  property  held 
primarily  for  sale"  is  apt  to  raise  administrative  difficulties. 
It  will  not  be  easy  to  determine  when  property  held  for  pro- 
ductive use  in  a  trade  or  business  is  held  "primarily  for  sale"; 

IT  Revenue  Act  of  1921,  §   202  (c)  1,  (d)  1,  (e). 

ifi  The  words  "investment,  or"  w^ere  inserted  in  the  bill  by  the  conferees 
at  the  last  moment.  They  were  originally  introduced,  however,  in  the 
House  (see  Conference  Report  of  Revenue  Bill  of  1921,  p.  17). 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      413 

and  it  will  be  no  easier  to  determine  when  property  is  held  for 
"productive  use  in  a  trade  or  business."  This  is  illustrated,  for 
instance,  by  the  difficulties  and  litigation  which  arose  in  con- 
nection with  the  words  "business  or  trade"  as  used  in  the  loss 
provision  of  the  1916  LawJ'  Although  permitting  the  tax-free 
exchange  of  much  property  the  exchange  of  which  for  other 
property  produced  taxable  profit,  the  provision  will  also  prohibit 
the  deduction  of  many  losses  of  a  character  which  have  hitherto 
been  deductible. 

Biisis  for  Determining  Gain  or  Loss  From  Sale.  For  the  pur- 
pose of  ascertaining  the  gain  derived  or  the  loss  sustained  from 
the  sale  or  exchange  of  property,  the  basis  provided  by  the 
Revenue  Act  of  1918  was  (a)  its  "fair  market  price  or  value" 
as  of  March  1,  1913,  if  acquired  prior  thereto,  or  (b)  if  acquired 
on  or  after  that  date  its  cost,  or  its  approved  inventory  value, 
the  gain,  profit  or  income  derived  from  sales  or  dealings  in 
property  being  the  amount  by  which  the  selling  price  of  the 
property  exceeds  such  "fair  market  price  or  value,"  cost,  or  ap- 
proved inventory  value. i'^  In  the  recent  cases  in  the  Supreme 
Court  involving  the  taxation  of  profits  derived  from  the  sale 
of  capital  assets,^-'  the  government  admitted  that  the  Commis- 
sioner had  hitherto  been  construing  the  statute  erroneously  and 
that  (a)  no  tax  could  be  imposed  when  the  selling  price  of 
property  was  less  than  the  purchase  price,  even  though  a  gain 
might  be  reflected  in  a  difference  between  the  selling  price  and 
the  value  of  the  property  on  March  1,  1913,  and  (b)  that  no 
deductible  loss  occurred  unless  the  selling  price  was  less  than 
the  purchase  price,  even  though  a  loss  might  be  reflected  in  a 
difference  between  the  selling  price  and  the  value  of  the  prop- 
erty on  March  1,  1913.  In  other  words,  it  was  admitted  that 
the  statute  contemplated  the  taxation  and  deduction  only  of 
real  or  actual  gains  or  losses,  represented  by  a  difference  between 
selling  price  and  cost.  Prior  to  the  enactment  of  the  Revenue 
Act  of  1921  the  treasury  department  (acting  under  the  authority 
of  the  1918  Law)  summarized  the  general  rule  bearing  upon 
the  determination  of  gain  or  loss  resulting  from  the  sale  or 

17  See  Revenue  Act  of  1916,  §  (i  (a)  fifth. 

1«  Revenue  Act  of  1918,  §202  (a);  Reg.  45,  Art.  1561,  as  amended  by 
T.  D.  3206,  T.  B.  33-21-1767.  The  above  provision  establishing  fair  market 
price  or  value  as  of  March  1,  1913,  as  a  basis  in  the  case  of  property  ac- 
quired prior  to  that  date  appeared  first  in  the  1916  Law,  no  reference  being 
made  in  the  1909  Law  or  the  1913  Law  to  any  basis  when  assets  disposed 
of  were  acquired  prior  to  the  incidence  of  the  tax. 

1^  See  cases  cited  in  footnote  3. 


414  FEDERAL  INCOME  TAX 

other  disposition  of  property  acquired  before  March  1,  1913,  as 
this  general  rule  was  affected  by  the  above  admission  and  sus- 
tained by  the  Supreme  Court.-^^  This  departmental  summary 
has  now  been  adopted  by  the  Revenue  Act  of  1921  as  the  general 
basis  for  determining  gain  or  loss  in  the  case  of  property  acquired 
before  March  1,  1913,  and  has  been  enacted  in  detail  in  that 
statute.  The  statute  also  changes  the  basis  provided  by  the 
1918  Law  for  the  ascertainment  of  gain  derived  or  loss  sustained 
in  the  case  of  the  disposition  of  property  acquired  by  gift.  Other- 
wise it  will  be  noted  that  the  present  statute  adopts  substantially 
the  basis  set  forth  in  the  Revenue  Act  of  1918.  The  basis  so 
provided 21  by  the  present  law  is  as  follows: 

"(a)  That  the  basis  for  ascertaining  the  gain  derived  or  loss 
sustained  from  a  sale  or  other  disposition  of  property,  real, 
personal,  or  mixed,  acquired  after  February  28,  1913,  shall  be 
the  cost  of  such  property;  except  that — 

"(1)  In  the  case  of  such  property,  which  should  be  included 
in  the  inventory,  the  basis  shall  be  the  last  inventory  value 
thereof ; 

"(2)  In  the  case  of  such  property,  acquired  by  gift  after  De- 
cember 31,  1920,  the  basis  shall  be  the  same  as  that  which  it 
would  have  in  the  hands  of  the  donor  or  the  last  preceding 
owner  by  whom  it  was  not  acquired  by  gift.  *  *  * 

20  See  Reg.  45,  Art.  1561.  It  is  to  be  regretted  that  the  Supreme  Court 
did  not  pass  expressly  upon  the  subject  matter  of  the  above  admission  made 
by  the  solicitor-general.  With  regard  to  gains  represented  by  a  difference 
between  selling  price  and  value  on  March  1,  1913,  in  cases  in  which  the 
selling  price  was  less  than  purchase  price,  the  admission  of  the  solicitor  was 
undoubtedly  necessary,  under  the  sixteenth  amendment,  because  such  a  gain 
could  not  constitutionally  be  taxed.  But  the  allowance  of  any  deduction  for 
loss  is  a  matter  in  which  Congress  is  not  inhibited  by  any  constitutional 
limitation,  and  to  deny  the  deduction  of  losses  represented  by  a  difference 
between  selling  price  and  value  on  March  1,  1913,  where  the  selling  price 
was  less  than  purchase  price,  is,  in  effect,  to  neutralize  a  loss  occurring  after 
the  incidence  of  the  tax  by  an  admittedly  nontaxable  gain  accruing  prior  to 
the  incidence  of  the  tax.  The  1918  law  plainly  stated  that  such  a  loss  should 
be  an  allowable  deduction  and  the  plain  terms  of  the  statute,  where  no  con- 
stitutional limitations  intervene,  should  be  respected,  whatever  the  result. 
(See  Chapter  47.)  Under  the  1921  law  the  intention  of  Congress  to  follow 
the  solicitor's  admission  is  clear,  but  a  provision  of  this  law  may  not  be 
used  in  interpreting  a  previous  statute. 

21  Revenue  Act  of  1921,  §  202  (a)  (b).  The  basis  in  regard  to  property 
acquired  by  gift  is  not  quoted  in  full  at  this  point.  It  will  be  found  in  full 
in  a  special  discussion  of  gains  derived  upon  the  sale  of  such  property 
(see  p.  458).  In  regard  to  .property  acquired  before  March  1,  1913,  the 
statute  is  an  enactment  in  detail  of  the  basis  set  forth  in  Article  1561  of 
Regulations  45,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY 


415 


"(3)  In  the  case  of  such  property,  acquired  by  bequest,  de- 
vise, or  inheritance,  the  basis  shall  be  the  fair  market  price  or 
value  of  such  property  at  the  time  of  such  acquisition.    *    *    * 

"(b)  The  basis  for  ascertaining  the  gain  derived  or  loss  sus- 
tained from  the  sale  or  other  disposition  of  property,  real,  per- 
sonal, or  mixed,  acquired  before  March  1,  1913,  shall  be  the  same 
as  that  provided  by  subdivision  (a)  ;  but — 

"(1)  If  its  fair  market  price  or  value  as  of  March  1,  1913,  is 
in  excess  of  such  basis,  the  gain  to  be  included  in  the  gross 
income  shall  be  the  excess  of  the  amount  realized  therefor  over 
such  fair  market  price  or  value; 

"(2)  If  its  fair  market  price  or  value  as  of  March  1,  1913,  is 
lov^er  than  such  basis,  the  deductible  loss  is  the  excess  of  the 
fair  market  price  or  value  as  of  March  1,  1913,  over  the  amount 
realized  therefor;  and 

"  (3)  If  the  amount  realized  therefor  is  more  than  such  basis, 
but  not  more  than  its  fair  market  price  or  value  as  of  March 
1,  1913,  or  less  than  such  basis,  but  not  less  than  such  fair 
market  price  or  value,  no  gain  shall  be  included  in  and  no  loss 
deducted  from  the  gross  income." 

Basis  in  Case  of  Property  Acquired  Before  March  1, 
1913.  The  statutory  basis  provided  for  determining  the  gain 
derived  or  loss  sustained  upon  the  disposition  of  property 
acquired  before  March  1,  1913,  has  been  indicated  in  the  preced- 
ing paragraph.  This  basis  is  the  same  as  that  most  recently 
adopted  by  the  treasury  department  under  the  1918  Law  and  the 
following  tabular  summary—  made  by  the  department  under 
that  law  will,  therefore,  be  helpful  under  the  present  law: 

In  the  case  of  property  acquired  before  March  1,  1913,  when 
its  fair  market  value  as  of  that  date  is  in  excess  of  its  cost,  the 
taxable  gain  is  the  excess  of  the  amount  realized  therefor  over 
such  fair  market  value. 


Cost. 

Fair  iiiar- 

kot  viilne 

March  1, 

1913. 

Sale  price. 

Taxable  gain. 

$10,000 

$15,000 

.$20,000 

$.j.000. 

Kxcess  of  aiiiount  rcalizoil  over  fair  market 
value  as  at  March  1,  1!)13.  Gain  accruing 
prior  to  March  1,  1013,  not  taxahlc. 

22  Reg.  45,  Art  1561,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767;  0.  D. 
1035,  T.  B.  38-21-1825,  overruling  such  decisions  as  T.  B.  M.  73,  T.  B.  19- 
19-493;  A.  R.  667,  T.  B.  45-21-1903. 


416 


FEDERAL  INCOME   TAX 


In  the  case  of  property  acquired  before  March  1,  1913,  when 
its  fair  market  value  as  of  that  date  is  lower  than  its  cost,  the 
deductible  loss  is  the  excess  of  such  fair  market  value  over  the 
amount  realized  therefor. 


Cost. 

Pair  mar- 
ket value 
March  1, 
1913. 

Sale  price. 

Deductible   loss. 

.$10,000 

!i;."'.,o<io 

$3,000 

?2.000. 

Excess    of    fair    market    value    over    amount 
ri'alized.      Loss    accruing    prior    to    March    1, 
191;!,   not   (leductilile. 

No  gain  or  loss  is  recognized  in  the  case  of  property  acquired 
before  March  1,  1913,  and  sold  or  disposed  of  at  more  than 
cost,  but  at  less  than  its  fair  market  value  as  of  that  date. 


Cost. 


.$10,000 


Fair  mar- 
ket value 
March  1, 
1913. 


.$30,000 


Sale  price. 


$20,000 


No  taxable  gain  or  deductible  loss.  Reason: 
A  gain  on  whole  transaction,  whicli  gain  is 
attributable  to  period  prior  to  March  1,  1913. 


No  gain  or  loss  is  recognized  in  the  case  of  property  acquired 
before  March  1,  1913,  and  sold  or  disposed  of  at  less  than  cost 
but  at  more  than  its  fair  market  value  as  of  that  date. 


Cost. 


$10,000 


Fair  mar- 
ket value 
March  1, 
1913. 


$3,000 


Sale  price. 


$.1,000 


No  taxable  gain  or  deductible  loss.  Reason : 
A  loss  on  whole  transaction,  which  loss  is 
attributable  to  period  prior  to  Marcli  1,  1913. 


Where  the  cost  is  equal  to  or  greater  than  the  fair  market 
value  as  at  March  1,  1913,  and  the  selling  price  exceeds  the 
cost,  the  taxable  gain  is  the  excess  of  the  selling  price  over  the 
cost. 


Cost. 

Fair  mar- 
ket value 
March  1, 
1913. 

Sale  price. 

Taxable  gain. 

$10,000 

$5,000 

$20,000 

$10,000. 

Reason :      Gain    on    whole    transaction,    all    of 

which    is    attributable    to    period    subsequent 

to   March  1,  1913. 

INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY 


417 


Where  the  fair  market  value  as  at  March  1,  1913,  is  greater 
than  the  cost  and  the  selling  price  is  less  than  the  cost,  the  de- 
ductible loss  is  the  amount  by  which  the  cost  exceeds  the  selling 
price. 


Cost. 

Kiilr  iiiiir- 

Mur.h  1. 
I'.il.-i. 

Sail'  price. 

DiMliictilde   Id.ss. 

$10.0(10 

$1.-1.000 

.i;.">.<Kio 

$.').0<I0. 

iieii.soii :  Loss  on  whole  triinsaetiou.  all  of 
wlikli  is  attrilmtalilo  to  pi'iiod  siil)se(|ueiU 
to  March  1,  lOi:!.  OiU.v  actual  U'ss  sustained 
deductible. 

Subsequent  Sale.  The  amount  of  income  derived  from  a 
subsequent  sale  for  cash  of  property  received  in  exchange  for 
other  property  on  or  after  March  1,  1913,  is  the  excess  of  the 
amount  so  received  over  the  "readily  realizable"  market  value 
("fair"  market  value,  under  the  1918  Law)  of  the  property 
acquired  at  the  date  of  the  acquisition.  If  the  property  received 
in  exchange  is  substantially  the  same  property  or  has  no  such 
value,  then  no  gain  or  loss  is  realized,  but  the  new  property  is  to 
be  regarded  as  substituted  for  the  old  property  and  upon  the 
sale  of  the  new  property  the  amount  of  income  derived  is  the 
excess  of  the  amount  so  received  over  the  cost  of  the  old  property. 
However,  if  the  old  property  was  acquired  prior  to  March  1, 
1913,  and  its  fair  market  price  or  value  as  of  that  date  is  in 
excess  of  its  cost  but  less  than  the  amount  received,  the  taxable 
gain  is  the  excess  over  such  value  as  of  March  1,  1913,  of  the 
amount  received.  No  gain  is  recognized  if  the  property  is  sold 
at  more  than  the  cost  of  the  old  property,  but  at  less  than  its 
fair  market  value  as  of  March  1,  1913.-'' 

Cost  of  Property.  The  cost  of  property  is  the  actual  price 
paid  for  it  when  acquired,  together  with  (a)  the  expense  of 
acquiring  it,  (b)  the  expense  of  selling  it,  (c)  the  cost  of  any 
improvements  or  betterments  which  have  been  made  with  respect 
to  the  property,-'^  and  (d)  carrying  charges,  provided  they  have 
been  capitalized  and  have  not  been  deducted  in  any  annual  return 
of  the  owner  filed  subsequent  to  the  incidence  of  the  income 
tax.-''  Interest  should  not  be  added  to  the  purchase  price  in 
order  to  ascertain  cost,-''  and  cost  must  be  reduced  by  the  amount 


•-':{  Rejr.  45,  Art.  1564,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 
-'-«  T.  D.  2090. 

-•''  T.  D.  2137.     This  rule  should  be  retained  under  the  present  law. 
-'■•Walsh  V.  Brewster,  41  Sup.  Ct.  Rep.  392;  Hays  v.  Gauley  Mountain  Coal 
Co.,  247  U.  S.  189.     In  this  case  the  court  said:  "That  the  sale  resulted  in  a 


418  FEDERAL  INCOME  TAX 

of  any  depreciation  or  depletion  sustained  and  deducted  since 
February  28,  1913.27  Cost  is  sometimes  composed  of  elements 
difficult  to  reduce  to  dollars  and  cents.  In  a  case  in  which  a  tax- 
payer purchased  land  from  his  mother  the  consideration  was  (a) 
an  amount  of  cash,  (b)  a  promise  to  support  the  mother  for 
life,  and  (c)  taking  out  an  insurance  policy  payable  to  the 
mother  if  the  taxpayer  should  predecease  her.  Upon  a  sale  of 
the  land  the  cost  was  determined  by  adding  to  (a)  the  cost  of 
a  year's  maintenance  of  the  mother  multiplied  by  her  life  ex- 
pectancy and  the  premiums  paid  or  to  be  paid  during  such  life 
expectancy  of  the  mother.^s 

Cost  of  Lease.  Where  a  lease  providing  that  repairs  or  im- 
provements made  by  the  lessee  reverted  to  the  lessor  upon  ter- 
mination, the  lessee  in  computing  his  profit  upon  an  assignment 
of  the  lease  is  entitled  to  deduct  from  the  sale  price  the  cost 
of  improvements  less  so  much  of  such  cost  as  had  previously 
been  returned  through  depreciation  deductions.^^ 

Stock  Received  As  Bonus.  It  was  held  under  the  1918  Law 
that  where  common  stock  is  received  as  a  bonus  with  the  pur- 
chase of  preferred  stock  or  bonds,  the  total  purchase  price  must 
be  fairly  apportioned  between  the  stock  and  securities  purchased 
for  the  purpose  of  determining  the  portion  of  the  consideration 
attributable  to  each  class  of  stock  or  securities  and  so  represent- 
ing its  cost,  but  if  that  should  be  impracticable  in  any  case,  no 

gain  or  profit  to  the  extent  of  $210,000,  the  difference  between  the  buying 
and  selling  prices,  is  not  to  be  doubted,  for  there  is  no  merit  in  the  conten- 
tion that  interest  should  be  added  to  the  purchase  price  in  order  to  ascer- 
tain its  cost.  The  money  that  went  into  the  purchase  was  not  loaned  at 
interest;  on  the  contrary,  by  the  very  fact  of  the  purchase  it  was  placed 
where  it  could  not  earn  interest  for  the  respondent  in  the  ordinary  sense, 
and  the  gain  represented  by  the  increase  of  selling  price  over  cost  price 
must  be  regarded  as  a  substitute  for  whatever  return  some  other  form  of 
investment  might  have  yielded."  The  court  refused  to  pass  on  this  ques- 
tion in  State  ex  rel.  Bundy  v.  Nygaard  (Wis.),  158  N.  W.  87. 

27  Reg.  45,  Art.  1561,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767.  It  is,  of 
course,  immaterial  whether  such  depreciation  or  depletion  is  subtracted  from 
cost  or  added  to  selling  price;  in  either  event  it  increases  the  profit.  Where 
a  flat  occupied  in  part  by  the  owner  is  sold,  cost  must  be  reduced  only 
by  depreciation  sustained  on  the  portion  used  for  rental  purposes  (0.  D. 
1026,  T.  B.  37-21-1810).  Inasmuch  as  no  deduction  for  depreciation  of  a 
personal  residence  is  allowable,  a  taxpayer  in  determining  the  gain  or  loss 
arising  from  the  sale  of  his  personal  residence,  continuously  occupied  by 
him  as  such,  is  not  required  to  reduce  the  cost  of  the  property  or  its  fair 
market  value  as  at  March  1,  1913,  by  the  depreciation  sustained.  (O.  D. 
600,  T.  B,  30-20-1085,  A.  R.  R.  249,  T.  B.  34-20-1168.) 

28  0.  D.  945,  T.  B.  24-21-1682. 

29  0.  D.  746,  T.  B.  50-20-1339. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY  419 

profit  on  any  subsequent  sale  of  any  part  of  the  stock  or  securi- 
ties will  be  realized  until  out  of  the  proceeds  of  sales  shall  have 
been  recovered  the  total  cost.^^ 

Selling  Price.  A  sale  of  property  usually  involves  the  payment 
of  cash  in  whole  or  in  part  therefor.  The  statute,  however,  taxes 
income  from  dealings  in  property  as  well  as  sales  thereof,  and 
reaches  transactions  such  as  exchanges  of  property,  which,  in 
effect,  may  be  sales  for  a  consideration  in  the  equivalent  of 
cash.  In  a  sense,  property  received  in  exchange  for  other  prop- 
erty constitutes  a  selling  price  other  than  cash,  and  in  such 
cases  the  determination  of  the  amount  thereof  and  the  gains, 
profits  or  income  of  the  vendor,  if  any,  presents  the  difficulties 
discussed  in  the  following  paragraphs. 

Market  Value.  It  has  been  indicated  that  in  many  instances 
when  property  acquired  prior  to  March  1,  1913,  is  disposed  of, 
its  "fair  market  price  or  value"  on  that  date  is  to  be  taken  in 
lieu  of  cost  in  determining  the  gain  derived,  or  the  loss  sustained, 
from  the  transaction.  Again,  when  property  is  disposed  of,  the 
owner  may  not  receive  cash ;  the  consideration  may  be,  in  whole 
or  in  part,  other  property.  In  other  words,  the  transaction  may 
constitute,  in  whole  or  in  part,  an  exchange  of  property  for 
property.  Particularly  is  this  true  in  regard  to  the  organi- 
zation and  reorganization  of  corporations.  In  such  cases  the 
selling  price  of  the  property  sold  was,  under  the  1918  Law, 
the  "fair  market  value,  if  any,"  of  the  property  received.^^ 
In  transactions  involving  the  sale  or  disposition  of  property, 
sometimes  referred  to  as  capital  transactions,  the  determination 
of  the  gain  derived  or  the  loss  sustained  may,  then,  require  the 
determination  of  the  "fair  market  price  or  value"  on  March  1, 
1913,  of  the  property  sold.  Under  the  1918  Law  it  might  require 
the  determination  of  the  "fair  market  value,  if  any"  of  the 
property  received  as  of  the  date  of  the  transaction.  Under  the 
present  law  it  may  require  the  determination  of  the  "readily 
realizable"  market  value  of  the  property  received  as  of  the  date 
of  the  transaction.^- 

30  Reg.  45,  Art.  39,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 

31  Revenue  Act  of  1921,  §202    (c)  ;  Revenue  Act  of  1918,  §202    (b). 

^-  The  market  price  or  value  of  property  on  jriven  dates  is  material  in 
ether  connections.  In  the  case  of  property  acquired  before  March  1,  1913, 
the  market  value  of  the  property  on  that  date  is  the  basis  or  capital  sum 
for  purposes  of  depreciation  or  depletion.  (Revenue  Act  of  1921,  §§  214  (a) 
8,  10,  234  (a)  7,  9;  Reg.  45,  Arts.  161  and  201.)  Likewise,  where  the 
property  is  purchased  for  stock,  the  market  value  of  the  stock  paid  for  it  at 
the  time  of  the  purchase  constitutes  its  cost  for  purposes  of  depreciation 
and  depletion    (Reg.  45,  Art.   167).    Services  may  be  paid   for  with   stock, 


420  FEDERAL  INCOME  TAX 

These  considerations  indicate  the  importance  of  a  careful 
analysis  of  the  term  "fair  market  price  or  value"  and  "fair 
market  value,  if  any,"  and  the  kind  of  evidence  by  which  such 
market  values  may  be  established. 

It  will  be  noted  that  when  establishing  a  basis  for  calculating 
the  selling  price  equivalent  of  property  sold  or  disposed  of,  the 
Revenue  Act  of  1918  used  the  expression  "fair  market  value, 
if  any."""'  When  referring  to  the  basis  for  computing  the  profit 
derived  or  loss  sustained  on  property  acquired  prior  to  March  1, 
1913,  both  that  statute  and  the  present  law  use  the  expression 
"fair  market  price  or  value." ^^^  The  treasury  department  contends 
that  the  word  "price"  is  narrower  in  its  scope  than  the  word 
"value"."""  It  has  nowhere,  however,  given  emphasis  to  the  ex- 
pression "if  any",  the  force  of  which  will  be  discussed  below. 
Irrespective  of  these  differences  of  phraseology,  there  is  a  funda- 
mental distinction  between  the  purposes  underlying  the  deter- 
mination of  fair  market  value  in  the  two  instances.  When  prop- 
erty is  exchanged  for  other  property,  the  property  received  may 
or  may  not  be  such  as  to  give  rise  to  income  within  the  meaning 
of  the  statute  and  Constitution.  It  is  admitted  even  by  the 
treasury  department  that  cases  may  exist  in  which  property 
may  have  no  fair  market  value  so  as  to  constitute  taxable  in- 
come.''^* On  the  other  hand,  it  is  admitted  by  the  treasury  de- 
partment and  well  settled  by  the  decisions  that  in  ascertaining 
the  gain  or  loss  resulting  from  a  sale  or  other  disposition  of 
property,  the  purpose  of  valuing  such  property  on  March  1, 
1913,  is  to  determine  the  amount  which  must  be  withdrawn 
from  the  selling  price  in  order  to  keep  the  capital  intact  and 
that  it  would  be  necessary  so  to  withdraw  the  value  of  the 
property  on  March  1,   1913,  even  if  there  were  no  statutory 

which  raises  question  of  the  market  value  of  the  stock  (which  constitutes 
income  to  the  recipient)  at  the  time  of  receipt.  (See  Chapter  15.)  Under 
the  Excess-Profits  Tax  Law,  where  tangible  property  is  acquired  from  a 
stockholder  as  a  gift  or  at  a  value  in  excess  of  the  consideration  paid  there- 
for, the  amount  of  the  excess  is  deemed  to  be  paid-in  surplus;  and  when 
the  actual  cash  value  of  tangible  property  exceeds  the  par  value  of  the 
stock  issued  therefor,  the  excess  over  such  par  value  may  be  treated  as 
paid-in  surplus.  (Revenue  Acts  of  1918  and  1921,  §326  (a)  (2),  Reg.  45, 
Art.  837.)  The  calculation  of  this  paid-in  surplus  necessitates  the  valu- 
ation of  such  tangible  property  at  the  date  of  acquisition.  For  cases  illus- 
trating these  several  connections  in  which  the  market  value  of  property 
becomes  important  see:  O.  D.  1008,  T.  B.  35-21-1788;  O.  D.  1064,  T.  B. 
42-21-1868. 

S3  Revenue  Act  of  1918,  §202    (b). 

34  Revenue  Act  of  1918,  §202   (a). 

35  T.   B.   R.   57,  T.   B.   19-19-494. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      421 

provision  therefor."'  This  would  argue  greater  necessity  for 
determining  some  market  value  as  of  March  1,  1913,  for  the 
property  disposed  of  than  for  determining  market  value  as  of 
the  date  of  the  transaction  for  the  property  received.  In  other 
words,  it  may  well  be  that  for  purposes  of  a  valuation  as  of 
March  1,  1913,  Congress  intended  that  the  phrase  "fair  market 
price  or  value"  be  given  a  much  broader  meaning  than  the 
phrase  "fair  market  value,  if  any,"  which  was  used  with  refer- 
ence to  property  received  in  an  exchange  of  property  for 
property. 

"Fair  Market  Value,  If  Any."  Passing  first  to  a  definition 
of  the  phrase  "fair  market  value,  if  any,"  it  will  be  noted  that 
the  1918  Law  provided:  "When  property  is  exchanged  for 
other  property,  the  property  received  in  exchange  shall,  for  the 
purpose  of  determining  gain  or  loss,  be  treated  as  the  equivalent 
of  cash  to  the  amount  of  its  fair  market  value,  if  any  *  *  *  ."=''* 

Interpreting  this  provision  the  treasury  department  ruled  as 
follows:  "Gain  or  less  arising  from  the  acquisition  and  sub- 
sequent disposition  of  property  is  realized  when  as  the  result  of 
a  transaction  between  the  owner  and  another  person  the  prop- 
erty is  converted  into  cash  or  into  property  (a)  that  is  essentially 
different  from  the  property  disposed  of,  and  (b)  that  has  a 
market  value.  In  other  words,  both  (a)  a  change  in  substance 
and  iiot  merely  in  form,  and  (b)  a  change  into  the  equivalent 
of  cash,  are  required  to  complete  or  close  a  transaction  from 
which  income  may  be  realized."-^" 

This  regulation  was  an  admission  in  general  terms  of  the 
principle  which  should  control  in  determining  whether  an  ex- 
change of  property  for  property  was  a  "closed  transaction"  and 
resulted  in  taxable  income  or  deductible  loss  under  the   1918 

•■{«T.  B.  R.  57,  T.  B.  19-19-494;  Rej?.  45,  Art.  1563,  and  Art.  1564,  as 
amended  by  T.  D.  3206,  T.  B.  33-21-1767. 

■'«TT.  B.  R.  57,  T.  B.  19-19-494;  Doyle  v.  Mitchell,  247  U.  S.  179;  Lynch 
V.  Turrish,  247  U.  S.  221;  Southern  Pacific  Co.  v.  Lowe,  247  U.  S.  330..  This 
is  important.  It  means  that  the  term  "fair  market  price  or  value"  as  used 
in  subdivision  (a)  1  of  §202  adds  nothing  to  the  common  law  rule  founded 
on  the  Constitution.  If  this  is  true,  the  meaning  of  the  tt>rm  as  used  in 
the  statute  is  of  little  moment. 

•''^  The  statements  contained  in  the  text  above  are  illustrated  by  the 
distinction  in  phraseology  contained  in  the  present  law  between  a  reference 
to  the  value  on  March  1,  1913,  of  property  exchanged  and  the  value  on  the 
date  of  acquisition  of  property  received.  In  the  former  case  the  1921  Law 
uses  the  same  expression  as  the  1918  Law  ("fair  market  price  or  value")  ; 
in  the  latter  case  it  uses  the  expression  "readily  realizable  market  value." 
Revenue   Act  of   1918,   §202    (b). 

39  Reg.  45,  Art.  1563. 


422  FEDERAL  INCOME  TAX 

Law.  For  the  present  the  discussion  will  ignore  the  question 
whether  there  has  been  "a  change  in  substance  and  not  merely 
in  form"^o  and  will  refer  to  the  question  whether  there  has 
been  a  change  "into  the  equivalent  of  cash,"  which  underlies 
the  discussion  of  the  term  "fair  market  value,  if  any."  In  other 
words,  in  providing  that  the  property  received  shall  be  treated 
as  the  equivalent  of  cash  to  the  extent  of  the  amount  of  its 
"fair  market  value,  if  any,"  the  1918  Law  clearly  contemplated 
that  the  term  "fair  market  value"  should  be  used  as  a  test  to 
determine  whether  property  was  the  "equivalent  of  cash."  It 
is  just  as  true  to  say  that  property  has  no  fair  market  value  if 
it  is  not  the  "equivalent  of  cash"  as  to  put  the  statement  in 
converse  form. 

Following  the  interpretation  by  the  treasury  department  just 
quoted,  in  its  most  general  statement  regarding  the  meaning  of 
the  term  "market  value",  the  department  made  no  distinction 
between  the  meaning  of  the  term  as  used  or  contemplated  in 
the  various  parts  of  the  Revenue  Act  of  1918.^^  The  statement 
was  as  follows :  "  *  *  *  the  fair  value  of  the  property  in  money 
as  between  one  who  wishes  to  purchase  and  one  who  wishes  to 
sell.  It  is  not,  however,  what  can  be  obtained  for  the  property 
when  the  owner  is  under  peculiar  compulsion  to  sell  or  the 
purchaser  to  buy;  nor  is  it  a  purely  speculative  value  which  an 
owner  could  not  reasonably  expect  to  obtain  for  the  property 
although  he  might  possibly  be  fortunate  enough  to  do  so. 
'Market  value'  is  the  price  at  which  a  seller  willing  to  sell  at 
a  fair  price  and  a  buyer  willing  to  buy  at  a  fair  price,  both  hav- 
ing reasonable  knowledge  of  the  facts,  will  trade.  It  implies  the 
existence  of  a  public  of  possible  buyers  at  a  fair  price." ^^^  These 
definitions  and  interpretations  w^ere  so  general,  however,  that 
they  help  very  little  in  a  determination  of  any  specific  question. 
Was  "fair  market  value"  intended  to  be  equivalent  to  "intrinsic 
value"  which  attaches  to  all  property,  or  did  it  mean  value  as 
established  upon  an  exchange,  or  something  between  these  two 
extremes?  The  treasury  department  admitted  the  general 
proposition  that  property  may  be  received  upon  an  exchange 
which  has  no  "fair  market  value"  and  is  not  equivalent  to  cash. 

40  For  instance,  an  exchange  of  a  stock  certificate  for  a  voting  trust  cer- 
tificate does  not  produce  income  because  the  conversion  is  merely  in  form. 
Questions  as  to  whether  a  conversion  has  been  more  than  formal  are  usually 
raised  in  connection  with  the  organization  and  reorganization  of  corpo- 
rations and  the  subject  will  be  discussed  below  under  that  heading. 

41  There  is   obviously  such   a   distinction   under  the   present   statute. 

42  T.  B.  R.  57,  T.  B.  19-19-494. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      423 

For  instance,  it  was  ruled  that  stock  in  a  "small,  closely  held 
corporation"  was  not  the  equivalent  of  cash  if  the  stock  has  no 
market  value,  which,  of  course,  implies  that  the  stock  of  small, 
closely  held  corporations  may  have  no  market  value.'"'  On  the 
other  hand,  in  another  ruling,  although  reiterating  the  rule  that 
property  received  upon  an  exchange  may  have  no  "fair  market 
value,"  the  department  held  thAt  in  determining  whether  prop- 
erty has  a  "fair  market  value"  all  available  evidence  must  be 
considered;  that  a  case  in  which  property  has  no  "fair  market 
value"  should  be  regarded  as  "unusual"  and  a  determination  that 
the  property  has  no  "fair  market  value"  should  not  be  made 
"lightly" ;  that  property  is  not  without  "fair  market  value" 
merely  because  there  is  a  considerable  divergence  of  opinion  as 
to  its  value.  The  department  took  the  view  that  property  had 
no  "fair  market  value  when  market  conditions  were  such  that 
there  icould  he  no  trading  in  the  property  in  question  at  a 
fair  price." ^^  The  force  of  the  words  "would  be"  is  to  be  noted. 
They  required  the  taxpayer  to  prove  not  that  there  was  or 
had  been  no  trading  or  other  evidence  of  value,  but  that  there 
tvould  be  none  if  the  property  were  put  up  for  sale.  The  de- 
partment refused  to  admit  that  property  has  no  fair  market 
value  when  there  was  "no  price  therefor  established  by  public 
sales  or  sales  in  the  way  of  ordinary  business" ;  it  held  that  the 
fact  that  there  is  no  market  price  or  current  price  so  established 
did  not  indicate  that  the  property  might  not  be  readily  sold 
at  a  fair  price.^''  Again,  although  the  department  admitted  that 
stock  in  a  small,  closely  held  corporation  might  have  no  "fair 
market  value,"  it  held  that  stock  in  such  a  corporation  "does  not 
ipso  facto  lack  'a  fair  market  value'  "  because  "evidence  as  to  the 
assets  and  liabilities  of  such  a  corporation  and  as  to  its  earnings 
may  furnish  very  definite  indications  as  to  its  'fair  market 
value'."  ^'"• 

When  the  assets  and  liabilities  and  earnings  of  a  coiporation 
are  resorted  to  in  order  to  obtain  the  value  of  the  stock  of  such 
corporation,  the  result  reached  constitutes  the  "intrinsic"  value 

•1-  See  Reg.  45,  Art.  1563. 

■»^  T.  B.  R.  57,  T.  B.  19-19-494. 

»•"'  T.  B.  R.  57,  T.  B.  19-19-494. 

"■•T.  B.  R.  57,  T.  B.  19-19-494.  This  ruling  went  on  to  stcite:  "Even  if  a 
corporation  is  newly  organized  and  has  never  done  business  as  such,  but 
has  succeeded  to  the  business  of  an  individual  or  partnership,  its  stock 
will  ordinarily  have  a  'fair  market  value'  ascertainable  by  reference  to 
it  assets  and  liabilities,  the  history  of  the  specific  business,  and  the  history 
and  conditions  of  the  industry  in  general." 


424  FEDERAL  INCOME  TAX 

of  such  stock.^'  Although  professing  the  general  principle  that 
property  might  have  no  "fair  market  value,"  the  treasury  de- 
partment ruled,  under  the  1918  Law,  that  intrinsic  value  might 
be  resorted  to,  if  not  as  equivalent  to  market  value,  at  least  as 
indicative  of  market  value.^"^  And  intrinsic  value  is  so  taken 
not  as  evidence  of  a  market  value  which  has  existed  or  which 
is  proved  by  past  or  present  transactions ;  it  is  taken  to  indicate 
an  hypothetical  or  potential  market  value — that  is,  what  the 
property  exchanged  would  bring  if  it  were  put  up  for  sale. 
While  there  are  numerous  authorities  defining  market  value  in 
such  a  way  as  to  include  intrinsic  value  when  there  is  no  evi- 
dence of  actual  sales  or  dealings  in  the  property  involved,  it  is 
to  be  noted  that  these  authorities  deal  with  cases  in  which  by 
reason  of  some  accomplished  fact  or  peculiar  circumstances  it  is 
€;ssential  to  make  a  fair  valuation.  In  other  words,  the  court  was 
required  to  value  the  property  involved  in  order  to  do  equity  in 
the  situation  at  bar.^^  There  are  authorities,  however,  making 
it  clear  that  there  is  a  popular  distinction  between  "market"  and 
"intrinsic"  value.''^    In  using  the  expression  "fair  market  value, 

47  The  Standard  Dictionary  defines  the  word  "intrinsic"  as  follows : 
"Pertaining-  to  the  nature  of  a  thing  or  person ;  not  simply  apparent  or  ac- 
cidental; inherent;  real;  true;  as,  the  intrinsic  value  of  a  bronze  medal  is 
small."  The  meaning  of  the  word  "intrinsic"  is  illustrated  by  the  following 
quotation  from  Virginia  v.  West  Virginia,  238  U.  S.  202:  "The  fact,  how- 
ever, that  there  was  no  sufficient  proof  of  market  value,  was  not  an  insuper- 
able obstacle  to  the  making  of  a  fair  valuation.  It  was  clearly  proper  to  in- 
troduce evidence  tending  to  show  the  intrinsic  value  of  the  shares  *  '*  * 
For  this  purpose,  resort  was  had  to  corporate  accounts  and  reports  of  the 
company's  affairs."    See  0.  D.  955,  T.  B.  26-21-1699. 

■iS  The  department  admits  the  distinction  between  the  capital  assets  of  a 
corporation  and  the  valuation  of  shares  owned  by  the  shareholders  in  A.  R. 
R.  33,  T.  B.  9-20-764  (see  also  T.  D.  2979,  amending  Reg.  45,  Art.  102), 
a  distinction  which  indicates  the  danger  of  resorting  to  intrinsic  value.  The 
distinction  between  resorting  to  intrinsic  value  as  indicative  of,  as  dis- 
tinguished from  equivalent  to,  market  value  is  more  apparent  than  real. 
If  it  is  to  be  resorted  to  as  indicative  of  market  value  when  no  other  evi- 
dence as  to  market  value  exists,  it  is  in  practical  effect  taken  as  the  equiva- 
lent of  market  value. 

^'^  Thus  in  a  condemnation  case  the  complainant's  property  has  been 
taken  from  him  by  virtue  of  the  power  of  eminent  domain.  Justice  re- 
quires that  he  be  compensated  and  this  necessarily  involves  the  determina- 
tion of  the  market  value  of  the  property  condemned.  Obviously,  in  such 
a  case,  the  court  is  required  to  determine  a  value  even  if  it  is  unable  to  do 
so  by  reference  to  actual  sales  or  dealings  in  the  same  kind  of  property. 
(See  North  Amer.  Tel.  Co.  v.  Northern  Pac.  Ry.  Co.,  254  Fed.  417.) 

'"i'*  This  is  proved  by  the  quotation  in  footnote  47  above,  from  Virginia 
V.  West  Virginia,  238  U.  S.  202.  See  Henry  v.  North  American  Ry.  Const. 
Co.,  158  Fed.  79;  Crichfield  v.  Julian,  147  Fed.  65;   Industrial  &  General 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      425 

if  any  "  did  Congress  intend  to  include  a  value  not  established 
by  any  sales  or  dealings  in  the  property  subject  to  valuation  and 
which  could  onlv  be  proved  by  speculation  as  to  what  the  public 
mUjht  pay  for  the  property  in  question?  In  answering  this  ques- 
tion it  is  necessary  to  keep  constantly  in  mind  the  purpose  or 
obtaining  "fair  market  value,  if  any,"  when  there  has  been  an 

Trust  V.  Tod,  180  N.  Y.  215,  73  N.  E.  7.   See  also  O.  D.  955   T.  B   26-21-1699 
and  O    D    10H4    T    B.  42-21-1868,  in  which  the  treasury  department  itself 
contraits  "market"  and  "intrinsic"  value.      It  -  ^^^^P^^^^J^f  ^^"vIll-^'^Rv 
slightly  different  viewpoint  in  North  Amer.  Tel.  Co    v.  Northern  Pac^Ry^ 
Co     4i    Fed    417,   as   follows:     "The   term   'market  value,   as   the  words 
faii'lv"  import,   indicates   price   established   in   a   market   where   the   ar  icle 
s  dealt  in  b;  such  a  multitude  of  persons,  and  such  a  large  number  of 
transactions. 'as  to  standardize  the  price.     Proof  of  such  a  -arket  va^ue 
can  only  be  made  by  one  of  the  recognized  methods  of  pi-ovnig  the  pnce 
current  in  a  market.    Individual  dealings  are  not  competent  to  prove  it.   The 
term   is.  however,  frequently  used   in   a  figurative  sense,  as  "meaning   the 
fair  or  reasonable  value  of  the  property-that  is,  such  value  as  the  piop- 
erty  would  have  if  it  were  dealt  in  according  to  the  practices  of  a  marke 
overt     This  is  the  meaning  which  the  term  usually  has  when  applied  to  real 
property      To  prove  market   value   when  it  is   used   in   this   secondary  or 
figurative   sense,   it   is   proper   to   receive   evidence   of   individual    transac- 
tions, even  offers  made  in  good  faith  for  property  of  like  charactei     the 
nature  of  the  property,  its  location,  its  rental  value,  the  uses  to  which  it 
can  be  put,  and  all  the  manifold  elements  which  are  admissible  to  show  the 
fair  and  reasonable  value  of  property  which  is  not  so  traded  in  as  to  give 
it   a   market  value  in   the   primary   sense   of  the  term."     It   is   argued   by 
economists  that  there  is  no   such  thing  as   intrinsic   value;   that   value   is 
market  value  since  nothing  has  any  value  except  as  related  to  other  things 
in  the  mind  of  a  buying  public.     This  may  be  true  economically,  but  it  does 
not  touch  the  question  under  discussion.    We  are  dealing  not  with  theories 
but  a  question  of  fact-what  people  mean  by  the  words  they  use    however 
inaccurately  they  may  use  them  from  the  economic  standpoint.     It  is  to  be 
regretted   that  the   Supreme  Court  did   not  pass  expressly   upon   the   sub- 
ject matter  of  the  above  admission   made   by  the  solicitor-general.     With 
regard  to  gains  represented  by  a  difference  between  selling  price  and  value 
on  March  1,  1913,  in  cases  in  which  the  selling  price  was  less  than  pur- 
chase   price,    the    admission    of    the    solicitor    was    undoubtedly    necessary, 
under   the   sixteenth    amendment,   because    such     a   gam     could     not     con- 
stitutionally be  taxed.     But  the  allowance  of  any  deduction  for  loss  is  a 
matter  in  which  Congress  is  not  inhibited  by  any  constitutional  limitation, 
and  to  deny  the  deduction  of  losses   represented   by   a  difference  heUveen 
selling  price  and  value  on  March  1,  1913,  where  the  selling  price  was  less 
than   purchase  price,  is  in  effect,  to  neutralize  a  loss  occurring  after  the 
incidence  of  the  tax  by  an  admittedly  non-taxable  gain  accruing  prior  to 
the  incidence  of  the  tax.     The  1918  law  plainly  stated   that   such  a   loss 
should  be  an  allowable  deduction  and  the  plain  terms  of  the  statute,  where 
no  constitutional  limitations  intervene,  should  be   respected,  whatever  the 
result.    (See  Chapter  47.)    Under  the  1921  Law  the  intention  of  Congress 
to  follow  the  solicitor's  admission  is  clear,  but  a  provision  of  this  law  may 
not  be  used   in   interpreting  a   previous  statute. 


426  FEDERAL  INCOME  TAX 

exchange  of  property  for  property.  If  the  fair  market  value  of 
the  property  exchanged  is  not  obtained,  the  tax  on  the  apprecia- 
tion in  value  of  the  property  to  the  date  of  the  transaction  is  not 
evaded;  it  is  only  postponed.  Eventually  it  must  be  paid,^'^ 
As  a  general  proposition  the  only  question  involved  is  tvhen 
the  tax  shall  be  paid.  The  determination  of  fair  market  value 
refers  merely  to  the  time  when  the  taxpayer  shall  pay  tax  upon 
the  appreciation  in  value  of  his  property.  He  is  required  to 
pay  when  he  receives  the  "equivalent  of  cash."  In  the  light  of 
this  purpose  it  may  be  doubted,  particularly  in  view  of  the  use 
of  the  words  "if  any",  whether  in  the  Revenue  Act  of  1918 
Congress  intended  to  ignore  the  popular  distinction  which  has 
just  been  indicated  between  "market"  or  primary  and  "intrinsic" 
or  secondary  value.  Under  the  broad  definition  of  market  value 
contained  in  some  authorities  there  will  be  much  property  having 
a  market  value  which  is  not  the  equivalent  of  cash.  It  would 
seem  rather  that  when  the  question  is  a  definition  of  the  "equiva- 
lent of  cash,"  the  term  "fair  market  value"  must  be  construed 
in  such  a  way  as  not  to  include  a  value  which  cannot  be  converted 
into  cash.'^s 

Even  if  this  doubt  be  resolved  in  favor  of  the  government,  ^^ 
it  is  apparent  that  the  rulings  referred  to  above  render  it  prac- 
tically impossible  for  the  taxpayer  to  prove  that  property  re- 
ceived upon  an  exchange  has  no  "fair  market  value."  Evidence 
of  no  sales  or  dealings  in  property  does  not  prove  absence  of 
such  value.  The  taxpayer  has  the  burden  of  proving  a  negative, 
that  there  tvould  be  no  fair  market  value,  if  he  oflfered  the  prop- 
erty in  question  for  sale.  There  are  cases  in  which  it  might 
seem  that  although  property  has  never  been  dealt  in  so  that 
no  market  actually  existed,  the  existence  of  a  market  in  the 
potential  sense  was  clear.  In  such  cases  the  property  received 
by  the  taxpayer  upon  an  exchange  is  the  "equivalent  of  cash," 
whether  or  not  it  has,  technically,  a  "fair  market  value."  But 
there  are  also  cases  in  which  it  might  be  inconvenient  at  least 

•">!  Under  the  1918  Law,  the  one  exception  to  this  rule  is  that  if  the  tax- 
payer gives  the  property  away  or  dies  and  the  property  is  sold  by  his  donees, 
heirs  or  legatees,  such  donees,  heirs  or  legatees  will  escape  tax  upon  the 
appreciation  to  the  date  when  they  receive  the  property.  Under  the  present 
law  a  gift  would  not  avoid  the  tax  on  property  appreciation. 

52  There  is  nothing  in  the  case  of  U.  S.  v.  Phellis,  42  Sup.  Ct.  Rep.  63,  con- 
flicting with  this  suggestion.  The  stock  distributed  in  this  case  was 
"marketable." 

o-"''  It  is  a  rule  of  statutory  construction  that  taxing  statutes  are  to  be 
construed  most  strictly  against  the  government  and  in  favor  of  the  tax- 
payer.    (Gould  V.  Gould,  245  U.  S.  151.) 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      427 

for  the  taxpayer  to  offer  the  property  involved  for  sale  in  order 
to  prove  that  it  had  no  market  value.  It  would  seem  that  in 
the  ordinary  case,  property  which  has  not  been  dealt  in  cannot 
be  dealt  in  upon  any  reasonable  basis.  Business  men  are  con- 
stantly trading  in  all  sorts  of  property.  The  fact  that  they  are 
not  dealing-  in  a  particular  kind  of  property  is  certainly  an 
indication  that  the  property  has  no  "fair  market  value."  The 
very  necessity  of  resorting  to  evidence  other  than  sales  and 
dealings  in  the  same  kind  of  property  to  prove  the  value  of 
property  goes  to  indicate  that  the  property  is  not  the  "equivalent 
of  cash."  In  other  words,  the  rulings  issued  under  the  1918 
law  practically  closed  the  door  on  the  possibility  of  proving 
absence  of  "fair  market  value,"  by  holding  that  the  absence  of 
sales  or  dealings  in  the  property  did  not  prove  that  there  was  no 
"fair  market  value."  The  fact  that  there  were  and  had  been 
no  such  sales  or  dealings  should  at  least  have  been  held  to  create 
a  presumption  that  no  "fair  market  value"  existed.^ 

"Readily  Realizable  Market  Value."  The  1921  Law  pro- 
vides that  on  an  exchange  of  property,  real,  personal  or  mixed, 
for  any  other  such  property,  no  gain  or  loss  shall  be  recognized 
unless  the  property  received  in  exchange  has  a  "readily  realiz- 
able market  value.""'  The  term  "readily  realizable  market  value" 
should  be  construed  in  the  light  of  the  definition  given  by  the 
treasury  department  under  the  1918  Law  to  the  term  "fair 
market  value,  if  any."  The  general  purpose  of  this  new  pro- 
vision is  to  modify  the  "presumption  in  favor  of  taxation," 
which  had  existed  under  the  1918  Law  (as  interpreted  by  the 
Treasury  Department)."'''  In  many  cases  arising  under  that  law 
the  taxpayer  realized  no  funds  with  which  to  pay  substantial 
taxes  imposed  upon  a  transaction  by  virtue  of  a  technical  con- 
struction of  the  statute.  Obviously,  the  desire  is  to  avoid  this 
evil  of  taxing  profits  which,  if  they  existed,  have  not  in  any  true 
sense  been  realized.  In  other  words,  the  present  law  recognizes 
the  hardship  and  injustice  of  taxing  profits  not  yet  converted  into 
any  real  cash  equivalent.  It  should  be  noted,  however,  that  the 
term  "readily  realizable  market  value"  is  somewhat  vague,  and 
the  application  of  the  term  to  each  particular  exchange  of  prop- 

•''•^  The  Finance  Committee  of  the  senate  has  expressed  this  most  aptly 
in  a  few  words,  as  follows:  "The  existing  law  makes  a  presumption  in  favor 
of  taxation.  The  proposed  act  modifies  that  presumption  *  *  *  >» 
It  may  have  been  a  more  accurate  statement,  if  the  committee  had  said: 
"The  existing  law  (as  enfoi'ced  by  the  department  *  *  *  )."  It  is 
a  question  whether  the  "existing"  law  was  properly  interpreted  by  the  de- 
partment. 

5"' Revenue  Act  of  1921,  §202    (c). 


428  FEDERAL  INCOME  TAX 

erty  will  not  be  easy.  The  problem  of  taxing  gains  derived  upon 
an  exchange  of  property  for  property  has  by  no  means  been 
solved.  The  present  statute  merely  indicates  a  general  intent 
to  restrict  taxable  income  upon  such  exchanges  to  income  which 
has  a  real  cash  equivalent. 

Fair  Market  Price  or  Value  as  of  March  1,  ISIS."*^  The  object 
of  valuing  property  as  of  March  1,  1913,  whether  for  purposes 
of  determining  the  gain  derived  or  the  loss  sustained  upon  a 
sale  or  disposal  thereof,  or  for  purposes  of  ascertaining  a  de- 
preciation or  depletion  capital  sum,  is  to  determine  the  amount 
which  must  be  regarded  as  capital  to  be  withdrawn  from  the 
selling  price  or  from  gross  income.  It  is  necessary  to  value  the 
property  as  of  March  1,  1913,  in  order  to  segregate  capital  and 
income  and  to  insure  the  exemption  of  the  former  from  tax. 
This  is  a  compelling  reason  for  a  valuation  as  of  March  1,  1913, 
upon  the  basis  of  whatever  evidence  is  available,  whether  it  be 
of  sales  or  actual  dealings  in  the  property  involved  or  something 
less  tangible  and  conclusive.  However  the  rule  may  be  with  re- 
gard to  the  "fair  market  value,  if  any,"  of  the  selling  price  or 
consideration  received  upon  disposal  of  property,  where  the 
underlying  issue  is  merely  whether  the  tax  shall  be  paid  at  one 
time  or  another,  it  is  clear  that  the  ''fair  market  price  or  value" 
of  property  as  of  March  1,  1913,  contemplates  a  valuation  upon 
the  best  evidence  obtainable.  It  may  be  that  there  is  nothing  to 
show  that  market  value  as  of  March  1,  1913,  is  greater  than 
previous  cost;  this  does  not  alter  the  fact  that  if  any  evidence 
exists,  even  though  it  be  of  a  less  conclusive  character  than 
actual  sales  and  dealings  in  the  property,  ks  to  the  "fair  market 
price  or  value"  of  property  as  of  March  1,  1913,  that  evidence 
should  be  employed  in  determining  such  value.  In  other  words, 
income  must  be  a  thing  sufficiently  real  to  be  capable  of  being 
taken  out  of  a  business  without  the  impairment  of  capital.  The 
exact  point  at  which  an  impairment  of  capital  begins  is  one  that 
cannot  easily  be  determined  with  precision  and  questions  of  doubt 
as  between  income  and  capital  must  be  resolved  in  favor  of  capi- 
tal.•'•'*  If  the  impairment  of  capital  is  to  be  avoided,  whether 
the  question  be  one  of  determining  the  taxpayer's  capital  at  the 
incidence  of  the  tax  with  regard  to  the  property  disposed  of  or 
one  of  depletion  or  depreciation,  all  evidence  of  value  as  of 
March  1,  1913,  must  be  resorted  to  and  the  term  "fair  market 

50  See  footnote  54. 

57  This  term  is  used  in  both  the  Revenue  Act  of  1921  and  the  Revenue 
Act  of   1918. 

58  T.  B.  R.  48.  T.  B.  16-19-457. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      429 

price  or  value"  as  of  that  date  cannot  be  so  limited  that  it  may 
be  proved  only  by  evidence  of  actual  dealings  in  the  property 
under  consideration  in  a  more  or  less  active  market. 

Proof  of  Market  Value.  There  are  various  methods  of  proving 
"market  value"  in  the  broad  sense  of  that  term.  They  are  dis- 
cussed below  without  reference  to  the  distinction  which  may  exist 
between  the  terms  "fair  market  value,  if  any,"  as  used  in  the 
Revenue  Act  of  1918,  and  "fair  market  price  or  value,"  as  used 
in  the  Revenue  Act  of  1921  and  the  1918  Law,  and  regulations 
issued  thereunder.  It  should  be  observed  at  the  outset  that  the 
fair  market  price  or  value  of  property  on  March  1,  1913,  or 
any  other  date,  is  a  question  of  fact  to  be  established  by  any 
evidence  which  will  reasonably  and  adequately  make  it  appear."''* 
None  of  the  methods  discussed  below  is  to  be  regarded  as  ex- 
clusive ;  one  or  more  of  them  may  be  used  accordingly  as  evidence 
is  available. 

Sales  or  Actual  Dealings  in  Similar  Property.  Probably 
the  most  reliable  method  of  ascertaining  the  value  of  property 
is  by  reference  to  sales  or  actual  dealings  in  similar  property. 
This  method  is  recognized  by  the  Treasury  Department,  and 
wherever  such  evidence  is  available,  it  should  be  used  to  establish 
market  value.''"  The  use  of  market  quotations,  as  established 
upon  an  exchange,  is  essentially  a  resort  to  sales  or  actual  deal- 
ings in  property  as  proof  of  value.  Price  current  lists  and  trade 
journal  quotations  are  also,  within  certain  limitations,  acceptable 
evidence  of  value.*^^     Where  this  method  is  adopted,  the  sales 

59  Reg.  45,  Art.  1561,  as  amended  by  T.  D.  3206,  T.   B.  33-21-1767. 

ooSee  O.  D.  7,  T.  B.  1-19-12;  0.  D.  995,  T.  B.  26-21-1699;  A.  R.  R.  403, 
T.  B.  10-21-1492;  A.  R.  R.  33,  T.  B.  9-20-764;  See  forms  A,  N,  0  and  T, 
in  which  the  value  of  mines,  oil  and  gas  wells,  and  timber  lands  is  to  be 
established  by  reference,  among  other  things,  to  sales  of  similar  property; 
see  also  Reg.  45,  Art.  1584,  in  which  market  value  for  purposes  of  in- 
ventories is  to  be  established  by  current  bid  prices. 

'■'1  Virginia  v.  West  Virginia,  238  U.  S.  202,  212;  Cliquot's  Champagne, 
3  Wall.  114,  141;  Fennerstein's  Champagne  (Fennerstein  v.  United  States), 
3  Wall.  145;  Chaffee  v.  United  States,  16  Wall.  516,  542;  Sisson  v.  Cleve- 
land &  T.  R.  Co.,  14  Mich.  489;  Cleveland  &  T.  R.  Co.  v.  Perkins,  17  Mich. 
296;  Whitney  v.  Thatcher,  117  Mass.  523;  Fairley  v.  Smith,  87  N.  C.  367; 
State  ex  rel.  Mosely  v.  Johnson,  144  N.  C.  257,  56  S.  E.  922,  929;  Nash  v. 
Classen,  163  111.  409,  45  N.  E.  276;  Washington  Ice  Co.  v.  Webster,  68 
Me.  449;  Harrison  v.  Glover,  72  N.  Y.  451.  As  a  preliminary  to  their  ad- 
mission as  evidence  in  the  courts,  such  quotations  must  be  accepted  as 
trustworthy  by  the  trade.  Indeed,  there  are  authorities  which  hold  they 
are  not  acceptable  without  reference  to  the  sources  from  which  the  quoted 
information  is  derived  and  some  proof  that  the  quotations  are  founded  upon 
actual  sales.  (See  Whalen  v.  Lynch,  60  N.  Y.  468,  at  p.  474;  Bunte  v. 
Schuman,  46  Misc.  593;  Fairley  v.  Smith,  87  N.  C.  271;  Norfolk  &  W.  R. 


430  FEDERAL   INCOME  TAX 

or  dealings  in  similar  property  offered  as  proof  should  bear  some 
reasonable  relation  in  volume  to  the  amount  of  property  being 
valued.  It  is  well  settled  that  when  the  market  value  of  a 
commodity  is  in  question,  proof  of  such  value  must  cover  the 
range  of  the  entire  market  and  must  not  contemplate  any  sudden 
or  transient  inflation  or  depression  of  price  resulting  from  in- 
dependent sources/^2  Thus,  the  selling  price  of  a  few  shares  of 
stock  is  of  little  value  in  determining  the  actual  worth  of  all  the 
stock  of  a  corporation. '^^  j^  jg  ^Iso  essential  that  the  sales  of 
similar  property  chosen  as  proof  of  market  value  on  any  given 
date  should  not  be  too  remote  in  point  of  time  from  the  date  of 
valuation.64 

Appraisal.  The  value  of  property  as  of  a  given  date  may 
be  proved  by  an  appraisal  made  by  a  disinterested  person 
familiar  with  values  of  the  kind  of  property  in  question  and  with 
conditions  affecting  such  values  at  the  time  involved.^^ 

Assessment  for  State  Tax  Purposes.  The  assessed  value 
of  property  for  purposes  of  state  taxation  constitutes  evidence 
of  the  value  of  the  property  and  may  be  used  where  the  value 
of  property  is  at  issue  for  federal  tax  purposes.*"'^ 

Cost  or  Cost  of  Reproduction.  Cost  or  cost  of  reproduction 
may  be  taken  as  evidence  of  value  as  of  a  given  date.*^^  If  cost 
is  taken,  proper  allowance  must  be  made  not  only  for  deprecia- 
tion, but  also  for  appreciation,  between  the  dates  of  acquisition 

Co.  V.  Reeves,  97  Va.  284,  33  S.  E.  606;  Vogt  v.  Cope  (Cal.),  4  Pac.  915; 
Fountain  v.  Wabash,  114  Mo.  App.  676;  Mt.  Vernon  Co.  v.  Teschner,  108 
Md.  158;  Doherty  v.  Harris,  230  Mass.  341.) 

62  Sutherland  on  Damages,  Vol.  9,  §233;  Todd  v.  Gamble,  148  N.  Y.  382, 
42  N.  E.  982;  Virginia  v.  West  Virginia,  238  U.  S.  202;  Stein  v.  Hart- 
shore,  123  App.  Div.  (N.  Y.)  467.  The  phrase  "in  the  volume  in  which 
ordinarily  purchased"  contained  in  Art.  1584  of  Reg.  45  is  an  illustration 
of  this  rule.  The  implication  contained  in  this  phrase  is  clearly  that  a 
few  isolated  transactions  in  the  commodity  being  inventoried  would  be 
inadequate  proof  of  market  value. 

63  Matter  of  Curtice,  111  App.  Div.  (N.  Y.)  230,  97  N.  Y.  Supp.  444, 
affirmed  185  N.  Y.  542,  77  N.  E.  1184. 

64  Matter  of  Valentine,  147  N.  Y.  Supp.  231. 

65  O.  D.  955,  T.  B.  26-21-1699.  See  also  Forms  A,  N,  0  and  T,  in  which  the 
value  of  mines,  oil  and  gas  wells,  and  timber  lands  is  to  be  established  by 
reference,  among  other  things,  to  sales  of  similar  property. 

66  See  Forms  A,  N,  O  and  T,  in  which  the  value  of  mines,  oil  and  gas 
wells,  and  timber  lands  is  to  be  established  by  reference,  among  other  things, 
to  sales  of  similar  property.  This  rule  is  applied  when  the  fair  market 
value  of  property  as  of  the  date  of  death  of  the  ovnier  is  in  question,  and 
the  property  has  been  valued  for  purposes  of  a  state  inheritance  tax.  (Reg. 
45,  Art.  562.) 

67  T.  B.  R.  57,  T.  B.  19-19-494. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY  431 

and  valuation.  The  amount  of  appreciation  is  frequently  the 
contested  issue,  however,  and  in  such  cases  cost  furnishes  no 
guide  in  obtaining  the  desired  result.  Cost  of  reproduction  may 
be  largely  a  question  of  expert  testimony. 

Capitalization  of  Income.  Another  test  of  the  value  of 
property  is  furnished  by  its  capacity  for  producing  income. 
Where  the  value  of  property  is  in  doubt,  the  income  produced 
by  the  property  may  be  capitalized  to  obtain  its  value  as  of  any 
given  date.  This  method  is  most  frequently  used  in  valuing  in- 
tangible property.  There  is  no  reason,  however,  why  tangible 
property  may  not  be  valued  similarly.  For  instance,  real  estate 
may  be  valued  by  capitalizing  its  rent  producing  capacity.'"'^ 

Prorating  on  Time  Basis.  Under  prior  laws  it  has  been 
the  practice  of  the  Treasury  Department  to  require  taxable  profit 
to  be  determined  by  first  ascertaining  the  difference  between  cost 
and  selling  price  and  then  prorating  the  result  according  to  the 
number  of  months  the  property  was  held  before  and  after  the  in- 
cidence of  the  tax.  The  Supreme  Court  has  referred  to  this 
method  as  a  matter  of  detail  to  be  settled  according  to  the  best 
evidence  obtainable  and  in  accordance  with  valid  departmental 
regulations,  and  permitted  the  method  to  stand  as  applied  in  the 
case  at  bar.""  While  this  method  should  be  used  only  as  a  last 
resort,  no  reason  appears  why  it  is  not  acceptable  in  principle. 
Where  the  value  of  property  is  definitely  known  on  two  dates  it 
is  fair  to  assume  that  the  appreciation  or  depreciation  occurring 
between  the  two  dates  occurred  evenly  over  the  intervening  pe- 
riod unless  there  is  some  direct  evidence  to  the  contrary,  and 
if  the  difference  is  prorated  on  a  time  basis  the  value  on  the 
desired  date  is  readily  established. 

Book  Value.  The  value  at  which  property  is  carried  on  the 
books  of  the  owner  is  not  conclusive  evidence  of  its  actual  value. 
Where  the  government  attempts  to  impose  a  tax  upon  the  differ- 
ence between  book  value  and  selling  price,  the  taxpayer  may 
show  by  other  evidence  the  actual  cost  of  the  property  or  the 
actual  value  thereof  at  the  incidence  of  the  tax.  Neither  is  the 
government  bound  by  the  value  at  which  property  is  carried  on 
the  books  of  the  owner."" 

<WA.  R.  M.  34,  T.  B.  10-20-777;  0.  D.  937,  T.  B.  23-21-1(5(59.  See  Peo. 
ex  rel.  Ogdensburg  Co.  v.  Pond,  13  Abb.  N.  C.  (N.  Y.)  1,  appeal  dis- 
missed 92  N.  Y.  643.' 

'•''••  Hays  V.  Gauley  Mountain  Coal  Co.,  247  U.  S.  189.  See  also  Great 
Northern  Ry.  Co.  v.  Lynch.  T.  D.  3147,  T.  B.  13-21-1532. 

i'l  Doyle  V.  Mitchell,  247  U.  S.  179;  U.  S.  v.  Guggenheim  Exploration  Co., 
238  Fed.  231;  Forty  Fort  Coal  Co.  v.  Kirkendall,  233  Fed.  704;  State  v. 
Lee   (Wis.)   178  N.  W.  471.     For  the  practice  under  the  1909  Law   in  re- 


432  FEDERAL  INCOME  TAX 

Miscellaneous  Evidence  of  Value.  In  addition  to  the 
methods  set  forth  in  the  preceding  paragraphs  there  may  be 
other  evidence  in  any  particular  case  of  a  more  or  less  general 
character  indicating  or  throwing  light  upon  market  value.  The 
value  of  property  may  be  indicated  in  the  course  of  litigation 
affecting  the  property,  such  as  a  partnership  accounting  or  a 
partition  action  or  the  administration  of  an  estate.  It  may  be 
indicated  in  reports  to  stockholders  of  a  corporation.  The  his- 
tory surrounding  any  property  under  valuation,  in  the  case  of 
real  property  or  oil  lands,  its  geographical  situation  and  the 
availability  of  a  market,  the  question  of  transportation  facilities, 
the  security  of  the  ov^ner's  title,  may  all  affect  the  property's 
value.  It  is  impossible  to  enumerate  or  classify  finally  the  evi- 
dence which  may  be  used  to  establish  market  value.  In  each 
particular  case  the  taxpayer  should  exhaust  the  evidence  obtain- 
able and  his  conclusion  should  be  based  on  a  thorough  considera- 
tion of  all  factors  that  may  be  evidential  of  the  value  in  ques- 
tion. 

Proof  of  the  Market  Value  of  Stock.  It  has  been  held  that  the 
value  of  shares  of  stock  on  March  1,  1913,  should  be  determined 
upon  the  basis  of  market  quotations  as  of  that  date  and  not  upon 
the  basis  of  book  values.'^  Where  the  market  quotations  vary 
on  the  date  of  valuation  the  average  price  for  the  day  should  be 
taken.'^2  j^  valuing  securities  as  of  March  1,  1913,  the  item  of 
good-will  indicated  by  a  sale  of  all  the  stock  of  the  corporation 
in  1916  should  be  valued  as  of  March  1,  1913,  by  the  application 
of  the  capitalization  percentage  based  on  earnings  attributable 
to  good-will. "3 

Shares  of  Same  Stock  Bought  at  Different  Prices.  When 
various  parcels  of  stock  of  the  same  issue  are  bought  and  sold 
on  different  dates  and  at  different  prices,  the  shares  sold  should 
be  identified,  if  possible,  by  the  numbers  of  the  certificates  cover- 
ing them,  and  the  cost  of  the  identical  shares  should  be  deducted 
in  order  to  determine  the  profit.     Where   it  is  impossible   to 

gard    to    book    entries,    see    T.    D.    2130,    and    Great    Northern    Ry.    Co.    v. 
Lynch,  U.  S.  Dist.  Ct.,  Dist.  of  Minn.,  T.  D.  3147,  T.  B.  13-21-1532. 

71  A.  R.  R.  33,  T.  B.  9-20-764.  For  the  distinction  between  the  value 
of  the  capital  assets  of  a  company  and  the  valuation  of  the  shares  owned 
by  the  shareholders,  see  People  v.  Coleman,  126  N.  Y.  433,  27  N.  E.  818. 

72  Letter  from  treasury  department  dated  November  2,  1916;  I.  T.  S. 
1919,  li  1857. 

7^>  A.  R.  R.  252,  T.  B.  34-20-1143.  In  this  case  the  treasury  department 
rejected  the  contention  that  the  amount  received  for  good  will  in  1916 
should  be  treated  as  having  ratably  accrued  over  the  entire  period  of 
existence   of   a  corporation   from  its   organization  to  the  date  of  sale. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      433 

identify  the  shares  in  this  manner,  the  shares  should  be  con- 
sidered to  be  sold  in  the  order  in  which  they  were  purchased, 
that  is,  the  cost  of  the  first  shares  purchased  should  be  deducted 
from  the  selling  price  of  the  first  shares  sold.'^ 

Proof  of  Value  of  Intangible  Property.  Intangible  property  is 
frequently  sold  and  its  value  on  a  given  date  then  becomes  the 
subject  of  valuation.  The  intangible  property  referred  to  in- 
cludes patents,  copyrights,  secret  processes  and  formulae,  good- 
will, trade-marks,  trade-brands,  franchises  and  other  like  prop- 
erty."'' Good-will  has  been  defined  by  the  Treasury  Department 
as  having  "not  merely  the  narrow  and  technical  meaning  which 
has  attached  to  it  in  numerous  court  decisions,"  but  as  including 
that  intangible  value  "which  always  attaches  to  a  more  than 
usually  profitable  enterprise  by  reason  of  its  proven  earning 
capacity.'""''  Any  profit  or  loss  resulting  from  a  sale  of  good- 
will can  be  taken  only  when  the  business,  or  a  part  of  it,  to 
which  the  good-will  attaches  is  sold,  in  which  case  the  profit  or 
loss  will  be  determined  upon  the  basis  of  the  cost  of  the  assets, 
including  good-will.  If  the  good-will  was  acquired  prior  to 
March  1,  1913,  the  taxable  gain  or  deductible  loss  should  be  as- 
certained in  accordance  with  the  rule  stated  above."  If  nothing 
was  paid  for  good-will  acquired  after  February  28,  1913,  no 
deductible  loss  with  respect  thereto  is  possible,  although  on  the 
other  hand,  upon  the  sale  of  the  business  there  may  be  a  profit. 
It  is  immaterial  that  good-will  may  never  have  been  carried 
on  the  books  as  an  asset.  The  burden  of  proof  is  on  the  tax- 
payer to  establish  the  cost  or  fair  market  value  on  March  1, 
1913,  of  the  good-will  sold.''"  No  depreciation  can  be  deducted 
from  gross  income  with  respect  to  good-will,  but  amounts  de- 
ducted on  account  of  depreciation  of  patents  or  copyrights  since 
February  28,  1913,  or  since  the  date  of  acquisition  if  subsequent 
thereto,  must  be  added  to  profit  or  deducted  from  loss,  as  the 
case  may  be,  in  determining  the  gain  or  loss  on  a  sale  of  patents 
or  copyrights."^ 

No  specific  rule  can  be  laid  down  for  determining  the  value 
of  intangible  property  which  would  be  applicable  in  all  cases 
and  under  all  circumstances.    The  committee  on  appeals  and  re- 

7^  Reg.  45,  Art.  39,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767.  Letter 
from  treasury  department  dated  February  26,  1916;  I.  T.  S.  1918,  Till  413 
and  1343;  Reg.  45.  Art.  36. 

7-"' See  Revenue  Act  of  1918,  §325   (a). 

7'!  A.  R.  R.  252,  T.  B.  34-20-1143. 

"  See  p.  428. 

7S  Reg.  45,  Art.  41,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 

7"  Reg.  45,  Art.  40,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 


434  '  FEDERAL  INCOME  TAX 

view,  however,  has  suggested  several  methods  of  valuing  good- 
will which,  while  not  to  be  regarded  as  controlling,  may  serve 
to  guide  the  taxpayer  in  valuing  intangibles.  It  has  been  the 
practice  of  distillers  and  wholesale  liquor  dealers  to  put  out 
under  popular  brands  only  so  much  goods  as  could  be  marketed 
without  affecting  the  established  market  price  therefor  and  to 
sell  other  goods  of  the  same  manufacture,  age  and  character 
under  other  brands  or  no  brand  at  all  at  figures  below  those 
which  the  well-known  brands  commanded.  In  such  cases  the 
difference  between  the  price  at  which  whiskey  was  sold  under  a 
given  brand  name  and  also  under  another  brand  name,  or  under 
no  brand,  multiplied  by  the  number  of  units  sold  during  a  given 
year  gives  an  accurate  determination  of  the  amount  of  profit 
attributable  to  that  brand  during  that  year,  and  where  this  prac- 
tice is  continued  for  a  period  long  enough  to  show  that  this 
amount  was  fairly  constant  and  regular  and  might  be  expected 
to  yield  annually  that  average  profit,  by  capitalizing  this  earning 
at  the  rate,  say,  of  20  per  cent.,  the  value  of  the  brand  is  fairly 
well  established. 

Another  method  is  to  compare  the  volume  of  business  done 
under  the  trade-mark  or  brand  under  consideration  and  profits 
made,  or  by  the  business  whose  good-will  is  under  considera- 
tion, with  the  similar  volume  of  business  and  profit  made  in 
other  cases  where  good-will  or  trade-marks  have  been  actually 
sold  for  cash,  recognizing  as  the  value  of  the  first  the  same  pro- 
portion of  the  selling  price  of  the  second,  as  the  profits  of  the 
first  attributable  to  brands  or  good-will,  is  of  the  similar  profits 
of  the  second. 

The  third  method  is  to  allow  out  of  average  earnings  over  a 
period  of  years  prior  to  March  1,  1913,  preferably  not  less  than 
five  years,  a  return  of  10%  upon  the  avetage  tangible  assets  for 
the  period.^"  The  surplus  earnings  will  then  be  the  average 
amount  available  for  return  upon  the  value  of  the  intangible 
assets,  and  it  is  the  opinion  of  the  committee  that  this  return 
should  be  capitalized  upon  the  basis  of  not  more  than  five  years' 
purchase — that  is  to  say,  five  times  the  amount  available  as  re- 
turn from  intangibles  should  be  the  value  of  the  intangibles. 
In  applying  this  method,  individuals  or  partnerships  in  deter- 
mining net  earnings  should  deduct  a  reasonable  amount  on  ac- 
count of  the  salaries  of  owners  actively  engaged  in  the  busi- 
ness.^i 

80  The  10%  should  be  applied  only  to  the  tangible  assets  entering  into  net 
worth  including  accounts  and  bills  receivable  in  excess  of  accounts  and 
bills  payable    (A.  R.  M.  68,  T.  B.  28-20-1048). 

81  O.  D.  937,  T.  B.  23-21-1669. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      435 

The  foregoing  is  intended  to  apply  particularly  to  businesses 
put  out  of  existence  by  the  prohibition  law,  but  will  be  equally 
applicable  so  far  as  the  third  formula  is  concerned,  to  other 
businesses  of  a  more  or  less  hazardous  nature.  In  the  case  of 
valuation  of  good-will  of  a  business,  which  consists  of  the  manu- 
facture or  sale  of  standard  articles  of  everyday  necessity  not 
subject  to  violent  fluctuations  and  where  the  hazard  is  not  so 
great,  the  Committee  is  of  the  opinion  that  the  figure  for  deter- 
mination of  the  return  on  tangible  assets  might  be  reduced  from 
10  to  8  or  9',  t  and  that  the  percentage  for  capitalization  of  the 
return  upon  intangibles  might  be  reduced  from  20  to  15' <  . 

In  any  or  all  of  the  cases  the  effort  should  be  to  determine 
what  net  earnings  a  purchaser  of  a  business  on  March  1,  1913, 
might  reasonably  have  expected  to  receive  from  it,  and  there- 
fore a  representative  period  should  be  used  for  averaging  actual 
earnings,  eliminating  any  year  in  which  there  were  extraordinary 
factors  affecting  earnings  either  way.  Also,  in  the  case  of  the 
sale  of  good-will  of  a  going  business  the  percentage  rate  of 
capitalization  of  earnings  applicable  to  good-will  shown  by  the 
amount  actually  paid  for  the  business  should  be  used  as  a  check 
against  the  determination  of  good-will  value  as  of  March  1,  1913, 
and  if  the  good-will  is  sold  upon  the  basis  of  capitalization  of 
earnings  less  than  the  figures  above  indicated  as  the  figures 
ordinarily  to  be  adopted,  the  same  percentage  should  be  used  in 
figuring  value  as  of  March  1,  1913.'^- 

A  contemporary  sale  of  stock  will  be  considered  as  having 
greater  weight  in  determining  the  value  of  a  corporation's 
assets,  including  good-will,  as  of  March  1,  1913,  than  values 
based  on  appraisal,"^' 

Exchange  for  Different  Kinds  of  Property.  Where  property  is 
exchanged  for  other  property  which  has  no  "readily  realizable 
market  value,"  together  with  money  or  other  property  which  has 
a  "readily  realizable  market  value,"  the  money  or  the  fair  market 
value  of  the  property  having  such  "readily  realizable  market 
value"  received  in  exchange  should  be  applied  against  and  re- 
duce the  basis  for  determining  gain  or  loss  provided  in  the  Reve- 
nue Act  of  1921  of  the  property  exchanged.  If  such  money  or 
the  fair  market  value  of  other  property  having  a  "readily  realiz- 
able market  value"  is  in  excess  of  such  basis,  such  excess  is 
taxable  income.  The  basis  so  reduced  will  then  be  used  in  deter- 
mining the  gain  derived  or  loss  sustained  upon  a  subsequent  dis- 
position of  the  property  received  which  has  no  "readily  realiz- 

82  A.  R.  M.  34,  T.  B.  10-20-777;  A.  R.  R.  252,  T.  B.  34-20-1143. 
s."?  O.  791,  T.  B.  1-19-22. 


436  ■  FEDERAL   INCOME   TAX 

able  market  value."  If  the  property  having  a  "readily  realiz- 
able market  value"  is  in  excess  of  such  basis,  then  the  entire 
proceeds  realized  upon  a  subsequent  disposition  of  the  property 
having  no  "readily  realizable  market  value"  will  be  taxable  in- 
come.'^^ 

Rule  Under  1918  Law.  If  property  was  exchanged  for  two 
different  kinds  of  property,  such  as  bonds  and  stocks,  the  bonds 
having  a  market  value  and  the  stock  none,  the  value  of  the  bonds 
was  to  be  compared  with  the  cost.  If  the  market  value  of  the 
bonds  was  less  than  such  cost  the  difference  represented  the  cost 
of  the  stock.  If  the  market  value  of  the  bonds  was  greater  than 
such  cost,  the  difference  represented  gain  and  was  taxable  at  the 
time  of  the  exchange  unless  the  original  property  was  acquired 
prior  to  March  1,  1913,  in  which  case  the  amount  of  gain  taxable 
was  computed  in  accordance  with  the  rule  stated  above."^-^  In 
either  case  the  entire  proceeds  of  such  stock  was  taxable.  If 
property  was  exchanged  for  two  different  kinds  of  property, 
such  as  bonds  and  stocks,  neither  having  a  fair  market  value, 
the  cost  of  the  original  property  was  required  to  be  apportioned, 
if  possible,  between  the  bonds  and  stock  for  the  purpose  of  deter- 
mining gain  or  loss  on  subsequent  sales.  If  no  fair  apportion- 
ment was  practicable,  no  profit  on  any  subsequent  sale  of  any 
part  of  the  bonds  or  stock  was  realized  until  out  of  the  proceeds 
of  sales  the  entire  cost  of  the  original  property  had  been  re- 
covered.'^'' 

Organization,  Reorganization,  Merger  and  Consolidation  of 
Corporations.  The  present  law  in  practical  effect  eliminates  the 
element  of  taxable  profit  and  deductible  loss  upon  the  reorganiza- 
tion merger  and  consolidation  of  corporations,  and  also  upon  the 
organization  of  a  corporation  where  the  stock  of  the  corporation 
received  by  the  former  owners  is  distributed  in  substantially  the 
same  proportion  as  the  former  interests  of  such  owners  and  the 
former  owner  or  owners  control  the  corporation.  The  purpose  of 
these  provisions  was  to  "permit  business  to  go  forward  with  the 
readjustments  required  by  existing  conditions." -^^  This  purpose 
and  the  urgent  necessity  for  amendment  of  the  Revenue  Act  of 
1918  in  these  respects  will  clearly  appear  from  the  discussion 
contained  in  succeeding  paragraphs  on  the  provisions  of  that 
statute  bearing  upon  the  organization  and  reorganization  of  cor- 

84  Revenue  Act  of  1921,  §202    (e). 

85  See  p.  428. 

86  Reg.  45,  Art.  1565,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 

87  See  Report  of  Finance  Committee  on  Internal  Revenue  Bill  of  1921, 
p.  11;  Report  of  Ways  and  Means  Committee,  p.  10. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY 


437 


norations     The  general  rule  under  the  Revenue  Act  of  1921  is 
thafon  an  exchange  of  property  for  other  property  havn,g  a 
"readily  realizable  market  value"  a  gain  may  be  derived  or  a  loss 
sustained.    But  even  if  the  property  received  m  exchange  has  a 
■•readUy  realizable  market  value"  no  gain  or  loss  will  be  recog- 
nized when  in  the  reorganization  of  one  or  more  corporations  a 
person  receives  in  place  of  any  stock  or  securities  owned  by  him, 
stock  or  securities  in  a  corporation  a  party  to  or  resulting  from 
such  reorganization.    The  word  "reorganization,     as  thus  u^ed 
includes  a  merger  or  consolidation  (including  the  acquisition  by 
one  corporation  of  at  least  a  majority  of  the  voting  stock  and  at 
least  a  ma.iority  of  the  total  number  of  shar-es  of  all  other  classes 
of  stock  of  another  corporation,  or  of  substantially  all  the  prop- 
erties of  another  corporation),  recapitalization,  or  mere  change 
in  identity,  form,  or  place  of  organization  of  a  corporation,  (how- 

ever  effected).  ,      j_,     n 

Neither  will  any  gain  or  loss  be  recognized  under  the  Revenue 
Act  of  1921  when  (a)  a  person  transfers  any  property,  real   per- 
sonal or  mixed,  to  a  corporation,  and  immediately  after  the  trans- 
fer is  in  control  of  such  corporation,  or  (b)  two  or  more  persons 
transfer  any  such  property  to  a  corporation,  and  immediately 
after  the  transfer  are  in  control  of  such  corporation,  and  the 
amounts  of  stock,  securities,  or  both  received  by  such  persons  are 
in  substantially  the  same  proportion  as  their  interests  in  the 
property  before  such  transfer.    A  person  is,  or  two  or  more  per- 
sons are  "in  control"  of  a  corporation  when  owning  at  least  80/. 
of  the  voting  stock  and  at  least  80';;  of  the  total  number  of  shares 
of  all  other  classes  of  stock  of  the  corporation.    Where  property 
is  exchanged  for  other  property  and  no  gain  or  loss  is  recognized, 
the  property  received  will  be  treated  as  taking  the  place  ot  the 
property  exchanged  therefor. 

When  money  or  other  property  of  "readily  reaUzable  market 
value"  is  received  upon  the  organization  or  reorganization  (as 
above  defined)  of  a  corporation,  other  than  stock  or  securities  in 
a  corporation  a  party  to  or  resulting  from  such  reorganization 
or  the  corporation  organized  as  indicated  above,  the  money  or 
the  fair  market  value  of  such  other  property  received  in  exchange 
will  be  applied  against  and  reduce  the  basis  for  determining  gain 
or  loss,  provided  by  the  Revenue  Act  of  1921,  of  the  property 
exchanged,  and  if  in  excess  of  such  basis,  will  be  taxable  to  the 
extent  of  the  excess.'^'^ 

8«  Revenue  Act  of  1921,  §  202. 


438  FEDERAL  INCOME  TAX 

Reorganization,  Merger,  Consolidation  of  Corporations  Under 
the  1918  Lavv.^''  When  property  was  exchanged  for  other  prop- 
erty, the  property  received  in  exchange  was  treated,  for  the 
purpose  of  determining  gain  or  loss,  under  the  1918  Law,  as  the 
equivalent  of  cash  to  the  amount  of  its  "fair  market  value,  if 
any" ;  but  when  in  connection  with  the  reorganization,  merger,  or 
consolidation  of  a  corporation  a  person  received  in  place  of  stock 
or  securities  owned  by  him  new  stock  or  securities  of  no  greater 
aggregate  par  or  face  value,  no  gain  or  loss  was  deemed  to  occur 
from  the  exchange,  and  the  new  stock  or  securities  received  were 
treated  as  taking  the  place  of  the  stock,  securities,  or  property 
exchanged.  When  in  the  case  of  any  such  reorganization,  mer- 
ger or  consolidation  the  aggregate  par  or  face  value  of  the  new 
stock  or  securities  received  was  in  excess  of  the  aggregate  par 

80  The  provision  discussed  in  this  paragraph  was  perhaps  the  most  ar- 
tificial and  illogical  provision  contained  in  the  Revenue  Act  of  1918.  It  made 
the  par  value  of  stock  a  test  of  taxability.  Par  value  has  no  relation 
whatever  to  actual  value,  as  is  well  stated  by  the  Supreme  Court  in  Virginia 
V.  West  Virginia,  238  U.  S..202,  as  follows:  "Statements  may  be  found  to 
the  effect  that  par  value  is  prima  facie  actual  value  (citing  cases);  but  if 
such  statements  can  be  deemed  to  announce  a  comprehensive  rule,  to  be 
applied  in  the  absence  of  evidence  as  to  the  property  and  business  of  the 
corporation,  we  cannot  regard  it  as  well  founded.  There  is  no  such  pre- 
sumption of  law,  and  common  experience  negatives  rather  than  raises  such 
an  inference  of  fact.  We  took  this  view  in  Fogg  v.  Blair,  139  U.  S.  118, 
127,  35  L.  Ed.  104,  107,  11  Sup.  Ct.  Rep.  476,  when  we  criticized  the  sup- 
position 'that  the  court,  in  the  absence  of  averment  or  proof  to  the  con- 
trary, would  assume  that  it  (stock)  was  worth  par,  or  had  substantial 
value.'  (Citing  cases).  Shares  represent  the  proportionate  interest  of  the 
shareholders  in  the  corporate  enterprise,  and  a  rule  that  this  interest,  in  the 
absence  of  all  supporting  evidence,  should  be  taken  as  actually  worth 
the  par  of  the  shares,  would  be  wholly  artificial.  There  is  no  exigency 
in  the  administration  of  justice  which  requires  or  justifies  such  an  ex- 
treme assumption."  Insofar,  however,  as  the  provision  served  to  permit 
reorganizations,  mergers  and  consolidations  to  be  effected  without  pre- 
cipitating tax  liability,  it  served  a  useful  purpose.  The  hardship  of  impos- 
ing a  heavy  tax  in  connection  with  reorganizations,  mergers  and  consolida- 
tions is  now  recognized  in  the  Revenue  Act  of  1921.  Such  proceedings  fre- 
quently leave  the  taxpayer  with  pieces  of  paper  representing  precisely  the 
same  property,  or  interest  in  property,  he  had  before.  Only  in  a  highly 
technical  sense — that  is,  by  virtue  of  the  doctrine  of  separate  corporate 
entity — can  it  be  said  that  he  has  anything  different.  There  has  been  mere- 
ly a  formal  exchange ;  substantially  he  has  the  same  property.  The  doctrine 
of  separate  corporate  entity  is  discussed  in  Chapter  10  footnote  55  as  applied 
to  the  organization  of  corporations  and  what  is  said  there  is  equally  ap- 
plicable here.  It  should  also  be  observed  in  this  connection  that  the  1918 
Law  implied  as  a  condition  to  taxability  that  the  new  stock  or  securities 
should  have  a  "fair  market  value."  This  introduces  the  question  discussed 
above  as  to  the  definition  of  the  term  "fair  market  value."    (See  p.  419.)  . 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY     439 

or  face  value  of  the  stock  or  securities  exchanged,  a  like  amount 

Z  ntr  or  face  value  of  the  new  stock  or  securities  received  was 
eated  Is  taking  the  place  of  the  stock  or  securities  exchanged, 
if  the  amount  of  the  excess  in  par  or  face  value  was   reae^ 

.,  sain  to  the  extent  that  "the  fair  market  value    of  the  new 
to' k  or  L^udties  was  greater  than  the  cost  (o>;  ■*^-;-;^„PXe 

to  March  1.  1913,  the  fair  market  value  as  of  that  date)  of  the 

stock  or  securities  exchanged.'"' 

«   .  „f  1.118    S20>   (bl     The  provisions  of  this  section  apply 

JXrJ^l^  ofl^in'  o     his^^o.  ^--  --■"-- 

nection  with  reorganizations,  T't  1414    A   R   R   156   T   6.2(5-20-1024.) 

dated  May  3    1916    L  T_^  S^  1918    i  ^^^  ^^^^^_  ^^^.^^  .^  ^^,_^^ 

re^iivlt.  in^rro"  he^irX'  s'Strtt'^Co^pan.  There  is 

'„    e'vwlnc:  other  than  the  difference  in  the  <.-'«="™,P- ;t%°:  f,! 

shares  of  stock,  that  any  gain,  profit  or  income  was  lealized  f«";"^=^^ 

T  t  tv,.  A-iv^-c  of  stoclt     It  is,  therefore,  the  opinion  of  this  omce 

of  the  capita,  which  ^e  originaUy   nvested^n  the  st  cK  of  th^^ 

5=S.^==tryirqt;^f::?S 
s;4ir„rscr;:^  i:t%fii^rpr.aL!nr 

o  porltion  or  its  stockholders.  If  the  stock  of  the  «-'  ™-^»^^^=  „  ^"^       7- 
ot  the  transaction  was  worth  "double  par,"  the  stock  »'  "^^  '^;'^«  ,;\, 

pany,  bein.  supported  by  "|™"-''^  ^^  ,-:XT for^h    o'm  ^^ited  in 
the  same  value,  and  the  exchange  of  the  new  stock    o 

::,rTLet::rTomir:L-yir?rn?rtr;:;t^tm^ 

rS'lsr/iaO.)    Where  the  a-^  "^  »=  -rporation  -re  transfei ,  .d^^to 
Z:t:  X,T^"'"V'^^  pt^:.::'in^the  new  corporation,  the 


440  FEDERAL  INCOME  TAX 

Definition.  The  phrase  "aggregate  par  value"  meant  the 
aggregate  par  value  of  stock  of  each  individual  stockholder,  ex- 
changed for  new  stock  and  the  aggregate  par  value  of  such  stock 

par  value  of  the  new  stock  was  considered  as  the  equivalent  of  cash  and 
taxable  to  the  extent  that  it  exceeded  the  cost  of  the  old.  Where  the 
stockholders  of  a  corporation  surrendered  their  stock  for  stock  of  less  par 
value,  they  were  permitted  to  claim  a  loss  on  the  difference  between  the 
cost  of  the  old  and  the  par  of  the  new.  (Letter  from  treasury  department 
dated  March  9,  1917;  I.  T.  S.  1918,  ^3222.)  In  later  rulings,  however, 
it  was  held  that,  upon  a  reorganization,  where  a  new  corporation  was 
formed  with  a  stock  of  larger  par  value,  the  transfer  of  assets  of  the  old 
to  the  new  and  the  exchange  of  stock  by  the  stockholders  of  the  old  for 
stock  of  a  greater  par  value  of  the  new  created  income  to  the  old  corpora- 
tion and  its  stockholders;  but  that  in  determining  the  amount  of  such 
income,  or  the  "amount  received"  by  the  old  corporation  and  the  "amount 
distributed"  to  its  stockholders,  the  par  value  of  the  stock  of  the  new 
corporation  would  only  be  taken  as  the  actual  value,  or  an  equivalent  of 
cash,  "in  the  absence  of  any  proof  to  the  contrary."  In  other  words,  al- 
though the  transaction  was  still  held  to  be  a  closed  and  completed  one, 
the  conclusive  presumption,  that  the  par  value  of  the  stock  of  the  new 
corporation  represented  actual  value  and  was  the  equivalent  of  cash,  was 
reduced  to  a  rebuttable  presumption;  and  the  value  of  such  stock  became  a 
matter  of  proof,  or  question  of  fact.  (Letter  from  treasury  department 
dated  November  10,  1917;  I.  T.  S.  1918,  TI1309;  letter  from  treasury  de- 
partment dated  December  8,  1917;  I.  T.  S.  1918,  ^1313;  letter  from  treas- 
ury department  dated  March  19,  1918;  I.  T.  S.  1918,  ^3222;  Reg.  33  Rev., 
Art.  101.  The  Supreme  Court  has  definitely  held  that  par  value  is  not 
even  prima  facie  evidence  of  actual  value  (Virginia  v.  West  Virginia,  238 
U.  S.  202,  219).  The  treasury  department  next  drew  a  distinction  be- 
tween reorganizations  involving  the  purchase  of  the  stock  and  those  in- 
volving the  purchase  of  the  assets  of  the  old  company.  It  was  held  that 
where  a  corporation  acquired  from  stockholders  the  stock  of  another  corpo- 
ration, giving  in  exchange  therefor  its  own  stock,  the  transaction  was  one 
by  which  the  corporation  acquiring  the  stock  became  the  sole  stockholder  of 
the  other  corporation  and  that  no  income  accrued  to  the  corporation  whose 
stock  was  thus  acquired.  This  was  true  even  though  later  the  holding 
corporation  caused  the  assets  of  the  underlying  company  to  be  transferred 
to  it  for  mere  nominal  consideration.  (Reg.  33  Rev.,  Art.  124.)  It  was 
held  that  if  a  corporation  sold  its  assets  in  whole  or  in  part  and  the  pur- 
chase price  was  paid  with  stock  issued  by  the  purchasing  company,  the 
purchase  price  would  be  the  actual  value  at  the  time  of  the  stock  issued  in 
payment  for  such  assets.  (Reg.  33  Rev.,  Art.  101;  letter  from  treasury 
department  dated  September  9,  1916;  I.  T.  S.  1918,  Tj  1297.)  If  the  shares 
of  stock  received  by  the  selling  corporation  were  distributed  to  its  stock- 
holders, the  fair  market  value  of  the  stock  so  distributed  in  excess  of  the 
cost  (or  fair  market  value  as  of  March  1,  1913)  of  the  stock  held  by 
them  in  the  selling  corporation  would  be  considered  income  to  the  stock- 
holders. (Letter  from  treasury  department  dated  September  9,  1916;  I. 
T.  S.  1918,  111297;  Reg.  33  Rev.,  Art.  101.)  If  the  excess  over  value  as 
of  March  1,  1913,  or  over  cost,  as  the  case  might  be,  included  any  surplus 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      441 

received  by  each  individual  stockholder.'"  The  word  "or"  as 
used  in  the  phrase  "stock  or  securities"  was  held  to  be  synony- 
mous with  the  word  "and"  and  a  person  might,  in  connection 
with  the  reorganization,  merger  or  consolidation  of  a  corpora- 
tion, turn  in  either  stock  or  securities,  or  both,  and  accept 
either  new  stock  or  securities,  or  both,  of  no  greater  par  or 
face  value,  without  being  liable  for  tax.''-  The  term  "reorgani- 
zation" was  held  to  mean  a  business  arrangement  whereby  the 
stock  and  bonds  of  a  corporation  were  readjusted  as  to  amount, 
income  or  priority,  or  the  issue  of  one  kind  of  stock  was  substi- 
tuted for  the  issue  of  another  kind,  or  the  property  was  sold  to  a 
new  corporation  for  new  stock  and  bonds,  or  was  sold  by  fore- 
closure of  a  mortgage  upon  it  to  a  purchaser  who  bought  for 
himself  and  his  associates,  and  included  the  various  proceedings 
and  transactions  by  which  succession  of  corporations  was  brought 
about,  and  also  the  proceedings  by  which  existing  corporations 
were  continued  under  a  different  organization  without  the  crea- 
tion of  a  new  corporation.^" 

The  term  "reorganization"  included  cases  of  corporate  adjust- 
ment where  stockholders  exchange  their  stock  for  the  stock  of 
a  holding  corporation,  provided  the  holding  corporation  and  the 
original  corporation,  in  which  it  held  stock,  were  so  closely  re- 
lated that  the  tw-o  corporations  were  affiliated."-*  A  merger  of 
two  or  more  corporations  was  defined  as  taking  place  when  one 
of  such  corporations  retained  its  corporate  existence  and  ab- 
sorbed the  other  or  others,  which  thereby  lost  their  corporate 
existence;  a  consolidation  was  defined  as  taking  place  when  a 
new  corporation  was  created  to  take  the  place  of  the  constituent 
corporations  which  were  themselves  dissolved  in  the  process."'' 
"Par  value"  in  foreign  currency  was  required  to  be  converted 
into  United  States  currency  at  the  rate  of  exchange  prevailing 
on  the  date  of  a  reorganization,  consolidation  or  merger.'"' 

Exchange  of  Stock  for  Other  Stock  of  No  Greater  Par 
Value.     In  general,  where  two    (or  more)    corporations  unite 

earned  since  March  1,  1913,  by  the  selling  company,  upon  which  the  in- 
come tax  had  been  paid,  the  excess  or  profits  resulting  from  the  sah' 
might  be  reduced  by  the  amount  of  such  tax-paid   surplus. 

'Ji  O.  D.  204,  T.  B.  10-19-353. 

i>2  0.  D.  335,  T.  B.  29-19-623. 

'•••">  Reg.  40  Rev.,  Art.  33.  See  Cook  on  Corporations,  7th  Edition,  ^  883. 
This  definition  was  made  for  stamp  tax  purposes.  See  U.  S.  v.  Phellis, 
42  Sup.  Ct.  Rep.  63. 

«4  Reg.  45,  Art.  1567.     See  U.  S.  v.  Phellis,  42  Sup.  Ct.  Rep.  63. 

"•"•Sol.  Op.  4,  T.  B.  22-20-981. 

9''>0.   D.   1058,   T.   B.   41-21-1589. 


442  FEDERAL  INCOME   TAX 

their  properties,  by  either  (a)  the  dissolution  of  corporation 
B  and  the  sale  of  its  assets  to  corporation  A,  or  (b)  the  sale 
of  its  property  by  B  to  A  and  the  dissolution  of  B,  or  (c)  the 
sale  of  the  stock  of  B  to  A  and  the  dissolution  of  B,  or  (d) 
the  merger  of  B  into  A,  or  (e)  the  consolidation  of  the  corpora- 
tions, no  taxable  income  within  the  meaning  of  the  1918  Law 
was  received  from  the  transaction  by  A  or  B  or  the  stockholders 
of  either,  provided  the  sole  consideration  received  by  B  and  its 
stockholders  in  (a),  (b),  (c),  and  (d)  was  stock  or  securities  of 
A,  and  by  A  and  B  and  their  stockholders  in  (e)  was  stock  or 
securities  of  the  consolidated  corporation,  in  any  case  of  no 
greater  aggregate  par  or  face  value  than  the  old  stock  and 
securities  surrendered.  So-called  "no-par-value  stock"  issued 
under  a  statute  or  statutes  which  require  the  corporation  to  fix 
in  a  certificate  or  on  its  books  of  account  or  otherwise  an  amount 
of  capital  or  an  amount  of  stock  issued  which  may  not  be  im- 
paired by  the  distribution  of  dividends,  was  deemed  to  have  a 
par  value  representing  an  aliquot  part  of  such  amount,  proper 
account  being  taken  of  any  preferred  stock  issued  with  a  prefer- 
ence as  to  principal.  In  the  case  (if  any)  in  which  no  such 
amount  of  capital  or  issued  stock  is  so  required,  "no-par-value 
stock"  received  in  exchange  was  regarded  as  having  in  fact  no 
par  or  face  value,  and  consequently  as  having  "no  greater  aggre- 
gate par  or  face  value"  than  the  stock  or  securities  exchanged 
therefor.'*'' 

A  number  of  cases  have  arisen  under  the  1918  Law  in  con- 
nection with  the  reorganization,  merger  and  consolidation  of 
corporations  in  which  the  stockholders  of  the  old  corporation 
or  corporations  have  been  held  free  from  tax  on  the  ground  that 
the  aggregate  par  or  face  value  of  the  stock  or  securities  re- 
ceived was  less  than  the  aggregate  par  or  face  value  of  those 
exchanged.  Each  of  these  decisions  is  based  upon  its  peculiar 
circumstances  and  should  be  used  with  caution  in  connection 
with  any  other  case.  In  view  of  the  importance  of  the  subject 
the  more  important  of  these  decisions  are  reviewed  below : 

1.  The  only  requirement  of  the  Revenue  Act  of  1918  was 
that  the  new  securities  received  upon  the  reorganization,  merger 
or  consolidation  of  a  corporation  or  corporations  should  have  no 
greater  face  value  than  the  old.  The  actual  value  of  the  respec- 
tive securities  was  immaterial.  The  nature  of  the  respective 
securities  was  also  immaterial;  either  the  old  or  new  securities 
might  be  bonds  or  stock,  or  both.'^s 

97  Reg.  45,  Art.  1567. 

98  T.  B.  R.  25,  T.  B.  6-19-267. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      443 

2.  Where  the  stockholders  of  one  of  several  banks  which 
were  consolidated  received  in  exchange  for  their  shares  stock 
of  the  consolidated  bank  of  no  greater  aggregate  par  or  face 
value  than  their  shares  in  the  old  bank,  bonds  purchased  by 
the  old  bank  subsequent  to  March  1,  1913,  at  80  being  taken 
over  by  the  consolidated  bank  at  70  and  later  sold  by  the  con- 
solidated bank  at  80,  the  department  held  that  there  was  no 
realization  of  gain  or  loss  at  the  time  of  consolidation  by  either 
the  old  bank  or  its  stockholders,  and  also  that  the  consolidated 
bank  did  not  receive  any  profit  on  the  sale  of  the  bonds  since  it 
should  have  placed  them  on  its  books  at  the  same  figure  at  which 
they  were  carried  by  the  old  bank.''-' 

3.  Mere  multiplication  of  the  number  of  shares  of  a  corpora- 
tion (resulting  from  the  exchange  of  four  new  shares,  each 
having  a  par  value  of  $25,  for  each  old  share  of  $100  par  value) 
when  not  accompanied  by  conversion  of  surplus  into  capital 
stock  or  revaluation  of  assets,  did  not  give  rise  to  taxable  gain 
or  income  to  stockholders  making  the  exchange.  Where  a  cor- 
poration amended  its  charter  so  that  instead  of  having  10,000 
shares  of  no-par  value,  the  same  stockholders  held  100,000  shares 
without  par  value,  neither  the  original  charter  nor  the  amend- 
ment having  any  stated  capital  in  dollars,  this  multiplication  of 
shares  being  not  accompanied  by  conversion  of  assets  into  capi- 
tal stock  or  any  revaluation  of  assets,  such  a  transaction  did  not 
give  rise  to  taxable  income  to  stockholders  making  the  ex- 
change.^^^^  Likewise  where  a  charter  of  a  corporation  is 
amended,  and  each  stockholder  receives  no-par  stock  for  par 
stock,  share  for  share,  no  deductible  loss  is  sustained  even  though 
the  no-par  stock  is  worth  less,  as  proved  by  actual  sales,  than 
the  cost  or  par  value  of  the  old  stock. ^'" 

4.  Where  a  corporation  was  insolvent  and  the  bondholders 
bid  in  the  property  at  foreclosure  sale  and  for  the  purpose  of 
reorganization  conveyed  it  to  a  new  corporation,  receiving  in 
exchange  for  their  bonds  stock  of  the  new  corporation  of  the 
same  par  value,  the  department  held  that  a  bondholder  might 
deduct  as  a  loss  under  the  1913  Law  the  amount  by  which  the 
cost  of  the  bonds,  or  their  fair  market  value  as  of  March  1, 
1913,  if  acquired  prior  thereto,  exceeded  the  fair  market  value 
at  the  time  of  the  exchange  of  the  stock  received  by  him.^"- 

9!>  0.  D.  418,  T.  B.  13-20-803. 

100  T.  B.  R.  39,  T.  B.  12-19-396. 

IMO.  D.  1080,  T.  B.  44-21-1891. 

102  s.  1294,  T.  B.  4-20-G98.  In  this  case  neither  of  the  old  insolvent  com- 
panies had  paid  interest  on  their  bonds  for  some  years  prior  to  the  fore- 
closure and  the  bonds   seemed   to  have  depreciated   in  value  by  March   1, 


444  FEDERAL   INCOME   TAX 

5.  In  a  case  in  which  two  existing  corporations  were  consoli- 
dated under  the  act  of  General  Assembly  of  the  State  of  Ohio, 
by  the  exchange  of  no-par  value  shares  of  the  new  corporation 
for  the  entire  assets  and  obligations  of  each  of  the  existing  cor- 
porations, which  in  turn  were  liquidated,  it  was  held  that  the 
no-par  value  stock  of  the  consolidated  corporation  would  be 
deemed  to  have  a  par  value  represented  by  the  aliquot  part  of 
the  total  book  value  of  the  properties  of  the  corporations  which 
were  consolidated  and  exchanged  for  the  no-par  value  shares. 
This  decision  was  based  upon  the  Ohio  statute  limiting  the 
declaration  of  dividends  to  surplus  profits  arising  from  the 
business  of  a  new  corporation.  Under  this  provision  the  net 
value  of  the  assets  of  the  corporations  which  were  consolidated 
might  not  be  less  than  the  amount  of  capital  stated  in  the  arti- 
cles of  incorporation  as  that  with  which  the  new  corporation  was 
to  carry  on  business.  It  was  not  required  to  be  in  excess  of  that 
amount.  If  in  fact  the  net  value  of  the  assets  of  the  corpora- 
tions which  were  consolidated  exceeded  the  amount  of  capital 
specified  in  the  articles  of  incorporation,  the  excess  was  deemed 
paid-in  surplus  out  of  which  dividends  might  be  paid.^""' 

Determination  of  Gain  or  Loss  from  Subsequent  Sale. 
The  new  stock  and  securities  received,  when  they  are  of  no 
greater  aggregate  par  or  face  value  than  the  stock  or  securities 
exchanged,  took  the  place,  under  the  1918  Law,  of  the  old  stock 
and  securities.  For  the  purpose,  therefore,  of  ascertaining  the 
gain  derived  or  loss  sustained  from  the  subsequent  sale  of  any 
stock  of  A  or  of  the  consolidated  corporation,  so  received,  the 
original  cost  to  the  taxpayer  of  the  stock  of  B  or  A  in  respect 
of  which  the  new  stock  was  issued,  less  any  untaxed  distribution 
made  to  the  taxpayer  by  A  out  of  the  former  capital  or  surplus 
of  B,  or  by  the  consolidated  corporation  out  of  the  former  capi- 
tal or  surplus  of  A  or  B,  was  the  basis  for  determining  the 
amount  of  such  gain  or  loss.  However,  the  gain  which  was  tax- 
able or  the  loss  which  was  deductible  in  the  case  of  the  subse- 
quent sale  of  any  stock  of  A  or  of  the  consolidated  corporation, 

1913,  practically  to  the  extent  of  the  value  of  the  stock  received  by  the 
bond-holders  in  the  new  corporation.  The  department  consequently  held 
that  the  taxpayer  sustained  no  deductible  loss  in  1914  when  the  reor- 
ganization was  effected.  It  will  be  noted  that  this  case  was  decided  under 
the  1913  Law  which  contained  no  provision  that  where  upon  the  reorgani- 
zation, merger  or  consolidation  of  a  corporation  a  person  receives  in  place 
of  stock  or  securities  owned  by  him  new  stock  or  securities  of  no  greater 
aggregate  par  or  face  value,  no  gain  or  loss  is  deemed  to  occur  from  the 
exchange.  (Revenue  Act  of  1918,  §202  (b).) 
lo;^'  Sol.  Op.  72,  T.  B.  45-20-1286. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      445 

SO  received,  when  the  stock  of  B  or  A  in  respect  of  which  new 
stock  was  issued  was  acquired  prior  to  March  1,  1913,  was  re- 
quired to  be  determined  in  accordance  with  the  rule  stated 
above  J'"  When  securities  of  a  single  class  were  exchanged  for 
new  securities  of  the  same  total  par  value  but  of  different  classes, 
for  the  purpose  of  determining  profit  or  loss  on  the  subsequent 
sale  of  any  of  the  new  securities,  the  proportion  of  the  original 
cost  to  be  allocated  to  each  class  of  new  securities  was  that  pro- 
portion which  the  market  value  of  the  particular  class  bore  to 
the  mai-ket  value  of  all  securities  received  on  the  date  of  the 
exchange.  If  the  securities  exchanged  were  acquired  prior  to 
March  1,  1913,  the  proportion  of  their  value  as  of  such  date  to 
be  allocated  to  each  class  of  new  securities  was  that  proportion 
which  the  market  value  of  the  particular  class  bore  to  the  mar- 
ket value  of  all  securities  received  on  the  date  of  the  exchange 
and  the  gain  or  loss  was  required  to  be  determined  in  accord- 
ance with  the  rule  stated  above.^""'  For  example,  if  100  shares 
of  common  stock,  par  value  $100,  were  exchanged  for  50  shares 
of  preferred  and  50  shares  of  common  each  of  $100  par  value, 
and  the  cost  of  the  old  stock  was  $250  per  share,  or  $2,500,  but 
the  market  value  of  the  preferred  on  the  date  of  the  exchange 
was  $110  per  share,  or  $5,500  for  the  50  shares,  and  the  market 
value  of  the  common  was  $440  per  share  or  $22,000  for  the  50 
shares  of  common,  one-fifth  of  the  original  cost,  or  $5,000,  would 
be  regarded  as  the  cost  of  the  preferred  and  four-fifths,  or 
$20,000,  as  the  cost  of  common.  The  same  method  of  computa- 
tion was  required  to  be  used  in  the  case  of  stock  acquired  prior 
to  March  1,  1913,  in  order  to  ascertain  the  proportion  of  such 
value  to  be  allocated  to  each  class  of  new  securities  on  that  date 
and  the  taxable  gain  or  deductible  loss  was  required  to  be  there- 
after computed  in  accordance  with  rule  stated  above. ^'"■'  Simi- 
larly, the  cost  after  reorganization,  merger,  or  consolidation  of 
the  assets  of  A,  or  of  the  consolidated  corporation,  was  the  sum 
of  the  cost  of  the  assets  of  A  and  B  for  the  purpose  of  ascertain- 
ing the  gain  or  loss  from  a  subsequent  sale.  However,  in  case 
the  assets  were  acquired  prior  to  March  1,  1913,  in  order  to 
compute  the  taxable  gain  or  deductible  loss,  the  fair  market  value 
as  of  such  date  was  also  required  to  be  ascertained  by  taking  the 
sum  of  the  fair  market  value  of  the  assets  of  A  and  B.i"^ 

i<>-»  See  p.  413. 
i""'  See  p.  413. 
Kx-  See  p.  413. 
i"»T  Reg.  45,  Art.  1568,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 


446  federal  income  tax 

Exchange  of  Stock  for  Other  Stock  of  Greater  Par 
Value.  If  in  the  case  of  any  reorganization,  merger,  or  con- 
solidation, the  aggregate  par  or  face  value  of  the  new  stock  or 
securities  received  was  in  excess  of  the  aggregate  par  or  face 
value  of  the  stock  or  securities  exchanged,  income  within  the 
meaning  of  the  1918  Law  would  be  realized  from  the  transaction 
by  the  recipients  of  the  new  stock  or  securities  to  an  amount 
limited  by  (a)  the  excess  of  the  par  or  face  value  of  the  new 
stock  or  securities  over  the  par  or  face  value  of  the  old,  and 
(b)  the  excess  of  the  fair  market  value  of  the  new  stock  or 
securities  over  the  cost  of  the  old,  unless  the  old  stock  or  securi- 
ties were  acquired  prior  to  March  1,  1913,  and  their  fair  market 
price  or  value  as  of  that  date  was  greater  than  their  cost,  in 
which  case,  the  fair  market  value  of  the  new  stock  or  securities 
must  be  in  excess  of  the  fair  market  value  as  of  March  1,  1913, 
of  the  old.  The  taxable  profit  was  (a)  or  (b),  whichever  was 
less.i"'^  There  was  no  election  whether  (a)  or  (b)  applied.  The 
fair  market  value  of  each  stockholder's  interest  was  required  to 
be  determined  as  of  the  date  the  reorganization,  merger  or  con- 
solidation was  consummated,  not  the  date  on  which  the  exchange 
of  stock  took  place.i"^ 

In  a  number  of  cases  involving  the  reorganization,  merger  or 
consolidation  of  corporations  in  which  the  aggregate  par  or  face 
value  of  the  stock  or  securities  received  exceeded  the  aggregate 
par  or  face  value  of  the  stock  or  securities  exchanged,  the  stock- 
holders of  the  old  corporation  or  corporations  were  held  liable 
to  tax.  Each  of  these  decisions  is  based  upon  its  peculiar  cir- 
cumstances and  should  be  used  with  caution  in  connection  with 
any  other  case.  In  view  of  the  importance  of  the  subject  the 
more  important  of  these  decisions  are  reviewed  below : 

1.  A  company  whose  operations  had  proved  very  profitable 
was  reorganized,  two  new  corporations  being  formed,  one  to 
take  over  its  production  business  and  the  other  its  pipe-line  busi- 
ness. By  the  reorganization  the  stockholders  of  the  old  company 
came  into  the  possession  of  stock  of  a  holding  company  and  the 
two  reorganized  companies  and  bonds  of  the  two  reorganized 
companies  of  a  greater  aggregate  par  or  face  value  than  their 
old  stock.  The  beneficial  interests  in  the  enterprise  remained 
the  same.  This  transaction  was  held  to  produce  taxable  income 
to  the  stockholders  of  the  old  company.iio 

108  Reg.  45,  Art.  1569,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 

109  O.  D.  1071,  T.  B.  43-21-1880. 

110  A.  R.  M.  67,  T.  B.  28-20-1049. 


447 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY 

2  Where  in  connection  with  a  reorganization  of  a  company 
a  stockholder  had  the  right  to  make  an  exchange  in  one  year, 
but  did  not  act.ally  make  the  exchange  until  the  lollowmg  year 
the  profit  accruing  was  deemed  income  in  the  year  m  which  the 

exchange  was  actually  made.^^^  ^..       ^  ^  ^     fV.o 

3  In  a   case  decided  under  the   Massachusetts  statute   the 
complainant  was  the  owner  of  2,300  shares  of  common  and  pre- 
ferred stock  of  an  ascertained  value  on  January  1,  1916   (the 
date  of^ncidence  of  the  Massachusetts  tax).     In  the  following 
July  she  used  this  stock  as  consideration  with  which  to  sub- 
scribe for  and  acquire  4,125  shares  of  common  stock  in  a  new 
and  different  corporation  formed  to  take  over  the  assets  of  the 
old,  the  new  stock  having  a  greater  total  par  value  than  the  old 
The  new  corporation  became  the  owner  of  substantially  all  of 
the  stock  of  the  old  company  and  caused  to  be  transferred  to 
itself  all  the  assets  of  the  old  company  and  carried  on  the  busi- 
ness of  the  latter  through  the  same  officers  without  interrup- 
tion and  without  outward  indication  of  change.    The  court  held 
that  the  complainant  was  subject  to  tax  on  the  difference  be- 
tween the  value  on  January  1,  1916,  of  the  stock  of  the  old 
company  and  the  market  value  of  the  stock  of  the  new  company 

at  the  time  of  transfer.^^-  -.noA  +v, 

4  Where  in  the  case  of  a  consolidation  effected  m  1920  the 
new  stock  received  exceeded  the  old  stock  in  par  value  but  its 
market  value  was  less  than  the  cost  in  1918  of  the  stock  ex- 
changed it  was  held  that  no  deductible  loss  was  sustained  • 
Where  the  market  value  of  the  stock  received,  taken  together 
with  certain  cash  received,  was  less  than  the  cost  of  the  old 
.tock  it  has  been  held  that  a  deductible  loss  was  sustained,  even 
though  the  par  value  of  the  new  stock  exceeded  the  par  value 

of  the  old  stock."^  ,    i^  i.     „ui^ 

5      The  members  of  a  joint-stock  company  were  held  taxable 

when  it  reorganized  into  a  corporation  and  the  par  value  of  the 

111  A.  R.  R.  289,  T.  B.  44-20-1274. 

112  Osgood  V.  Tax  Commissioner.  235  Mass.  88,  12b  N.  E.  371.  The 
court  saTd  "Although  the  property  owned  by  the  new  corporation  was 
identical  with  that  owned  by  the  old  corporation,  it  nevertheless  plainly 
Identical  wiint  ^     *       *       *     The  stock  obtained  by  the  com- 

riLftrou;  tlC'was  different  in  Idnd  and  not  merely  in  de.i-ee 
?omtha  which  she  owned  before.  It  was  not  the  same  corporation  and 
;:  stock  iLlf  was  different  in  nature,  a  change  of  ^n-tmeiU  ,^^^^^.^^-; 
„,ade  both  in  name  and  essence."  (See  also  Stone  v.  Tax  Commi.sionet , 
235  Mass.  93,  126  N.  E.  373.) 

113  0.  D.   932,  T.  B.   22-21-1660. 

114  0.   D.  970,  T.  B.  28-21-1722. 


448  FEDERAL  INCOME  TAX 

stock  received  was  greater  than  the  par  value  of  their  respective 
interests  in  the  joint-stock  company.ii» 

6.  A  case  of  great  importance  involving  the  reorganization 
of  a  corporation  and  arising  under  the  1913  Law  has  been  re- 
cently decided  by  the  Supreme  Court.^^''  The  facts  were  briefly 
as  follows: 

A  New  Jersey  corporation,  having  a  large  surplus  sufficient 
to  cover  the  distribution  indicated  below,  transferred  all  its 
assets  and  good-will  to  a  Delaware  corporation  which  assumed 
all  the  obligations  of  the  New  Jersey  corporation  except  capital 
stock  and  funded  debt.  The  New  Jersey  company  retained  some 
cash  to  redeem  one  issue  of  mortgage  bonds  and  with  some  of 
the  debenture  stock  received  from  the  Delaware  company  re- 
deemed its  preferred  stock  and  another  issue  of  bonds,  the 
balance  of  debenture  stock  received  being  just  equal  to  the  out- 
standing common  capital  stock  of  the  New  Jersey  company  and 
being  retained  in  the  treasury  of  the  New  Jersey  company.  In 
addition  to  this  debenture  stock  the  New  Jersey  company  also 
received  an  amount  of  common  capital  stock  of  the  Delaware 
company  with  a  par  value  of  twice  the  outstanding  common 
stock  of  the  New  Jersey  company.  Each  common  stockholder 
of  the  New  Jersey  company  retained  his  common  stock  and 
received  two  shares  of  common  stock  of  the  Delaware  company 
for  each  share  held  by  him  in  the  New  Jersey  company.  Imme- 
diately after  the  reorganization  the  personnel  of  stockholders 
and  officers  of  the  two  corporations  was  identical,  and  the  com- 
mon stockholders  of  each  corporation  had  the  same  proportion- 
ate stockholding.  The  New  Jersey  company  did  not  liquidate, 
but  continued  as  a  going  concern,  although  it  ceased  doing  busi- 
ness with  the  exception  of  the  redemptions  above  indicated,  the 
holding  of  the  above  debenture  stock,  and  the  collection  and 
disposition  of  dividends  thereon.  The  Commissioner  held  that 
the  common  stock  of  the  Delaware  company  received  by  the 
common  stockholders  of  the  New  Jersey  company  constituted 
income  to  such  stockholders  to  the  extent  of  its  fair  market  value, 
which  value  was  apparently  not  in  dispute.  The  Supreme  Court, 
reversing  the  court  of  claims,  and  sustaining  the  Commissioner, 
held:  (a)  The  true  inquiry  must  be  whether  the  stock  of  the 
Delaware  company  received  as  a  dividend  by  the  stockholders 
of  the  New  Jersey  company  constituted  "a  gain  derived  from 
capital,  not  a  gain  accruing  to  capital,  nor  a  growth  or  incre- 

115  0.  D.   1051,  T.  B.  40-21-1851. 

iifiU.  S.  V.  Phellis,  42  Sup.  Ct.  Rep.  63.     See  also  Rockefeller  v.  U.  S.; 
N.  Y.  Trust  Co.  v.  Edwards,  42  Sup.  Ct.  Rep.  68. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY  449 

ment  of  value  in  the  investment,  but  a  gain,  a  profit,  something 
of  exchangeable  value  proceeding  from  the  property,  severed 
from  the  capital  invested,  and  coming  in,  that  is,  received  or 
drawn  by  the  claimant  for  his  separate  use,  benefit  and  dis- 
posal." (b)  The  transfer  of  the  New  Jersey  company's  assets 
in  exchange  for  stock  of  the  Delaware  company  and  the  distri- 
bution of  such  stock  among  the  stockholders  of  the  New  Jersey 
company  changed  the  former  situation  materially ;  the  stockhold- 
ers of  the  New  Jersey  company  received  assets  of  exchangeable 
and  actual  value  "severed  from  their  capital  interest"  in  the  New 
Jersey  company.  Prior  to  the  distribution  the  common  stock- 
holders of  the  New  Jersey  company  had  merely  a  contingent 
right  to  participate  eventually  in  the  accumulated  surplus  of 
that  company;  after  the  distribution  they  had  new  individual 
property  rights  which  they  severally  were  entitled  to  retain 
and  enjoy  or  sell  and  transfer.  In  the  language  of  the  court, 
"whether  he  (the  stockholder)  sold  the  new  stock  for  money  or 
retained  it  in  preference,  in  either  case  when  he  received  it  he 
received  as  his  separate  property  a  part  of  the  accumulated  profits 
of  the  old  company  in  which  previously  he  had  only  a  potential 
and  contingent  interest",  (c)  A  comparison  of  the  market  value 
of  the  stockholders'  shares  in  the  New  Jersey  corporation  imme- 
diately before  with  the  aggregate  market  value  of  the  shares 
plus  the  dividend  shares  immediately  after  the  transaction,  as 
demonstrating  that  there  was  neither  a  pecuniary  gain  nor  loss  in 
the  transaction,  is  immaterial.  Any  dividend  or  distribution, 
whether  paid  in  money  or  assets,  reduces  the  intrinsic  value  of 
the  shares  of  stock  to  which  the  distribution  or  dividend  apper- 
tains, (d)  Looking  through  the  substance  of  the  entire  transac- 
tion the  Delaware  company  can  not  be  regarded  as  identical  with 
the  New  Jersey  company,  but  must  be  treated  as  a  substantial 
corporate  body  with  separate  entity.  The  new  corporation  was 
incorporated  in  a  different  state;  it  had  a  greater  authorized  capi- 
tal stock;  the  identity  of  officers  in  the  two  corporations  depended 
on  the  continued  and  unanimous  consent  or  concurrent  action  of 
a  multitude  of  individual  stockholders  actuated  by  motives  and 
infiuences  necessarily  to  some  extent  divergent ;  the  identity  of 
the  stockholders  was  but  a  temporary  condition  subject  to  change 
at  any  moment  at  the  option  of  any  individual,  and  the  very  fact 
of  the  transfer  of  the  assets  by  the  one  company  to  the  other 
evidenced  the  actual  separateness  of  the  two  companies. 

7.  In  a  case  arising  under  the  1909  Law  the  defendant  pur- 
chased in  1909  certain  properties,  the  legal  title  to  which  was 
taken  in  the  name  of  its  president,  as  trustee.     Later  in  the 


450  FEDERAL  INCOME  TAX 

same  year,  pursuant  to  a  plan  for  increasing  the  capital  stock 
of  the  defendant,  these  properties  were  conveyed  by  the  trus- 
tee to  a  corporation  which  had  been  formed  for  the  express 
purpose  of  thus  acquiring  and  using  them  in  carrying  out  the 
recapitalization  scheme.  The  consideration  of  the  conveyance 
was  the  issuance  by  the  latter  company  to  the  trustee  of  prac- 
tically its  entire  capital  stock.  The  stock  thus  issued  to  the 
trustee  was  immediately  transferred  by  him  to  the  defendant, 
which,  in  turn,  distributed  it  among  its  stockholders,  share  for 
share.  Thereupon,  in  furtherance  of  the  recapitalization  plan, 
a  merger  was  effected  between  the  defendant  and  the  new 
company.  For  purposes  of  the  merger,  the  value  of  properties 
so  conveyed  to  the  new  company  (which  constituted  all  of  its 
assets)  was  fixed  at  the  same  figure  as  that  at  which  the  trus- 
tee had  conveyed  them  to  that  company;  also,  before  the  stock 
was  distributed  among  the  defendant's  stockholders,  it  was 
formally  valued  by  its  directors  at  par.  The  par  value  of  such 
stock  greatly  exceeded  the  price  at  which  the  property  had 
originally  been  purchased  by  the  defendant.  The  defendant 
did  not  include  as  income  in  its  return  the  apparent  profit  result- 
ing from  the  difference  between  the  price  which  it  had  originally 
paid  for  the  properties  and  the  price  at  which  it  had  ostensibly 
sold  them  to  the  new  company.  The  government  took  the  posi- 
tion that  the  illegal  profit — both  the  purchase  and  sale  having 
taken  place  within  the  year  1909 — was  taxable  income  of  that 
year  under  the  1909  Law,  but  the  court  held  to  the  contrary.!^''' 
Determination  of  Gain  or  Loss  from  Subsequent  Sale. 

117  Alpha  Portland  Cement  Co.  v.  U.  S.,  261  Fed.  339.  The  court  said: 
"  *  *  *  it  is  apparent  that  while,  as  a  matter  of  form  and  of  book- 
keeping, the  defendant  did  realize  a  very  considerable  profit  during  the 
tax  year  in  question  on  the  purchase  and  transfer  of  these  properties, 
yet  in  reality  it  made  no  profit  whatever.  The  ultimate  and  real  result 
of  the  various  transactions  was  that  the  defendant  purchased  some  prop- 
erties at  one  figure,  and  in  working  out  a  plan  of  recapitalization  valued 
them  at  a  higher  figure.  The  intermediary  corporation,  to  which  the  legal 
title  of  the  properties  was  conveyed  by  the  trustee,  was  brought  into  be- 
ing by  the  defendant  for  the  express  purpose  of  working  out  the  re- 
capitalization plan,  and  ceased  to  exist  as  a  separate  entity  after  that 
plan  had  been  carried  out.  The  defendant  was  no  richer  after  the  alleged 
sale  than  it  was  before,  notwithstanding  the  book  entries,  resolutions  of 
directors,  transfers  of  title,  etc.  Viewed  in  this  light,  we  think  that  it  needs 
no  argument  to  demonstrate  that  the  case  falls  within  the  principle  of  the 
decisions  of  the  Supreme  Court  in  Southern  Pacific  v.  Lowe,  247  U.  S.  330,  38 
Sup.  Ct.  540,  62  L.  ed.  1142,  and  Gulf  Oil  Corp.  v.  Lewellyn,  248  U.  S. 
71,  39  Sup.  Ct.  35,  63  L.  ed.  133.  Indeed,  it  cannot  be  distinguished  on 
principle  from  the  decision  of  this  court  in  Baldwin  Locomotive  Works 
v.  McCoach,  221   Fed.  59,  136  C.  C.  A.  660." 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY  451 

On  a  subsequent  sale  of  the  new  stock  or  securities  received 
when  they  were  of  greater  aggregate  par  or  face  value  than  the 
stock  or  securities  exchanged,  the  cost  to  the  taxpayer  of  the 
new  stock  or  securities  was  held  to  be  the  cost  of  the  old  stock 
or  securities  plus  the  profit  taxed  on  the  exchange.^^^ 

Exchange  of  Property  for  Stock.  Where  property  was  trans- 
ferred to  a  corporation  in  exchange  for  its  stock  the  Treasury 
Department  held,  under  the  1918  Law,  that  the  exchange  con- 
stituted a  closed  transaction,  that  the  former  owner  of  the 
property  realized  a  gain  or  loss  if  the  stock  had  a  market  value 
and  such  market  value  was  greater  or  less  than  the  cost  of  the 
property  given  in  exchange,  but  that  if  the  property  was  acquired 
prior  to  March  1,  1913,  the  amount  of  taxable  gain  or  deductible 
loss  was  to  be  determined  in  accordance  with  the  rules  stated 
above.ii"  -phg  definition  of  the  term  "market  value,"  as  used 
in  this  regulation,  has  been  discussed  above.  The  organization 
of  a  corporation  furnishes  one  of  the  leading  examples  of  ex- 

ns  Reg.  45,  Art.  1569,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 

iWSee  p.  413;  Reg.  45,  Art.  1566,  as  amended  by  T.  D.  3206,  T.  B. 
33-21-1767.  The  provision  of  the  1921  Law  upon  this  point  has  been  dis- 
cussed above.  (See  p.  446.)  ^  The  conference  committee  struck  out  a 
provision  of  the  senate  report  on  the  Revenue  Act  of  1918  to  the  effect 
that  when  a  person  or  persons  owning  property  received  in  exchange 
for  such  property  stock  of  a  corporation  formed  to  take  over  such  property, 
no  gain  or  loss  was  to  be  deemed  to  accrue  from  the  exchange  and  the  new 
stock  or  securities  received  were  to  be  treated  as  taking  the  place  of  the 
stock,  securities,  or  properties  exchanged.  The  treasury  department  first 
ruled  that  where  property  was  transferred  to  a  corporation  in  exchange 
for  its  stock,  if  the  previous  owner  of  the  property  received  50';f  or  more 
of  the  stock  of  the  corporation,  so  that  an  interest  of  50 9r  or  more  in  such 
property  remained  in  him,  then  no  gain  or  loss  was  realized  by  such 
owner  from  the  transaction.  For  the  purpose  of  ascertaining  the  gain  or 
loss  from  the  subsequent  sale  by  the  stockholder  of  any  stock  so  received  for 
such  property,  the  stock  was  to  be  considered  as  substituted  for  the  property, 
and  the  cost  of  the  property  or  (if  acquired  prior  thereto)  its  fair  market 
value  as  of  March  1,  1913,  was  the  basis  for  determining  the  amount  of  such 
gain  or  loss.  For  the  purpose  of  ascertaining  gain  or  loss  from  the  subse- 
quent sale  by  the  corporation  of  any  such  property;  the  cost  of  the  property 
to  the  former  owner  or  (if  acquired  prior  thereto  by  him)  its  fair  market 
value  as  of  March  1,  1913,  was  the  basis  for  determining  the  amount  of 
such  gain  or  loss.  If,  however,  the  exchange  of  property  and  stock  in- 
volved less  than  50 9f  of  the  stock  of  the  corporation,  such  exchange  con- 
stituted a  closed  transaction,  and  the  former  owner  of  the  property  was  held 
to  have  realized  a  gain  or  loss  if  the  stock  had  a  market  value  and  such 
market  value  was  greater  or  less  than  the  cost  or  (if  acquired  prior  there- 
to) the  fair  market  value  as  of  March  1,  1913,  of  the  property  given  in 
exchange.  This  ruling  was  later  considered  by  the  treasury  department  not 
to  be  warranted  in  law,  and  was  modified  to  conform  with  the  text  above. 
(See  T.  D.  2924.) 


452  FEDERAL   INCOME   TAX 

change  of  property  presenting  the  question  as  to  what  constitutes 
"fair  market  value,  if  any."  Two  questions  are  presented  upon 
the  organization  of  a  corporation:  (1)  Has  the  property  trans- 
ferred to  the  corporation  been  converted  into  property  essentially 
different  from  the  property  disposed  of,  and  (2)  has  it  been 
converted  into  property  having  "a  fair  market  value,"  Has 
there  been  a  change  in  substance  as  well  as  form,  and  a  change 
into  the  "equivalent  of  cash"?^-"  Unless  the  answer  to  both 
these  questions  is  in  the  affirmative,  the  transaction  was  not 
"closed"  within  the  meaning  of  the  1918  Law,  and  there  was  no 
taxable  gain  or  deductible  loss.  If  property  was  transferred  to 
a  going,  established  corporation  having  an  active  market  for  its 
stock  and  a  small  fraction  of  that  stock  was  taken  in  payment 
thereof,  the  consideration  undoubtedly  should  have  been  treated, 
under  the  1918  Law,  as  the  "equivalent  of  cash."  It  was  con- 
vertible into  money.i-^  There  was  also  a  change  in  substance 
as  well  as  form.  On  the  other  hand,  where  an  individual  trans- 
ferred assets  to  a  newly  formed  corporation  in  exchange  for  all 
its  stock,  it  is  equally  apparent  that  he  has  not  received  the 
equivalent  of  cash.  His  stock  was  not  convertible  into  money.^— 
The  department  admitted  that  if  a  taxpayer  exchanged  property 
for  stock  in  "a  small,  closely  held  corporation,"  no  income  was 
realized  if  the  stock  had  no  market  value,  but  its  definition 
(under  the  1918  Law)  of  market  value  was  so  broad  as  to  render 
it  difficult  to  conceive  of  a  stock  which  would  not  have  market 
value.i-^  In  considering  this  question,  it  seems,  moreover,  that 
there  has  been  some  confusion  between  the  two  tests  just  indi- 
cated. In  a  case  of  the  transfer  of  assets  to  a  newly  formed 
corporation  in  exchange  for  all  of  its  stock,  has  there  been  a 
change  in  substance?  The  department's  example  of  a  change 
in  form  only  was  the  case  of  a  man  owning  10  shares  of  listed 
stock  exchanging  his  stock  certificate  for  a  voting  trust  cer- 
tificate.124  This  was,  of  course,  a  conversion  merely  in  form, 
but  was  it  anything  more  than  a  formal  conversion  when  an 

120  See  Reg.  45,  Art.  1563. 

1^1  See  Tennant  v.   Smith,    (1893)    A.   C.   150. 

1--'  The  stock  received  might  be  valued  on  the  basis  of  sales  made  soon 
after  its  receipt  by  the  taxpayer,  according  to  A.  R.  R.  156,  T.  B.  26-20- 
1024.  The  market  value  of  the  stock  received  should  theoretically,  at  least, 
have  been  taken  on  the  precise  date  when  it  is  received.  Certainly,  the 
value  should  not  be  taken  as  of  a  later  date  if  new  factors  have  intervened 
between  the  date  of  receipt  and  the  date  of  the  dealings  therein  which 
affect  such  value. 

i^-'!  See  p.  419. 

12-t  Reg.  45,  Art.  1563. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      453 

individual  transferred  assets  to  a  newly  formed  corporation  in 
exchange  for  all  of  its  stock?  After  the  exchange  he  has  pieces 
of  paper  representing  exactly  the  same  property  he  had  before 
the  exchange.  The  pieces  of  paper  stand  in  the  place  of  the 
property  exchanged.  Were  these  pieces  of  paper  "other  prop- 
erty," to  use  the  words  of  the  Revenue  Act  of  1918?  In  one 
sense,  he  was  the  corporation,  in  spite  of  the  legal  fiction  of 
separate  corporate  entity.  There  was  certainly  no  more  than 
a  formal  change  except  insofar  as  the  separate  entity  of  the 
corporation  was  respected.  It  seems  doubtful  if  the  courts  will 
allow  a  tax  to  be  imposed  upon  an  individual  in  such  a  case.  While 
the  precise  point  has  never  been  decided,  frequent  decisions  in 
the  United  States  courts,  including  the  Supreme  Court,  dis- 
regard paper  transactions  for  income  tax  purposes,  and  even 
disregard  the  doctrine  of  corporate  entity  for  many  purposes. ^-^ 
In  several  cases  in  which  property  was  turned  over  to  a  corpo- 
ration formed  for  the  purpose,  the  Treasury  Department  held 
the  owner  of  the  property  taxable  to  the  extent  of  the  differ- 
ence between  the  market  value  (as  defined  by  the  department) 
of  the  stock  received  and  the  value  of  the  property  on  March 
1,  1913,  or  its  cost,  if  acquired  subsequently  to  that  date  even 
though  the  beneficial  interest  in  the  property  was  not  sub- 
stantially changed  by  the  transaction. ^^c     ^he  facts  in  these 

125  80.  Pac.  Co.  V.  Lowe,  247  U.  S.  330;  Gulf  Oil  Corp.  v.  Lewellyn,  248 
U.  S.  71.  In  the  dictum  in  U.  S.  v.  Alpha  Portland  Cement  Co.,  257  Fed. 
432,  242  Fed.  978,  261  Fed.  339,  Judge  Dickinson,  speaking  on  the  income 
tax  alleged  to  be  due  by  reason  of  the  receipt  of  certain  stock  upon  the 
reorganization,  said  "If  the  law  is  construed  with  these  grounds,  indicating 
this  policy  in  mind,  we  must  construe  the  words  'income  received'  as  meaning 
actually  received,  and  not  to  include  something  which  exists  merely  as  a 
figment  of  the  imagination."  The  modern  tendency  of  the  courts  is  to 
disregard  paper  or  bookkeeping  transactions  for  purposes  of  determinincr 
income  tax  liability.  (See  Doyle  v.  Mitchell,  247  U.  S.  279;  Forty  Fort 
Coal  Co.  V.  Kirkendall,  233  Fed.  704;  U.  S.  v.  Guggenheim  Exploration  Co., 
238  Fed.  231),  to  look  beyond  the  corporate  form  to  the  purpose  of  it,  and  to 
ignore  the  corporate  entity  in  favor  of  the  substance  of  things  (See  Mc- 
Caskill  v.  U.  S.,  216  U.  S.  504;  U.  S.  v.  Lehigh  Valley  Co.,  220  U.  S.  254; 
U.  S.  V.  Milwaukee  Co.,  142  Fed.  247,  253;  In  re  Watertown  Paper  Co.,  169 
Fed.  252.)  But  see  U.  S.  v.  Phellis,  42  Sup.  Ct.  Rep.  63;  Eisner  v.  Macomber, 
254  U.  S.  189.  The  doctrine  of  corporate  entity  is  discussed  more  fully 
in   Chapter   10. 

120  The  department  bases  its  attitude  in  this  respect  in  large  part  upon 
the  refusal  of  Congress  in  drafting  the  Revenue  Act  of  1918  to  permit  to 
go  into  the  law  as  enacted  a  provision  proposed  in  a  senate  amendment  to  the 
effect  that  when  a  person  or  persons  o\vning  property  received  in  exchange 
for  such  property  stock  in  a  corporation  formed  to  take  over  such  property, 
no  gain  or  loss  was  to  be  deemed  to  accrue  from  the  exchange.  (See  A.  R. 
R.  173,  T.  B.  28-20-1050;   A.  R.  M.  67,  T.  B.  28-20-1049.) 


454  FEDERAL   INCOME  TAX 

v:ases  and  the  decisions  of  the  department  are  briefly  reviewed 
below :  ^~" 

.1.  Several  individuals  secured  leases  on  certain  land.  Sub- 
sequently and  prior  to  March  1,  1913,  they  entered  into  a  con- 
tract with  another  individual  whereby  3,000  acres  of  the  land 
were  assigned  to  the  latter  individual  under  the  so-called 
checkerboard  plan  and  under  which  the  assignee  obligated  him- 
self to  develop  the  field.  If  oil  or  gas  was  not  found  in  the  field 
by  a  well  drilled  to  the  depth  of  1,200  feet,  the  assignee  had 
the  option  of  abandoning  the  contract.  The  assignee  went  upon 
the  property  and  drilled  a  well  after  March  1,  1913,  which 
struck  oil.  Subsequently  in  August,  1913,  the  leases  in  ques- 
tion were  transferred  to  a  corporation  in  exchange  for  the 
stock  thereof,  the  major  portion  of  which  was  sold  by  the  stock- 
holders in  1916.  Under  these  circumstances  the  department  held 
the  stockholders  of  the  corporation  taxable  in  the  year  1913  on 
the  difference  between  the  value  of  the  stock  received  by  them 
in  August,  1913,  and  the  value  of  their  stock  as  of  March  1. 
1913.  In  determining  such  value  as  of  March  1,  1913,  it  was 
recommended  that  the  original  cost  of  the  leases  transferred  to 
the  corporation  plus  the  approximate  cost  of  the  wells  sufficient 
to  determine  whether  or  not  oil  was  present  should  be  accepted : 
that  upon  the  sale  of  the  stock  in  1916  the  profit  should  be 
computed  on  the  basis  of  the  value  of  the   stock  in   August, 

1913.128 

2.  A  taxpayer  individually  built  and  owned  a  railroad  con- 
structed for  the  sole  purpose  of  carrying  the  product  of  his 
mills  to  stations  on  other  roads  for  distribution.  In  1914  the 
state  railroad  commission  required  the  incorporation  of  this 
road.  The  commission  permitted  the  issuance  of  stock  by  the 
corporation  in  an  amount  somewhat  exceeding  the  net  assets 
of  the  road  upon  the  basis  of  an  appraisal  on  March  1,  1913, 
and  the  cost  of  additions  between  that  date  and  the  date  of 
incorporation,  making  due  allowance  for  bond  issue.  The  tax- 
payer contended  that  the  property  was  worth  at  the  time  of 
incorporation  the  amount  for  which  it  was  incorporated  and 
that  (a)  a  profit  was  made  in  1914  at  the  time  of  incorpora- 
tion, and  (b)  a  loss  was  suffered  upon  the  sale  of  the  stock  in 
1917.  The  department  held  that  while  in  the  ordinary  case 
of  an  exchange  of  property  for  stock,  the  latter  would  be  deemed 
to  be  worth  its  par  value  in  the  absence  of  evidence  to  the  con- 
trary, the  above  appraisal  indicated  a  value  of  less  than  par. 

127  See  in  addition  to  cases  below,  A.  R.  M.  94,  T.  B.  47-20-1310. 

128  A.  R.  R.  173,  T.  B.  28-20-1050. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      455 

Consequently  the  loss  claimed  upon  the  sale  in  1917  was  con- 
verted into  a  profit  by  the  use  of  the  appraised  value  of  the 
railroad  property  in  lieu  of  the  par  value  of  the  capital  stock 
issued  by  the  company.  The  department  agreed  with  the  tax- 
payer's general  contention  indicated  under  (a)  above,  but  the 
use  of  such  appraised  value  precluded  any  profit  upon  the  organi- 
zation of  the  corporation  in  1914.1-'-^' 

3.  In  a  case  in  which  an  inventor  formed  a  company  and 
issued  stock  based  upon  his  invention,  the  market  value  of  which 
when  issued  was  unknown,  but  for  which  stock  the  inventor  sub- 
sequently proceeded  to  establish  a  market,  receiving  as  com- 
pensation shares  of  the  company's  stock  which  he  sold  after- 
wards in  the  open  market  at  more  than  par  value,  the  depart- 
ment held  that  the  amount  received  for  the  stock  when  sold  in 
excess  of  its  par  value  might  reasonably  be  attributed  to  the 
inventor's  efforts  at  publicity  and  the  market  value  of  the  stock 
when  received  considered  equal  to  its  par  value. ^•"'" 

Evasion  of  Tax  on  Sale  of  Corporate  Assets  by  Conveyance  to 
Trustees.  A  change  of  form  from  that  of  a  corporation  or  asso- 
ciation to  that  of  a  trust  or  partnership  accompanied  by  a 
transfer  of  capital  assets  to  trustees  for  the  benefit  of  share- 
holders followed  by  a  sale  of  such  assets  at  a  price  in  excess  of 
the  cost  thereof  to  the  corporation  or  association,  and  the  dis- 
tribution of  proceeds  to  the  beneficiaries  (shareholders),  such 
change  being  made  for  the  main  purpose  of  avoiding  the  tax 
which  would,  under  the  1918  Law,  have  accrued  to  the  corpora- 
tion if  the  sale  had  been  made  by  it,  has  been  disregarded  by  the 
Treasury  Department  as  a  mere  sham  to  avoid  assessment  of 
tax  against  the  corporation  or  association  upon  the  profit  derived 
from  such  sale,  and  the  corporation  or  association  has  been  re- 
quired to  return  as  income  any  profit  derived  as  though  the 
sale  had  been  made  by  it  directly.^^i 

129  A.  R.  R.  126,  T.  B.  22-20-967. 

13"  O.   962,  T.   B.   1-20-656. 

i-"?!  S.  1385,  T.  B.  19-20-928.  Sec,  however,  L.  O.  1062,  T.  B.  14-21-1548. 
For  cases  on  the  general  principle  that  where  the  effect  of  a  transaction  is  to 
evade  the  payment  of  a  tax,  the  courts  will  look  beyond  the  surface  facts 
and  sham  devices  and  inquire  into  the  real  nature  of  the  transaction.  See 
Sisler  v.  Foster,  72  Ohio  437,  74  N.  E.  649;  People  v.  Albany  Ins.  Co.,  92 
N.  Y.  458;  People  v.  Sawyer,  27  N.  Y.  Supp.  202;  Pollard  v.  First  Natl. 
Bank,  47  Kans.  406,  28  Pac.  202;  Ransom  v.  Burlinpton.  Ill  Iowa  77, 
82  N.  W.  427;  Stefel  v.  Brown,  24  Mo.  App.  102;  Holly  Springs,  etc.  v. 
Supervisors,  52  Miss.  281;  Jones  v.  Seward  Co.,  10  Nebr.  154,  4  N.  W.  946; 
Mitchell  V.  Commissioners,  9  Kans.  344,  91  U.  S.  206;  Albany  City  National 
Bank  v.  Maher,  6  Fed.  417,  19  Blatch.  175;  Shotwell  v.  Moore,  45  Ohio  632, 
16  N.  E.  470,  129  U.  S.  590;  Durham  v.  State,  6  Ind.  App.  23,  32  N.  E. 


456  FEDERAL   INCOME  TAX 

Property  Acquired  by  Bequest,  Devise  or  Inheritance.     The 

Revenue  Act  of  1921  prescribes  an  explicit  basis  for  determining 
gain  or  loss  upon  the  disposition  of  property  acquired  by  bequest, 
devise  or  inheritance.  The  basis  prescribed  is  "the  fair  market 
price  or  value  of  such  property  at  the  time  of  such  acquisi- 
tion." 1^2  'pj^jg  jg  a  statutory  enactment  of  the  basis  provided 
by  regulations  under  the  1918  Law.  The  taxable  gain  derived  or 
loss  sustained  upon  the  sale  or  other  disposition  of  such  prop- 
erty will  be  the  difference  between  the  price  received  and  such 
fair  market  value,  making  proper  allowance  for  depreciation  or 
depletion  deducted  with  respect  to  the  property.  If  the  prop- 
erty was  so  acquired  by  bequest,  devise,  or  inheritance  prior 
to  March  1,  1913,  the  fair  market  price  or  value  on  that  date 
will  be  used  in  calculating  the  gain  or  loss  in  the  manner  indi- 
cated above.133  por  the  purpose  of  determining  the  profit  or 
loss  from  the  sale  of  property  acquired  by  bequest,  devise  or 
inheritance  since  February  28,  1913,  its  value  as  appraised  for 
the  purpose  of  the  federal  estate  tax,  or  in  the  case  of  estates 
not  subject  to  that  tax,  its  value  as  appraised  in  the  state  court 
for  the  purpose  of  state  inheritance  taxes,  should  be  deemed 
to  be  its  fair  market  value  when  acquired.^^^  This  provision 
applies  to  the  acquisition  of  property  or  property  interests  which 
a  decedent  has  created  in  contemplation  of  or  intended  to  take 
effect  in  possession  or  enjoyment  at  or  after  his  death  (whether 
such  transfer  or  trust  is  made  or  created  before  or  after  the 
passage  of  the  1921  Law) .  Any  transfer  of  a  material  part  of  his 
property  in  the  nature  of  a  final  disposition  or  distribution 
thereof,  made  by  the  decedent  within  two  years  prior  to  his 
death  without  a  fair  consideration,  will  be  deemed  to  have  been 
made  in  contemplation  of  death  unless  the  contrary  is  shown. 
The  provision  also  applies  to  the  acquisition  of  property  or 
property  interests  passing  under  a  general  power  of  appoint- 
ment  exercised   by   a   decedent    (1)    by   will,   or    (2)    by    deed 

104;  Peppleton  v.  Yamhill,  8  Ore.  337.  See  also  Southern  Pacific  Co.  v. 
Lowe,  247  U.  S.  330;  Gulf  Oil  Corporation  v.  Lewellyn,  248  U.  S.  71.  The 
distinction  between  a  legal  avoidance  and  an  improper  evasion  must  be  kept 
in  mind.  (Bullen  v.  Wisconsin,  240  U.  S.  625;  U.  S.  v.  Isham,  17  Wall. 
476.) 

132  Revenue  Act  of  1921,  §202   (a)   3. 

133  See  p.  413. 

134  Reg.  45,  Art.  1562,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767;  O. 
D.  667,  T.  B.  39-20-1209.  This  is  only  a  presumption  which  may  be  re- 
butted by  competent  evidence  (A.  R.  M.  7,  T.  B.  30-19-637). 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      457 

executed  in  contemplation  of,  or  intended  to  take  effect  in  pos- 
session or  enjoyment  at  or  after,  his  death. i''"' 

Where  real  estate  was  devised  by  a  testator  to  his  widow  for 
her  life  with  the  direction  that  upon  her  death  the  property 
should  be  sold  and  the  proceeds  divided  among  their  children, 
the  basis  for  ascertaining  the  gain  or  loss  on  a  sale  of  such 
real  estate  and  the  distribution  of  the  proceeds  to  the  children 
has  been  held  to  be  the  value  of  the  children's  rights  at  the  time 
such  rights  vested  or  on  March  1,  1913,  if  they  vested  prior 
thereto.  Under  the  doctrine  of  equitable  conversion  the  interest 
of  the  children  was  regarded  as  personalty  instead  of  realty,  yet 
the  estate  acquired  by  the  children  was  a  remainder  and  vested 
at  the  death  of  the  testator.^"'"'  In  spite  of  the  provision  that 
the  land  should  be  sold  the  children  could  have  taken  the  actual 
land  itself  after  the  death  of  the  life  tenant  instead  of  the 
proceeds  from  its  sale-^*^"  The  only  difference  between  the  sub- 
ject matter  disposed  or  by  sale  in  behalf  of  the  children  after 
the  death  of  the  life  tenant  and  that  acquired  by  them  on  the 
death  of  the  testator  was  that  the  former  carried  with  it  the 
actual  possession  of  the  property  and  the  latter  did  not.  Not- 
withstanding that  fact,  the  right  to  the  possession  vested  in 
the  children  at  the  death  of  the  testator;  the  enjoyment  alone 
was  postponed  to  the  death  of  the  life  tenant.  Likewise,  all 
the  rights  which  the  children  acquired  with  respect  to  the  land 
vested  at  the  death  of  the  testator  and  were  as  perfect  then 
as  at  the  death  of  the  life  tenant.!-'-'^  The  remainder  acquired 
by  the  children  on  the  death  of  the  testator  was  essentially  the 
same  property  as  the  fee  simple  sold  in  their  behalf  after  the 
death  of  the  life  tenant.  It  has  also  been  held  by  the  Treasury 
Department  that  the  exemption  in  the  statute  given  to  property 
acquired  by  gift,  bequest,  devise  or  descent,  refers  merely  to 
the  value  of  the  property  at  the  time  acquired  and  not  to  any 
value  subsequently  attaching  to  the  property  because  of  the 
actual  or  anticipated  arrival  of  the  period  of  enjoyment.  Thus, 
in  the  above  case,  while  the  possession  of  the  property  devised 
did  not  vest  in  the  children  until  the  death  of  the  widow,  the 
property  was  acquired  by  the  children  in  right  on  the  death 
of  the  testator,  and  the  measure  of  gain  or  loss  on  the  sale  of 

I-!"' See  Revenue  Act  of  1921,  §402  (c),  (e). 

1-i'i  Cropley  v.  Cooper,  19  Wall.  (U.  S.)  167,  22  L.  ed.  109;  Kelly  v. 
Gonce,  49  111.  App.  82;*DeVaughn  v.  McLeroy,  82  Ga.  687.  10  S.  E.  211. 

I-'"  Jarman  on  Wills,  p.  562. 

i-^Scofield  et  al.  v.  Olcott  et  al.,  120  111.  362,  11  N.  E.  351.  352;  Nichols 
V.  Levy,  5  Wall,   (U.  S.)   433,  442-3. 


458  FEDERAL   INCOME   TAX 

the  property  was  held  to  be  the  difference  between  the  selling 
price  and  the  fair  market  price  or  value  of  the  remainder 
interest  of  the  children  on  March  1,  1913,  the  testator  having 
died  prior  to  that  date.  Had  the  testator  died  subsequently 
to  March  1,  1913,  the  measure  would  have  been  the  difference 
between  the  selling  price  and  the  fair  market  price  or  value 
on  the  date  of  the  testator's  death.^-^*^  The  basis  for  the  deter- 
mination of  gain  or  loss  upon  the  sale  of  a  vested  remainder 
interest  has  been  held  to  be  the  value  of  the  interest  at  the  date 
of  the  death  of  the  testator,  or  March  1,  1913,  if  the  testator 
died  prior  to  that  date.  This  has  been  held  to  be  true  even  in 
the  case  of  an  interest  subject  to  being  divested  in  the  event  of 
the  death  of  the  remaindermen  without  issue  prior  to  the  death 
of  the  life  tenant,  or  by  the  disposition  of  the  property  devised 
during  the  life  tenant's  lifetime.^^"  Where  in  the  bequest  of 
property  the  remaindermen  have  only  a  contingent  interest 
prior  to  the  death  of  the  life  tenant,  the  basis  of  determining 
gain  or  loss  from  a  sale  of  the  property  by  the  remaindermen 
is  its  value  as  of  the  date  of  death  of  the  life  tenant.!*! 

Property  Acquired  by  Gift.  An  essential  change  is  made  by 
the  Revenue  Act  of  1921  in  prescribing  the  basis  for  ascertain- 
ing the  gain  derived  or  loss  sustained  from  a  sale  or  other  dis- 
position of  property  acquired  by  gift  after  December  31,  1920. 
It  is  provided!^-  that  in  the  case  of  such  property  "the  basis 
shall  be  the  same  as  that  which  it  would  have  in  the  hands  of  the 
donor  or  the  last  preceding  owner  by  whom  it  was  not  acquired 
by  gift.  If  the  facts  necessary  to  determine  such  basis  are 
unknown  to  the  donee,  the  Commissioner  shall,  if  possible,  obtain 
such  facts  from  such  donor  or  last  preceding  owner,  or  any 
other  person  cognizant  thereof.  If  the  Commissioner  finds  it 
impossible  to  obtain  such  facts,  the  basis  shall  be  the  value  of 
such  property  as  found  by  the  Commissioner  as  of  the  date  or 
approximate  date  at  which,  according  to  the  best  information 
the  Commissioner  is  able  to  obtain,  such  property  was  acquired 
by  such  donor  or  last  preceding  owner."  In  the  case  of  such 
property  acquired  by  gift  on  or  before  December  31,  1920,  the 
basis  for  ascertaining  gain  or  loss  from  a  sale  or  other  disposi- 
tion thereof  is  the  fair  market  price  or  value  of  such  property 
at  the  time  of  such  acquisition.  This  provision  does  not  apply 
to  gifts  made  in  contemplation   of  death,  nor  to  gifts  made 

• 

139  Sol.  Op.  35,  T.  B.  33-20-1126. 

140  0.   D.   694,  T.   B.  43-20-1255. 

141  O.  D.  727,  T.  B.  46-20-1301. 

142  Revenue  Act  of  1921,  §  202  (a)  2. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY     459 

to  take  effect  in  possession  or  enjoyment  at  or  after  death. 
Such  testamentary  gifts  are  treated  as  bequests  or  devises.^^=' 

The  purpose  of  this  provision  may  be  gathered  from  the  fol- 
lowing statement  :i^^  "No  explicit  rule  is  found  in  the  present 
statute  for  determining  gain  or  loss  resulting  from  the  sale  of 
such  property,  but  the  treasury  department  has  held  that  the 
proper  basis  for  such  determination  is  the  fair  market  price 
or  value  of  such  property  at  the  time  of  its  acquisition  by  the 
donee.  This  rule  has  been  the  source  of  serious  abuse.  Tax- 
payers who  have  property  the  value  of  which  has  increased, 
give  such  property  to  wives  or  relatives,  by  whom  it  may  be 
sold  without  taxation  of  the  increase  in  value  which  took  place 
while  the  property  was  owned  by  the  donor." 

Gifts  Under  1918  Law.  As  indicated  in  the  quotation  m 
the  preceding  paragraph,  under  the  1918  Law,  the  basis  for 
ascertaining  gain  or  loss  in  the  case  of  property  acquired  by 
gift  was  the  fair  market  price  or  value  of  the  property  at  the 
time  of  acquisition  by  gift."^  The  following  opinion  was  issued 
under  the  1918  Law  in  definition  of  gifts : 

(a)  Where  it  appears  that  the  owner  of  property  has  pur- 
ported to  transfer  it  without  consideration  to  a  member  of  his 
own  family,  or  to  any  other  person  with  whom  he  is  in  con- 
fidential relations,  and  that  shortly  thereafter  a  profitable  sale 
of  the  security  or  property  so  transferred  has  occurred,  such 
facts  constitute  2)rima  facie  evidence  that  the  purported  gift 
was  not  an  actual  gift  and  that  the  transfer  was,  in  fact,  merely 
colorable.  In  such  case  the  so-called  gift  should  be  ignored  m 
calculating  tax,  and  the  case  should  be  investigated  for  evidence 
on  which  a  charge  of  fraud  could  be  supported  in  a  contest. 

(b)  The  prima  facie  case  made  out  by  the  facts  mentioned 
in  the  preceding  paragraph  may  be  rebutted  by  proof  which 
establishes  that  it  w?cS  not  a  transaction  primarily  for  the  ad- 
vantage of  the  donor,  and  that  there  was  no  agreement  or 
understanding,  tacit  or  otherwise,  that  the  donor  was  to  receive 
back  the  proceeds  or  at  any  time  control  their  disposition.  Mere 
statements  by  the  parties  to  the  effect  that  the  gift  was  genuine 
are  regarded  as  of  little  weight;  the  best  proof  that  a  gift  was 
a  real  gift  would  consist  of  Jacts  showing  that  the  position  or 

14".  See  Report  of  Finance  Committee  on  Internal  Revenue  Bill  of  1921, 

p.  11.    See  p.  456. 

14-t  See  Report  of  Finance  Committee  on  Internal  Revenue  Bill  ot  IJZl, 
D   10:  Report  of  Ways  and  Means  Committee,  p.  9. 

145  Reg  45,  Art.  1562,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767.  See 
0.  D.  1112,  T.  B.  48-21-1940. 


460  FEDERAL   INCOME   TAX 

relationship  of  the  parties  is  such  as  to  show  a  reasonable  occa- 
sion for  such  a  gift  being  made,  and  such  as  to  explain  the  sale 
by  the  donee.  Inquiry  should  be  made  as  to  the  disposition  of 
the  proceeds. 

(c)  Where  a  taxpayer  purports  to  make  a  gift  to  a  member 
of  his  family  or  to  a  person  in  a  confidential  relation  to  him- 
self, but  no  sale  occurs,  the  question  whether  such  gift  was 
real  or  merely  colorable  is  one  to  be  decided  on  all  of  the  facts. 
The  mere  fact  that  such  conveyance  is  made  may  not  lawfully 
be  regarded  as  proof  of  fraud;  but  if  the  effect  of  the  gift  is 
to  diminish  tax  liability,  and  it  appears,  either  at  the  time  of 
the  gift  or  at  any  time  thereafter,  that  the  donor  is  deriving 
advantage  from  the  property  which  he  purported  to  give  away, 
such  facts  constitute  prima  facie  evidence  that  the  gift  was 
only  colorable  and  the  transaction  should  be  treated  as  a  nullity 
unless  other  facts  are  developed  which  show  that  it  was  a  true 
gift.  If  such  a  gift  is  colorable  only  and  made  for  the  purpose 
of  escaping  tax,  the  donor  is  guilty  of  fraud  and  subject  to 
penalty  and  punishment  therefor, i^" 

An  individual  in  1893  purchased  a  tract  of  land  and  deeded  it 
to  his  wife.  Shortly  thereafter  a  part  of  the  land  was  sold, 
the  purchaser  subsequently  defaulting  under  a  purchase  money 
mortgage  and  the  husband  some  time  before  March  1,  1913, 
bought  in  the  property  at  a  foreclosure  sale  placing  the  title 
again  in  his  wife's  name,  the  wife  from  1913  to  1917,  inclusive, 
including  the  income  from  the  property  in  her  income-tax  re- 
turns. In  1917  the  property  was  transferred  to  the  husband, 
but  the  deed  was  never  recorded.  For  1918  the  income  from 
the  property  was  reported  by  the  husband.  In  1919  the  prop- 
erty was  again  sold,  the  wife  giving  the  deed.  The  treasury 
department  held  that  the  wife  was  at  all  times,  during  the 
period  in  question,  the  real  owner  of  the  property,  and  any  gain 
or  loss-  upon  the  sale  thereof  in  1919  should  be  included  in  her 
return  for  that  year,  since  the  land  was  deeded  to  the  wife  as 
a  bona  fide  gift  in  1893,  and  since  the  husband  who  loaned  the 
money  to  the  purchaser  and  of  right  held  the  mortgage  upon 
the  property  allowed  the  deed  to  remain  in  his  wife's  name 
when  he  bought  the  property  in  at  the  foreclosure  sale,  and 
since  all  the  income  for  the  years  1913  to  1917,  inclusive,  was 
reported  in  the  wife's  returns,  indicating  the  husband's  ac- 
knowledgment of  her  right  to  it.  There  were  other  circum- 
stances indicating  that  the  unrecorded  deed  of  1917  was  not 
considered  by  the  parties  as  a  valid  and  binding  transfer.   The 

i-ir.  S.  1022,  T.  B.  7-i9-290. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      461 

deed  of  transfer  in  1919  when  the  property  was  sold  was  exe- 
cuted in  the  wife's  name  and  the  mortgage  to  secure  a  portion 
of  the  purchase  price  was  taken  in  her  name  and  later  assigned 
to  the  huband,  the  wife  continuing  to  be  the  record  owner  until 
the  deed  of  sale,^^" 

Sale  of  Homestead.  The  basis  for  determining  gain  or  loss 
from  the  sale  of  a  homestead  acquired  from  the  government 
will  be  the  fair  market  value  of  the  homestead  at  the  date  of 
its  acquisition.  The  date  of  acquisition  of  a  homestead  acquired 
by  public  grant  is  the  date  of  entry  upon  the  land.  The  taxpayer 
will  not  be  entitled  to  add  to  the  value  of  the  homestead  the 
amount  expended  for  relinquishment  in  order  to  clear  the  land 
office  records,  nor  any  fees  paid  to  the  government,  but  the  cost 
of  improvements  may  be  added  to  the  value  as  of  the  date  of 
acquisition.^^"*  The  above  rule  is  limited  to  the  original  entry- 
man,  and  has  no  application  to  the  case  of  those  acquiring  gov- 
ernment lands  in  any  other  way  than  under  the  homestead 
laws."" 

Sales  and  Dealings  in  Bonds.  It  has  been  held  under  the  1918 
Law  that  the  property  received  on  exchange  of  a  so-called  con- 
vertible bond  for  stock  pursuant  to  such  a  privilege  granted  in 
the  bond  may  produce  income  if  the  stock  received  in  exchange 
has  a  fair  market  value  in  excess  of  the  cost  of  the  bond.^^o 
The  exchange  of  old  bonds  of  a  corporation  for  bonds  of  a  new 
issue  having  an  extended  maturity  date  and  bearing  a  higher 
rate  of  interest  has  also  been  held  to  be  an  exchange  of  property 
which  may  result  in  gain  or  loss.^''^  No  taxable  income  accrued 
under  the  1918  Law  on  an  exchange  of  bonds  purchased  prior  to 
March  1,  1913,  for  57 ^V  of  the  face  value  of  the  old  bonds  in 
new  bonds  of  the  same  company  and  43 '^  in  cash.  The  cash  was 
regarded  as  a  return  of  part  of  the  March  1,  1913,  value  of  the 
old  bonds,  and  the  cost  of  the  new  bonds  for  the  purpose  of 
computing  gain  or  loss  in  case  of  sale  or  other  disposition  of 
such  bonds  was  deemed  to  be  the  difference  between  the  cash 
received  at  the  time  of  exchange  and  the  value  of  the  old  bonds 
on  March  1,  1913.1"'-     Where  a  corporation  reduced  its  capital 

1^7  o.  D.  543,  T.  B.  24-20-999. 

"SO.  D.  386,  T.  B.  5-20-712;  0.  880,  T.  B.  17-19-470.  If  the  date  of  ac- 
quisition was  prior  to  March  1,  1913,  see  p.  413  for  the  method  of  com- 
puting taxable  gain  or  deductible  loss  in  case  of  sale. 

149  O.  D.  601,  T.  B.  30-20-1086. 

150  Reg.  45,  Art.  1563. 

151  0.  D.  308,  T.  B.  25-19-580. 

152  0.  D.  98,  T.  B.  2-19-143. 


462  FEDERAL   INCOME  TAX 

stock  by  one-half  and  a  stockholder  therein  surrendered  his  cer- 
tificate for  10  shares  acquired  prior  to  March  1,  1913,  and 
received  in  exchange  a  new  certificate  for  5  shares  and  an 
amount  of  cash,  it  was  held  under  the  1918  Law  that  the  amount 
by  which  the  cash  exceeded  the  value  as  of  March  1,  1913,  of  the 
5  shares  surrendered  represented  taxable  income  to  the  stock- 
holder for  the  year  in  which  the  exchange  took  place.  The  5 
new  shares  were  held  to  have  taken  the  place  of  the  5  old  shares 
for  which  no  payment  in  cash  was  received.^^^ 

Municipal  Bonds  Purchased  at  a  Premium  or  Discount.  When 
municipal  bonds  are  purchased  at  a  premium  and  held  to  ma- 
turity, their  purchase  price,  including  the  premium,  determines 
whether  there  is  a  gain  or  loss  on  the  bonds,  the  gain  or  loss 
to  be  measured  according  to  whether  the  bonds  were  purchased 
before  or  after  March  1,  191S.^-'^  Profit  derived  from  state  and 
municipal  securities  purchased  at  a  discount  is  not  taxable  in 
the  hands  of  the  person  holding  such  obligations  at  maturity 
except  that  in  no  case  may  such  exemption  exceed  the  total 
discount  at  which  the  securities  were  originally  sold  by  the  state 
or  municipality.  Inasmuch  as  no  person  other  than  the  mu- 
nicipality can  pay  the  interest  borne  by  the  obligations  of  the 
municipality  (whether  such  interest  is  paid  at  a  specified  rate 
or  in  the  form  of  realized  discount) ,  any  person  selling  munic- 
ipal bonds  for  an  amount  in  excess  of  the  cost  of  the  bonds  to 
him  may  realize  a  taxable  profit,  even  though  the  bonds  were 
issued  at  a  discount.^^^ 

Surrender,  Exchange  and  Sale  of  Insurance  Policies.  An  in- 
surance policy  is  property .1''*^  In  determining  the  question  of 
the  taxable  gain  arising  upon  exchanges  of  insurance  policies, 
such  exchanges  are  to  be  divided  into  classes  as  follows : 

(1)  Cases  in  which  the  second  policy  at  the  time  of  issu- 
ance has  no  readily  determinable  cash  value,  and 

(2)  Cases  in  which  the  second  policy  at  the  time  of  issu- 
ance has  a  readily  determinable  cash  value,  and 

(a)  The  value  of  the  surrendered  policy  as  of  March  1, 
1913,  is  greater  than  the  gross  premiums  charged  prior  to  that 
date,  less  amounts  returned,  deducted  or  abated  therefrom,  or 

(b)  The  value  of  the  surrendered  policy  as  of  March  1, 
1913,  is  not  greater  than  the  gross  premiums  charged  prior  to 
that  date,  less  amounts  returned,  deducted,  or  abated  therefrom. 

153  O.  D.  693,  T.  B.  43-20-1254. 

154  See  0.  D.  726,  T.  B.  46-20-1300. 

155  See  O.  D.  737,  T.  B.  48-20-1321. 

156  Ionia  Co.  Savings  Bank  v.  McLean,  84  Mich.  629,  48  N.  W.  159. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY  463 

In  cases  falling  in  Class  1  no  taxable  gain  arises  from  the 
exchange. 

In  cases  falling  in  Class  2(a)  the  taxable  gain,  if  any,  aris- 
ing from  the  exchange  is  the  amount  whereby  (1)  the  sum  of 
the  value  of  the  policy  surrendered  as  of  March  1,  1913,  plus 
the  gross  premiums  subsequently  charged,  less  amounts  re- 
turned, deducted,  or  abated  therefrom,  is  exceeded  by  (2)  the 
cash,  if  any,  received  upon  surrender  of  the  first  policy,  plus 
the  cash  value  of  the  second  policy. 

In  cases  falling  in  Class  2(b)  the  taxable  gain,  if  any,  aris- 
ing from  the  exchange  is  the  amount  whereby  (1)  the  gross 
premiums  charged  at  any  time,  either  before  or  on  or  after 
March  1,  1913,  less  sums  returned,  deducted,  or  abated  there- 
from, are  exceeded  by  (2)  the  cash,  if  any,  received  upon  sur- 
render of  the  first  policy  plus  the  cash  value  of  the  second 
policy.i^'^ 

The  surrender  value  of  an  insurance  policy  as  of  March  1, 
1913,  may  be  used  as  a  basis  for  the  purpose  of  ascertaining  the 
gain  derived  from  the  sale  or  other  disposition  thereof.^^s  The 
distinction  has  been  made  between  the  surrender  of  a  policy 
and  the  sale  thereof  to  some  one  other  than  the  company  which 
wrote  the  policy,  and  the  ruling  made  that  upon  such  a  sale 
the  cash  surrender  value  on  March  1,  1913,  is  the  basis.^''^''  But 
it  would  seem  that  upon  any  disposition  of  an  insurance  policy, 
whether  to  the  insurer  or  a  third  party,  the  insured  is  entitled 
to  use  the  aggregate  premiums  paid  as  a  basis  for  ascertain- 
ing any  taxable  gain,  if  the  amount  thereof  is  greater  than  sur- 
render value  on  March  1,  1913,  plus  net  premiums  subsequently 
charged.  In  other  words,  the  ruling  at  the  beginning  of  this 
paragraph  would  seem  to  express  the  correct  basis  for  deter- 
mining gain  upon  a  sale  as  well  as  a  surrender  or  exchange.!*^ 
Where  a  corporation  which  carried  insurance  policies  on  the 
lives  of  its  officers  under  which  it  was  named  as  the  beneficiary 
sells  the  policies  for  a  sum  less  than  the  total  premiums  paid 

i'"'<  Sol.  Op.  55,  T.  B.  3(5-20-1181;  Reg.  45,  Art.  87.  as  amended  by  T.  D. 
3206,  T.  B.  33-21-1767;  O.  D.  379,  T.  B.  4-20-701.  This  ruling  was  made 
under  the  1918  Law.  Under  the  present  law,  if  an  insurance  policy  is  held 
"for  investment"  and  is  exchanged  for  property  of  a  "like  kind  or  use", 
(another  policy)  there  would  seem  to  be  no  taxable  profit.  On  the  point  that 
insurance  policies  are  held  for  investment  to  some  extent  see  Penn  Mutual 
Life  Insurance  Co.  v.  Lederer,  252  U.  S.  523. 

i-'-S  Reg.  45,  Art.  87,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 

i-'fi  0.  D.  379,  T.  B.  4-20-701. 


464  FEDERAL   INCOME   TAX 

(and  not  deducted  from  gross  income) ,  no  part  of  the  amount 
received  for  the  policies  is  taxable.i^^ 

Sale  of  Mines,  Oil  and  Gas  Wells.  In  computing  the  gain  or 
loss  from  the  sale  of  mines,  oil  and  gas  wells  discovered  on  or 
after  March  1,  1913,  a  taxpayer  is  not  entitled  to  set  up  the 
value  as  of  the  date  of  discovery,  or  within  30  days  thereafter, 
as  the  basis  of  the  computation.  The  provision  fixing  the  basis 
for  determining  gain  or  loss  from  the  sale  of  property  or  its 
cost,  as  the  case  may  be,  contains  no  exception  except  that  fair 
market  value  on  March  1,  1913,  may  be  used  in  certain  in- 
stances. The  provision  relating  to  value  at  the  date  of  dis- 
covery, or  within  30  days  thereafter,  relates  to  the  depletion 
allowance  and  not  to  a  sale  of  mines,  oil  and  gas  wells.^"''- 

Sales  of  Property  Involving  Installment  and  Deferred  Pay- 
ments. While  the  Revenue  Act  of  1918  contained  no  provision  re- 
specting the  taxation  of  profits  from  sales  of  property  involving 
installment  and  deferred  payments,  the  treasury  department  per- 
mitted taxpayers  to  report  as  income  that  proportion  of  each 
installment  payment  which  the  gross  profit  when  the  property 
is  paid  for  bears  to  the  gross  contract  price.^^^  The  Revenue 
Act  of  1921  refers  to  such  transactions  in  its  provisions  re- 
specting exchanges  of  property  and  provides  that  nothing  in 
such  provisions  shall  be  construed  to  prevent  (in  the  case  of 
property  sold  under  contract  providing  for  payment  in  install- 
ments) the  taxation  of  that  portion  of  any  installment  payment 
representing  gain  or  profit  in  the  year  in  which  such  payment 
is  received.i^^  The  remaining  paragraphs  of  this  chapter  deal 
with  the  taxation  of  profits  from  such  transactions  and  from 
the  sale  of  real  estate  in  lots. 

It  is  to  be  noted  that  the  above  provision  of  the  Revenue 
Act  of  1921  refers  only  to  the  method  of  computing  the  tax  and 

160  See  O.  D.  1037,  T.  B.  38-21-1827. 

161  0.  D.  724,  T.  B.  45-20-1297. 

162  Sol.  Op.  26,  T.  B.  29-20-1068.  This  ruling,  though  made  under  the 
Revenue  Act  of  1918,  is  equally  applicable  under  the  present  law.  The 
fact  that  this  construction  of  the  statute  involves  a  discrimination  in  favor 
of  a  discoverer  who  operates  and  against  a  discoverer  who  sells,  does  not 
affect  this  conclusion,  since  the  statute  is  free  from  ambiguity.  Moreover, 
a  construction  of  the  statute  permitting  a  taxpayer  to  set  up  a  value  as  of 
the  date  of  discovery,  or  within  30  days  thereafter,  for  the  purpose  of  de- 
termining gain  or  loss  upon  a  sale  would  negative  the  provisions  of  the 
statute  limiting  the  surtax  and  the  war-profits  and  excess-profits  tax  upon 
a  sale  of  mines,  oil  and  gas  wells. 

16.".  Reg.  45,  Art.  42,  as  amended  by  T.  D.  3082. 
164  Revenue  Act  of  1921,  §202  (f). 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY  465 

allocating  income  upon  sales  involving  installment  payments  It 
would  seem  that  the  rules  established  by  the  Revenue  Act  of 
1921  for  the  determination  of  the  existence  of  a  gam  or  loss  that 
is,  whether  a  gain  or  loss  may  be  said  to  occur,  will  apply  to 
transactions  involving  installment  and  deferred  payments.  There 
is  certainly  no  reason  why  such  transactions  should  be  classed 
differently  for  this  purpose  from  transactions  which  do  not  in- 
volve installment  payments.  It  is  also  to  be  noted  that  the  capi- 
tal gain  provision  may  apply  to  transactions  involving  install- 
ment and  deferred  payments  and  that  the  provision  that  no  gain 
or  loss  shall  be  recognized  when  property  held  for  investment  or 
for  productive  use  in  trade  or  business  is  exchanged  for  property 
of  a  like  kind  or  use  may  apply  to  some  of  the  transactions  dis- 
cussed in  the  following  paragraphs. 

Sale  of  Personal  Property  on  Installment   Plan.     Dealers   m 
personal   property   ordinarily   sell   either  for   cash,   or   on  the 
personal  credit  of  the  buyer,  or  on  the  installment  plan.  Occa- 
sionally a  fourth  type  of  sale  is  met  with,  in  w^hich  the  buyer 
makes  an  initial  payment  of  such  a  substantial  nature    (for 
example,  a  payment  of  more  than  25^;)   that  the  sale   though 
involving   deferred   payments,   is   not  one  on   the   installment 
plan      In  sales  on  personal  credit,  and  of  the  substantial  pay- 
ment type  just  mentioned,  obligations  of  purchasers  are  to  be 
regarded  as  the  equivalent  of  cash,i«^'  but  a  different  rule  applies 
to  sales  on  the  installment  plan.     Dealers  in  personal  property 
who   sell   on   the   installment  plan   usually   adopt   one   of   four 
w^ys  of  protecting  themselves  in  case  of  default:   (a)  through 
an  agreement  that  title  is  to   remain   in   the  seller  until  the 
buyer  has  completely  performed  his   part  of  the  transaction; 
(b)  by  a  form  of  contract  in  which  title  is  conveyed  to  the  pur- 
chaser immediately,  but  subject  to  a  lien  for  the  unpaid  portion 
of  the  purchase  price;  (c)  by  a  present  transfer  of  title  to  the 
purchaser,  who  at  the  same  time  executes  a  reconveyance  in 
the  form  of  a  chattel  mortgage  to  the  seller;  or  (d)  by  convey- 

I'i.-.  The  treasury  department  recognizes  that  in  many  sales  of  that  type 
the  obligations  of  purchasers,  even  though  represented  by  notes  or  other 
paper  in  negotiable  form,  can  not  be  discounted  or  otherwise  converted  into 
cash  without  material  loss  because  of  lack  of  credit  on  the  part  of  the  buyer 
and  the  nature  of  the  property  covered  by  such  contract.  In  such  cases  the 
profits  from  such  sales  may  be  computed  in  accordance  with  the  rules  pre- 
scribed for  sales  or  contracts  for  sale  of  personal  property  on  the  install- 
ment plan,  provided  the  taxpayer  chooses  to  do  so  as  a  matter  of  consistent 
practice  and  attaches  to  his  return  a  statement  disclosing  that  fact  and 
showing  conclusivelv  that  the  obligations  of  the  purchasers  are  not  the 
equivalent  of  cash.     (0.  D.  715.  T.  B.  45-20-1287.) 


466  FEDERAL  INCOME   TAX 

ance  to  a  trustee  pending  performance  of  the  contract  and 
subject  to  its  provisions.  The  general  purpose  and  effect  being 
the  same  in  all  of  these  plans,  it  is  desirable  that  a  uniformly 
applicable  rule  be  established.  The  rule  prescribed  is  that  in 
the  sale  or  contract  for  sale  of  personal  property  on  the  install- 
ment plan,  whether  or  not  title  remains  in  the  vendor  until  the 
property  is  fully  paid  for,  the  income  to  be  returned  by  the 
vendor  will  be  that  proportion  of  each  installment  payment 
which  the  gross  profit  to  be  realized  when  the  property  is  paid 
for  bears  to  the  gross  contract  price.  Such  income  may  be 
ascertained  by  taking  as  profit  that  proportion  of  the  total  cash 
collections  received  in  the  taxable  year  from  installment  sales 
(such  collections  being  allocated  to  the  year  against  the  sales 
of  which  they  apply)  which  the  annual  gross  profit  to  be 
realized  on  the  total  installment  sales  made  during  each  year 
bears  to  the  gross  contract  price  of  all  such  sales  made  during 
that  respective  year.  In  any  case  where  the  gross  profit  to  be 
realized  on  a  sale  or  contract  for  sale  of  personal  property  has 
been  reported  as  income  for  the  year  in  which  the  transaction 
occurred,  and  a  change  is  made  to  the  installment  plan  of  com- 
puting net  income,  no  part  of  any  installment  payment  received 
subsequently  to  the  change,  representing  income  previously 
reported  on  account  of  such  transaction,  should  be  reported  as 
income  for  the  year  in  which  the  installment  payment  is  re- 
ceived; the  intent  and  purpose  of  this  provision  is  that  where 
the  entire  profit  from  installment  sales  has  been  included  in 
gross  income  for  the  year  in  which  the  sale  was  made,  no  part 
of  the  installment  payments  received  subsequently  on  account 
of  such  previous  sales  shall  again  be  subject  to  tax  for  the 
year  or  years  in  which  received.  Where  the  taxpayer  makes 
a  change  to  this  method  of  computing  net  income  his  balance 
sheet  should  be  adjusted  conformably.  If  for  any  reason  the 
vendee  defaults  in  any  of  his  installment  payments  and  the 
vendor  repossesses  the  property,  the  entire  amount  received  on 
installment  payments,  less  the  profit  already  returned,  will  be 
income  of  the  vendor  for  the  year  in  which  the  property  was 
repossessed,  and  the  property  repossessed  must  be  included  in 
the  inventory  at  its  original  cost  to  himself,  less  proper  allow- 
ance for  damage  and  use,,  if  any.  If  the  vendor  chooses  as  a 
matter  of  consistent  practice  to  treat  the  obligations  of  pur- 
chasers as  the  equivalent  of  cash,  such  a  course  is  permissible.^*'''^ 

I6fi  Reg.  45,  Art.  42,  as  amended  by  T.  D.  3082.  In  England  it  has  been 
held  that  the  phrase,  "annuities  or  other  annual  profits  or  gains,"  as  used 
in  5  &  6  Vict.,  Chapter  35,  §  102,  which  imposes  an  income  tax  on  same,  does 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      467 

Scope  of  Method.  The  treatment  outlined  above  for  sales 
of  personal  property  on  the  installment  plan  is  not  limited  to 
dealers  alone,  or  to  sellers  of  chattels  as  distinguished  from  sell- 
ers of  other  forms  of  personal  property,  such  as  corporate  stock. 
The  retention  of  a  lien  upon  the  property  sold  as  security  for  the 
purchaser's  agreement  to  pay,  does  not  alter  this  conclusion, "'^  if 
the  principal  stockholder  of  a  corporation  sells  stock  to  employees 
of  a  company  for  consideration  of  10  per  cent,  cash  and  the  bal- 
ance in  installment  payments  secured  by  notes  covering  a  period 
of  10  years,  that  proportion  of  each  installment  payment  received 
during  the  taxable  year  which  the  gross  profit  to  be  realized  bears 
to  the  gross  contract  price  should  be  reported  as  income  for  the 
year  during  which  installment  payments  were  received. ^"'^ 

Computation  of  Income  from  Installment  Sales  of  Per- 
sonal Property.  Income  from  installment  sales  to  be  returned 
in  each  taxable  year  will  consist  of:  (1)  Such  part  of  the  install- 
ments received  during  the  year  (excluding  those  installments 
received  on  account  of  property  repossessed  during  the  year)  as 
represents  realized  profit.  Installments  received  during  the  year 
are  to  be  included  whether  the  sales  were  effected  in  an  earlier 
or  in  the  current  taxable  year.  The  profit  on  such  installments 
should  be  computed  by  taking  the  same  percentage  of  the  in- 
stallment receipts  as  the  gross  profit  to  be  realized  on  the  total 
installment   sales  made  during  the  taxable  year  bears   to   the 

not  apply  to  installments  of  the  purchase  price  of  an  estate,  although  such 
payments  are  due  yearly  and  extend  over  a  long  period  of  years,  the  in- 
stallments being  regarded  as  parts  of  a  debt  or  capital,  and  not  profits  and 
gains  to  which  the  act  applies,  and  this  even  though  a  part  of  the  install- 
ments consists  of  profits.  (Foley  v.  Fletcher  (1858),  3  Hurst.  &  N.  769, 
157  Eng.  Reprint,  G78,  28  L.  J.  Exch.  N.  S.  100,  5  Jur.  N.  S.  342,  7  Week. 
Rep.  141,  4  Mor.  Min.  Rep.  130.)  In  regard  to  sales,  both  of  real  and  per- 
sonal property,  where  title  passes  immediately  to  the  vendee,  the  treasury 
department's  early  rulings  required  the  return  of  the  profits  from  the  sale 
as  income  for  the  year  in  which  the  sale  was  made.  If  the  buyer  forfeited 
his  contract  and  failed  to  meet  any  of  the  payments  contracted  to  be  made, 
the  vendor  was  permitted  to  deduct  from  his  gross  income  as  a  loss  such 
proportion  of  the  defaulted  payments  as  was  previously  returned  as  income. 
The  early  rulings,  where  title  did  not  pass  absolutely  to  the  vendee,  are  con- 
tained in  a  letter  from  the  treasury  department  dated  March  14,  1917;  In- 
come Tax  Primer,  December  17,  1917,  Question  32.  On  April  25,  1918,  in 
T.  D.  2707  the  treasury  department  modified  Reg.  33  Rev.,  Arts.  117  and 
120  and  established  the  ruling  that  until  personal  property  sold  on  the  in- 
stallment plan  is  fully  paid  for.  the  income  to  be  returned  by  the  vendor 
will  be  that  proportion  of  each  installment  payment  which  the  gross  profit 
to  be  realized  when  the  property  is  paid  for  bears  to  the  gross  contract  price 

i*''7S.  1353,  T.  B.  13-20-806;  O.  D.  482,  T.  B.  18-20-894. 

108  O.  D.  134,  T.  B.  4-19-212. 


468  FEDERAL   INCOME   TAX 

gross  contract  price  of  all  such  sales.  Any  necessary  corrections 
to  produce  a  more  accurate  result  can  be  made  as  at  the  end  of 
the  taxable  year,  (2)  The  profits,  if  any,  on  contracts  which 
during  the  year  have  been  canceled,  the  goods  being  repossessed 
by  the  vendor.  In  such  cases  the  entire  profit  realized  on  the 
canceled  contract,  less  so  much  thereof  as  has  been  returned  in 
previous  years,  should  be  returned  as  profit  of  the  taxable  year 
in  which  the  goods  are  repossessed.  In  estimating  such  profit 
the  value  of  the  repossessed  article  (taken  at  its  cost  to  vendor, 
less  proper  allowance  for  damage  and  use)  should  be  taken  into 
account,  as  well  as  all  installments  received  on  account  of  the 
contract.  Where  an  installment  house  makes  sales  which  are 
not  on  the  installment  plan,  the  profit  on  such  completed  sales  will 
be  determined  in  the  regular  manner.^'''' 

The  following  is  an  illustration  of  the  computation  of  income 
from  sales  of  personal  property  on  the  installment  plan:  In  1917 
goods  which  cost  $10,000  are  sold  on  installment  plan  for  $20,000. 
Collections  on  account:  1917,  $10,000;  1918,  $9,800.  One  con- 
tract, originally  for  $500,  is  defaulted  in  1918  and  the  goods 
which  cost  the  vendor  $250  are  repossessed,  being  then  worth 
$50.  Installments  on  this  defaulted  contract  had  been  paid  as 
follows:  1917,  $100;  in  1918,  $200.  The  profits  to  be  returned  in 
1918  are: 

Under   (1)   50'v    of  $9,600  ($9,800— $200) $4,800 

Under  (2)  total  installments  received $300 

Less-Profit  returned  in  1917 $  50 

Shrinkage  in  goods  repossessed 

($250— $50)   200 

250 

50 

Total  profit  returnable  in  1918 $4,850 

For  simplicity,  the  above  illustration  omits  sales  in  1918.  If  sales 
in  1918  contain  a  different  percentage  of  profit  than  those  in 
1917,  some  adjustment  may  be  necessary.  Where  the  adoption 
of  the  method  outlined  above  involves  a  change  in  the  method 
of  computing  net  income,  the  taxpayer's  balance  sheet  should  be 
adjusted  conformably  as  of  the  date  when  the  change  is  effected. 
If  the  vendor  chooses  as  a  matter  of  consistent  practice  to  treat 

ifiO  Letter  from  treasury  department  dated  April  26,  1919;  L  T.  S.  1921, 
II  969. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      469 

the  obligations  of  purchasers  as  the  equivalent   of  cash,   such 
a  course  is  permissible.'"" 

Method  of  Accounting  to  Be  Employed.  The  following 
has  been  adopted  where  a  taxpayer  engaged  in  merchandising 
upon  the  installment  plan  has  heretofore  made  returns  upon  the 
basis  of  treating  the  profit  upon  installment  sales  as  realized  as 
at  the  date  of  sale  and  now  wishes  to  change  to  the  basis  of 
reporting  the  profit  as  being  realized  as  at  the  date  of  collection 
of  the  outstanding  accounts.  In  accordance  with  the  rule  above 
stated  the  balance  sheet  as  at  the  beginning  of  the  taxable  year, 
which  should  be  filed  as  a  part  of  the  return,  will  carry  the  install- 
ment sales  contracts  unliquidated  and  remaining  in  force  as  at  the 
date  that  this  system  of  accounting  is  adopted  and  made  effective 
by  the  taxpayer,  as  accounts  receivable,  such  unliquidated  in- 
stallment sales  contracts  having  been  inventoried  and  determined 
as  at  that  date.  Cash  collections  on  account  of  such  contracts 
will  be  credited  directly  to  such  accounts  receivable  and  no  part 
of  such  collections  will  be  included  in  computing  realized  profits 
for  the  taxable  year.  As  from  the  beginning  of  the  taxable  year, 
the  following  accounts  should  be  set  up: 

(a)  Goods  purchased,  which  will  be  charged  with  the 
amount  of  inventory  of  the  goods  on  hand  at  the  beginning  of  the 
taxable  year  and  with  the  expenditures  for  goods  purchased 
during  the  year. 

(b)  Goods  sold  (cost  values),  which  will  be  credited  with  the 
cost  value  of  all  goods  sold  during  the  year. 

(c)  Installment  sales  contracts  (year  date),  which  \vi\\  be 
charged  only  with  the  amount  of  installment  sales  contracts 
made  during  the  year  specified.  This  account  for  each  year 
will  be  credited  with  all  cash  collected  during  that  yeai",  or  in 
subsequent  years,  upon  installment  sales  contracts  for  that 
year  only,  and  with  the  unpaid  installments  of  defaulted  or 
canceled  contracts  for  that  year. 

(d)  Unrealized  gross  profits  on  installmoit  sales  co)itracts 
(year  date),  which  will  be  credited  only  with  the  amount  of 
unrealized  gross  profits  upon  installment  sales  contracts  made 
during  the  year  specified.  This  amount  will  be  the  total  of  the 
installment  sales  contracts  for  that  year  reduced  by  the  cost 
or  inventory  value,  (as  carried  in  account  (a)  goods  purchased), 
of  the  actual  goods  sold  and  covered  by  the  contracts ;  the  balance 

ITO  Letter  from  treasury  department  dated  July  10.  1919;    I.  T.  S.   1919, 
H  348G,  T.  D.  3082. 


470  FEDERAL   INCOME   TAX 

remaining  being  the  amount  of  the  unrealized  gross  profits.    The 
proforma  monthly  (or  annual)  journal  entry  would  be: 

Dr.     Cr. 

Installment  sales  contracts  (year  date,)  $.  . .  . 

To  goods  sold  (cost  value) $.  . .  . 

Unrealized  gross  profits  on  installment  sales 

contracts  (year  date) • $ ,  . ,  . 

(e)  ReaUzed  2^^^(^fits  on  installment  sales  contracts,  which 
will  be  credited  from  month  to  month  (or  at  the  end  of  the 
year),  with  the  profits  realized  by  cash  collections  upon  all 
installment  sales  contracts  of  any  year.  Such  profits  should 
be  computed  by  taking  the  same  percentage  of  the  cash  col- 
lections made  during  the  taxable  year  on  account  of  installment 
sales  contracts  of  either  that  or  prior  years,  as  the  total  un- 
realized profits  on  installment  sales  contracts  for  the  year  against 
which  the  collection  applies,  bear  to  the  total  installment  sales 
made  during  that  respective  year.  Corresponding  debits  should 
be  made  to  uny^ealized  gross  profits  on  installment  sales  contracts 
for  the  year  affected  by  such  collections.  If  adjustments  to  any 
or  all  of  these  various  accounts  become  necessary  in  order  that 
it  or  they  may  accurately  reflect  the  facts,  such  adjustments 
may  be  made  either  monthly  or  as  at  the  end  of  the  taxable 
year.i'i 

C.  0.  D.  and  "will  call"  sales  should  be  included  in  the  inventory 
at  the  close  of  the  year,  if  the  merchandise  has  not  been  actually 
shipped  to  the  customers,  unless  such  merchandise  has  been  in- 
cluded in  sales  of  the  taxable  year,  in  which  case  it  should  be 
excluded  from  inventory .1^- 

It  will  be  noted  that  the  foregoing  plan  which  will  be  per- 
mitted upon  an  explicit  statement  of  facts  made  to  the  Com- 
missioner by  a  taxpayer  engaged  in  merchandising  upon  the 
installment  plan  is  not  a  change  from  an  accrual  basis  to  a  cash 
received  and  paid  basis.  In  the  opinion  of  the  Commissioner, 
the  income  of  a  merchandising  concern  can  not  be  correctly 
reflected  upon  the  latter  basis,  as  the  use  of  inventories  is  abso- 
lutely essential.  The  plan  herein  outlined  is,  therefore,  merely 
such  a  modification  or  adaptation  of  the  ordinary  accrual  method 
of  accounting  as  in  the  opinion  of  the  Commissioner  will  en- 
able the  accounts  of  the  taxpayer  clearly  to  reflect  his  net  in- 
come.    Where  in  the  past  another  method  has  been  used  that 

171  0.  D.  623,  T.  B.  32-20-1118,  modifying  T.  B.  R.  24,  T.  B.  8-19-36. 
1T2  0.  D.  24,  T.  B.  1-19-36. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      471 

has  failed  to  reflect  the  taxpayer's  net  income  an  amended  re- 
turn or  returns  for  such  year  may  be  made.^^^ 

If  books  have  been  so  kept  that  the  cost  of  each  article  sold 
was  not  shown,  gross  profit  may  be  determined  by  taking  the 
average  percentage  of  gross  profit  on  gross  sales.  If  several 
different  lines  of  merchandise  are  handled  on  which  the  average 
percentages  of  profit  differ,  the  gross  profit  on  total  sales  of  each 
different  class  of  merchandise  should  be  computed  separately. ^"^ 

In  cases  of  continuous  accounts  covering  sales  of  personal 
property,  the  income  from  which  is  reported  on  the  installment 
plan,  the  cash  payments  received  should  be  allocated  in  accord- 
ance with  the  generally  recognized  principle  of  law  governing 
such  cases,  that  is,  that  failing  application  by  the  vendee,  the 
cash  payments  should  be  applied  to  the  earliest  items  of  the 
account.i""^ 

It  has  been  ruled  that  a  taxpayer  who  sells  merchandise  on 
the  installment  plan  may  not  allocate  the  expenses  incident  to 
producing  the  income  to  the  year  in  which  the  profits  on  the  sale 
of  the  goods  are  realized,  but  should  deduct  such  expenses  in 
the  year  in  which  incurred  and  paid  or  accrued.^''' 

TREATMENT  OF  BAD  DEBTS.  The  amount  to  be  deducted  from 
gross  income  as  a  bad  debt  in  cases  of  sales  of  personal  property 
on  the  installment  plan  in  which  the  unpaid  installment  obliga- 
tions of  the  purchaser  become  worthless  and  are  charged  off  and 
the  property  is  not  recovered  by  the  vendor  is  such  proportion 
of  the  defaulted  payments  as  represents  the  capital  investment, 
that  is,  the  cost  of  the  goods  sold,  and  this  amount  must  be  de- 
ducted for  the  year  in  which  the  default  occurred.  This  rule 
may  be  made  clear  if  the  accounting  procedure  suggested  above  is 
followed  under  the  conditions  given  in  the  following  example : 

Let  it  be  assumed  that  the  taxpayer's  installment  sales  (con- 
tracts) for  the  year  1919  w^ere  $300,000  and  that  the  cost  of  the 
goods  sold  and  covered  by  such  contracts  was  $100,000;  then  the 
unrealized  gross  profits  would  be  $200,000  and  the  rate  of  profit 
for  that  year  would  be  established  at  66-;;  per  cent. 

Let  it  be  assumed,  further,  that  during  the  years  1919  and  1920 
the  cash  collections  on  account  of  such  contracts  were  $266,700; 
then  the  entries  covering  these  transactions  would  be  as  foUoAvs : 

Installment  sales  contracts,  1919 $300,000 

To  goods  sold  (cost  value) $100,000 

IT.!  O.  D.  (528,  T.  B.  33-20-1118,  modifying  T.  B.  R.  24,  T.  B.  8-19-313. 

174  0.  D.  25.  T.  B.  1-19-37. 

1".  O.  D.  815,  T.  B.  8-21-1460;  0.  D.  1045,  T.  B.  39-21-1838. 

1T<!  O.  D.  844,  T.  B.  11-21-1508. 


472  FEDERAL   INCOME   TAX 

To  unrealized  gross  profits  on  installment 

sales  contracts,  1919 200,000 

Rate  of  gross  profit — -/■«  or  66-/^  per  cent. 
Unrealized  gross  profits  on  install- 
ment sales   contracts,   1919 177,800 

To  realized  profits  on  install- 
ment sales  contracts 177,800 

Cash    collections    during    1919    and 

1920  for  account  of  1919 $266,700 

%   thereof 177,800 

At  the  close  of  1920  the  accounts,  as  aff'ected  by  the  above 
transactions,  would  stand  as  below: 

Debits.  Credits. 

Cash $236,700     Goods     sold     (cost 

Installment  sales  con-  value)     $100,000 

tracts,    1919 33,300     Unrealized  gross 

profits,    etc 22,200 

300,000     Realized  profits,  etc.      177,800 


500,000 


Of  the  above  balance  of  $33,300  to  the  debit  of  installment  sales 
contracts,  two-thirds,  or  $22,200  (shown  as  a  balance  to  the 
credit  of  unrealized  gross  profits),  is  to  be  accounted  for  and 
taxed  as  profits  as,  when,  and  if  collected.  The  remaining  one- 
third  is  the  capital  investment  representing  the  cost  of  goods 
sold. 

But  let  it  be  assumed  that  the  whole  or  any  part  of  the  bal- 
ance of  the  installment  sales  contracts,  amounting  to  $33,300, 
was  defaulted  in  1919  or  at  any  later  time ;  then  the  question 
arises:  How  should  the  loss  occasioned  by  such  defaults  be 
treated  for  purposes  of  determining  the  income  and  excess  profits 
tax? 

The  answer  is  that  the  proper  portion  (two-thirds  in  this  case) 
of  the  amount  of  the  defaulted  payments  should  be  charged 
against  the  unrealized  profits  and  the  balance  (in  this  case  one- 
third),  representing  the  cost  of  the  goods  sold,  should  be  allowed 
to  the  taxpayer  as  a  deduction  for  losses  actually  sustained  during 
the  taxable  year. 

This  method  of  treatment  should  be  followed  whether  the 
goods  are  or  are  not  recovered.  If  the  goods  are  not  recovered, 
it  correctly  reflects  the  facts  without  further  entries  upon  the 
books.    If  the  goods  are  recovered,  their  fair  market  value  at  the 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      473 

time  of  recovery  should  be  credited  as  realized  profits  for  that 
year,  with  a  corresponding  debit  to  the  account  of  goods  pur- 
chased. The  dilference  (debit  balance)  between  the  two  accounts 
of  goods  purchased  and  goods  sold  should  rellect  the  value  of  the 
physical  inventory  at  any  given  date.^" 

Combination  of  Cash,  Charge  and  Installment  Sales.  A 
corporation  doing  business  on  both  a  cash  and  installment  basis 
should  report  profits  on  the  installment  sales  on  the  basis  out- 
lined above.  The  cash  sales,  each  of  which  represents  a  com- 
pleted and  closed  transaction,  should  be  reported  separately,  that 
is,  the  entire  profits  derived  from  every  cash  sale  must  be  re- 
ported as  income  in  the  return  for  the  year  in  which  the  sale 
was  made.^""^ 

In  the  case  of  a  combination  of  cash,  charge,  and  installment 
sales,  the  cost  of  the  goods  sold  is  obtained  in  the  usual  manner 
which  is  the  sum  of  the  opening  inventory  and  purchases  for 
the  year  less  the  closing  inventory.  The  percentage  of  gross 
profit  on  sales  for  the  year  is  the  percentage  which  the  gross 
profit  from  all  sales  is  of  the  total  sales  for  the  year,  regardless 
of  whether  cash,  charge,  or  installment  sales.  The  percentage  of 
gross  profit  for  a  particular  year  applied  to  the  total  collections 
for  that  year  gives  the  gross  income  from  sales  for  such  year. 
This  percentage  remains  the  same  for  collections  on  installment 
sales  contracts  for  a  particular  year  regardless  of  whether  such 
collections  are  made  in  the  year  in  which  the  sale  was  made  or 
in  a  later  year.  Collections  made  in  subsequent  years  on  prior 
installment  sales  contracts  must,  of  course,  be  allocated  and 
credited  to  the  year  in  which  the  sale  was  made.  In  addition 
to  the  special  accounts  enumerated  above  the  other  accounts 
which  would  normally  be  maintained  are  the  same  as  those  of  an 
ordinary  business  adapted  if  necessary  to  furnish  the  informa- 
tion desired  at  the  close  of  thp  accounting  period.^"'' 

Change  in  Method  of  Reporting.  In  cases  where  the  tax- 
payer has  in  the  past  exercised  the  option  of  reporting  the  profit 
as  realized  as  at  the  date  of  sale  and  now  wishes  to  change  to  a 
basis  of  reporting  the  profit  as  realized  as  at  the  date  of  collec- 
tion of  the  outstanding  installments,  either  of  which  method  is 
allowable,  amended  returns  for  years  prior  to  the  date  that  the 
above  outlined  system  of  accounting  is  adopted  and  made  effective 
by  the  taxpayer,  will  not  be  required  or  allowed  unless  in  the 
opinion  of  the  Commissioner  such  former  method  has  failed  to 

i"0.  D.  792,  T.  B.  6-21-1427. 
nso.  D.  23,  T.  B.  l-19-8r). 


474  FEDERAL   INCOME  TAX 

reflect  the  net  incomej^*^  The  Commissioner  will  not  approve 
such  a  change  merely  because  the  taxpayer  will  derive  an  advan- 
tage from  decreased  tax  liability.  When  a  change  is  approved 
the  taxpayer  will  be  required  to  adhere  to  it  in  his  returns  for 
subsequent  years  and  the  first  return  made  under  the  changed 
method  should  be  accompanied  by  a  letter  of  explanation. ^^^ 

Sale  of  Real  Estate  Involving  Deferred  Payments.  Deferred 
payment  sales  of  real  estate  ordinarily  fall  into  two  classes  when 
considered  with  respect  to  the  terms  of  sale,  as  follows:  (1)  In- 
stallment transactions,  in  which  the  initial  payment  is  relatively 
small  (generally  less  than  one-fourth  of  the  purchase  price)  and 
the  deferred  payments  usually  numerous  and  of  small  amount. i^- 
They  include  (a)  sales  where  there  is  immediate  transfer  of  title 
when  a  small  initial  payment  is  made,  the  seller  being  protected 
by  a  mortgage  or  other  lien  as  to  deferred  payments,  and  (b) 
agreements  of  purchase  and  sale  which  contemplate  that  a  con- 
veyance is  not  to  be  made  at  the  outset,  but  only  after  all  or  a 
substantial  portion  of  the  agreed  installments  have  been  paid. 
(2)  Deferred  payment  sales  not  on  the  installment  plan,  in  which 
there  is  a  substantial  initial  payment  (ordinarily  not  less  than 
one-fourth  of  the  purchase  price),  deferred  payments  being  se- 
cured by  a  mortgage  or  other  lien.  Such  sales  are  distinguished 
from  sales  on  the  installment  plan  by  the  substantial  character  of 
the  initial  payment  and  also  usually  by  a  relatively  small  number 
of  deferred  payments.  In  determining  how  these  classes  shall  be 
treated  in  levying  the  income  tax,  the  question  in  each  case  Is 
whether  the  income  to  be  reported  for  taxation  shall  be  based 
only  on  amounts  actually  received  in  a  taxing  year,  or  on  the 
entire  consideration  made  up  in  part  of  agreements  to  pay  in  the 
future.is3  jvjo  realization  of  gain  or  loss  arises  from  a  mere 
contract  to  sell  real  estate  in  the  future.  The  sale  is  held  to  oc- 
cur at  the  time  a  deed  passes  or  at  the  time  possession  and  the 
burdens  and  benefits  of  ownership  are  from  a  practical  stand- 
point transferred  to  the  buyer,  whichever  occurs  first.  Pay- 
ments made  prior  to  the  sale  are  to  be  applied  in  reduction  of 
cost  so  far  as  they  do  not  exceed  cost ;  being  treated  as  income 
to  the  extent,  if  any,  to  which  cost  is  exceeded.^'"^^ 

170  O.  D.  1107,  T.  B.  47-21-1930. 

1S'»  0.  D.  623,  T.  B.  32-20-1118,  modifying  T.  B.  R.  24,  T.  B.  8-19-313. 

181  O.  D.  24,  T.  B.  1-19-36. 

182  See  A.  R.  M.  140,  T.  B.  46-21-1918. 
iS.'i  Reg.  45,  Art.  44. 

184  O.  988,  T.  B.  8-20-751. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      475 

Sale  of  Real  Estate  on  Installment  Plan.  In  the  two 
kinds  of  transactions  included  in  class  (1)  in  the  foregoing  para- 
graph, installment  obligations  assumed  by  the  buyer  are  not 
ordinarily  to  be  regarded  as  the  equivalent  of  cash,  and  the  vendor 
may  report  as  his  income  from  such  transactions  in  any  year 
that  proportion  of  each  payment  actually  received  in  that  year 
which  the  gross  profit  to  be  realized  when  the  property  is  paid 
for  bears  to  the  gross  contract  price.  If  the  return  is  made 
on  this  basis  and  the  vendor  repossesses  the  property  after  de- 
fault by  the  buyer,  retaining  the  previous  payments,  the  entire 
amount  of  such  payments,  less  the  profit  previously  returned, 
will  be  income  to  the  vendor,  and  will  be  so  returned  for  the  year 
in  which  the  property  was  repossessed,  and  the  property  repos- 
sessed must  be  included  in  the  inventory  less  any  depreciation. 
If  the  taxpayer  chooses,  as  a  matter  of  settled  practice  con- 
sistently followed,  to  treat  the  obligations  of  the  purchaser  as 
equivalent  to  cash  and  to  report  the  profit  derived  from  the  en- 
tire consideration,  cash  and  deferred  payments,  as  income  for  the 
year  when  the  sale  is  made,  this  is  permissible.  If  so  treated  the 
rule  prescribed  in  the  following  paragraph  will  apply.^'*-' 

Deferred  Payment  Sales  of  Real  Estate  Not  on  the  In- 
stallment Plan.  In  class  (2)  in  the  next  to  the  last  paragraph 
above  the  obligations  assumed  by  the  buyer  are  much  better  se- 
cured because  of  the  margin  afforded  by  the  substantial  first  pay- 
ment, and  experience  shows  that  the  greater  number  of  such 
sales  are  eventually  carried  out  according  to  their  terms.  These 
obligations  for  deferred  payments  are  therefore  to  b6  regarded  as 
equivalent  to  cash,  and  the  profit  indicated  by  the  entire  consider- 
ation is  taxable  income  for  the  year  in  which  the  initial  payment 
was  made  and  the  obligations  assumed.  If  the  buyer  defaults 
and  the  seller  regains  title  to  the  land  by  agreement  or  process  of 
law,  retaining  payments  previously  made,  he  may  deduct  from  his 
gross  income  as  a  loss  in  the  year  of  repossession  any  excess 
of  the  amount  previously  reported  as  income  over  the  amount 
actually  received,  and  must  include  such  real  estate  in  his  inven- 
tory at  its  original  cost  to  himself  less  any  depreciation.^*^" 

In  the  case  of  real  estate  sales  involving  deferred  payments, 
even  though  substantial  first  payment  is  made,  if  the  notes 
given  by  buyers  of  real  estate  can  not  be  discounted  nor  sold 
on  account  of  lack  of  credit  of  the  buyers,  sj.ich  notes  need  not 
be  regarded  as  the  equivalent  of  cash,   and  the  vendors  may 

183  Reg.  45,  Art.  45. 
186  Reg.  45,  Art  46. 


476  FEDERAL   INCOME   TAX 

report  as  their  income  from  the  proposed  transaction  for  each 
year  only  the  proportion  of  each  payment  actually  received 
in  that  year  which  the  gross  profit  to  be  realized  when  the 
property  is  paid  for  bears  to  the  gross  contract  price.^'^'^ 

Where  pursuant  to  a  contract  to  sell  real  estate  executed  in 
one  year  at  which  time  a  small  cash  consideration  was  paid, 
delivery  of  the  deed  and  transfer  of  possession  taking  place  in 
the  next  year,  in  which  latter  year  a  substantial  payment  was 
made  and  notes  secured  by  mortgage  for  the  unpaid  balance 
were  given,  it  has  been  held  that  the  vendor  should  report  the 
profit  realized  from  the  transaction  as  gross  income  for  the 
latter  year  and  that  the  small  advance  payment  made  in  the 
earlier  year  should  be  treated  as  a  return  of  capital  since  it 
was  less  than  the  cost  of  the  property  to  the  vendor  and  did 
not,  therefore,  constitute  taxable  income  for  the  earlier  year.i'*^ 

Where  a  tract  of  land  was  sold  on  November  1,  1919,  1/10 
of  the  purchase  price  accompanying  the  bid,  4/10  being  paid 
in  December,  1919,  and  the  balance  in  January,  1920,  at  which 
time  a  proper  conveyance  of  title  was  delivered  to  the  purchaser, 
the  sale  should  be  treated  as  a  cash  transaction  for  1919  and  the 
entire  profit  realized  be  returned  as  income  for  that  year.^'^'' 

Where  an  individual  sold  real  estate  receiving  in  the  year 
of  sale  over  Vi  of  the  total  selling  price,  the  contract  providing 
that  the  balance  should  be  paid  in  four  annual  installments 
thereafter,  such  deferred  payments  being  secured  by  crop  mort- 
gages and  additional  collateral  security,  it  has  been  held  that 
the  payments  received  in  the  year  of  sale  were  sufficiently  sub- 
stantial in  amount  to  require  the  vendor  to  report  in  that  year 
the  entire  profit  realized  on  the  sale.^'"^ 

Where  an  individual  sold  real  estate  which  was  mortgaged  to 
secure  a  loan  made  by  a  state,  the  vendor  agreeing  to  make 
payment  partly  in  cash,  assumed  payment  of  the  morgtgage 
held  by  the  state  and  gave  the  vendor  a  mortgage  to  cover  the 
balance  of  the  sale  price,  it  has  been  held  that  the  vendor  has 
received  the  full  amount  of  the  sale  price  in  cash  or  its  equivalent 
and  should  report  the  entire  profit  realized  as  income  for  the 
year  in  which  the  sale  was  consummated,  notwithstanding  that 

IS-  O.  D.  181,  T.  B.  8-19-314. 

ISS  A.  R.  R.  13,  T.  B.  2-20-671.  See  also  O.  D.  751,  T.  B.  51-20-1350;  0.  D. 
842,  T.  B.  11-21-1506'and  letter  from  treasury  department  dated  April  27, 
1921;  I.  T.  S.  1921,  112991. 

180  O.  D.  568,  T.  B.  27-20-1037. 

190  O.  D.  569,  T.  B.  27-20-1038. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      477 

the  state  refused  to  accept  the  vendee's  promise  to  pay  in  lieu 
of  the  vendor's  original  liability  for  payment  of  the  note  in  case 
of  default  by  the  vendee. i'" 

In  1920,  a  partnership  owning  a  sawmill  business  entered  into 
a  contract  for  the  sale  of  its  property  to  a  corporation.  In  accord- 
ance with  the  contract,  the  corporation  made  a  cash  payment  of 
$200,000  down  and  obtained  possession  of  the  mill  plant  and 
equipment,  a  large  tract  of  timber,  together  with  certain  leases 
and  other  rights,  and  all  the  timber  owned  by  the  partnership 
on  certain  other  sections  of  land.  The  contract  also  required  the 
corporation  to  make  large  cash  payments  in  one,  two,  three  and 
four  years,  respectively,  from  the  date  of  the  contract,  and  it 
was  provided  that  as  each  of  the  stipulated  payments  was  made, 
there  should  be  released  to  the  corporation  all  the  timber  owned 
by  the  partnership  on  certain  other  specified  sections  of  land. 
Upon  making  the  last  payment  stipulated  in  the  contract  a 
warranty  deed  to  the  property  covered  by  the  contract  was  to  be 
executed  and  delivered  to  the  corporation.  A  bond  was  given 
by  the  vendors  for  the  execution  and  delivery  of  such  warranty 
deed  upon  the  fulfillment  of  the  conditions  by  the  vendee.  The 
entire  transaction  was  covered  by  the  contract  and  the  bond,  the 
obligations  of  the  vendee  not  being  represented  by  notes  or  other 
negotiable  paper  in  any  form.  It  was  held  that  the  sale  of  the 
property  covered  by  the  contract  should  be  considered  as  having 
taken  place  only  when  and  as  the  stipulated  payments  were  made 
and  the  property  released  to  the  corporation.  The  sale  of  each 
parcel  of  the  property  should,  therefore,  be  treated  as  a  separate 
transaction.i"- 

Where,  under  the  terms  of  a  contract  of  sale  of  land  near  de- 
veloped oil  territory,  one-half  of  the  consideration  was  to  be 
paid  in  cash  and  one-half  in  oil  at  the  market  price  after  the 
land  is  developed,  the  vendor  having  no  recourse  if  oil  is  not 
found,  it  was  held  that  the  part  of  the  consideration  represented 
by  the  right  to  receive  oil,  in  case  oil  is  found,  has  not  a  definitely 
ascertainable  value,  and  hence  is  not  to  be  considered  the  equiva- 
lent of  cash.  No  taxable  income  will  be  reahzed  by  reason  of  the 
sale  until  the  amount  received  by  the  vendor  in  cash,  plus  the 
cash  value  of  oil  received,  exceeds  the  cost  of  the  property.^^'' 

Sale  of  Real  Estate  in  Lots.  Where  a  tract  of  land  is  pur- 
chased with  a  view  to  dividing  it  into  lots  or  parcels  of  ground 

it»i  O.  D.  409,  T.  B.  11-20-784. 

102  0.  D.  835,  T.  B.  10-21-1493. 

103  O.  D.  889,  T.  B.  17-21-1591. 


478  FEDERAL  INCOME  TAX 

to  be  sold  as  such,  the  cost  must  be  equitably  apportioned  to  the 
several  lots  or  parcels  and  made  a  matter  of  record  on  the  books 
of  the  taxpayer,  to  the  end  that  any  gain  derived  from  the  sale 
of  any  such  lots  ok  parcels  which  constitutes  taxable  income  may 
be  returned  as  income  for  the  year  in  which  the  sale  was  made. 
This  rule  contemplates  that  there  will  be  a  measure  of  gain  or 
loss  on  every  lot  or  parcel  sold,  and  not  that  the  capital  invested 
in  the  entire  tract  shall  be  extinguished  before  any  taxable  in- 
come shall  be  returned.  The  sale  of  each  lot  or  parcel  will  be 
treated  as  a  separate  transaction  and  the  gain  or  loss  will  be  ac- 
counted for  in  accordance  with  the  rules  for  determining  gain 
or  loss  from  sales, i'^^  Profit  realized  on  the  sale  of  lots,  the 
selling  price  of  which  includes  the  cost  of  certain  development 
work  already  made  or  to  be  made  in  accordance  with  the  con- 
tract of  sale,  should  be  based  on  the  cost  of  the  land  to  the 
vendor  making  the  sale,  plus  the  actual  and  estimated  future 
expenditures  for  development.  If  the  estimated  future  ex- 
penditures should  be  subsequently  ascertained  to  be  incorrect, 
amended  returns  should  be  filed  as  the  basis  for  an  adjustment 
of  the  tax  for  the  years  affected.  The  cost  of  such  develop- 
ment having  been  taken  into  consideration  in  determining 
profit,  expenditures  for  this  purpose  can  not  be  deducted 
from  gross  income  in  subsequent  returns.^''-^  The  purchase  of 
real  estate  with  the  intention  of  reselling  it  as  a  whole  will  not 
avoid  the  above  method  of  treatment,  if,  in  fact,  the  land  is  sold 
in  several  parts.  The  sale  of  a  perpetual  easement  on  a  specified 
number  of  acres  of  land  to  a  railroad  company  is  to  be  treated  as 
though  it  were  an  outright  sale  of  land  where  legal  title  passes 
at  the  time  of  sale,  unless  for  some  reason  the  fee  of  the  owner 
has  more  than  a  merely  nominal  value,  as  for  example,  where  the 
land  is  underlaid  by  a  mine.^^*^ 

i«4Reg.  45,  Art.  43,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767.     See 
Chapter  17. 

195  0.  D.  567,  T.  B.  27-20-1036;  O.  D.  226,  T.  B.  12-19-399. 

196  0.  D.  1072,  T.  B.  43-21-1881. 


CHAPTER  18 

INCOME  FROM   INTEREST,  RENT  AND  ROYALTIES  * 

Both  the  Revenue  Act  of  1921  and  the  Revenue  Act  of  1918 
expressly  provide  that  gross  income  shall  include  gains,  profits, 
and  income  derived  from  "interest"  and  from  "rent."  The  law 
does  not  expressly  cover  income  from  royalties,  which  falls, 
however,  under  the  broad  expression  "income  derived  from  sales, 
or  dealings  in  property,  whether  real  or  personal,  growing  out 
of  the  ownership  or  use  of  or  interest  in  such  property ;  also 
gains  or  profits  and  income  derived  from  any  source  whatever," 
Interest  is  ordinarily  taxable  in  the  hands  of  citizens  and  resi- 
dents and  domestic  corporations,  whether  received  from  debtors 
in  this  country  or  debtors  in  foreign  countries.  It  is  taxable  in 
the  hands  of  non-resident  aliens  and  foreign  corporations  when 
it  is  paid  on  bonds,  notes  or  other  interest-bearing  obligations 
of  residents,  corporate  or  ptherwise.^ 

Interest  Exempt  from  Tax.  The  law  expressly  provides  that 
interest  upon  the  obligations  of  a  state,  territory  or  political 
subdivision  thereof,  or  the  District  of  Columbia  or  any  posses- 
sion of  the  United  States,  or  securities  issued  under  provisions 
of  the  Federal  Farm  Loan  Act  of  Jul}^  17,  1916,  or  interest  upon 
the  obligations  of  the  United  States  issued  prior  to  September  1, 
1917,  (and  to  a  limited  extent  the  interest  on  obligations  issued 
after  that  date)  and  bonds  issued  by  the  War  Finance  Corpora- 
tion (to  a  limited  extent)  shall  not  be  included  in  gross  income, 
and  shall  be  exempt  from  income  tax.- 

Interest  upon  ITnited  States  Obligations.  Although  interest 
upon  the  obligations  of  the  United  States  is  in  general  exempt 
from  tax,  in  the  case  of  such  obligations  issued  after  September 
1,  1917,  which  include  treasury  certificates  of  indebtedness,  war 
savings  certificates  and  the  Liberty  bond  issues  (except  the  First 

1  Revenue  Act  of  1921,  §§213  (a)  and  233;  Revenue  Act  of  1918,  §§213 
(a)  and  223.  See  Chapters  4  and  12  as  to  interest  taxable  in  the  hands  of 
nonresident  aliens  and  foreign  corporations.  As  to  interest,  see  Reg.  33, 
Art.  67;  Letter  from  treasury  department  dated  February  18,  1915;  I.  T.  S. 
1919,  Tf923;  Reg.  45,  Art.  54.  As  to  rent,  see  letters  from  Treasury  Depart- 
ment dated  February  9  and  February  26,  1915.  I.  T.  S.  1919,  U  920.  Unless 
the  taxpayer  keeps  his  books  on  a  basis  other  than  that  of  actual  receipts,  he 
should  report  interest,  rent  and  royalties  as  income  of  the  year  in  which  pay- 
ment thereof  is  actually  or  constructively  received  by  him. 

2  Revenue  Act  of  1921,  §  213  (b)  4 ;  Revenue  Act  of  1918,  §  213  (b)  4. 

479 


480  FEDERAL   INCOME   TAX 

Liberty  Loan  31/2  per  cent,  bonds),  the  interest  is  exempt  from 
tax  only  if  and  to  the  extent  provided  in  the  acts  authorizing  the 
issue  thereof,  as  amended  and  supplemented."  There  are  five  is- 
sues of  so-called  Liberty  Loan  bonds  comprising  ten  different 
classes  of  bonds  and  notes.  These  ten  classes  are  as  follows:  (1) 
First  Liberty  Loan  31/2 'a  Bonds;  (2)  First  Liberty  Loan  Con- 
verted 4:7c  Bonds;  (3)  First  Liberty  Loan  Converted  41/4% 
Bonds  (dated  May  9,  1918)  ;  (4)  First  Liberty  Loan  41/4%  Bonds 
(dated  October  24,  1918)  ;  (5)  Second  Liberty  Loan  4%;  Bonds; 
(6)  Second  Liberty  Loan  Converted  4%':<  Bonds;  (7)  Third  Lib- 
erty Loan  414',;  Bonds;  (8)  Fourth  Liberty  Loan  414%  Bonds; 
(9)  Victory  (Fifth)  Liberty  Loan  3%%  Notes;  (10)  Victory 
(Fifth)  Liberty  Loan  4349<  Notes.  The  respective  acts^  author- 
izing the  issue  of  these  obligations  grant  exemption  in  every 
case  from  any  normal  ^  tax  upon  the  interest  therefrom.  Some 
of  the  obligations  are  wholly  exempt  from  the  surtax  or  the 
excess-profits  tax  (in  the  case  of  corporations),  while  others 
carry  no  exemption  from  such  taxes.  In  addition,  many  of  the 
obligations  carry  limited  or  partial  exemptions  as  appear  in  the 
following  paragraphs.  The  Revenue  Act  of  1921  has  further 
amended  and  supplemented  the  various  Acts  authorizing  the 
issue  of  Liberty  bonds  and  has  consolidated  the  Liberty  bond 
tax  exemptions.''  As  a  result  the  exemptions  under  the  1921 
law  differ  considerably  from  those  previously  granted. 

Tax  Exemptions  of  Liberty  Bonds  and  Victory  Notes  Under 
the  1918  Law.  L  Under  the  1918  Law,  the  following  bonds  and 
notes  were  exempt  from  all  federal,  state,  and  local  taxation, 
except  (a)  estate  or  inheritance  taxes  and  (b)  federal  income 
surtaxes  and  profits  taxes,  as  follows: 

■'  Reg.  45,  Art.  77.  Under  earlier  income  tax  laws,  interest  upon  the  obli- 
gations of  the  United  States  was  expressly  included  as  taxable  income  (see 
Act  of  March  2,  1867).  Under  the  1909  Law  the  attorney-general  held  that 
interest  on  national  bonds  should  be  included  as  income  of  corporations,  since 
the  tax  was  not  on  property,  but  a  tax  on  the  privilege  of  carrying  on  busi- 
ness (28  Op.  Atty.  Gen.  138). 

^  Act  of  April  24,  1917;  Act  of  September  24,  1917;  Act  of  April  4,  1918; 
Act  of  July  9,  1918;  Act  of  March  3,  1919;   Revenue  Act  of  1921,  §1328. 

5  This  word  applies  to  the  income  tax  on  corporations  as  well  as  the 
normal  tax  on  individuals.  (Official  announcement  by  treasury  department, 
dated  April  23,  1919;  L  T.  S.  1921,  H  1238. 

c  Revenue  Act  of  1921,  §  1328. 


INCOME  FROM  INTEREST,  RENT  AND  ROYALTIES 


481 


1.  First  Liberty  loan  convert- 

ed 4  per  cent  bonds  of 
1932-1947   (first  4s). 

2.  First    Liberty    loan    con- 

verted 4Vi  per  cent 
bonds  of  1932-1947  (first 
414s,  issue  of  May  9, 
1918). 

3.  First   Liberty   loan   second 

converted  4V4  per  cent, 
bonds  of  1932-1947  (first 
414s,  issue  of  October 
24,  1918). 

4.  Second  Liberty  loan  4  per 

cent  bonds  of  1927-1942 
(second  4s). 

5.  Second    Liberty    loan    con- 

verted 41/4  per  cent 
bonds  of  1927-1942  (sec- 
ond 4Vis). 

6.  Third  Liberty  loan  414  per 

cent  bonds  of  1928 
(third  41.4s). 

7.  Fourth    Liberty    loan    41/4 

per  cent  bonds  of  1933- 
1938   (fourth  414s). 

8.  Victory    Liberty   loan    4% 

per  cent  convertible  gold 
notes  of  1922-1923  (434, 
per  cent  Victory  notes). 

IL     4  ver  cent  and  414  per  cent  bonds  were  entitled  to  limited 
exemptions  from  federal  income  surtaxes  and  excess- 
profits  taxes,  as  follows: 
4  per  cent  and  41/4  per  cent  Liberty  bonds  (but  not  4^1.  per  cent 
Victory  notes)    were  entitled   to  certain   limited   exemptions 
from  graduated  additional  income  taxes,  commonly  known  as 
surtaxes,   and  excess-profits   and   war-profits   taxes,   then   or 
thereafter  imposed  by  the  United  States,  upon  the  income  or 
profits  of  individuals,  partnerships,  associations,  or  corpora- 
tions, in  respect  to  the  interest  on  principal  amounts  thereof, 
as  follows: 


Were  exempt,  under  the  1918 
law,  both  as  to  principal 
and  interest,  from  all  taxa- 
tion then  or  thereafter  im- 
posed by  the  United  States, 
any  state,  or  any  of  the 
possessions  of  the  United 
States,  or  by  any  local  tax- 
ing authority  except  (a) 
estate  or  inheritance  taxes, 
and  (b)  graduated  addi- 
tional income  taxes,  com- 
monly known  as  surtaxes, 
and  excess-profits  and  war- 
profits  taxes,  then  or  there- 
after imposed  by  the  Uni- 
ted States,  upon  the  income 
or  profits  of  individuals, 
partnerships,  associations, 
or  corporations. 


482  FEDERAL   INCOME   TAX 

$5,000  in  the  aggregate  of  first  4s,  first  414s  (issues  of  May  9 
and  October  24,  1918)  second  4s  and  414s,  third  4V4,s, 
fourth  414s,  treasury  certificates,  and  war-savings  certifi- 
cates." 

30,000  of  first  4i^s  (issue  of  October  24,  1918,  only),  until  the 
expiration  of  two  years  after  the  termination  of  the  war. 

30,000  of  fourth  414s,  until  the  expiration  of  two  years  after 
the  termination  of  the  war. 

30,000  in  the  aggregate  of  first  4s,  first  4i/4,s  (issues  of  May 
9  and  October  24,  1918),  second  4s  and  414s,  third  414s, 
and  fourth  414s,  as  to  the  interest  received  on  and  after 
January  1,  1919,  until  the  expiration  of  five  years  after 
the  termination  of  the  war. 

45,000  in  the  aggregate  of  first  4s,  first  4i/4,s  (issue  of  May  9, 
1918,  only),  second  4s  and  4i/4s,  and  third  4ViS,  as  to  the 
interest  received  after  January  1,  1918,  until  the  expira- 
tion of  two  years  after  the  termination  of  the  war;  this 
exemption  conditional  on  original  subscription  to,  and  con- 
tinued holding  at  the  date  of  the  tax  return  of  two-thirds 
as  many  bonds  of  the  fourth  Liberty  loan."^ 

20,000  in  the  aggregate  of  first  4s,  first  414s  (issues  of  May  9 
and  October  24,  1918),  second  4s  and  4i/4,s,  third  414s,  and 
fourth  414s,  as  to  the  interest  received  on  and  after  Jan- 
uary 1,  1919;  this  exemption  conditional  upon  original  sub- 
scription to,  and  continued  holding  at  the  date  of  the  tax 
return  of  one-third  as  many  notes  of  the  Victory  Liberty 
loan,  and  extending  through  the  life  of  such  notes  of  the 
Victory  Liberty  loan.^ 

"  Where  a  husband  and  wife  each  own  in  his  own  or  her  own  right  bonds 
of  these  issues  not  exceeding  $5,000,  each  is  entitled  to  exclude  the  income 
therefrom  in  computing  the  tax  on  their  joint  incomes,  and  minor  children 
having  separate  estates  are  also  entitled  to  the  exemption.  (Letter  from 
treasury  department  dated  October  8,  1917,  L  T.  S.  1921,  Tj  1244.)  A  taxpayer 
is  entitled  to  the  exemption  of  $5,000  of  his  aggregate  holdings,  not  on 
$5,000  of  each  class  of  obligations  (T.  D.  2585). 

s  It  has  been  held  that  an  individual  who  originally  subscribed  to  bonds 
of  the  Fourth  Liberty  Loan  to  an  amount  not  exceeding  $30,000  in  accord- 
ance with  the  government  plan  and  who  made  payments  in  accordance  with 
such  plan  was  not  required  to  pay  for  such  bonds  in  full  on  or  before  De- 
cember 31,  1918,  in  order  to  obtain  this  exemption.  Likewise,  if  an  individual 
subscribed  for  bonds  of  the  Fourth  Liberty  Loan  through  a  bank  by  agreeing 
to  pay  the  subscription  price  in  installments  acceptable  to  the  bank,  and  make 
payments  in  accordance  with  this  plan,  it  was  not  necessary  for  such  indi- 
vidual to  pay  for  the  bonds  in  full  on  or  before  December  31,  1918,  in  order 
to  obtain  this  exemption.  Letter  from  treasury  department  dated  January  3, 
1919,  I.  T.  S.  1919,  11990.) 

9  For  the  purpose  of  this  exemption  Victory  notes  of  either  series  issued 
upon  conversion  of  Victory  notes  of  the  other  series  which  were  originally 


INCOME  FROM  INTEREST.  RENT  AND  ROYALTIES  483 

III.  31/2  ])er  cent  bonds  ami  3%  per  cent  notes  were  exempt 
from  all  federal,  state,  and  local  taxation,  except  estate  or 
inheritance  taxes,  as  follows: 

1.  P'irst  Liberty  loan  31/2      Were  exempt,   under  the   1918  Law, 

per    cent    bonds    of         both  as  to  principal  and  interest, 
1932-1947.  from  all  taxation  (except  estate  or 

inheritance   taxes)    then   or  there- 

2.  Victory    Liberty    loan  after  imposed  by  the  United  States, 

3%    per    cent    con-         any   state,   or  any   of  the  posses- 
vertible    gold   notes  sions  of  the  United  States,  or  by 

of  1922-1923.1"  any  local  taxing  authority. 

Bonds  Originally  Subscribed  for  and  Held  at  the  Date 
OF  THE  Tax  Return.  The  amount  of  interest  upon  Liberty 
bonds  of  any  particular  loan  exempt  from  surtax  and  war-profits 
and  excess-profits  tax  was  in  no  case  based  on  the  amount  of 
bonds  of  that  loan  subscribed  for  and  still  held  at  the  time  of 
filing  the  return.  However,  the  conditional  exemption  of  inter- 
est upon  Liberty  bonds  of  other  loans  by  reason  of  original  sub- 
scription and  continued  holding  of  Liberty  bonds  of  the  fourth 
loan,  or  Victory  notes,  was  based  upon  the  amount  of  Liberty 
bonds  of  the  fourth  loan  and  Victory  notes  originally  sub- 
scribed for  and  still  held  by  the  taxpayer  at  the  time  of  filing 
his  return. 1'  The  words  "the  date  of  the  tax  return"  as  used 
in  the  supplement  to  the  Second  Liberty  Loan  Act  were  held  to 
mean  the  date  on  which  the  return  is  filed  with  the  collector. 
Consequently  a  taxpayer  holding  the  prescribed  amount  of 
fourth  Liberty  loan  bonds  on  December  31,  1918,  but  who  dis- 
posed of  them  on  January  1,  1919,  before  his  return  had  been 
filed,  was  not  allowed  the  exemption  referred  to.'-'  An  indi- 
vidual who  inherited  fourth  Liberty  Loan  bonds  or  Victory  Loan 
notes  which  were  originally  subscribed  for  by  the  decedent  was 
not  entitled  to  the  collateral  exemption  of  interest  on  bonds  of 
previous  issues  to  which  the  decedent  as  the  original  subscriber 

subscribed  for  by  any  taxpayer  will  be  deemed  to  have  been  originally  sub- 
scribed for  by  such  taxpayer.  (T.  D.  2857.)  The  total  possible  exemptions 
from  federal  income  surtaxes  and  profits  taxes,  subject  to  conditions  above 
summarized,  was  $160,000. 

i"T.  D.  2836;  Official  .statement  by  the  Secretary  of  the  Treasury,  dated 
April  14,  1919;  I.  T.  S.  1921,  *!  1238;  Reg.  45,  Art.  80  (a)  ;  Reg.  45,  Arts. 
78-80;  Letter  from  treasury  department  dated  March  20,  1919;  I.  T.  S.  1919, 
1i  3278. 

11  O.  D.  493,  T.  B.  19-20-913. 

y^O.  D.  213,  T.  B.  11-19-375. 


484  FEDERAL   INCOME   TAX 

would  have  been  entitled.^^  Where,  under  a  will,  the  income  of 
an  estate  was  to  be  paid  to  the  widow  for  life,  and  upon  her 
death  to  be  divided  equally  among  the  surviving  children,  it  was 
held  that  upon  distribution  of  the  estate  on  the  death  of  the 
widow,  the  surviving  children  should  not  be  considered  original 
subscribers  to  Liberty  bonds  originally  subscribed  to  by  the 
estate.  The  estate  and  the  ultimate  beneficiaries  are  distinct 
entities. 1^  Where  a  taxpayer  has  held  at  any  time  or  times, 
within  the  taxable  year  Liberty  Loan  bonds  (any  issues  except 
the  first  unconverted).  United  States  certificates  of  indebted- 
ness, or  war  savings  stamps,  the  total  interest  received  being 
equal  to  or  in  excess  of  the  interest  for  one  year  on  an  aggre- 
gate principal  of  $5,000,  credit  might  be  taken  to  an  amount  not 
exceeding  such  amount  of  interest  for  one  year  on  the  aggre- 
gate principal  of  $5,000.1^  In  case  a  taxpayer  converted  his 
Liberty  bonds  or  Victory  notes  originally  subscribed  for  from 
one  denomination  into  another,  or  from  registered  bonds  into 
coupon  bonds  or  vice  versa,  he  would  be  considered  the  original 
subscriber  to  the  new  bonds  or  notes  for  the  purpose  of  the 
collateral  exemptions,  if  the  new  bonds  or  notes  were  of  the 
same  issue  as  the  ones  originally  subscribed  for.i^ 

Exemption  Determined  by  Bonds  Held  at  End  of  Year. 
Where  a  taxpayer  converted  bonds  in  the  course  of  a  year,  he 
was  deemed,  for  purposes  of  the  income  tax,  to  have  held  for  the 
entire  year  the  bonds  into  which  his  earlier  bonds  were  con- 
verted. All  amounts  paid  at  the  time  of  conversion  of  bonds  for 
adjustment  of  interest  were  to  be  subtracted  from  amounts  re- 
ceived at  the  first  interest  payment  after  conversion  and  only 
the  difference  between  amounts  received  and  amounts  paid  was 
required  to  be  included  in  the  return  of  taxpayer.^"  All  interest 
accrued  on  434  per  cent  Victory  notes  at  the  date  of  any  con- 
version by  the  taxpayer  into  3%  per  cent  Victory  notes  were, 
for  the  purposes  of  computing  net  income,  deemed  to  be  interest 
upon  4%  per  cent  Victory  notes,  and  were  entitled  only  to  the 
exemptions  from  taxation  to  which  interest  on  4%  per  cent 
Victory  notes  were  entitled.  Any  and  all  amounts  received  by 
any  taxpayer  from  the  United  States  by  way  of  adjustment  of 

13  0.  D.  405,  T.  B.  8-20-752. 

14  O.  D.  1000,  T.  B.  34-21-1779. 

15  0.  D.  227,  T.  B.  13-20-807. 

16  O.  D.  718,  T.  B.  45-20-1290. 

17  Letter  from  treasury  department  dated  March  25,  1919;  I.  T.  S.  1921, 
!1 1243. 


INCOME  FROM  INTEREST,  RENT  AND  ROYALTIES  485 

accrued  interest  upon  conversion  of  4'li  per  cent  Victory  notes 
into  33 4  per  cent  Victory  notes  were  deemed  to  be  interest  upon 
4%  per  cent  Victory  notes.  All  interest  accrued  on  3%  per 
cent  Victory  notes  at  the  date  of  any  conversion  by  the  tax- 
payer into  4'H  per  cent  Victory  notes  was  for  the  purposes  of 
computing  net  income,  deemed  to  be  interest  upon  3"' j.  per  cent 
Victory  notes,  and  was  entitled  to  the  exemptions  from  taxation 
to  which  interest  on  3%  per  cent  Victory  notes  was  entitled.'^ 

Liberty  Bonds  Held  by  Banks,  The  excess  of  the  amount 
of  bonds  purchased  by  a  bank  from  the  government  over  the 
amount  of  such  bonds  subscribed  for  by  the  customers  through 
the  bank  during  the  respective  periods  designated  by  the  gov- 
ernment for  receiving  subscriptions  was  regarded  as  being  the 
amount  of  principal  of  bonds  originally  subscribed  for  by  the 
bank  for  its  own  investment.  Such  bonds  were  to  be  listed 
in  the  return  of  the  bank  as  property  of  the  bank  and  the 
interest  on  such  bonds  was  taxable  income  to  the  bank  except 
to  the  extent  provided  in  the  Liberty  Loan  Acts  and  the  supple- 
ments thereto.  The  bonds  subscribed  for  by  the  customers 
during  the  subscription  periods  on  which  no  default  had  oc- 
curred were  deemed  the  property  of  the  customers  and  were 
not  to  be  listed  in  the  return  of  the  bank,  and  the  interest  re- 
ceived from  the  government  on  account  of  such  bonds  was  not 
to  be  returned  by  the  bank  as  income,  but  was  to  be  reported  in 
the  returns  of  the  customers.^"  A  bank  which  takes  over  Lib- 
erty bonds  after  default  by  individual  subscribers  can  not  be 
considered  an  original  subscriber  to  such  bonds.-" 

Tax  Exemptions  of  Liberty  Bonds  and  Victory  Notes  Under 
the  1921  Law.  The  Revenue  Act  of  1921  has  amended  and  sup- 
plemented the  various  Acts  authorizing  the  issues  of  Liberty 
bonds  and  Victory  notes  and  has  now  consolidated  the  exemp- 
tions appertaining  to  such  bonds  and  notes.  It  is  now  provided 
that  on  and  after  January  1,  1921,  4"^^  and  41/0'^'  Liberty  bonds 
shall  be  exempt  from  graduated  additional  income  taxes,  com- 
monly known  as  surtaxes,  and  excess-profits  and  war-profits 
taxes,  now  or  hereafter  imposed  by  the  United  States  upon  the 
income  or  profits  of  individuals,  partnerships,  corporations,  or 
associations,  in  respect  to  the  interest  on  aggregate  principal 
amounts  thereof  as  follows:  Until  the  expiration  of  two  years 
after  the  date  of  the  termination  of  the  war  between  the  United 

i«  T.  D.  2865. 

If  O.  D.  192,  T.  B.  8-19-331;  O.  D.  1(5,  T.  B.  1-19-28. 

2f>T.  B.  R.  28,  T.  B.  6-19-271. 


486  FEDERAL    INCOME   TAX 

States  and  the  German  government,  as  fixed  by  proclamation 
of  the  President  on  $125,000  aggregate  principal  amount ;  and 
for  three  years  more  on  $50,000  aggregate  principal  amount.-^ 
The  date  of  the  termination  of  the  war  has  been  fixed  by  the 
President's  proclamation  as  July  2,  1921.-2  The  exemptions 
provided  above  are  stated  to  be  in  addition  to  the  exemptions 
provided  in  Section  7  of  the  Second  Liberty  Bond  Act,--''  viz., 
interest  on  the  principal  amount  of  $5,000  in  the  aggregate  of 
first  4's,  first  414's  (issues  of  May  9  and  October  24,  1918), 
second  4's  and  4V4's,  third  414's,  fourth  414's,  treasury  certifi- 
cates and  war  savings  certificates,-^  and  also  in  addition  to  the 
exemption  contained  in  §  1  (3)  of  the  Supplement  to  the  Second 
Liberty  Bond  Act,  viz. :  The  interest  on  an  amount  of  bonds, 
the  principal  of  which  does  not  exceed  $30,000,  issued  upon 
conversion  of  31/2^.  bonds  of  the  First  Liberty  Loan  in  the  exer- 
cise of  any  privilege  arising  as  a  consequenceof  the  issue  of  bonds 
of  the  Fourth  Liberty  Loan.  The  exemptions  provided  by  the 
Revenue  Act  of  1921,  however,  are  in  lieu  of  the  exemptions 
provided,  and  free  from  the  conditions  and  limitations  imposed 
by  §  1  (1)  and  (2)  if  the  Supplement  to  the  Second  Liberty 
Bond  Act  and  §  2  of  the  Victory  Liberty  Loan  Act.-"' 

As  a  result,  then,  under  the  1921  law,  interest  on  all  issues  of 
Liberty  bonds  and  victory  notes  are  exempt  from  the  normal 
tax  and  from  the  income  tax  on  corporations. 

The  surtax  and  excess-profits  tax  exemptions  permitted  under 
the  1921  law  (all  other  surtax  and  excess-profits  tax  exemptions 
formerly  permitted  being  repealed  as  of  January  1,  1921,  except 
in  the  case  of  the  31/2'/'^  Liberty  bonds  and  the  3%/f  Victory 
notes  which  carry  total  exemption  through  their  respective  lives) 
are  as  follows : 

(1)  Interest  on  an  aggregate  principal  amount  not  exceeding 
$5,000  of  Liberty  bond  issues  (4's  and  414's)  after  the  first,  in- 
cluding in  such  later  issues  bonds  of  the  First  Liberty  Loan 
converted,  treasury  certificates  and  war  savings  certificates  (no 
time  limit)  $5,000. 

(2)  Interest  on  an  aggregate  principal  amount  of  bonds  (4's 
and  414's)  not  exceeding  $30,000  issued  upon  conversion  of 
31/2%  bonds  of  the  First  Liberty  Loan  in  the  exercise  of  any 

21  Revenue  Act  of  1921,  §  1328. 

22  Proclamation  by  the  President  of  the  United  States,  dated  November  14, 
1921.    See  I.  T.  S.  1921,  1|  3213. 

23  Act  of  September  24,  1917. 
2^  See  footnote  6. 

25  Revenue  Act  of  1921,  §  1328  (b). 


INCOME  FROM  INTEREST,  RENT  AND  ROYALTIES  487 

privilege  arising  as  a  consequence  of-  the  issue  of  bonds  of  the 
Fourth  Liberty  Loan  (until  July  2,  1923)  $30,000 

(3)  Interest  on  a  principal  amount  of  4's  and  41/4  s  (until 
July  2,  1923)  ^  ^     ^l"- 

Providing  exemption  on  a  total  principal  amount  until  July 
2  1923  (as  before  in  amount,  but  in  no  wise  contingent  on  orig- 
inal subscription  to  and  continued  holding  of  bonds  of  the  Fourth 
Liberty  Loan,  or  Victory  notes,  and  not  limited  to  the  l^fe^oj J^j 

I'^tter)  ^.       T   1'     o 

(4)  An  additional  exemption  for  three  years  after  July  I, 
1923   of  the  interest  on  a  principal  amount  of  4's  and  414's 

'  $50,000. 

Providing  exemption  during  and  until  the  expiration  of  the 
last  three  years  of  the  tive-year  period  after  the  termination  of 
the  war  (July  2,  1921)  ($20,000  more  than  under  the  1918  law 
and  in  no  wise  contingent  on  original  subscription  to,  and  con- 
tinued holding  of,  and  not  limited  to  life  of  the  Victory  notes, 
which  will  have  matured  before  the  three-year  period  begins) 
of  the  interest  on  a  principal  amount  of  $55,000. 

(5)  After  the  above  three-year  period  until  all  Liberty  bonds 
have  matured  an  exemption  of  the  interest  on  a  principal  amount 

-  $5,000. 

of  .      .        1 

Liberty  Bonds  Carried  by  Banks.  The  amount  ot  interest  re- 
ceived by  the  bank  from  its  customers  on  account  of  bonds  car- 
ried for  them  (including  the  amount  represented  by  any  coupons 
retained  by  the  bank  by  way  of  adjustment  of  accrued  interest) 
constitutes  taxable  income  to  the  bank,  and  no  part  of  such 
interest  is  exempt  from  tax  inasmuch  as  it  is  not  interest  on 
obligations  of  the  United  States  but  is  interest  on  money  ad- 
vanced to  the  customers.-'-'  In  cases  where  there  have  been  a 
great  many  changes  in  the  amount  of  Liberty  bonds  of  the  vari- 
ous classes,  or  other  securities  of  the  United  States,  held  by  a 
bank  during  the  year,  it  will  be  permissible  to  determine  the 
amount  of  interest  derived  from  each  class,  in  excess  of  the 
maximum  exemption  applicable  from  the  books  or  other  records 
of  the  bank.  The  correct  amount  of  interest,  subject  to  tax, 
received  or  accrued,  must  be  shown  and  a  statement  attached 
to  the  return  showing  how  the  interest  was  determined.-' 

Certificates  of  Indebtedness  Issued  by  Director-General  of  Rail- 
roads. Certificates  of  indebtedness  issued  by  the  director-gen- 
eral of  railroads  are  held  to  be  obligations  of  the  United  States 

200.  D.  192,  T.  B.  8-19-331;  O.  D.  Kn  T.  B.  1-19-28. 
VJ7  0.  D.  31,  T.  B.  1-19-43. 


488  FEDERAL   INCOME   TAX 

but  not  such  obligations  as  are  exempt  from  income,  war-profits, 
and  excess-profits  taxes.^s 

War  Finance  Corporation  Bonds.  The  War  Finance  Corpora- 
tion Act  makes  the  same  provision  for  the  exemption  of  interest 
upon  bonds  issued  by  the  War  Finance  Corporation  as  is  pro- 
vided in  the  case  of  Second  Liberty  Loan  Bonds ;  that  is,  interest 
on  an  amount  of  such  bonds,  the  principal  of  which  does  not 
exceed  in  the  aggregate  $5,000  owned  by  any  individual,  part- 
nership, corporation  or  association  is  exempt.-^  Under  the  1918 
Law  this  exemption  of  $5,000  was  in  addition  to  the  $5,000 
exemption  allowed  under  the  Liberty  Loan  Act  of  April  24,  1917, 
which  amount  includes  Liberty  bonds  of  any  issue  (excluding 
first) ,  war  savings  certificates  and  certificates  of  indebtedness.-^^ 

Postal  Savings  Accounts.  .Interest  credited  to  postal  savings 
accounts  upon  moneys  deposited  in  postal  savings  banks  on  or 
before  September  1,  1917,  was  exempt  from  income  tax,  while 
interest  credited  upon  deposits  made  subsequently  to  September 
1,  1917,  was  liable  to  tax  under  the  1918  law.'"^  The  Revenue 
Act  of  1921  exempts  all  interest  on  postal  savings  certificates 
of  deposit.3- 

Food  Administration  Grain  Corporation  Notes.  Interest  on 
Food  Administration  Grain  Corporation  notes  is  not  exempt 
from  income  tax."'^ 

Interest  from  Federal  Land  Bank  and  National  Farm  Loan 
Association.  As  the  Federal  Farm  Loan  Act"^  provides  that 
every  federal  land  bank  and  every  national  farm  loan  association, 
including  the  capital  and  reserve  or  surplus  therein  and  the  in- 
come derived  therefrom,  shall  be  exempt  from  taxation,  except 
taxes  upon  real  estate,  and  that  farm  loan  bonds,  with  the  income 
therefrom,  shall  be  exempt  from  taxation,  the  income  derived 
from  dividends  on  stock  of  federal  land  banks  and  national  farm 
loan  associations  and  from  interest  on  such  farm  loan  bonds  is 
not  subject  to  the  income  tax.^s 

Obligations  of  the  Possessions  of  the  United  States.  Interest 
paid  on  the  obligations  of  possessions  of  the  United  States  is 

2S  0.  D.  206,  T.  B.  10-19-356. 

20  Act  of  April  5,  1918  (Public  No.  121),  §  16;  0.  781,  T.  B.  1-19-116.  See 
Note  6. 

•"'0  O.  D.  212,  T.  B.  11-19-374. 
:51  Reg.  45,  Art.  77. 

32  Revenue  Act  of  1921,  §  213  (b)  4. 

33  Telegram  from  treasury  department  dated  April  13,  1919;  I.  T.  S.  1921, 
ll  1248. 

34  Act  of  July  17,  1916,  §  26. 

35  Reg.  45,  Art.  75. 


INCOME  FROM  INTEREST,  RENT  AND  ROYALTIES  489 

exempt.-'*"'  The  interest  from  bonds  issued  by  the  people  of  Porto 
Rico  is  exempt."'"  Interest  on  bonds  and  certificates  of  indebted- 
ness issued  by  the  Philippine  government  is  exempt.-'"'  Bonds 
issued  by  the  military  government  of  Santo  Domingo  in  behalf 
of  and  payable  from  the  revenues  of  the  Dominican  Republic 
while  that  country  was  under  temporary  military  occupation  by 
the  United  States  are  not  obligations  of  the  United  States  or  of 
a  possession  of  the  United  States. -"'''•• 

Obligations  of  Territories.  Interest  on  the  obligations  of  the 
territories,  or  political  subdivisions  thereof,  is  exempt.^" 

Obligations  of  the  District  of  Columbia.  Interest  upon  obliga- 
tions of  the  District  of  Columbia  is  now  exempt. ^^ 

Interest  on  the  Obligations  of  States.  The  same  principle 
which  denies  to  a  state  power  to  raise  revenue  by  taxation  on 
federal  property,  or  sources  of  revenue,  or  means  of  carrying 
on  its  duties,  forbids  taxation  of  state  revenue  for  federal  pur- 
poses.-*- Therefore  the  United  States  has  no  power  under  the 
Constitution  to  tax  either  the  instrumentalities  or  the  property 
of  a  state.^''  A  municipal  corporation  is  a  portion  of  the  sover- 
eign power  of  a  state  and  is  not  subject  to  taxation  by  Congress 
upon  its  municipal  revenue.'^  But  the  exemption  of  state  agen- 
cies does  not  extend  to  those  used  by  the  state  in  carrying  on 
an  ordinary  private  business.'*-'^  Interest  on  the  obligations  of 
a  state  is,  therefore,  expressly  exempt.  The  1909  Law,  however, 
being  an  excise  tax  and  not  an  income  tax,  was  valid  although 
measured  by  income  which  included  interest  from  state  secu- 
rities.^''  Interest  received  on  certificates  of  indebtedness  known 
as  fire  relief  certificates,  issued  in  the  State  of  Minnesota,  is 
considered  interest  upon  the  obligations  of  a  state  and  not  tax- 

3<J  Revenue  Act  of  1921,  §213  (b)  4;  Revenue  Act  of  1918,  §213   (b)  4. 

••!7  0.  D.  368,  T.  B.  3-20-684. 

:5^0.  D.  34,  T.  B.  1-19-46;  O.  D.  922,  T.  B.  21-21-1648. 

•"•!'  O.  D.  420,  T.  B.  13-20-807. 

^0  Revenue  Act  of  1921,  §213  (b)  (4);  Revenue  Act  of  1918,  §213  (b) 
(4).  Such  interest  was  not  exempt  under  the  1916  Law,  since  the  law  did 
not  expressly  include  territories  in  the  exemption  provision.  (Revenue  Act 
of  1916,  §4.) 

•11  Such  interest  was  not  expressly  included  in  the  exemption  provision  of 
the  1916  Law.  Compare  Revenue  Act  of  1918,  §213  (b)  4;  Revenue  Act  of 
1921,  §  213  (b)  4  and  Revenue  Act  of  1916,  §  4. 

4- Collector  v.  Day,  11  Wall.  113;  Dobbins  v.  Erie  Co.,  16  Pet.  444;  Am- 
brosini  v.  U.  S.,  187  U.  S.  1. 

^•■^  Pollock  V.  Farmers'  Loan  and  Trust  Company,  157  U.  S.  429,  584. 

■>^  U.  S.  V.  B.  &  0.  Railroad  Company,  17  Wall.  322. 

^•'  South  Carolina  v.  U.  S.,  199  U.  S.  437. 

*«  Flint  V.  Stone-Tracy  Co.,  220  U.  S.  107. 


490  FEDERAL   INCOME  TAX 

able.^*"  It  has  been  held  that  bonds  issued  by  Michigan  agricul- 
tural or  horticultural  societies  which  are  authorized  under  the 
laws  of  that  state,  if  duly  organized  as  corporations,  to  issue 
interest-bearing  bonds,  the  payment  of  the  principal  and  interest 
of  which  is  secured  by  mortgage  or  mortgages  upon  the  real 
estate  of  the  societies,  are  not  obligations  of  a  state  or  political 
subdivision  thereof  since  neither  the  State  of  Michigan  nor  any 
political  subdivision  thereof  obligates  itself  to  pay  either  the 
principal  or  interest  of  these  bonds.^^ 

Political  Subdivision  of  a  State.  A  political  subdivision 
denotes  any  division  of  a  state  or  territory  made  by  the  proper 
authorities  thereof  acting  within  their  constitutional  powers  for 
the  purpose  of  carrying  out  a  portion  of  those  functions  of  the 
state  or  territory  which  by  long  usage  and  the  inherent  neces- 
sities of  government  have  always  been  regarded  as  public.'*'^  The 
attorney-general  has  held  that  special  assessment  districts 
created  for  a  public  purpose,  such  as  the  improvement  of  streets 
and  public  highways,  the  provision  of  sewage,  gas  and  light  and 
the  reclamation,  drainage,  or  irrigation  of  land  are  districts  for 
public  use,  and  consequently  political  subdivisions  of  the  state, 
within  the  meaning  of  the  law.''*  Political  subdivisions  of  a  state 
or  territory,  within  the  meaning  of  the  exemption,  include  special 
assessment  districts  so  created,  such  as  road,  water,  sewer,  gas, 
light,  reclamation,  drainage,  irrigation,  levee,  school,  harbor, 
port  improvement,  and  similar  districts  and  divisions  of  a  state 
or  territory."*!     However,  a  district  without  power  to  exercise 

i'  0.  D.  30,  T.  B.  1-19-42. 

J8  O.  D.  983,  T.  B.  31-21-1751. 

^f*  A  political  subdivision,  according  to  the  court  in  the  case  of  Smith  v. 
Howell,  60  N.  J.  L.  384,  is  "A  division  of  the  state,  with  its  inhabitants 
organized  for  the  public  advantage  and  not  in  the  interest  of  particular  in- 
dividuals or  classes,  the  chief  design  of  which  is  the  exercise  of  governmental 
functions,  and  to  the  electors  residing  within  which  is,  to  some  extent,  com- 
mitted the  power  of  local  government." 

W  Opinion  of  Atty.  Gen.  dated  January  30,  1914.  In  the  course  of  his 
opinion  the  Atty.  Gen.  said:  "*  *  *  where  the  power  to  levy  a  tax  is 
given  a  district  by  the  state,  presumptively  that  district  is  created  for  a  pub- 
lic use,  and  is  exercising  a  public  function.  *  *  *  j^q^  does  it  make  any 
diflFerence  that  the  tax  is  measured  by  the  benefit  conferred."  But  he  re- 
frained from  expressing  any  opinion  whether  assessment  districts  might  not 
be  created  for  a  purely  private  purpose  so  as  to  bring  them  within  the  prin- 
ciples laid  down  in  the  South  Carolina  Dispensary  case,  199  U.  S.  437,  rather 
than  within  those  which  governed  U.  S.  v.  B.  &  0.  Railroad  Company,  17 
Wall.  322. 

■51  Reg.  45,  Art.  74;  T.  D.  1946. 


INCOME  FROM  INTEREST,  RENT  AND  ROYALTIES  491 

nnv  governmental  function,  created  for  the  purpose  of  making 
some  improvement,  primarily  beneficial  to  the  property  located 
in  an  1  comprising  the  district,  is  not,  within  the  meaning  of 
hese  acts  a  political  subdivision  of  the  state.  Obligations  ,ssued 
ini^ment  'for  such  J-^^-^--^ ir ^^1  ^ 
reto'tr':;^;:  oTt^state  or  of  any  polUic.  sub^.^ 

;rp:rtr:::n\:;th-rrsti::tet 

^  r^d'from  obligations  which  are  a  ^-ect  charge  against  o 
,ien  upon  benefited  Pi^penyj^^nte,^^^^^^  ,  ^„^^.t  be  re^ 
tiirnpfl  MS  income  oi  tne  recipiti"L-  vyntiv. 
western  staes  irrigation  districts  are  created  by  an  election  du  y 
TaUed  for  the  purpose,  the  county  assessor  assessing  all  property 
benefited  n  the  assessment  rolls  of  the  county  and  co  ec  ing  a 
tax  thereon  in  the  same  manner  as  other  taxes  are  collected  t 
rheid  th^t  such  districts  are  political  subdivisions  of  a  state 
and  Interest  on  their  bonds  is  exempt.-     Bonds  issued  by 

municipality  for  public  purpo.ses  in  -^<=°;<';"  .^^^'^^^^^f^  „ 
citv  charter  law  of  the  state  to  cover  defeiied  installments  oi 
asLsment    against  real  estate  for  the  cost  of  certain  public 
m;rovements,'the  bonds  being  a  lien  upon  all  the  property  ben 
efited  to  the  extent  of  unpaid  assessments  and  mteiest  thereon 
and  containing  recitals  that  they  are  chargeable  only  to  the 
narticular  property  described   therein,  are  held  to  be  obliga 
ffon    of  a  p'olMcal  subdivision  of  a  state,  notwithstanding  they 
were  not  a  general  liability  of  the  city.-     Certificates  of  sae 
Ts  ued  by  a  county  or  other  political  subdivision  of  a  s  ate  in 
onnection  with  the  sale  of  P'-Pe^y  for  non-payment  o    taxes 
are  not  obligations  of  a  state  or  political  «»bd;™  «"  l]^^'^- 

Interest  on  a  claim  against  a  city,  recovered  by  a  .lodgment 
several  ™ars  after  the  claim  accrued,  is  held  to  be  interest  on 
the  obligaUon  of  a  political  subdivision  of  a  state  and,  there- 

'"  wCTmunicipality  issues  promissory  notes,  it  is  held  that 
surpromissory  notes  are  the  obligations  of  a  political  subdi- 
vision of  a  state  or  territory." 

•'■2  R€g.  33  Rev.,  Art.  84. 

-a  o.  D.  544,  T.  B.  24-20-1000. 

M  r>  n  447   T.  B.  16-20-843.  .  „ . , 

.5  0.  D.  327:  T.  B.  28-19-611;  O.  D.  1114,  T.  B.  48-21-1944. 

r.r.O.  D.  591,  T.  B.  29-20-1071. 

.-.-  0.  D.  817,  T.  B.  8-21-1462. 


492  FEDERAL   INCOME   TAX 

Where  a  noninterest-bearing  warrant  is  issued  by  a  county  in 
payment  for  services  or  supplies  and  in  order  that  the  person 
furnishing  the  services  or  suppHes  may  secure  from  a  bank  the 
face  vahie  of  such  warrant  the  county  executes  an  additional 
warrant  to  the  bank  for  an  amount  representing  interest  on 
the  warrant,  it  is  held  that  the  full  amount  of  the  warrant  rep- 
resenting interest  is  exempt  from  tax  inasmuch  as  it  is  interest 
paid  by  the  county  for  the  use  of  money  paid  by  the  bank  on 
the  warrant  issued  for  services  and  supplies.-'"'''^ 

A  corporation  is  engaged  in  paving  work  for  various  munici- 
palities in  a  state.  The  statutes  of  that  state  provide  that 
municipal  improvements,  including  pavements,  shall  be  paid  for 
by  assessments  issued  to  the  contractor.  These  assessments  bear 
interest  from  the  date  of  acceptance  of  the  work  by  the  city  en- 
gineer. The  contractor  receives  interest  from  this  source  from 
the  date  of  acceptance  of  the  work  to  the  date  of  delivery  of  the 
evidences  of  indebtedness.  Under  an  agreement  with  a  bank 
for  advancing  to  it  money  to  pay  operating  expenses  the  certifi- 
cates of  indebtedness  were  assigned  to  the  bank.  Accordingly, 
the  corporation  did  not  receive  the  certificates  of  indebtedness. 
The  company  did,  however,  receive  interest  which  accrued  from 
the  date  of  acceptance  of  the  work  by  the  city  engineer  to  the 
date  of  delivery  of  the  certificates  to  the  bank.  It  has  been  held 
that  the  interest  received  by  the  contractor  for  the  period  be- 
tween the  date  of  acceptance  of  the  work  and  the  date  of  de- 
livery of  the  certificates  is  exempt  from  taxation,  as  the  debt  was 
an  obligation  exempt  within  the  meaning  of  the  statute.  The 
contract  of  assignment  to  the  bank  did  not  take  effect  until  de- 
livery of  the  certificates.  Consequently,  the  interest  which  ac- 
crued during  the  interim  between  acceptance  and  delivery  was 
the  property  of  the  contractor.^^ 

When  a  city  acquires  property  for  park  purposes  by  con- 
demnation proceedings  and  pays  for  it  by  special  assessments 
upon  the  districts  considered  to  be  specially  benefited  by  the 
proposed  improvement,  assessments  being  payable  in  install- 
ments over  a  period  of  10  years,  and  in  order  to  obtain  funds 
with  which  immediately  to  compensate  the  owners  of  the  prop- 
erty condemned,  the  city  issues  "park  fund  certificates"  in  the 
nature  of  10-year  bonds,  payable  out  of  the  assessments  col- 
lected, such  park  fund  certificates  are  obligations  of  the  munici- 

5S0.  D.  870,  T.  B.  15-21-1561. 
59  O.  D.  999,  T.  B.  34-21-1778. 


INCOME  FROM  INTEREST,  RENT  AND  ROYALTIES  493 

pality,  a  political  subdivision  of  the  state,  and  the  interest  paid 
thereon  by  the  city  in  behalf  of  the  legally  authorized  assess- 
ment districts  under  its  control  is  not  subject  to  tax."" 

MORTGAGES   ASSUMED   BY   STATE   OR   MUNICIPALITY.     Although 

interest  on  state  or  municipal  bonds  is  exempt  from  the  tax,  yet 
where  a  state  or  municipality  has  purchased  a  public  utility 
subject  to  a  mortgage,  and  the  mortgage  retains  its  original 
character,  even  though  the  state  or  municipality  assumes  the 
mortgage  indebtedness  and  pays  the  interest  thereon,  the  mort- 
gage does  not  become  an  obligation  of  the  state  or  municipality 
within  the  meaning  of  the  law  and  the  interest  thereon  is  not 
exempt.'"'^ 

Interest  on  Bonds  of  Exempt  Organizations.  Although  a  cor- 
poration may  be  exempt''-  from  tax  on  its  income,  yet  interest 
on  the  bonds  of  such  an  organization  is  taxable  income  to  the 
bondholder.'''^ 

Reporting-  Exempt  Income.  Income  from  United  States  obli- 
gations issued  prior  to  September  1,  1917,  interest  on  bonds  of 
states,  territories  (and  political  subdivisions  thereof),  posses- 
sions of  the  United  States  and  the  District  of  Columbia,  need  not 
be  included  in  gross  income,  but  the  amount  of  such  securities 
owned  by  the  taxpayer  and  the  income  therefrom  was,  under  the 
1918  Law,  required  to  be  stated  in  his  return.''^  This  require- 
ment is  not  continued  in  the  Revenue  Act  of  1921. 

Accrued  Interest  on  Obligations  at  Time  of  Purchase.  Where 
a  purchaser  pays  the  price  of  the  security  purchased  and  an  ad- 
ditional sum  representing  accrued  interest,  the  amount  of  in- 
terest received  on  the  next  interest  date  should  not  be  reported 
in  full.  The  amount  of  accrued  interest  at  the  time  of  purchase 
represents  the  return  of  capital  to  the  purchaser  and  he  should 
deduct  such  amount  from  the  interest  received,  and  report  tfte 
remainder  only.  The  seller  of  the  security  should  account  in  his 
return  for  the  accrued  interest  received  at  the  time  of  sale,  since 
to  him  that  amount  is  income."'''    The  rule  stated  above  does  not 

wo.  D.  491,  T.  B.  19-20-911. 

'•>!  Reg.  45,  Art.  74 ;  T.  D.  2090. 

•■■-  Revenue  Act  of  1921,  §  231;  Revenue  Act  of  1918,  §  231. 

<>'•  Letter  from  treasury  department  dated  July  30,  1914;  I.  T.  S.  1918, 
TI1319. 

64  Revenue  Act  of  1918,  §  213  (b)  4.    See  Chapter  42. 

6"' Reg.  33  Rev.,  Art.  4;  Letter  from  treasury  department  dated  February 
5,  1915;  I.  T.  S.  1918,  1|  360.  In  a  later  ruling  the  treasury  department  de- 
clined to  permit  the  taxpayer  in  such  a  case  to  report  all  of  the  interest 
•  received  as  income  and  to  deduct  the  amount  of  accrued  interest  paid  at  the 
time  of  purchase  as  an  expense  or  as  interest  paid  by  the  purchaser.  (Letter 
dated  March  8,  1915,  I.  T.  S.  1917,  11237.) 


494  FEDERAL   INCOME   TAX 

apply  to  coupons  detached  from  bonds  and  negotiated,  which 
themselves,  after  being  detached,  become  noninterest-bearing 
negotiable  securities.  If  such  coupons  are  detached  and  sold, 
and  resold,  they  lose  their  character  as  interest  and  become  capi- 
tal. Dealings  in  them  are  to  be  treated  as  dealings  in  other 
capital  assets,  and  profit  and  loss  computed  accordingly.  The 
burden  is  on  the  taxpayer  to  show  what  part  of  moneys  paid  or 
received  by  him  on  account  of  a  transaction  involving  the  sale 
or  purchase  between  interest  dates  of  interest-bearing  obliga- 
tions should  be  allocated  to  capital  investment  and  what  part 
to  accrued  interest.  In  the  absence  of  such  showing,  the  con- 
struction most  favorable  to  the  government  should  be  adopted.''*' 
In  the  case  of  treasury  certificates  of  indebtedness  which  are 
offered  by  the  government  at  par  and  accrued  interest  and  not 
at  a  discount,  only  the  coupon  interest  can  be  considered  exempt 
from  normal  tax,  and  from  surtax  to  the  extent  provided  by  the 
act  approved  September  24,  1917.''' 

Interest  on  Bank  Deposits.  Interest  on  bank  deposits  or  on 
certificates  of  deposit,  credited  to  the  account  of  the  depositor  by 
the  bank,  is  income  for  the  year  in  which  the  credit  is  made. 
This  is  true  even  though  the  bank  nominally  has  a  rule,  seldom  or 
never  enforced,  that  it  may  require  a  certain  number  of  days' 
notice  in  advance  of  cashing  depositors'  checks."^ 

Interest  Received  and  Paid  by  Brokers.  Where  the  customers 
of  a  brokerage  house  buy  securities,  paying  only  a  part  of  the 
purchase  price  and  paying  interest  on  the  balance,  and  the  bro- 
kerage house  buys  such  securities  from  others,  paying  only  a 
part  of  the  purchase  price  and  paying  interest  on  the  balance, 
the  brokerage  house  must  include  in  its  return  as  gross  income 
the  interest  received  from  the  customers  and  may  deduct  as 
interest  the  amount  of  interest  it  pays  on  such  purchases.'*'* 

Bond  Interest  Paid  in  Scrip.  Where  a  corporation  which  de- 
faulted in  the  payment  of  its  bond  interest  was  reorganized, 

CO  Sol.  Op.  46,  T.  B.  37-20-1191. 

«7  0.  D.  729,  T.  B.  46-20-1303. 

•••■^  Reg.  33,  Art.  67 ;  Letter  from  treasury  department  dated  February  18, 
1915;  I.  T.  S.  1919,  "(1855.  Reg.  4.5,  Art.  54.  See  Chapter  4,  as  to  the  case 
of  such  interest  accruing  to  nonresident  aliens. 

69  Altheimer  Rawlings  Investment  Co.  v.  Allen,  248  Fed.  688,  petition  for 
writ  of  certiorari  to  United  States  Supreme  Court  denied  November  11, 
1918;  see  T.  D.  2686  and  T.  D.  2441.  This  case  was  decided  under  the  1909 
Law,  but  the  principle  seems  to  apply  under  the  language  of  the  present  law. 
Interest  would  be  deducted  in  full  if  paid  on  collateral  the  subject  of  sale  in 
the  ordinary  course  of  business.  The  amount  of  such  interest  deductible  in 
the  case  of  corporations  was  limited  under  the  1916  Law.  See  appendix  to 
the  1920  edition  of  this  book. 


INCOME  FROM  INTEREST.  RENT  AND  ROYALTIES  495 

and  the  new  corporation  issued  scrip,  payable  at  certain  fixed 
dates,  and  bearing  interest  at  6S' ,  in  exchange  for  the  coupons 
representing  the  defaulted  interest,  such  scrip  is  held  to  be 
the  equivalent  of  cash  and  taxable  as  interest  in  the  hands  of 
the  recipient."" 

Interest  on  Bonds  Purchased  at  a  Premium.  Interest  received 
or  accrued  on  bonds  purchased  at  a  premium,  according  to  the 
method  employed  in  keeping  books,  represents  income  for  the 
year  in  which  received  or  accrued  at  the  rate  carried  by  the  bonds 
and  not  at  the  rate  which  would  be  realized  after  amortizing 
the  premium.'^ 

Interest  Accruing  Prior  to  March  1,  19i:J.     Interest  due  prior 
to  March  1,  1913,  could  have  been  reduced  to  possession  on  de- 
mand prior  to  the  incidence  of  the  income  tax.    It  is,  therefore, 
capital.     Interest  accruing  on  or  after  that  date  is  taxable  in- 
come.    Where  an  interest-bearing  claim  held  on  February  28, 
1913,  is  paid  in  whole  or  in  part  after  that  date,  any  gain  de- 
rived from  the  payment  of  the  claim  is  taxable.     The  amount 
of  such  gain  is  the  excess  of  the  proceeds  of  the  claim   (both 
principal  and  interest)   exclusive  of  any  interest  accrued  since 
February  28,  1913,  already  returned  as  income,  over  the  cost 
thereof  (both  principal  and  interest  then  accrued).     However, 
the  gain  which  is  taxable  where  the  fair  market  value  of  the 
claim  as  of  March  1,  1913,  is  greater  than  the  cost  thereof,  is 
the  excess  of  the  amount  received  over  such  value.    No  gain  re- 
sults where  the  amount  received  from  the  claim  is  more  than 
the  cost  thereof  but  less  than  its  fair  market  value  as  of  March 
1,  1913.'-  Where  a  farm  was  sold  in  1910  under  a  contract  calling 
for  annual  payments  of  principal  and  interest  for  10  years,  a 
deed  being  given  in  1919,  and  the  unpaid  purchase  price  being 
secured  by  notes,  it  has  been  held  that  payments  of  principal 
received  subsequent  to  1910  are  not  subject  to  tax,  but  that  for 
the  years  in  which  income  tax  laws  have  been  in  force,  the  vendor 
should  have   included   as   income   any   interest   received    which 

T"0.  D.  5(J3,  T.  B.  26-20-1032. 

71  0.  D.  622,  T.  B.  32-20-1117. 

7- Reg.  45,  Art.  87,  as  amended  by  T.  D.  320(5,  T.  B.  33-21-1767.  Even 
where  interest  has  been  in  default  since  a  time  prior  to  March  1,  1913.  and 
funds  to  pay  the  same  have  accrued  since  that  date,  it  has  been  held  that  the 
interest  represents  income  accrued  to  the  owners  of  the  bonds  prior  to  the 
,  incident  of  the  tax,  and  hence  does  not  constitute  taxable  income  when  re- 
ceived thereafter.  (Letter  from  Collector  at  Cincinnati  dated  March  16, 
1915,  embodying  decision  of  the  treasury  department;  L  T.  S.  1919,  V.  1010.) 
The  same  principle  was  applied  by  the  court  under  the  1909  Law.  (North- 
ern Pacific  Railway  Co.  v.  Lynch.  U.  S.  Dist.  Ct,  Dist.  of  Minnesota.  T.  D. 
3048,  T.  B.  33-20-1122. 


496  FEDERAL   INCOME   TAX 

accrued  subsequent  to  February  28,  1913,  on  deferred  payments. 
Likewise  he  should  report  the  interest  received  on  the  notes 
given  for  the  balance  of  the  purchase  price  in  1919. ''•^ 

Discount.  The  excess  of  the  face  value  of  a  so-called  bank 
acceptance  as  collected  at  its  maturity,  over  the  amount  paid 
therefor  by  a  person  collecting  the  acceptance  at  maturity,  is 
not  interest,  but  is  taxable  income  when  the  face  value  of  the 
acceptance  is  collected."^  Profit  derived  from  noninterest- 
bearing  state  and  municipal  securities  purchased  at  a  discount 
and  held  until  maturity  is  not  taxable  where  it  clearly  appears 
that  the  return  from  the  investment  in  the  hands  of  the  tax- 
payer is  due  solely  to  the  compensation  received  from  the  state 
or  municipality  in  lieu  of  interest  for  the  use  of  the  taxpayer's 
money.  In  no  case  may  such  exemption  exceed  the  total  discount 
at  which  the  securities  were  originally  sold  by  the  state  or  mu- 
nicipality.'^  The  realized  discount  on  a  sale  of  municipal  secu- 
rities prior  to  maturity  can  not  be  treated  as  compensation  "in 
lieu  of  interest"  paid  by  a  municipality,  but  is  profit  subject  to 
tax.  Only  the  holder  of  the  note  at  maturity  is  entitled  to  treat 
the  realized  discount  as  income  exempt  from  tax.™  Inasmuch 
as  no  person  other  than  the  municipality  can  pay  the  interest 
borne  by  the  obligations  of  the  municipality  (whether  such  in- 
terest is  paid  at  a  specified  rate  or  in  the  form  of  realized  dis- 
count) any  person  selling  municipal  bonds  for  an  amount  in 
excess  of  the  cost  of  the  bonds  to  him  realizes  a  taxable  profit  to 
the  extent  of  such  excess  amount  even  though  the  bonds  were 
issued  at  a  discount.  If,  therefore,  a  bank  sells  at  $98  municipal 
bonds  issued  at  $94.50  and  purchased  by  it  at  $96.10  it  will  de- 
rive a  taxable  profit  of  $1.90  on  each  bond  sold.  If,  however, 
it  holds  the  bonds  to  maturity  and  receives  $100,  the  difference 
between  the  purchase  price  of  the  bonds  and  the  amount  received 
or  $3.90  will  represent  exempt  income  to  it."^" 

Where  a  municipality  borrows  money  from  a  bank  with  which 
to  pay  its  bills  covering  expenses,  the  promissory  notes  given 
for  the  money  borrowed  being  issued  at  a  discount,  and  it  being 
also  provided  that  if  the  notes  are  not  paid  when  due  they  will 
also  draw  interest  from  maturity  until  paid,  it  has  been  held 

73  O.  D.  646,  T.  B.  35-20-1165.  The  English  courts  have  followed  the  same 
rule  in  dealing  with  such  contracts;  see  Hudson's  Bay  Co.  v.  Thew,  Gt. 
Br.  Tax  Cases,  Vol.  VII,  Pt.  II,  p.  206. 

74  0.  1024,  T.  B.  16-20-865. 

T5  0.  D.  647,  T.  B.  35-20-1166,  reversing  O.  D.  238,  T.  B.  13-20-416;  0.  D. 
774,  T.  B.  2-21-1396. 

76  O.  D.  774,  T.  B.  3-21-1396. 

77  O.  D.  762,  T.  B.  1-21-1369. 


INCOME  FROM  INTEREST,  RENT  AND  ROYALTIES  497 

that  both  the  discount  and  the  interest  on  the  principal  of  the 
note  after  maturity  are  exempt  from  income  and  profits  taxes 
in  the  hands  of  the  bank  as  interest  upon  the  obhgations  of  a 
political  subdivision  of  a  state. ""^  Where  a  noninterest-bearing 
warrant  is  issued  by  a  county  in  payment  for  services  or  sup- 
plies for  an  amount  which  represents  the  purchase  price  of  the 
services  or  supplies  plus  interest  on  such  amount  until  the  date 
of  maturity  of  the  warrant  and  the  person  to  whom  such  war- 
rant is  issued  discounts  it  at  a  bank  in  order  to  secure  money 
thereon,  the  matter  of  the  discount  is  a  transaction  wholly  be- 
tween the  party  to  whom  the  warrant  is  issued  and  the  bank,  and 
the  discount  is  not  free  from  tax.  This  ruling  applies  whether 
negotiations  for  discounting  such  warrant  are  made  by  the 
county,  or  by  the  owner  of  the  warrant.'" 

Rent.  Rent,  like  all  other,  income,  may  be  received  in  cash,  in 
kind,  or  in  the  equivalent  of  cash.  The  questions  arising  under 
the  income  tax  law  with  regard  to  rent  usually  relate  to  the  tax- 
able period  for  which  rent  income  is  to  be  reported  or  to  situa- 
tions involving  the  payment  of  rent  in  some  form  other  than 
cash.  The  following  paragraphs  deal  with  the  latter  kind  of 
question : 

Value  of  Improvements  Made  by  Tenant.  Where,  under 
the  terms  of  a  lease  a  tenant  agrees  to  erect  a  building  or  to 
expend  during  the  period  of  the  lease  a  certain  fixed  sum  in 
making  improvements  upon  the  freehold  of  the  lessor,  the  build- 
ing or  permanent  improvement  becomes  a  part  of  the  realty 
unless  otherwise  agreed  upon  between  the  contracting  parties. 
The  treasury  department  has  modified  its  previous  ruling  that 
improvements  made  by  a  tenant  are  income  to  the  lessor  at  the 
expiration  or  termination  of  the  lease  and  has  now  ruled  that 
when  buildings  are  erected  or  improvements  are  made  by  a 
lessee  in  pursuance  of  an  agreement  with  the  lessor,  and  such 
buildings  or  improvements  are  not  subject  to  removal  by  the 
lessee,  the  lessor  receives  income  at  the  time  when  such  buildings 
or  improvements  are  completed,  to  the  extent  of  the  fair  market 
value  of  such  buildings  or  improvements  subject  to  the  lease. 
This  amount  would  ordinarily  be  the  difference  between  the 
value  of  the  land  free  from  the  lease  without  such  improvements 
and  the  value  of  the  land  subject  to  the  lease  with  such  improve- 
ments. If,  for  any  other  reason  than  a  bona  fide  purchase  from 
the  lessee  by  the  lessor,  the  lease  is  terminated,  so  that  the  lessor 
comes  into  possession  and  control  of  the  property  prior  to  the 

"SO.  D.  85(i,  T.  B.  L3-21-1530. 
~^0.  D.  870,  T.  B.  15-21-1561. 


498  FEDERAL   INCOME   TAX 

time  originally  fixed  for  the  termination  of  the  lease,  the  lessor 
receives  additional  income  for  the  year  in  which  the  lease  is  so 
terminated  to  the  extent  that  the  value  of  such  buildings  or  im- 
provements when  he  became  entitled  to  such  possession  exceeds 
the  fair  market  price  or  value  thereof  to  him  as  determined 
when  the  same  completed  became  part  of  the  realty.  No  appre- 
ciation in  value  due  to  causes  other  than  the  premature  termina- 
tion of  the  lease  shall  be  included.  Conversely,  if  the  buildings 
or  improvements  are  destroyed  prior  to  the  expiration  of  the 
lease  the  lessor  is  entitled  to  deduct  as  a  loss  of  the  year  when 
such  destruction  takes  place  the  fair  market  price  or  value  of 
such  buildings  or  improvements  subject  to  the  lease  as  deter- 
mined when  the  same  completed  became  a  part  of  the  realty, 
less  any  salvage  value  subject  to  the  lease,  to  the  extent  that 
such  loss  was  not  compensated  by  insurance.  If  the  buildings 
or  improvements  destroyed  were  acquired  prior  to  March  1, 
1913,  the  deduction  will  be  based  on  the  cost  or  the  value  subject 
to  the  lease,  as  of  that  date,  whichever  is  lower,  less  any  salvage 
value  subject  to  the  lease,  to  the  extent  that  such  loss  was  not 
compensated  by  insurance.^"  The  following  example  has  been 
given  by  the  treasury  department  to  illustrate  the  proper  con- 
struction of  the  above  ruling : 

A,  in  1915,  leases  certain  land  to  B  for  20  years.  B  agrees, 
in  part  consideration  for  the  lease,  to  erect  on  the  leased  ground 
a  building,  specifications  agreed  upon,  of  an  estimated  life  of 
25  years  and  to  cost  $50,000,  which  building  is  not  to  be  subject 
to  removal  by  B.    The  building  is  completed  in  1920. 

A  realizes  income  in  1920,  the  year  in  which  title  to  the  build- 
ing passes.  The  measure  of  the  income  is  the  present  value  to 
A  of  the  building,  of  an  estimated  life  of  25  years  and  cost  of 
$50,000,  the  use  and  enjoyment  of  which  is  postponed  for  15 
years.  The  depreciated  value  of  the  building  at  the  termination 
of  the  period  of  the  lease  will  be  approximately  $20,000 — that  is, 
cost  less  depreciation  sustained.  The  income  of  A,  then,  is  the 
discounted  value  of  $20,000  receivable  at  the  end  of  15  years. 
If  market  value  reflects  intrinsic  value,  this  amount  should  equal 
the  difference  between  the  value  of  the  land  free  from  the  lease 
without  the  buildings  and  the  value  of  the  land  subject  to  the 
lease  with  the  building.  However,  any  other  evidence  available 
should  be  considered  in  determining  this  present  worth  to  the 

w  Reg.  45,  Art.  48,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767.  See  also 
Cryan  v.  Wardell,  263  Fed.  248;  Miller  v.  Gearin,  258  Fed.  225.  "A  ground 
rent"  under  a  Virginia  lease,  should  be  returned  as  rent  (O.  D.  1089,  T.  B. 
45-21-1905). 


INCOME  FROM  INTEREST.  RENT  AND  ROYALTIES  499 

taxpayer  of  the  legal  title  to  the  encumbered  building.  Since 
A  has  included  in  income  only  the  depreciated  value  of  the  build- 
ing, he  is  entitled  to  a  depreciation  deduction  with  respect  to 
such  building  only  for  the  years  after  the  termination  of  the 
period  of  the  lease  when  A  has  come  into  possession.  This 
depreciation  deduction  to  which  A  is  entitled  for  1935  and  sub- 
sequent years  should  be  computed  on  a  basis  of  the  estimated 
remaining  life  of  the  building  and  a  "cost"  value  equal  to  the 
market  value  placed  on  the  encumbered  building  by  A  in  the 
year  of  its  erection,  i.  e.,  the  annual  depreciation  deduction  for 
1935  and  subsequent  years  will  be  the  quotient  obtained  by 
dividing  (a)  the  value  of  the  improvements  to  A  as  determined 
by  him  when  the  same  completed  became  part  of  the  realty,  by 
(b)  the  number  of  years  in  the  estimated  remaining  life  of  the 
improvements  from  the  termination  of  the  lease. 

In  any  case  in  which  the  term  of  the  lease  is  greater  than  the 
estimated  life  of  the  improvement  no  income  should  be  ac- 
counted for  by  the  lessor  at  the  time  of  the  passage  of  title. 
Also  if  the  improvements  will  have  no  value  at  the  termination 
of  the  lease,  as  is  often  the  case  in  mining  leases,  no  income  is 
realized  by  the  lessor."^' 

Payments  by  Tenant  on  Behalf  of  Landlord.  In  general, 
sums  paid  by  a  tenant  for  the  use  of  property,  although  to  an- 
other than  the  landlord,  are  properly  to  be  regarded  as  rent  and 
constitute  income  of  the  landlord.'^-  Where  under  the  t^rms  of 
a  lease  a  tenant  pays  or  incurs  liability  for  taxes,  repairs  or 
interest  for  and  on  behalf  of  the  landlord,  such  payments  con- 
stitute income  to  the  landlord.  The  theory  covering  these  trans- 
actions is  that  the  tenant  is  acting  merely  as  agent  for  the  land- 
lord in  making  the  payments.  The  expenses  are  deductible  by 
the  landlord,  and  the  amounts  used  to  defray  such  expenses  must 
be  reported  by  the  landlord  as  his  income.^"'  Such  payments 
may  be  deducted  by  the  tenant  as  rent  in  the  year  in  which  they 
are  paid.*^* 

Receipt  of  Rent  in  Kind.  Where  rent  is  received  in  the 
form  of  produce,  as  for  instance,  a  share  of  the  crops  of  a  farm, 
and  such  produce  or  crops  have  no  definite  market  value,  the 
amount  realized  on  the  sale  of  such  share  must  be  included  as  in- 
come in  the  year  in  which  the  share  is  disposed  of  or  reduced  to 

RIM.  2714,  T.  B.  8-21-1474. 
82Ref,'.  45,  Art.  48. 

H.'5Rep:.  33  Rev.,  Art.  4;  T.  D.  30r)2,  T.  B.  37-20-1198.  anitMidiiifr  Rep.  45. 
Arts.  48,  109  and  164. 
84  Reg.  33  Rev.,  Art.  8. 


500  FEDERAL   INCOME   TAX 

money  or  its  equivalent.  Where  board  or  lodging  is  given  as  the 
equivalent  of  rent,  the  value  of  such  board  or  lodging  is  required 
to  be  included. 

Constructive  Receipt  of  Rent.  In  a  case  decided  under 
the  1909  Law,  four  railroad  companies  formed  a  corporation  for 
the  purpose  of  securing  for  themselves  terminal  services.  All 
the  stock  of  the  terminal  company  was  held  by  the  four  railroad 
companies  in  equal  parts  and  all  its  operating  expenses  were 
paid  by  the  railroad  companies  pro  rata.  In  order  to  finance 
the  terminal  company,  a  large  sum  of  money  was  necessary  and 
the  railroad  companies  agreed  to  pay  the  annual  interest  and 
sinking  fund  requirements  of  a  loan  from  a  trust  company  to 
the  terminal  company  in  equal  parts,  the  loan  being  secured  by 
a  mortgage  on  the  property  of  the  terminal  company.  The 
property  was  to  become  the  unencumbered  property  of  the 
terminal  company  on  final  payment  of  the  mortgage  indebted- 
ness ;  the  payments  by  the  railroad  companies  could  not  be  said 
to  be  voluntary,  but  were  in  accordance  with  certain  formal 
agreements  with  both  the  terminal  companj^  and  the  trust  com- 
pany. The  court  held  that  the  amount  of  interest  paid  by  the 
railroad  companies  direct  to  the  trust  company  was  income  to 
the  terminal  company.  The  railroad  companies  made  use  of  the 
facilities  and  services  of  the  terminal  company  in  two  ways: 
First,  by  the  use  of  its  property ;  and  second,  through  the  services 
of  its  employees.  The  second  was  paid  for  by  the  pro  rata 
contribution  to  operating  expenses.  The  consideration  for  the 
use  of  the  property  was  the  payment  of  the  interest  into  the 
sinking  fund.  Such  payments  were  in  lieu  of  compensation  for 
the  enjoyment  of  the  property  used  and  were  in  the  nature  of 
rent  received  by  the  terminal  company  and  to  be  accounted  for 
in  its  returns  as  such.^^ 

In  another  case,  a  corporation  leased  all  of  its  property  to 
another  corporation  for  a  term  of  years  in  consideration  of  an 
annual  rental,  payments  to  be  made  semi-annually  in  each  year 
during  the  term  of  the  lease.  The  lessee  company  was  the  owner 
of  a  large  part  of  the  capital  stock  of  the  lessor  company  and 
it  was  the  practice  of  the  former  company  to  pay  the  annual 
rental,  not  directly  to  the  lessor  company,  but  to  remit  to  the 
latter  company's  stockholders  on  the  days  when  the  rental  was 
due  their  proportion  of  such  rental  based  on  the  amount  of 
each  stockholder's  stockholding  in  the  lessor  corporation.  Had 
the  lessee  corporation  paid  the  entire  rental  to  the  lessor  corpo- 

85  Houston  Belt  &  Terminal  Co.  v.  U.  S.,  250  Fed.  1. 


INCOME  FROM  INTEREST,  RENT  AND  ROYALTIES  501 

ration,  it  would  have  recei¥ed  back  as  dividends  the  difference 
between  the  total  rental  and  the  amount  remitted  to  the  other 
stockholders  of  the  lessor  corporation.    The  treasury  department 
held  that,  in  effect,  the  lessee  corporation  paid  out  the  entire 
rental  each  year  and  as  a  stockholder  had  returned  to  it  a  portion 
of  such  amount  as  a  dividend  on  its  holdings  of  stock  in  the 
lessor  corporation,  and  the  mere  fact  that  it  did  not  actually 
pay  to  the  lessor  corporation  the  full  amount  of  such  rental 
and  then  have  formally  paid  to   it  by   the   latter  company   a 
dividend  did  not  change  the  substance  of  the  transaction.    The 
lessor   corporation   was   in   constructive   receipt   of  the   entire 
rental,  notwithstanding  the  fact  that  the  form  of  receiving  it 
and  paying  it  out  again  as  dividends  was  not  gone  through.*"' 

Royalties.  Amounts  received  as  royalties  are  income  in  the 
taxable  year  of  receipt,  actual  or  constructive,  or  in  the  taxable 
year  in  which  they  accrue,  accordingly  as  the  taxpayer  reports 
his  income  on  the  basis  of  receipts  or  accruals.  Royalties  fall 
under  the  broad  expression  "income  derived  from  sales,  or  deal- 
ings in  property,  whether  real  or  personal,  growing  out  of  the 
ownership  or  use  of  or  interest  in  such  property ;  also  gains  or 
profits  and  income  derived  from  any  source  whatever."  In 
the  provisions  of  the  Revenue  Act  of  1921  imposing  the  tax  on 
nonresident  aliens,  "royalties  from  property  located  in  the 
United  States"  are  expressly  included  in  the  gross  income  of 
such  taxpayers.^" 

ROYALTIES  FROM  MINES.  It  has  been  contended  that  royalties 
received  under  leases  of  oil,  gas,  and  solid  minerals  are  in  fact 
not  income  but  payments  of  installments  on  the  purchase  price 
of  the  natural  deposit.  The  nature  and  effect  of  such  leases  has 
been  the  subject  of  some  difference  of  opinion  in  the  courts.  It 
has  been  held  that  the  leases  are  leases  in  name  only ;  that  they 
are  in  fact  conveyances  of  the  ore  body  or  oil  and  gas  in  place 
as  a  part  of  the  realty ;  that  the  so-called  royalties  merely  repre- 

Sii  A.  R.  R.  589,  T.  B.  30-21-1747.  See  also  Renselaer  &  Saratoga  R.  R.  Co. 
V.  Irwin,  249  Fed.  726,  writ  of  certiorari  denied,  24G  U.  S.  G71;  Northern 
Co.  V.  Lowe,  250  Fed.  856;  Anderson  v.  Morris  &  Essex  R.  R.  Co.,  2l(.  Fed. 

83 

ST  Revenue  Act  of  1921,  §  217  (a)  4.  Revenue  Act  of  1921,  i;  213  (a) .  It 
has  been  held  that  royalties  received  by  a  corporation  in  accordance  with  a 
contract  by  which  it  has  assigned  the  patent  rights  to  manufacture  machines, 
etc.,  are  income  and  should  be  so  accounted  for  (Reg.  33  R^^v.  Art  113;  letter 
from  treasury  department  dated  January  24.  1916;  I.  T.  S.  1918.  1^1262) 
and  that  royalties  paid  to  a  proprietor  by  those  who  are  allowe.l  to  develop 
or  use  property  or  operate  under  some  right  belonging  to  such  proprietor  are 
also  to  be  accounted  for  as  income.  (Reg.  33  Rev.,  Art.  4.) 


502  FEDERAL   INCOME   TAX 

sent  payments  for  so  much  land  and  are  in  no  just  sense  income, 
but  mere  conversions  of  the  capital. '^'^  On  the  other  hand,  it  has 
been  held  that  leases  of  solid  mineral  rights  do  not  constitute  a 
sale  of  any  part  of  the  land  or  a  sale  of  ore  in  place,  and  that  the 
royalties  payable  constitute  the  rents  and  profits  of  the  land.^^ 

88  See  Hook  v.  Garfield  Coal  Co.,  112  la.  210,  83  N.  W.  963;  Wilson  v. 
Youst,  43  W.  Va.  826,  28  S.  E.  781;  Manning  v.  Frazier,  96  111.  279;  Spooner 
V.  Phillips,  62  Conn.  62,  24  Atl.  524;  Wilcox  v.  Middlesex  County,  103  Mass. 
544;  Plummer  v.  Hillsdale  Coal  etc.  Co.,  163  Fa.  483,  28  Atl.  853;  Barnsdall 
V.  Bradford  Gas  Co.,  225  Pa.  338,  74  Atl.  207. 

«>T.  D.  2152;  Von  Baumbach  v.  Sargent  Land  Co.,  242  U.  S.  503;  U.  S. 
V.  Biwabik  Mining  Co.,  247  U.  S.  116;  Stratlon's  Independence  v.  Howbert, 
231  U.  S.  399,  34  Sup.  Ct.  136;  Chemung  Iron  Co.  v.  Lynch,  269  Fed.  368; 
State  V.  Evans,  99  Minn.  220,  108  N.  W.  958;  Boeing  v.  Owsley,  122  Minn. 
190,  142  N.  W.  129;  State  v.  Royal  Mineral  Association,  132  Minn.  232,  156 
N.  W.  128;  Reg.  v.  Westbrook,  10  Q.  B.  178,  205,  22  Eng.  Rul.  Cas.  623.  For 
a  thorough  discussion  of  the  first  three  cases  cited  above  see  the  discussion 
of  the  subject  of  depletion  by  lessees  under  prior  laws  in  Chapter  27.  This 
discussion  will  throw  light  upon  the  subject  of  royalties  from  mines.  The 
leases  involved  in  the  Sargent  case  were  leases  of  iron  ore  lands  and  they 
contained  substantially  the  following  provisions:  (1)  that  the  owners  leased 
to  the  lessees  exclusively  all  the  lands  described  for  the  purpose  of  explor- 
ing for,  mining,  and  removing  the  ore  which  might  be  found  therein  for  the 
period  of  fifty  years;  (2)  the  lessees  were  given  the  exclusive  right  to  oc- 
cupy and  control  the  leased  premises  and  to  erect  all  necessary  buildings, 
etc.,  thereon,  (3)  right  was  reserved  to  the  lessors  to  enter  for  the  purpose 
of  ascertaining  the  amount  of  ore  mined  and  removed  and  of  making  obser- 
vations, etc.;  (4)  the  lessees  agreed  to  pay  in  most  cases  a  certain  price 
per  ton  for  all  ore  mined  and  removed;  (5)  the  lessees  agreed  to  mine  and 
ship  a  specified  quantity  of  ore  each  year  in  default  of  which  they  agreed  to 
pay  the  lessors  for  a  minimum  amount;  (6)  the  lessees  agreed  to  pay  taxes 
and  to  keep  the  property  free  from  encumbrances;  (7)  the  lessors  reserved 
the  right  to  terminate  the  lease  upon  default  of  the  lessees;  (8)  the  lessees 
had  the  right  to  terminate  the  leases  upon  sixty  days  notice.  The  Supreme 
Court  held  that  moneys  received  under  these  leases  did  not  represent,  in 
whole  or  in  part,  conversion  of  the  investment  of  the  lessors  from  ore  into 
money,  but  on  the  contrary  they  represented  the  rents  and  profits  of  the  land 
to  be  accounted  for  as  income  by  the  recipient  lessors.  In  the  Biwabik  case 
the  leases  involved  contained  substantially  similar  pi'ovisions  and  the  lands 
leased  contained  deposits  of  iron  ore.  The  court  expressly  stated  in  this  case 
that  its  findings  in  the  Sargent  case  left  "little  room  to  suppose  that  this 
court  made  its  decision  concerning  the  rights  of  the  lessor  influenced  by 
the  fact  that  the  land  itself  was  the  chief  thing,  and  the  ownership  of  it 
after  the  exhaustion  of  the  minerals  one  of  the  controlling  reasons  in  reach- 
ing the  conclusion  announced  in  that  case."  The  court  repeated  its  decision 
in  the  Sargent  case  that  the  lessee  was  in  no  legal  sense  the  purchaser  of 
ore  in  place.  Owing  to  the  migratory,  fugitive,  and  volatile  character  of  oil 
and  gas  the  rights  and  ownership  therein  are  to  be  determined  according  to 
special  rules  and  not  according  to  the  rules  which  prevail  in  the  case  of  ore. 
coal  and  other  solid  minerals.     (Ohio  Oil   Co.  v.   Indiana,  177   U.   S.   190; 


INCOME  FROM  INTEREST.  RENT  AND  ROYALTIES  503 

It  has  been  held  under  the  1913  and  1916  Laws  that  a  Pennsyl- 
vania mining  lease  containing  the  provisions  indicated  in  the 
footnote  below  does  not  constitute  a  sale  of  the  coal  in  place 
and  that  royalties  received  thereunder  are  income  to  the  lessors."" 
Income  from  oil  royalties  must  be  returned  in  the  taxable  year 
received,  even  though  the  title  to  the  producing  land  is  in  litiga- 
tion.''i  When  land  purchased  in  1914  and  having  no  mineral 
rights  value  at  the  time  of  purchase,  is  subsequently  leased  on 
a  royalty  basis  for  oil  and  gas  development,  amounts  received 
from  the  sale  of  interests  in  such  royalty  have  been  held  to  be 
income  for  the  year  of  receipt,  subject  to  proper  adjustment 
on  account  of  depletion  sustained."- 

ROYALTiEs  FROM  PATENTS  AND  COPYRIGHTS.  Royalties  on 
patents  are  income.-'--  Taxpayers  receiving  royalties  from  pat- 
ents, copyrights,  or  other  similar  forms  of  property,  may  deduct 
from  each  payment  a  proportionate  part  of  the  cost  thereof  as 
representing  a  return  of  capital.  This  is  more  fully  discussed 
in  a  subsequent  chapter."^ 

Brown  v.  Spilman,  155  U.  S.  665.)  It  may  be  that  royalties  upon  oil  and 
gas  leases  are  for  this  reason  distinguishable  from  royalties  upon  solid 
mineral  leases,  but  the  point  has  never  been  expressly  determined  with 
reference  to  the  income  tax. 

!•<>  S.  1365,  T.  B.  18-20-900.  The  provisions  of  the  lease  under  consideration 
were  as  follows:  (1)  To  demise,  lease  and  let  to  the  lessee  all  coal  in,  upon 
and  under  certain  lands  owned  by  the  lessor.  (2)  The  lessee  was  given  the 
right  to  mine,  remove,  and  dispose  of  the  coal.  (3)  The  lessor  retained  the 
privilege  at  any  time  after  the  expiration  of  the  first  10  years  of  the  lease 
to  sell  the  leased  property  upon  giving  6  months'  notice  to  the  lessee  and 
affording  the  lessee  an  opportunity  to  purchase  the  property. 
(4)  The  lease  was  not  to  be  assigned  by  the  lessee  without  the  consent  of 
the  lessor.  (5)  The  lessor  retained  absolutely  the  right  to  sell  the  property 
subject  to  the  terms  of  lease.  Upon  termination  of  this  lease,  a 
new  lease  agreement  was  made  containing,  among  other  provisions,  the  fol- 
lowing: (1)  Term  of  lease,  10  years.  (2)  Lessee  to  mine  and  remove  as 
much  coal  as  possible  by  reasonably  diligent  mining  operations.  (3)  The 
lessee  agreed  not  to  assign  the  lease  without  consent  of  the  lessor,  but  had 
the  right  to  sublet  portions  of  the  surface  without  consent  of  the  lessor. 
(4)  Upon  failure  of  the  lessee  to  comply  with  all  conditions  of  the  agree- 
ment, the  lessor  had  the  right  to  declare  a  forfeiture  of  the  unexpired 
portion  of  the  lease. 

!'^  O.  D.  825,  T.  B.  9-21-1477.  If  any  part  of  the  royalty  income  is  ordered 
by  the  court  to  be  paid  over  to  another,  any  tax  previously  paid  thereon  will 
be  credited  or  refunded  upon. presentation  of  the  proper  claim.  This  ruling 
is  criticised  in  Chapter  33.    See  also  0.  D.  971,  T.  B.  28-21-1723. 

«•-'  0.  D.  644,  T.  B.  35-20-1163. 

!•:"•  Reg.  45,  Art.  48. 

!'^  See  Chapter  20. 


CHAPTER  19 

INCOME   FROM   DIVIDENDS 

The  law  expressly  states  that  the  gross  income  of  a  taxpayer 
shall  include  gains,  profits  and  income  derived  from  dividends.^ 
Important  amendments  made  by  the  Revenue  Act  of  1921  upon 
the  subject  of  dividends  are  (1)  the  recognition  that  stock  divi- 
dends are  not  constitutionally  taxable,  (2)  the  statement  con- 
clusively of  certain  provisions  formerly  stated  as  presumptions, 
and  (3)  the  statutory  enactment  of  the  rule  that  a  taxable  cor- 
porate distribution  shall  be  taxable  as  of  the  date  when  the 
cash  or  other  property  distributed  is  made  unqualifiedly  sub- 
ject to  the  demand  of  the  distributee,  and  (4)  the  two  amend- 
ments indicated  in  the  next  paragraph.  A  change  is  made 
necessary  in  the  definition  of  dividends  by  the  abolition  of  per- 
sonal service  corporations  as  of  December  31,  1921,  and  the 
presumption  contained  in  the  1918  Law  as  to  dividends  dis- 
tributed during  the  first  60  days  of  a  taxable  year  is  made  in- 
applicable after  December  31,  1921,  as  of  which  date  the  excess- 
profits  tax,  to  which  this  presumption  related,  is  repealed. 

Definitions.  A  notable  change  made  by  the  1921  Law  is  the 
provision  permitting  accretions  in  the  value  of  property 
accrued  prior  to  March  1,  1913,  as  well  as  earnings  and  profits 
accumulated  prior  to  that  date,  to  be  distributed  free  from 
tax  after  earnings  and  profits  accumulated  since  February  28, 
1913,  have  been  distributed.^  In  accordance  with  the  decision 
of  the  Supreme  Court^  stock  dividends  are  expressely  stated  not 
to  be  taxable  dividends.*  As  defined  in  the  Revenue  Act  of 
1921,  the  term  "dividend"  (with  one  exception  where  it  is  used 
in  connection  with  dividends  paid  on  policies  by  insurance  com- 
panies) means  any  distribution  made  by  a  corporation  to  its 
shareholders  or  members,  whether  in  cash  or  in  other  property, 
out  of  its  earnings  or  profits  accumulated  since  February  28, 
1913,  except  a  distribution  made  by  a  personal  service  corpora- 

1  Revenue  Act  of  1921,  §§213  (a)  and  233;  Revenue  Act  of  1918,  §§213 
(a)  and  233.  The  Revenue  Act  of  1916  provided  that  subject  only  to  such 
exemptions  and  deductions  as  were  thereinafter  allowed,  the  net  income 
of  a  taxpayer  should  include  gains,  profits  and  income  derived  from  divi- 
dends (Revenue  Act  of  1916,  §  2  (a) ). 

2  Revenue  Act  of  1921,  §201   (b). 

3  Eisner  v.  Macomber,  252  U.  S.  189. 

4  Revenue  Act  of  1921,  §201   (d). 

504 


INCOME    FROM    DIVIDENDS  ^05 


1917.  and  P""'  '^^  ^^^  ^^^'^^  „'  i^^g  (,,ith  the  same  exception 
rot^daboUTwasde^flned  therein  to  mean  (1)  any  distribution 
made  by  a  corporation,  other  than  a  personal  service  corpora- 
""t/it^  shareholders  or  members,  whether  in  cash  or  m 
rjr  r  :rtroHn  ieU  of  tiie  corporation,  out  of  its  eatings 
or  nrofits  accumulated  since  February  28,  1913,  o  {^)  any 
:uch  dt    ibution  made  by  a  personal-service  corporation  out  of 

rrtirnfanrS  oTpUts  realized  thereby  were  taxed  to 

%trb?:oW  r  ut?r  ird^nnitions  any  distribution 
it  IS  to  utJ  ii^tc^  Knoinpqs    though   extraordinary   in 

in   thp  ordinary  course  oi    business,   uiuu^u   c 
m  the /^^^  ";;'•;  corporation  of  earnings  or  profits 

— lateTl^'^f  u^^.y  .S,    -^jsj^--- •  l"trm:; 

=at^n."oft'h^  oth^rittir'Tdis-^f  L  is  not  out 

r::r„in.s  or  profits  --'-tC^uertrSIcember'si, 

[^t  tll^T^e^ol^^^^^-^^'^^^  it  does  not 
b!com  a  d  V  dend  wUhin  the  meaning  of  the  law  by --o"  ^J 
theTct  that  it  is  called  a  dividend  by  the  corporation  making 

^"r^^M    ASSOCUT.O.S.      Since_  associations    iolM^^ 

IZ  Z.yt  rt^ed' ..^he  n'et  earnings  of  such  organiza- 
5Revcnue  Act  of  1918,  §  201  (.).    Aftev  January  1,  1922,  p.,.ona.  servic. 

corporations  are  ^-^f^^^^ '^^l' ^:;'^%Z°:t  Arts.  1541  and  1543      It  .viU 

t;  Revenue  Act  of  1918,  §  ZUi   ^a;  ,  xv  ^        ,  ^^.^^^^  ^^.^^^ 

be  noted  that  this  definition,  as  ^°"^P^^-'-^;^,."f^V^;i,t.ibutions   omitted   the 
its   provisions   for  personal   ---^.^Xt;Tthe      or  r-accumulated''  for 

words,  "or  ordered  to  be  "^f ^^   ^^^,^f ''^'"^^ibuttons  made  "in  other  prop- 
..accrued";  and  also  -P--ly  -eluded  d.st^b^Uon^  J  ^^^    ^^^ 

ertv  "    See  Revenue  Act  of  1910,  §  31   ^a),  ^eg.  o 

7  Revenue  Act  of  1918,  §  201   (O  ;  Reg.  45,  Art.  1548. 

8  See  O.  932,  T.  B.  25-19-579. 

0  Reg.  45,  Art.  1543.  i,„4^«  "associations,  joint-stock  com- 

10  The  definition  of  "corporations 'includes     assomt  j  ^^^ 

panics,  and  insurance  -mpanies"   (Revenue  A,t  of  19-1.  .-, 
•  of  1918,  U;  see  also  T.D.  2152;  T.D,  213  0. 


506  FEDERAL   INCOME   TAX 

tions  when  distributed  should  be  considered  dividends.!^  The 
recipient  of  profits  or  associations  or  limited  partnerships 
should,  therefore,  ascertain  whether  the  asociation  or  partner- 
ship is  paying  the  tax  as  a  corporation  and  in  such  event  should 
treat  any  part  of  the  net  profits  of  the  association  received  by 
him  as  dividends. 

Excessive  Compensation.  Payments  of  compensation  to  the 
stockholding  officers  or  employees  of  a  corporation,  to  the  extent 
that  such  payments  are  in  excess  of  a  reasonable  return  for 
services  rendered,  may  be  regarded  as  dividends,  as  indicated 
in  another  chapter.^- 

DlviDENDS  IN  THE  FORM  OF  ROYALTIES.  A  royalty  paid  by 
a  corporation  to  one  of  its  officers,  who  is  also  majority  stock- 
holder, for  the  use  of  a  patent  upon  an  article  manufactured 
and  sold  by  the  corporation,  if  in  excess  of  a  reasonable 
amount,  taking  into  consideration  all  the  facts  in  the  particu- 
lar case  will  represent  a  distribution  of  profits  and  will  be 
taxable  to  the  recipient  as  dividends,^-' 

Compromise  of  Preferred  Dividends.  Preferred  stock- 
holders whose  dividends  are  in  arrears  have  no  enforceable 
claim  against  the  corporation  unless  and  until  a  dividend  be  de- 
clared by  the  directors  and  consequently  are  not  "creditors". 
A  payment  or  settlement  pursuant  to  the  compromise  by  corpo- 
rate directors  of  accumulated  dividends  on  preferred  stock,  the 
payment  or  settlement  consisting  partly  of  cash,  partly  of 
shares  of  preferred  stock,  and  partly  shares  of  common  stock, 
has  been  held  to  be  a  dividend  within  the  meaning  of  the  Mass- 
achusetts Income  Tax  Law,  since  the  money  and  stock  are  paid 
from  or  based  upon  earnings. ^^ 

Taxes  Paid  for  Shareholders  to  Be  Considered  as  Divi- 
dends. Where  a  corporation,  such  as  a  bank,  pays  taxes 
assessed  upon  the  respective  interests  of  its  shareholders,  under 
laws  which  require  the  corporation  to  pay  such  taxes  on  behalf 
of  its  shareholders,  the  pro  rata  amount 'so  paid  on  his  shares 
was  required  under  the  1918  Law  to  be  reported  by  the  stock- 
holder as  a  dividend.  The  same  amount  might  also  be  deducted 
as  a  tax  of  the  stockholder  paid  for  him  by  the  corporation 
as  his  agent.  The  net  result  of  reporting  such  amount  as  a 
dividend,  and  claiming  the  same  amount  as  a  deduction,  was 

11  See  Chapter  8. 

12  See  Chapter  22.  See  also  Chapter  15. 

13  0.  D.  440,  T.  B.  14-20-835. 

14  Wilder  v.  Trefry  (Mass.),  125  N.  E.  689.  See,  however,  p.  531  as  to 
dividends  paid  in  stock. 


INCOME    FROM    DIVIDENDS  507 

that  the  amount  of  tax  is  offset  against  the  stockholder's  income 
from  other  sources  in  assessing  the  normal  tax.'"'  Under  the 
present  law  such  taxes  are  deductible  by  tne  corporation  and  the 
stockholder  may  not  deduct  themJ'' 

Distributions  Which  Are  Not  Dividends.     A  distribution  by  a 
corporation  out  of  earnings  or  profits  accumulated,  or  increase 
in  value  of  property  accrued,  prior  to  March  1,  1913,  or  out  of 
any  assets  except  earnings  or  profits  accumulated   since   Feb- 
ruary 28,  1913,  is  not  a  dividend  within  the  meaning  of  the 
statute.     A  distribution  by  a  personal  service  corporation  out 
of  earnings  or  profits  accumulated  since  December  31,   1917, 
and  prior  to  January  1.  1922,  is  not  a  dividend.    A  distribution 
out  of  earnings  or  profits  accumulated,  or  increase  in  the  value 
of  property  accrued,  before  March  1,  1913,  is  free  from  tax  as 
a  dividend ;  out  of  assets  other  than  earnings  or  profits  accumu- 
lated since  February  28,  1913,  may  or  may  not  be  free  from  tax, 
according  as  each  stockholder  receives  more  or  less  than  he  paid 
for  his  stock.     However,  if  such  stock  was  acquired  prior  to 
March  1,  1913,  and  the  fair  market  value  as  of  such  date  was 
greater  than  the  cost  thereof  and  less  than  the  sum  received 
in  distribution,  the  amount  which  is  taxable  is  the  excess  over 
such  market  value  as  of  March  1,  1913,  of  the  sum  received  in 
the  distribution,  but  no  gain  is  recognized  if  the  amount  re- 
ceived in  distribution  is  more  than  the  cost,  but  less  than  the 
fair  market  value  of  the  stock  on  March  1,  1913.     In  the  case 
of  a  personal  service  corporation  a  distribution  out  of  earnings 
or  profits  accumulated  since  December  31,  1917,  and  prior  to 
January  1,  1922,  is  taxed  to  the  stockholders  as  though  they 
were  partners. i"    Where  a  corporation  offers  its  employees  the 
opportunity  to  purchase  shares  of  its  stock,  and  the  title  to  the 
stock  remains  in  the  corporation  until  it  is  fully  paid  for,  it 
is  held  that  the  so-called  dividends  accredited  to  the  account 
of  the  employees  purchasing  the  stock  as  part  payment  for  the 
stock  are  not  in  fact  dividends,  as  dividends  cannot  legally  be 
declared    on    unissued    or    treasury    stock.      The    amounts    so 
credited,  w^hich  are  measured  by  the  dividends  declared  on  the 
outstanding  stock,  constitute  additional  compensation  to  the  em- 
ployees and  are  taxable  as  such.^'^ 

1''  See  Chapter  24. 

1'- Revenue  Act  of  1921,  §§  234  (a)  3,  214,  (a)  3. 

IT  Revenue  Act  of  1921,  r^f'l ;  Rep:.  45  Art.  1543,  as  amended  by  T.  D. 
3206,  T.  B.  33-21-1767. 

1^0.  D.  763,  T.  B.  1-21-1370;  0.  D.  791,  T.  B.  6-21-1426. 


508  FEDERAL   INCOME   TAX 

Dividends  on  Life  Insurance  Policies.  It  is  a  custom  of  in- 
surance companies  to  return  each  year  a  portion  of  the  premium 
paid  by  the  insured.  The  amount  so  returned  is  usually  desig- 
nated as  a  "dividend"  and  is  either  received  in  cash  by  the  in- 
sured or  applied  by  him  to  the  reduction  of  the  next  annual  pre- 
mium. The  law  expressly  provides  that  amounts  received  as  a  re- 
turn of  premiums  paid  by  the  taxpayer  is  not  income. ^^  Where, 
however,  dividends  are  received  on  a  paid-up  policy  their  amount 
should  be  considered  the  same  as  dividends  from  corporations,-"^ 
unless,  of  course,  the  dividend  was  not  paid  by  the  insurance  com- 
pany out  of  earnings  or  profits  accumulated  since  the  incidence 
of  the  tax. 

Dividends  from  Co-operative  Associations.  Dividends  paid 
by  co-operative  associations,  acting  as  sales  agents  for  farmers 
or  others,  in  the  nature  of  a  periodical  refund  or  rebate  to  mem- 
bers or  prospective  members  or  patrons  generally,  are  wholly  dif- 
ferent from  ordinary  distributions  based  upon  stockholdings  and 
may  be  excluded  from  gross  income  by  their  recipients.  Any 
profits  of  such  associations  made  from  nonmembers  and  distrib- 
uted to  members  in  the  guise  of  rebates,  are,  of  course,  subject  to 

tax.-i  i     r  1  ! 

Dividends  from  Federal  Reserve  Bank.  The  Federal  Re- 
serve Act  of  December  23,  1913,  provides  that  Federal  Reserve 
banks,  including  the  capital  stock  and  surplus  therein  and  the 
income  derived  therefrom,  shall  be  exempt  from  taxation,  ex- 
cept taxes  upon  real  estate.  Such  exemption  attaches  to  and 
follows  the  income  derived  from  dividends  on  stock  of  Federal 
Reserve  banks  in  the  hands  of  the  stockholders,  so  that  the 
dividends  received  on  the  stock  of  Federal  Reserve  banks  are  not 
subject  to  the  income  tax.  Dividends  paid  by  member  banks, 
however,  are  treated  like  dividends  of  ordinary  corporations.^^ 

Dividends  and  Interest  from  Federal  Land  Bank  and 
National  Farm  Loan  Association.  As  the  Federal  Farm  Loan 
Act  of  July  17,  1916,  provides  that  every  Federal  Land  bank  and 
every  National  Farm  Loan  association,  including  the  capital  and 
reserve  or  surplus  therein  and  the  income  derived  therefrom, 
shall  be  exempt  from  taxation,  except  taxes  upon  real  estate,  and 
that  Farm  Loan  bonds,  with  the  income  therefrom,  shall  be 
exempt  from  taxation,  the  income  derived  from  dividends  on 

19  Revenue  Act  of  1921,  §  213  (b)  2;  Revenue  Act  of  1918,  §213  (b)  2. 

20  T.  D.  2137. 

21  Reg.  45,  Art.  522;  T.  D.  2737.     See  Chapter  13. 

22  Reg.  45,  Art.  76;  Federal  Reserve  Bulletin,  April  1,  1916. 


INCOME    FROM    DIVIDENDS      •  509 

stock  of  Federal  Land  banks  and  National  Farm  Loan  associa- 
tions and  from  interest  on  such  Farm  Loan  bonds  is  not  subject 
to  the  income  tax.-'- 

Extent  to  Which  Dividends  are  Taxable.  The  extent  to  which 
dividends  are  taxable  depends  upon  the  status  of  the  paying 
corporation  and  upon  the  status  of  the  recipient  of  the  dividends. 
As  a  general  rule  the  income  from  dividends  is  subject  only  to 
the  surtax.  However,  dividends  from  (1)  domestic  corporations 
taxable  only  with  reference  to  income  from  sources  within  the 
United  States  and  (2)  foreign  corporations  50'*'  or  less  of  whose 
income  for  the  three-year  period  ending  with  the  close  of  the 
taxable  year  preceding  the  declaration  of  dividends  was  from 
sources  within  the  United  States  are  liable  to  the  noiTnal  tax  as 
well  as  the  surtax.-^ 

Dividends  Paid  By  Domestic  Corporations.-^  Under  the 
present  law,  dividends  paid  by  domestic  corporations  (except 
domestic  corporations  taxable  only  with  reference  to  income  from 
sources  within  the  United  States  and  personal  service  corpora- 
tions, as  indicated  in  a  paragraph  following)  if  received  by  an 
individual,  are  subject  only  to  the  surtax,  the  amount  thereof 
being  allowed  as  a  credit  for  purposes  of  the  normal  tax.'-''  If  the 
recipient  is  a  nonresident  alien,  the  credit  of  such  dividends  for 
purposes  of  the  normal  tax  will  be  allowed  only  if  such  recipient 
files  a  return  of  his  total  income  received  from  all  sources  within 
the  United  States  in  the  manner  prescribed  by  the  statute.-" 
Such  dividends  are  deductible  by  a  corporation,  domestic  or 
foreign.-^ 

23  Reg.  45,  Art.  75;  Reg.  33  Rev.,  Art.  86.  Revenue  Act  of  1918,  §  231  (13). 

-'4  Revenue  Act  of  1921,  §  216  (a). 

-•"'  Under  the  1918  Law  dividends  paid  by  a  domestic  corporation  liable  to 
income  tax  or  by  a  personal  service  corporation  out  of  earnings  or  profits 
upon  which  income  tax  had  been  imposed  were  not  subject  to  the  normal  tax 
if  received  by  an  individual  (Revenue  Act  of  1918,  §  216  (a)).  If  the  recip- 
ient was  a  non-resident  alien,  the  credit  of  such  dividends  for  normal  tax  pur- 
poses was  allowed  only  if  he  filed  a  return  of  total  income  from  all  sources 
within  the  United  States  (Revenue  Act  of  1918,  §217).  If  such  dividends 
were  received  by  a  corporation,  domestic  or  foreign,  the  amount  thereof  was 
allowed  as  a  deduction  (Revenue  Act  of  1918,  §234  (a)  6,  (b).)  Dividends 
paid  to  non-resident  alien  individuals  or  to  non-resident  foreign  corpora- 
tions by  domestic  corporations  doing  no  business  and  owning  no  property 
m  the  United  States  were  not  taxable  at  all  (Reg.  45,  Art.  92). 

^«See  Revenue  Act  of  1921,  §§  216  (a),  262. 

-'7  Revenue  Act  of  1921,  §§216  (a),  217  (g). 

•js  Revenue  Act  of  1921,  §234  (a)  6.  Under  the  1913  Law  corporations 
were  not  permitted  to  deduct  amounts  received  as  dividends  from  corpora- 
tions subject  to  the  income  tax.     This  was  likewise  true  of  the  2''.-  tax  im- 


510  federal  income  tax 

Dividends  Paid  By  Personal  Service  Corporations.^s 
Under  the  1921  Law  dividends  paid  by  personal  service  corpora- 
tions out  of  earnings  or  profits  upon  which  income  tax  has  been 
imposed  are  taxable  as  stated  in  the  preceding  paragraph.  The 
special  class  of  corporations  known  as  personal  service  corpora- 
tions is  abolished  by  the  1921  Law  as  of  December  31,  1921. 
Therefore,  dividends  paid  by  a  personal  service  corporation  are 
now  taxable  as  stated  in  the  preceding  paragraph,  unless  they 
are  paid  out  of  earnings  or  profits  accumulated  between  De- 
cember 31,  1917,  and  January  1,  1922.-^" 

Dividends  Paid  By  Foreign  Corporations.  The  present  law 
contains  a  substantial  departure  from  the  1918  Law  in  its  treat- 
ment of  dividends  paid  by  foreign  corporations.  Foreign  corpora- 
tions are  now  divisible  in  this  respect  into  (1)  those  which  derive 
more  than  50 'A  of  their  gross  income  for  the  three-year  period 
ending  with  the  close  of  the  taxable  year  preceding  the  declara- 
tion of  dividends  (or  for  such  part  of  such  period  as  the  corpora- 
tion has  been  in  existence)  from  sources  within  the  United 
States  and  (2)  those  which  derive  50 -v  or  less  of  such  gross 
income  from  sources  within  the  United  States.  Dividends  paid 
by  foreign  corporations  included  in  (1)  above  are  subject  only  to 
the  surtax  if  received  by  an  individual,  the  amout  thereof  being 
allowed  as  a  credit  for  purposes  of  the  normal  tax.  If  the  recipi- 
ent is  a  nonresident  alien,  the  credit  of  such  dividends  for  normal 
tax  purposes  will  be  allowed  only  if  the  nonresident  alien  files  a 
return  of  total  income  received  from  all  sources  within  the  United 
States  in  the  manner  prescribed  by  the  statute.  If  such  dividends 
are  received  by  a  corporation,  domestic  or  foreign,  the  amount 
thereof  is  allowed  as  a  deduction.  A  foreign  corporation,  how- 
ever, in  order  to  be  entitled  to  the  deduction,  must  file  a  return  in 
the  manner  indicated  in  the  case  of  non-resident  alien  indi- 
viduals.^i  Dividends  paid  by  foreign  corporations  included  in  (2) 
above  are  subject  to  the  normal  tax,  as  well  as  the  surtax,  in 
the  hands  of  citizens  and  residents,  since  they  may  not  be  cred- 
ited for  purposes  of  the  normal  tax  of  citizens  and  residents. 

posed  by  the  1916  Law,  but  for  the  purpose  of  the  4%  tax  imposed  by  the 
1917  Law  the  amount  of  such  dividends  was  permitted  as  a  credit.  (Reve- 
nue Act  of   1917,  §3;   Reg.  33  Rev.,  Art.   105.) 

-^  Under  the  1918  Law,  dividends  paid  by  personal  service  corporations 
out  of  earnings  or  profits  upon  which  income  tax  had  been  imposed,  that  is, 
earnings  or  profits  accumulated  between  February  28,  1913,  and  January  1, 
1918,  were  liable  to  tax  as  stated  in  footnote  25.  (Revenue  Act  of  1918, 
§§  216  (a),  234  (a)  6,  and  217.) 

•■50  Revenue  Act  of  1921,  §§201    (a),  218    (d). 

31  Revenue  Act  of  1921,  §§216   (a),  234   (a)   6,   (b)   217. 


INCOME    FROM    DIVIDENDS  511 

In  the  case  of  nonresident  aliens  or  foreign  corporations  they 
do  not  constitute  income  from  sources  within  the  United 
States."'-  When  received  by  a  domestic  corporatio)!  dividends 
paid  by  foreign  corjjorations,  included  in  (2)  above,  are  not 
deductible.-'^ 

Legal  and  Beneficial  Owners  of  Stock  on  Which  Divi- 
dends Are  Paid.  The  fact  that  an  individual  may  not  have  legal 
title  to  the  stock  on  which  dividends  are  declared  does  not  alter 
the  rules  stated  in  the  preceding  paragraphs.  If  he  is  the  actual 
beneficial  owner,  the  amount  which  is  received  by  a  trustee  in 
the  form  of  dividends  may  be  treated  as  dividends  by  a  bene- 
ficiary in  making  his  return,  and,  similarly,  dividends  received 
by  a  partnership  may  be  treated  as  dividends  received  by  the 
individual  partners.-'^  When  dividends  are  received  by  one  who 
is  not  the  actual  owner  of  the  stock,  but  is  the  owner  of  record, 
he  is  not  required  to  include  the  amount  thereof  in  his  own 
return 25  ]j^^  proceeds  in  accordance  with  the  rules  stated  else- 
where in  this  book.*''" 

Distribution  in  Liquidation  Under  the  1918  Law.  The  Revenue 
Act  of  1918  provided  that  "amounts  distributed  in  the  liquida- 
tion of  a  corporation  shall  be  treated  as  payments  in  exchange 
for  stock  or  shares,  and  any  gain  or  profit  realized  thereby  shall 
be  taxed  to  the  distributee  as  other  gains  or  profits." •■^    Under 

•'52  Revenue  Act  of  1921,  §§217  (a)  2,  216  (a). 

•5;>  Revenue  Act  of  1921,  §  234  (a)  6.  The  rule  stated  in  the  paragraph 
above  classifies  foreign  corporations  upon  a  different  theory  from  that 
which  underlay  the  classification  under  the  1918  Law.  Under  that  law,  for- 
eign corporations  were  divisible  into  (1)  those  deriving  no  income  from 
sources  within  the  United  States  and  (2)  those  deriving  income  from  sources 
within  the  United  States,  however  small  the  amount  thereof.  Dividend* 
paid  by  corporations  included  in  (1)  were  treated  in  the  same  manner  as 
dividends  paid  by  foreign  corporations  included  in  class  (2)  in  the  text 
above;  dividends  paid  by  foreign  corporations  included  in  class  (2)  were 
treated  in  the  same  manner  as  dividends  paid  by  corporations  within  class 
(1)  in  the  text  above  (Revenue  Act  of  1918,  §§  216  (a),  234  (a)  6,  217;  Reg. 
45,  Art.  92;  Letter  from  treasury  department  dated  June  9,  1919;  I.  T.  S. 
1921,  11 1661).  This  classification  superseded  the  rule  laid  down  for  pur- 
poses of  the  excess-profits  tax  in  1917  to  the  effect  that  if  a  foreign  cor- 
poration paid  income  tax  on  a  part  of  its  net  income  its  dividends  should  be 
treated  to  that  extent  as  dividends  paid  by  domestic  corporations  (Reg.  41, 
Art.  27). 

■■5-1  Revenue  Act  of  1921,  §§218,  219;  Revenue  Act  of  1918,  §§218,  219; 
see  U.  S.  v.  Colby,  251  Fed.  982,  affirmed,  258  Fed.  27.  See  Chapters  6 
and  8. 

•5^"' Letter  from  treasuiy  depaitment  dated  November  21,  1916;  I.  T.  S. 
1918,  11272. 

■''>  See  Chapter  5. 

■'•'  Revenue  Act  of  1918.  §  201  (c). 


512  FEDERAL   INCOME   TAX 

this  provision  of  law  the  treasury  department  ruled  that  so-called 
liquidation  or  dissolution  dividends  were  not  "dividends,"  and 
amounts  so  distributed,  ivhether  or  not  inchiding  any  surplus 
earned  since  February  28,  1913,  were  regarded  as  payments 
for  the  stock  of  the  dissolved  corporation.  Any  excess  so  re- 
ceived over  the  cost  of  his  stock  to  the  stockholder  constituted 
income  to  such  stockholder.  However,  if  such  stock  was  ac- 
quired prior  to  March  1,  1913,  and  the  fair  market  value  as  of 
such  date  was  greater  than  the  cost  but  less  than  the  amount 
so  distributed,  the  taxable  income  was  the  excess  over  such  fair 
market  value  of  the  amount  received,  but  no  gain  was  recog- 
nized if  the  amount  received,  although  more  than  cost,  was  less 
than  the  fair  market  value  of  the  stock  on  March  1,  1913.  A 
distribution  in  liquidation  of  the  assets  and  business  of  a  cor- 
poration, which  was  a  return  to  the  stockholder  of  the  value  of 
his  stock  upon  a  surrender  of  his  interest  in  the  corporation, 
was  distinguished  from  a  dividend  paid  by  a  going  corporation 
out  of  current  earnings  or  accumulated  surplus  when  declared 
by  the  directors  in  their  discretion,  which  was  held  to  be  in  the 
nature  of  a  recurrent  return  upon  the  stock.^^    It  was  held  under 

38  Reg.  45,  Art.  1548,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767.  See 
also  Reg.  45,  Arts.  1541  and  1543;  A.  R.  R.  67,  T.  B.  17-20-877.  The  treasury 
department  has  held  to  the  same  effect  under  the  1916  Law.  (See  S.  971, 
T.  B.  2-19-141;  T.  B.  R.  71,  T.  B.  22-19-580.  This  ruling  was  founded 
largely  upon  the  distinction  drawn  by  the  United  States  Supreme  Court  in 
the  cases  of  Lynch  v.  Turrish,  247  U.  S.  221,  and  Lynch  v.  Hornby,  247 
U.  S.  339.  It  is  to  be  noted  that  the  question  in  both  these  cases  was  whether 
earnings  or  profits  accumulated  prior  to  March  1,  1913,  should  be  consid- 
ered as  dividends.  The  question  was  not:  Shall  earnings  or  profits  accu- 
mulated subsequent  to  March  1,  1913,  be  considered  as  dividends?  In  de- 
termining the  former  question  the  Supreme  Court  drew  a  distinction  accord- 
ing to  whether  or  not  the  distribution  was  a  dividend  in  ordinary  course  or 
a  final  dividend  in  liquidation.  This  distinction  does  not  affect  the  answer 
to  the  second  question.  The  issue  in  the  Turrish  and  Hornby  cases  was 
whether  certain  earnings  or  profits  were  essentially  capital  or  income  for 
tax  purposes,  whether  they  were  taxable  as  income  or  exempt  as  capital. 
On  the  other  hand,  the  question  arising  in  the  interpretation  of  §  201  of 
the  Revenue  Act  of  1918  pertains  to  the  character  of  the  taxability  of  cer- 
tain earnings  and  profits.  The  Supreme  Court  did  not  hold  in  the  Turrish 
case  that  corporate  gains  and  profits  accumulated  prior  to  March  1,  1913, 
are  not  "dividends"  if  paid  to  a  stockholder  upon  a  winding  up  of  the  affairs 
of  a  corporation ;  it  declared  that  such  earnings  or  profits  had  become  capital 
and  were  exempt  therefore  from  tax  when  distributed.  It  did  not  hold  in 
the  Hornby  case  that  corporate  gains  and  profits  accumulated  prior  to 
March  1,  1913,  are  dividends  because  they  were  paid  to  a  stockholder  by  a 
corporation  continuing  in  business  or  a  going  concern ;  it  declared  that  such 
earnings  or  profits  did  not  come  into  fruition  as  income  to  the  stockholder 
until  by  virtue  of  an  exercise  of  affirmative  discretion  on  the  part  of  the 


INCOME    FROM    DIVIDENDS  513 

the  1918  Law,  however,  that  a  distribution  of  earnings  or  profits 
prior  to  any  vote  or  resolution  providing  for  liciuidation  was 
an  ordinary,  not  a  liquidating,  dividend,  even  though  the  stock- 
holders subsequently  voted  to  go  into  liquidation  and  to  distribute 

directors  they  were  declared,  that  is,  until  they  were  separated  from  the 
corporation's  {general  assets  and  the  stockholder's  interest  was  transformed 
from  an  inchoate  and  contingent  interest  in  them  to  a  definite  and  fixed 
share.  It  will  be  argued  that  a  distribution  which  would  have  been  a 
"dividend"  under  the  Hornby  case  was  held  not  to  be  a  "dividend"  in  the 
Turrish  case,  solely  because  it  was  made  upon  the  licjuidation  of  the  paying; 
corporation  and  that  therefore  the  essence  of  what  would  ordinarily  be  a 
"dividend"  under  the  1918  Law  is  changed  by  the  same  token.  This  argu- 
ment is  based  upon  the  fallacy  that  the  taxability  of  earnings  or  profits  ac- 
cumulated since  the  incidence  of  the  tax  is  to  be  determined  according  to 
the  same  differentiation  applying  in  the  case  of  earnings  or  profits  accu- 
mulated prior  thereto.  But,  as  stated  above,  the  Turrish  and  Hornby  cases 
divided  on  the  question  when,  with  reference  to  the  incidence  of  the  tax,  a 
distribi(tioH  became  income.  They  did  not  settle  the  question:  What  kinds 
of  income  are  certain  concededly  taxable  earnings  or  profits?  The  court 
was  not  attempting  in  the  Turrish  and  Hornby  cases  to  distinguish  between 
"dividends"  and  other  distributions.  It  was  drawing  a  line  between  capital 
and  income,  income  received  prior  to  March  1,  1913,  having  the  status  of 
capital.  Although  the  Commissioner  ruled  in  the  Turrish  case  that  the 
$79,975  representing  the  excess  of  the  amount  received  by  Turrish  over  the 
par  value  of  his  shares  upon  their  surrender  was  income  for  the  year  1914. 
this  ruling  was  reversed  by  the  district  court,  the  circuit  court  of  appeals 
(236  Fed.  653)  and  the  Supreme  Court.  The  reversal  was  not  upon  the  ex- 
press ground  that  the  Commissioner  had  erred  in  taxing  "dividends"  as  gains 
and  profits,  resulting  from  the  sale  of  property,  but  such  a  decision  was  un- 
necessary in  view  of  the  court's  more  fundamental  and  sweeping  conclu- 
sion that  the  dividends  in  question  were  not  taxable  at  all,  because  they 
were  capital.  The  Supreme  Court  did  not  decide  that  they  were  taxable 
as  ordinai-y  gains  or  profits.  Such  a  decision  w^ould  have  been  academic,  if 
not  inconsistent  with  its  main  conclusion.  There  is  absolutely  nothing  in 
the  Turrish  case  requiring  the  taxation  of  corporate  earnings  or  profits 
accumulated  subsequent  to  March  1,  1913,  as  gains  and  profits  from  the 
sale  and  exchange  of  property,  except  a  ruling  of  the  Commissioner  which 
was  completely  set  aside  by  the  courts  upon  the  most  fundamental  ground 
possible.  Effect  should  be  given,  if  possible,  to  the  entire  Revenue  Act  of 
1918,  and  no  part  should  be  permitted  to  perish  by  construction.  One  part 
should  not  be  allowed  to  defeat  another  part  if  by  any  reasonable  construc- 
tion the  two  can  stand  together  (U.  S.  v.  Ninety-Nine  Diamonds,  139  Fed. 
961).  The  treasury  department's  construction  of  subdivision  (c)  of  §201 
seems  to  be  a  violation  of  this  cardinal  rule  of  statutory  construction.  The 
theory  underlying  the  exemption  of  dividends  from  the  normal  tax  is  that 
the  normal  tax  upon  them  had  already  been  paid  by  the  corporation  de- 
claring them.  So  far  as  the  subject  of  any  corporate  distribution  may  rep- 
resent earnings  or  profits  accumulated  subsequent  to  February  28,  1913,  it 
has  been  subjected  to  the  normal  tax  in  the  hands  of  the  paying  corpora- 
tion. So  far  as  the  7iormal  ta.v  is  concerned,  it  is  capital,  like  the  undis- 
tributed income  of  estates  or  trusts  upon  which  the  fiduciary  has  paid  the 


514  FEDERAL   INCOME   TAX 

remaining  capital."''^  Where  a  corporation  surrendered  its  char- 
ter on  January  31,  1920,  its  business  being  thereafter  continued 
as  a  partnership  by  the  stockholders,  and  distributed  its  sur- 
plus and  undivided  profits  as  of  December  31,  1919,  as  a  liqui- 
dating dividend,  the  net  income  of  the  company  for  the  one 

tax.  §  201  (c)  seems  clearly  to  be  directed  at  another  profitable  element 
involved  in  a  liquidation — the  excess  of  the  amount  received  upon  a  liqui- 
dation over  the  value  of  the  stock  on  March  1,  1913  (or  its  cost  if  acquired 
subsequently  thereto),  plus  the  earnings  and  profits  accumulated  subse- 
quently to  February  28,  1913.  This  is  a  very  different  gain  or  profit  from 
the  taxable  earnings  or  profits  distributed.  Moreover,  it  will  be  noted  that 
the  Revenue  Act  of  1918  uses  the  word  "any"  in  §  201  (a)  1.  The  word  has 
just  been  carefully  qualified  by  a  parenthetical  clause — "(except  in  1|  (10) 
of  subdivision  (a)  of  §  234)".  In  view  of  the  familiar  meaning  of  the  word 
"any"  and  the  careful  qualification  immediately  prior  to  it  (which  dis- 
misses the  possibility  that  congress  intended  any  further  qualifications)  in 
§  201  (a)  1,  it  becomes  essential  that  §  201  (c)  be  read  not  as  an  exception, 
but  as  supplementary  to  §201  (a),  intended  to  reach  another  kind  of  pos- 
sible profit  than  that  contemplated  in  §201  (a).  Again,  §201  (c),  as  it 
stands,  need  not  be  construed  as  a  qualification  of  §201  (a).  The  phrase 
"other  gains  or  profits"  includes  "dividends."  (§213  (a)).  In  so  far,  then, 
as  the  gain  or  profit  realized  is  a  dividend  it  should  be  taxed  as  a  dividend, 
that  is,  it  should  be  subjected  only  to  the  surtaxes.  Both  the  Turrish  and 
Hornby  cases  were  decided  under  the  Act  of  October  3,  1913,  which  did  not 
contain  the  definition  of  the  term  "dividend"  to  be  found  in  the  Revenue  Act 
of  1916  and  the  1918  Law.  The  Supreme  Court  admitted  that  its  decision  in 
the  Hornby  case  would  have  been  different  had  the  1913  Law  contained  any 
such  definition.  Two  further  rules  of  statutory  interpretation  should  re- 
solve any  doubt  remaining  on  this  question.  (1)  The  courts  will  avoid,  if 
possible,  any  interpretation  resulting  in  absurdity,  inconsistency,  glaring 
inequality  or  palpable  injustice,  giving  effect  to  the  spirit  rather  than  the 
letter.  (See  Ch.  47.)  (2)  In  the  interpretation  of  statutes  levying  taxes 
it  is  also  the  established  rule  not  to  extend  their  provisions,  by  implication, 
beyond  the  clear  import  of  the  language  used,  or  to  enlarge  their  opera- 
tions so  as  to  embrace  matters  not  specifically  pointed  out.  (See  Ch.  47.) 
If  the  mere  fact  that  a  distribution  out  of  a  corporation's  earnings  or  profits 
accumulated  since  February  28,  1913,  is  made  upon  the  liquidation  of  the 
corporation  renders  such  earnings  or  profits  liable  a  second  time  to  the 
normal  tax,  the  manner  of  distribution  supplants  the  character  of  income 
as  the  decisive  test  of  taxability.  If  a  distribution  made  by  a  corporation 
out  of  its  earnings  or  profits  accumulated  since  February  28,  1913,  is  held 
under  the  1918  Law  to  be  a  dividend  only  when  made  by  a  going  corpora- 
tion, the  burden  of  the  taxpayer  is  increased, — the  taxpayer  is  subjected  to 
an  additional  tax  of  4  or  8%  upon  dividends  received  as  a  part  of  a  liquida- 
tion. The  clear  import  of  the  language  used  in  §  201  does  not  require  this — 
to  say  the  least — and  any  remaining  doubt  should  be  resolved  against  the 
government  and  in  favor  of  the  citizen.  As  will  be  seen  by  the  next  para- 
graph, congress  has  recognized  the  injustice  of  the  interpretation  of  the 
treasury  department  of  §  201  (c)  and  provided  against  its  continuance  in 
the  1921  Law. 

39  A.  R.  M.  93,  T.  B.  47-20-1309. 


INCOME    FROM    DIVIDENDS  515 

month  of  its  existence  in  1920  being  distributed  by  crediting 
the  amount  to  the  profit  and  loss  account  of  the  partnership, 
it  was  held  that  such  a  liquidating  dividend  credited  to  the  part- 
nership was  taxable  to  the  former  stockholders  as  if  actually 
distributed  to  them.-*'^ 

Retirement  of  Capital  Stock.  Payments  by  a  corporation 
to  its  stockholders  in  retiring  its  own  stock  have  been  held  not 
to  be  dividends  within  the  meaning  of  the  1918  Law  if  the 
liquidation  was  in  pursuance  of  an  obligation  arising  out  of  the 
stock  contract,  unless  it  appeared  that  the  corporation  had  an 
option  of  distributing  its  assets  with  a  debit  to  capital  stock 
account  or  to  surplus  account.  Any  excess  received  by  the  stock- 
holders upon  such  retirement  over  the  cost  of  the  stock  was  held 
to  be  a  taxable  profit.^'  In  a  case  in  which  a  corporation  retired 
twice  the  amount  of  additional  stock  previously  issued  in  con- 
nection with  the  performance  of  government  contracts  during 
the  war,  the  amount  representing  the  par  value  of  the  stock 
being  charged  to  capital  account  and  an  excess  over  par  value 
paid  by  the  corporation  to  retire  the  stock  being  charged  to  sur- 
plus accumulated  prior  to  March  1,  1913,  it  was  held  that  the 
distribution  was  not  a  dividend  within  the  meaning  of  the  1918 
Law  but  was  a  distribution  in  part  liquidation.  Any  excess  over 
the  cost  of  the  stock  was  held  to  be  subject  to  the  normal  tax 
and  the  surtax  in  the  hands  of  the  stockholders.-*- 

Proceeds  of  Liquidation  Received  in  Installments. 
Where  the  assets  of  a  corporation  in  process  of  liquidation  are 
being  disposed  of,  the  proceeds  being  distributed  to  the  stock- 
holders in  installments,  and  it  is  not  known  what  the  total  pro- 
ceeds will  be,  and  consequently  the  amount  of  profit  to  the  stock- 
holders can  not  be  definitely  determined,  it  was  held  under  the 
1918  Law  that  a  stockholder  should  return  no  portion  of  the 
installment  payments  as  income  until  the  amount  actually  re- 
ceived exceeded  the  cost  of  the  stock  to  him,  or  its  fair  market 
value  as  at  March  1,  1913,  if  acquired  prior  to  that  date.  How- 
ever, if  the  corporation  entered  into  a  contract  for  the  sale  of 
its  assets  at  a  stipulated  price,  the  purchaser  making  payment 
in  installments,  the  portion  of  each  liquidating  payment  to  the 
stockholder  representing  profit  was  held  to  be  returnable  as  in- 
to O.  D.  912,  T.  B.  20-21-1(530. 

41  O.  D.  8(;0,  T.  B.  2-20-(?(i7.  Such  profit  would  probably  be  held  liable  to 
the  normal  tax  as  well  as  the  surtax.  See  Chapter  17  as  to  the  rule  if  the 
stock  was  acquired  prior  to  March  1,  1913. 

42  0.  D.  479,  T.  B.  18-20-891.     See  also  O.  D.  488,  T.  B.  19-20-908. 


516  FEDERAL   INCOME   TAX 

come  for  the  year  during  which  received.^"^  In  a  case  in  which 
s  corporation  assigned  its  principal  asset  (a  mortgage  payable 
in  annual  installments  with  interest)  to  trustees  in  trust  for  its 
stockholders  and  then  instituted  liquidation  proceedings,  the 
beneficiaries  under  the  trust  receiving  proportionate  shares  of 
principal  and  interest  as  paid  to  the  trustees,  it  was  held  under 
the  1918  Law  that  the  profit  of  the  stockholders  from  the  sur- 
render of  their  stock  was  not  definitely  ascertainable  and  that 
no  amount  was  required  to  be  reported  as  income  until  the  total 
sum  received  in  liquidation  exceeded  the  cost  of  the  stock  to  the 
stockholders.'*^ 

Partial  Liquidation  of  Corporations.  It  has  been  held  that 
where  two  or  more  national  banks  were  consolidated,^-^  each 
constituent  bank  contributing  capital,  surplus  and  undivided 
profits  in  an  aggregate  amount  less  than  its  existing  capital, 
surplus  and  undivided  profits,  the  remaining  capital,  surplus  and 
undivided  profits  of  each  constituent  bank  being  liquidated  by 
trustees  and  the  proceeds  thereof  distributed  2?^'o  7'ata  among 
the  stockholders  thereof,  so  that  each  stockholder  of  a  con- 
stituent corporation  received  from  the  consolidated  corporation 
new  shares  of  stock  therein  upon  surrender  of  his  old  shares 
and  also  received  from  his  trustees  his  pro  rata  share  of  the 
proceeds  of  the  noncontributed  assets  when  liquidated,  such 
stockholder,  if  he  acquired  the  stock  on  or  after  March  1,  1913, 
was  required  under  the  1918  Law  to  pay  both  normal  tax  and 
surtax  on  (1)  his  share  of  the  proceeds  of  the  liquidated  assets 
in  excess  of  the  cost  of  that  portion  of  his  old  stock  representing 
the  capital  assets  so  liquidated;  and  (2)  any  profit  derived  from 
the  sale  of  his  new  stock,  such  profit  to  be  computed  by  deducting 
from  the  selling  price  of  the  new  stock  the  cost  of  that  part  of 
the  old  stock  represented  by  the  new  stock  which  he  sold.  Any 
gain  accrued  prior  to  March  1,  1913,  v/as  held  exempt  if  the  old 
stock  was  acquired  prior  to  that  date.**"' 

■i3  O.  D.  343,  T.  B.  30-19-685.  The  first  part  of  this  ruling  is  covered  by 
the  provisions  of  §202  (c),  and  the  proceeds  distributed  would  go  to  re- 
duce the  basis  for  ascertaining  gain  or  loss.  It  is  a  question  whether  this 
would  be  true  of  the  second  part  of  the  ruling — if  the  price  were  stipulated — 
in  view  of  subdivision  (f )  of  §  202.  However,  it  would  seem  that  even  if 
the  amount  of  gain  should  be  calculated  with  respect  to  each  installment, 
the  taxpayer  would  not  be  obliged  to  report  any  gain  under  the  present  law 
until  the  proceeds  exceeded  the  basis. 

4i  O.  D.  461,  T.  B.  16-20-874.  The  same  conclusion  would  seem  necessary 
under  the  present  law. 

45  Under  the  Act  of  November  7,  1918   (40  Stat.  1043). 

40  Sol.  Op.  115,  T.  B.  36-21-1797. 


INCOME    FROM    DIVIDENDS  517 

Distribution  in  Liquidation  Under  1921  Law.  The  Revenue 
Act  of  1921  omits  the  provision  as  to  distributions  in  liqui- 
dation contained  in  the  1918  Law'-  and  provides^''  that  any 
distribution  (whether  in  cash  or  other  property)  made  by 
a  corporation  to  its  shareholders  or  members  otherwise  than 
out  of  (1)  earnings  or  profits  accumulated  since  February  28, 
1913,  or  (2)  earningfs  or  profits  accumulated  or  increase  in  value 
of  property  accrued  prior  to  March  1,  1913,  shall  be  applied 
against  and  reduce  the  cost,  or  value  as  of  March  1,  1913,  for 
the  purpose  of  ascertaining  the  gain  derived  or  the  loss  sustained 
from  the  sale  or  other  disposition  of  the  stock  or  shares  by  the 
distributee.  Under  the  present  lav^,  then,  earnings  or  profits 
accumulated  since  February  28,  1913,  whether  distributed  in 
liquidation  or  as  ordinary  dividends,  will  be  taxed  as  dividends 
and  subject  only  to  the  surtaxes  and  will  no  longer  be  taxed  as 
other  gains  and  profits  in  the  case  of  liquidation  as  under  the 
1918  Law.  Congress  has  now  definitely  provided  against  the 
unfair  and  unwarranted  practice  of  the  treasury  department 
under  the  1918  Law  of  subjecting  such  earnings  or  profits  to 
both  the  normal  tax  and  the  surtax  in  case  of  the  mere  accident 
of  their  distribution  in  the  liquidation  of  a  corporation. 

Presumption  as  to  Source  of  Distribution.  In  the  case  of  a  cor- 
poration any  distribution  (which  in  the  case  of  a  personal  serv- 
ice corporation  does  not  include  distributions  out  of  earnings  or 
profits  accumulated  between  December  31,  1917,  and  January  1 , 
1922)  to  stockholders  is  made  so  far  as  possible  (a)  from  earn- 
ings or  profits;  (b)  during  the  year  1918  or  thereafter  from 
earnings  or  profits  accumulated  since  February  28,  1913;  (c) 
if  during  the  first  60  days  of  a  taxable  year,  from  earnings  or 
profits  accumulated  during  preceding  taxable  years;  and  (d)  if 
during  the  remainder  of  a  taxable  year  after  the  first  60  days, 
from  earnings  or  profits  accumulated  during  the  taxable  year 
up  to  the  date  of  distribution.  The  presumption  contained  in 
clauses  (c)  and  (d)  affects  the  determination  of  invested  capital 
for  the  purpose  of  the  excess-profits  tax,  which  is  repealed  by 
the  Revenue  Act  of  1921  as  of  December  31,  1921,  and  the  provi- 
sion creating  the  presumption  is  expressly  made  inapplicable  after 
that  date.  In  ascertaining  w^hether  or  not  a  distribution  was 
made  out  of  earnings  or  profits  of  the  taxable  year  there  should 
first  be  set  aside  a  proper  reserve  for  the  payment  of  accrued 
income  and  war-profits  and  excess-profits  taxes.     In  the  case  of 

4T§201   (c). 

•t*^  Revenue  Act  of  1921,  §201   (c).     See  footnote  38. 


518  FEDERAL   INCOME  TAX 

a  personal  service  corporation  any  distribution  is  deemed  to  have 
been  made  so  far  as  possible  (a)  from  earnings  or  profits;  (b) 
during  the  year  1918  or  thereafter  from  earnings  or  profits  ac- 
cumulated since  February  28,  1913;  (c)  if  during  the  first  60 
days  of  a  taxable  year,  from  the  most  recently  accumulated  earn- 
ings or  profits  of  preceding  taxable  years;  and  (d)  if  during 
the  remainder  of  the  taxable  year  after  the  first  60  days,  from 
earnings  or  profits  accumulated  during  the  taxable  year  up  to 
the  date  of  distribution.  The  first  60  days  of  any  taxable  year 
includes  March  1,  except  during  a  leap  year.^-* 

Dividends  From  Earnings  or  Profits  Accumulated  Prior  to 
March  1,  1913.  Under  the  1918  Law  any  distribution  was  deemed 
to  have  been  made  from  earnings  or  profits  unless  all  earnings 
and  profits  had  first  been  distributed.  Any  distribution  made 
in  the  year  1918  or  any  year  thereafter  was  deemed  to  have  been 
made  from  earnings  or  profits  accumulated  since  February  28, 
1913,  but  any  earnings  or  profits  accumulated  prior  to  March  1, 
1913,  might  be  distributed  in  stock  dividends  or  otherwise,  ex- 
empt from  the  tax,  after  the  earnings  and  profits  accumulated 
since  February  28,  1913,  had  been  distributed.^^     with  an  ex- 

49  Revenue  Act  of  1921,  §.201;  Revenue  Act  of  1918,  §201;  Reg.  45,  Art 
1542.  See  A.  R.  R.  577,  T.'  B.  38-21-1824;  A.  R.  R.  127,  T.  B.  23-20-992; 
0.  D.  5,  T.  B.  1-19-9;  O.  D.  4,  T.  B.  1-19-8.  In  A.  R.  R.  127  it  is  held  that 
the  60-day  presumption  applies  to  the  determination  of  invested  capital 
alone,  but  it  w^ould  seem  to  affect  the  determination  of  the  source  of  dis- 
tributions of  personal  service  corporations  made  betw^een  January  1,  1918, 
and  March  1,  1918,  and  for  that  reason  the  text  above  retains  the  reference 
to  this  presumption  in  the  case  of  personal  service  corporations.  It  w^ill 
have  no  effect  in  the  case  of  distributions  by  personal  service  corporations 
during  the  first  60  days  of  1922,  since  it  is  repealed  as  of  December  31, 
1921.  It  is  stated  in  the  Finance  Committee  Report  on  the  Internal  Revnue 
Bill  of  1921  (p.  10)  in  regard  to  §201:  "Minor  obscurities  in  the  present 
law^  have  been  clarified  by  stating  conclusively  certain  provisions  w^hich 
heretofore  have  been  stated  as  presumptions."  The  reference  is  apparently 
to  the  substitution  of  the  word  "is"  for  the  words  "shall  be  deemed  to  have 
been." 

•^'"Revenue  Act  of  1918,  §201  (b).  Compare  with  Revenue  Act  of  1916, 
§31,  added  by  Revenue  Act  of  1917.  (See  Reg.  45,  Arts.  1542  and  1543.) 
The  conflict  in  the  cases  in  the  lower  federal  Courts  under  the  1913  Law,  as 
to  the  taxability  of  dividends  distributed  subsequent  to  the  incidence  of  the 
tax  from  earnings  which  accrued  prior  thereto  (the  law  itself  being  silent 
on  that  point)  was  settled  by  the  1917  provision.  In  Lynch  v.  Turrish, 
247  U.  S.  221,  it  was  held  that  a  sum  received  by  a  stockholder  in  excess  of 
the  par  value  of  his  stock,  exclusively  from  the  increase  in  value  of  his 
stock  prior  to  March  1,  1913,  on  account  of  the  gradual  advance  of  the 
value  of  the  property  of  the  corporation  prior  to  that  date,  was  not  income 
when  distributed  by  the  corporation  after  the  incidence  of  the  tax.  In 
Lynch  v.  Hornby,  236  Fed.  661,  decided  at  the  same  time,  the  lower  court 


INCOME    FROM    DIVIDENDS  519 

held  that  dividends  received  by  a  stockholder  by  the  conversion  of  prop- 
erty into  money  and  the  distribution  after  the  incidence  of  the  tax,  was 
not  taxable  where  the  dividend  represented  the  value  of  property  owned  by 
the  corporation  on  March  1,  1913,  including?  the  increase  of  the  value  of  its 
timber  lands  and  sitrplntt  from  itn  b/isiiiesa  operations,  the  court  announcing 
that,  in  its  opinion,  no  property  held  by  the  corporation  or  the  stockholiler 
whether  oritrinal  capital  or  previously  earned  surplus  income,  gains  or 
profits,  was  intended  to  be  made,  or  was  made  taxable  as  income  by  the  1913 
Law,  so  far  as  it  represented  the  value  of  such  property  on  March  1,  1913. 
The  Supreme  Court  reversed  this  decision,  247  U.  S.  339,  distinguishing*  the 
case  from  the  situation  in  Lynch  v.  Turrish  on  the  ground  that  the  dividends 
to  Hornby  were  not  single  and  final,  and  did  not  represent  the  winding  up 
or  liquidation  of  the  entire  assets  and  business  of  the  company,  and  a  return 
to  him  of  the  value  of  his  stock  upon  his  surrender  of  his  entire  interest, 
and  on  the  ground  that  congress  drew  a  distinction  between  a  stockholder's 
undivided  share  or  interest  in  the  gains  and  profits  of  the  corporation  prior 
to  the  declaration  of  a  dividend,  and  his  participation  in  the  dividends  de- 
clared and  paid;  the  court  proceeding  on  the  theory  that  the  stockholder  is 
in  the  ordinary  case  a  different  entity  from  a  corporation  and  that  congress 
was  at  liberty  to  treat  dividends  coming  to  him  as  constituting  a  part  of  his 
income  when  they  came  to  hand,  even  though  they  might  appear  upon  an- 
alysis to  be  a  mere  realization  in  possession  of  an  inchoate  and  contingent 
interest  that  the  stockholder  had  in  a  surplus  of  corporate  assets  previously 
existing.  The  court  distinctly  held  that  under  the  1913  Law  dividends  de- 
clared and  paid  in  the  ordinary  course  by  a  corporation  to  its  stockholders 
after  March  1,  1913,  whether  from  current  earnings  or  from  a  sitrplua  ac- 
cumulated prior  to  that  date,  were  taxable  as  income  to  the  stockholder. 
(See  Skinner  v.  Union  Pacific  Coal  Co.,  249  Fed.  152.)  The  case  of  Pea- 
body  V.  Eisner,  247  U.  S.  347,  followed  Lynch  v.  Hornby  in  principle.  In 
Southern  Pacific  Co.  v.  Lowe,  238  Fed.  847,  the  district  court  held  that  divi- 
dends from  surplus  accumulated  prior  to  March  1,  1913,  were  not  taxable 
if  the  surplus  represented  an  increase  in  the  value  of  the  assets  of  the  cor- 
poration, but  were  taxable  if  the  surplus  was  accumulated  from  earnings  or 
profits  of  the  corporation  prior  to  the  incidence  of  the  tax.  This  decision 
was  reversed  by  the  Supreme  Court  (247  U.  S.  330),  but  only  on  the  ground 
that  the  corporation  which  paid  the  dividend  and  the  corporation  which 
received  it  w^ere  in  substance  identical  corporations,  the  stockholder,  there- 
fore, not  being  the  ordinary  stockholder  contemplated  in  Lynch  v.  Hornby. 
(See  also  Hays  v.  Gauley  Mountain  Coal  Co.,  247  U.  S.  189;  U.  S.  v.  Cleve- 
land, etc.,  Rv.  Co.,  247  U.  S.  195;  Doyle  v.  Mitchell  Bros.,  247  U.  S.  179; 
Gulf  Oil  Corporation  v.  Lewellyn,  248  U.  S.  71  and  T.  D.  2740;  Trefry  v. 
Putnam,  227  Mass.  522,  116  N.  E.  904;  State  ex  rel.  Moon  Co.  v.  Wisconsin 
Tax  Commission,  16G  Wis.  287,  163  N.  W.  639,  165  N.  W.  470,  appeal  dis- 
missed by  U.  S.  Supreme  Court,  249  U.  S.  621;  Van  Dyke  v.  Milwaukee, 
(Wis.)  146  N.  W.  812,  150  N.  W.  509;  State  ex  rel.  Pfister  v.  Widule.  (Wis.) 
103  N.  W.  641;  State  v.  Franklin  Bank,  10  Ohio  91;  Bailey  v.  Railroad  Co., 
22  Wall.  603,  106  U.  S.  109;  Collector  v.  Hubbard,  12  Wall.  1.) 


520  FEDERAL   INCOME  TAX 

ception  discussed  in  a  subsequent  paragraph  ^^  the  Revenue  Act 
of  1921  carries  substantially  the  same  provision  with  respect  to 
earnings  and  profits  accumulated  prior  to  March  1,  1913.  For 
the  purposes  of  the  Revenue  Act  of  1921  every  distribution  is 
made  out  of  earnings  or  profits,  and  from  the  most  recently 
accumulated  earnings  or  profits,  to  the  extent  of  such  earnings 
or  profits  accumulated  since  February  28,  1913;  but  any  earn- 
ing_s  or  profits  accumulated  or  increase -in  value  of  property  ac- 
crued prior  to  March  1,  1913,  may  be  distributed  exempt  from 
the  tax,  after  the  earnings  and  profits  accumulated  since  Feb- 
ruary 28,  1913,  have  been  distributed.  If  any  such  tax-free 
distribution  has  been  made  the  distributee  will  not  be  allowed 
as  a  deduction  from  gross  income  any  loss  sustained  from  the 
sale  or  other  disposition  of  his  stock  or  shares  unless,  and  then 
only  to  the  extent  that,  the  basis  provided  for  ascertaining  gain 
or  loss  exceeds  the  sum  of  (1)  the  amount  realized  from  the 
sale  or  other  disposition  of  such  stock  or  shares,  and  (2)  the  ag- 
gregate amount  of  such  distributions  received  by  him  thereon.^^ 

Rulings  Under  1917  and  1918  Laws.  Several  important  rul- 
ings were  made  under  the  1918  and  previous  laws  in  regard  to 
the  exemption  of  distributions  consisting  of  earnings  or  profits 
accumulated  prior  to  March  1,  1913,  as  indicated  below: 

1.  Stock  dividends  do  not  constitute  a  distribution  of  earn- 
ings and  the  presumptive  allocation  as  to  earnings  does  not 
apply  to  them;  hence  a  dividend  paid  in  cash  by  a  company 
was  deemed  to  represent  a  distribution  of  its  earnings  or  sur- 
plus accumulated  since  February  28,  1913,  and  remaining  un- 
distributed at  the  date  of  payment,  regardless  of  the  issuance 
by  the  corporation  of  any  stock  dividends  since  February  28, 
1913,  and  prior  to  the  date  of  payment  of  the  cash  dividend. 
Where  a  corporation,  having  a  surplus  accumulated  in  part  prior 
to  March  1,  1913,  transferred  to  its  capital  account  a  portion 
of  its  surplus,  issued  new  stock  representing  the  amount  so 
transferred  to  the  capital  account  and  then  declared  a  dividend 
payable  in  part  in  cash  and  in  part  in  shares  of  the  new  issue 
of  stock,  that  portion  of  the  dividend  paid  in  cash  was  deemed 
to  have  been  paid  out  of  surplus  accumulated  since  February 
28,  1913,  to  the  extent  of  the  earnings  and  profits  accumulated 
since  that  date,  and  was  subject  to  tax,  but  the  portion  of  the 
dividend  paid  in  stock  was  held  exempt.^^ 

51  See  p.  525. 

52  Revenue  Act  of  1921,  §201    (b).    See  Chapter  17. 

53  0.  D.  587,  T.  B.  29-20-1065. 


INCOME    FROM    DIVIDENDS  521 

2.  In  the  case  of  a  corporation  having  had  earnings  in  any 
year  since  March  1,  1913,  a  dividend  was  deemed  to  be  out  of  such 
earnings  even  though  such  earnings  had  been  more  than  offset 
by  subsequent  losses  so  that  there  had  been  a  net  operating 
deficit  since  March  1,  1913/'^ 

3.  In  the  case  of  a  corporation  with  profits  accumulated  prior 
to  March  1,  1913,  but  none  accumulated  between  that  date  and 
January  1,  1918,  and  paying  dividends  during  the  first  60  days 
of  1918,  such  dividends  were  deemed  to  have  been  paid  from 
earnings  or  profits  accumulated  after  December  31,  1917.-"' 

4.  In  a  case  in  which  in  1919  a  corporation  paid  three  de- 
ferred dividends  on  its  outstanding  first  preferred  stock,  the  divi- 
dends being  those  due  February  1  and  August  1,  1910,  and  Feb- 
ruary 1,  1911,  the  actual  surplus  necessary  to  pay  them  having 
accumulated  prior  to  December  31,  1911,  it  was  claimed  that  the 
terms  of  issue  of  the  stock  prescribed  when  the  dividends  be- 
came due,  the  company  merely  having  the  privilege  of  deferring 
payment;  and  that  it  was  the  understanding  of  the  company 
that  its  surplus  was  held  to  pay  past  due  dividends.  The  stock 
certificates  contained  a  provision  in  accordance  with  which  the 
deferred  dividends  were  paid  and  the  stock  redeemed.  It  was 
held  that  the  three  deferred  dividends  would  be  considered  to 
have  been  paid  out  of  earnings  and  profits  accumulated  since 
February  28,  1913,  unless  it  could  be  shown  that  all  earnings 
and  profits  accumulated  since  that  date  were  first  distributed. 
If  this  could  not  be  shown,  the  distribution  was  held  to  con- 
stitute income  to  the  recipient  stockholders  subject  to  surtax 
but  not  to  the  normal  tax.'"'^ 

5.  Where  the  principal  stockholder  paid  in  to  a  corporation 
a  sum  of  money  for  which  no  stock  was  issued  and  on  which  no 
interest  was  charged,  it  being  entered  upon  the  company's  books 
as  a  contribution  of  capital  and  never  treated  as  an  account  pay- 
able, the  repayment  of  this  sum  to  the  stockholder  was  deemed 
to  be  out  of  undivided  profits  or  earned  sui^plus  so  far  as  pos- 
sible and  not  a  return  of  capital,  unless  the  undivided  profits 

•'•■♦  0.  D.  610,  T.  B.  31-20-1098;  T.  B.  R.  43,  T.  B.  12-19-395.  The  treasury 
department  construed  the  phrase  "profits  accumulated"  to  mean  profits 
which  had  been  earned  and  not  dissipated  by  subsequent  losses.  (A.  R.  M. 
82,  X-  B.  40-20-1219.) 

35  T.  B.  R.  43,  T.  B.  12-19-395.  The  effect  of  this  ruling  was  to  subordinate 
subdivision  (e)  of  §201  to  subdivision  (b),  the  former,  together  with 
subdivision  (d),  providing  for  the  method  and  rate  of  taxation  and  the 
latter  for  liability  to  taxation. 

•■'••■■  0.  D.  587.  T.  B.  29-20-1065. 


522  FEDERAL   INCOME   TAX 

and  earned  surplus  accumulated  since  1913  had  been  first  dis- 
tributed as  dividends.''" 

6.  It  has  been  held  that  a  distribution  made  from  the  pro- 
ceeds recovered  in  1916  on  a  claim  for  unlawful  restraint  of 
trade  suffered  in  the  years  1891  to  1904,  which  was  in  litigation 
and  existed  as  a  chose  in  action  arising  ex  delicto  long  prior  to 
March  1,  1913,  was  not  from  profits  accrued  after  March  1, 
1913,  and  was  not  taxable  under  the  1916  Law,  in  the  absence 
of  evidence  that  the  claim  was  of  greater  value  in  1916  than 
on  March  1,  1913.''8 

Rulings  Under  the  1916  Law.  The  1916  Law,  prior  to  its 
amendment  by  the  1917  Law,  did  not  contain  any  presumptive 
provision  as  to  the  source  of  corporate  distributions.  The  treas- 
ury department  ruled  that  dividends  could  be  declared  from  any 
specified  fund,  that  is,  a  dividend  could  be  declared  from  surplus 
accumulated  prior  to  March  1,  1913,  and  consequently  be  free 
from  tax  in  the  hands  of  the  stockholders,  although  the  corpo- 
ration had  surplus  and  undivided  profits  accumulated  since  that 
date  sufficient  to  pay  the  dividend.^"^'*  The  presumption  provi- 
sion contained  in  the  1917  amendment  to  the  1916  Law  was  held 
not  to  apply  to  any  distribution  made  prior  to  August  6,  1917, 
out  of  earnings  or  profits  accrued  prior  to  March  1,  1913.  The 
treasury  department  held  that  if  a  dividend  was  declared  prior 
to  August  6,  1917,  out  of  earnings  or  profits  accrued  prior  to 
March  1,  1913,  such  dividend  would  be  deemed  to  be  from  the 
most  recently  accumulated  profits  or  surplus  unless  the  dividend 
was  also  paid  prior  to  August  6,  1917.  In  other  words,  the  pro- 
vision in  regard  to  "most  recently  accumulated  earnings  or 
profits"  has  reference  to  the  earnings  or  profits  in  existence  at 
the  time  of  the  payment  of  the  dividend,  and  not  the  time  of 
declaration.^^ 

"i  T.  B.  M.  82,  T.  B.  23-19-552. 

•IS  Park  V.  Gilligan,  U.  S.  Dist.  Ct.,  So.  Dist.  Ohio;  I.  T.  S.  1921,  H  3067. 

•"'•'  But  a  stockholder  who  received  payments  from  a  corporation  because 
of  his  stock  ownership  therein,  which  payments  were  not  the  result  of  a 
formal  declaration  of  dividends  and  which  were  not  then  entered  on  the 
books  against  surplus  accrued  prior  to  March  1,  1913,  was  held  taxable 
with  respect  to  such  distribution  of  corporate  profits  as  dividends.  The 
formal  declaration  of  such  dividends  by  the  directors  at  a  date  one  year 
after  the  dividends  had  been  paid  and  subsequent  entries  made  on-  the 
corporate  books,  did  not  have  the  effect  of  relieving  the  taxpayer  of  tax. 
(O.  932,  T.  B.  25-19-579.) 

fi^  Letter  from  treasury  department  dated  February  9,  1918;  I.  T.  S. 
1918,  TI3099;  telegram  from  treasury  department  dated  January  31,  1918;  I. 
T.  S.  1918,  ^3069;  telegram  from  treasury  department  dated  July  5,  1918; 
I.   T.   S.   1918,  113592. 


INCOME    FROM    DIVIDENDS  523 

The  presumption  was  held  applicable  even  though  profits  of 
the  corporation  were  invested  in  obligations  of  the  United  States 
issued  after  September  1,  1917,  as  the  investment  of  earnings 
did  not  prevent  them  from  being  distributed  as  dividends.'*' 
It  was  immaterial  what  disposition  had  been  made  of  the  funds 
earned  in  the  taxable  year;"-'  the  net  income  as  disclosed  by  the 
books  as  having  accrued  up  to  the  date  on  which  the  dividends 
were  paid  was  deemed  to  be  distributed  thereby.''-'  In  view  of 
the  difficulties  which  many  corporations  had  in  determining 
whether  earnings  in  1917  up  to  the  date  of  dividend  payment 
in  that  year  were  sufficient  to  cover  the  dividend  paid,  corpo- 
rations were  permitted  to  distribute  the  earnings  for  the  ac- 
counting period  for  which  the  dividend  in  question  was  paid 
ratably  over  the  period  for  the  purpose  of  determining  the 
amount  of  earnings  during  the  period  up  to  the  date  of  pay- 
ment."* In  determining  the  source  of  earnings  from  which  a 
particular  distribution  was  made,  a  corporation  was  permitted 
to  treat  the  undivided  profits  and  surplus  of  the  current  year 
as  reduced  by  payments  for  income  and  excess-profits  taxes, 
cr  if  keeping  its  accounts  upon  an  accrual  basis  by  proper  re- 
serves for  such  taxes,  although  such  payments  or  reserves  were 
not  deductible  in  computing  the  income  of  the  corporation  for 
income  and  excess-profits  taxes.'"'"'  In  this  respect  the  language 
of  the  present  law  and  the  1918  Law  is  substantially  the  same 
as  that  of  the  1916  Law,  as  amended,  and  the  above  rulings  still 
apply. 

Book  Entries.  In  determining  whether  a  distribution  was 
made  out  of  earnings  or  profits  accumulated  after  or  before 
March  1,  1913,  it  was  held  under  the  1918  Law  that  due  consid- 
eration must  be  given  to  the  facts  and  that  mere  book  entries 
increasing  or  decreasing  the  surplus  would  not  be  conclusive.'"''"' 
"Where  original  entries  on  the  books  and  records  of  a  corpora- 
tion showed  that  a  dividend  paid  prior  to  August  6,  1917,  repre- 
sented a  distribution  of  earnings  accumulated  prior  to  March  1, 
1913,  the  dividend  was  held  exempt  from  tax  under  the  1918 
Law  even  though  it  was  not  specifically  stated  in  the  resolution 

*"'i  Letter  from  treasury  department  dated   May  27,   1918;    I.   T.   S.   1921, 

TI860. 

«2  Id. 

«3  T.  D.  2659. 

M  T.  D.  2G78. 

'■'-'T.  D.  2700;  T.  D.  2736;  Letter  from  treasury  department  dated 
May  13,  1918;  L  T.  S.  1919,  TJ  808. 

'■-<■•  Reg.  45,  Art.  1543.  See  Southern  Paeirtc  Co.  v.  Lowe.  247  U.  S.  330; 
Gulf  Oil  Corporation  v.  Lewellyn,  248  U.  S.  71. 


524  FEDERAL   INCOME  TAX 

authorizing  payment  of  the  dividend  that  it  was  to  be  paid  from 
such  earnings/'^  It  has  been  held  that  a  dividend  will  be  deemed 
to  have  been  paid  out  of  current  earnings  to  the  extent  possible 
and  taxable  to  the  recipient  accordingly,  notwithstanding  that 
there  was  an  actual  impairment  of  capital  and  the  books  show 
an  apparent  surplus  based  on  an  arbitrary  valuation  of  good-will, 
trade-marks,  etc.^^ 

Such  Dividends  Exempt  Only  to  Stockholders  of  First 
Corporation.  Under  the  1916  Law  it  was  held  that  where  divi- 
dends had  been  paid  from  surplus  accrued  prior  to  March  1, 
1913,  they  were  free  from  tax  in  the  hands  of  the  stockholder, 
but  if  such  stockholder  was  a  corporation,  upon  the  distribution 
to  its  stockholders  of  the  sum  so  received  as  dividends,  the  fund 
became  taxable  to  the  stockholders  of  the  second  corporation  as, 
to  the  holding  company,  such  sum  did  not  represent  earnings 
or  profits  accrued  prior  to  March  1,  1913.  While  the  law  pro- 
vided for  the  exemption  of  dividends  from  corporate  funds 
earned  prior  to  March  1,  1913,  it  was  held  it  did  not  provide  for 
tracing  the  identity  or  character  of  such  dividends  after  the 
receipt  thereof  by  the  stockholders  of  the  corporation  which 
earned  the  fund  prior  to  the  incidence  of  the  tax.^^ 

Dividends  Received  by  an  Estate.  Dividends  received  by 
an  estate  are  not  exempt  because  paid  from  surplus  accumulated 
prior  to  the  creation  of  the  estate,  but  are  taxable  either  to  the 
beneficiaries  if  the  income  is  distributable,  or  to  the  estate  if  it 
is  not  distributable,""  unless  paid  from  earnings  or  profits  accu- 
mulated by  the  corporation  prior  to  March  1,  1913. 

Dividends  From  Exempt  Income.  Although  interest  on  state 
bonds  and  certain  other  obligations  is  not  taxable  when  received 

•57  0.  D.  655,  T.  B.  36-20-1180. 

6S  O.  D.  163,  T.  B.  6-19-266.  This  ruling  seems  to  violate  the  fundamental 
rule  that  book  entries  are  only  evidential  and  are  not  conclusive  (See  Doyle 
V.  Mitchell,  247  U.  S.  179).  If  the  dividend  in  question  vi^as  in  fact  a 
distribution  of  capital,  it  should  be  free  from  tax  notwithstanding  any  "ap- 
parent" surplus  based  on  arbitrary  valuations.  This  is  practically  the 
effect  of  T.  D.  2734  in  which  it  was  held  (when  a  stock  dividend  was  con- 
sidered taxable)  that  stock  dividends  created  from  a  revaluation  of  capital 
assets  or  to  represent  value  placed  upon  trade-marks,  good-will,  etc.,  were 
not  taxable  to  the  shareholder. 

69  Letter  from  treasury  department  dated  July  23,  1917;  I.  T.  S.  1918, 
11  284.  Contra,  State  ex  rel.  Moon  v.  Nygaard  (Wis.)  175  N.  W.  810,  decided 
under  the  Wisconsin  statute. 

'J'O  Letter  from  treasury  department  dated  October  19,  1915;  I.  T.  S. 
1921,  If  665.  The  principle  of  the  decision  in  Matter  of  Osborne,  209  N.  Y. 
450  was  referred  to  in  this  letter  and  held  to  have  no  application  to  the 
income  tax  law. 


INCOME    FROM    DIVIDENDS  525 

by  a  corporation,  upon  amalgamation  with  the  other  funds  of  the 
corporation  such  income  loses  its  identity  and  when  distributed 
to  stockholders  in  dividends  is  taxable  to  the  same  extent  as 
other  dividends. "• 

Distribution  From  Depletion  or  Depreciation  Reserve.  A  re- 
serve set  up  out  of  gross  income  by  a  corporation  and  main- 
tained for  the  purpose  of  making  good  any  loss  of  capital  assets 
on  account  of  depletion  or  depreciation  is  not  a  part  of  its  sur- 
plus out  of  which  ordinary  dividends  may  be  paid.  A  distribu- 
tion made  from  such  a  reserve  will  be  considered  a  liquidating 
dividend.  No  distribution,  however,  will  be  deemed  to  have  been 
made  from  such  a  reserve  except  to  the  extent  that  the  amount 
paid  exceeds  the  surplus  and  undivided  profits  of  the  corpora- 
tion.'^■- 

Dividends  Paid  From  an  Appreciation  of  Corporate  Assets 
Prior  to  March  1,  1913.  It  was  held  under  the  1918  Law  that  a 
profit  made  by  a  corporation  in  1918  or  subsequent  years  from 
the  realization  of  appreciation  of  corporate  assets  accrued  be- 
fore March  1,  1913,  is  taxable  income  to  the  stockholder  when 
distributed  as  a  dividend  in  1918  or  subsequent  years.  In  other 
words,  if  a  corporation  purchased  capital  assets  in  1910  for 
$10,000,  which  had  a  value  on  March  1,  1913,  of  $20,000,  and 
sold  the  assets  in  1918  for  $20,000,  the  realized  gain  of  $10,000 
was  held  taxable  when  distributed  to  the  stockholders. "■'  The 
1921  Law  would  require  a  different  conclusion,  since  it  expressly 
provides  for  the  exemption  of  distributions  of  "any  increase  in 
value  of  property  accrued  prior  to  March  1,  1913.""^ 

Dividends  Paid  From  an  Appreciation  of  Corporate  Assets  Sub- 
sequent to  March  1,  1913.  Any  distribution  (whether  in  cash  or 
other  property)   made  by  a  corporation  to  its  shareholders  or 

n  Reg.  45,  Art.  1541;  Reg.  33  Rev.,  Art.  4. 

T'^  Reg.  45,  Art.  1549,  as  amended  by  T.  D.  3206,  T.  B.  33-21-17G7;  0.  D. 
736,  T.  B.  48-20-1320.  The  taxation  of  liquidating  dividends  is  discussed 
on  p.  517. 

"•■5  L.  O.  1073,  T.  B.  43-21-1878.  This  conclusion  was  founded  upon  the 
cases  of  Lynch  v.  Hornby,  247  U.  S.  339;  Lynch  v.  Turrish  (discussed  in 
footnotes  38  and  50);  Gray  v.  Darlington,  15  Wall.  63;  Eisner  v.  Macomber, 
252  U.  S.  189;  and  Merchants  Loan  &  Trust  Co.  v.  Smietanka,  41  Sup.  Ct. 
Rep.  386;  T.  D.  3173.  The  distribution  was  taxable  under  the  Hornby  and 
Turrish  cases  unless  it  was  a  distribution  made  out  of  earnings  or  profits 
accumulated  prior  to  March  1,  1913.  (Revenue  Act  of  1918,  §201  (b).) 
Since  advance  growth  or  increment  in  value  are  not  "earnings  or  profits" 
within  the  meaning  of  the  other  cases  cited  above  until  realized  through 
sale,  the  above  increment  in  value,  which  accrued  prior  to  March  1,  1913, 
was  not,  therefore,  an  earning  or  profit  until  1918. 

7-»  Revenue  Act  of  1921,  §201    (b). 


526  FEDERAL  INCOME   TAX 

members  otherwise  than  out  of  (1)  earnings  or  profits  accumu- 
lated since  February  28,  1913,  or  (2)  earnings  or  profits  accu- 
mulated or  increase  in  value  of  property  accrued  prior  to  March 
1,  1913,  will  be  applied  against  and  reduce  the  basis  provided 
for  ascertaining  the  gain  derived  or  the  loss  sustained  from  the 
sale  or  other  disposition  of  the  stock  or  shares  by  the  dis- 
tributeeJ^ 

Distributions  of  Capital.  Distributions  of  capital  by  corpora- 
tions do  not  become  income  because  they  are  called  dividends. 
The  reason  why  dividends  paid  out  of  earnings  and  profits  ac- 
cumulated prior  to  March  1,  1913,  are  free  from  tax  is  that  such 
earnings  and  profits  are  assumed,  for  income  tax  purposes,  to 
have  the  status  of  capital.  It  has  been  held  that  a  dividend 
declared  and  paid  by  a  corporation  which  was  in  part  illegal 
because  in  excess  of  true  earnings,  and  which  dividend  was 
later  rescinded  by  the  corporation,  was  not  taxable  to  the  stock- 
holders to  the  extent  that  the  corporation  had  a  legal  right  to 
force  rescission  and  repayment  and  to  the  extent  that  such  rescis- 
sion and  repayment  were  actually  made.™  But  where  a  dividend 
is  legally  declared  by  a  corporation,  which  later  is  voluntarily 
returned  by  the  stockholders  to  avoid  an  impairment  of  its  capi- 
tal (the  corporation  in  a  later  year  having  received  an  addi- 
tional assessment  of  taxes  for  the  year  in  which  the  dividends 
were  paid)  the  amount  thereof  is  subject  to  tax  in  the  year  in 
which  received  by  the  stockholders  and,  being  a  contribution  to 
capital,  may  not  be  deducted  from  gross  income  by  the  stock- 
holders in  the  year  in  which  repaid.'^''' 

Dividends  Taxable  in  Year  Received.  The  mere  declaration  of 
a  dividend  is  not  a  distribution.  All  dividends  are  taxable  at 
the  rates  for  the  year  in  which  actually  or  constructively  received 
(that  is,  "when  the  cash  or  other  property"  forming  the  subject 
of  distribution  is  "made  unqualifiedly  subject  to  their  (the  stock- 
holders') demands")  regardless  of  when  the  earnings  and 
profits  out  of  which  they  were  paid  were  accumulated.'''^     This 

75  Revenue  Act  of  1921,  §201  (c).  Under  this  provision  a  distribution 
of  increment  in  the  value  of  corporate  assets  accuring  after  March  1,  1913, 
might  be  made  free  from  tax  provided  the  distribution  did  not  exceed  cost 
(or  value  on  March  1,  1913)  but  for  the  presumption  that  distributions 
are  from  earnings  or  profits  to  the  extent  thereof.  In  the  absence  of  earn- 
ings or  profits  accumulated  since  March  1,  1913,  such  increment  might 
be   distributed  without  tax  to  the  extent  indicated. 

76  T.  B.  M.  77,  T.  B.  20-19-502. 

77  Sol.  Op.  110,  T.  B.  25-21-1691. 

78  Reg.  45,  Arts.  31  and  1541 ;  Letter  from  treasury  department  dated 
February  18,  1915;  I.  T.  S.  1918,  TI271;  Revenue  Act  of  1918,  §201. 


INCOME    FROM    DIVIDENDS  527 

is  now  an  express  provision  of  the  statute,  but  the  rule  had 
become  firmly  established  prior  to  the  enactment  of  the  Revenue 
Act  of  1921.''-' 

In  a  recent  case  suit  was  brought  by  the  stockholders  of  a 
corporation  in  1917  to  compel  the  corporation  to  distribute  accu- 
mulated cash  surplus,  as  a  result  of  which  the  court  ordered  the 
distribution  made,  with  interest  from  the  date  of  the  decree. 
The  corporation  took  no  steps  to  comply  with  this  order,  and  no 
dividend  was  declared  and  no  amount  made  available  to  the 
stockholders,  but  the  company  appealed  the  case.  The  judgment 
of  the  lower  court  was  not  affirmed  until  February,  1919,  at 
which  time  the  amounts  in  question  were  distributed  to  the  stock- 
holders. The  treasury  department  held  that  no  amounts  became 
available  to  the  stockholders  as  income  until  the  judgment  of 
the  lower  court  was  affirmed  in  1919.-"  Since  the  date  of  pay- 
ment rather  than  the  date  of  receipt  was  the  governing  factor 
in  determining  when  a  dividend  should  be  treated  as  taxable 
income  under  the  1917  and  1918  Laws  a  dividend  paid  in  Mis- 
souri and  received  there  by  stockholders  on  December  30,  1917, 
but  not  received  by  stockholders  in  California  until  January, 
1918,  was  held  taxable  in  the  1917  returns  to  the  California 
stockholders.^! 

Dividends  Paid  in  Equivalent  of  Cash.  The  Revenue  Act  of 
1921  includes  in  its  definition  of  the  term  "dividends"  any  dis- 
tribution made  by  a  corporation  to  its  shareholders  or  members 
"whether  in  cash  or  in  other  property." '^- 

Dividends  Paid  in  Property.  It  is  well  settled  that  dividends 
paid  in  securities  or  other  property  (other  than  its  own  stock), 
in  which  the  earnings  of  a  corporation  have  been  invested,  are 
income  to  the  recipients  to  the  amount  of  the  fair  market  value 
of  such  property  when  receivable  by  the  stockholders.  If  such 
stock  is  subsequently  sold,  the  diflFerence  between  its  market 
value  at  the  date  of  receipt   (actual  or  constructive)    and  the 

7!»  Revenue  Act  of  1921,  jj  201  (e).  This  provision  may  have  been  prompted 
by  the  dictum  in  Park  v.  Gilliuan,  U.  S.  Dist.  Ct.,  So.  Dist.  Ohio;  I.  T.  S. 
1921,  IT  30rt7,  to  the  effect  that  amounts  merely  "credited"  as  dividends  and 
not  "actually  segregated  from  the  general  assets  of  the  company"  were 
not  income. 

s'^A.  R.  R.  124,  T.  B.  2.5-20-1012.     See  Revenue  Act  of  1921,  §201    (e). 

•'^1  O.  D.  97,  T.  B.  2-19-140.  Likewise,  under  the  present  law  such  dividends 
would  seem  to  be  subject  to  the  demand  of  the  California  stockholders  in 
the  earlier  year,  though  they  would  have  difficulty  in  enforcing  the  de- 
mand. 

'<- Revenue  Act  of  1921,  §201  (a).  The  Revenue  Act  of  1918  included 
stock  dividends,  but  they  are  no  longer  taxable  (see  p.  531). 


528  FEDERAL   INCOME   TAX 

selling  price  is  additional  income  or  loss,  as  the  case  may  be.  A 
dividend  paid  in  stock  of  another  corporation  is  not  a  stock 
dividend.  Where  a  corporation  declares  a  dividend  payable  in 
stock  of  another  corporation,  setting  aside  the  stock  to  be  so 
distributed  and  notifying  the  stockholders  of  its  action,  the  in- 
come arising  to  the  recipients  of  such  stock  is  its  fair  market 
value  at  the  time  the  dividend  becomes  payable.^^ 

In  a  recent  case  the  directors  of  a  corporation  voted  an  issue 
of  debenture  bonds  from  the  surplus  or  undivided  profits  and 
distributed  the  bonds  to  its  stockholders.  The  stockholders  con- 
tended that  the  distribution  of  these  debenture  bonds  was 
analogous  to  the  payment  of  a  stock  dividend  and  that  they 
should  not  be  subject  to  tax  on  the  value  of  the  bonds.  It  was 
contended  that  the  bonds  had  the  characteristic  features  of  pre- 
ferred stock  and  that  in  case  of  insolvency  or  bankruptcy  the 
debenture  holders  would  not  rank  as  general  creditors.  The 
court  held,  however,  that  the  plaintiffs  received  an  actual  pay- 
ment (in  the  form  of  securities  available  for  distribution  in 
the  market  and  entirely  severed  or  distinguished  from  their 
control  of  the  property  as  stockholders)  of  profits  which  the 
company  wished  to  distribute  as  earnings  to  its  stockholders. 
The  distribution  to  the  stockholders  of  the  debenture  bonds  was 
a  distribution  of  obligations  which,  like  promissory  notes,  call 
for  the  payment  of  cash  and  do  not  invest  the  holder  with  merely 
a  diflferent  form  of  holding  of  stock.  Since,  so  far  as  these 
debenture  bonds  were  concerned  the  corporation  was  solvent, 
there  could  be  no  question  between  the  persons  receiving  these 
dividends  and  creditors  as  to  priority  of  payment  and  to  what- 
ever extent  they  might  be  of  value  this  value  was  separate  from 
any  stockholders'  control  of  the  corporation.  The  court  held  that 
the  stockholders  were  subject  to  tax  on  that  portion  of  the  value 
of  the  bonds  representing  surplus  earned  after  March  1,  1913.^* 

Where  a  national  bank  utilized  a  portion  of  its  undivided 
profits  in  the  creation  of  a  savings  bank  and  trust  company,  the 
stock  of  said  savings  bank  and  trust  company  being  issued  in 
the  names  of  trustees  for  all  shareholders  of  the  national  bank, 

83  Reg.  45,  Art.  1544 ;  Reg.  33  Rev.,  Art.  4.  Letter  from  treasury  depart- 
ment dated  November  12,  1918;  I.  T.  S.  1921,  11875;  O.  D.  471,  T.  B.  17-20- 
883;  T.  D.  3052,  T.  B.  33-20-1141.  In  Peabody  v.  Eisner,  247  U.  S.  347, 
a  case  arising  under  the  1913  Law^,  a  distribution  in  stock  of  another  corpo- 
ration w^as  held  not  to  be  a  stock  dividend  and  was  held  to  be  taxable 
even  though  it  partially  represented  surplus  acquired  prior  to  March  1, 
1913. 

84Doerschuck  v.  U.  S.,  274  Fed.  739,  T.  D.  3170,  T.  B.  24-21-1681.  See 
0.  D.  801,  T.  B.  7-21-1441. 


INCOME    FROM    DIVIDENDS  529 

and  the  certificates  of  stock  of  the  national  bank  showing  on  the 
face  thereof  that  the  holders  are  entitled  to  their  pro  rata  share 
of  the  capital  stock  of  the  savings  bank  and  trust  company,  the 
stockholders  will  be  deemed  to  have  received  a  dividend  in  specie 
and  will  be  liable  for  tax  on  the  value  of  certificates  of  stock  in 
the  new  corporation  received  by  them/^"^ 

Property  Dividend  Upon  Reorganization.  Where  a  corpo- 
ration engaged  in  the  producing,  manufacturing  and  transport- 
ing petroleum,  and  owning  and  operating  a  pipe  line  for  the 
transportation  thereof,  having  a  surplus  in  excess  of  the  value 
of  such  pipe  line,  transfers  the  pipe  line  property  to  a  new 
corporation  organized  for  the  purpose,  the  stock  of  the  new 
corporation  being  issued  first  to  the  producing  corporation  and 
then  by  it  distributed  to  its  stockholders,  the  Supreme  Court 
has  held  the  stock  so  received  by  such  stockholders  to  be  a  divi- 
dend paid  in  property  within  the  meaning  of  the  1913  Law.  The 
same  conclusion  was  reached  in  a  case  presenting  substantially 
the  same  facts  except  that  the  stock  of  the  new  pipe  line  corpo- 
ration was  transferred  directly  to  the  stockholders  of  the  pro- 
ducing corporation.^*' 

Dividends  Paid  in  Liberty  Bonds.  The  fact  that  dividends 
are  paid  in  Liberty  Bonds  does  not  exempt  them  from  tax. 
When  Liberty  Bonds  are  used  as  a  medium  of  payment,  whether 
in  discharge  of  a  private  debt  or  in  payment  of  a  corporate 
dividend,  the  profit  or  gain  derived  by  the  recipient  is  neverthe- 

•S5  0.  D.  152,  T.  B.  5-19-243. 

86  Rockefeller  v.  U.  S.,  N.  Y.  Trust  Co.  v.  Edwards,  42  Sup.  Ct.  Rep.  68. 
The  court  said  in  these  cases:  "Looking  to  the  substance  of  thinjrs  the 
difference  is  unessential.  In  each  case  the  consideration  moved  from  the 
oil  company  in  its  corporate  capacity,  the  new  company's  stock  issued  in 
exchange  for  it  was  distributed  among  the  oil  company's  stockholders  in 
their  individual  capacity,  and  was  a  substantial  fruit  of  their  ownership 
of  stock  in  the  oil  company,  in  effect  a  dividend  out  of  the  accumulated 
surplus.  *        *        *     Nevertheless  the  new   stock  represented   assets  of 

the  oil  companies  standing  in  the  place  of  the  pipe  line  properties  that 
before  had  constituted  portions  of  their  surplus  assets,  and  it  was  capable 
of  division  among  stockholders  as  the  pipe  line  properties  were  not.  The 
distribution,  whatever  its  effect  upon  the  aggregate  interests  of  the  mass 
of  stockholders,  constituted  in  the  case  of  each  individual  a  gain  in  the 
form  of  actual  exchangeable  assets  transferred  to  him  from  the  oil  com- 
pany for  his  separate  use  in  partial  realization  of  his  former  indivisible 
and  contingent  interest  in  the  corporate  surplus.  It  was  in  substance  and 
effect,  not  merely  in  form,  a  dividend  of  profits  by  the  corporation,  and 
individual  income  to  the  stockholder."  See  also  U.  S.  v.  Phellis,  42  Sup.  Ct. 
Rep.  63,  discussed  at  length  in  Chapter  17. 


530  FEDERAL  INCOME  TAX 

less  subject  to  income  tax,'^'^  The  stockholder  should  make  re- 
turn of  the  dividend  paid  in  Liberty  Bonds  on  the  basis  of  the 
cash  value  of  the  Liberty  Bonds  at  the  time  of  their  receipt  by 
him.88 

Scrip  Dividends.  Dividends  paid  in  scrip  have  been  held  to 
be  equivalent  to  a  payment  in  cash  and  an  investment  of  the 
cash  in  the  scrip  and  accordingly  taxable  to  the  extent  of  the 
face  value  of  the  scrip.  Such  dividends  are  held  subject  to  tax 
in  the  year  in  which  the  v^arrants  are  issued.  In  the  event  of 
a  failure  to  realize  the  face  value  of  the  scrip,  it  was  held  under 
the  1918  Law  that  a  loss  might  be  claimed  in  the  year  in  which 
the  stockholder  parted  with  the  scrip.'^"'  Where  an  insurance 
company  issues  certificates  of  profit  based  upon  premiums  re- 
ceived on  marked  off  risks  of  the  previous  year,  such  certificates 
maturing  in  six  years  and  subject  to  future  losses  and  expenses 
until  redeemed,  interest  being  payable  annually  upon  their  face 
value,  it  has  been  held  that  such  certificates  are  in  the  nature 
of  scrip  dividends.  Inasmuch  as  they  might  be  affected  by  gains 
or  losses  of  the  company  during  their  maturing  period,  the  cer- 
tificates were  held  not  to  be  income  until  the  taxable  year  of 
maturity  or  redemption.  The  amount  of  interest  payable  an- 
nually on  the  certificates  constitutes  taxable  income  for  the  year 
in  which  received.^^ 

S7  Letter  from  treasury  department  dated  June  30,  1917;  I.  T.  S.  1919, 
TJ785;  Letter  from  treasury  department  dated  June  22,  1917;  I.  T.  S.  1921, 
^  908.  The  second  of  these  letters  is  based  upon  an  opinion  on  the  subject 
obtained  from  the  Attorney  General  by  the  treasury  department.  The  ques- 
tion was  raised  by  reason  of  the  language  of  the  act  authorizing  the  first 
issue  of  Liberty  Bonds  (Act  of  April  24,  1917,  Public  No.  3)  which  exempted 
the  principal  and  income  from  taxation. 

'^•'^  Letter  from  treasury  department  dated  November  12,  1918;  I.  T.  S. 
1921,  11875. 

J^i^Reg.  45,  Art.  1544;  0.  D.  589,  T.  B.  29-20-1067;  Letter  from  treasury 
department  dated  January  19,  1915;  I.  T.  S.  1918,  ^260.  Scrip  dividends 
were  held  taxable  under  the  act  of  June  30,  1864,  Bailey  v.  Railroad  Com- 
pany, 22  Wall.  603,  106  U.  S.  109.  It  is  a  question  whether  scrip  divi- 
dends redeemable  in  cash  or  stock  are  not  to  be  considered  as  stock  divi- 
dends, particularly  if  upon  redemption  all  stockholders  take  stock  rather 
than  cash.  (See  U.  S.  v.  Mellon,  U.  S.  Dist.  Ct.,  W.  Dist.  Pa.,  I.  T.  S.  1921, 
^3091.)  In  any  event,  it  is  to  be  doubted  whether  scrip  dividends  are  prop- 
erly taxable  at  their  face  value  in  the  year  in  which  the  warrants  are  issued. 
The  credit  of  the  corporation  paying  the  dividends  and  the  interest  the 
scrip  bears  is  a  material  point.  The  scrip  certificates  may  be  readily 
convertible  into  cash  and  in  such  case  the  market  or  discounted  value  there- 
of would  clearly  be  income  unless  the  scrip  dividend  is  a  stock  dividend. 
But  if  there' is  no  market  for  the  scrip,  it  is  to  be  doubted  whether  it 
constitutes  income  until  cash  or  its  equivalent  is  received. 

90  o.  D.  589,  T.  B.  29-20-1067. 


INCOME    FROM    DIVIDENDS  531 

Stock  Dividends.    The  1913  Law  was  silent  as  to  stock  divi- 
dends and  while  the  treasury  department  at  first  held  that  such 
dividends  were  not  subject  to  tax,  it  subsequently  changed  its 
attitude  and  held  stock  dividends  to  be  the  equivalent  of  cash 
and  to  constitute  taxable  income  under  the  same  conditions  as 
cash  dividends."^     The  1916  Law  expressly  provided  that  stock 
dividends  should  be  taxable.     It  defined  a  stock  dividend  as  a 
distribution  by  a  corporation  out  of  its  earnings  or  profits  ac- 
crued since  March  1,  1913,  and  payable  to  its  shareholders  in 
stock  of  the  corporation.    It  was  provided  that  such  stock  divi- 
dends should  be  considered  income  to  the  amount  of  the  earn- 
ings or  profits  so  distributed."-    The  Revenue  Act  of  1918  also 
expressly  provided  that  stock  dividends  should  be  taxable.     It 
defined  a  stock  dividend  as  a  distribution  made  by  a  corpora- 
tion, other  than  a  personal  service  corporation,  to  its  share- 
holders or  members  in  stock  of  the  corporation  out  of  its  earn- 
ings or  profits  accumulated  since  February  28,  1913,  or  in  the 
case  of  a  personal  service  corporation  any  such  distribution  out 
of  earnings  or  profits  accumulated   since   February  28,   1913, 
and  prior  to  January  1,  1918."3     The  United  States  Supreme 
Court  reversed  the  decision  of  the  treasury  department  as  to 
the  1913  Law  and  held  that  stock  dividends  were  not  taxable 
under  that  law.^* 

Notwithstanding  the  broad  language  of  the  opinion  in  that 
case  the  treasury  department  declared  that  since  only  the  lan- 
guage of  the  1913  Law  and  not  the  language  of  the  1916  or  1918 
Laws  was  before  the  court,  it  did  not  necessarily  follow  that 
stock  dividends  were  not  taxable  under  the  provisions  of  the 
1916  and  1918  Laws,  and  it  continued  to  assess  the  tax  on 
such  dividends.'*"'    This  question  has  now  definitely  been  set  at 

!>i  T.  D.  2274,  dated   December  22,  1915. 

i'li  Revenue  Act  of  1916,  §31  added  by  Revenue  Act  of  1917.  The  1916 
Law  prior  to  the  amendment  contained  substantially  the  same  definition  of 
stock  dividends. 

93  Revenue  Act  of  1918,  §201   (a). 

04  Towne  v.  Eisner,  245  U.  S.  418.  It  has  been  held  that  a  corporation 
stockholder  is  not  taxable  under  the  1909  Law  on  stock  dividends  received. 
(U.  S.  V.  Philadelphia  B.  &  W.  R.  Co.,  262  Fed.  188.) 

95  See  letter  to  Collectors  dated  January  10,  1918,  I.  T.  S.  1919.  ^811. 
In  the  opinion  of  the  treasury  department  the  court  did  not  decide  that 
such  dividends  could  not  be  income  within  the  meaning  of  the  Sixteenth 
Amendment,  but  expressly  recognized  that  the  word  "income"  might  have 
a  different  meaning  in  the  statute  from  the  meaning  in  the  Constitution. 


532  FEDERAL   INCOME  TAX 

rest  by  a  case^'^  holding  that  the  provision  of  the  1916  Law  by 
which  stock  dividends  were  in  terms  stated  to  be  income  and  to 
be  taxable  as  such  to  the  same  extent  as  cash  dividends  was  un- 
constitutional. In  this  case  the  United  States  Supreme  Court 
clearly  holds  that  from  every  point  of  view,  neither  under  the 
Sixteenth  Amendment  nor  otherwise,  has  congress  power  to  tax 
without  apportionment  a  true  stock  dividend  made  lawfully  and 
in  good  faith,  or  the  accumulated  profits  behind  it,  as  income 
of  the  stockholder.  The  present  law  expressly  declares  that  a 
stock  dividend  shall  not  be  subject  to  tax  "but  if  after  the  distri- 
bution of  any  such  dividend  the  corporation  proceeds  to  cancel  or 
redeem  its  stock  at  such  time  and  in  such  manner  as  to  make  the 
distribution  and  cancellation  or  redemption  essentially  equivalent 
to  the  distribution  of  a  taxable  dividend,  the  amount  received 
in  redemption  or  cancellation  of  the  stock  shall  be  treated  as  a 
taxable  dividend  to  the  extent  of  the  earnings  or  profits  accumu- 
lated by  such  corporation  after  February  28,  1913.^'^ 

Definition  of  Stock  Dividend.  It  is,  therefore,  important 
to  consider  the  definition  of  the  term  "stock  dividend"  which  is  so 
exempted  from  tax.  The  decision  above  referred  to  holding  that 
stock  dividends  are  not  constitutionally  taxable  has  been  declared 
by  the  Treasury  Department  to  sustain  the  following  proposi- 
tions :  98 

1.  Where  a  corporation,  being  authorized  so  to  do  by  the  laws 
of  the  state  in  which  it  is  incorporated,  transfers  a  portion  of 
its  surplus  to  capital  account,  issues  new  stock  representing  the 
amount  of  the  surplus  so  transferred,  and  distributes  the  stock 
so  issued  to  its  stockholders,  such  stock  is  not  income  to  the  stock- 
holders and  the  stockholders  incur  no  liability  for  income  tax 
by  reason  of  its  receipt. 

2.  Where  a  corporation,  being  authorized,  increases  its 
capital  stock,  and  simultaneously  declares  a  cash  dividend  equal 
in  amount  to  the  increase  in  its  capital  stock,  and  gives  to  its 
stockholders  a  real  option  either  to  keep  the  money  for  their  own 
or  to  reinvest  it  in  the  new  shares,  such  dividend  is  a  cash  divi- 

96  Eisner  v.  Macomber,  252  U.  S.  189.  The  procedure  on  claiming  credit 
or  refund  of  taxes  erroneously  paid  on  stock  dividends  is  indicated  in  the 
supplement  to  the  1920  edition  of  this  book,  p.  195.  See  M.  2429  and  M. 
2436,  T.  B.  11-20-789  A,  789  B;  0.  D.  625,  T.  B.  32-20-1123. 

97  Revenue  Act  of  1921,  §  201  (d).  The  reference  of  this  provision  is  to 
stock  dividends,  not  paid  in  good  faith.  In  Eisner  v.  Macomber,  the  court 
said:  "  *  *  *  we  are  considering  the  taxability  of  bona  fide  stock 
dividends  only." 

9ST.   D.   3052,   T.   B.  33-20-1141. 


INCOME    FROM    DIVIDENDS  533 

dend  and  is  income  to  the  stockholders  whether  they  reinvest 
it  in  the  new  shares  or  not/''-' 

3.  Where  a  corporation,  which  is  nut  permitted  under  the 
laws  of  the  state  in  which  it  is  incorporated  to  issue  a  stock 
dividend,  increases  its  capital  stock  and  at  the  same  time  de- 
clares a  cash  dividend  under  an  agreement  with  the  stock- 
holders to  reinvest  the  money  so  received  in  the  new  issue  of 
capital  stock,  such  dividend  is  subject  to  tax  as  income  to  the 
stockholder.!""' 

4.  Where  a  corporation,  having  a  surplus  accumulated  in 
part  prior  to  March  1,  1913,  and  being  thereunto  lawfully  au- 
thorized, transfers  to  its  capital  account  a  portion  of  its  sur- 
plus, issues  new  stock  representing  the  amount  so  transferred 
to  the  capital  account  and  then  declares  a  dividend  payable  in 
part  in  cash  and  in  part  in  shares  of  the  new  issue  of  stock, 
that  portion  of  the  dividend  paid  in  cash  will,  to  the  amount 
of  the  surplus  accumulated  since  March  1,  1913,  be  deemed  to 
have  been  paid  out  of  such  surplus,  and  be  subject  to  tax,  but 
the  portion  of  the  dividend  paid  in  stock  will  not  be  subject  to 
tax  as   income.^"' 

»9See  also  T.  B.  R.  42,  T.  B.  12-19-398;  0.  D.  565,  T.  B.  27-20-1034; 
T.  B.  R.  63,  T.  B.  22-19-529.  But  the  option  must  be  real.  Looking  through 
the  form  to  substance,  it  has  been  held  that  a  dividend  payable  in  cash  but 
actually  paid  in  the  case  of  1740  out  of  112,080  shares  of  stock  of  the 
paying  corporation,  the  acceptance  of  such  payment  in  stock  being  a  mat- 
ter of  agreement  by  a  large  proportion  of  the  stockholders  as  a  part  of  a 
refinancing  arrangement  and  the  paying  corporation  having  in  fact  no 
funds  to  pay  the  dividends  in  cash,  was  a  stock  dividend  w^ithin  the  mean- 
ing of  the  1913  Law  (U.  S.  v.  Mellon,  U.  S.  Dist.  Ct.,  W.  Dist.  Pa.;  L  T.  S. 
1921,  TI3091). 

!•"'  The  same  reasoning  applies  to  national  banks  which  are  authorized 
by  law  to  issue  only  cash  dividends  (see  Instructions  of  the  Comptroller 
of  the  Currency  relative  to  the  organization  and  powers  of  national  banks 
for  1919,  p.  56).  Cash  dividends  declared  by  a  national  bank  coupled  with 
the  right  to  apply  the  same  to  the  purchase  of  an  increase  in  capital  stock 
are  therefore  subject  to  the  surtax  in  the  hands  of  the  stockholder.  (I.  T. 
S.  1921,  112514;  O.  D.  588,  T.  B.  29-20-1066.)  It  has  been  held  that  where 
an  assessment  of  income  tax  has  been  treated  by  both  parties  in  the  court 
below  as  an  assessment  on  a  stock  dividend  and  has  been  so  treated  in  the 
assessment  of  tax  by  the  Commissioner,  it  cannot  be  upheld  in  the  Cir- 
cuit Court  of  Appeals  as  an  assessment  on  a  cash  dividend  althoujih  the 
corporation's  surplus  was  distributed  by  check,  which  was  endorsed  by 
the  stockholders  in  exchange  for  the  stock,  the  assessment  having  been 
made  on  a  value  of  the  stock  which  was  more  than  double  the  face  of  the 
check.  The  assessment  must  be  made  by  the  Commissioner  and  cannot  be 
made  by  the  court.     (Loomis  v.  Wattles,  266  Fed.  876.) 

101  See  also  O.  D.  587,  T.  B.  29-20-1065. 


534  FEDERAL   INCOME  TAX 

5.  Where  a  corporation  increases  its  capital  stock  and  the 
stockholders  are  permitted  to  purchase  the  new  issue  of  stock 
for  one-half  par,  the  corporation  transferring  from  surplus 
to  capital  one-half  the  par  value  of  the  new  shares  issued,  each 
stockholder  receiving  such  new  stock  may  treat  one-half  the 
stock  received  as  a  stock  dividend. ^"■- 

6.  A  stock  dividend  paid  in  true  preferred  stock  is  exempt 
from  tax  the  same  as  though  the  dividend  were  paid  in  common 
stock,  but  if  the  stock  issued  and  distributed  as  a  dividend  ranks 
with  or  prior  to  the  interest  of  general  creditors  (with  respect 
to  the  payment  of  either  interest  or  principal),  it  can  not  be 
considered  true  preferred  stock,  and  must  be  treated  as  income 
to  the  recipient.1031 

7.  A  corporation  declared  a  dividend  payable  in  stock  of  the 
company  at  par.  In  making  the  distribution  of  fractions  of 
shares  scrip  certificates  were  issued  and  in  order  to  facilitate  the 
disposal  for  the  stockholders  of  their  scrip,  where  they  did  not 
desire  to  purchase  additional  scrip  to  entitle  them  to  a  full  share 
of  new  stock,  the  corporation  sold  in  the  open  market  as  an 
agent  of  the  stockholders  the  scrip  certificates  received  for  frac- 
tional shares  of  dividend  stock,  this  sale  being  entirely  optional 
with  the  stockholders.  It  was  held  that  the  scrip  certificates 
received  as  a  dividend  did  not  i-epresent  a  cash  dividend  but  a 
stock  dividend  and  were  not  subject  to  tax.^*^^ 

Income  Derived  on  Sale  of  Stock  Received  as  Dividend.!^'' 
Stock  issued  by  a  corporation  as  a  dividend  does  not  constitute 
taxable  income  to  a  stockholder  in  such  corporation,  but  gain 
may  be  derived  or  loss  sustained  by  the  stockholder  from  the  sale 
of  such  stock.  The  amount  of  taxable  gain  derived  or  deductible 
loss  sustained  from  the  sale  of  such  stock  or  from  the  sale  of 
the  stock  with  respect  to  which  it  is  issued,  will  be  determined 
in  accordance  with  the  rules  regarding  the  basis  for  determining 
gain  or  loss  from  sales  set  forth  elsewhere  in  this  book,io*^  after 
the  cost,  or  both  the  cost  and  fair  market  value  as  of  March  1, 
1913,  if  acquired  prior  thereto,  of  both  the  old  and  the  new 
shares  is  determined  in  accordance  with  the  following  rules : 

(1)  Where  the  stock  issued  as  a  dividend  is  all  of  substantial- 
ly the  same  character  or  preference  as  the  stock  upon  which  the 

102  A.  R.  M.  128,  T.  B.  22-21-1659. 

103  0.  D.  801,  T.  B.  7-21-1441. 

104  0.  D.  859,  T.  B.  14-21-1538. 

105  The  rule  set  forth  in  this  paragraph  issued  prior  to  the  enactment 
of  the  Revenue  Act  of  1921,  would  seem  to  be  applicable  thereunder. 

106  See  Chapter  17. 


INCOME    FROM    DIVIDENDS  535 

stock  dividend  is  paid,  the  cost  of  each  share,  and  when  acquired 
prior  to  March  1,  1913,  the  fair  market  value  as  of  such  date,  will 
be  the  quotient  of  the  cost,  or  such  fair  market  value  of  the  old 
shares  of  stock,  divided  by  the  total  number  of  the  old  and  new 
shares. ^"■^ 

(2)  Where  the  stock  issued  as  a  dividend  is  in  whole  or  in 
part  of  a  character  or  preference  materially  different  from  the 
stock  upon  which  the  stock  dividend  is  paid,  the  cost,  and  when 
acquired  prior  to  March  1,  1913,  the  fair  market  value  as  of  such 
date,  of  the  old  shares  of  stock  should  be  divided  between  such 
old  stock  and  the  new  stock,  in  proportion,  as  nearly  as  may  be, 
to  the  respective  values  of  each  class  of  stock,  old  and  new,  at  the 
time  the  new  shares  of  stock  are  issued,  and  the  cost,  and  when 
acquired  prior  to  March  1,  1913,  the  fair  market  value  as  of  such 
date,  of  each  share  of  stock  will  be  the  quotient  of  the  cost  or 
such  fair  market  value  as  of  March  1,  1913,  of  the  class  to  which 
such  share  belongs  divided  by  the  number  of  shares  in  that  class. 

(3)  Where  the  stock  with  respect  to  which  a  stock  dividend 
is  issued  was  purchased  at  different  times  and  at  different  prices 
and  the  identity  of  the  lots  can  not  be  determined,  any  sale  of 
the  original  stock  will  be  charged  to  the  earliest  purchases  of  such 
stock,  and  any  sale  of  dividend  stock  issued  with  respect  to  such 
stock  will  be  presumed  to  have  been  made  from  the  stock  issued 
with  respect  to  the  earliest  purchased  stock,  to  the  amount  of  the 
dividend  chargeable  to  such  stock.^"*^ 

(4)  Where  the  stock  with  respect  to  which  a  stock  dividend 
is  declared  was  purchased  at  different  times  and  at  different 
prices,  and  the  identity  of  the  lots  can  or  can  not  be  determined, 
but  the  dividend  stock  issued  with  respect  to  such  stock  can  not 
be  identified  as  having  been  issued  with  respect  to  any  particular 
lot  of  such  stock,  then  any  sale  of  such  dividend  stock  will  be 
presumed  to  have  been  made  from  the  stock  issued  with  respect 
to  the  earliest  purchased  stock,  to  the  amount  of  the  stock  divi- 
dend chargeable  to  such  stock.^'^'^ 

Where  the  resolution  of  the  board  of  directors  of  a  corporation, 
declaring  a  stock  dividend,  provided  that  no  fractional  shares  of 
stock  should  be  issued,  but  that  all  fractions  of  shares  should  be 
united  into  whole  shares  and  sold  by  the  treasurer  and  the  pro- 
ceeds  thereof  paid   to   the   stockholders   entitled   thereto,   such 

i"T  This  method  has  been  upheld  in  Towne  v.  McElliRott,  U.  S.  Dist.  Ct, 
So.  Dist.  of  New  York,  decided  August  6,  1921. 

i"'^Reg.  45,  Art.  1547,  as  amended  by  T.  D.  320(i,  T.  B.  33-21-17tw. 

i""Reg.  45,  Art.  1547,  as  amended  by  T.  D.  3238,  T.  B.  44-21-1901;  0.  D. 
478,   T.   B.   18-20-890. 


536  FEDERAL   INCOME   TAX 

resolution  having  been  approved  by  the  stockholders,  it  was  held 
that  the  stockholders  by  approving  the  action  of  the  board  of 
directors  approved  and,  in  fact,  authorized  the  action  of  the 
treasurer  in  uniting  and  selling  the  fractional  shares  and  paying 
over  the  proceeds  therefrom  to  those  stockholders  entitled  there- 
to, and  that  those  stockholders  entitled  to  receive  fractional 
shares,  but  who  actually  received  cash  representing  their  portion 
of  the  proceeds  of  the  sale  of  the  fractional  shares  should  com- 
pute the  gain  or  loss  thereon  under  the  rules  stated  above. i^o  It 
has  been  held  that  stockholders  receiving  a  stock  dividend  upon 
stock  purchased  at  different  times  subsequent  to  February  28, 
1913,  and  at  different  prices,  may  not  use  as  a  basis  for  com- 
puting gain  or  loss  upon  the  sale  of  such  dividend  stock,  the 
quotient  of  the  total  cost  of  the  purchased  stock  divided  by  the 
total  number  of  old  and  new  shares  added  together.  Each  share 
of  dividend  stock  sold  must  be  allocated  to  a  particular  lot  of 
purchased  stock  and  the  basis  for  determining  gain  or  loss  upon 
the  sale  of  any  such  stock  shall  be  determined  by  using  the 
cost  of  the  shares  to  which  such  dividend  share  has  been  allocated. 
If  the  particular  lots  can  not  be  identified,  the  provisions  of 
(3)  above  must  be  followed.  If,  however,  the  taxpayer  is  able 
to  identify  his  various  purchases,  he  may  allocate,  according  to 
his  wishes,  the  stock  received  as  a  dividend,  except  that  no  share 
of  purchased  stock  may,  for  the  purpose  of  this  computation, 
be  credited  with  more  than  its  proportionate  share  of  the  divi- 
dend stock.  In  computing  the  gain  or  loss  upon  the  sale  of  the 
purchased  stock  it  is  held  that  the  same  basis  must  be  used  in 
each  case  as  is  used  in  computing  the  gain  or  loss  resulting  from 
the  sale  of  dividend  stock  allocated  to  the  particular  lot  of  pur- 
chased stock  which  is  sold.^^^ 

Stock  Dividends  Resulting  From  Revaluation  of  Assets. 
When  stock  received  in  payment  of  a  dividend  resulting  from  a 
revaluation  of  assets  or  stock  in  respect  of  which  any  such  divi- 
dend was  paid,  is  sold,  the  cost  of  each  share  of  stock,  whether 
old  or  new,  for  the  purpose  of  ascertaining  the  gain  or  loss  re- 
sulting from  its  sale,  is  the  quotient  of  the  cost  of  the  old  stock, 
if  acquired  on  or  after  March  1,  1913,  or  its  fair  market  price  or 
value  as  of  that  date  if  acquired  prior  thereto,  divided  by  the 
number  of  old  and  new  shares  added  together.  The  profit  so  as- 
certained from  the  sale  of  such  stock  is  income  subject  to  both 
normal  and  surtax  in  the  year  in  which  the  sale  is  made.^^^ 

no  0.  D.  781,  T.  B.  5-21-1412. 

1110.  D.  735,  T.  B.  48-20-1319. 

112  T.  D.  2734;  S.  1081,  T.  B.  11-19-368;  A.  R.  R.  6,  T.  B.  30-19-634. 


INCOME    FROM     DIVIDENDS  537 

Taxation  of  Dividends  at   Rates  in  Force  in  Previous  Years. 

Under  the  1916  Law,  as  amended,  the  rate  of  tax  on  dividends 
received  in  1917  depended  upon  the  year  in  which  the  amount 
distributed  as  dividends  was  earned  by  the  paying  corporation. 
The  law  provided  expressly  that  the  dividends  should  be  a  part 
of  the  annual  income  of  the  distributee  for  the  year  in  which 
received,  but  should  be  taxed  to  the  distributee  at  the  rates  pre- 
scribed by  law  for  the  years  in  which  such  profits  or  surplus 
were  accumulated  by  the  corporation.^ i-'  This  provision  was 
limited  to  stock  dividends  under  the  1918  Law,  and  since  such 
dividends  were  held  exempt  from  tax,  the  provision  has  no  appli- 
cation under  that  law."'  It  is  also  inapplicable  under  the  present 
law,  which  taxes  all  dividends  at  the  rates  in  force  in  the  year 
in  which  they  are  actually  or  constructively  received. 

113  Revenue  Act  of  1916,  §  31,  added  to  by  Revenue  Act  of  1917. 
"■»  Revenue   Act   of   1918,   §201. 


CHAPTER  20 

RECEIPTS  AND  INCOME  FROM  MISCELLANEOUS  SOURCES 

After  specifying  a  number  of  sources  of  income,  the  Revenue 
Act  of  1921,  like  the  Revenue  Act  of  1918,  provides  that  the 
gross  income  of  the  taxpayer  shall  include  gains  or  profits  and 
income  derived  from  any  source  whatever.^  In  this  chapter  are 
set  forth  the  rulings  on  income  from  sources  not  covered  by  the 
preceding  chapters  and  on  certain  receipts  which  are  not  income. 
The  principal  change  made  by  the  Revenue  Act  of  1921  dis- 
cussed in  this  chapter  is  the  new  statutory  provision  for  replace- 
ment funds  which,  it  will  be  noted,  differs  from  the  rule  hereto- 
fore established  by  departmental  practice  and  is  made  retro- 
active. Other  less  important  changes  are  the  partial  exemption 
of  dividends  on  interest  from  building  and  loan  associations, 
the  exemption  of  war  pensions,  and  the  provision  with  regard 
to  an  employees'  profit-sharing  fund. 

Alimony.  Alimony  is  not  income,  as  it  does  not  arise  from  any 
business  transaction,  and  is  not  founded  on  any  contract,  but  on 
the  natural  and  legal  duty  of  the  husband  to  support  the  wife.- 
An  allowance  based  on  a  separation  agreement  is  also  exempt 
from  tax.3  It  follows  that  the  husband  cannot  deduct  amounts 
paid  as  alimony  or  an  allowance  paid  under  a  separation  agree- 
ment from  his  gross  income  for  the  purpose  of  the  tax.* 

Amount  Paid  for  Option  to  Purchase  Interest  in  Royalties.  An 
amount  paid  simply  to  bind  an  option  to  purchase  an  interest 
in  royalties  to  be  derived  from  certain  patents,  which  does  not 
affect  the  ownership  of  the  patents,  is  income  and  not  a  return 
of  the  capital  invested  in  the  patents.^ 

Amount  Received  by  Tenant  as  Compensation  for  Vacating 
Premises.  A  sum  of  money  paid  to  a  taxpayer  pursuant  to  an 
agreement  reached  upon  the  termination  of  a  leasehold  con- 
tract before  its  expiration,  and  for  the  purpose  of  defraying  a 
personal  expense  in  the  nature  of  storage  charges  upon  the  tax- 

1  Revenue  Act  of  1921,  §213   (a)  ;  Revenue  Act  of  1918,  §213   (a). 

2  Gould  V.  Gould,  245  U.  S.  151.  This  decision  reversed  the  ruling  of 
the  treasury  department  on  the  point.  It  may  not  be  deducted  by  the  hus- 
band  (see  Chapter  20). 

3  Reg.  45,  Art.  73. 

4  Reg.  45,  Art.  291. 

5  0.  D.  1028,  T.  B.  37-21-1813. 


538 


INCOME   FROM    MISCELLANEOUS   SOURCES  539 

payer's  household  goods,  constitutes  an  item  of  gross  income 
within  the  meaning  of  the  statute.'' 

Cancelled  Debts.  The  cancellation  and  forgiveness  of  indebt- 
edness is  dependent  on  the  circumstances  for  its  effect."  It  may 
amount  to  a  payment  of  income  or  to  a  gift  or  to  a  capital 
transaction.  If,  however,  a  creditor  merely  desires  to  benefit  a 
debtor  and  without  any  consideration  therefor  cancels  the  debt, 
the  amount  of  the  debt  is  a  gift  from  the  creditor  to  the  debtor 
and  need  not  be  included  in  the  latter's  gross  income.  If  a  stock- 
holder in  a  corporation  which  is  indebted  to  him  gratuitously 
forgives  the  debt,  the  transaction  amounts  to  a  contribution  to 
the  capital  of  the  corporation.''  Transactions  involving  the 
rendering  of  returns  in  consideration  of  the  cancellation  of  an 
indebtedness  are  treated  elsewhere  in  this  book.^ 

Involuntary  Sale.  In  general,  profits  actually  realized  through 
the  sale  of  property  are  not  exempt  because  tlie  sale  was  in- 
voluntary. An  involuntary  sale  constitutes  a  closed  and  com- 
pleted transaction  for  the  purpose  of  detennining  gain  or  loss,  *^ 
unless  the  taxpayer  proceeds  to  establish  a  replacement  fund.ii 
Where  property  owned  by  an  estate  was  in  1906  listed  by  a 
city  to  be  condemned  for  public  purposes,  but  was  not  destroyed 
until  1917,  during  which  year  a  verdict  was  rendered  awarding 
the  estate  an  amount,  with  interest  at  the  rate  of  6%  per  annum 
from  1906,  mandamus  proceedings  being  instituted  to  enforce 
the  settlement  of  this  award,  and  in  1920  the  estate  received 
payment  of  the  face  value  of  the  claim,  together  with  interest 
accrued  since  1906,  and  costs,  it  has  been  held  that  as  the  tax- 
payer had  a  claim  on  March  1,  1913,  for  the  payment  of  this 
amount  with  interest  accrued  to  that  date,  the  measure  of  tax- 
able income  is  the  difference  between  the  fair  market  value 
of  the  claim  for  the  principal  and  interest  on  March  1,  1913, 
and  the  sum  actually  received  representing  such  principal  and 
accrued  interest.  The  cost  of  mandamus  proceedings  was  a 
replacement  of  the  amount  expended  by  the  estate  in  the  col- 
lection of  a  due  debt  and  should  not  be  included  in  the  gross 
income  of  the  estate.     However,  the  cost  of  such  mandamus 

6  A.  R.  R.  617,  T.  B.  37-21-1812. 

7Rep:.  45,  Art.  51.  See  Great  Northern  Ry.  Co.  v.  Lynch,  T.  D.  3147, 
T.  B.  13-21-1532,  in  which  it  was  held  under  the  1909  Law  that  unpaid  obli- 
gations written  off  the  books  because  of  the  runninpr  of  the  statute  of  limita- 
tions constituted  income  in  the  year  written  off. 

8U.  S.  V.  Oregon-Washington,  etc.  Co.,  251  Fed.  211. 

9  See  Chapter  15. 

10  A.  R.  R.  1,  T.  B.  25-19-587. 

11  See  paragraph  "Replacement  Fund  for  Loss." 


540  FEDERAL   INCOME   TAX 

proceedings  can  not  be  taken  as  a  deduction  in  computing  net 
income  of  the  estate  for  the  year  in  which  expended. i-  The 
requisition  of  property  by  the  government  in  1917  for  war  uses 
and  payment  therefor  of  a  price  named  by  the  commission  of  the 
war  department  is  considered  a  sale  or  other  disposition  of 
property.13 

Compensation  for  Loss.  In  the  case  of  property  which  has  been 
lost  or  destroyed  in  whole  or  in  part  through  fire,  storm,  ship- 
wreck, or  other  casualty,  or  where  the  owner  of  property  has  lost 
or  transferred  title  by  reason  of  the  exercise  of  the  power  of 
requisition  or  eminent  domain,  including  cases  where  a  volun- 
tary transfer  or  conveyance  is  induced  by  reason  of  the  fact  that 
a  technical  requisition  or  condemnation  proceeding  is  immi- 
nent,^^  that  amount  received  by  the  owner  as  compensation  for 
the  property  which  is  in  excess  of  the  cost  of  the  property  con- 
stitutes gain.  However,  the  gain  which  is  taxable  in  the  case 
where  the  property  was  acquired  before  March  1,  1913,  and 
its  fair  market  value  as  of  that  date  was  greater  than  its  cost, 
is  the  excess  over  such  value  of  the  amount  received.  No  taxable 
gain  results  when  the  amount  received  is  more  than  the  cost, 
but  less  than  the  fair  market  value  of  the  property  as  of  March 
1,  1913.  In  any  case  proper  provision  must  be  made  for  de- 
preciation to  the  date  of  the  loss,  damage,  or  transfer.  The 
transaction  is  not  regarded  as  completed  at  this  stage,  however, 
if  the  taxpayer  proceeds  immediately  in  good  faith  to  replace 
the  property,  or  if  he  makes  application  to  establish  a  replace- 
ment fund  as  provided  in  the  following  paragraph.  In  such  a 
case,  under  the  regulations  issued  under  the  1918  Law,  the  gain, 
if  any,  was  measured  by  the  excess  of  the  amount  received  over 
the  amount  actually  and  reasonably  expended  to  replace  or  re- 
store the  property  substantially  in  kind,  exclusive  of  any  ex- 
penditures for  additions  or  betterments.  The  new  or  restored 
property  effects  a  replacement  in  kind  only  to  the  extent  that 
it  serves  the  same  purpose  as  the  property  which  it  replaces 
without  added  capacity  or  other  element  of  additional  value. 
Such  new  or  restored  property  may  not  be  valued  in  the  accounts 
of  the  taxpayer  at  an  amount  in  excess  of  the  cost,  or  its  value 
as  of  March  1,  1913,  if  acquired  before  that  date  and  such  value 
as  of  such  date  is  higher  than  the  cost  (after  making  proper  pro- 
vision in  either  case  for  depreciation  to  the  date  of  the  loss, 

12  0.  D.  591,  T.  B.  29-20-1071. 

13  0.  D.  897,  T.  B.  18-21-1604.  See  p.  543,  however,  as  to  establishing 
a  replacement  fund  in  such  cases. 

14  See  A.  R.  M.  101,  T.  B.  50-20-1341. 


INCOME   FROM    MISCELLANEOUS   SOURCES  541 

damage  or  transfer),  of  the  original  property,  plus  the  cost 
of  any  actual  additions  and  betterments.  If  the  taxpayer  does 
not  elect  to  replace  or  restore  the  property,  the  transaction  will 
then  be  deemed  to  be  completed  and  the  gain  will  be  the  differ- 
ence between  the  cost  of  the  property  and  the  amount  of  the 
compensation  received.  If  such  property  was  acquired  prior  to 
March  1,  1913,  and  its  fair  market  value  as  of  that  date  was 
greater  than  such  cost,  the  taxable  gain  will  be  the  excess  over 
such  fair  market  value  of  the  amount  of  the  compensation  re- 
ceived. However,  no  gain  will  be  taxable  when  the  amount 
received  is  more  than  the  cost  of  such  property,  but  less  than 
its  fair  market  value  as  of  March  1,  1913.  In  any  event  proper 
provision  must  be  made  for  depreciation  to  the  date  of  the  loss, 
damage,  or  transfer.  This  ruling  has  no  application  to  property 
which  is  voluntarily  sold  or  disposed  of.^''  It  applies  to  resi- 
dential and  farming  property.!^ 

Compensation  for  Loss  Under  1921  Law.  The  above  ruling 
was  not  made  under  any  specific  provision  of  the  1918  Law, 
but  there  has  been  embodied  in  the  Revenue  Act  of  1921  the 
following  provision:  If  property  is  compulsorily  or  involun- 
tarily converted  into  cash  or  its  equivalent  as  a  result  of  (a) 
its  destruction  in  whole  or  in  part,  (b)  theft  or  seizure,  or  (c) 
an  exercise  of  the  power  of  requisition  or  condemnation,  or  the 
threat  or  imminence  thereof;  and  if  the  taxpayer  proceeds 
forthwith  in  good  faith,  under  regulations  prescribed  by  the 
Commissioner  with  the  approval  of  the  secretary,  to  expend 
the  proceeds  of  such  conversion  in  the  acquisition  of  other 
property  of  a  character  similar  or  related  in  service  or  use  to 
the  property  so  converted,  or  in  the  acquisition  of  80  per  centum 
or  more  of  the  stock  or  shares  of  a  corporation  owning  such 
other  property,  or  in  the  establishment  of  a  replacement  fund, 
then  there  shall  be  allowed  as  a  deduction  such  portion  of  the 
gain  derived  as  the  portion  of  the  proceeds  so  expended  bears 
to  the  entire  proceeds.  The  Act  provides  that  this  provision 
prescribing  the  conditions  under  which  a  deduction  may  be 
taken  in  respect  of  the  proceeds  or  gains  derived  from  the  com- 
pulsory or  involuntary  conversion  of  property  into  cash  or  its 
equivalent,  apply  "so  far  as  may  be  practicable  to  the  exemption 
or  exclusion  of  such  proceeds  or  gains  from  gross  income  under 
prior  income,  war-profits  and  excess-profits  tax  acts."^"    It  will 

15  Reg.  45,  Art.  49,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 
ifiO.  D.  513,  T.  B.  21-20-949. 

IT  Revenue  Act  of  1921,  §§214   (a)   12  and  234   (a)   14.    See  also  Revenue 
Act  of  1921,  §202   (d)   2. 


542  FEDERAL   INCOME   TAX 

be  seen  that  the  provision  of  the  1921  Law  changes  the  basis  for 
determining  gain  or  loss  from  such  transactions.  Under  the 
regulations  promulgated  under  the  1918  Law,  the  cost  of  the 
property  was  disregarded  and  the  gain  was  the  excess  of  the 
amount  received  for  the  property  over  the  amount  expended  in 
the  replacement  thereof.  Under  the  present  law  the  gain  or 
loss  is  first  computed  by  taking  the  difference  between  cost  and 
the  amount  received  for  the  property.  From  the  gain  (if  any)^ 
a  deduction  may  be  taken  of  that  portion  of  such  gain  which 
the  portion  of  the  amount  expended  in  replacement  bears  to  the 
entire  amount  received.  Thus,  under  the  1918  Law,  if  a  tax- 
payer received  $100,000  for  his  property  and  replaced  it  by  an 
expenditure  of  $80,000,  his  taxable  gain  was  $20,000,  irrespec- 
tive of  the  cost  of  the  property.  Under  the  present  law,  if  the 
property  cost  $70,000,  $100,000  was  received  for  it  and  $80,000 
was  spent  in  replacing  it,  the  gain  would  be  $30,000,  but  there 
may  be  deducted  from  such  gain  4/5  thereof,  leaving  a  taxable 
gain  of  $6,000.  This  new  provision  may,  in  some  cases,  pro- 
vide much  greater  relief  than  was  formerly  granted  and  it  would 
seem  that  taxpayers  will  be  allowed  to  recompute  such  gains 
and  if  they  are  reduced  by  the  application  of  the  new  method- 
may  be  allowed  a  credit  or  refund  of  any  excess  taxes  previously 
paid. 

In  addition,  the  1921  Law  permits  taxpayers,  instead  of 
actually  replacing  the  lost  or  converted  property,  to  take  advan- 
tage of  the  above  provision  by  acquiring  80%  or  more  of  the 
stock  or  shares  of  a  corporation  owning  such  property  similar 
or  related  in  service  or  use  to  the  property  converted. 

Rulings  Under  1918  Law.  The  following  rulings  were  made 
under  the  1918  Law,  upon  the  subject  discussed  in  the  previous 
paragraphs : 

(1)  An  amount  in  excess  of  recovery  for  loss  expended  for 
replacement  of  an  asset  "in  kind"  is  not  deductible  as  a  loss 
when  the  entire  fund  so  recovered  is  equal  to  or  greater  than 
the  book  value  of  the  asset.  Thus,  where  the  cost  of  the  asset 
is  $5,000,  the  replacement  cost  $5,000  and  the  recovery  $4,000, 
there  is  a  deductible  loss  of  $1,000,  but  where  the  cost  of  the 
asset  is  $5,000,  the  replacement  cost  $11,000,  and  the  recovery 
$10,000  the  taxpayer  may  not  deduct  $1,000  (the  diflPerence  be- 
tween the  replacement  cost  and  the  amount  of  recovery)  as  a 
loss.  This  excess  is  to  be  treated  as  a  capital  expenditure  which 
is  recoverable  through  depreciation  deductions.^^ 

ISA.  R.  M.  122,  T.  B.  18-21-1607.  * 


INCOME   FROM    MISCELLANEOUS  SOURCES  543 

(2)  Where  a  taxpayer  elects  to  replace  a  vessel  by  one  some- 
what larger,  so  long  as  the  general  type  of  the  boat  is  the  same 
as  the  boat  lost  or  destroyed,  it  may  fairly  be  taken  as  a  replace- 
ment in  kind,  insofar  as  it  equals  the  tonnage  of  the  original 
vessel.  There  should  be  charged  against  the  replacement  fund 
only  such  portion  of  the  cost  of  the  new  vessel  as  would  represent 
the  cost  of  a  boat  of  the  carrying  capacity  of  the  old  vessel, 
with  allowance  for  depreciation. i" 

(3)  Where  the  government,  having  requisitioned  vessels  from 
a  taxpayer  for  use  in  the  war,  returns  the  same  vessels  in  an 
unfit  condition  for  their  former  use,  giving  the  taxpayer  a  sum 
of  money  in  lieu  of  restoration,  the  vessels  are  deemed  to  be 
substantially  different  property  from  that  taken  from  the  tax- 
payer, and  the  taxpayer  may  elect  to  sell  the  vessels  returned 
and  place  the  proceeds,  together  with  the  money  paid  in  lieu  of 
restoration,  in  a  replacement  fund.-'^ 

(4)  Where  the  owner  of  a  requisitioned  tug  uses  the  proceeds 
to  buy  barges,  he  does  not  replace  in  kind  within  the  meaning  of 
the  above  rulings.^^ 

(5)  The  purchase  of  a  steamship  from  a  subsidiary,  from 
the  replacement  fund  of  another  subsidiary,  can  not  be  con- 
sidered a  replacement  in  view  of  the  provisions  of  the  income- 
tax  law  governing  the  taxation  of  affiliated  corporations.- 

Replacement  Fund  for  Loss.  The  1921  Law  gives  the  Commis- 
sioner, with  the  approval  of  the  secretary,  authority  to  make 
regulations  respecting  the  use  of  replacement  funds.--^  The  fol- 
lowing regulation  was  issued  under  the  1918  Law: 

In  any  case  in  which  the  taxpayer  elects  to  replace  or  restore 
the  lost,  damaged  or  transferred  property,  but  where  it  is  not 
practicable  to  do  so  immediately,  he  may  obtain  permission  to 
establish  a  replacement  fund  in  his  accounts  in  which  the  entire 
amount  of  the  compensation  so  received  shall  be  held  without 
deduction  for  the  payment  of  any  mortgage,  and  pending  the 
disposition  thereof  the  accounting  for  gain  or  loss  thereupon 
may  be  deferred  for  a  reasonable  period  of  time,  to  be  deter- 
mined by  the  Commissioner.-^     In  such  a  case  the  taxpayer 

19  T.  B.  M.  61,  T.  B.  15-19-443. 

20  T.  B.  R.  41,  T.  B.  12-19-400. 

21  O.  914,  T.  B.  20-19-504. 

22  A.   R.  M.   142,  T.  B.  48-21-1942.    See  Chapter  10. 

2»  Revenue  Act  of  1921,  §§214    (a)    12  and  234    (a)    14. 

24  The  period  during  which  the  replacement  fund  may  be  maintained 
may  properly  be  limited  to  one  year  with  the  privilege  of  the  taxpayer 
to  apply  at  the  end  thereof  for  a  further  extension  (T.  B.  M.  (51,  T.  B. 
15-19-443). 


544  FEDERAL   INCOME  TAX 

should  make  application  to  the  Commissioner  on  Form  1114  for. 
permission  to  establish  such  a  replacement  fund  and  in  his  ap- 
plication should  recite  all  the  facts  relating  to  the  transaction, 
including  the  nature  of  the  property,  the  character  and  extent 
of  the  loss,  the  manner  and  date  of  securing  compensation,  the 
date  of  acquisition  of  the  property  and  its  cost  or  fair  value 
on  March  1,  1913,  the  amount  of  compensation,  the  amount 
necessary  to  make  the  damage  good,  a  description  of  the  replace- 
ment intended  and  the  steps  already  taken  to  that  end,  the  prob- 
able date  of  compensation,  the  estimated  additional  excess- 
profits  and  income  taxes  assessable  upon  the  income  carried  to 
the  replacement  fund,  and  all  other  matters  which  might  affect 
a  determination.  He  must  undertake  that  he  will  proceed  as 
expeditiously  as  possible  to  replace  or  restore  such  property. 
The  taxpayer  will  be  required  to  furnish  a  bond  with  such  surety 
as  the  Commissioner  may  require  for  an  amount  not  less  than 
the  estimated  additional  income  and  war-profits  and  excess- 
profits  taxes  assessable  by  the  United  States  upon  the  income 
so  carried  to  the  replacement  fund.  The  estimated  additional 
taxes,  for  the  amount  of  which  the  claimant  is  required  to  fur- 
nish security,  should  be  computed  at  the  rates  at  which  the 
claimant  would  have  been  obliged  to  pay,  taking  into  considera- 
tion the  remainder  of  his  net  income  and  resolving  against  him 
all  matters  in  dispute  affecting  the  amount  of  the  tax.  Only 
surety  companies  holding  certificates  of  authority  from  the  sec- 
retary of  the  treasury  as  acceptable  sureties  on  federal  bonds 
will  be  approved  as  sureties.  The  application  should  be  exe- 
cuted in  triplicate,  so  that  the  Commissioner,  the  applicant  and 
the  surety  or  depositary  may  each  have  a  copy.  This  ruling  has 
no  application  to  property  which  is  voluntarily  sold  or  disposed 
of.25 

Damages  in  Personal  Actions.  Damages  in  the  form  of  yearly 
payments  throughout  the  life  of  the  injured  party,  recovered 
through  the  compromise  of  a  threatened  suit  for  breach  of 
promise  of  marriage,  are  not  regarded  as  a  return  of  capital 
since  the  benefits  of  which  the  injured  party  was  deprived  were 
merely  anticipatory.     Such  payments  are  within  the  statutory 

25  Reg.  45,  Art.  50;  see  Form  1114.  Prior  to  the  promulgation  of  this 
regulation,  the  taxpayer,  at  his  option,  might,  in  lieu  of  furnishing  a  bond 
as  above  indicated,  deposit  as  security  for  the  estimated  additional  amount 
of  tax,  obligations  of  the  United  States  issued  after  September  1,  1917, 
such  obligations  to  be  held  in  trust  in  a  bank  or  trust  company  approved 
by  the  Commissioner  (T.  D.  2706).  See  Revenue  Act  of  1921,  §  1329  as  to 
deposit  of  Liberty  bonds  in  lieu  of  sureties. 


INCOME   FROM    MISCELLANEOUS   SOURCES  545 

definition  of  income  and  are  taxable  to  the  recipient.-^^  The 
ahenation  of  a  wife's  affections  is  not  such  a  personal  injury 
as  to  entitle  the  recipient  of  damages  therefor  to  exemption  as 
to  such  damages.  However,  so  far  as  such  damages  represent 
compensation  for  sickness  resulting  from  the  alienation,  they  are 
exempt.-''  Money  recovered  as  damages,  in  libel  proceedings  is 
subject  to  tax.-8 

Embezzled  Moneys.  It  has  been  held  that  moneys  embezzled 
are  not  such  income  as  the  law  intended  to  tax.-^ 

Income  from  Employees'  Profit-Sharing  Fund.  Where  the 
members  of  a  firm  establish  an  employees'  profit-sharing  fund 
by  transferring  a  given  sum  of  money  to  certain  employees  in 
trust,  such  fund  being  invested  in  the  business  of  the  firm  and 
the  interest  paid  annually  to  a  certain  class  of  employees,  who 
hold  certificates  entitling  them  to  participate  in  the  profits  of 
the  fund,  such  certificates  being  subject  to  cancellation  at  the 
pleasure  of  the  firm,  the  income  from  the  fund  was  held,  under 
the  1918  Law,  to  be  taxable  as  a  part  of  the  firm's  income.^^" 
Under  the  Revenue  Act  of  1921,  amounts  distributed  to  em- 
ployees from  such  funds  are  taxable  to  the  distributees  to  the 
extent  of  the  excess  of  the  amounts  received  over  amounts  paid 
in  by  such  employees.-^^ 

Excess  of  Salvage  Value  of  Discarded  or  Destroyed  Property 
Plus  Depreciation  Allowances  Over  Cost.  When  property  is  dis- 
carded and  salvaged,  the  depreciation  allowance  plus  the  salvage 
value  may  slightly  exceed  or  fall  slightly  below  the  cost  of  the 
property.  In  the  case  of  a  gain  over  cost  this  must  be  treated 
as  income.  If  the  depreciation  allowance  plus  salvage  falls  be- 
low the  cost,  the  diff'erence  may  be  treated  as  a  loss.  The  fact 
that  a  taxpayer  in  past  years  neglected  to  allow  for  sufficient 
depreciation  does  not  make  the  resulting  discrepancy  between 
the  book  values  of  equipment  and  its  salvage  value  at  the  time 
it  is  retired  from  service  deductible  as  a  loss.  In  such  cases  the 
taxpayer  may  avail  himself  of  a  larger  deduction  for  deprecia- 

26  O.  D.  501,  T.  B.  20-20-931. 

27  S.  1384,  T.  B.  24-20-997.  Though  the  alienation  of  a  wife's  affections 
is  a  personal  injury  (Leicester  v.  Hoadley,  66  Kans.  113,  71  Pac.  318; 
Tinker  v.  Colwell,  193  U.  S.  473,  487),  the  term  "personal  injuries"  in 
§  213    (b)    6  is  held  to  mean  physical  injuries  only. 

28  S.  957,  T.  B.  1-19-21. 

2!»  Rau  V.  U.  S.,  260  Fed.  131,  136. 

■•50  S.  1329,  T.  B.  9-20-766. 

31  Revenue  Act  of  1921,  §219   (f). 


546  FEDERAL   INCOME   TAX 

tion  by  submitting  amended  returns  for  previous  years,  and 
showing  that  the  previous  depreciation  rate  was  not  reason- 
able.32 

Income  of  Independent  Contractor  from  State  Contract.  Any 
profit  received  from  a  state  or  political  subdivision  thereof  by 
an  independent  contractor  is  taxable  income.  Where  warrants 
are  issued  by  a  city,  town  or  other  political  subdivision  of  a 
state,  and  are  accepted  by  the  contractor  in  payment  for  public 
work  done,  the  face  value  of  such  warrants  must  be  returned 
as  income.  If,  for  any  reason,  the  contractor  upon  conversion 
of  the  warrants  into  cash  does  not  receive  and  can  not  recover 
the  full  face  value  of  the  warrants  so  returned,  he  may  allow- 
ably deduct  from  gross  income  for  the  year  in  which  the  war- 
rants are  converted  into  cash  any  loss  sustained.^^ 

Increment  to  Sinking  Funds.  Where  a  sinking  fund  is  set 
aside  for  the  purpose  of  meeting  obligations  at  a  future  date,  all 
increment  to  that  fund  as  a  result  of  investments  is  income  to 
the  creator  of  the"  fund.  Where  a  sinking  fund,  controlled  by 
trustees,  has  been  invested  in  the  bonds  of  the  corporation  which 
created  the  fund,  and  the  corporation  pays  the  trustees  interest 
on  such  bonds,  the  amount  thereof  may  be  deducted  as  if  paid 
to  any  other  bondholders,  but  the  same  amount  must  be  included 
as  income  to  the  corporation  from  the  sinking  f und.^^ 

Labor  Union  Benefits.  Benefits  paid  by  a  labor  union  to  mem- 
bers during  a  strike  constitute  taxable  income.^^ 

Legacies.  A  legacy  is  a  gift  and  the  value  thereof  is  not  con- 
sidered income  to  the  recipient,  but  all  income  from  the  legacy 
is  taxable.  Unless  clearly  inconsistent  with  the  intention  of  the 
testator,  a  legacy  is  held  to  be  vested  rather  than  contingent,  and 
where  there  is  a  vested  interest  the  income  therefrom,  whether 
distributed  or  not,  is  subject  to  the  tax  from  the  time  of  death 
of  the  testator,  as  income  of  the  legatee.^*^ 

Payment  of  Claims.  In  the  case  of  an  estate  which  on  March 
1,  1913,  owned  a  claim  against  some  individual  or  business  or 
government  organization,  the  difference  between  the  amount 
received  in  payment  of  the  claim  and  the  actual  value  of  the 
claim  March  1,  1913,  is  either  gain  or  loss,  as  the  case  may  be, 
to  be  reported  in  the  return  for  the  year  in  which  the  claim 

32  S.  1217,  T.  B.  30-19-639.  This  decision  appears  to  have  been  based 
upon  the   1913   Law. 

33  Reg.  45,  Art.  37;  Reg.  33  Rev.,  Art.  108. 

34  T.   D.   2161. 

35  O.  D.  552,  T.  B.  25-20-1011. 

36  T.  D.  2090. 


INCOME   FROM    MISCELLANEOUS   SOURCES  547 

was  settled.  Interest  accrued  on  the  claim  from  March  1,  1913, 
to  date  of  settlement  is  taxable  income  to  the  estate.  If  pay- 
ment was  received  in  securities  which  can  be  proved  to  have 
been  worth  less  than  face  value,  the  amount  to  be  reported  as 
taxable  income  is  reduced  accordingly.  If  the  securities  are 
sold,  taxable  income  will  be  realized  or  a  deductible  loss  sus- 
tained to  the  extent  of  the  difference  between  the  amount  re- 
ceived from  the  sale  and  the  actual  value  of  the  securities  at  the 
time  acquired.'^^ 

Payments  Received  Through  Mistake.  If  a  taxpayer  receives, 
through  mistake,  an  amount  in  payment  of  a  contract  in  excess 
of  the  amount  agreed  upon  in  the  contract,  the  excess  is  not 
taxable  income.  It  is  in  the  nature  of  a  liability  to  the  party 
with  whom  the  contract  was  made."''^ 

Pensions.  Pensions  and  retiring  allowances  paid  by  the  United 
States  government  are  subject  to  the  income  tax,"*^  as  also  are 
pensions  paid  by  any  other  government,  or  by  any  private  inter- 
est, under  any  contract  express  or  implied.  If,  however,  a  so- 
called  "pension"  is  a  mere  gratuity  or  gift  it  is  not  taxable  as 
income  to  the  recipient.  When  one  enters  the  service  of  an 
employer  who  has  inaugurated  a  pension  system,  such  system 
is  one  of  the  inducements  for  entering  the  employment,  and  in 
such  circumstances  the  fact  that  the  pension  is  part  of  the  com- 
pensation received,  and  not  a  gift,  is  very  clear.  Even  when 
the  pension  is  granted  after  the  employment  has  been  com- 
menced and  without  any  compulsion,  legal  or  moral,  of  the  em- 
ployer, it  may  still  fairly  be  regarded  as  additional  compensa- 
tion. When  the  pensions  are  awarded  by  one  to  whom  no 
services  have  been  rendered  and  who  has  received  no  direct 
benefit  from  the  services  rendered,  they  can  not  be  regarded 
as  additional  compensation.^"  Thus,  pensions  paid  by  the  United 
States  government  to  widows  of  soldiers,  as  such,  were  held 
under  the  1918  Law  not  to  be  taxable  income  for  the  reason 
that  such  pensions  are  not  awarded  as  compensation  for  services 
rendered  to  the  United  States  government  by  the  widows  and 
are  mere  gifts  or  gratuities.-'^  The  Revenue  Act  of  1918  ex- 
pressly provides  that  pensions  from  the  United  States  for 
service  of  the  beneficiary  or  another  in  the  military  or  naval 

37  0.   D.  6,  T.   B.   1-19-11. 

38  O.  D.  14,  T.  B.  1-19-26. 

39  Reg.  45,  Art.  32;  T.  D.  2090. 

40  O.  1040,  T.  B.  28-20-1051. 

«  O.  D.  957,  T.  B.  26-21-1701. 


548  FEDERAL  INCOME   TAX 

forces  of  the  United  States  in  time  of  war  are  exempt.*-  Where 
an  insurance  company  entered  into  a  contract  with  one  of  its 
employees  agreeing  in  the  event  of  the  death  of  the  latter  to 
pay  to  his  widow  for  a  period  of  five  years  all  renewal  premiums 
on  business  originated  by  him  it  has  been  held  that  such  pre- 
miums constitute  taxable  income  to  the  widow.'*^ 

There  is  no  essential  difference  in  the  payments  to  teachers 
and  the  widows  of  teachers  by  the  Carnegie  Foundation  for  the 
advancement  of  teaching  from  those  made  to  indigent  persons 
by  ordinary  charitable  societies,  and  they  are,  therefore,  mere 
gifts  or  gratuities.  The  fact  that  they  take  the  form  of  pensions 
and  are  within  the  dictionary  definition  of  the  term  "pension" 
does  not  take  them  out  of  the  definition  of  the  term  "gift." 
The  terms  "pension"  and  "gift"  are  not  mutually  exclusive.  The 
same  payments  may  be  both  pensions  and  gifts.** 

Property  Acquired  by  Gift.  The  value  of  property  acquired 
by  gift,  bequest,  devise  or  descent  (but  not  the  income  from 
such  property)  is  exempt.  Such  property  need  not  be  reported 
as  income  by  the  recipient.*''  Money  and  real  or  personal  prop- 
erty received  as  gifts,  or  received  under  a  will  or  under  statutes 
of  descent  and  distribution,  are  exempt  from  tax,  although  the 
income  therefrom  derived  from  investment,  sale  or  otherwise 
is  not.*''  The  question  whether  or  not  a  given  transaction  con- 
stitutes a  bona  fide  gift,  so  as  to  make  the  income  from  the  prop- 
erty transferred  taxable  to  the  donee  rather  than  to  the  donor, 
will  depend  upon  the  intention  of  the  parties.*'^' 

The  following  have  been  held  to  be  gifts:  (1)  An  amount 
of  principal  paid  under  a  marriage  settlement.  (2)  Christmas 
presents,  gratuities,  voluntary  contributions  and  donations.  An 
exception,  however,  is  made  in  the  case  of  clergymen.*^  (3) 
Donations  made  to  employees  and  others,  which  do  not  have  in 
them  the  element  of  compensation  or  are  in  excess  of  reasonable 
compensation  for  services,*'^  including  the  salary  of  an  employe 

42  Revenue  Act  of  1921,  §213   (b)    (9). 

43  A.   R.  M.  115,  T.  B.  11-21-1505. 

44  0.  1040,  T.  B.  28-20-1051,  overruling  T.  B.  2-20-670.    See  In  re  Strong 

1  Tax  Cas.  207;  Blakeston  v.  Cooper,  5  Tax  Cas.  347;   Turner  v.  Cuxson, 

2  Tax  Cas.  422;  Turton  v.  Cooper,  5  Tax  Cas.  148. 

45  Revenue  Act  of  1921,  §§213  (b)  and  233;  Revenue  Act  of  1918,  §§213 
(b)   and  233. 

46  Reg.  45,  Art.  73. 

47  A.  R.  R.  367,  T.  B.  4-21-1405. 

48  See   Chapter   15. 

49  Reg.  45,  Art.  107.  For  a  discussion  of  so-called  gifts  which  are  in  fact 
payment  for  services  see  Chapter  22. 


INCOME  FROM    MISCELLANEOUS   SOURCES  549 

paid  for  a  limited  period  after  his  death  to  a  relative  or  dependent, 
in  recognition  of  the  services  rendered  by  the  employee,  no  serv- 
ices being  rendered  by  the  recipient.-"'"  (4)  An  amount  returned 
by  an  employee  to  a  corporation  as  part  of  his  compensation 
previously  received  under  a  valid  contract/"*^  (5)  Installments 
paid  to  beneficiaries  under  an  endowment  policy  taken  out  by 
another,  but  any  dividends  included  in  such  installments  will  be 
taxable  to  the  beneficiaries."'-  (6)  Personal  transportation  passes 
issued  by  a  railroad  company  to  its  employees  and  their  families, 
to  be  used  when  not  engaged  on  business  for  the  company,  and 
which  are  not  provided  for  in  the  contracts  of  employment.-''^ 

Of  course,  any  amount  paid  by  one  person  out  of  his  income 
to  another,  as  a  gift,  is  not  deductible  from  the  gross  income 
of  the  giver.5^  An  owner  of  non-tax-free  Liberty  bonds  who 
has  made  an  absolute  gift  of  the  coupons  attached  to  the  bonds 
covering  interest  due  for  a  number  of  years  will  be  required 
to  include  in  his  return  the  interest  which  accrues  each  year 
on  the  bonds,  and  to  pay  any  tax  that  may  be  due  thereon.^^ 
Where  an  executor  receives  a  bequest  conditioned  upon  his  con- 
tinuous performance  of  duties  as  executor,  such  a  bequest  will 
be  deemed  compensation  for  his  services,  although  it  is  ex- 
pressly additional  to  the  executors'  legal  commissions.^*' 

Rights  to  Subscribe  to  Stock.  The  Treasury  Department  has 
held  that  where  a  stockholder  acquires  the  right  to  subscribe 
to  new  stock  of  the  corporation  and  sells  that  right  the  amount 
received  is  income.^'^    If  he  exercises  the  right,  it  was  held  that 

50  T.  D.  2090;  Reg.  33,  Art.  6;  0.  D.  1017,  T.  B.  36-21-1798. 

51  0.  D.  1073,  T.  B.  43-21-1882. 

52  0.  D.  1108,  T.  B.  47-21-1931. 

53  O.  D.  946,  T.  B.  24-21-1685. 

5-t  See  O.  D.  912,  T.  B.  20-19-505. 

55  0.  D.  120,  T.  B.  3-19-181. 

56  O.  980,  T.  B.  4-20-700.  This  ruling  is  based  upon  the  theory  that  the 
bequest    is,    in    effect,    additional    compensation    for    services    as    executor. 

The  law  taxes  compensation  for  personal  services  "in  whatever  form 
paid"  (Revenue  Act  of  1921,  §213;  Revenue  Act  of  1918,  §213).  Not- 
withstanding this  comprehensive  clause,  the  ruling  seems  a  doubtful  inter- 
pretation of  a  statute  which  expressly  exempts  bequests.  (See  Bullen  v. 
Wisconsin,  240  U.  S.  625.) 

57  Reg.  45,  Art.  39,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767;  T.  B. 
M.  73,  T.  B.  19-19-495;  Letter  from  treasury  department  dated  February 
27,  1915,  I.  T.  S.  1918,  ^420.  In  Trefry  v.  Putnam,  227  Mass.  522,  116  N. 
E.  904,  in  which  the  court  held  that  gains  derived  from  a  sale  of  rights  to 
subscribe  for  new  shares  of  stock  were  taxable  as  income  under  the  Mass- 
achusetts Income  Tax  Law,  the  court  said  in  part:  "Such  rights  are  them- 
selves a  species  of  intangible  property.  They  come  to  the  stockholder  as  a 
gratuity.     They  are  a  new  thing  of  value  which  he  did  not  possess  before. 


550  FEDERAL  INCOME   TAX 

no  income  accrues  until  the  stock  subscribed  for  is  sold.  In  a 
recent  case^^  decided  by  a  district  court,  this  principle  laid  down 
by  the  treasury  department  has  been  considerably  modified.  In 
this  case  the  court  held  that  the  decision  of  the  Massachusetts 
court^^  upon  which  the  ruling  of  the  department  was  based  was 
no  longer  persuasive  since  the  decision  of  the  Supreme  Court, 
holding^o  that  stock  dividends  are  not  income.  In  this  case  the 
taxpayer  acquired  35  shares  of  stock  at  $710  per  share.  The 
capital  stock  of  the  company  was  doubled  and  the  taxpayer  was 
given  the  right  to  subscribe  to  35  more  shares  for  $150  per 
share,  and  sold  his  rights  for  $358.48  per  share.  The  court 
held  that  the  entire  amount  derived  from  the  sale  of  such  rights 
was  not  income.  The  court  said  in  part :  'The  plaintiff  in  the 
right  of  every  share  it  held  and  which  had  cost  it  $710,  could, 
by  paying  $150  a  share  more,  get  another,  so  that  it  would  have 
two,  which  in  the  aggregate  would  have  cost  it  $860  or  $430 
apiece.  There  would  be  no  way  of  distinguishing  between  the 
old  and  the  new.  If  the  latter  was  something  which  had  not 
before  existed  almost  the  same  might  be  truthfully  said  of  the 
former.  Its  characteristics  had  undergone  a  great  change. 
Before  the  issue  of  the  new  stock,  it  represented  one  twenty- 
thousandth  of  the  capital  of  the  company;  afterwards  it  stood 
for  bui  only  forty-thousandths.  Moreover,  if  the  plaintiff  had, 
in  person,  taken  the  new  stock,  and  had  had  its  old  and  new 
consolidated  into  one  certificate,  and  had  subsequently  sold  a 
part  of  its  holdings,  it  could  not  say  that  that  with  which  it 
parted  was  out  of  the  old  or  out  of  the  new,  or  partly  out  of 
both.  In  determining  its  cost  for  the  calculation  of  the  profit  or 
loss  upon  resale,  it  would  be  necessary  to  assume  that  they  had 
one  and  all  cost  the  holder  an  equal  amount,  which  in  the  case 
of  the  plaintiff  here  was  $430  a  share."  In  selling  the  rights, 
a  part  of  the  consideration  was  that  the  buyer  should  assume 
the  payment  of  the  $150  per  share  so  that  the  taxpayer  really 

The  amount  for  which  he  sells  them  is  a  gain.  *  *  *  They  are  not 
regarded  ordinarily  as  a  profit  from  the  prosecution  of  the  business,  but 
are  an  inherent  and  constituent  part  of  the  shares.  *  *  *  Their 
sale  resulted  from  an  exercise  of  judgment  to  that  effect  on  the  part  of 
the  stockholder.  They  are  indistinguishable  in  principle  from  a  sale  of  the 
stock  itself,  and  gains  derived  from  sales  of  such  rights  fall  within  the 
same  class  of  income.  The  statute  in  this  regard  is  not  in  conflict  with 
the   amendment." 

•jS  Safe  Deposit  &  Trust  Co.  of  Baltimore  v.  Miles,  U.  S.  Dist.  Ct.,  Dist. 
of  Md.,  decided  May  26,  1921;  I.  T.  S.  1921,  113033. 

S9Trefry  v.  Putnam,  227  Mass.  522,  116  N.  E.   904. 

60  See  Chapter  19. 


INCOME   FROM    MISCELLANEOUS   SOURCES  551 

received  $150+$358.48,  or  $508.48  for  each  share.  The  gain 
made  on  each  share  on  the  transaction  was,  therefore,  the  differ- 
ence ($78.48)  between  the  amount  so  received  ($508.48)  and 
the  cost  of  each  share  ($430) .  Thirty-five  shares  were  still  held 
by  the  taxpayer  and  when  they  are  sold  the  profit  on  each  share 
will  be  the  amount  by  which  the  selling  price  per  share  exceeds 
$430. 

Sale  of  Good-Will.  Where  a  corporation  sells  its  assets,  in- 
cluding good-will,  to  a  competing  corporation,  one  condition  to 
the  sale  being  an  agreement  by  the  president  of  the  vendor  cor- 
poration not  to  engage  in  similar  business,  for  which  he  is  paid 
a  money  consideration,  the  amount  so  received  by  the  president 
does  not  represent  a  conversion  of  capital,  but  is  income  for  the 
year  of  its  receipt.^'^ 

Sale  of  War-Savings  Stamps.  Income  received  by  an  indi- 
vidual or  corporation  due  to  selling  war-savings  stamps  at  the 
appreciated  value  should  be  reported  as  income  for  the  year 
in  which  the  sales  were  consummated."- 

Shares  in  Building  and  Loan  Association.  The  1921  Law  con- 
tains a  new  provision  which  exempts  so  much  of  the  amount  re- 
ceived by  an  individual  after  December  31,  1921,  and  before 
January  1,  1927,  as  dividends  or  interest  from  domestic  build- 
ing and  loan  associations,  operated  exclusively  for  the  purpose 
of  making  loans  to  members,  as  does  not  exceed  $300.^3  In  gen- 
eral, an  amount  credited  to  shareholders  of  a  building  and  loan 
association,  when  such  credit  passes  without  restriction  to  the 
shareholder,  has  a  taxable  status  as  income  for  the  year  of  the 
credit.  Where  the  amount  of  such  accumulation  does  not  be- 
come available  to  the  shareholder  until  the  maturity  of  a  share, 
the  amount  of  any  share  in  excess  of  the  aggregate  amount  paid 
in  by  the  shareholder  is  income  for  the  year  of  the  maturity 
of  the  share.c^  If  a  building  and  loan  association  subscription 
was  made  prior  to  March  1,  1913,  and  the  share  subscribed  for 
had  a  cash  surrender  value  on  March  1,  1913,  and  any  year 
thereafter  in  excess  of  the  amount  paid  in  by  the  shareholder, 
the  determination  of  any  profit  realized  at  the  time  of  cash 
surrender  or  for  the  year  of  the  maturity  of  the  share  will  be 

ci  O.  D.  668,  T.  B.  39-20-1210;  L.  O.  1045,  T.  B.  41-20-1231;  A.  R.  R.  250, 
T.  B.  34-20-1157. 

fi2  0.  D.  21,  T.  B.  1-19-33. 

63  Revenue  Act  of  1921,  §213   (b)    (10). 

64  Reg.  45,  Art.  54 ;     Letter  from  treasury  department  dated  February  8, 
1917;  L  T.  S.  1919,  TI  949. 


552  FEDERAL   INCOME   TAX 

based  on  the  proceeds  in  excess  of  the  cash  surrender  value  as 
of  March  1,  1913,  plus  the  aggregate  amount  paid  in  subsequent 
thereto/^s 

Taxes  on  Profits  from  Sale  of  Property  Paid  by  Vendee.  In  a 
case  where  the  vendee  of  a  business  agrees  that  in  addition  to 
the  purchase  price  he  will  pay  the  income  and  excess-profits 
taxes  of  the  vendor  arising  from  the  sale  of  such  business,  it 
has  been  ruled  that  such  taxes  paid  by  the  vendee  constitute 
additional  taxable  income  to  the  vendor.^^ 

Tax  Paid  by  Debtor  on  Account  of  Tax-Free  Covenant  Bond. 
Under  the  1918  Law,  it  was  held  that  where  a  debtor  corpora- 
tion, in  pursuance  of  a  tax-free  covenant  clause  in  its  bonds 
paid  the  2%  normal  tax,  the  amount  of  the  tax  paid  by  the  cor- 
poration was  income  to  the  bondholder.  The  obligor,  in  pur- 
suance of  a  contract  voluntarily  entered  into  guaranteed  to 
pay  a  direct  liability  of  the  taxpayer  which  consisted  in  paying 
a  certain  amount  of  normal  tax  for  him  to  the  government.  The 
reduction  of  the  payment  of  his  tax  liability  under  such  a  con- 
tract was  held  to  constitute  income  to  him  by  reducing  his  ex- 
penditures in  that  amount.  The  fact  that  the  amount  of  the 
liability  was  paid  direct  to  the  government  instead  of  to  the 
taxpayer,  did  not  preclude  such  an  amount  from  constituting 
income  to  the  taxpayer.'"'^  The  Revenue  Act  of  1921,  however, 
expressly  provides  that  the  amount  of  such  taxes  shall  not  be 
included  in  the  gross  income  of  the  obligee.*"'^ 

Compensation  by  Insurance.  Insurance  money  is  clearly  a  sub- 
stitute for  the  assets  lost  or  destroyed.  If  the  insurance  money 
is  in  excess  of  the  cost  of  the  property  it  may  be  used  to  restore 
the  property  or  be  placed  in  a  fund  for  that  purpose  for  a  rea- 
sonable time  until  restoration  can  be  made,  final  accounting  for 
tax  on  the  excess  over  the  amount  actually  and  reasonably  ex- 
pended to  replace  or  restore  the  property  substantially  in  kind, 
being  deferred  until  the  restoration  or  replacement  has  taken 
place.  If  the  taxpayer  does  not  elect  to  restore  the  property  the 
transaction  will  then  be  deemed  to  be  completed.  The  rulings 
applicable  in  either  alternative  have  been  given  in  the  earlier 
part  of  this  chapter.'''^    Where  a  company  had  a  fire  in  its  plant 

r>^>  O.  D.  446,  T.  B.  15-20-842. 

o«  Telegram  from  treasury  department  dated  May  2,  1919;  I.  T.  S.  1921, 
H  907. 

O'J' Letter  from  treasury  department  dated  September  13,  1919;  I.  T.  S. 
1921,  11904. 

««  Revenue  Act  of  1921,  §234   (a)    (3). 

69  See  p.  540. 


INCOME   FROM    MISCELLANEOUS   SOURCES  553 

which  necessitated  shutting  clown  for  a  day  and  recovered  an 
amount  under  a  use  and  occupancy  policy  of  insurance  for  the 
loss  of  use  of  its  factory  it  is  held  that  sums  recovered  under 
such  a  policy  are  nothing  more  than  compensation  for  the  loss 
of  anticipated  profits,  and  whether  such  sums  are  less  than, 
equal  to,  or  in  excess  of  such  anticipated  profits  for  the  period 
of  nonuse,  they  nevertheless  represent  income."^ 

Proceeds  of  Life  Insurance.  The  proceeds  of  life  insurance 
policies  paid  upon  the  death  of  the  insured  were  exempt  from 
tax  under  the  Revenue  Act  of  1918. if  paid  to  individual  bene- 
ficiaries, directly  or  in  trust,  or  to  the  estate  of  the  insured, 
but  not  if  to  a  corporation  beneficiaryji  Under  the  present 
law,  the  proceeds  of  such  policies  are  exempt  irrespective  of 
who  the  beneficiary  may  beJ-  If  the  proceeds  are  paid  in  in- 
stallments under  the  terms  of  the  policy  none  of  the  install- 
ments is  subject  to  tax,  but,  it  appears,  if  the  proceeds  are  paid 
in  installments  by  agreement  between  the  beneficiary  and  the 
insurance  company  the  installments  may  be  free  from  tax  until 
they  aggregate  the  amount  of  insurance  payable  on  the  death 
of  the  insured,  and  any  amount  in  excess  of  that  sum,  due  to 
deferring  the  payments,  is  income.  Where  an  individual  is  the 
beneficiary  it  seemed  to  be  immaterial,  under  the   1918  Law, 

"'»  O.  D.  697,  T.  B.  43-20-1258.  See  paragraph  "Recoveries  on  Losses," 
p.  658. 

Ti  Revenue  Act  of  1918,  §§213  (b)  and  233  (a).  Reg.  45,  Art.  72.  The 
1916  Law  provided  that  the  proceeds  of  life  insurance  policies  were  exempt 
only  when  paid  to  an  individual  beneficiary  upon  the  death  of  the  insured, 
and  not  when  paid  to  the  estate  of  the  insured.  The  senate  introduced  a 
provision  in  the  1918  Law  to  exempt  the  proceeds  of  life  insurance  policies 
regardless  of  to  whom  they  were  paid  but  the  Conference  Committee  lim- 
ited the  exemption  to  proceeds  paid  only  to  individual  beneficiaries  or  to 
the  estate  of  the  insured.  In  the  vast  majority  of  cases  the  difference  be- 
tween such  proceeds  and  the  premiums  paid  on  the  insurance  represents  the 
loss  to  a  corporation  in  disturbance  of  its  organization  or  impairment  of 
good-will  occasioned  by  the  death  of  the  officer  or  employee  insured.  The 
proceeds  of  the  policy  over  and  above  premiums  paid  in  represents  compen- 
sation for  such  loss  and  is  in  no  true  sense  income.  It  is  true  that  the 
exemption  of  such  proceeds  might  render  possible  the  evasion  of  the  tax 
by  the  over-capitalization  of  the  value  of  the  insured's  life  and  activities 
to  the  corporation,  in  which  case,  owing  to  the  perpetuity  of  a  corporation's 
existence,  the  policy  would  be  an  investment ,  perhaps  similar  to  an  en- 
dowment policy  taken  out  by  an  individual.  This  mere  possibility  of  tax 
evasion,  however,  does  not  justify  the  imposition  of  a  hardship  upon  the 
well-run  enterprise  by  the  taxation  as  jyt-ofit  of  what  is  essentially  com- 
pensation for  a  definite  and  substantial  loss.  The  force  of  this  criticism 
has  been  recognized  by  the  1921  Law,  as  indicated  above. 

T2  Revenue  Act  of  1921,  §213   (b)    (1). 


554  FEDERAL  INCOME  TAX 

whether  or  not  the  premiums  were  paid  by  the  insured  or  by 
the  beneficiary,  since  the  law  granted  an  absolute  exemption 
with  respect  to  the  proceeds  of  the  policy;  under  the  present 
law  it  would  also  seem  immaterial,  even  if  the  beneficiary  were 
a  corporation.  In  the  case  of  a  corporation  beneficiary  of  insur- 
ance taken  out  on  the  lives  of  officers  or  of  employees  the  pro- 
ceeds, less  the  total  of  any  premiums  paid  thereon  (and  not 
deducted  from  net  income  in  the  year  in  which  paid,  as  was 
permitted  prior  to  the  year  1917),  was  held  to  be  income  under 
the  1918  Law.'''^  Such  proceeds  are  entirely  exempt  under  the 
present  law.  Since  June  25,  1918,  no  assessment  of  any  fed- 
eral tax  may  be  made  on  any  allotments,  family  allowances, 
compensation  or  death  or  disability  insurance  payable  under  the 
War  Risk  Insurance  Act  of  September  2,  1914,  as  amended, 
even  though  the  benefit  accrued  before  that  date.'^-^  The  1921 
Law  specifically  exempts  such  income.'^-^  This  applies  also  to 
dividends  on  life  insurance  policies  issued  by  the  bureau  of  war 
risk  insurance.'''^ 

Amounts  received  under  the  terms  of  an  ordinary  life,  con- 
tinuous installment  bond  contract  issued  by  a  life  insurance 
company  are  exempt.  This  applies  not  only  to  the  installment 
payments  received,  but  also  to  any  dividends  received  under  the 
terms  of  the  bond.'^^  Where  under  a  life  insurance  policy  there 
is  payable  to  a  first  beneficiary  named  6%  per  annum  of  the 
face  value  of  the  policy  during  life,  and,  upon  the  death  of  the 
first  beneficiary,  the  face  value  of  the  policy  is  payable  to  a 
second  beneficiary,  the  payments  to  the  first  beneficiary  are  a 
part  of  the  proceeds  of  the  policy,  and  are  not  to  be  included 
in  gross  income.'^^  If  a  beneficiary  has  the  option  of  receiving 
insurance  proceeds  upon  the  death  of  the  insured  or  of  leaving 
the  money  with  the  company  to  draw  interest,  and  the  latter 
course  is  adopted,  it  has  been  held  that  the  beneficiary  in  effect 
loans  the  money  to  the  company  and  the  interest  so  received  is 
taxable  income  in  the  year  of  receipt.  If  there  is  no  such  option, 
the  rule  is  otherwise.'^^ 

Tontine  Insurance.  When  a  taxpayer  takes  out  an  insur- 
ance policy  on  the  tontine  plan  in  1902  and  in  1917  receives  the 

73  Letter  from  treasury  department  dated  March  15,  1918;  I.  T.  S.  1918, 
113290;  Reg.  45,  Art.  541. 

74  Reg.  45,  Art.  72. 

75  Revenue  Act  of  1921,  §213   (b)    (9). 

76  0.  D.  1037,  T.  B.  38-21-1827. 

77  0.  D.  433,  T.  B.  14-20-825. 

78  0.  995,  T.  B.  10-20-778. 

79  0.  D.  612,  T.  B.  31-20-1101. 


INCOME   FROM    MISCELLANEOUS   SOURCES  555 

total  accumulated  dividends,  the  face  value  of  the  policy  being 
payable  to  assured  in  1922,  if  living,  the  amount  received  in 
1917  is  not  income  for  that  year.  The  excess  of  the  amount  re- 
ceived at  maturity  of  the  policy  plus  all  dividends  received 
thereon,  over  the  total  premiums  paid  prior  to  March  1,  1913, 
or  the  cash  surrender  value  of  the  policy  as  of  that  date,  which- 
ever is  greater,  plus  the  premiums  paid  subsequent  to  March  1, 
1913,  will  represent  taxable  income  to  be  reported  for  the  year 
in  which  received.^^ 

Dividends  on  Life  Insurance  Policies.  Dividends  paid  on 
life  insurance  policies  that  have  not  matured,  whether  or  not 
such  dividends  are  drawn  in  cash  by  the  insured  or  applied  to 
the  reduction  of  the  annual  premium  due,  are  not  considered 
items  of  taxable  income.  Distributions  on  paid-up  policies  which 
are  made  out  of  earnings  of  the  insurance  company  subject  to 
tax  are  in  the  nature  of  corporate  dividends  and  are  income 
of  an  individual  only  for  the  purpose  of  the  surtax.  The  former 
represents  merely  a  return  of  a  part  of  the  premium  thereto- 
fore paid  by  the  insured,  while  the  latter  represent  a  distribu- 
tion of  income  earned  by  the  insurance  companies  on  the  pre- 
miums paid  by  the  insured.-^^ 

Surrender  Value  of  Insurance  Policies.  When  an  insured 
person  discontinues  insurance  prior  to  the  maturity  of  his 
policy,  he  is  entitled  to  a  certain  surrender  value  which  is  paid 
to  him  by  the  insurance  company.  The  amount  so  received 
represents  the  return  to  the  insured  of  a  part  of  the  premiums 
he  has  paid  in  the  past,  and  is  therefore  not  income.  If  the 
amount  should  exceed  the  aggregate  of  premiums  paid,  the  ex- 
cess would  be  taxable  income.^- 

Endow^ment  Policies.  Where  an  endowment  policy  is  paid 
to  the  insured,  it  is  exempt  from  tax  to  the  extent  that  the 
payment  represents  a  return  without  interest  to  the  insured  of 
amounts  paid  by  him  from  time  to  time  as  premiums,  but  is 
taxable  on  the  excess.'^^  Thus,  if  over  a  period  of  years  the  in- 
sured has  paid  $700  in  premiums,  and,  at  the  expiration  of  the 
terms  receives  $1,000  from  the  insurance  company,  $300  of  that 
sum  is  taxable  income,  but  the  $700,  representing  return  of  pre- 
miums, is  not  income. 

SOO.  D.  490,  T.  B.  19-20-910. 
SI  Reg.  45,  Art.  47;  T.  D.  2137. 

82  Revenue  Act  of  1921,  §  213  (b)  (2)  ;  Revenue  Act  of  1918,  §  213  (b) 
2;  Reg.  45,  Arts.  47  and  72;  T.  D.  2090;  T.  D.  2152;  Letter  from  treasury 
department  dated  February  8,  1917;  I.  T.  S.  1921,  111197. 

83  Revenue  Act  of  1921,  §213  (b)  (2);  Revenue  Act  of  1918,  §213  (b) 
2;  Reg.  45,  Arts.  47  and  72;  T.  D.  2090;  T.  D.  2152. 


556  federal  income  tax 

Accident,  Health  or  Workmen's  Compensation  Insur- 
ance. Amounts  received  through  accident  or  health  insurance 
or  under  workmen's  compensation  acts  as  compensation  for 
personal  injuries  or  sickness  are  exempt,  whether  the  insured 
be  alive  or  dead  and  whether  received  by  him,  his  estate  or  other 
beneficiaries.^^  The  amount  of  any  damages  received  by  the  in- 
dividual injured  or  sick,  if  living,  or  his  estate  or  other  bene- 
ficiaries entitled  to  receive  such  damages,  if  dead,  whether  by 
suit  or  agreement,  on  account  of  such  injuries  or  sickness  is 
also  exempt.^-^ 

Annuities.  The  Revenue  Act  of  1921,  like  the  1918  Law,  pro- 
vides that  the  amount  received  by  the  insured  as  a  return  of 
premiums  paid  by  him  under  life  insurance,  endowment  or 
annuity  contracts  either  during  the  term  or  at  the  maturity  of 
the  term  mentioned  in  the  contract  or  upon  surrender  of  the 
contract  is  exempt  from  taxation.'^'''  Under  this  provision  of 
law  the  treasury  department  has  ruled  as  follows:  Annuities 
paid  by  religious,  charitable  and  educational  corporations  under 
an  annuity  contract  are  subject  to  tax  to  the  extent  that  the 
aggregate  amount  of  the  payments  to  the  annuitant  exceeds  any 
amounts  paid  by  him  as  consideration  for  the  contract.  An 
annuity  charged  upon  devised  land  is  income  taxable  to  the 
annuitant,  whether  paid  by  the  devisee  out  of  the  rents  of  the 
land  or  from  other  sources.  The  devisee  is  not  required  to  re- 
turn as  taxable  income  the  amount  of  rent  paid  to  the  annuitant, 
and  he  is  not  entitled  to  deduct  from  his  taxable  income  any 
sums  paid  to  the  annuitant.     Where  an  insured  receives  under 

s-t  Revenue  Act  of  1921,  §213  (b)  (6);  Revenue  Act  of  1918,  §213  (b) 
(6)  ;  Reg.  45,  Art.  72.  Accident  insurance  was  first  considered  income  (to 
the  extent  that  it  exceeded  the  aggregate  premiums  paid)  but  amounts  re- 
ceived from  a  railroad  company,  by  w^ay  of  reimbursement  for  expenses 
incident  to  an  accident  were  not  income.  These  rulings  were  revoked,  and 
it  was  held  in  pursuance  of  an  opinion  of  the  Attorney  General  (based  upon 
Doyle  v.  Mitchell  Brothers,  247  U.  S.  179,  affirming  235  Fed.  686;  Lynch 
V.  Turrish,  247  U.  S.  221;  and  Southern  Pac.  Co.  v.  Lowe,  247  U.  S.  330) 
that  the  proceeds  of  accident  insurance  policies  received  by  an  individual 
on  account  of  injuries  sustained  by  him  through  accident  were  not  income 
under  the  1916  Law  as  amended.    (T.  D.  2747.) 

85  Revenue  Act  of  1921,  §213  (b)  (6);  Revenue  Act  of  1918,  §213  (b) 
(6)  ;  Reg.  45,  Art.  72.  Under  the  1916  Law  amounts  received  as  the  result 
of  a  suit  or  compromise  for  "pain  and  suffering"  were  at  first  held  to  be 
income.    (T.  D.  2135.)    This  ruling  was  subsequently  revoked.    (T.  D.  2747.) 

80  Revenue  Act  of  1921,  §213  (b)  (2);  Revenue  Act  of  1918,  §213  (b) 
(2). 


INCOME   FROM    MISCELLANEOUS   SOURCES  557 

life  insurance,  endowment  or  annuity  contracts,  sums  in  excess 
of  the  premiums  paid  therefor,  such  excess  is  income  for  the 
year  of  its  receipt.^'^ 

•^T  Reg.  45,  Art.  47;  O.  D.  612,  T.  B.  7-19-289.  Under  the  1913  Law  it  was 
held  that  the  amount  by  which  the  sum  received  exceeded  the  sum  paid 
and  coming  into  the  hands  of  the  person  making  the  contracts  and  pay- 
ment was  income.  It  was  also  first  held  that  "when  the  settlement  under 
such  contract  and  payment  is  made  in  more  than  one  payment  each  pay- 
ment will  be  considered  as  being  composed  of  interest  and  a  proportionate 
part  of  the  principal,"  and  "where  the  entire  annuity  is  composed  of  an 
interest  return  upon  the  principal  sum  paid  therefor,  the  entire  annuity 
is  income."  (T.  D.  2090.)  The  matter  quoted,  however,  was  afterward 
stricken  out  of  the  ruling.    (T.  D.  2152.) 


CHAPTER  21 

DEDUCTIONS — IN  GENERAL 

Certain  deductions  are  specified  in  the  law  for  computing  the 
net  income  of  an  individual  or  a  corporation. ^  Both  the  Revenue 
Act  of  1918  and  the  present  law  also  expressly  provide  that  cer- 
tain items  shall  not  be  deductible  in  the  case  of  both  individuals 
and  corporations.-  While  the  deductions  allowed  corporations 
and  individuals  are  based  upon  the  same  principles,  they  vary 
in  some  particulars,  because  of  differences  in  the  status  of  these 
two  classes  of  taxpayers.  Thus,  an  individual  may  deduct  chari- 
table contributions  or  gifts  made  within  the  taxable  year,  while 
no  corresponding  deduction  is  allowed  to  corporations.  The 
separate  provisions  made  in  the  case  of  individuals  for  the  de- 
duction of  losses  sustained  in  any  transaction  entered  into  for 
profit  though  not  connected  with  trade  or  business,  and  losses  of 
property  not  connected  with  trade  or  business,  if  arising  from 
fires,  storms,  etc.,  have  no  counterparts  in  regard  to 
corporations,  since  a  corporation's  transactions  are  all  entered 
into  for  profit  and  are  connected  with  its  business.  All  losses 
of  a  corporation  may  therefore  be  deducted,  unless  they  are  in- 
curred in  ultra  vires  transactions.  Certain  special  deductions  are 
allowed  in  the  case  of  insurance  companies  which  are  not  neces- 
sary in  the  case  of  individuals,  and  other  kinds  of  corporations.^ 
Dividends  from  domestic  corporations  and  from  certain  foreign 
corporations  are  allowed  as  a  deduction  to  corporations  and  to 
individuals  only  as  a  credit  for  the  purpose  of  the  normal  tax. 
The  general  effect  of  the  Revenue  Act  of  1918  as  compared  with 
preceding  laws  was  to  place  individuals  and  corporations  more 
nearly  upon  the  same  footing  in  regard  to  deductions,  and  this 
policy  is  continued  in  the  present  law.  In  the  case  of  nonresident 
aliens  and  foreign  corporations  the  deductions  are  intended  in 
general  to  be  limited  to  expenses,  losses,  etc.,  paid  or  incurred  in 
the  creation  of  income  taxed  by  this  government.*  The  special 
provisions  applicable  to  individuals,  corporations,  nonresident 
aliens  and  foreign  corporations  are  set  forth  in  the  chapters  deal- 
ing respectively  with  those  subjects.    The  general  provisions  and 

1  Revenue  Act  of  1921,  §§214,  234;  Revenue  Act  of  1918  §§214,  234. 

2  Revenue  Act  of  1921,  §§215,  235;  Revenue  Act  of  1918,  §§215,  235. 

3  See  Chapter  11. 

4  See  Chapters  4  and  12.     See  A.  R.  M.  100,  T.  B.  49-20-1331. 

558 


DEDUCTIONS — IN    GENERAL  559 

principles  applicable  to  all  taxpayers  are  discussed  in  this  and 
the  following  chapters.  The  main  amendments  made  by  the 
Revenue  Act  of  1921  discussed  in  this  chapter  are  the  changes 
made  in  respect  to  charitable  contributions  and  the  provision  in 
regard  to  the  shrinkage  in  the  value  of  a  life  or  terminable  in- 
terest acquired  by  gift,  bequest  or  inheritance. 

Only  the  Deductions  Specified  in  the  Statute  Are  Allowed.  Al- 
though the  tax  is  imposed  on  the  "net  income"  of  a  taxpayer,  yet 
the  term  "net  income"  is  used  as  defined  in  the  statute,  and  not 
as  known  generally  in  accounting  practice.  Some  deductions  dic- 
tated by  prudence  and  good  business  management  are  not  recog- 
nized or  countenanced  by  the  law.  Only  those  deductions  which 
are  expressly  specified  in  the  statute  may  be  taken  for  income  tax 
purposes.  It  may  be  observed  that  the  present  law,  to  a  greater 
degree  than  any  preceding  law,  follow^s  the  lines  of  commercial 
usage  in  defining  net  income.^ 

Deductions  Must  Be  Actual.  The  deductions  specified  in  the 
statute  can  be  deducted  by  the  taxpayer  only  when  they  represent 
actual  payments  or  actual  liabilities.  It  is  not  permissible,  for  in- 
stance, for  a  taxpayer  owning  the  property  used  and  occupied  for 
his  or  its  own  business  purposes  to  include  as  a  deduction  the 
rental  value  of  the  property  so  owned.  Neither  is  it  permissible 
to  deduct  an  amount  representing  the  interest  which  might  be 
earned  on  the  capital  employed  in  the  business,  if  such  capital 
were  invested  or  employed  otherwise,  or  were  so  placed  as  to  earn 
a  given  rate  of  interest.''  The  deductions  claimed  must  ordinarily 
be  those  represented  by  actual  cash  disbursements  unless  the  tax- 
payer keeps  his  books  on  some  other  basis  than  that  of  actual 
receipts  and  disbursements. 

Deductions  Not  to  Be  Duplicated.  Where  a  deduction  may,  or 
should  be,  claimed  as  one  of  the  items  specifically  stated  in  the 
law,  such  deduction  should  not  also  be  included  under  another 
head.  Thus,  where  a  deduction  is  claimed  as  depreciation  or  as  a 
loss,  the  same  amount  should  not  also  be  deducted  as  a  business 
expense,  or  if  the  cost  of  tools  or  small  articles  has  been  charged 
to  expense,  depreciation  should  not  be  claimed  thereon,  as  this 
would  be  claiming  the  same  deduction  twice.  Interest  paid  by  a 
corporation  constitutes  a  separate  deduction  and  should  not  be 
taken  into  account  as  a  part  of  the  cost  of  manufacture." 

•T  One  notable  variation  even  in  the  present  law  as  construed  by  the  Treas- 
ury department  is  the  treatment  of  corporate  organization  expenses. 

«T.  D.  2137.  Hays  v.  Gauley  Mountain  Coal  Co.,  247  U.  S.  189;  Walsh 
V.  Brewster. 

T  See  Revenue  Act  of  1921,  §  247    (c)  ;  T.  D.  2137. 


560  FEDERAL   INCOME   TAX 

Income  and  Deductions  Reported  on  Same  Basis.  Net  income 
means  gross  income  less  statutory  deductions.  The  statutory 
deductions  are  in  general,  though  not  exclusively,  expenditures, 
other  than  capital  expenditures,  connected  with  the  production  of 
income.  The  surtax  is  imposed  upon  net  income ;  the  normal 
tax  upon  net  income  less  credits.  Though  taxable  net  income 
is  wholly  a  statutory  conception  it  follows,  subject  to  certain 
modifications  as  to  exemptions  and  as  to  some  of  the  deductions, 
the  lines  of  commercial  usage.  Subject  to  these  modifications 
statutory  "net  income"  is  commercial  "net  income."^  Deductions 
are  to  be  reported  when  the  amounts  claimed  therefor  are 
"paid  or  incurred"  or  "paid  or  accrued"  on  the  books  of  the  tax- 
payer; that  is,  when  they  are  actually  paid  or  become  a  fixed 
liability  according  to  the  method  of  accounting  employed  by  the 
taxpayer.  In  other  words,  net  income  is  computed  on  the  basis 
of  actual  receipts,  or  on  the  basis  of  accrued  receipts.  Deductions 
must  be  claimed  on  the  same  basis  as  that  upon  which  gross  in- 
come is  reported.  They  must  usually  be  claimed  for  the  year 
in  which  the  income  with  the  production  of  which  they  are  con- 
nected is  reported.  The  taxable  year  as  a  unit  of  time  applies  to 
both  gross  income  and  deductions. 

Deductions  in  the  Equivalent  of  Cash.  It  is  not  always  neces- 
sary that  an  amount  claimed  as  a  deduction  be  paid  out  in  cash. 
Just  as  income  may  be  received  in  kind  or  in  the  equivalent  of 
cash,  so  deductions  may  be  represented  by  payments  in  some 
form  other  than  actual  cash.  For  instance,  it  has  been  held  that 
commissions  allowed  salesmen  and  paid  in  stock  may  be  deducted 
as  expense,  if  so  charged  on  the  books  of  the  corporation,  at  the 
actual  value  of  such  stock,^ 

When  Charges  Deductible.  Each  year's  return,  so  far  as  prac- 
ticable, both  as  to  gross  income  and  deductions  therefrom,  should 
be  complete  in  itself,  and  taxpayers  are  expected  to  make  every 
reasonable  effort  to  ascertain  the  facts  necessary  to  make  a  cor- 
rect return.  The  expenses,  liabilities  or  deficits  of  one  year  can 
not  be  used  to  reduce  the  income  of  a  subsequent  year.  A  person 
making  returns  on  an  accrual  basis  has  the  right  to  deduct  all 
authorized  allowances,  whether  paid  in  cash  or  set  up  as  a  liabil- 
ity, and  it  follows  that  if  he  does  not  within  any  year  pay  or 
accrue  certain  of  his  expenses,  interest,  taxes  or  other  charges, 
and  makes  no  deduction  therefor,  he  can  not  deduct  from  the  in- 
come of  the  next  or  any  subsequent  year  any  amounts  then  paid 

8  Reg.  45,  Art.  21. 

9  T.  D.  2625;  T.  D.  2433;  Reg.  33  Rev.,  Art.  126;  Reg.  33,  Art.  47. 


DEDUCTIONS — IN   GENERAL  561 

in  liquidation  of  the  previous  year's  liabilities.  A  loss  from  theft 
or  embezzlement  occurring  in  one  year  and  discovered  in  another 
is  deductible  only  for  the  year  of  its  occurrence.  Any  amount  paid 
pursuant  to  a  judgment  or  otherwise  on  account  of  damages  for 
personal  injuries,  patent  infringement  or  otherwise,  is  deductible 
from  gross  income  when  the  claim  is  put  in  judgment  or  paid, 
less  any  amount  of  such  damages  as  may  have  been  compensated 
for  by  insurance  or  otherwise.  If  subsequently  to  its  occurrence, 
however,  a  taxpayer  first  ascertains  the  amount  of  a  loss  sus- 
tained during  a  prior  taxable  year  which  has  not  been  deducted 
from  gross  income,  he  might,  under  the  1918  Law,  render  an 
aniended  return  for  such  preceding  taxable  year,  including  such 
amount  of  loss  in  the  deductions  from  gross  income,  and  may  file 
a  claim  for  refund  of  the  excess  tax  paid  by  reason  of  the  failure 
to  deduct  such  loss  in  the  original  return. ^'^  But  under  the  present 
law  losses  may  be  deducted  as  of  a  taxable  period  different  from 
that  in  which  they  were  sustained  if,  in  the  opinion  of  the  Com- 
missioner, they  should  be  deducted  as  of  such  a  different  period. ^^ 
A  more  detailed  discussion  of  when  deductions  should  be  taken 
will  be  found  elsewhere  in  this  book.^- 

Contributions  to  Charities.  A  citizen  or  resident  is  allowed  to 
deduct  from  his  net  income  contributions  or  gifts  made  within 
the  taxable  year  to  or  for  the  use  of:  (a)  The  United  States,  any 
state,  territory,  or  any  political  subdivision  thereof,  or  the  Dis- 
trict of  Columbia,  for  exclusively  public  purposes ;  (b)  any  corpo- 
ration, or  community  chest,  fund,  or  foundation,  organized  and 
operated  exclusively  for  religious,  charitable,  scientific,  literary, 
or  educational  purposes,  including  posts  of  the  American  Legion 
or  the  Women's  Auxiliary  units  thereof,  or  for  the  prevention  of 
cruelty  to  children  or  animals,  no  part  of  the  net  earnings  of 
which  inures  to  the  benefit  of  any  private  stockholder  or  individ- 
ual ;  or  (c)  the  special  fund  for  vocational  rehabilitation  author- 
ized by  the  Vocational  RehabiHtation  Act.i-'  The  1918  Law  ex- 
pressly permitted  the  deduction  of  gifts  or  contributions  when 
made  to  corporations  or  associations  organized  and  operated  ex- 
clusively for  religious,  charitable,  scientific  or  educational  pur- 
poses, or  to  societies  for  the  prevention  of  cruelty  to  children  or 
animals,  or  to  the  vocational  rehabilitation  fund.^^  The  above 
specification  of  posts  of  the  American  Legion  or  the  Women's 

.10  Reg.    45,    Art.    111. 

11  Revenue   Act  of  1921,   §   214    (a)    6;   234    (a)    4. 

12  See  Chapter  33. 

1- Revenue  Act  of  1921,  §  214  (a)  11. 
14  Revenue  Act  of  1918,  §  214  (a)  4. 


562  FEDERAL   INCOME   TAX 

Auxiliary  units  thereof,  was  not  made  in  the  1918  Law,  nor  did 
that  law  include  "literary"  organizations.  Aside  from  the  voca- 
tional rehabilitation  fund  the  1918  Law  in  terms  limited  this 
deduction  to  corporations  (which  included  "associations")  but  a 
gift  to  a  common  agency  (as  a  war  chest)  for  several  such  corpo- 
rations or  associations  was  held  to  be  the  same  as  a  gift  directly 
to  them.1'5  The  1918  Law  did  not  expressly  permit  the  deduction 
of  gifts  "for  public  purposes"  as  indicated  under  (a)  above,  but 
such  gifts  may  have  been  deductible  under  certain  circumstances 
as  indicated  below.  Like  the  1918  Law  the  present  law  limits 
the  deduction  for  gifts  or  contributions  to  an  amount  which  in 
all  the  above  cases  combined  does  not  exceed  15%  of  the  tax- 
payer's net  income  as  computed  without  the  benefit  of  the 
deduction.  In  case  of  a  nonresident  alien  individual  this  de- 
duction is  allowable  only  as  to  contributions  or  gifts  made  to 
domestic  corporations,  or  to  community  chests,  funds,  or  founda- 
tions, created  in  the  United  States,  or  to  such  vocational  re- 
habilitation fund.  Such  contributions  or  gifts  are  allowable  only 
if  verified  under  rules  and  regulations  prescribed  by  the  Com- 
missioner, with  the  approval  of  the  secretary.!*^ 

The  character  of  the  organization  receiving  a  gift  rather  than 
the  purpose  to  which  the  gift  is  put  is  ordinarily  the  test  of  de- 
ductibility.i'  In  connection  with  a  claim  for  this  deduction  the 
following  information  was  required  to  be  stated  on  returns  of 
income  and  will  undoubtedly  be  required  to  be  so  stated  under  the 
present  law:  (a)  The  name  and  address  of  each  organization 
to  which  a  gift  was  made,  (b)  The  approximate  date  and 
amount  of  the  gift  in  each  case.  Donations  made  by  a  partner- 
ship may  be  prorated  among  the  individual  partners  for  the  pur- 
pose of  their  individual  returns.^^  This  deduction  is  not  allowed 
to  corporations.!^  The  deduction  discussed  in  this  paragraph  does 
not  apply  to  gifts  by  estates  and  trusts.^o 

Contributions  in  Equivalent  of  Cash.  Where  a  gift  is 
other  than  money  the  basis  for  calculation  of  the  amount  of  the 

15  Reg.   45,   Art.   251. 

ifi  Revenue  Act  of  1921,  §214    (a)    11. 

17  0.  D.  465,  T.  B.  16-20-863. 

18  Letter  from  Treasury  Department  dated  May  23,  1918;  I.  T.  S.  1921, 
11553. 

19  Thus,  Red  Cross  contributions  are  not  deductible  by  corporations  (T. 
D.  2847;  Telegram  from  Treasury  Department  dated  May  23,  1918;  I.  T.  S. 
1918,  ^3436).  Contributions  are  allowed  to  corporations,  however,  in  some 
cases  when  they  have  consideration  in  some  form  so  as  to  take  them  out  of 
the  class  of  gratuities.     See  Chapters  10  and  22. 

20  See  Chapter  6. 


DEDUCTIONS — IN    GENERAL  563 

gift  is  the  cost  of  the  property,  if  acquired  after  February  28, 
1913,  or  its  fair  market  value  as  of  March  1,  1913,  if  acquired 
prior  thereto,  after  deducting  from  such  cost  or  value  the  amount, 
if  any,  which  has  been  or  which  should  have  been  set  aside  and 
deducted  in  the  current  year  and  previous  years  from  gross  in- 
come on  account  of  depreciation,  and  which  has  not  been  paid 
out  in  making  good  the  depreciation  sustained.-^ 

Examples  of  Deductible  Contributions.  Contributions  of 
the  following  character  have  been  held  to  be  deductible  under  this 
provision  of  the  1918  statute,  subject  to  the  15%  limitation: 

1.  Pew  rents  and  assessments  and  dues  paid  to  churches  ;  — 

2.  Contributions  to  a  board  of  education  of  a  school  district 
which  has  been  created  a  body  corporate  by  the  laws  of  a  state  ;-'5 

3.  Contributions  to  a  fund  established  for  the  pensioning 
of  members  of  a  municipal  police  force,  where  such  fund  is  in 
control  of  a  committee  constituted  by  law;^^ 

4.  Premiums  on  a  life  insurance  policy  when  the  beneficiary 
is  an  exempt  charitable  corporation,  provided  the  beneficiary  can 
not  be  changed  at  the  option  of  the  insured  ;^'^ 

5.  Contributions  for  the  support  of  an  association  organized 
and  operated  exclusively  for  the  purpose  of  giving  musical  con- 
certs, the  programs  being  of  an  educational  character,  and  no  part 
of  the  net  earnings  inuring  to  the  benefit  of  any  private  stock- 
holder or  individual;-'^' 

6.  Contributions  to  the  Council  of  National  Defense;-'^ 

7.  Contributions  to  an  association  incorporated  under  the  laws 
of  Porto  Rico  for  the  purpose  of  soliciting  and  obtaining  donations 
to  be  used  in  reconstruction  work  and  for  charitable  purposes  in 
portions  of  Porto  Rico  devastated  by  earthquake  and  tidal 
wave ;  -^ 

8.  Contributions  to  an  association  the  object  of  which  is  to 
erect  a  monumental  building  as  a  museum  and  depositary  for 
records,  flags,  trophies,  etc.,  of  the  late  war,  such  museum  being 

-'IT.  D.  2998,  superseding-  T.  D.  2966  and  T.  D.  2977;  T.  B.  15-20-856. 
See  O.  979,  T.  B.  7-20-740.  Under  an  earlier  ruling  the  fair  market  value 
of  the  gift  at  the  time  the  gift  is  made  was  the  basis  for  the  deduction 
(Letter  from  treasury  department  dated  August  14,  1919;  I.  T.  S.  1919. 
113550.) 

22  A.   R.   M.   2,   T.   B.   26-19-590. 

23  S.  1052,  T.  B.  8-19-321. 

24  8.   1202,  T.  B.  27-19-602. 

25  0.  D.  299,  T.  B.  24-19-566. 

26  S.   1176,  T.   B.  23-19-546. 

27  S.  992,  T.  B.  3-19-191. 

28  0.   D.   345,   T.   B.   30-19-641. 


564  FEDERAL   INCOME   TAX 

held  to  be  of  an  educational  nature,  even  though  the  provisions 
of  its  charter  authorized  it  to  construct,  equip,  operate  and  main- 
tain other  memorials  in  the  nature  of  statues,  monuments,  mem- 
orials, assembly  halls,  memorial  halls,  music  halls,  memorial 
art  galleries,  or  any  other  building  or  thing  to  commemorate 
persons,  causes,  occasions,  events  or  principles.-"  A  contribution 
of  money  towards  the  cost  of  an  article  presented  by  the  con- 
tributors to  a  corporation  organized  exclusively  for  educational 
purposes  is  deductible  from  the  gross  income  of  the  donors  within 
the  15%  limitation. 

Examples  of  Nondeductible  Contributions.  Contributions 
of  the  following  character  were  held  not  deductible  under  the 
1918  Law: 

1.  Contributions  to  the  National  Dry  Federation  ;•''" 

2.  Contributions  made  for  the  purpose  of  purchasing  land  and 
improving  same  for  use  as  a  public  park  or  recreation  ground, 
which  is  to  be  dedicated  as  a  memorial  to  soldiers  and  sailors  who 
served  in  the  late  war;3i 

3.  Contributions  by  citizens  of  a  city  for  the  purpose  of  in- 
ducing an  industrial  plant  to  locate  in  their  city ;  2- 

4.  The  value  of  property  given  to  a  public  high  school  for 
athletic  purposes  ;-'''3 

5.  Contributions  to  a  family  cemetery  corporation  organized 
under  the  laws  of  New  York;-"^^ 

6.  Contributions  or  gifts  made  to  a  corporation  organized 
and  operated  exclusively  for  the  purpose  of  erecting  and  main- 
taining monuments  or  other  like  memorials  are  not  allowable 
deductions  in  computing  net  income  of  individuals  contributing 
thereto,  even  though  no  part  of  the  net  earnings  of  such  corpo- 
ration inures  to  the  benefit  of  any  private  stockholder  or  individ- 
ual, such  corporations  not  being  charitable  or  educational  insti- 
tutions within  the  meaning  of  the  Revenue  Act  of  1918  ;35 

7.  Contributions  to  an  association  engaged  in  disseminating 
propaganda  to  encourage  the  passage  of  labor  legislation,  since 
such  an  association  is  not  an  educational  association;-^" 

20  A.  R.  R.  301,  T.  B.  45-20-1294,  reversing  O.  D.  649,  T.  B.  35-20-1170. 
30  o.  D.   44,   T.  B.   1-19-61. 
310.   D.   104,   T.   B.   2-19-152. 

32  O.  D.  39,  T.  B.  1-19-56. 

33  0.  D.  126,   T.  B.   3-19-192. 

34  0.  D.  217,  T.  B.  11-19-379. 

35  S.  1246,  T.  B.  8-20-755.  See  Molly  Varnum  Chapter,  D.  A.  R.,  v.  City  of 
Lowell,  204   Mass.  487,  90   N.   E.   893. 

30  S.  1362,  T.  B.  22-20-971. 


DEDUCTIONS — IN   GENERAL  565 

8.  Contributions  to  a  trust  company  (a  corporation)  in  trust 
to  invest  and  disburse  them  for  charitable  purposes,  the  cor- 
poration to  which  the  gift  is  made  not  being  organized  and 
operated  exclusively  for  charitable  purposes.-'''  "Contributions 
or  gifts"  are  construed  to  mean  gifts  of  money  or  property.  The 
value  of  services  rendered  to  charitable  institutions  may  not  be 
deducted  ;2s 

9.  A  gift  of  real  estate  to  a  city  to  be  maintained  perpetually 
as  a  public  park;^^ 

10.  Contributions  to  a  memorial  fund  of  which  a  corporation 
is  trustee  and  which  is  controlled  by  a  Board  of  Directors  and 
organized  not  to  engage  in  a  charitable  undertaking  itself,  but  to 
distribute  its  income  to  charitable  institutions  and  to  worthy 
indivijJuals;'*^ 

11.  Contributions  made  to  a  "Citizens  Club",  an  unincorpo- 
rated association  which  derives  its  income  from  annual  member- 
ship fees,  rental  of  its  auditorium  and  music  hall,  amounts  col- 
lected from  its  dining  room,  pool  tables,  bowling  alleys,  etc., 
the  club  never  having  been  self-supporting  and  the  deficit  of  each 
year  being  made  up  by  contributions,  the  club  furnishing  to  its 
members  facilities  for  which  they  pay  approximately  one-fifth  of 
the  cost,  where  the  primary  objects  sought  to  be  obtained  by  the 
organization  and  operation  of  the  club  are  the  "civic,  social  and 
moral  betterment  of  its  members  and  the  promotion  of  every 
enterprise  that  concerns  the  well-being  of  the  community",  the 
"promotion  of  educational  and  cultural  activities  which  shall 
provide  such  information  and  facts  as  will  better  enable  its  con- 
stituency to  form  accurate  and  unbiased  judgment  of  public 
questions",  and  also  the  promotion  of  athletic  and  recreational 
activities. ^^ 

Items  Not  Deductible.  Certain  items  are  expressly  declared 
not  to  be  deductible  in  computing  net  income,  as  indicated  in 
the  following  paragraphs : 

Personal,  Living  or  Family  Expenses.  In  computing  net 
income  no  deduction  is  allowed  in  respect  of  personal,  living  or 
family  expenses.^-'  These  expenses  may  be  said  to  be  covered  by 
the  arbitrary  sum  allowed  as  a  personal  exemption. 

37  0.  D.  669,  T.  B.  39-20-1211.     The  Revenue  Act  of  1918  makes  no  pro- 
vision for  the  deduction  of  charitable  contributions  to  a  trust. 
•■«0.  D.  712,  T.  B.  44-20-1277. 

39  Reg.  45,  Art.  251.    See  also  Reg.  33  Rev.,  Art.  8. 

40  O.  D.  872,  T.  B.  15-21-1563. 

41  A.  R.   R.  379,  T.  B.  6-21-1435. 

42  Revenue  Act  of  1921,  §  21^  (a)  ;  Revenue  Act  of  1918,  §  215  (a). 


566  FEDERAL  BNCOME   TAX 

The  following  items  have  been  held  to  be  personal,  living  or 
family  expenses  and  as  such  are  not  deductible: 

(1)  Alimony  and  an  allowance  paid  under  a  separation  agree- 
ment; amounts  paid  as  damages  for  breach  of  promise  to 
marry ;  ^-^ 

(2)  Insurance  paid  on  a  dwelling  owned  and  occupied  by  a 
taxpayer  including  premiums  paid  on  insurance  taken  out  under 
the  War  Risk  Insurance  Act,  whether  or  not  subsequently  con- 
verted ;  or  insurance  premiums  paid  by  a  wife  on  the  life  of  her 
husband  when  she  is  the  beneficiary  of  the  insurance;^* 

(3)  Amounts  expended  in  defending  a  suit  for  damages  al- 
leged to  have  been  caused  by  the  negligent  operation  of  an  auto- 
mobile owned  and  operated  for  personal  convenience;**^ 

(4)  Rent  paid  for  property  used  for  residential  purposes;*^ 

(5)  Amounts  expended  for  purchasing  furnishings  and  main- 
taining the  residential  portion  of  an  embassy ;  the  entertainment 
expenses  of  ambassadors  ;'*^ 

(6)  Expenses  incurred  by  doctors  in  taking  post-graduate 
courses  ;^'^ 

(7)  Expenses  incurred  by  school  teachers  in  attending  sum- 
mer schools  ;.'*^ 

(8)  Expenses  incurred  by  a  railroad  conductor  in  the  pur- 
chase of  uniforms  which  he  is  required  to  wear  during  business 
hours ;  -^o 

■13  Reg.  45,  Art.  291;  O.  D.  546,  T.  B.  24-20-1003;  0.  D.  275,  T.  B.  20-19- 
507.  In  a  case  in  which  a  trust  fund  was  created  by  a  divorced  husband  to 
continue  during  the  life  of  his  former  wife  as  a  guaranty  of  payment  to 
her  of  a  stipulated  amount  in  lieu  of  alimony,  any  income  in  excess  of  the 
stipulated  amount  to  be  paid  to  him  and  the  principal  to  revert  to  him  upon 
her  death,  the  Treasury  Department  first  held  that  the  principal  of  the 
trust  is  a  part  of  the  estate  of  the  husband,  that  he  is  the  real  beneficiary 
of  the  trust,  and  that  the  entire  income  from  the  trust  fund  must  be  in- 
cluded in  his  return.  (0.  D.  399,  T.  B.  6-20-730)  but  this  decision  has  been 
overruled   (O.  D.  1092,  T.  B.  45-21-1910.) 

44  Reg.  45,  Art.  291;  0.  D.  828,  T.  B.  9  21-1481 ;  0.  D.  48,  T.  B.  1-19-65. 

45  A.  R.  R.  444,  T.  B.  12-21-1527. 

40  Reg.  45,  Art.  241.  In  the  case  of  a  professional  man  who  uses  a  part 
of  his  house  for  his  office,  such  portion  of  the  rent  as  is  properly  attributable 
to  such  office  is  deductible,  but  if  such  house  is  used  only  incidentally  for 
receiving  clients,  patients  or  callers,  no  part  of  the  rent  is  deductible. 

47  0.  D.  1020,  T.  B.  36-21-1802. 

4S0.  D.  984,  T.  B.  31-21-1755. 

49  0.  D.  892,  T.  B.  17-21-1595. 

50  0.  D.  951,  T.  B.  25-21-1692. 


DEDUCTIONS — IN   GENERAL  567 

(9)  The  cost  of  equipment  of  an  army  officer  to  the  extent 
that  it  is  specifically  required  by  his  profession  and  takes  the 
place  of  an  article  required  in  civilian  life;"i 

(10)  Payments  for  the  medical  services  of  a  throat  specialist 
made  by  a  professional  singer ;  "•- 

(11)  The  attorney's  fees  paid  by  a  taxpayer  engaged  in  the 
retail  drug  business  in  connection  with  the  prosecution  for  the 
illegal  sale  of  narcotics  ;^''^ 

(12)  Provisions  withdrawn  by  a  taxpayer  who  is  the  sole 
proprietor  of  a  business  for  personal  or  family  use;"^^ 

(13)  Expenditures  for  the  safekeeping  of  securities  and  ren- 
tal of  safe  deposit  boxes  ;53 

(14)  Allowances  made  to  minor  children  whether  said  to  be 
in  consideration  of  services  or  otherwise  ;^^'  and 

(15)  Campaign  expenses  of  a  congressman.-" 
Traveling  Expenses  Under  the  1921  Law.  Traveling  ex- 
penses (including  the  entire  amount  expended  for  meals  and 
lodging)  while  away  from  home  in  the  pursuit  of  a  trade  or  busi- 
ness are  made  expressly  deductible  by  the  Revenue  Act  of  1921."''^ 
This  provision  takes  effect  as  of  January  1,  1921,  and  is  a  much 
needed  reversal  of  the  impracticable  regulations  issued  under  the 
1918  Law  in  regard  to  traveling  expenses. 

Traveling  Expenses  Under  Previous  Laws.  Under  the 
1916,  1917  and  1918  Laws'''^  traveling  expenses,  as  ordinarily  un- 
derstood, included  railroad  fares  and  meals  and  lodging.  If  the 
trip  was  undertaken  for  other  than  business  purposes,  such 
railroad  fares  were  held  to  be  personal  expenses  and  such  meals 
and  lodging  were  living  expenses.  If  the  trip  was  on  business,  the 
reasonable  and  necessary  traveling  expenses,  including  railroad 
fares,  and  meals  and  lodging  in  an  amount  in  excess  of  any  ex- 
penditures ordinarily  required  for  such  purposes  when  at  home, 
became  business  instead  of  personal  expenses.  If,  then,  an  in- 
dividual whose  business  required  him  to  travel  received  a  salary 

•'51  Reg.  45,  Art.  291.  Accordingly,  the  cost  of  a  sword  is  deductible,  hut 
the  cost  of  a  uniform  is  not. 

52  0.  D.  1032,  T.  B.  37-21-1819. 

53  O.  D.  952,  T.  B.  25-21-1693. 

54  0.  D.  998,  T.  B.  34-21-1777. 

55  Telegram  from  Treasury  Department  dated  March  8,  1921 ;  I.  T.  S. 
1921,  112837. 

56  Reg.  45,  Art.  291.  The  same  rule  was  followed  under  the  Civil  War  in- 
come tax  laws   (7  Int.  Rev.  Rec.  60.) 

57  0.  D.  864,  T.  B.  14-21-1549. 

58  Revenue   Act  of  1921,  §214    (a)    1. 

59  See  0.  D.  1015,  T.  B.  34-21-1795. 


568  FEDERAL   INCOME   TAX 

as  full  compensation  for  his  services,  without  reimbursement 
for  traveling  expenses,  or  was  employed  on  a  commission  basis 
with  no  expense  allowance,  his  expenses  for  railroad  fares,  and 
expenses  for  meals  and  lodging  in  an  amount  in  excess  of  any 
expenditures  ordinarily  required  for  such  purposes  when  at  home, 
were  deductible  from  gross  income.  If  an  individual  received 
a  salary  and  was  also  repaid  his  actual  traveling  expenses,  he 
was  required  to  include  in  gross  income  an  amount  thereof 
equal  to  the  ordinary  expenditures  required  for  meals  and  lodging 
when  at  home,  as  such  amount  was  held  to  be  additional  compen- 
sation to  the  taxpayer.  If  an  individual  received  a  salary  and  also 
an  allowance  for  meals  and  lodgings,  as,  for  example,  a  per  diem 
allowance  in  lieu  of  subsistence,  any  excess  of  the  cost  of  such 
meals  and  lodging  over  the  allowance  (plus  the  ordinary  expen- 
ditures required  for  such  purposes  when  at  home)  was  deductible, 
but  any  excess  of  the  allowance  over  such  expenses  (minus  such 
ordinary  expenditures)  was  taxable  income.  Congressmen  and 
others  who  received  a  mileage  allowance  for  railroad  fares  were 
required  to  return  as  income  any  excess  of  such  allowance  over 
their  actual  expenses  for  such  fares.  A  payment  for  the  use  of 
a  sample  room  at  a  hotel  for  the  display  of  goods  was  a  business 
expense.  This  contemplated  that  only  such  expenses  as  were 
reasonable  and  necessary  in  the  conduct  of  the  business  and  di- 
rectly attributable  to  it  might  be  deducted.  A  taxpayer  claiming 
the  benefit  of  the  deductions  referred  to  herein  was  required  to 
attach  to  his  return  a  statement  showing  (1)  the  nature  of  the 
business  in  which  engaged;  (2)  number  of  days  away  from  home 
during  the  calendar  year  on  account  of  business;  (3)  number  of 
members  in  taxpayer's  family  dependent  upon  him  for  support ; 
(4)  average  monthly  expense  incident  to  meals  and  lodging  for 
entire  family,  including  taxpayer  himself  when  at  home ;  (5) 
average  monthly  expense  incident  to  meals  and  lodging  when  at 
home  if  taxpayer  had  no  family;  (6)  total  amount  of  expenses 
incident  to  meals  and  lodging  while  absent  from  home  on  business 
during  taxable  year;  (7)  total  amount  of  excess  expenditures 
incident  to  meals  and  lodging  while  traveling  on  business  and 
claimed  as  a  deduction ;  (8)  total  amount  of  other  expenses  in- 
cident to  travel  and  claimed  as  a  deduction.  Claims  for  the  de- 
ductions referred  to  herein  were  required  to  be  substantiated, 
when  required  by  the  Commissioner,  by  records  showing  in  detail 
the  amount  and  nature  of  the  expenses  incurred.^'o    The  ''home" 

•50  Reg.  45,  Art.  292,  as  amended  by  T.  D.  3101,  T.  B.  51-20-1360.  See 
also  In  re  Assessment  of  Taxes  of  T.  A.  Hayes,  16  Haw.  796;  Galm  v.  U.  S., 
39  Ct.  Cls.  55;  A.  R.  R.  572,  T.  B.  29-21-1735;  0.  D.  893,  T.  B.  17-21-1596; 


DEDUCTIONS — IN   GENERAL  569 

contemplated  by  the  above  ruling  is  the  home  maintained  for  the 
purpose  of  carrying  on  business  and  not  the  distant  parental  home 
of  the  taxpayer."'  The  cost  of  transportation  paid  by  a  salaried 
employee  living  at  a  distance  from  his  employment,  in  order  to  go 
to  and  return  from  such  employment,  has  been  held  not  to  be 
deductible.    This  ruling  referred  to  commuters'  fares.'-- 

Where  a  taxpayer  makes  a  contract  of  employment  with  an 
employer  in  this  country,  and  upon  completion  of  such  contract 
he  makes  a  second  contract  with  another  employer  in  a  foreign 
country,  without  allowance  for  traveling  expenses,  the  expendi- 
ture incurred  in  reaching  such  place  of  employment  was  not  re- 
garded as  an  expense  incurred  in  furtherance  of  a  trade  or 
business,  under  the  1918  Law,  but  rather  as  an  expenditure  to 
fulfill  a  condition  precedent  to  such  employment  in  a  trade  or 
business.  The  test  was  held  to  be  whether  an  expense  is  in- 
curred primarily  because  of  business  as  the  immediate  cause 
inducing  the  expenditure. "-"^ 

Amounts  expended  by  a  secretary  to  a  member  of  congress 
and  by  his  assistants  for  railroad  fares,  in  making  trips  from 
their  homes  to  Washington  and  return  in  connection  with  their 
duties,  might  be  claimed  as  a  deduction  in  computing  net  income 
under  the  1918  Law.''^ 

0.  D.  924,  T.  B.  21-21-1650;  O.  D.  905,  T.  B.  19-21-1621;  A.  R.  R.  266,  T.  B. 
41-20-1230;  0.  D.  864,  T.  B.  14-21-1549.  Prior  to  the  promulgation  of  the 
above  regulations  and  rulings  the  regulations  of  the  department  con- 
templated that  if  an  individual  undertook  a  trip  on  business  only  his  railroad 
fares  and  other  incidental  expenses  attributed  to  business  and  not  ex- 
penses for  meals  and  lodging  were  deductible,  on  the  theory  that  expenses 
for  meals  and  lodgings  were  living  expenses.  It  was  then  recognized  that 
a  certain  amount  expended  while  on  such  a  trip  might  be  attributed  solely 
to  the  business,  but  the  fact  that  wherever  a  person  may  be,  at  home  or 
abroad,  he  necessarily  must  have  personal  and  living  expenses,  which  are 
not  deductible,  was  not  disregarded.  In  examples  (a),  (b)  and  (c)  above, 
this  principle  was  kept  in  mind  and  each  class  referred  to  was  put  on  the 
same  basis  as  to  such  expenses  (M.  2688,  T.  B.  2-21-1389,  containing 
examples  showing  the  applicability  of  the  above  ruling.) 

<>i  0.  D.  1021,  T.  B.  36-21-1803. 

ci'S.  1048,  T.  B.  8-19-317.  This  conforms  to  the  British  practice  (See 
Cook  V.  Knott,  2  Gt.  Br.  Tax  Cas.  246;  Revell  v.  Directors,  3  Gr.  Br.  Tax 
Cas.  12).  Its  validity  may  be  doubtful.  The  present  law  does  not  seem 
to  contemplate  the  deduction  of  such  expenses  as  "traveling  expenses," 
since  they  are  hardly  paid  while  the  taxpayer  is  away  from  home,  in  the 
sense  of  the  statute. 

«:iO.  D.  451,  T.  B.  15-20-848.  Under  the  present  law  it  would  probably 
also  be  held  that  this  expense  was  not  "in  pursuit  of  a  trade  or  business." 

w  O.  D.  865,  T.  B.  14-21-1550. 


570  FEDERAL   INCOME  TAX 

Improvements  and  Betterments.  Like  the  1918  Law  the 
Revenue  Act  of  1921  provides  expressly  in  the  case  of  individuals 
and  corporations  that  no  deduction  shall  be  allowed  in  respect 
of  any  amount  paid  out  for  new  buildings,  or  for  permanent  im- 
provements or  betterments  made  to  increase  the  value  of  any 
property  or  estate.^s  Amounts  expended  for  additions  and  better- 
ments add  to  the  value  of  the  property  and  are  considered  as  a 
capital  investment.*^'^  If  expenditures  are  made  for  permanent 
improvements  and  betterments  they  are  treated  as  any  othe** 
investment  of  capital ;  that  is,  if  the  asset  in  which  the  capital  is 
invested  is  one  on  which  depreciation  may  be  claimed,  the  amount 
expended  for  the  permanent  addition  or  betterment  is  added  to 
the  cost  of  the  property  for  the  purpose  of  determining  the  annual 
depreciation  allowance  thereafter.  The  statute  merely  intends  to 
prohibit  the  deduction  of  the  entire  amount  in  the  year  in  which 
the  expenditure  is  made.  In  a  case  in  which  in  1915  the  airshaft 
of  a  company's  mine  caved  in,  causing  the  destruction  of  a  fan, 
boiler  and  drum,  and  the  company  did  not  charge  off  the  loss  in 
1915  because  it  had  no  net  income  during  that  year,  but  restored 
the  equipment  in  1917,  it  has  been  held  that  such  cost  is  not 
merely  a  replacement  chargeable  to  expense,  but  is  a  capital  ex- 
penditure and  consequently  not  deductible."^ 

Examples  of  Capital  Expenditures.  The  following  have 
been  held  to  be  investments  of  capital  and  not  deductible  business 
expenses : 

(1)  Amounts  expended  for  securing  copyright  and  plates 
which  remain  the  property  of  the  person  making  the  payments ;  •^^ 

(2)  The  cost  of  defending  title  or  perfecting  title  to,  or  re- 
ducing an  assessment  for  a  local  benefit  against,   property;"^ 

(3)  Amounts  expended  for  architect's  services ;  ™ 

65  Revenue  Act  of  1921,  §§215  (b)  235;  Revenue  Act  of  1918,  §§215  (b) 
235. 

60  Reg.  33,  Art.  118.  Interest  and  taxes  paid  by  a  corporation  in  con- 
nection virith  the  construction  of  its  original  plant  are  deductible  from  its 
gross  income  under  the  Revenue  Act  of  1913,  even  though  such  payments 
are  properly  chargeable  to  capital  account  and  are  so  charged  by  the  cor- 
poration on  its  books,  provided  the  corporation  amends  its  returns  so  as  to 
exclude  the  interest  and  taxes  so  deducted  from  capital  account.  (S.  935, 
T.  B.  1-19-50.) 

67  A.  R.  R.  97,  T.  B.  19-20-920. 

68  Reg.  45,  Art.  293. 

69  Reg.  45,  Art.  293;  0.  D.  739,  T.  B.  48-20-1324.  Such  cost  constitutes 
a  part  of  the  cost  of  the  property. 

70  Reg.  45,  Art.  293.    Such  amounts  are  a  part  of  the  cost  of  the  building. 


DEDUCTIONS — IN    GENERAL  571 

(4)  Commissions  paid  in  purchasing  securities;"^ 

(5)  Amounts  to  be  assessed  and  paid  under  an  agreement  be- 
tween bondholders  or  stockholders  of  a  corporation,  to  be  used  in 
a  reorganization  of  the  corporation  ;'- 

(6)  An  assessment  paid  by  a  stockholder  of  a  national  bank 
on  account  of  his  statutory  liability;"'' 

(7)  Expenditures  of  a  railroad  for  sidings  and  spur  tracks;"^ 

(8)  State  bar  examination  fees  and  traveling  expenses  in- 
curred and  paid  by  a  lawyer  in  securing  admission  to  practice 
his  profession;'"' 

(9)  Amounts  expended  for  improvements  required  by  the 
United  States  public  health  service  to  be  made  on  property  in 
order  to  make  it  rat  proof  as  a  preventive  measure  against  bu- 
bonic plague;"" 

(10)  Commissions  on  sales  paid  by  a  corporation  to  an  officer 
or  employee  in  consideration  for  refraining  from  engaging  in 
a  like  business  for  a  stipulated  period;"" 

(11)  An  expenditure  in  1920  for  the  installation  of  dipping 
vats  for  the  purpose  of  complying  with  a  tick-eradication  law,  it 
appearing  that  such  vats  will  be  of  no  profitable  use  after  the 
time  fixed  by  law  for  the  eradication  of  the  cattle  tick;"^ 

(12)  Bills  for  material  used  in  the  construction  of  a  tax- 
payer's house  left  unpaid  by  an  absconding  contractor,  the  tax- 
payer being  required  to  pay  such  bills  ;'^ 

(13)  The  cost  of  land  title  abstract  books  ;-'^*^   . 

(14)  Legal  expenses  paid  by  a  nonresident  alien  in  securing 
the  return  of  property  and  income  from  the  Alien  Property  Cus- 
todian ;/^^ 

(15)  The  expenditure  for  labor  incident  to,  and  the  cost  of 
material  entering  into,  the  installation  of  apparatus  leased  by 
the  owner  under  a  lease  by  which  the  lessor  is  obliged  to  maintain 

"1  Reg.   45,   Art.   293.     Commissions   for   selling   securities   are   an   offset 
against  selling  price. 

72  Reg.  45,  Art.  293. 

73  Reg.  45,  Art.  293;  A.  R.  R.  588,  T.  B.  30-21-1744;  O.  D.  918,  T.  B.  20- 
21-1640. 

74  Grand   Rapids  &  Indiana  Ry.  Co.  v.   Doyle,  245  Fed.  792,  T.  D.  2210. 

75  0.  D.  452,  T.  B.  15-28-49. 

76  0.  D.  730,  T.  B.  46-20-1304. 

77  L.  O.  1045,  T.  B.  41-20-1231. 

78  O.  D.  738,  T.  B.  48-20-1322. 
70  0.  D.  925,  T.  B.  21-21-1651. 
so  O.  D.  1049,  T.  B.  39-21-1843. 
81  0.  D.  1048,  T.  B.  39-21-1842. 


572  FEDERAL   INCOME  TAX 

the  apparatus  without  charge,  the  value  of  the  apparatus  at  the 
expiration  of  the  lease  being  less  than  cost  of  removal  ;''^-  and 

(16)  A  sum  paid  upon  a  partnership  dissolution  to  cover  a 
retiring  partner's  estimated  share  of  future  profits."*" 

Public  Utilities.  In  a  decision  under  the  1909  Law  it  was 
held  that  the  fact  that,  under  the  laws  of  California,  a  public  util- 
ities corporation  is  not  the  owner  of  the  property,  but  merely 
intrusted  with  the  use  thereof,  did  not  entitle  it  to  more  favorable 
treatment  than  other  corporations.  Money  received  from  the  con- 
sumers to  pay  for  service  connections  to  be  laid  in  public  streets 
was  held  to  be  income  on  which  the  corporation  was  held  liable 
to  pay  a  tax,  notwithstanding  that  all  or  nearly  all  of  the  sums 
so  received  may  have  been  expended  in  betterments  and  exten- 
sion of  its  system.  Moneys  expended  for  service  connections  and 
pipe  extensions  were  regarded  as  invested  in  permanent  improve- 
ments, and  as  not  falling  within  any  of  the  permitted  classes  of 
deductions  mentioned  in  the  statute.'^^  They  were  held  not  to  be 
in  the  nature  of  improvements  made  merely  to  facilitate  the 
transaction  of  a  growing  business,  the  expenses  of  which  have 
been  held  deductible.'^"* 

Expense  of  Restoring  Property.  The  Revenue  Act  of  1918 
and  the  present  law  both  provide  expressly,  in  the  case  of  individ- 
uals and  corporations,  that  no  deduction  shall  be  allowed  in 
respect  of  any  amount  expended  in  restoring  property  or  in  mak- 
ing good  the  exhaustion  thereof  on  which  an  allowance  is  or  has 
been  made.'^*''  This  is  also  a  reasonable  limitation,  since  if  such 
property  is  subject  to  wear  or  tear  or  depletion,  the  additional 
amount  so  invested  in  the  property  may  be  taken  into  considera- 
tion in  computing  the  allowance  for  depreciation  or  depletion. 
The  cost  of  remodeling  buildings  for  manufacturing  a  different 
product  is  such  a  capital  expenditure.*^^ 

Insurance  on  Employees.  No  deduction  is  permitted  for  any 
amount  paid  in  premiums  on  any  life  insurance  policy  covering 
the  life  of  any  employee  or  any  person  financially  interested  in 
any  trade  or  business  carried  on  by  the  taxpayer,  when  the  tax- 

82  0.  D.  1082,  T.  B.  44-21-1894. 

83  O.  D.  1033,  T.  B.  37-21-1820.  Such  a  payment  is  additional  cost  of  the 
retiring  partner's  share  of  assets  and  should  be  apportioned  to  the  various 
assets  acquired. 

84  Union  Hollywood  Water  Co.  v.  Carter,  238  Fed.  329. 

83  See  Mutual  Benefit  Life  Ins.  Co.  v.  Herold,  198  Fed.  199,  affirmed  201 
Fed.  918. 

86  Revenue  Act  of  1921,  §§  215  (c),  235;  Revenue  Act  of  1918,  §§  215,  235. 

87  See  0.  D.  1001,  T.  B.  34-21-1780. 


DEDUCTIONS — IN   GENERAL  573 

payer  is  directly  or  indirectly  a  beneficiary  under  such  policy.^*^ 
But  if  the  taxpayer  is  in  no  sense  a  beneficiary  under  such  a 
policy,  except  as  he  may  derive  advantage  from  the  increased 
efficiency  of  the  employee,  and  pays  the  premiums  purely  as 
reasonable  additional  compensation  of  such  employee,  they  are 
allowable  deductions.  Under  the  1918  Law  whether  the  proceeds 
of  such  policies  paid  upon  the  death  of  the  insured  might  be 
excluded  from  gross  income  or  must  be  included  therein  depends 
upon  whether  the  beneficiary  was  an  individual  or  a  corporation.^^ 
But  under  the  present  law  they  may  be  excluded  by  either  an 
individual  or  corporation.'"*  Where  a  corporation  insures  the  life 
of  its  president,  the  stockholders  being  beneficiaries  in  proportion 
to  their  stockholdings  and  the  wife  of  the  president  (not  herself  a 
stockholder)  being  a  beneficiary  in  proportion  to  her  husband's 
stockholdings,  no  deduction  for  the  payment  of  premiums  can  be 
allowed  since  the  corporation  itself  is  indirectly  a  beneficiary  un- 
der the  policy.  The  premiums  paid  on  such  a  policy  are  a  charge 
against  surplus  and  represent  dividends  to  the  stockholders  to  the 
extent  that  such  premiums  are  paid  out  of  earnings  or  surplus 
accumulated  since  February  28,  1913.  This  applies  as  well  to  the 
officer  upon  whose  life  the  insurance  is  carried.''^  The  rule  as 
to  the  deductibility  of  premiums  paid  on  insurance  carried  by 
a  corporation  upon  the  lives  of  its  officers  or  employees,  where 
the  corporation  is  itself  the  beneficiary,  is  not  altered  by  the 
form  of  the  policy  taken  out.  Consequently  premiums  paid  on 
term  insurance  policies  as  well  as  on  life  and  endowment  policies 
under  the  conditions  stated  are  not  deductible  in  computing  the 
net  income  of  the  corporation  subject  to  tax.*^-  A  corporation 
which,  in  order  to  protect  itself  against  the  loss  of  services  of  a 
valuable  salesman,  increased  his  salary  with  the  understanding 

^'^  Revenue  Act  of  1921,  §§215,  235;  Revenue  Act  of  1918,  §§215  (d),  235 
It  was  held  by  the  Treasury  Department  that  the  corresponding  provision 
of  the  1916  Law,  as  amended  (Revenue  Act  of  1916,  §  32,  added  by  Revenue 
Act  of  1917),  applied  to  all  forms  of  life  insurance,  the  premiums  upon 
which  the  individual,  partnership  or  corporation  might  pay,  whoever  might 
be  the  beneficiaries.  (Reg.  33  Rev.,  Art.  236.)  Prior  to  the  passage  of  this 
provision  it  was  held  by  the  Treasury  Department  that  such  premiums 
were  deductible  (T.  D.  2090.)  This  ruling  was  subsequently  reversed  and 
it  was  held  thereafter  that  premiums  were  not  deductible  (T.  D.  2519,  dated 
August  30,  1917.)  It  seems,  from  the  language  of  this  latter  Treasury  De- 
cision, that  it  was  not  intended  to  have  a  retroactive  effect  for  years  prior  to 
1917. 

89  See  Reg.  45,  Art.  294,  as  amended  by  T.  D.  3019,  T.  B.  22-20-972. 

90  See  Revenue  Act  of  1921,  §§  213  (b)  233.     See  Chapters  14  and  20. 

91  O.  D.  659,  T.  B.  37-20-1193. 
9-'  O.   D.   699,   T.   B.  43-20-1261. 


574  FEDERAL   INCOME   TAX 

that  he  would  take  out  a  life  insurance  policy  in  favor  of  the 
corporation  and  pay  the  premiums  thereon,  may  deduct  only  so 
much  of  the  salary  as  is  in  excess  of  the  premiums  paid  inasmuch 
as  the  corporation  is  the  beneficiary  under  the  policy  and  in 
reality  pays  the  premiums  thereon  by  reason  of  having  increased 
the  employee's  salary  for  that  express  purpose.'*-^  Premiums  paid 
by  a  corporation  on  the  life  of  a  guarantor  of  a  debt  or  a  debtor 
to  the  corporation  are  deductible,  the  amount  received  as  a  distri- 
bution of  surplus  by  the  insurance  company  being  income,  as 
well  as  any  excess  of  any  amounts  received  in  the  policy  over  its 
cash  surrender  value  on  March  1,  1913.-'^ 

When  a  taxpayer  borrows  money  for  business  purposes  and  is 
required  to  take  out  life  insurance  in  favor  of  his  creditor  as 
security  for  the  loan,  the  premiums  paid  for  such  insurance  may 
be  deducted  as  a  business  expense  until  the  maturity  and  pay- 
ment of  the  loan.  This  rule  does  not  apply  unless  the  policy  was 
taken  out  for  the  sole  purpose  of  using  it  as  security  for  the  loan. 
A  taxpayer  is  not  permitted  to  deduct  the  premiums  paid  on  a 
policy  taken  out  prior  to  the  negotiations  for  a  loan  and  later 
assigned  to  the  lender  as  security  for  such  loan.  The  subsequent 
assignment  of  the  policy  to  the  lender  is  merely  incidental  to  the 
purpose  for  which  the  policy  was  secured,  and  no  additional 
expense  is  incurred  or  loss  sustained  by  virtue  of  its  temporary 
use  as  collateral.  The  increase  in  the  cash  surrender  value  of  a 
policy  accruing  during  the  period  it  is  used  as  collateral  is  not 
to  be  considered  in  computing  the  net  income  of  the  person  who 
pays  the  premium.  A  corporation  which  takes  out  a  policy  on 
the  life  of  one  of  its  officers  for  the  purpose  of  using  the  policy  as 
collateral  may  not  deduct  the  premiums  paid  thereon.-'-'' 

In  case  a  loan  is  renewed  for  the  full  amount,  and  a  policy  of  in- 
surance taken  out  in  favor  of  the  lender  for  the  express  purpose 
of  securing  the  loan  is  continued  as  security,  the  premium  paid 
thereon  by  an  individual  taxpayer  is  deductible  as  a  business 
expense  under  the  same  conditions  applicable  in  the  c^se  of  the 
original  loan. 

If  partial  payment  is  made  upon  the  maturity  of  the  loan,  and 
the  loan  is  renewed  for  the  reduced  amount,  the  premium  paid  is 
deductible  only  to  the  extent  that  it  is  paid  on  insurance  required 
as  security  for  the  reduced  amount  of  the  loan,^^' 

'■>■'  0.  D.  688,  T.  B.  42-20-1247. 

WO.  D.  1109,  T.  B.  47-21-1938;  O.  D.  38,  T.  B.  1-19-55. 
!••'•  0.  D.  711,  T.  B.  44-20-1276;  O.  D.  396,  T.  B.  6-20-726;  O.  D.  1011,  T.  B. 
35-21-1791. 

9''.  O.  D.  843,  T.  B.  11-21-1507. 


DEDUCTIONS — IN    GKNERAL  •^>'^''> 

Special  Assessmonis  A«ainsl  l.ocal  lienefils.  AlihouKh  assess- 
monts  aKainst  local  lu'iicrits  arc  fmiiu-iitly  referred  to  as  taxes, 
and  are  imposed  by  local  governments,  they  are  not  deductible  as 
taxes,  if  "of  a  kind  tending'  to  increase  the  value  of  the  property 
assessed."""  The  quoted  w(«rds  were  added  by  the  Revenue  Act 
of  1918,  and  are  continued  in  the  present  law.  Under  the  1916 
Law,  which  did  not  contain  this  provision,  such  assessments  as, 
for  instance,  for  paving,  curbing,  installing  sewerage  and  water 
systems,  etc.,  were  held  to  be  expenditures  which  add  to  the 
value  of  the  property  and  were  re(iuired  to  be  capital ized,  that 
is,  added  to  the  cost  of  the  property  for  the  purpose  of  determin- 
ing the  loss  or  gain  in  a  subsequent  sale  of  such  property.'-"^ 

Shrinkage  in  Vahie  of  Life  or  Terminable  Interest  Ac(|iiired  by 
Gift,  Request  or  Inheritance.  Under  a  new  provision  of  the 
Revenue  Act  of  1921  amounts  paid  under  the  laws  of  any  state, 
territory.  District  of  Columbia,  possession  of  the  United  States, 
or  foreign  country  as  income  to  the  holder  of  a  life  or  terminable 
interest  ac(iuired  by  gift,  bequest,  or  inheritance  may  not  be 
reduced  or  diminished  by  any  deduction  for  shnnkage  (by  what- 
ever named  called)  in  the  value  of  such  interest  due  to  the  lapse 
of  time,  nor  by  any  deduction  allowed  by  the  Revenue  Act  of  1921 
for  the  purpose  of  computing  the  net  income  of  an  estate  or  trust 
but  not  allowed  under  the  laws  of  such  state,  territory.  District 
of  Columbia,  possession  of  the  United  States,  or  foreign  country 
for  the  purpose  of  computing  the  income  to  which  such  holder 
is  entitled."" 

i.TKovcnu.  Ac-l  of   ID'il,  §§214    (a)    li/l'M    (a)    .*{;    Ri-vc.uu'   Art  ..f   I'JlH. 

§§214    (a)    :i;  234    (a)    3. 

"MA'tter   from  Treasury  Department  dated   Deeemlxr  — ,    1  .n  i ,    i-    '•   •->• 

1919,  11  1883. 

!•!»  Revenue  Act  of   l'.»21,  §215    (b). 


CHAPTER  22 

DEDUCTION  OF  BUSINESS  EXPENSES 

The  Revenue  Act  of  1921,  like  the  Revenue  Act  of  1918,  per- 
mits to  corporations  the  deduction  o*f  all  the  ordinary  and  neces- 
sary expenses  paid  or  incurred  during  the  taxable  year  in  carry- 
ing on  any  trade  or  business,  including  a  reasonable  allowance 
for  salaries  or  other  compensation  for  personal  services  actually 
rendered,  and  including  rentals  or  other  payments  required  to 
be  made  as  a  condition  to  the  continued  use  or  possession  of 
property  to  which  the  corporation  has  not  taken  or  is  not  taking 
title,  or  in  which  it  has  no  equity. ^  The  two  laws  permit  in- 
dividuals the  same  deduction,  except  that  the  property  with  re- 
spect to  which  rentals,  or  other  payments  required  to  be  made, 
may  be  deducted,  must  be  used  "for  purposes  of  the  trade  or 
business"  carried  on  by  the  individual,  ^  and  that  the  1921  Law 
contains  a  provision  which  was  not  contained  in  the  1918  Law, 
permitting  individuals  to  deduct  traveling  expenses  (including 
the  entire  amount  expended  for  meals  and  lodging)  while  away 
from  home  in  the  pursuit  of  a  trade  or  business.-''  The  deduc- 
tion of  business  expenses  is  allowed  in  the  case  of  nonresident 
aliens  and  nonresident  foreign  corporations  if  and  to  the  extent 
that  they  are  connected  with  income  arising  from  a  source 
within  the  United  States;  and  the  proper  apportionment  and 
allocation  of  their  deduction  with  respect  to  sources  of  income 
within  and  without  the  United  States  must  be  determined  in 
accordance  with  the  statute  and  under  rules  and  regulations 
prescribed  by  the  Commissioner  with  the  approval  of  the  sec- 
retary.^   The  special  provisions  applicable  to  nonresident  aliens, 

1  Revenue  Act  of  1921,  §  234  (a)  1;  Revenue  Act  of  1918,  §  234  (a)  1. 

2  Revenue  Act  of  1921,  §  214  (a)  1;  Revenue  Act  of  1918,  §  214  (a)  1. 

3  Revenue  Act  of  1921,  §  214  (a)  1.  See  Chapter  21,  as  to  traveling 
expenses. 

4  Revenue  Act  of  1921,  §§214  (b)  and  234  (b)  ;  Revenue  Act  of  1918, 
§§214  (b)  and  234  (b).  The  1916  Law  permitted  to  individuals  the  deduc- 
tion of  the  "necessary  expenses  actually  paid  in  carrying  on  any  business  or 
trade,"  (Revenue  Act  of  1916,  §5  (a)),  and  in  the  case  of  corporations  all 
the  ordinary  and  necessary  expenses  paid  within  the  year  in  the  mainte- 
nance and  operation  of  the  business  and  properties  of  the  corporation,  in- 
cluding rentals  or  other  payments  required  to  be  made  as  a  condition  to  the 
continued  use  or  possession  of  property  to  which  the  corporation  has  not 
taken,  or  is  not  taking,  title  or  in  which  it  has  no  equity.'"  The  Revenue 
Acts  of  1918  and  1921  further  qualify  the  expenses  deductible  as  stated  in 

576 


DEDUCTION    OF   BUSINESS    EXPENSES  577 

and  domestic  corporations  and  foreign  corporations  are  dis- 
cussed in  the  chapters  on  these  subjects.  The  discussion  in 
this  chapter  is  limited  to  the  rules  applying  generally  to  all 
taxpayers.  As  a  general  rule,  the  expenses  which  may  be  de- 
ducted are  those  necessary  for  the  creation  of  the  income  which 
is  taxed.  It  should  be  noted,  however,  that  the  language  of  the 
law  contains  some  express  limitations,  which  are  more  fully  dis- 
cussed in  the  following  paragraphs. 

"Ordinary  and  Necessary  Expenses."  Both  the  1918  Law 
and  the  1921  Law  provide  for  the  deduction  of  "all  the  ordinary 
and  necessary  expenses  paid  or  incurred  during  the  taxable  year 
in  carrying  on  any  trade  or  business.""'  The  Revenue  Act  of 
1916  provided  for  the  deduction  by  corporations  of  "all  the  ordi- 
nary and  necessary  expenses  paid  within  the  year  in  the  mainte- 
nance and  operation  of  its  business  and  properties."'"'  Under 
the  1916  Law  it  has  been  held  that  three  conditions  are  im- 
posed by  the  Congress  upon  the  allowance  of  a  deduction  under 
this  heading:  First,  the  deduction  claimed  must  be  for  "ex- 
penses *  *  *  in  the  maintenance  and  operation  of  its  business 
and  properties";  second,  they  must  be  "ordinary";  and  third, 
they  must  be  "necessary."  If  they  are  not  expenses  in  the 
maintenance  and  operation  of  the  business  and  properties  of 
the  corporation  they  are  not  deductible. 

To  be  deductible,  expenditures  must  consist  of  that  which  is 
spent  or  expended  or  the  cost  involved  in  the  maintenance  and 
operation  of  the  business  and  properties. 

It  is  not  enough  that  a  deduction  claimed  should  be  expenses. 
They  must  also  be  "ordinary  and  necessary."  The  use  of  the 
co-ordinate  conjunction  requires  that  "expenses"  to  be  deduc- 
tible be  both  "ordinary"  and  "necessary."  Neither  qualifica- 
tion alone  satisfies  the  requirement  of  the  statute.  "Ordinary" 
is  defined  by  Webster's  dictionary  as  "common,  usual,  often 
recurring." 

Construing  the  phrase  "ordinary  and  necessary  expenses" 
in  the  connection  in  which  it  is  used,  it  seems  that  the  deduc- 

the  text  above  by  stipulating  that  they  all  be  "ordinary"  as  well  as  "neces- 
sary," allows  their  deduction  if  "incurred"  as  well  as  "paid"  omitting  the 
word  "actually"  in  connection  with  the  word  "paid."  (Revenue  Act  of 
1916,  §  12  (a).)  In  the  case  of  nonresident  aliens  the  deduction  was  limited 
to  business  conducted  within  the  United  States  and  in  the  case  of  foreign 
corporations  to  business  and  property  within  the  United  States. 

•^Revenue  Act  of  1918,  §§214  (a)  1,  and  234  (a)  (1);  Revenue  Act  of 
1921,  §§214  (a)    (1)  and  234   (a)    (1). 

fi  Revenue  Act  of  1916,  §12   (a). 


578  FEDERAL  INCOME  TAX 

tion  intended  to  be  allowed  is  only  of  the  usual  or  common 
and  essential  or  reasonably  necessary  expenses  in  the  case  of  a 
corporation  doing  a  similar  kind  and  volume  of  business,  and, 
by  implication,  that  extraordinary  or  unnecessary  expendi- 
tures in  the  maintenance  or  operation  of  the  business  or 
properties  are  excluded.  Nor,  it  seems,  can  the  words  "ordi- 
nary and  necessary"  be  construed  as  referring  to  the  character 
of  the  expenses  only  and  not  also  their  amount.  To  the  popular 
mind  "ordinary  and  necessary  expenses"  of  a  corporation  are 
those  which  are  usual  and  essential  to  the  doing  of  a  like  kind 
and  volume  of  business  by  corporations  generally. 

Under  this  definition  of  "ordinary  and  necessary  expenses," 
the  question  of  whether  or  not  an  expenditure  claimed  as  a 
deduction  is  legally  obligatory  upon  the  corporation  and  the 
question  of  the  date  when  the  contract  was  entered  into  with 
reference  to  the  incidence  of  the  taxing  act  and  the  motive 
in  entering  into  the  contract  would  all  seem  to  be  immaterial.'^ 

Business  Expenses.  Business  expenses,  whether  subtracted 
from  total  receipts  in  computing  gross  income  or  deducted  from 
gross  income  in  computing  net  income,  include  all  items  entering 
into  what  is  ordinarily  known  as  the  cost  of  goods  sold,  together 
with  selling  and  management  expenses,  except  such  items  as 
are  otherwise  allowed  by  the  law  as  deductions.  Among  the 
items  to  be  treated  as  business  expenses  are  material,  labor, 
supplies  and  repairs  in  the  case  of  a  manufacturer,  while  a 
merchant  would  include  his  purchases  of  goods  bought  for  re- 
sale. In  either  case  the  amount  to  be  taken  as  a  deduction 
in  any  year  should  be  determined  by  taking  into  consideration 
the  inventory  at  the  beginning  and  end  of  the  year.  Other 
items  that  may  be  included  as  business  expenses  are  reasonable 
compensation  for  the  services  of  officers  and  employees,  advertis- 
ing and  other  selling  expenses,  together  with  insurance  pre- 
miums against  fire,  storm,  theft,  accident  or  other  similar  losses 
in  the  case  of  a  business,  and  rental  for  the  use  of  .business 
property.  A  taxpayer  is  entitled  to  deduct  the  necessary  ex- 
penses paid  in  carrying  on  his  business  from  his  gross  income 
from  whatever  source.^ 

7L.  O.  1045,  T.  B.  41-20-1241.  For  a  definition  of  the  term  "expense"  see 
People  V.  Board  of  Supervisors,  60  N.  Y.  Supp.  1122.  For  a  definition  of  the 
word  "necessary"  as  excluding  "extraordinary,"  see  Chicago  A.  R.  R.  v. 
House,  172  111.  601,  50  N.  E.  151;  Brown  v.  City  of  Corry,  175  Pa.  St.  528, 
34  Atl.  854,  855.  See  also  Mayor,  etc.,  of  City  of  Baltimore  v.  Chesapeake 
&  Potomac  Telephone  Co.,  92  Md.  692,  48  Atl.  465,  468. 

8  Reg.  45,  Art.  101.  The  1916  Law  permitted  the  deduction  by  corpora- 
tions of  "all  the  ordinary  and  necessary  expenses  paid     *     *     *     jjj  ^^g 


DEDUCTION    OF   BUSINESS   EXPENSES  579 

Where  in  addition  to  his  salary  as  an  employee,  a  taxpayer  re- 
ceives sundry  amounts  from  various  periodicals  for  articles  con- 
tributed by  him,  his  activities  in  this  respect  being  sufficiently 
frequent  to  constitute  his  writing  a  business,  it  has  been  held 
that  the  expenses  incurred  for  information  servfces,  magazines, 
stationery,  and  supplies  used  in  connection  with  the  production 
of  the  articles  referred  to  may  be  deducted  as  a  business  ex- 
pense, but  the  cost  of  books  is  held  to  be  a  capital  expense  and 
as  such  not  deductible.  There  may  be  taken  as  a  deduction  an 
amount  representing  depreciation  on  books,  typewriter,  fur- 
niture, and  other  equipment  of  a  permanent  character  in  pro- 
portion to  their  use  in  connection  with  the  production  of  such 
articles,  providing,  however,  that  no  other  deduction  in  respect 
thereof  has  been  or  is  being  claimed  in  a  return.  When  trips 
are  made  for  the  express  purpose  of  securing  facts  for  an 
article,  there  may  be  deducted  from  gross  income  the  reasonable 
and  necessary  traveling  expenses  including  railroad  fares,  as 
well  as  expenses  for  meals  and  lodging." 

Under  an  option  to  purchase  or  so-called  "bond  and  lease" 
agreement  concerning  mineral  property  providing  for  the  pay- 
ment of  royalties  on  ore  mined  and  for  the  payment  at  stated 
times  of  the  amounts  necessary  to  bring  the  total  amounts  paid  to 
certain  specified  sums,  and  giving  an  option  to  the  purchaser 
to  take  title  to  the  property  upon  the  payment  of  a  specified 
amount  upon  which  the  royalties  and  deficiency  payments  are 
credited  as  part  of  the  purchase  price,  the  amounts  paid  as 
royalties  constitute  operating  expenses  and  are  deductible  as 
such  in  determining  net  income.  The  additional  sums  paid  to 
make  up  the  amounts  of  the  several  installments  when  due 
are  capital  investments  in  the  nature  of  bonuses  recoverable 

maintenance  and  operation  of  its  business  and  properties."  The  1918  Law 
permits  the  deduction  by  corporations  of  "all  the  ordinary  and  necessary 
expenses  paid  *  *  *  in  carrying  on  any  trade  or  business,"  which  seems 
to  be  a  broader  phrase  than  that  used  in  the  1916  Law.  (Compare  Revenue 
Act  of  1916,  §  12  (a)  with  Revenue  Act  of  1918,  §  234  (a)  1.)  Expenses  of 
operation  were  held  under  the  1916  Law  to  include  all  expenditures  for  ma- 
terial, labor,  fuel,  and  other  items  entering  into  the  cost  of  the  goods  sold 
or  inventoried  at  the  end  of  the  year,  and  all  other  expenses  incurred  in  the 
operation  of  the  business,  except  such  as  were  required  by  the  act  to  be 
segregated  in  the  return  (Reg.  33,  Art.  114),  or  had  been  considered  in 
determining  the  cost.  (Grand  Rapids,  etc.  Ry.  Co.  v.  Doyle,  245  Fed.  792; 
T.  D.  2210.) 

9  0.  D.  805,  T.  B.  7-21-1446.  As  to  the  deductibility  of  traveling  ex- 
penses see  Chapter  21. 


580  FEDERAL   INCOME   TAX 

through  deductions  for  depletion,  computed  upon  the  total  sum 
of  such  additional  payments  to  the  end  of  the  tax  year.i^^ 

As  the  bonus  paid  for  delivery  of  a  steamship  at  a  date  earlier 
than  that  contracted  for  adds  nothing  to  the  value  of  the  vessel 
after  the  contract  date  of  delivery  the  amount  so  paid  is  properly 
chargeable  as  a  business  expense  and  is  deductible  from  income 
received  between  the  date  of  delivery  of  the  vessel  and  the 
date  it  would  have  been  delivered  had  no  bonus  been  paid.^i 

Where  an  officer  of  a  bank  was  appointed  receiver  and  trustee 
of  an  insolvent  debtor  of  the  bank,  and  before  accepting  office, 
agreed  that  he  would  turn  over  to  the  bank  whatever  compensa- 
tion he  received,  it  has  been  held  that  the  amount  of  compensa- 
tion so  received  by  the  officer  during  the  taxable  year  should 
be  reported  by  him  as  gross  income,  and  that  the  amount  of 
such  compensation  turned  over  to  the  bank  in  accordance  with 
the  agreement  referred  to  may  be  deducted  by  him  as  a  busi- 
ness expense.i- 

In  addition  to  the  above  the  following  items  have  been  held 
deductible  as  business  expenses:  (1)  Fees  paid  to  secure  em- 
ployment;  ^"^  (2)  dues  paid  to  an  organized  labor  union  ;i^  (3) 
amounts  expended  by  members  of  Congress  for  clerk  hire  in 
excess  of  the  allowance  made  by  the  government  ;^^  (4)  expenses 
incurred  by  a  taxpayer  engaged  in  trade  or  business  in  making  a 
trip  to  Washington  in  connection  with  an  additional  tax  assessed 
by  the  bureau  of  internal  revenue,  upon  his  trade  or  business  ;i'^ 
(5)  amounts  expended  for  office  rent  and  clerical  help  by  a  tax- 
payer whose  income  is  derived  principally  from  investments  in 
stocks  and  bonds,  if  he  can  show  in  his  return  that  such  ex- 
penses are  ordinary  and  necessary  within  the  meaning  of  the 
statute  ;i"  (6)  the  subscription  price  paid  by  a  taxpayer  for  a 
technical  magazine  or  trade  journal  to  be  used  by  him  as  a  means 
of  furthering  his  business  interests;^"*  (7)  the  payment  of  an 
addition  to  tax  for  delinquency  in  filing  a  return  when  such  addi- 

1"  Sol.  Op.  86,  T.  B.  4-21-1406. 
11  O.  D.  664,  T.  B.  38-20-1203. 
1-  0.  D.  1009,  T.  B.  35-21-1789. 
1:5  O.  D.  579,  T.  B.  28-20-1055. 
l■^  O.  D.  450,  T.  B.  15-20-846. 
15  0.  D.  310,  T.  B.  25-19-583. 
ICO.  D.  849,  T.  B.  12-21-1518. 
i<  O.  D.  877,  T.  B.  16-21-1576. 
^^  O.  D.  785,  T.  B.  5-21-1417. 


DEDUCTION    OF    BUSINESS    EXPENSES  581 

tion  is  incident  to  carrying  on  a  business  or  trade;'"'  (8)  the  cost 
of  erecting  a  portion  of  a  siding  from  a  railroad  to  his  property 
borne  by  a  taxpayer,  the  siding  to  be  owned  and  operated  by  the 
railroad;-"  (9)  an  amount  expended  by  a  taxpayer  for  attorney's 
fees  in  defending  a  suit  for  negligence  brought  by  a  tenant  in- 
jured on  the  taxpayer's  farm.-' 

The  following  items  have  been  held  not  to  be  deductible  as 
business  expenses:  (1)  The  cost  of  transportation  paid  by  a 
salaried  employee  living  at  a  distance  from  his  employment  in 
order  to  go  and  return  from  such  employment;'--  (2)  amounts 
expended  in  defending  a  suit  for  damages  alleged  to  have  been 
caused  by  the  negligent  operation  of  an  automobile  owned  and 
operated  for  personal  convenience.-'^  Where  ships  in  process 
of  construction  under  contract  were  requisitioned  by  the  ship- 
ping board,  completed,  and  then  reconveyed  to  the  company  from 
which  they  were  requisitioned  for  an  amount  in  excess  of  the 
contract  price,  the  entire  cost  is  held  to  be  a  capital  expendi- 
ture and  the  excess  of  the  cost  over  the  contract  price  is  not 
deductible  as  a  loss  or  a  business  expense.-^ 

Business  Expenses  Connected  With  Leasehold  Property. 
The  law  provides  for  the  deduction  as  expense  of  rentals  or  other 
payments  required  to  be  made  as  a  condition  to  the  continued 
use  or  possession,  for  purposes  of  the  trade  or  business  in  the 
case  of  an  individual,  and  in  all  cases  by  corporations,  of  prop- 
erty to  which  the  taxpayer  has  not  taken  or  is  not  taking  title, 
or  in  which  he  has  no  equity.-'  Where  a  leasehold  is  acquired  for 
business  purposes  for  a  specified  sum,  the  purchaser  may  take 
as  a  deduction  in  his  return  an  aliquot  part  of  such  sum  each 
year,  based  on  the  number  of  years  the  lease  has  to  run.-'' 
Not  only  is  rent  paid  for  business  property  deductible  as  an 
expense,  but  also  amounts  paid  to  secure  immediate  possession 
of  property  purchased  from  a  tenant  in  possession.  Sums  so 
paid  should  be  spread  as  a  deduction   in  equal  amounts  over 

i!>0.  926,  T.  B.  23-19-551.  The  payment  of  an  addition  to  tax  because 
of  a  false  or  fraudulent  return  may  not  ordinarily  be  deducted  in  the  case 
of  an  individual  who  himself  was  guilty  of  making  a  fraudulent  return. 

-'«'  O.  D.  1019,  T.  B.  36-21-1800. 

^1  O.  D.  1117,  T.  B.  48-21-1947. 

22  S.  1048,  T.  B.  8-19-317.     Such  cost  is  held  to  be  a  personal  expense. 

23  A.  R.  R.  444,  T.  B.  12-21-1527. 

24  O.  D.  851,  T.  B.  12-21-1520. 

2r.  Revenue  Act  of  1921,  §§214  (a)  1  and  234  (a)  1;  Revenue  Act  of 
1918,  §§214  (a)  1  and  234  (a)  1. 

2<;Reg.  45,  Art.  109;  T.  D.  3062,  T.  B.  37-20-1198. 


582  FEDERAL   INCOME   TAX 

the  term  of  the  outstanding  lease,^^  Where  a  lessor  pays  a 
fixed  sum  to  secure  the  cancellation  of  a  lease  on  business 
property,  the  sum  so  paid  is  an  allowable  deduction  in  aliquot 
parts  for  the  year  of  cancellation  and  the  succeeding  years 
of  the  life  of  the  lease.^s  Attorneys'  fees  in  connection  with 
securing  such  a  cancellation  are  also  a  proper  deduction.^^  Where 
the  lessee  of  business  premises  pays  to  the  lessor  as  damages 
a  lump  sum  in  consideration  of  the  lessor's  cancellation  of  a 
lease  for  a  term  of  years,  the  sum  paid  equalling  a  certain 
amount  for  each  month  of  the  unexpired  term,  it  is  held  that 
the  amount  paid  is  an  allowable  deduction  as  a  business  ex- 
pense. The  amount  of  the  damages  is  deductible  for  the  year 
in  which  actually  paid  or  accrued  depending  upon  the  method 
of  accounting  employed.^^  The  expense  of  restoring  property  at 
the  expiration  of  a  lease  is  an  allowable  deduction  only  in  the 
year  in  which  it  is  actually  incurred.^!  The  value  as  of  March  1, 
]913,  of  a  leasehold  acquired  prior  to  that  date,  can  not  be 
used  in  determining  the  amount  deductible  each  year  by  the 
lessee  when  the  leasehold  was  acquired  on  the  basis  of  annual 
rental  payments  equal  to  a  percentage  of  the  income  derived 
from  the  leased  property,  no  specified  sum  having  been  paid 
in  addition  to  the  annual  rentals.  The  amount  deductible  by 
the  lessee  each  year  is  the  rental  payment.^^-  A  lessor  of  resi- 
dential property  is  entitled  to  deduct  the  water  rent  paid  in 
the  District  of  Columbia  on  such  property,  since  in  such  case 
the  rent  is  a  business  expense  incident  to  the  lease  of  the  prop- 
erty. Where  water  rent  is  paid  on  residential  property  by 
the  person  occupying  it  as  such,  it  becomes  a  personal  expense 
and  is  not  an  allowable  deduction. ^3 

Advertising  Expenses.  A  corporation  may  deduct  the  ex- 
penses of  a  national  campaign  of  advertising  its  manufactured 
product  in  the  year  in  which  paid  or  accrued  and  may  not 
carry  such  expenses  as  a  deferred  asset  and  charge  them  off 
over  a  period  of  years.^*  Amounts  expended  in  outfitting  a 
baseball  team  which  represents  the  taxpayer,  and  the  uniforms 

27  O.  D.  585,  T.  B.  28-20-1061. 

28  0.  D.  397,  T.  B.  6-20-727;  A.  R.  R.  178,  T.  B.  28-20-1054. 

29  A.  R.  R.  178,  T.  B.  28-20-1054. 

30  0.  D.  974,  T.  B.  28-21-1726. 

31  0.  D.  516,  T.  B.  21-20-952. 

32  O.  D.  675,  T.  B.  40-20-1220. 

33  O.  D.  719,  T.  B.  45-20-1291. 

34  O.  D.  1039,  T.  B.  38-21-1829. 


DEDUCTION    OF   BUSINESS   EXPENSES  583 

of  which  bear  the  name  of  the  taxpayer  the  players  represent, 
if  considerable  publicity  is  thereby  obtained,  may  be  deducted 
like  other  advertising  expenses.^^ 

Expenses  Relating  to  Patents.  A  royalty  paid  by  a  cor- 
poration to  one  of  its  officers,  who  is  also  a  majority  stockholder, 
for  the  use  of  a  patent  upon  an  article  manufactured  and  sold 
by  the  corporation  is  deductible  as  a  business  expense,  pro- 
vided the  amount  so  paid  is  reasonable,  considering  the  value 
of  the  invention  and  its  salability  in  the  open  market.  Any 
payment  so  made  in  excess  of  a  reasonable  amount  would 
represent  a  distribution  of  profits,  and  consequently  would  not 
be  deductible.'^*^  Amounts  expended  by  a  corporation  in  litiga- 
tion defending  its  right,  title,  and  interest  in  a  patent  after 
the  patent  has  been  issued  are  not  a  part  of  the  cost  of  the 
patent  and  thus  capital  expenditure;  such  amounts  may  con- 
sequently be  deducted  as  an  operating  expense.^^ 

Professional  Expenses.  A  professional  man  may  claim  as  the 
cost  of  supplies  used  by  him  in  the  practice  of  his  profession, 
expenses  paid  in  the  operation  and  repair  of  an  automobile  used 
in  making  professional  calls,  dues  to  professional  societies  and 
subscriptions  to  professional  journals,  the  rent  paid  for  office 
rooms,  the  expense  of  the  fuel,  light,  water,  telephone,  etc., 
used  in  such  offices,  and  the  hire  of  office  assistants.  Amounts 
expended  for  books,  furniture  and  professional  instruments  and 
equipment  of  a  permanent  character  are  not  allowable  as  deduc- 
tions.38  A  professional  singer  may  not  deduct  payments  to  a 
throat  specialist.^^ 

Rent  for  Residential  Property.  In  the  case  of  a  profes- 
sional man  who  rents  property  for  residential  purposes  but  re- 
ceives there  clients,  patients,  or  callers  in  connection  with  his 
professional  work  (his  place  of  business  being  elsewhere)  no 
part  of  the  rent  is  deductible  as  expense.^" 

Cost  of  Manufacturing  Products.  A  manufacturer  might,  un- 
der the  1916  Law,  include  as  elements  of  the  cost  of  manufac- 
tured products,  the  cost  of  raw  material,  the  labor  cost  of  the 
men  actually  working  on  such  products,  as  well  as  the  cost  of 
supervisory  labor  such  as  that  of  foremen,  inspectors,  overseers, 
etc.,  provided  such  expenditures  were  not  separately  deducted 

35  O.  D.  1030,  T.  B.  37-21-1815. 
30  O.  D.  440,  T.  B.  14-20-835. 
37  A.  R.  R.  98,  T.  B.  20-20-934. 
3S  Reg.  45,  Art.  104. 

39  0.  D.  1032,  T.  B.  37-21-1819. 

40  Reg.  33  Rev.,  Art.  8. 


584  FEDERAL   INCOME  TAX 

from  gross  income. ^^  This  ruling  permits  certain  items  of  wages 
and  salaries  to  be  included  in  the  cost  of  the  manufactured 
product,  or  to  be  separately  listed  as  labor,  wages,  commissions, 
etc. 

Cost  of  Materials.  Taxpayers  carrying  materials  and  supplies 
on  hand  should  deduct  as  expenses  the  charges  for  materials 
and  supplies  only  to  the  amount  that  they  are  actually  con- 
sumed and  used  in  operation  during  the  year  for  which  the 
return  is  made,  provided  that  the  cost  of  such  material  and 
supplies  has  not  been  taken  into  account  in  determining  net 
income  for  any  previous  year.  If  a  taxpayer  carries  materials 
or  supplies  on  hand  for  which  no  record  of  consumption  is 
kept  or  of  which  physical  inventories  at  the  beginning  and  end 
of  the  year  are  not  taken,  it  will  be  permissible  for  the  taxpayer 
to  deduct  from  gross  income  as  expenses  the  total  cost  of  such 
supplies  and  materials  as  were  purchased  during  the  year  for 
which  the  return  is  made,  provided  the  net  income  is  clearly 
reflected  by  this  method. ^■- 

Repairs.  Incidental  repairs  made  to  the  business  property  of 
a  taxpayer,  which  neither  add  to  the  value  of  the  property  nor 
appreciably  prolong  its  life,  but  keep  it  in  an  operating  condi- 
tion, are  deductible  as  expense,  provided  the  plant  or  property 
account  is  not  increased  by  the  amount  of  such  expenditures."^-'' 
This  is  true  of  repairs  made  by  a  lessee  of  property  who  by  the 
terms  of  the  lease  is  required  to  return  the  leased  properties 
at  the  end  of  the  lease  in  the  same  condition  they  were  in  at  the 
date  of  the  lease.^^  Expenditures  for  replacing  worn-out  parts 
such  as  gears,  bolts,  nuts,  valves,  etc.,  so  long  as  such  replace- 
ments are  not  pursued  to  the  extent  of,  and  for  the  purpose 
of  finally  restoring  the  machinery  or  equipment  as  a  whole, 
constitute  incidental  repairs  and  are  deductible  as  operating 
expenses.  In  addition,  depreciation  on  the  property  so  repaired 
may  be  claimed  in  order  to  replace  the  machinery,  equipment 
or  building  when,  as  an  entirety,  it  is  worn  out  or  is  worthless 
for  the  purpose  for  which  it  is  intended.^s 

-n  T.  D.  2152. 

42  Reg.  45,  Art.  102. 

4?'  Reg.  33,  Art.  131 ;  Reg.  45,  Art.  103.  Maintenance  means  the  upkeep 
or  preserving  of  the  condition  of  the  property  to  be  operated  and  does  not 
mean  additions  to  the  equipment,  property  or  improvements  of  former  con- 
dition of  the  property.  Grand  Rapids,  etc.,  Ry.  Co.  v.  Doyle,  245  Fed.  792; 
T.  D.  2210. 

44  0.  D.  1014,  T.  B.  35-21-1794. 

45  Reg.  45,  Art.  103.  Letter  from  treasury  department  dated  September 
19,   1916. 


DEDUCTION    OF   BUSINESS   EXPENSES  585 

Where  a  corporation  engaged  in  buying  and  selling  real  estate 
purchases  a  piece  of  property  and  holds  it  for  a  profit,  the  inter- 
est, taxes,  and  ordinary  repairs  incident  to  the  property  repre- 
sent charges  for  the  year  in  which  paid  or  are  so  charged  upon 
the  books  as  to  represent  liabilities  of  the  corporation  and  are 
allowable  deductions  in  computing  net  income  even  though  in 
excess  of  the  gross  income  derived  from  the  property.  Such 
charges  are  not  capital  expenditures  if  the  corporation  has 
any  income  from  which  to  deduct  them  and  they  should  not  be 
added  to  the  cost  of  the  property  in  determining  the  amount  of 
gain  or  loss  arising  from  its  sale  except  to  the  extent  that  the 
corporation  has  no  gross  income  from  any  source  against  which 
to  deduct  such  expenditures  for  the  taxable  year  in  which  they 
were  made.^*'' 

Office  Furniture  and  Equipment.  An  ordinary  amount 
expended  for  renewal  of  office  furniture  and  equipment,  and 
charged  to  expense,  has  been  held  not  to  be  invested  in  assets, 
but  to  be  a  proper  expense  of  maintenance  of  the  business  of  an 
insurance  company,  which  it  was  entitled  to  deduct  in  ascer- 
taining its  taxable  net  income  under  the  1909  Law.  The  com- 
pany had  expended  in  one  year  $1,213  for  ordinary  renewals 
of  office  furniture,  in  another  year  $1,379,  and  an  additional 
sum  of  $1,808  for  ordinary  renewals  of  attendants'  uniforms, 
door  mats,  window  shades,  awning,  small  hardware,  oils  and 
other  articles  of  like  character  and  also  the  sum  of  $2,244  for 
ordinary  renewals  of  office  equipment,  consisting  of  lamps, 
alterations  of  fixtures,  shades,  meters,  fans,  plugs,  wirings,  etc., 
and  these  expenditures  were  no  greater  than  the  average  of 
similar  expenditures  for  other  years  and  did  not  exceed  5' i  of 
the  cost  of  all  the  plaintiflF's  existing  furniture  and  equipment 
similar  to  the  articles  detailed,  and  none  of  the  items  was  consid- 
ered in  the  corporation's  books  or  statement  as  assets  because  of 
their  rapid  depreciation.  The  articles  mentioned  were  of  a 
perishable  and  transient  nature,  and  properly  charged  to  ex- 
pense of  maintenance,  since  they  apparently  did  no  more  than 
maintain  in  proper  condition  and  repair  the  ordinary  equipment 
of  office  furniture  and  supplies.'^ 

Expenditures  for  Alterations.  In  the  case  of  a  company 
which  expended  approximately  $5,000  for  alterations  in  its  home 
office,  apparently  solely  with  a  view  of  facilitating  the  carrying 

^••'  O.  D.  398,  T.  B.  6-20-728.       " 

17  Mutual  Benefit  Life  Ins.  Co.  v.  Herold,  198  Fed.  199,  affirmed  201 
Fed.  918. 


586  '  FEDERAL  INCOME  TAX 

on  of  its  business,  it  was  held  under  the  1909  Law  that  such 
amount  was  properly  deducted  as  an  expense.  The  court  said 
in  part:  "It  should  be  remembered,  also,  that  in  these  days  of 
up-to-date  business  method  requirements  it  often  becomes  neces- 
sary for  business  concerns  to  change  the  lay-out  and  appoint- 
ments of  the  places  wherein  they  carry  on  business,  with  a  view 
to  economy  in  space,  a  saving  of  unnecessary  labor,  and  the 
bettering  of  working  conditions  of  employees,  to  the  end  that 
a  net  saving  of  running  expenses  will  result.  In  view  of  the 
consistent  expansion  of  the  plaintiff's  business,  which  the  evi- 
dence shows,  it  would  seem  that  the  amount  expended  for  the 
changes  made  in  the  office  ought  not,  under  the  circumstances, 
to  be  considered  unreasonable  or  unusual,  and  that,  therefore, 
the  amount  claimed  might  well  have  been  allowed  as  an  item  of 
deduction.  It  seems  to  the  court  that  business  concerns,  in 
matters  of  this  kind,  should  be  allowed  a  reasonable  discretion, 
and  the  law  so  enforced  as  to  help  rather  than  to  hinder  them 
in  making  reasonable  progress  in  the  development  of  their  busi- 
ness, for  it  must  appear  to  any  one  giving  the  matter  a  moment's 
consideration  that  the  more  successful  a  business  the  larger 
the  results,  even  from  the  standpoint  of  taxes  accruing  to  the 
government."  *s 

Repairs  and  Improvements  Made  by  a  Tenant.  Where  a 
lease  requires  the  tenant  to  make  all  necessary  repairs  or  im- 
provements, which  repairs  or  improvements  revert  to  the  land- 
lord at  the  expiration  of  the  lease,  the  tenant  may  charge  the 
cost  of  all  such  repairs  and  improvements  as  an  expense  of  do- 
ing business.  If  the  improvements  are  somewhat  permanent  in 
character,  the  expense  should  not  be  all  deducted  in  one  year, 
but  should  be  prorated  over  the  number  of  years  constituting 
the  term  of  the  lease,  and  the  amount  deductible  in  each  year 
would  be  the  aliquot  part  of  such  cost.^o  Taxes  or  other  expenses 
paid  by  the  tenant  for  the  landlord  should  be  deducted  by  the 
tenant  as  expense. 

Cost  of  Buildings  Erected  by  Tenant  Under  Terms  of 
Lease.  Where  under  the  terms  of  a  lease,  a  tenant  agrees  to 
erect  a  building,  or  to  expend  during  the  rental  period  a  fixed 
sum  in  making  improvements  upon  the  freehold,  the  building 
or  permanent  improvements  become  a  part  of  the  realty,  unless 
otherwise  agreed  upon  between  the  contracting  parties.  As  the 
use  of  the  building  or  permanent  improvement  by  the  tenant, 

48  Connecticut  Mutual  Life  Ins.  Co.  v.  Eaton,  218  Fed.  206. 

49  T.  D.  2137. 


DEDUCTION    OF   BUSINESS   EXPENSES  587 

during  the  term  of  the  lease,  is  a  part  of  the  consideration  of 
the  contract,  the  cost  of  such  buildings  or  improvements  may 
be  prorated  by  the  tenant  over  the  leased  term  and  deducted, 
at  an  annual  rate,  as  a  part  of  the  necessary  expenses  actually 
paid  in  carrying  on  any  business  or  trade.  The  tenant  may  also 
deduct  thie  cost  of  incidental  repairs  and  maintenance  to  such 
buildings  and  improvements,  but  no  depreciation  may  be  claimed 
v^ith  respect  to  such  buildings  and  improvements.^*^  If  the  build- 
ing is  erected,  or  permanent  improvements  are  made  after  the 
lease  is  partially  expired,  the  cost  thereof  may  be  divided  by 
the  number  of  years  the  lease  then  has  to  run,  and  if  the  life 
of  the  lease  is  longer  than  the  estimated  life  of  the  building  or 
improvements,  the  cost  may  be  divided  by  the  number  of  years 
such  building  or  improvements  are  expected  to  last,  instead  of 
the  number  of  years  constituting  the  life  of  the  lease.^^ 

Buildings  Used  for  Rental  Purposes.  A  landlord  may  claim 
as  an  expense  any  amounts  expended  for  maintenance  of  the 
property  or  its  use  for  rental  purposes,  including  amounts  paid 
for  repairs,  insurance,  fuel,  light  and  water,  and  janitor  and  ele- 
vator service,  if  any .5-  Where  the  landlord  occupies  a  part  of 
the  building  as  his  own  dwelling  he  should  not  deduct  such  pro- 
portion of  the  expenses  of  operating  the  building  as  inure  to  his 
personal  benefit,  as  that  part  constitutes  personal  or  living  ex- 
penses which  are  not  deductible.  Thus,  if  a  landlord  lives  in 
one-half  of  the  building,  one-half  of  the  expenses  are  not  an 
allowable  deduction  in  his  return. 

Reserves.  Payments  by  a  corporation  to  a  trustee  during  a 
taxable  year  and  set  aside  for  a  "maintenance  fund"  to  be  con- 
trolled solely  by  the  trustee  pursuant  to  a  provision  in  the  by- 
laws of  the  company  requiring  such  payments,  are  not  deductible. 
Such  amounts  held  by  the  trustee  and  accumulated  are  an  asset 
of  the  corporation  and  any  gain  accruing  therefrom  is  income  of 
the  corporation. "••■• 

Insurance  on  Property.  Insurance  premiums  paid  on  property 
used  for  business  purposes,  or  rented  or  leased  to  secure  an  in- 
come, are  an  allowable  deduction."'^    Premiums  on  crop  insurance 

f>OReg.  45,  Art.  109;  T.  D.  2442;  Reg.  33,  Art.  115;  T.  D.  3062;  T.  B. 
37-20-1198;  A.  R.  R.  384,  T.  B.  7-21-1456. 

•'>i  Reg.  45,  Art.  109;  letter  from  treasury  department  dated  February 
27,  1917;  I.  T.  S.  1918,  111506. 

52  Letter  from  the  treasury  department  dated  February  26,  1915;  I.  T. 
S.  1919,  ^920. 

r--'!  0.   D.   1047,  T.   B.  39-21-1840. 

54  Reg.  45,  Art.  101;  T.  D.  2090. 


588  FEDERAL   INCOME   TAX 

taken  out  as  a  protection  against  a  loss  on  account  of  crop 
conditions  are  deductible  as  a  business  expense.-"' 

Fidelity  Insurance.  Where  an  employee  is  required  to  furnish 
a  bond  and  pay  the  premium  thereon,  as  a  necessary  incident  to 
his  employment,  the  amount  so  paid  may  be  deducted  by  him  as 
an  expense.'^'"'  Thus  premiums  paid  on  indemnity  bonds  fur- 
nished by  government  employees  for  the  faithful  performance 
of  their  duties  constitute  allowable  deductions.''"  If  the  em- 
ployer pays  the  premium  it  may  be  included  in  his  business 
expense. 

Insurance  Reserves.  Funds  set  aside  by  a  corporation  for  in- 
suring its  own  property  are  not  a  proper  deduction  as  a  business 
expense,  but  any  loss  actually  sustained  may  be  deducted,  al- 
though actually  paid  out  of  a  fund  so  set  aside.-"''' 

Insurance  Under  Workmen's  Compensation  Law.  Under  the 
Workmen's  Compensation  Law  of  a  state,  employers  are  re- 
quired either  to  make  periodical  payments  to  the  state  in- 
surance fund  created  to  compensate  employees  for  injuries  re- 
ceived in  the  course  of  their  employment,  or  to  maintain  a 
benefit  fund  providing  for  the  payment  of  such  compensation, 
giving  a  bond  as  additional  security  for  the  payment  of  such 
compensation.  Where  the  employer  makes  the  periodical  pay- 
ments to  the  insurance  fund  of  a  state  such  payments  are  allow- 
able deductions  for  the  year  in  which  paid  or  accrued.  If,  how- 
ever, the  employer  maintains  a  fund  actually  depositing  periodi- 
cally in  a  trust  company  an  amount  to  be  held  in  reserve  as  a 
special  fund  for  the  payment  of  compensation  as  injuries  occur, 
the  amount  thus  deposited  is  not  an  allowable  deduction  from 
gross  income,  since  there  is  no  means  of  determining  how  much 
of  this  fund  will  be  used  for  the  purpose  for  which  it  is  held. 
In  such  case  the  actual  amount  paid  during  a  year  to  the  em- 
ployees as  compensation  where  injuries  occur  is  a  proper  deduc- 
tion for  that  year  whether  the  amount  so  paid  is  greater  or  less 
than  the  deposits  made  during  the  period  to  the  fund  which  is 
maintained. •"'•' 

Subtraction  for  Redemption  of  Trading  Stamps.  Where  a  tax- 
payer, for  the  purpose  of  promoting  his  business,  issues  with 
sales  trading  stamps  or  premium  coupons  redeemable  in  mer- 
chandise or  cash,  he  should  in  computing  the  income  from  such 

•^3  0.  D.  215,  T.  B.  11-19-377. 
•'X5T.   D.  2090. 

37  0.  D.  878,  T.  B.  16-21-1577. 

38  Reg.  33,  Art.  122. 

39  O.  D.  964,  T.  B.  27-21-1712. 


DEDUCTION    OF   BUSINESS   EXPENSES  589 

sales  subtract  only  the  amount  received  or  receivable  which 
will  be  required  for  the  redemption  of  such  part  of  the  total 
issue  of  trading  stamps  or  premium  coupons  issued  during  the 
taxable  year  as  will  eventually  be  presented  for  redemption. 
This  amount  will  be  determined  in  the  light  of  the  experience  of 
the  taxpayer  in  his  particular  business  and  of  other  users  engaged 
in  similar  businesses.  The  taxpayer  should  file  for  each  of  the 
five  preceding  years,  or  such  number  of  these  years  as  stamps  or 
coupons  have  been  issued  by  him,  a  statement  showing  (a)  the 
total  issue  of  stamps  during  each  year,  (b)  the  total  stamps 
redeemed  in  each  year,  and  (c)  the  percentage  for  each  year 
of  the  stamps  redeemed  to  the  stamps  issued  in  such  year.  A 
similar  statement  should  also  be  presented  showing  the  experi- 
ence of  other  users  of  stamps  or  coupons  whose  experience  is 
relied  upon  by  the  taxpayer  to  determine  the  amount  to  be  sub- 
tracted from  the  proceeds  of  sales.  The  Commissioner  will 
examine  the  basis  used  in  each  return,  and  in  any  case  in  which 
the  amount  subtracted  in  respect  of  such  stamps  or  coupons  is 
found  to  be  excessive  an  amended  return  or  amended  returns 
will  be  required.'"* 

Propaganda  Expenses.  Sums  of  money  expended  for  lobbying 
purposes,  the  promotion  or  defeat  of  legislation,  the  exploitation 
of  propaganda,  including  advertising  other  than  trade  advertis- 
ing, and  contributions  for  campaign  expenses,  are  not  deductible 
from  gross  income.''^ 

Commissions.  Commissions  paid  to  a  real  estate  agent  for 
collecting  rents  and  managing  property  are  allowed  as  a  busi- 
ness expense  to  the  owner.  Commissions  paid  to  salesmen  as 
a  part  of  the  expense  of  conducting  business  are  also  allowed 
as  a  deduction.^-  Commissions  paid  in  purchasing  and  selling 
securities  are  a  part  of  the  cost  or  selling  price  of  the  securi- 
ties and  are  not  otherwise  deductible."''  Advances  made  to  sales- 
men during  a  taxable  year  in  excess  of  commissions  earned 
constitute  an  allowable  deduction,  where  the  taxpayer  is  obli- 
gated under  its  contracts  with  its  salesmen  to  make  such  ad- 
vances as  long  as  they  remain  in  its  employ,  and  where  such 
advances  will  never  be  repaid  except  to  the  extent  that  com- 
missions earned  in  a  subsequent  year  exceed  the  guaranteed 
advances  of  that  year."^ 

<"'"Reg  45,  Art.  87;  Reg.  33  Rev.,  Art.  141. 

<"'iReg.  45,  Art.  562;  T.  D.  2137. 

<■''-;  T.  D.  2090. 

•!•"-  Reg.  45,  Art.  293 ;  Reg.  33  Rev.,  Art.  8. 

«4A.  R.   R.  374,  T.  B.  6-21-1429. 


590  FEDERAL  iNCOME   TAX 

Entertainment  Money.  So-called  spending  or  treating  money 
actually  advanced  by  business  enterprises  to  their  traveling 
salesmen,  as  a  part  of  the  selling  expense  of  their  product,  is  a 
proper  deduction.  There  must,  however,  be  some  showing  that 
all  of  the  allowance  claimed  as  a  deduction  has  been  actually 
expended  for  the  purpose  for  which  the  allowance  is  made, 
namely,  the  selling  of  the  product  in  question.'^^  Expenses  ac- 
crued in  furnishing  entertainment  to  the  taxpayers'  employees 
by  means  of  picnics  or  dances  are  not  deductible/'^ 

Salaries  and  Compensation  for  Personal  Services.  The  1916 
Law  did  not  expressly  mention  "salaries"  in  the  provisions 
allowing  the  deduction  of  business  expenses.*^^  The  1921  Law, 
like  the  1918  Law,  expressly  authorizes  the  deduction  by  em- 
ployers of  "a  reasonable  allowance  for  salaries  or  other  com- 
pensation for  personal  services  actually  rendered." ^^  The 
rulings  hold  the  test  of  deductibility  to  be  whether  in  fact  pay- 
ments of  salaries  are  reasonable  and  are  purely  for  services  or 
include  "some  other  element."  In  the  case  of  any  compensa- 
tion, however  determined,  which  exceeds  amounts  ordinarily 
paid  for  like  services  in  like  enterprises  under  like  circum- 
stances, the  burden  is  upon  the  taxpayer  to  show  that  the 
amount  paid  is  solely  the  purchase  price  of  services.  The  form 
or  method  of  fixing  compensation  is  not  decisive  as  to  deduc- 
tibility. While  any  form  of  contingent  compensation  invites 
scrutiny  as  a  possible  distribution  of  earnings  of  the  enterprise, 
it  does  not  follow  that  payments  on  a  contingent  basis  are  to  be 
treated  fundamentally  on  any  basis  different  from  that  applying 
to  compensation  at  a  flat  rate.  Generally  speaking,  if  contingent 
compensation  is  paid  pursuant  to  a  free  bargain  between  the 
enterprise  and  the  individual  made  before  the  services  are  ren- 
dered, not  influenced  by  any  consideration  on  the  part  of  the 
employer  other  than  that  of  securing  on  fair  and  advantageous 
terms  the  services  of  the  individual,  it  should  be  allowed  as  a  de- 
duction even  though  in  the  actual  working  out  of  the  contract 
it  may  prove  to  be  greater  than  the  amount  which  would  ordi- 
narily be  paid.     In  any  event  the  allowance  for  compensation 

65  T.  D.  2090. 

6«  0.  D.  1030,  T.  B.  37-21-1815. 

67  Revenue  Act  of  1916,  §  5  (a)   and  §  12   (a). 

68  Revenue  Act  of  1921,  §§  214  (a)  (1)  and  234  (a)  (1)  ;  Revenue  Act  of 
1918,  §§  214  (a)  and  234  (a).  These  provisions  seem  to  authorize  the  Com- 
missioner to  disallow  such  part  of  any  salary  payments  as  appear  un- 
reasonable in  view  of  the  services  rendered,  notwithstanding  that  the 
salary  may  actually  have  been  paid  under  a  valid  contract. 


DEDUCTION    OF   BUSINESS   EXPENSES  591 

paid  may  not  exceed  what  is  reasonable  in  all  the  circumstances. 
It  is  in  general  just  to  assume  that  reasonable  and  true  com- 
pensation is  only  such  amount  as  would  ordinarily  be  paid  for 
like  services  by  like  enterprises  in  like  circumstances.  The 
circumstances  to  be  taken  into  consideration  are  those  existing 
at  the  date  when  the  contract  for  services  was  made,  not  those 
existing  at  the  date  when  the  contract  is  questioned.*^^ 

The  problem  of  determining  reasonable  compensation  for  per- 
sonal services  is  one  of  difficulty,  in  that  there  are  few  general 
rules  which  can  be  laid  down  as  guides  to  a  decision.  Many 
factors  are  involved,  such  as  the  character  and  amount  of  re- 
sponsibility, ease  or  difficulty  of  the  work  itself,  time  required, 
working  conditions,  future  prospects,  living  conditions  of  the 
locality,  individual  ability,  technical  training,  profitableness  to 
the  employer  of  the  services  rendered,  and  the  number  of  avail- 
able persons  capable  of  performing  the  duties  of  the  position. 
These  and  other  factors  have  a  bearing,  and  the  amount  of 
weight  to  be  attached  to  each  one  can  be  determined  only  in  the 
light  of  the  circumstances  in  each  particular  case.™  A  large 
number  of  cases  have  arisen  under  the  Revenue  Act  of  1918 
and  prior  laws,  dealing  with  the  question  of  what  under  the 
particular  facts  presented  constitutes  a  reasonable  compensa- 
tion for  personal  services.'^  The  decisions  made  are  of  com- 
paratively little  general  value,  but,  in  addition  to  the  above  dis- 
cussion of  the  subject,  the  following  general  principles  should  be 
applied  in  the  determination  of  the  question  as  it  arises  in  any 
particular  case: 

6fl  T.  D.  2696,  Reg.  45,  Arts.  105,  106.  It  was  held  under  the  1916  Law 
that  reasonableness  was  ordinarily  the  controlling  test  of  the  deductibility 
of  salaries  determined  after  services  had  been  rendered.  In  certain  in- 
stances apparently  of  this  sort  it  was  permitted  to  be  shown  that  the  com- 
pensation was  fixed  according  to  a  custom  or  practice  having  virtually  the 
force  of  a  contract.  Where  this  was  not  true  and  it  was  for  the  management 
to  fix  a  fair  compensation  it  was  assumed  that  true  compensation  was  only 
such  amount  as  would  ordinarily  be  paid  in  like  circumstances  by  similar 
enterprises;  in  other  words,  that  the  fair  criterion  was  what  the  recipient 
could  get  by  rendering  the  same  services  to  another  employer.  (T.  D. 
2696.) 

70  T.  B.  M.  44,  T.   B.   10-19-362. 

71  A.  R.  R.  31,  T.  B.  9-20-768;  A.  R.  M.  30,  T.  B.  9-20-767;  A.  R.  R.  32, 
T.  B.  9-20-769;  A.  R.  M.  39,  T.  B.  14-20-829;  A.  R.  R.  53,  T.  B.  14-20-830; 

A.  R.  R.  61,  T.  B.  15-20-847;  0.  D.  504,  T.  B.  20-20-935;  A.  R.  R.  223,  T. 

B.  32-20-1119;  T.  B.  M.  86,  T.  B.  22-19-534;  T.  B.  M.  70,  T.  B.  18-19-401; 
T.  B.  R.  46,  T.  B.   15-19-444. 


592  FEDERAL   INCOME   TAX 

1.  Each  case  must  be  decided  on  its  own  merits;  there  is  no 
warrant  for  fixing  any  maximum  limit  for  deductible  salaries."^- 

2.  Salaries  voted  before  the  passage  of  any  excess-profits  tax 
law  are  subject  to  a  less  severe  test  of  reasonableness  than 
salaries  voted  thereafter  and  unless  they  bear  a  close  relation- 
ship to  stockholdings  will  almost  invariably  be  allowed.""' 

3.  Salaries  voted  subsequently  to  the  passage  of  the  1917 
Excess-Profits  Tax  Law  will  not  be  disallowed  if,  after  deduct- 
ing the  salaries,  the  company  has  left  a  normal  return  on 
invested  capital  or  if  the  deduction  does  not  reduce  the  net 
earnings  subject  to  tax  below  that  of  competing  concerns  which 
secure  the  services  of  officers  and  employees  by  open  bargain- 
ingJ4 

4.  If  salaries  are  reasonable  in  amount  in  view  of  all  the 
circumstances,  they  will  not  be  disallowed  even  if  based  on 
stockholdings.  Relationship  to  stockholdings  will  not  per  se 
disqualify  salaries;  it  will  require  their  disallowance  only  if 
unreasonable.^'' 

5.  Generally  speaking,  salary  or  compensation  agreements 
made  in  advance  between  an  enterprise  with  its  officers  and  em- 
ployees are  not  subject  to  the  same  degree  of  scrutiny  as  agree- 
ments made  after  the  services  are  rendered."^' 

6.  In  cases  where  compensation  is  determined  after  services 
have  been  rendered  reasonableness  is,  ordinarily,  the  test  of 
deductibility." 

7.  Salaries  voted  subsequently  to  the  close  of  any  taxable 
year  and  to  the  closing  of  the  books  for  such  year,  in  the  ab- 
sence of  contract  obligation,  are  not  deductible."'* 

8.  Salaries  will  not  be  considered  collectively,  but  the  sala- 
ries paid  individually  will  be  analyzed  carefully  to  determine 
their  reasonableness  and  whether  they  are  purely  payment  for 
services  rendered.'^" 

'■^T.  B.  R.  46,  T.  B.  15-19-444;  A.  R.  M.  138,  T.  B.  39-21-1841. 
t:^' A.  R.  R.  53,  T.  B.  14-20-830;  A.  R.  M.  30,  T.  B.  9-20-767;  A.  R.  R.  346, 
T.  B.  51-20-1352;  but  see  L.  0.  1045,  T.  B.  41-20-1231. 

74  A.  R.  R.  53,  T.  B.  14-20-830;  but  see  A.  R.  R.  223,  T.  B.  32-20-1119; 
A.  R.  R.  435,  T.  B.  13-21-1528. 

75  A.  R.  R.  32,  T.  B.  9-20-769;  A.  R.  M.  30,  T.  B.  9-20-767. 

'(>  A.  R.   R.  31,   T.  B.  9-20-768;   A.   R.   M.   39,   T.   B.   14-20-829;    but  see 
L.  O.  1045,  T.  B.  41-20-1231. 
.     "A.  R.   R.  61,  T.   B.   15-20-847;   O.   D.  504,  T.  B.  20-20-935. 

T.'^T.  B.  M.  86,  T.  B.  22-19-534;  O.  D.  497,  T.  B.  19-20-917;  A.  R.  R. 
493,  T.  B.  20-21-1637;  A.  R.  R.  519,  T.  B.  22-21-1662. 

7!>A.   R.   M.   138,   T.    B.   39-21-1841. 


DEDUCTION    OF   BUSINESS   EXPENSES  593 

9.  The  amount  of  salary  fixed  by  a  board  of  directors  is  pre- 
sumptively valid,  but  not  conclusively  so,  and  the  government 
has  the  right  to  attack  the  action  of  the  board  of  directors  and 
show  by  evidence,  not  that  a  given  salary  is  too  much,  but  that, 
in  the  circumstances,  the  whole  or  some  part  of  it  is  not  salary 
at  all,  but  is  profits  diverted  to  a  stockholding  officer  under  the 
guise  of  salary.'^" 

Salaries  Constituting  a  Distribution  of  Dividends.    Any 
amount  paid  in  the  form  of  a  salary,  but  not  in  fact  as  the 
purchase  price  of  services   is  not  deductible.     In  the  case  of 
corporations,  a  salary  paid  to  an  officer  or  employee  who  is  not 
a  stockholder  is  a  proper  deduction  if  it  fulfills  the  requirements 
stated  in  the  preceding  paragraph.     Where  the  officer  or  em- 
ployee is  also  a  stockholder,  the  salary  deduction  is  subjected  to 
closer  scrutiny.  An  ostensible  salary  may  be  a  distribution  of  a 
dividend  on  stock,  especially  in  the  case  of  a  corporation  having 
a  few  stockholders,  practically  all  of  whom  draw  salaries.     If 
m  such  a  case  the  salaries  are  based  upon  or  bear  a  close  rela- 
tionship to  the  stockholdings  of  the  officers  or  employees,  the 
presumption  will  be  that  the  salaries,  if  in  excess  of  those  ordi- 
narily paid  for  similar  services,  are  not  paid  wholly  for  services 
rendered,  but  in  part  as  a  distribution  of  earnings  upon  the 
stock.^^     In  the  case  of  excessive  payments  by  corporations,  if 
such  payments  correspond  or  bear  a  close  relationship  to  stock 
holdings,  the  amount  of  the  excess  should  be  treated  as  divi- 
dends and  would  thus  be  exempt  from  the  normal  tax  in  the 
hands  of  the  recipients.'^- 

>^"  U.  S.  V.  Philadelphia  Knitting  Mills  Co.,  273  Fed.  65,  decided  under 
the  1909  Law.     See  A.  R.  M.  138,  T.  B.  39-21-1841. 

«i  Res.  45,  Art.  105.  It  was  first  held  that  the  following-  rules  should  be 
observed  in'  connection  with  such  payments:  (a)  the  services  must  be 
actually  performed,  (b)  the  amount  must  be  no  more  than  a  fair  and 
reasonable  compensation  for  services  rendered,  and  (c)  the  compensation 
should  not  depend  upon  the  interest  of  the  officer  or  employee  in  the  cor- 
poration as  a  stockholder  or  vary  from  year  to  year  with  the  earnings 
of  the  corporation.  (T.  D.  2152;  letter  from  treasury  department  dated 
February  2,  1915;  I.  T.  S.  1918,  HH  1389  and  1811.)  See  subparagraph  9, 
of  the  preceding  paragraph.  Under  the  1909  Law  it  was  held  that  in 
addition  the  salary  paid  to  an  officer  who  was  a  stockholder  must  be 
authorized  by  the  board  and  made  a  matter  of  record  on  the  minute  book 
of  the  corporation,  in  order  to  be  an  allowable  deduction.  (T.  D.  1742.1 
Where  a  company  was  composed  of  two  stockholders  who  divided  the  net 
profits  between  them,  calling  it  compensation,  it  has  been  held  by  the  courts 
that  the  money  paid  out  was  equivalent  to  a  dividend.  (Jacobs  and 
Davies,  Inc.,  v.  Anderson,  228  Fed.  505;  T.  D.  2262.) 

s^Reg.  45,  Art.  106;  T.  D.  2696;  O.  D.  1012,  T.  B.  35-21-1792.  See  also 
Reg.  33,  Art.  119.     It  is  conceivable,  of  course,  that  an  individual  may  ren- 


594  FEDERAL  INCOME  TAX 

Salaries  Constituting  a  Waste  of  Assets.  An  ostensible 
salary  paid  by  a  corporation  may  be  in  part  a  waste  or  appro- 
priation of  assets  of  the  corporation,  especially  where  salaried 
employees  are  in  control  of  the  corporation  through  holding,  di- 
rectly or  indirectly,  a  majority  of  its  stock.  In  the  case  of  a 
large  corporation  with  many  stockholders  owning  a  substantial 
minority  of  its  stock  the  tendency  of  officers  unduly  to  inflate 
their  salaries  must  be  taken  into  account.  In  such  cases  pay- 
ments representing  a  waste  or  appropriation  of  assets  of  the  cor- 
poration by  officers  who  control  it  and  fix  their  compensation 
in  violation  of  the  rights  of  the  corporation  are  held  not  to  be 
deductible  to  the  amount  of  their  excess  over  a  reasonable  com- 
pensation. While  disallowed  as  a  deduction  to  the  corporation 
such  payments  are  required  to  be  treated  as  compensation  of 
the  individuals,  subject  to  the  normal  tax,  compensation  illegally 
secured  being  none  the  less  subject  to  tax  in  all  respects.^^ 

Salaries  Constituting  Part  Payment  for  Property.  An 
ostensible  salary  may  be  in  part  payment  for  property.  This 
may  occur,  for  example,  where  a  partnership  sells  out  to  a  cor- 
poration, the  former  partners  agreeing  to  continue  in  the  serv- 
ice of  the  corporation.  In  such  case  it  may  be  found  that 
the  salaries  of  the  former  partners  are  not  merely  for  services, 
but  in  part  constitute  payment  for  the  transfer  of  their  busi- 
ness. The  amount  of  the  excess  should  be  treated  by  the  cor- 
poration as  a  capital  expenditure  and  by  the  recipient  as  part 
of  the  purchase  price.^* 

Excessive  Payments  by  Individuals  or  Partnerships.  In 
the  case  of  excessive  payments  by  individuals  or  partnerships, 
the  amounts  disallowed  should  ordinarily  be  treated  as  shares 
of  the  profits  of  a  partnership,  except  that  a  payment  for  prop- 
erty should  be  treated  by  the  individual  or  partnership  as  a 
capital  expenditure  and  by  the  recipient  as  part  of  the  purchase 
price.s^ 

der  services  of  great  value  to  a  corporation  of  which  he  is  the  chief  stock- 
holder and  it  seems  reasonable  that  he  should  be  entitled  to  compensation 
for  services  he  actually  performs  in  addition  to  his  dividends  as  a  stock- 
holder since  as  a  stock  holder  he  is  under  no  duty  to  devote  any  part  of 
his  time  to  the  business  of  the  corporation. 

83  Reg.  45,  Arts.  105,  106.  Under  the  1916  Law^  if  a  compensation  con- 
tract with  the  majority  stockholder  or  stockholders  was  approved  by  all 
the  stockholders,  as  well  as  by  the  directors,  it  might  however  be  dealt 
with  like  any  other  contract.      (T.  D.   2696.) 

84  Reg.   45,   Arts.   105,   106. 

85  Reg.  45,  Art.  106. 


DEDUCTION    OF   BUSINESS   EXPENSES  595 

Salaries  Paid  to  Enlisted  Men.  An  individual,  partner- 
ship or  corporation  continuing  to  pay  an  officer  or  employee  his 
salary  or  compensation,  or  part  thereof,  while  he  serves  in  the 
United  States  army  or  navy  or  while  he  has  undertaken  services 
for  the  government  at  Washington  or  elsewhere  at  reduced  or 
nominal  compensation,  is  permitted  to  deduct  the  amount  as  an 
expense,  on  the  theory  that  the  business  purpose  of  the  continu- 
ance of  such  compensation  is  to  preserve  the  organization  and 
secure  the  return  after  the  war  of  such  officers  or  employees."*"' 

Compensation  Paid  to  Employees  During  Absence  at 
Schools.  Where  a  corporation  encourages  or  requires  its  em- 
ployees to  attend  part-time  schools  it  may  deduct  as  a  business 
expense  reasonable  amounts  paid  as  compensation  to  such  em- 
ployees during  their  absence  from  employment  while  attending 
such  schools.s^ 

Allowances  to  Minor  Children.  The  father  is  legally  en- 
titled to  the  services  of  his  minor  children.  Allowances  which 
he  gives  them,  whether  said  to  be  in  consideration  of  services  or 
otherwise,  are  not  allowable  deductions.^^ 

Bonuses  and  Profit  Sharing  Payments.  The  rules  and  regula- 
tions'*^^ in  regard  to  the  deductibility  of  special  payments  made  as 
extra  compensation  to  officers  or  employees  of  an  enterprise,'"^  do 
not  permit  of  a  ready  determination  of  every  question,'*^  but  indi- 
cate an  increasing  liberality  on  the  part  of  the  treasury  depart- 
ment toward  the  allowance  of  such  payments  as  deductions.  All 
such  payments  to  officers  or  employees  having  any  considerable 
interest  in  the  profits  of  the  enterprise  through  stock  ownership 
or  otherwise  are  subject  to  careful  analysis  in  the  same  manner 
as  salaries.  The  scope  of  this  scrutiny  has  been  treated  in  the 
foregoing  paragraphs.     As  previously  stated,  while  any  form  of 

8ti  Reg.  45,  Art.  108;  T.  D.  2660;  letter  from  treasury  department 
dated  October  4,  1916;  I.  T.  S.  1918,  Tj  1391. 

«7  0.   D.   850,   T.  B.   12-21-1519. 

ss  Reg-,  45,  Art.  291.     See  Chapter  21. 

so  Reg.  45,  Art.  107;  T.  D.  2696;  T.  D.  2616;  T.  D.  2152;  T.  D.  2090;  Reg. 
33  Rev.,  Arts.  8  and  138;  letter  from  treasury  department  dated  June  25, 
1914;  I.  T.  S.  1918,  1|  1398;  mimeograph  letter  to  collectors  No.  1314,  I.  T.  S. 
1918,  TJ1401;  letter  from  treasury  department  dated  November  12,  1917; 
L  T.   S.  1918,  111407. 

o<>  The  later  rulings  treat  the  question  irrespective  of  the  status  of 
the  payor  of  the  bonus,  establishing  the  same  rule,  so  far  as  deductibility 
is  concerned,  in  the  case  of  individuals,  partnerships  and  corporations. 
The  term  "enterprise"  is  used  in  the  text  to  include  all  these  three  forms  of 
business  activity. 

01  They  are  said  "to  indicate  a  basis  of  solution"  when  applied  "in  the 
light  of  full  knowledge  of  the  facts  in  the  particular  case."     (T.  D.  2696.) 


596  FEDERAL   INCOME   TAX 

contingent  compensation  invites  scrutiny  as  a  possible  distribu- 
tion of  earnings  of  the  enterprise,  it  does  not  follow  that  pay- 
ments on  a  contingent  basis  are  to  be  treated  fundamentally  on 
any  basis  different  from  that  applying  to  compensation  at  a  flat 
rate.  Just  as  in  the  case  of  salaries,  the  test  is  whether  the 
payments  are  made  in  good  faith  and  are  in  fact  purely  for  serv- 
ices or  include  "some  other  element."  Generally  speaking,  if 
contingent  compensation  is  paid  pursuant  to  a  friendly  bargain 
between  the  enterprise  and  the  individual,  made  before  the  serv- 
ices are  rendered,  not  influenced  by  any  consideration  on  the  part 
of  the  employer  other  than  that  of  securing  on  fair  and  advan- 
tageous terms  the  services  of  the  individual,  the  contingent  com- 
pensation should  be  allowed  as  a  deduction ;  even  though  in  the 
final  working  out  of  the  contract  it  may  prove  to  be  greater  than 
the  amount  which  would  ordinarily  be  paid.  Reasonableness  is 
ordinarily  the  controfling  test  of  the  deductibility  in  the  case  of 
bonuses  and  special  compensation  for  services,  as  in  the  case  o:^ 
salaries.  Summarizing  the  latest  rulings"-  the  following  rules 
may  be  stated  as  a  basis  for  the  determination  of  the  question 
whether  special  payments  made  as  extra  compensation  to  oflScers 
and  employees  of  an  enterprise  are  deductible  under  the  heading 
of  business  expenses:  (a)  the  fundamental  test  is  w^hether  or  not 
such  payments  are  made  as  compensation  for  services  rendered ; 
(b)  if  payments  of  compensation  for  services  rendered  are  made 
in  pursuance  of  a  contract  express  or  imphed  (which  need  not  be 
in  writing)  "•"  or  a  long-time  practice  (practically  an  implied  con- 
tract), regularly  employed,  of  paying  to  employees  certain  sums 
in  addition  to  their  stipulated  salaries,  constituting  a  condition, 
if  not  a  contract,  whereby  the  employees  may  reasonably  expect 
for  greater  or  better  service  rendered,  additional  pay,  they  are 
deductible;  (c)  if  payments  are  made  as  compensation  for  serv- 
ices rendered,  but  not  in  pursuance  of  a  contract  expressed  or 
implied  or  a  long-time  practice  as  above  stated,  the  total  amount 
of  salary  and  extra  compensation  may  not  exceed  a  reasonable 
compensation  for  the  services  rendered;  (d)  bonuses  or  additions 
to  salaries  voted  subsequent  to  the  close  of  any  taxable  year  and 
also  subsequent  to  the  closing  of  the  books  for  such  taxable  year 
will  not  be  considered  such  ordinary  and  necessary  expenses  of 
doing  business  during  such  year  as  are  deductible."^    The  early 

»2Reg.  45,  Art.  107;   T.  D.  2696. 

^•"5  A  written  contract  is,  of  course,  better  evidence  in  case  any  question 
arises. 

94  0.   D.  497,  T.   B.   19-20-917. 


DEDUCTION   OF   BUSINESS  EXPENSES  597 

condition  that  payments  of  bonuses  or  extra  compensation  could 
not  be  dependent  upon  the  earnings  of  the  paying  corporation  no 
"onger  obtains  except  insofar  as  it  may  throw  light  upon  the  ques- 
tion  of  whether  or  not  the  payments  in  question  are  made  as 
compensation  for  services  rendered.";'  .     ,     ,     ,  ,    ,j     . 

Tn  a  case  in  which  three  officers  and  principal  stockholders 
of  a  corporation  were  paid  a  commission  and  salary  aggregating 
50'i  of  the  gross  margin  on  the  business  developed  by  each, 
such  commission  and  salary  were  held  reasonable  because  he 
ZlZ  of  the  corporation  was  dependent  almost  solely  upon  the 
nprsonal  efforts  of  such  officers.'"' 

'additional  compensation  paid  in  stock.    Where,  for  the 
purpose  of  distribution  as  additional  compensation  to  its  em- 
ntovees    a   corporation   purchases    its   own   stock   in    the   open 
marke  '  the  market  value  of  such  stock  at  the  time  of  di^^tribution 
"the  amou"  which  the  corporation  is  entitled  to  deduct  as  an 
rdinary  and  necessary  expense  of  business  assuming,  of  course, 
that  the  compensation  is  reasonable  and  proper."     A  propoi- 
ttnate  part  of  the  par  value  of  a  company's  stock,  delivered  to 
a  trustee  to  be  held  in  escrow  for  the  benefit  of  certain  employees 
/X  company,  which  stock  is  to  be  delivered  to  them  ah 
expiration  of  a  number  of  years  in  recognition  of  faithful  seivice, 
may  be  taken  as  a  deduction  for  each  of  such  years  during  the 
Terfod  the  trustee  holds  the  stock,  providing  the  corporation  keeps 
its  books  on  an  accrual  basis. 

'...-.The  early  rulings  held  in  effect  that  paynaents  '"^\^'' J"  ''"[^"'^'Hl 
as  eJtra  coZensatfon  to  officers  and  employees  might  "e  leducted:      a 
tf  i    was  clearly  shown  that  they  were  made  as  '•T^^^^^^J^.^^ZZ 

A     .1.    (h\    \f  thev  were   paid   in  pursuance  of   a   contiact  expiess  oi 
rendered      (b).f  they  we.ep  P^  ^^^^  .^  ^^.^.^^,    ^^^    ^  ^^^^  ^^^^ 

and   was   equivalent    to   a    contract   within   this   heading;    (^^^^7    7^; 

t    r.f    ««lnrv    and     extra    compensation    was    not    greatei     than     a 

reTsl"  blfcoCensaU:'   f^'the  services  rendered;    (d,    if  *ey  -e  not 

conditional  upon  the  earnings  »'  ^^a^Ts^r.e  8    TTheT  t      s"tr: 

dependent  upon  the  services  rendered.      (See  note  »y.) 
later  modified,  as  indicated  in  the  text  above. 

<H>T    R    M    81    T.   B.  23-19-554.  ,       ,  . 

I"  R  M  1  i,  T.  B.  11-21-1509.  This  ruling  is  based  on  the  depart- 
ments" pnor  ruling  that  a  corporation  realizes  no  gain  or  ^oss  from  the 
purchaseTf  its  own  stock  (Reg.  45,  Art.  542)  and  on  ^-l-^ ^^^^^^f  "\^, 
simnar  case  that  the  employee's  additional  compensation  is  the  value  of 
the  stock  when  received    (O.   D.  570,  T.   B.  27-20-1039). 


598  FEDERAL   INCOME   TAX 

If  the  employee  for  whom  the  stock  was  deposited  should 
forfeit  his  right  to  receive  the  stock,  the  corporation  must  report 
as  income  in  the  year  in  which  the  right  to  receive  the  stock 
is  forfeited,  the  amounts  taken  as  a  deduction  in  previous  years 
on  account  of  the  forfeited  stock.^'^ 

Gifts,  Gratuities  or  Donations  to  Employees.  Gifts  or 
gratuities  made  by  an  enterprise  to  its  employees  are  not  proper 
deductions  under  the  heading  of  expense.  Even  where  such  pay- 
ments are  called  extra  compensation,  if  they  are  in  fact  gratuitous 
or  voluntary  payments  for  which  no  services  are  rendered,  their 
character  as  gifts  is  not  changed.  The  custom  of  paying  bonuses 
or  Christmas  gifts  to  employees,  even  though  it  has  been  the  prac- 
tice of  the  enterprise  for  a  long  time  to  make  such  gifts,  does  not 
render  the  amount  so  paid  a  proper  deduction  as  expense  if  the 
gift  is  purely  voluntary  and  gratuitous.^^  On  the  other  hand, 
gifts  or  bonuses  to  employees  will  constitute  allowable  deductions 
from  gross  income  when  such  payments  are  made  in  good  faith 
and  as  additional  compensation  for  the  services  actually  rendered 
by  the  employees,  provided  such  payrnents,  when  added  to  the 
stipulated  salaries,  do  not  exceed  a  reasonable  compensation  for 
the  services  rendered.  Donations  made  to  employees  and  others, 
which  do  not  have  in  them  the  element  of  compensation  or  are  in 
excess  of  reasonable  compensation  for  services,  are  considered 
gratuities  and  are  not  deductible  from  gross  income. i*^" 

Pensions.  Under  the  1916  Law  the  deduction  of  amounts  paid 
as  pensions  was  allowed  or  disallowed  upon  the  basis  of  the  gen- 
eral provisions  i^'i  of  that  law  permitting  the  deduction  of  all  the 
necessary  expenses  of  individuals  in  carrying  on  any  business  or 
trade  and  the  ordinary  and  necessary  expenses  of  corporations 
paid  in  the  management  and  operation  of  their  business  and  prop- 
erties. The  Revenue  Acts  of  1921  and  1918  expressly  provide  ^^s 
that  these  expenses  include  "a  reasonable  allowance  for  salaries 
and  other  compensation  for  personal  services  actually  rendered." 
But  the  intent  is  probably  not  to  exclude  pensions  by  reason  of 
services  which  have  been  rendered.  It  has  been  ruled  that 
amounts  paid  for  pensions  to  retired  employees  or  to  their  fam- 
ilies or  others  dependent  upon  them,  or  on  account  of  injuries 

9S0.  D.  124,  T.  B.  3-19-186. 

9«Reg.  45,  Art.  107.     See  T.  D.  2090;  T.  D.  2152;  mimeograph  letter  to 
collectors,  No.  1314;  L  T.  S.  1918,  H  1407. 

100  Reg.  45,  Art.  107. 

101  Revenue  Act  of  1916,  §§  5a  and   12a. 

102  Revenue  Act  of  1921,  §§214  (a)  (1)  and  234  (a)  (1);  Revenue  Act 
of  1918,  §§214  (a)   1  and  234  (a)   1. 


DEDUCTION    OF    BUSINESS   EXPENSES  599 

received  by  employees,  and  lump  sum  amounts  paid  as  compensa- 
tion for  injuries,  are  a  proper  deduction  as  ordinary  and  neces- 
sary expenses.  Such  deductions  are  limited  to  the  amount  not 
compensated  for  by  insurance  or  otherwise.  No  deduction  may 
be  made  for  contributions  to  a  pension  fund  held  by  the  corpora- 
tion the  amount  deductible  in  such  case  being  the  amount  act- 
ually paid  to  the  employee.  When  the  amount  of  the  salary  of 
an  officer  or  employee  is  paid  for  a  limited  period  after  his  death 
to  his  widow  or  heirs  in  recognition  of  the  services  rendered  by 
the  individual,  such  payments  may  be  deducted.i"'^ 

Donations.    Donations  by  business  concerns  may  or  may  not 
be  held  to  be  proper  deductions  as  expense.     There  must  be  a 
consideration  in  some  form  to  take  the  donation  out  of  the  class 
of  gratuities.     When  a  donation  legitimately  represents  a  con- 
sideration for  a  benefit  flowing,  directly  or  indirectly,  to  the 
donor,  as  an  incident  of  its  business,  it  is  an  allowable  deduction 
It  has  been  held  that  a  corporation  engaged  m  the  agricultural 
business  can  not  be  allowed  to  make  deductions  on  account  of  do- 
nations to  fairs,  churches,  and  associations;  such  donations,  al- 
though made  for  the  purpose  of  obtaining  and  preserving  the 
good-will  of  the  farmers,  being  mere  gratuities.    Where  a  street 
railway  company  donates  a  sum  of  money  to  an  organization  in- 
tending to  hold  a  convention  in  the  city  in  which  the  company 
operates,  with  the  expectation  that  the  holding  of  such  conven- 
tion will  augment  its  income  because  a  greater  number  of  people 
will  use  its  street  cars,  the  donation  has  been  held  to  be  deduct- 
ible    A  donation  to  a  hospital,  under  agreement  that  employees 
of  the  donor  are  to  have  a  ward  for  their  use  in  case  of  accident 
or  illness,  is  a  proper  deduction.    Donations  made  for  purposes 
connected  with  the  operation  of  the  business,  when  limited  to 
charitable  institutions,  hospitals  or  educational  institutions,  con- 
ducted for  the  benefit  of  employees  or  their  dependents,  are  within 
this  class,  but  such  donations  should  be  reduced  by  any  amount 
repaid  to  the  corporation  by  the  employees.    Expenses  incurred 
in  advertising  and  promoting  the  sale  of  Liberty  bonds  and  war 
savings  stamps  over  the  corporation's  name  were  held  deduct- 
ible.io^ 

lOSRes  45  Art.  108.  This  reverses  the  earlier  rulings  of  the  treasury 
deparf^ent  regarding  salaries  paid  to  the  -idow  c-  heirs  of  the  employee 
after  his  death.      (Reg.  33  Rev..  Art.  13B;   T    D.  2090 

104  Ree-  45  Art  562;  T.  D.  2847;  Reg.  33  Rev.,  Art.  134,  letter  iiom 
tre  su^y'depLment  da'ted  May  23,  1918;  I.  T.  S  1918  ^  3^37  elegra.. 
from  tiLsury  department  dated  May  23,  1918;  I.  T.  S.  1918,  113436,  0. 
D.  682,  T.  B.  41-20-1236. 


600  FEDERAL   INCOME   TAX 

Donations  made  to  the  American  Red  Cross,  United  War  Work- 
ers, Liberty  loan  drives  and  the  Salvation  Army  are  held  not  to 
be  deductible  as  business  expenses.  Donations  made  by  indus- 
trial and  railway  corporations  to  the  Young  Men's  Christian 
Associations  are  held  not  to  be  deductible  even  where  the  associa- 
tions are  located  on  the  property  of  these  corporations  and  are 
operated  for  the  benefit  of  the  employees  of  such  corporations. i""' 

A  corporation  may  not  deduct  the  amount  paid  into  a  pension 
fund  for  the  benefit  of  its  employees  in  the  taxable  year.  This 
rule  obtains,  although  the  corporation  constitutes  itself  a  trustee 
of  the  sum  contributed  to  pay  the  income  thereof  to  its  em- 
ployees, but  reserving  absolute  discretion  as  to  the  selection  of 
the  employees  to  be  benefited.^'"'  Donations  by  a  corporation  to  a 
pension  fund  for  the  benefit  of  its  officers  and  employees,  the 
fund  being  organized  entirely  separate  and  distinct  from  the 
corporation,  having  its  own  set  of  books,  making  its  own  invest- 
ments, and  paying  its  own  expenses,  legal  title  of  which  does  not 
remain  in  the  corporation,  are  deemed  to  be  donations  to  a  chari- 
table institution  conducted  for  the  benefit  of  the  corporation's 
employees  or  their  dependents,  representing  a  consideration  for  a 
benefit  flowing  directly  to  the  corporation  as  an  incident  of  its 
business,  and  are  allowable  deductions  from  gross  income. '"" 

In  a  case  in  which  certain  corporations  and  individuals  contrib- 
uting largely  to  the  taxes  of  a  municipality  the  financial  condition 
of  which  would  not  permit  the  erection  of  certain  bridges,  donated 
the  cost  of  such  bridges,  it  has  been  held  that  such  donations 
do  not  represent  a  consideration  for  a  benefit  flowing  directly  to 
the  corporations  and  individuals  as  an  incident  to  their  business, 
even  though  the  municipal  and  industrial  life  of  the  city  was 
dependent  to  the  largest  possible  extent  upon  the  bridges  and  the 
entire  city  was  benefited  by  their  erection. ^"■'^  Payments  to 
trustees  by  a  cemetery  corporation  during  the  taxable  year  of  a 
certain  percentage  of  the  proceeds  of  sales  of  cemetery  lots  set 
aside  for  a  maintenance  fund   to  be   controlled   solely   by   the 

1<»5A.  R.  R.  373,  T.  B.  4-21-1411;  Reg.  45,  Art.  562.  As  to  Red  Cross 
donations  see  T.  D.  2847.  Corporations  which  had  erroneously  included 
as  deductions  for  1918,  contributions  to  the  Red  Cross  and  other 
recognized  war  organizations  were  required  within  30  days  from  August 
16,  1921,  to  file  a  statement  under  oath  showing  the  amount  of  such  de- 
ductions claimed,  the  amount  of  net  income  as  reported  and  as  corrected, 
and  the  additional  amount  of  tax  due   (T.  D.  3215,  T.  B.  36-21-1807). 

KXiS.   965,   T.   B.   2-19-164. 

^•»7  0.   D.   110,   T.   B.  2-19-165. 

i<"^0.   D.   607,   T.   B.   30-20-1094. 


DEDUCTION    OF    BUSINESS    EXPENSES  601 

trustees  thereof  are  not  deductible  from  the  gross  income  of  the 
corporation  even  though'  such  payments  are  required  by  state 
law.i"'' 

MEMBERSHIP  Fees  and  Dues.  Membership  fees  or  dues  paid 
by  individuals  and  corporations  to  a  chamber  of  commerce  or 
board  of  trade  are  deductible  as  a  business  expense,  provided  the 
membership  is  employed  as  a  means  of  advancing  the  business  in- 
terests of  the  individual  or  corporation.^^"  Membership  dues  paid 
to  a  certain  lumber  exporters'  association  organized  for  the  pur- 
pose of  promoting  in  all  lawful  ways  the  general  business  interests 
of  exporters  of  forest  products  by  the  collection  and  dissemination 
to  its  members  of  information  and  statistics  relating  to  such  ex- 
port business,  this  purpose  being  accomplished  by  protecting  the 
lumber  export  business  against  unjust  discriminations  and  re- 
strictions, by  the  establishment  of  uniform  practices,  customs, 
and  usages  in  the  trade  and  by  the  establishment  of  an  inspection 
and  classification  service  for  the  use  and  protection  of  members, 
represent  a  consideration  for  benefits  flowing  directly  to  the  payor 
as  an  incident  of  its  business,  and  consequently,  may  be  deducted 
as  a  business  expense.'"  Assessments  paid  by  member  banks  to 
a  clearing  house  as  a  means  of  furthering  their  business  interests 
may  be  deducted  as  business  expenses  in  the  returns  of  such 
banks.' '- 

Payments  from  Earnings  of  Public  Utility  Paid  to  State.  In 
the  case  of  a  public  utility  acquired,  constructed,  operated  or 
maintained  by  a  taxpayer  under  contract  with  any  state,  terri- 
tory, or  political  subdivision  thereof,  or  with  the  District  of  Col- 
umbia, containing  an  agreement  that  a  portion  of  the  net  earn- 
ings of  such  public  utility  shall  be  paid  to  the  state,  territory,  or 
political  subdivision  thereof,  or  the  District  of  Columbia,  the 
amount  so  paid  may  be  deducted  by  the  taxpayer  as  a  necessary 
expense  in  transacting  business. 'i'- 

i<»n  O.  D.  529,  T.  B.  22-20-975. 

110  0.  D.  421,  T.  B.  13-20-808. 

111  O.    D.   496,   T.   B.    19-20-916. 
11-  O.  D.  747,  T.  B.  50-20-1342. 

11=5  Revenue  Act  of  1921,  §213  (b)  (7);  Revenue  Act  of  1918,  §213  (b) 
(7)  ;  Rep:.  45,  Art.  84;  T.  D.  2090;  see  Revenue  Act  of  1916,  §  11    (b). 


CHAPTER  23 

DEDUCTION   OF   INTEREST 

The  Revenue  Act  of  1918  provided  that  citizens  and  residents 
and  domestic  corporations  might  deduct  all  interest  paid  or  ac- 
crued within  the  taxable  year  on  indebtedness,  except  on  indebt- 
edness incurred  or  continued  to  purchase  or  carry  obligations  or 
securities  (other  than  obligations  of  the  United  States  issued  after 
September  24,  1917),  the  interest  upon  which  was  wholly  exempt 
from  taxation  as  income  to  the  taxpayer.  Nonresident  aliens  and 
foreign  corporations  might  deduct  that  proportion  of  such  inter- 
est which  the  amount  of  his  or  its  gross  income  from  sources 
within  the  United  States  bore  to  the  amount  of  his  or  its  gross  in- 
come from  all  sources  within  and  without  the  United  States.^  The 
general  provision  of  the  1921  Law  permitting  the  deduction  of  in- 
terest is  the  same  as  that  of  the  1918  Law  except  that  there  is 
added  to  the  parenthetical  exception  the  words  "and  originally 
subscribed  for  by  the  taxpayer".-  In  the  case  of  nonresident 
aliens  and  foreign  corporations  the  deduction  of  interest  is  al- 
lowed only  if  and  to  the  extent  that  it  is  connected  with  income 
from  sources  within  the  United  States  and  the  proper  appor- 
tionment and  allocation  with  respect  to  sources  of  income  within 
and  without  the  United  States  must  be  determined  in  accordance 
with  the  statute  and  under  rules  and  regulations  prescribed  by 
the  Commissioner  with  the  approval  of  the  secretary.-^  But  this 
deduction,  under  both  laws,  is  allowed  to  a  nonresident  alien 
only  if  he  files  a  true  and  accurate  return  of  his  total  income  from 
all  sources,  corporate  or  otherwise,  in  the  manner  prescribed^ 
by  the  law.  In  all  cases,  interest  upon  indebtedness  incurred  or 
continued  to  purchase  or  carry  obligations  or  securities  (other 
than  obligations  of  the  United  States  issued  after  September  24, 
1917) ,  the  interest  upon  which  is  wholly  exempt  from  the  income 
tax  to  the  taxpayer,  may  not  be  deducted.  Thus,  a  citizen  or  resi- 
dent may,  with  the  exception  above  stated,  deduct  all  interest 
paid  or  accrued  within  the  taxable  year  on  his  indebtedness.  This 

1  Revenue  Act  of  1918,  §§214  (a)  2,  234  (a)  2;  Reg.  45,  Art.  121.  The 
limitations  imposed  by  the  1916  law  upon  the  amount  of  interest  which  might 
be  deducted  by  corporations  is  discussed  in  Chapter  10.  See  also  appendix 
to*  the  1920  edition  of  this  book. 

2  Revenue  Act  of  1921,  §§214   (a)  2  and  234   (a)   2. 

3  Revenue  Act  of  1921,  §§214   (b)   and  234   (b).     See  Chapter  4. 

4  Revenue  Act  of  1918,  §217;   Revenue  Act  of  1921,  §217   (g). 

602 


DEDUCTION  OF  INTEREST  603 

includes  not  only  indebtedness  incurred  for  business  purposes,  but 
indebtedness  incurred  for  any  purpose,  such  as  for  the  purpose  of 
buying  dwelling  houses  or  any  articles  or  things  of  personal  use. 
It  is  immaterial  what  term  is  applied  to  payments  on  the  obliga- 
tions of  a  corporation  if  such  payments  are  in  fact  interest.-'' 

Interest  on  Capital.  Interest  calculated  as  being  a  charge 
against  income  on  account  of  capital  or  surplus  invested  in  the 
business,  but  which  does  not  represent  a  payment  on  an  interest- 
bearing  obligation,  is  not  an  allowable  deduction  from  gross  in- 
come; that  is  to  say,  the  interest  which  the  money  might  earn  if 
otherwise  invested  is  not  a  deductible  charge  against  income." 

Indebtedness  Incurred  or  Continued  to  Purchase  or  Carry  Tax- 
Exempt  Securities.  The  Revenue  Act  of  1921  does  not  permit  the 
deduction  of  interest  paid  or  accrued  on  ''indebtedness  incurred  or 
continued  to  purchase  or  carry  obligations  or  securities  (other 
than  obligations  of  the  United  States  issued  after  September  24, 
1917) ,  and  originally  subscribed  for  by  the  taxpayer,"  the  interest 
upon  which  is  wholly  exempt  from  taxation  under  this  title."  ^ 
State  and  municipal  bonds  are  obligations  or  securities  falling 
within  this  class,  as  well  as  national  bonds  issued  prior  to  Sep- 
tember 1,  1917.  Interest  on  indebtedness  incurred  for  the  pur- 
chase of  Liberty  bonds  of  the  second  issue  (the  interest  on  which 
is  not  entirely  exempt  from  the  surtax)  was  held  deductible  re- 
gardless of  the  limitation  contained  in  the  1917  Law.^  By  the 
parenthetical  clause  of  the  1918  provision  taking  obligations  of 
the  United  States  issued  after  September  24,  1917,  out  of  the 
exception  to  the  deductibility  of  interest,  the  Revenue  Act  ot 
1918  made  it  clear  that  interest  on  indebtedness   incurred  or 

5  0.   D.   1060,  T.   B.  41-21-1861. 

fiReg.  45,  Art.  122. 

"  The  words  "and  originally  subscribed  for  by  the  taxpayer",  were  not 
contained  in  the  1918  Law.  Revenue  Act  of  1921,  §§  214  (a)  2,  and  234 
(a)   2. 

8  Revenue  Act  of  1918,  §§214  (a)  2,  234  (a)  2.  Prior  to  its  amendment 
by  the  Revenue  Act  of  1917,  it  was  held  under  the  1916  Law  that  interest 
paid  on  indebtedness  might  be  deducted,  whether  or  not  the  indebtedness 
was  incurred  for  the  purchase  of  bonds,  the  interest  upon  which  was 
exempt  from  taxation.  This  ruling  in  effect  permitted  a  double  deduction, 
that  is,  the  interest  on  the  money  so  borrowed  could  be  deducted  and  the  in- 
come derived  from  the  money  so  borrowed  and  invested  could  also  be 
deducted.  The  1917  Law  did  not  permit  the  deduction  of  interest  paid 
on  "indebtedness  incurred  for  the  purchase  of  obligations  or  securities 
the  interest  upon  which  is  exempt  from  taxation  as  income  under  this 
title."  (Revenue  Act  of  1916,  §§  5  (a),  12  (a),  as  amended  by  the  Revenue 
Act  of  1917.) 
•    »Reg.  45,  Art.  121;  T.  D.  2511. 


604  FEDERAL    INCOME    TAX 

continued  to  purchase  or  carry  Liberty  bonds  of  the  second  and 
subsequent  loans  would  be  allowed  as  a  deduction.^"  The  exten- 
sion of  the  exception  to  the  deductibility  of  interest  first  con- 
tained in  the  1918  Law  and  continued  in  the  present  law  to  in- 
debtedness ''continued"  as  well  as  "incurred,"  and  incurred  or  con- 
tinued to  "carry"  as  well  as  to  "purchase"  tax-exempt  securities 
should  be  noted.  The  limitation  imposed  by  the  1921  Law  on  the 
deduction  of  interest  on  indebtedness  incurred  or  continued  to 
purchase  or  carry  obligations  of  the  United  States  issued  after 
September  24,  1917,  by  the  addition  of  the  words  "and  originally 
subscribed  for  by  the  taxpayer,"  will  have  far-reaching  eff"ects, 
as  there  are  probably  few  taxpayers  who  are  still  paying  in- 
terest on  their  original  subscriptions  to  such  bonds. 

Interest  Paid  or  Accrued  Within  the  Year.  The  1909  Law  pro- 
vided for  the  deduction  of  "interest  actually  paid  within  the 
year"  and  it  was  contended  by  the  treasury  department  that  this 
provision  required  that  the  interest  should  be  both  accrued  and 
paid  within  the  same  year.  It  was  held,  however,  that  interest 
actually  paid  within  the  year  although  previously  accruing  should 
be  permitted  as  a  deduction. ii  The  1913  Law  provided  for  the 
deduction  of  interest  paid  within  the  year  by  individuals,  and 
"interest  accrued  and  paid  within  the  year"  by  corporations.  In 
a  ruling  under  that  law  it  was  held  that  in  the  case  of  corpora- 

K'ReK.  45,  Art.  121;  O.  D.  40,  T.  B.  1-19-57.  The  provision  of  the  1918 
Law  permitting  the  deduction  of  all  interest  paid  or  accrued  within  the 
taxable  year  was  the  subject  of  some  criticism  on  the  ground  that  it  per- 
mitted a  reduction  of  the  income  tax  by  the  purchase  of  non-taxable  se- 
curities with  borrowed  money.  The  remedy  proposed  was  that  the  interest 
deduction  be  limited  to  an  amount  bearing  the  same  proportion  to  the 
total  interest  paid  upon  indebtedness  which  the  taxpayer's  income  derived 
from  taxable  sources  bore  to  his  income  from  all  sources.  The  provision 
of  the  1918  Law  as  it  stood  permitted  the  deduction  of  interest  paid  or 
accrued  on  indebtedness  incurred  or  continued  to  purchase  or  carry  ob- 
ligations of  the  United  States  issued  after  September  2U,  1917.  The  paren- 
thetical exception  to  the  general  restriction  upon  the  deduction  of  interest 
was  designed  to  stimulate  the  sale  of  Liberty  Bonds.  It  will  be  remembered 
that  the  Victory  or  Fifth  Liberty  Loan  consisted  of  two  kinds  of  notes; 
that  is,  (1)  A^i'/c  three/four  year  convertible  gold  notes  exempt  from  state 
and  local  taxes  except  estate  and  inheritance  taxes  and  from  normal  Federal 
taxes,  (2)  85%  three/four  year  convertible  gold  notes  exempt  from  all 
Federal,  state  and  local  taxes  except  estate  and  inheritance  taxes.  It 
could  hardly  have  been  contemplated  at  the  time  §§  214  (a)  2  and  234 
(a)  2  (a)  of  the  Revenue  Act  of  1918  were  drawn  that  the  Victory  Loan 
would  include  any  wholly  exempt  notes  or  bonds. 

11  Anderson  v.  42  Broadway  Co.,  213  Fed.  777.  The  Supreme  Court  in 
reversing  the  lower  court  (239  U.  S.  69)  did  not  pass  on  the  question  of 
deducting  interest  accrued  in  one  year  and  paid  in  another. 


DEDUCTION  OF  INTEREST  605 

tions  the  deduction  should  be  limited  to  interest  which  had  both 
accrued  and  been  paid  within  the  same  year.'-  The  1916  Law  per- 
mitted the  deduction  of  interest  "paid  within  the  year."'"'  The 
Revenue  Act  of  1921,  like  the  1918  Law,  permits  the  deduction 
of  interest  "paid  or  accrued  within  the  taxable  year."'^  It  does 
not  seem  essential  under  these  provisions  that  interest  should 
have  accrued  or  become  payable  in  the  year  in  which  it  is  paid  in 
the  case  of  taxpayers  reporting  on  a  basis  of  cash  receipts  and 
disbursements. 

Where  a  decree  was  made  by  a  lower  court  in  1917  requir- 
ing a  corporation  to  distribute  dividends,  the  decision  being 
affirmed  in  1919  and  a  decree  entered  requiring  payment  of  in- 
terest from  the  date  of  the  decree  in  the  lower  court,  the  divi- 
dend, with  interest,  being  paid  in  1919  in  accordance  with  the 
decree,  it  has  been  ruled  that  the  total  amount  paid  should  not 
be  treated  as  a  dividend,  but  only  the  amount  originally  decreed 
by  the  lower  court.  This  decree  established  the  relationship  of 
debtor  and  creditor  between  the  corporation  and  its  shareholders, 
and  the  final  decree  not  merely  affirmed  the  relationship,  but 
awarded  interest  on  the  amount  of  the  debt.  The  fact  that  the 
interest  on  the  debt  ran  from  the  date  of  the  decree  in  the 
lower  court  to  the  date  of  payment  in  1919  does  not  require 
an  application  of  the  principle  of  accrual  with  reference  to  pay- 
ment or  receipt  of  interest,  as  it  was  not  known  that  interest 
would  be  awarded  or  what  the  rate  of  interest  would  be  until 
the  appellate  court  entered  its  decree.  The  interest  on  the 
amount  of  the  dividends  paid  in  1919  in  accordance  with  the 
decree  of  the  Supreme  Court,  represented  interest  paid  by  the 
corporation,  and  was  deductible  for  the  year  in  which  paid.''' 

Where  a  lumber  company  entered  into  a  contract  for  the  pur- 
chase of  a  timber  tract,  agreeing  to  pay  for  the  quantity  of 
timber  which  it  was  estimated  would  be  cut  each  year,  payment 
to  be  made  at  the  time  each  block  is  cut  at  a  certain  rate  per 

i-'T.  D.  I960. 

1»  Revenue  Act  of  1916,  §§5  (a),  12  (a),  as  amended  by  the  Revenue 
Act  of  1917. 

14  Revenue  Act  of  1921,  §§  214  (a)  2  and  234  (a)  2;  Revenue  Act  of  1918, 
§§214  (a),  2,  234  (a)  2.  The  term  "paid  or  accrued"  is  to  be  construed 
according  to  the  method  of  accounting  upon  the  basis  of  which  the  net 
income  of  the  taxpayer  is  computed.  (Revenue  Act  of  1921,  §  200;  Revenue 
Act  of  1918,  §200.)  Under  the  1916  Law,  corporations  keeping  books  of 
account  on  an  accrual  basis  were  permitted  to  deduct  interest  for  the  year 
whether  paid  or  not,  when  such  interest  was  shown  as  a  charge  against 
accrued  income  upon  the  books  of  account  (T.  D.  2625). 

i-'O.  D.  778,  T.  B.  4-21-1407. 


606  FEDERAL    INCOME    TAX 

thousand  feet,  plus  interest  at  6%  per  annum  from  the  date  of 
contract,  it  has  been  held  that  inasmuch  as  the  interest  charge 
did  not  accrue  and  become  payable  until  the  timber  was  cut,  it 
was  not  a  proper  deduction  until  that  time.  The  agreement  was 
an  executory  contract  to  purchase  the  timber  and  no  interest  is 
deductible  except  as  the  contract  is  executed.  The  interest  pay- 
ment does  not  constitute  an  operating  expense  of  the  company, 
but  enters  into  the  cost  of  the  lumber  produced  that  year.i''^ 

Interest  on  Taxes.  Interest  paid  or  accrued  on  overdue  federal 
income  and  excess-profits  taxes  is  held  not  to  be  a  part  of  the  tax 
but  is  deductible  as  interest.!^ 

Maryland  and  Pennsylvania  Ground  Rent.  Payments  made  for 
Maryland  or  Pennsylvania  ground  rents  are  not  deductible  as  in- 
terest.18 

Interest  on  Real  Estate  Mortgage.  Interest  paid  by  the  tax- 
payer on  a  mortgage  upon  real  estate  of  which  he  is  the  legal  or 
equitable  owner,  even  though  the  taxpayer  is  not  directly  liable 
upon  the  bond  or  note  secured  by  such  mortgage,  may  be  de- 
ducted as  interest  on  his  indebtedness. ^'^ 

16  0.  D.  595,  T.  B.  29-20-1075. 

1"  This  applies  to  all  interest  added  to  the  tax  under  the  provisions  of 
§  250  of  the  Revenue  Act  of  1918  and  §  250  of  the  Revenue  Act  of  1921. 
O.  922,  T.  B.  7-20-745;   0.  D.  319,  T.  B.   26-19-595. 

18  Reg.  45,  Art.  121. 

19  Reg.  45,  Art.  121. 


CHAPTER  24 

DEDUCTION  OF  TAXES 

The  provisions  of  the  Revenue  Act  of  1921,  with  respect  to 
the  deduction  of  taxes  in  the  case  of  citizens  and  residents  and 
domestic  corporations  are,  in  general,  and  with  one  exception  as 
to  taxes  paid  by  corporations  for  their  shareholders,  the  same 
as  those  of  the  1918  Law.  The  1918  Law  specified  the  taxes 
which  might  be  deducted;  the  Revenue  Act  of  1921  provides  for 
the  deduction  of  all  taxes  except  those  specified  as  not  deduct- 
ible. The  provisions  of  the  1918  Law  respecting  the  deduction 
of  taxes  by  nonresident  aliens  and  foreign  corporations  are  given 
below.  The  Revenue  Act  of  1921  provides  that  such  taxpayers 
may  be  allowed  the  deduction  for  taxes  granted  to  citizens  and 
residents  and  domestic  corporations  if  and  to  the  extent  such 
deduction  is  connected  with  income  from  sources  within  the 
United  States  and  the  proper  apportionment  and  allocation  of 
such  deduction  must  be  determined  in  accordance  with  the  defini- 
tions of  income  from  sources  within  and  sources  without  the 
United  States  set  forth  in  the  law  and  under  rules  and  regula- 
tions prescribed  by  the  Commissioner  with  the  approval  of  the 
secretary.^ 

In  the  case  of  citizens  and  residents  and  domestic  corporations 
the  provisions  of  the  Revenue  Act  of  1918  for  the  deduction  of 
taxes  were  the  same.  Such  taxpayers  might  deduct  taxes  paid 
or  accrued  within  the  taxable  year  imposed  (a)  by  the  authority 
of  the  United  States,  except  income,  war-profits,  and  excess- 
profits  taxes;  or  (b)  by  the  authority  of  any  of  its  possessions, 
except  the  amount  of  income,  war-profits  and  excess-profits  taxes 
allowed  as  a  credit  against  the  tax  of  the  taxpayer;  or  (c)  by 
the  authority  of  any  state  or  territory,  not  including  those  as- 
sessed against  local  benefits  of  a  kind  tending  to  increase  the 
value  of  the  property  assessed;  or  (d)  by  the  authority  of  any 
foreign  country  except  the  amount  of  income,  war-profits  and 
excess-profits  taxes  allowed  as  a  credit  against  the  tax  of  the 
taxpayer.  Nonresident  aliens  and  foreign  corporations  were 
allowed  to  deduct  the  taxes  included  in  items  (a),  (b),  and  (c) 
above;  in  lieu  of  the  taxes  included  in  item  (d)  above  they  were 
allowed  to  deduct  taxes  imposed  by  the  authority  of  any  foreign 
country    (except   income,   war-profits   and   excess-profits   taxes, 

'-Revenue  Act  of  1921,  §§214  (b)   and  234   (b). 

607 


608  FEDERAL    INCOME    TAX 

and  taxes  assessed  against  local  benefits  of  a  kind  tending  to  in- 
crease the  value  of  the  property  assessed),  upon  property  or 
business.-  The  Revenue  Act  of  1921  allows  the  deduction,  in  the 
case  of  citizens  and  residents  and  domestic  corporations,  of  taxes 
paid  or  accrued  within  the  taxable  year  except  (a)  income,  war- 
profits  and  excess-profits  taxes  imposed  by  the  authority  of  the 
United  States,  (b)  so  much  of  the  income,  war-profits  and  excess- 
profits  taxes  imposed  by  the  authority  of  any  foreign  country 
or  possession  of  the  United  States,  as  is  allowed  as  a  credit 
against  the  tax  of  the  taxpayer,  (c)  taxes  assessed  against  local 
benefits  of  a  kind  tending  to  increase  the  value  of  the  property 
assessed.  A  citizen  or  resident  may  not  deduct  taxes  imposed 
upon  his  interest  as  shareholder  or  member  of  a  corporation, 
which  are  paid  by  the  corporation  without  reimbursement  from 
the  taxpayer,  the  deduction  of  such-  taxes  now  being  expressly 
allowed  to  the  corporation.'*  The  provisions  of  the  1921  Law  as 
to  nonresident  aliens  and  foreign  corporations  have  been  indi- 
cated above.  The  deduction  of  taxes  by  nonresident  aliens  under 
both  laws  is  only  allowed  if  they  file  a  true  and  accurate  return 
of  income  from  all  sources,  corporate  or  otherwise,  in  the  United 
States  in  the  manner  prescribed  by  law."^  In  addition  to  the 
taxes  which  are  allowed  as  a  deduction  from  gross  income  in 
computing  net  income,  certain  taxes  are  permitted  to  be  credited 
against  the  tax  otherwise  payable.  These  credits  are  discussed 
in  a  chapter  following."' 

Taxes  Paid  or  Accrued  Within  the  Year.  Under  the  1913  and 
1916  Laws  the  provisions  permitting  the  deduction  of  taxes  ex- 
pressly limited  such  deduction  to  taxes  paid  within  the  year.  It 
was  held  by  the  treasury  department  that  reserves  for  taxes 
could  not  be  established,  as  only  sums  actually  paid  within  the 
year  could  be  deducted,  that  is,  the  aggregate  of  the  amounts 
actually  paid  as  shown  by  the  cash  book.''    The  Revenue  Act  of 

^Revenue  Act  of  1918,  §§214  (a)  3,  234  (a)  3.  Reg.  45,  Art.  131. 
Under  the  1916  Law,  in  the  case  of  nonresident  aliens  and  foreign  cor- 
porations the  taxes  which  might  be  deducted  were  limited  to  those  assessed 
by  the  United  States  or  its  territories  or  possessions  or  under  the  authority 
of  any  state,  county,  school  district  or  municipality  or  other  taxing  sub- 
division of  any  state,  paid  within  the  United  States,  within  the  year,  except 
such  taxes  as  were  not  deductible  by  any  class  of  taxpayers.  (Revenue 
Act  of  1916,  §§6  (a),  12  (b).)  For  the  special  rulings  applicable  to 
nonresident  aliens  and  foreign  corporations  see  Chapters  4  and  10. 

•".Revenue  Act  of  1921,  §§214  (a)  3  and  234   (a)   3. 

4  Revenue  Act  of  1921,  §    217;  Revenue  Act  of  1918,  §217. 

f'See   Chapter  32. 

"Reg.  33,  Arts.   156,  158. 


DEDUCTION  OF  TAXES  609 

1921,  like  the  1918  Law,  provides  for  the  deduction  of  taxes 
"paid  or  accrued."  The  term  "paid  or  accrued"  is  to  be  con- 
strued according  to  the  method  of  accounting  upon  the  basis 
of  which  the  net  income  of  the  taxpayer  is  computed.'  The 
Revenue  Act  of  1921  provides  that  for  the  purpose  of  their  de- 
duction, estate,  inheritance,  legacy,  and  succession  taxes  accrue 
on  the  due  date  thereof  except  as  otherwise  provided  by  the 
law  of  the  jurisdiction  imposing  such  taxes.^ 

The  New  York  state  franchise  tax  imposed  for  the  privilege 
of  doing  business  in  that  state  for  the  fiscal  year  of  the  state 
ending  October  31,  1920,  is  based  on  1918  income,  but  is  not 
due  and  payable  until  a  later  date.  A  taxpayer  making  a  calendar 
year  return  on  an  accrual  basis  may  deduct  two-twelfths  of 
such  tax  in  his  return  for  1919  and  ten-twelfths  in  his  return  for 
1920."  Munitions  taxes  are  properly  chargeable  against  the  in- 
come of  the  year  in  which  the  munitions  are  made  and  sold  or 
otherwise  disposed  of.  When  the  books  of  the  manufacturer  are 
kept  upon  an  accrual  basis  the  amount  of  such  taxes  should  be 
included  as  a  deduction  from  income,  and  the  liability  therefor 
should  appear  upon  the  books  of  account  of  the  company  at 
the  close  of  the  taxable  year.^^^  It  has  been  ruled  that  a  cor- 
poration might  not  accrue  munitions  taxes  for  1916  and  1917 
and  deduct  as  expenses  the  amount  so  accrued  during  each 
year  in  its  munitions  tax  return  for  that  year  before  the  final 
computation  of  the  munitions  tax  had  been  made.  The  muni- 
tions tax  as  finally  computed  must  be  deducted  in  the  income 
tax  return  for  the  year  in  which  the  tax  is  accrued,  irrespective 
of  the  year  in  which  the  tax  is  actually  paid.^^  Taxpayers  must 
use  either  the  accrual  method  or  the  receipts  and  disburse- 
ments method  consistently.  A  corporation  making  a  return 
for  a  fiscal  year  ending  during  the  calendar  year  1917,  but  prior 
to  October  3,  was  not  entitled  to  deduct  from  gross  income  both 

"i  Revenue  Act  of  1918,  §  200.  The  provision  of  the  1916  Law  allowing 
individuals  and  corporations  to  report  on  a  basis  other  than  that  of  actual 
receipts  and  disbursements,  and  the  rulings  by  the  treasury  department 
thereunder,  first  seemed  to  permit,  and  later  required,  in  the  case  of  in- 
dividuals or  corporations  reporting  on  an  accrual  basis,  the  deduction  of 
taxes  accrued  on  their  books  or  the  amounts  reserved  for  the  payment  of 
taxes,  providing  such  amounts  did  not  exceed  the  actual  liability  incurred 
during  the  year.     (T.  D.  2433;  L.  O.  1059,  T.  B.  10-21-1503). 

^^  Revenue  Act  of  1921,  §§214   (a)   3  and  234   (a)  3. 

9  0.  D.  371,  T.  B.  3-20-687.     See  also  O.  D.  388,  T.  B.  5-20-715. 

10  A.   R.   M.  26,  T.   B.  5-20-713. 

11  A.  R.  M.  29,  T.  B.  9-20-770.  It  must  be  assumed  that  the  corporation 
involved  in  this  ruling  reports  on  an  accrual  basis. 


610  FEDERAL    INCOME    TAX 

the  federal  income  tax  paid  prior  to  January  1,  1917,  and  the 
income  tax  accrued  on  its  books  of  account  during  the  months 
of  the  fiscal  year  falling  within  the  calendar  year  1916.^- 

Federal  Duties  and  Excise  Taxes.  Import  or  tariff  duties 
paid  to  the  proper  customs  officers,  and  business,  license,  privi- 
lege, excise  and  stamp  taxes  paid  to  internal  revenue  collectors, 
are  deductible  under  the  1918  and  1921  Laws,  provided  they  are 
not  added  to  and  made  a  part  of  the  expenses  of  the  business 
or  the  cost  of  articles  of  merchandise  with  respect  to  which 
they  are  paid,  in  which  case  they  can  not  be  separately  de- 
ducted.'■■  An  individual  may  claim  as  a  deduction  the  amount 
of  war  tax  paid  on  facilities  furnished  by  public  utilities,  which 
includes  the  tax  on  railroad  and  steamship  fares  and  the  tax 
paid  on  admissions  and  dues.  The  war  excise  taxes  imposed  on 
articles  sold  or  leased  by  the  manufacturer,  producer,  or  im- 
porter^-* were  levied  against  and  paid  by  the  manufacturer,  pro- 
ducer or  importer  and  were  not  deductible  by  the  individual 
purchaser.  The  consumption  taxes  imposed  by  the  Revenue  Act 
of  1918 ^'"^  on  semi-luxuries  sold  by  dealers  were  paid  by  the  pur- 
chaser and  were  deductible  by  him.^'' 

Capital  Stock  Tax.  For  the  purpose  of  computing  other  income 
subject  to  income  and  excess-profits  taxes,  the  capital  stock  tax 
may  be  deducted  from  the  gross  income  for  the  year  for  which 
such  taxes  accrue,  if  accounts  of  the  corporate  taxpayers  are 
kept  on  the  accrual  basis,  or  may  be  deducted  from  gross  income 
for  the  year  in  which  paid,  if  accounts  are  kept  on  the  disburse- 
ment basis. ^' 

Federal  Estate  Taxes.  The  treasury  department  ruled  that 
federal  estate  taxes  were  not  deductible  in  computing  net  in- 
come, but  in  a  recent  case^'^  the  Supreme  Court  of  the  United 
States  has  reversed  the  department's  ruling.  In  that  case  the 
court  took  the  view  that  the  question  of  the  deductibility  of 
federal  estate  taxes  turns  entirely  upon  the  statutory  provisions 
under  which  the  estate  tax  and  the  income  tax  are  collected. 
The  provision  in  the  Revenue  Act  of  1918  for  the  deduction 
of  "taxes  paid  or  accrued  within  the  taxable  year  imposed  (a) 
by  the  authority  of  the  United  States,  except  income,  war-profits, 

1^  S.  1305,  T.  B.  8-20-754. 

13  Reg.  45,  Art.  132;   O.  D.   137,  T.  B.  4-19-216. 

14  See  Revenue  Act  of  1918,   §  900. 
1-^  Revenue   Act  of  1918,   §  904. 
ifiO.  D.  287,  T.  B.  22-19-535. 

17  Letter  from  treasury  department  dated  June  7,  1919;  I.  T.  S.  1921, 
H 1364. 


DEDUCTION  OF  TAXES  611 

and  excess-profits  taxes"  is  explicit  and  unambiguous.  The 
words  of  its  major  clause  are  comprehensive  and  include  every 
tax  which  is  charged  against  the  estate  by  the  authority  of  the 
United  States.  The  excepting  clause  specifically  enumerates 
what  is  to  be  excepted.  Estate  taxes  were  as  well  known  at  the 
time  the  provision  was  framed  as  the  ones  particularly  excepted. 
The  estate  tax  is  called  a  "tax"  by  the  statute  imposing  it.  It 
is  made  a  general  charge  on  the  gross  estate  and  is  to  be  paid 
out  of  it  by  the  administrator  or  executor  substantially  as  other 
taxes  and  charges  are  paid.  The  department  has  also  ruled 
that  interest  upon  an  overdue  federal  estate  tax  is  not  deduct- 
ible.T*  Since  this  decision  is  predicated  upon  the  reasoning  that 
since  the  statute  describes  the  interest  as  constituting  "part  of 
the  tax"-"  and  therefore  it  is  not  possible  to  make  a  sound  dis- 
tinction between  the  tax  and  interest  thereon,  it  would  now  seem 
that  the  interest  upon  an  overdue  federal  estate  tax  may  be 
deducted.  The  Revenue  Act  of  1921  provides  that,  for  the  pur- 
pose of  their  deduction,  estate,  inheritance,  legacy  and  succes- 
sion taxes  accrue  on  the  due  date  thereof  except  as  otherwise 
provided  by  the  law  of  the  jurisdiction  imposing  such  taxes.-^ 

Excise  Taxes  Paid  to  Cuban  Government.  The  Republic  of 
Cuba  imposes  on  all  corporations  operating  sugar  plantations  in 
Cuba  a  tax  of  a  certain  amount  on  each  bag  of  sugar  produced. 
This  tax  is  based  on  production,  not  on  income,  and  is  in  the 
nature  of  an  excise  tax.  It  was  held  under  the  1918  Law  that 
a  domestic  corporation  might  deduct  from  gross  income  in  its 
return  to  the  United  States  government  the  amount  of  such  tax 
paid  to  the  Cuban  government,  but  might  not  claim  the  amount 
as  a  credit  agaijist  the  total  tax  due  to  the  United  States.-- 

Taxes  Imposed  by  the  Authority  of  any  Foreign  Country.  The 
term  "foreign  country",  as  used  in  the  law,  has  been  held  to 
mean  the  composite  whole  made  up  of  all  the  subdivisions  of  a 
foreign  state  subject  to  the  same  central  control.  Each  of  the 
subdivisions,  in  this  sense,  is  not  a  "country"  but  a  part  of  a 
"country".  The  Province  of  British  Columbia,  therefore,  does 
not  come  within  the  meaning  of  the  term  "foreign  country". 
It  was  held  under  the  1918  Law  that  amounts  of  mineral  tax 

IS  U.  S.  V.  Woodward,  65  L.  ed.  728,  Ct.  D.  15,  T.  B.  26-21-1706. 
l»  0.  D.  594,  T.  B.  29-20-1074. 

20  Revenue  Act  of  1918,  §  406. 

21  Revenue  Act  of  1921,  §§214    (a)   3  and  234   (a)   3. 

22  O.  D.  372,  T.  B.  3-20-688. 


612  FEDERAL    INCOME    TAX 

and  income  tax  paid  to  the  province  of  British  Columbia  by  a 
domestic  corporation  are  deductible  as  business  expenses.--^ 

Depositors'  Guaranty  Fund.  Banking  corporations,  which  pur- 
suant to  the  laws  of  the  states  in  which  they  are  doing  busi- 
ness are  required  to  set  apart,  keep  and  maintain  in  their  banks 
the  amount  levied  and  assessed  against  them  by  the  state  au- 
thorities as  a  ''depositors'  guaranty  fund,"  may  deduct  from  their 
gross  income  the  amount  so  set  apart  each  year  to  this  fund, 
provided  that  such  fund,  when  set  aside  and  carried  to  the  credit 
of  the  state  banking  board  or  duly  authorized  state  officer, 
ceases  to  be  an  asset  of  the  bank  and  may  be  withdrawn  in  whole 
or  in  part  upon  demand  by  such  board  or  state  officer  to  meet 
the  needs  of  these  officers  in  reimbursing  depositors  in  insolvent 
banks,  and  provided  further  that  no  portion  of  the  amount  thus 
set  aside  and  credited  is  returnable  under  the  laws  of  the  state 
to  the  assets  of  the  banking  corporation.  If,  however,  such 
amount  is  simply  set  upon  the  books  of  the  bank  as  a  reserve  to 
meet  a  contingent  liability  and  remains  an  asset  of  the  bank, 
it  will  not  be  deductible  except  as  it  is  actually  paid  out  as  re- 
quired by  law  and  upon  demand  of  the  proper  state  officers.-^ 

Automobile  License  Fees.  It  has  been  ruled  that  automobile 
license  fees  are  ordinarily  taxes  and  therefore  deductible.-^ 

Securities  Taxes.  Amounts  paid  to  states  under  secured  debts 
laws  in  order  to  render  securities  tax-exempt  are  deductible.-*^ 

State  Tax  on  Massachusetts  Trust  Companies.  It  has  been 
held  that  Massachusetts  trust  companies  may  deduct  the  amount 
of  the  tax  levied  by  the  state  on  their  corporate  franchises,  the 
amount  of  such  taxes  being  based  on  their  capital  stock,  surplus 
and  undivided  profits  at  the  time  the  assessment  is  made.-'^ 

Taxing  Subdivisions  of  Territories.  It  was  provided  by  the 
1916  law  that  "taxes  paid  within  the  year  imposed  by  the  au- 
thority of  the  United  States  (except  income  and  excess-profits 
taxes)  or  of  its  territories,  or  possessions,  or  any  foreign  coun- 
try, or  by  the  authority  of  any  state,  county,  school  district, 
or  municipality,  or  other  taxing  subdivision  of  any  state,  not 
including  those  assessed  against  local  benefits"  were  deductible.-^ 
No  express  provision  was  made  for  the  deduction  of  taxes  im- 

23  O.  D.  1050,  T.  B.  39-21-1844. 

24  Reg.   45,   Art.   567;    T.    D.   2152. 

25  Reg.  45,   Art.   131. 

26  Reg.  45,  Art.  131. 

27  O.  D.  1043,  T.  B.  38-21-1833. 

28  Revenue  Act  of  1916,  §§5,  6,  12  (a)  and  12  (b),  as  amended  by 
Revenue  Act  of  1917. 


DEDUCTION  OF  TAXES 


613 


posed  by  the  authority  of  ''any  taxing  subdivision"  of  any  ter- 
ritory. The  Revenue  Act  of  1918  provided-"'  for  the  deduction 
of  taxes  imposed  by  a  taxing  subdivision  of  any  territory.  Such 
taxes  may  be  deducted  under  the  present  law  since  they  are  not 
expressly  excepted  from  those  taxes  which  are  allowed  as  a 
deduction. 

Taxes  Paid  by  Vendee  for  Vendor.  If,  in  pursuance  of  a 
contract,  a  vendee  corporation  agrees  to  pay  the  income  and 
excess-profits  taxes,  on  profits  arising  out  of  the  sales  returned 
by  the  vendor  corporation  on  a  calendar-year  basis,  such  vendee 
corporation  may,  if  it  reports  on  an  accrual  basis  for  a  fiscal 
year  ending  in  October  of  the  calendar  year,  submit  an  amended 
return  in  which  the  extent  of  the  accrual  of  such  taxes  in  such 
fiscal  year  is  deducted  from  gross  income.  If,  however,  such 
contracts  are  regularly  entered  into  by  the  vendee  corporation 
as  a  consistent  practice,  the  vendee  corporation  should  be  allowed 
the  deduction  as  for  the  year  in  which  the  taxes  are  paid  or 
detennined,  unless  gross  distortion  of  income,  as  between  years, 
results.'^" 

Taxes  Paid  by  a  Tenant.  Where  a  tenant  pays  the  taxes  on 
property  leased  by  him,  he  may  consider  the  amount  so  paid 
as  an  additional  payment  of  rent  and  may  deduct  it  as  an  ex- 
pense of  carrying  on  his  business."'^  To  the  landlord  the  amount 
is  equivalent  to  an  additional  payment  of  rent  and  must  be  re- 
ported as  such,  but  he  may  also  deduct  the  amount,  as,  to  him, 
it  is  a  tax  paid  during  the  year  by  the  tenant  as  his  agent.  The 
transaction  is  tantamount  to  a  payment  of  the  sum  by  the  tenant 
to  the  landlord  and  a  repayment  by  the  landlord  to  the  tenant,  as 
his  agent,  for  the  purpose  of  satisfying  the  tax."-  Assessments 
for  local  benefits  paid  by  a  tenant  for  his  landlord  according 
to  agreement  are  held  to  be  additional-  rent  paid  by  the  tenant, 
and  therefore  deductible  from  his  gross  income.  The  amount 
so  received  by  the  landlord  is  taxable  income  to  him,  but  because 
of  its  nature  is  not  an  allowable  deduction  from  his  gross  in- 
come.^^ 

Taxes  Not  Deductible.  The  Revenue  Act  of  1921  and  the 
Revenue  Act  of  1918  expressly  provide  that  no  taxpayer  shall 
deduct  (a)  income,  war-profits  and  excess-profits  taxes  imposed 
by  the  authority  of  the  United  States,  (b)  taxes  assessed  against 

29  Revenue  Act  of  1918,  §§214   (a)   3,  234   (a)   3. 

30  A.  R.  M.  16,  T.  B.  2-20-669. 

31  T.  D.  2090. 

32  Reg.   45,    Art.    109. 

33  O.  D.  373,  T.  B.  3-20-689. 


614  FEDERAL    INCOME    TAX 

local  benefits  of  a  kind  tending  to  increase  the  value  of  the 
property  assessed,  and  (c)  taxes  paid  by  a  corporation  pursuant 
to  a  so-called  "tax-free"  covenant  contained  in  its  bonds,  mort- 
gages, deeds  of  trust,  or  other  similar  obligations;  and  the  1918 
Law  provided  that  nonresident  aliens  and  foreign  corporations 
might  not  deduct  (a)  income,  war-profits  and  excess-profits  taxes 
imposed  by  the  authority  of  any  foreign  country,  and  (b)  taxes 
assessed  against  local  benefits  of  a  kind  tending  to  increase  the 
value  of  the  property  assessed  imposed  by  the  authority  of  any 
foreign  government."'^  Nonresident  aliens  and  foreign  corpo- 
rations are  now  allowed  the  same  deduction  for  taxes  as  citi- 
zens and  residents  and  domestic  corporations  subject  to  the 
limitations  stated  in  the  introductory  paragraph  of  this  chapter. 
Although  income,  war-profits  and  excess-profits  taxes  imposed 
by  the  authority  of  any  possession  of  the  United  States,  or  any 
foreign  country  (in  the  case  of  citizens  or  residents  or  domestic 
corporations)  are  not  allowed  as  a  deduction,  they  are  allowed 
as  a  credit  against  tax."'"*  The  10%  tax  imposed  by  the  Revenue 
Act  of  1916  as  amended,  on  the  undistributed  net  income  of 
corporations  is  considered  an  income  tax  and  is  therefore  not 
deductible.-^''  War-profits  and  excess-profits  taxes  are  allowed 
as  a  credit  to  domestic  or  foreign  corporations  against  the  in- 
come tax  for  the  same  taxable  year.-''  Additions  to  tax  because 
of  a  delinquent  return  may  be  deducted  from  gross  income  and 
will  not  be  disallowed  on  the  ground  that  they  are  part  of  the 
income  or  profits  taxes  within  the  provisions  of  law  forbidding 
the  deduction  from  gross  income  of  such  taxes.-^'^     Taxes  paid 

3-t  Revenue  Act  of  1921,  §§214    (a)    3,  234    (a)    3;   Revenue  Act  of  1918, 
§§214   (a)   3  and  234   (a)   3. 

33  Revenue  Act  of  1921,  §§  222  and  238;  Revenue  Act  of  1918,  §§  222,  238. 

S'J  Letter  from  treasury  department  dated  April   1,   1919;    L   T.   S.   1919, 
1!  3285. 

37  Prior  to  its  amendment  by  the  Revenue  Act  of  1917  it  was  held  under 
the  1916  Law  that  the  income  tax  paid  on  income  of  one  year,  whether  paid 
by  the  taxpayer  or  withheld  at  the  source,  was  property  deductible  from 
the  net  income  of  the  following  year.  (T.  D.  2135.)  The  1917  amendment 
provided  that  income  and  excess-profits  taxes  paid  by  the  taxpayer  should 
not  be  allowed  as  a  deduction  (Revenue  Act  of  1916,  §§5,  6,  12  (a)  and 
12  (b)  as  amended  by  the  Revenue  Act  of  1917),  but  in  assessing  the 
income  tax  the  net  income  embraced  in  a  return  made  under  the  1917  Law 
was  credited  by  the  Commissioner  with  the  amount  of  any  excess-profits 
taxes  imposed  by  Act  of  Congress  and  assessed  for  the  same  calendar  or 
fiscal  year  upon  the  taxpayer,  and  in  the  case  of  a  member  of  a  partnership, 
with  his  proportionate  share  of  such  excess-profits  taxes  imposed  upon 
the  partnership.  (Revenue  Act  of  1916,  §  29,  added  by  Revenue  Act  of 
1917.) 
.  38  0.   926,   T.   B.  23-19-551. 


DEDUCTION  OF  TAXES 


615 


by  a  corporation  for  its  stockholders  have  been  held  by  the 
courts  under  prior  laws  not  to  be  deductible,  but  the  present 
law  makes  such  taxes  deductible  by  the  corporation  and  not  by 
the  shareholder.'""'     Postage  is  not  a  tax  and  is  therefore  not 

deductible.^" 

TAXES  Assessed  Against  Local  Benefits.    The  taxes  con- 
templated bv  the  law  as  deductible  are  those  which  are  paid  to 
defray  the  expense  of  running  the  government.    Where  the  tax- 
payer pays  an  assessment  for  something  which  will  directly  bene- 
fit him  or  his  property  it  is  not  considered  to  be  a  tax  in  the 
true  sense,  but  rather  in  the  nature  of  an  investment  in  property. 
The  Revenue  Act  of  1921  and  the  Revenue  Act  of  1918  expressly 
provide  that  taxes  assessed  against  local  benefits   "of  a  kind 
tending  to  increase  the  value  of  the  property  assessed"  shall 
not  be  deductible.  ^^    It  has  been  ruled  that  so-called  taxes,  more 
properly  assessments,  paid  for  local  benefits,  such  as  street,  side- 
walk and  other  like  improvements,  imposed  because  of  and  meas- 
ured by  some  benefit  inuring  directly  to  the  property  against 
which  the  assessment  is  levied,  do  not  constitute  an  allowable 
deduction   from   gross   income.     A  tax    is   considered   assessed 
against  local  benefits  when  the  property  subject  to  the  tax  is 
limited  to  the  property  benefited.     Special  assessments  are  not 
deductible,  even  though  an  incidental  benefit  may  inure  to  the 
public  welfare.     The  taxes  deductible  are  those  levied  for  the 
general  public  welfare  by  the  proper  taxing  authorities  at  a  like 
rate  against  all  property  in  the  territory  over  which  such  au- 
thorities have  jurisdiction.     Assessments  under  the  statutes  of 
California  relating  to  irrigation  and  of  Iowa  relating  to  drain- 
age, and  under  certain  statutes  of  Tennessee  relating  to  levees, 
are' limited  to  property  benefited,  and  when  it  is  clear  that  the 
assessments  are  so  limited,  the  amounts  paid  thereunder  are  not 
deductible  as  taxes.    Taxpayers  will  be  required  to  show,  in  their 
income  tax  returns,  the  nature  of  assessments  paid  under  the 
Illinois  drainage  laws,  inasmuch  as  such  laws  provide  both  for 
special  assessments  for  benefits  and  for  general  taxation,  de- 
pending in  some  instances  upon  ordinances  promulgated  by  the 
trustees  of  drainage  districts.^-     When  assessments  are  made 
for  the  purpose  of  maintenance  or  repair  of  local  benefits,  the 
taxpayer  may  deduct  the  assessments  paid  as  an  expense  in- 

39  Revenue  Act  of  1921,  §§  214    (a)    3   and  234    (a)    3. 
W  Reg.    45,    Art.    131. 

41  Revenue  Act  of  1918,  §214   (a)   3;  Revenue  Act  of  1921,  §§214   (a)   3 

and  234  (a)  3. 

42  0.  928,  T.  B.  24-19-561. 


616  FEDERAL    INCOME    TAX 

curred  in  business,  if  the  payment  of  such  assessments  is  neces- 
sary to  the  conduct  of  his  business.  Where  the  assessments 
are  made  for  the  purpose  of  constructing  local  benefits,  the  pay- 
ments by  the  taxpayer  are  in  the  nature  of  capital  expenditures 
and  are  not  deductible.  Where  assessments  are  made  for  the 
purpose  of  both  construction  and  maintenance  or  repairs,  the 
burden  is  on  the  taxpayer  to  show  the  allocation  of  the  amounts 
assessed  to  the  different  purposes.  If  the  allocation  can  not  be 
made,  none  of  the  amounts  so  paid  is  deductible.^''^ 

Taxes  Paid  Under  "Tax-Free"  Covenants.  Where  a  cor- 
poration pays  taxes  for  its  bondholders  under  stipulations  in 
bonds  agreeing  to  pay  the  interest  in  full  regardless  of  any  tax 
which  it  may  be  required  to  withhold  or  deduct,  the  amount  of 
taxes  so  paid  on  behalf  of  such  bondholders  is  not  a  proper 
deduction  by  the  corporation.^^  It  was  ruled  under  the  1918 
Law  that  the  bondholder  might,  however,  treat  the  amount  so 
paid  for  him  as  his  tax  and  deduct  the  same,  if  it  was  a  tax 
levied  by  a  state;  if  levied  by  the  federal  government  he  could 
not  deduct  the  amount  as  the  law  expressly  prohibited  deduction 
of  the  federal  income-tax.  The  amount  of  income-tax  paid  for 
a  bondholder  by  an  obligor  pursuant  to  a  tax-free  covenant  in 
its  bonds  was  ruled  to  be  in  the  nature  of  additional  interest 
paid  the  bondholder  and  was  required  to  be  included  in  his  gross 
income.^3  The  Revenue  Act  of  1921  expressly  provides  that 
such  taxes  shall  not  be  included  in  the  gross  income  of  the 
obligee.^" 

State  Inheritance  Taxes.  State  inheritance  taxes  paid  by 
the  executor  or  administrator  of  an  estate  of  a  deceased  person, 
which  are  provided  by  law  to  be  deducted  from  the  respective 
legacies  or  distributive  shares,  are  not  allowable  deductions  in 
computing  the  net  income  of  such  estate  subject  to  tax,  even 
though  the  will  contain  a  direction  to  pay  inheritance  taxes  out 
of  the  residue.  An  inheritance  tax  is  upon  the  transfer  of  the 
property  and  not  upon  the  estate  of  the  decedent  or  upon  the 
executor  or  administrator,  although  the  latter  is  required  to  pay 
it.  In  general,  taxes  paid  or  accrued  within  the  year  imposed  by 
the  authority  of  any  state,  or  otherwise,  are  limited  to  those  im- 
posed upon  the  taxpayer  and  do  not  include  taxes  paid  by  him 

•iSReg-.  45,  Art.  133,  as  amended  by  T.  D.  2937.  See  also  T.  D.  2090; 
Reg.   33,  Art.   153. 

■1^  Revenue  Act  of  1921,  §234  (a)  3;  Revenue  Act  of  1918,  §234  (a)  3. 
See  T.  D.  1948.     The  rulings  on  this  point  are  contained  in  Chapter  20. 

«Reg.  45,  Art.  31. 

4«  Revenue  Act  of  1921,   §234    (a)    3. 


DEDUCTION  OF  TAXES  617 

on  behalf  of  another,  even  though  he  is  required  by  law  to  make 
such  payment.  Since,  moreover,  state  inheritance  taxes  are  im- 
posed upon  the  transfer  before  the  property  reaches  the  legatee 
or  the  distributee,  and  merely  diminish  the  capital  share  of  the 
estate  received  by  him,  such  taxes  are  not  imposed  upon  the 
legatee  or  distributee  and  are  not  an  allowable  deduction  from 
his  gross  income.^" 

Taxes  Paid  by  Corporation  for  Stockholders  Under  1921  Law. 
The  Revenue  Act  of  1921  provides  that  taxes  imposed  upon  a 
taxpayer  upon  his  interest  as  shareholder  or  member  of  a  corpo- 
ration, which  are  paid  by  the  corporation  without  reimburse- 
ment from  the  taxpayer,  may  not  be  deducted  by  such  share- 
holder or  member,  but  may  be  deducted  by  the  corporation. ■*"' 
The  1918  Law  was  silent  on  this  point  and  the  treasury  depart- 
ment took  the  opposite  view.  The  rulings  made  on  this  subject 
imder  the  1918  Law  are  given  in  the  following  paragraph. 
.  Taxes  Paid  by  Corporation  for  Stockholders  Under  1918  Law. 
Under  the  statutes  of  many  of  the  states  taxes  are  assessed 
against  the  stockholders  of  banks,  the  bank  being  required  to  pay 
the  tax  on  behalf  of  its  stockholders.  Banks  paying  taxes 
assessed  against  their  stockholders  on  account  of  their  owner- 
ship of  the  shares  of  stock  issued  by  such  banks  were  not  per- 
mitted, under  the  1918  Law,  to  deduct  the  amount  of  taxes  so 
paid.  The  shares  of  stock  being  the  property  of  the  stock- 
holders, to  the  extent  that  the  taxes  assessed  on  the  value  of 
the  shares  of  stock  are  property  taxes  the  holders  were  con- 
sidered to  be  primarily  liable  for  their  payment.  As  federal 
statutes  prohibit  states  from  imposing  any  tax  upon  national 
banks  except  upon  the  value  of  their  real  estate,  in  cases  where 
states  levy  a  tax  on  the  stock  of  such  banks  and  make  it  the 
duty  of  the  banks  to  pay  such  tax  for  the  stockholders,  such 
payments  were  held  not  deductible  from  the  gross  income  of  such 

^"  Reg.  45,  Art.  134;  letter  from  treasury  department  dated  February 
10,  1916;  I.  T.  S.  1918,  1111486,  796  and  1669;  T.  D.  2933;  Prentiss  v.  Eisner, 
260  Fed.  589,  affirmed  267  Fed.  16,  decided  under  the  1913  Law.  In  this 
case,  speaking  of  the  New  York  Inheritance  Tax,  the  lower  Court  said : 
"The  condition  of  the  devolution  of  the  property  is  the  receipt  of  the  trans- 
fer tax  by  the  state.  *  *  *  j  *  *  *  q^^^  convinced  that  the  tax 
cannot  properly  be  regarded  as  an  imposition  upon  either  the  property  or 
the  right  to  receive  a  gross  amount  of  the  property  of  a  decedent  represented 
by  a  legacy,  devise  or  distributive  share,  but  that  the  property  and  the  right 
to  receive  it  passed,  reduced  by  the  amount  of  the  tax  measured  by  a  per- 
centage of  the  value  of  the  gross  share."  (T.  D.  2933.)  See  also  Op.  A. 
G.  1,  T.  B.  16-20-875;  O.  812,  T.  B.  13-19-419. 

48  Revenue  Act  of  1921,  §§214   (a)   3  and  234   (a)   3. 


618  FEDERAL    INCOME    TAX 

banks.  This  rule  applied  also  in  the  case  of  corporations  other 
than  banks,  upon  the  value  of  whose  stock  taxes  were  assessed 
to  the  stockholders.^''  As  a  general  rule  the  amounts  of  taxes 
so  paid  by  a  corporation  for  its  stockholders  are  not  collected 
from  the  stockholders,  the  corporation  charging  the  taxes  as  an 
item  of  expense.  Such  taxes,  however,  were  required  to  be 
reported  by  the  stockholders  respectively  as  taxes  paid  by  them, 
according  to  their  proportionate  interests  in  the  corporation.-"'" 
The  amount  of  the  taxes  so  paid  were  also  required  to  be  treated 
as  additional  dividends  from  the  net  earnings  of  the  corporation.-'''^ 
While  it  has  been  decided,  under  the  1909  Law,""-  that  taxes 
paid  to  a  state  by  various  corporations  upon  shares  of  their 
stock  owned  by  another  corporation  were  not  deductible  from 
gross  income  of  the  latter  corporation  as  taxes  "paid  by  it," 
such  taxes  not  being  paid  by  this  corporation,  but  in  its  behalf 
by  other  corporations,  the  practice  of  the  treasury  department 
in  this  regard  was,  however,  to  allow  the  deduction  of  such  taxes 
by  the  corporation  in  whose  behalf  they  were  paid.     Under  the 

■t'-'  Reg.  45,  Alt.  566.  In  such  cases  it  was  held  under  the  1909  Law,  that 
the  bank  was  not  entitled  to  deduct  the  amount  of  taxes  so  paid  as  the  tax 
was  not  a  tax  upon  the  bank  or  upon  its  property.  (Eliot  Nat.  Bank  v. 
Gill,  210  Fed.  933;  T.  D.  1763;  but  see  U.  S.  v.  Guaranty  Trust  &  Savings 
Bank,  253  Fed.  291.)  This  rule  was  continued  under  the  1913  Law  and  the 
1916  Law,  such  taxes  being  held  to  be  against  the  property  of  the  private 
stockholders  and  not  against  either  the  corporation  or  its  property.  (North- 
ern Trust  Company  v.  McCoach,  215  Fed.  991;  T.  D.  2135.)  The  require- 
ments of  a  State  law  that  a  bank  shall  pay  for  the  stockholder  cannot  be 
construed  as  authority  under  which  the  bank  may  deduct  the  tax.  (T.  D. 
2161.)  Where  a  statute  requires  the  bank  to  pay  the  tax  and  gives  it  a  lien 
upon  the  shares,  the  bank  is  not  entitled  to  deduct  the  tax.  (Eliot  National 
Bank  v.  Gill,  210  Fed.  833,  affirmed  218  Fed.  600;  National  Bank  of  Com- 
merce V.  Allen,  211  Fed.  743,  affirmed  223  Fed.  472,  petition  to  the  United 
States  Supreme  Court  for  writ  of  certiorari  denied  October  25,  1915.)  Where 
the  statute  gives  the  bank  the  option  either  to  pay  the  tax  out  of  its  general 
funds  or  to  collect  the  same  from  its  stockholders,  that  fact  does  not  change 
the  character  of  the  tax  as  a  tax  against  the  property  of  the  individual  stock- 
holders, and  the  bank  cannot  deduct.  (Northern  Trust  Co.  v.  McCoach,  215 
Fed.  991.)  Even  though  the  state  statute  makes  no  provision  for  recovery 
from  the  several  shareholders  of  their  proportional  part  of  the  amount  so 
paid,  the  bank  cannot  deduct.  (First  Nat.  Bank  v.  McNeel,  238  Fed.  559.) 
The  absence  of  an  express  provision  in  the  statute  does  not  show  that  there 
is  no  such  right  of  recovery,  or  that  the  intention  was  for  the  tax  to  fall 
ultimately  upon  the  bank  and  not  upon  the  stockholders.  (Home  Savings 
Bank  v.  Des  Moines,  205  U.  S.  503.) 

50  Reg.  45,  Art.  566;   T.  D.  2135. 

51  Reg.   45,   Art.   566.      See   Chapter    19. 

52  U.  S.  V.  Aetna  Life  Ins.  Co.,  260  Fed.  333;   T.  D.  2927. 


DEDUCTION  OF  TAXES  619 

Revenue  Act  of  1918,  amounts  received  by  stockholders  of  a 
corporation  as  dividends  from  another  corporation  taxable  upon 
its  net  income  were  also  allowable  deductions.'^'  The  proper 
procedure  of  the  corporation  in  whose  behalf  the  taxes  were  so 
paid  would  seem,  therefore,  to  be  to  include  the  taxes  in  its 
gross  income,  to  deduct  them  from  gross  income  as  dividends 
received,  and  to  deduct  them  as  taxes  paid/-^ 

In  accordance  with  the  above  general  rules,  it  was  held  under 
the  1918  Law  that  trust  companies,  building  and  loan  associa- 
tions and  savings  banks  of  Oregon,-"'-"  state  banks,  savings  banks 
and  trust  companies  of   South  Dakota,-  banking   mstitutions 
of  Louisiana,  ^'^  banks  of  California-  and  Massachusetts,"' might 
not  deduct  the  amount  of  tax  assessed  against  the  stockholders 
thereof  upon  the  value  of  their  shares.    The  "Classification  Tax 
Law"  of  Montana'^"  levies  a  tax  upon  the  "moneyed  capital 
of  Montana  banks  assessable  directly  against  the  banks  which 
are  primarily  liable  therefor.     It  was  held  that  beginning  with 
the  year  1919,  such  banks  were  entitled  to  deduct  the  amount 
of  the  tax  paid  to  that  state  on  moneyed  capital  and  that  the 
stockholders  of  such  banks  were  not  required  to   mclude   the 
amounts  thus  paid  by  the  banks  in  their  respective  returns  nor 
allowed  to  deduct  such  amounts  from  gross  income.  • 

Where  shares  of  stock  were  sold  after  the  tax  had  been  as- 
sessed, but  prior  to  the  time  it  was  paid  by  the  corporation 
on  behalf  of  the  stockholders,  the  one  holding  the  stock  on  the 
date  when  a  tax  became  due  and  payable  was  the  one  entitled 
to  report  the  amount  as  a  dividend  and  deduct  the  amount  as  a 

tax  paid  by  him."-  ,     .       , 

Under  the  provisions  of  the  New  York  state  tax  law  on  oi 
before  the  1st  day  of  June  each  year  a  bank  located  in  New 

5;?  Revenue    Act   of    1918,    §234    (a)    6. 

.-.4  0.  858,  T.  B.  7-19-302;  0.  D.  199,  T.  B.  9-19-344. 

•v.  O    D.  70,  T.  B.  1-19-99. 

50  A.  R.  M.  88,  T.  B.  44-20-1281. 

57  0.   D.   987,   T.   B.   31-21-1758. 

5S  o.  D.  976,  T.  B.  28-21-1729. 

rvJ  0.  D.  954,  T.  B.  25-21-1696. 

w  Chapter  21,  Sess.  Laws,  1919. 

r.i  O  D  787  T  B  5-21-1420.  This  ruling  was  not  applicable  to  tti- 
case  of  national  banks  with  respect  to  which  the  Federal  statutes  prohibit 
the  imposition  of  a  tax  by  any  State  except  upon  the  value  of  real  estate. 
»-.2  Letter  from  treasury  department  dated  February  25,  1916;  1.  1.  b. 
1918  H  490.  An  earlier  ruling  in  a  letter  dated  March  2,  1915,  held  that 
the  stockholder  owning  the  stock  at  the  time  the  taxes  were  assessed  was 
the  one  entitled  to  the  deduction,  but  the  later  ruling  referred  to  above 
seems  to   indicate  the  later  attitude  of  the  treasury  department. 


620  FEDERAL    INCOME    TAX 

York  City  is  required  to  furnish  the  department  of  taxes  and 
assessments  of  the  city  of  New  York  with  a  statement  under 
oath,  of  the  condition  of  the  bank  on  the  1st  day  of  May  next 
preceding.  On  the  basis  of  the  report  thus  filed,  a  tax  is  assessed 
against  the  shares  of  the  bank's  stock.  On  or  before  December 
15,  the  department  of  taxes  and  assessments  is  required  to  make 
a  statement  of  the  bank  assessment  and  the  tax  and  forthwith 
to  mail  the  same  to  the  bank  and  to  send  a  certified  copy  thereof 
to  the  receiver  of  taxes,  whose  duty  it  is  to  collect  the  tax. 
The  law  provides  that  it  is  the  duty  of  the  bank  to  collect  the 
tax  due  upon  its  shares  of  stock  and  to  pay  the  same  in  the 
city  of  New  York  to  the  receiver  of  taxes  thereof  on  or  before 
the  olst  day  of  December.  Inasmuch  as  it  appears  that  May  1 
is  the  date  upon  which  the  assessment  is  deemed  to  be  made, 
it  has  been  held  that  stockholders  of  record  as  of  that  date  rather 
than  the  stockholders  of  record  as  of  December  31,  were  en- 
titled to  a  deduction  on  account  of  the  tax  paid.^^ 

Procedure  in  Case  of  Banks  Improperly  Taking  Deduc- 
tion IN  1919.  Banks  which  deducted  in  their  returns  of  in- 
come for  1919,  taxes  assessed  against  their  stockholders  on  ac- 
count of  their  ownership  of  the  shares  of  stock  issued  by  such 
banks  must  file  a  statement  showing  the  amount  of  such  deduc- 
tions claimed,  the  amount  of  the  net  income  as  reported  and  as 
corrected,  and  the  amount  of  additional  tax  due  by  reason  of 
the  erroneous  claiming  of  the  deduction.  The  total  amount  of 
additional  tax  shown  to  be  due  by  such  statement  should  be  paid 
at  once,  together  with  interest  at  the  rate  of  1  per  cent  a  month 
on  the  amount  of  the  deficiency  of  each  installment  from  the 
original  due  date.  The  deduction  of  these  taxes  being  clearly 
attributable  to  negligence  on  the  part  of  the  taxpayer,  there 
should  also  be  added  to  the  additional  tax  shown  to  be  due  in 
each  case  the  penalty  of  5%  provided  by  the  statute."^  In  cases 
where  the  above  procedure  is  followed  amended  returns  will  not 
be  required,  and  the  statements  referred  to  when  received  will 
be  filed  with  the  original  returns  in  lieu  of  amended  returns.*'^ 

63  0.  D.  839,  T.  B.  10-21-1500. 

64  Revenue  Act  of  1918,  §250   (b). 
63  0.   D.   944,   T.   B.   23-21-1677. 


CHAPTER  25 

DEDUCTION  OF  LOSSES 

The  Revenue  Act  of  1921,  like  the  Revenue  Act  of  1918,  pro- 
vides in  the  case  of  individuals  that  in  computing  net  income 
there  may  be  allowed  as  deductions,  if  sustained  during  the 
taxable  year  and  not  compensated  for  by  insurance  or  other- 
wise, (a)  losses  incurred  in  trade  or  business,  (b)  losses  in- 
curred in  any  transaction  entered  into  for  profit,  though  not 
connected  with  the  trade  or  business,  (c)  losses  of  property 
not  connected  with  the  trade  or  business  if  arising  from  fires, 
storms,  shipwreck,  or  other  casualty  or  from  theft. ^  The  ex- 
tent to  which  losses  may  be  deducted  by  nonresident  aliens, 
foreign  corporations  and  certain  citizens  and  domestic  corpo- 
rations taxable  only  on  income  from  sources  within  the  United 
States  is  more  fully  discussed  in  previous  chapters.-  Individ- 
uals and  corporations  may  also  deduct  debts  ascertained  to 
be  worthless  and  charged  off  within  the  taxable  year.^  In  the 
case  of  corporations  all  losses  sustained  during  the  taxable  year 
and  not  compensated  for  by  insurance  or  otherwise  may  be  de- 
ducted.^ The  rules  discussed  in  this  chapter  are  those  applicable 
to  corporations  and  individuals  generally.  The  Revenue  Act  of 
1918  contained  a  provision,  not  previously  contained  in  any 
prior  law,  for  the  deduction  of  net  losses  in  certain  cases  from 
the  income  of  the  preceding  year,"*  and  also  a  provision  as  to 
losses  in  inventory  and  from  rebates  ascertained  after  the  close 
of  the  taxable  year."  The  Revenue  Act  of  1921  contains  several 
new  and  important  provisions  in  addition  to  the  general  pro- 
visions stated  above  as  to  the  deduction  of  losses.  The  changes 
as  to  such  deductions  by  nonresident  aliens  and  foreign  corpo- 
rations are  discussed  elsewhere."  Under  the  1918  Law,  losses, 
to  be  deductible,  were  required  to  be  sustained  during  the  year 

1  Revenue  Act  of  1921,  §214  (a)  4,  5,  6;  Revenue  Act  of  1918,  §214  (a) 
4,  5,  6.     Reg.  45,  Art.  141. 

2  See  Chapters  4  and  12. 

3  Revenue  Act  of  1921,  §§214  (a)  7  and  234  (a)  5;  Revenue  Act  of 
1918,  §§214    (a)   7  and  234   (a)    5. 

4  Revenue  Act  of  1921,  §234  (a)  4;  Revenue  Act  of  1918,  §234  (a)  4. 
Losses  sustained  by  a  corporation  in  ultra  vires  transactions  are  not  de- 
ductible.    (0.  968,  T.  B.  1-20-660). 

5  Revenue  Act  of  1918,  §  204. 

6  Revenue  Act  of  1918,  §§214    (a)    12  and  234    (a)    14. 

7  See  Chapters  4  and  12. 

621 


622  FEDERAL    INCOME    TAX 

in  which  the  deduction  was  taken.  The  present  law  provides 
that  losses  shall  be  deducted  as  of  the  taxable  year  in  which  sus- 
tained, unless,  in  order  to  clearly  reflect  the  income,  the  loss 
should,  in  the  opinion  of  the  Commissioner,  be  accounted  for  as 
of  a  different  period.  Reasonable  additions  to  reserves  for  bad 
debts  may  now,  in  the  discretion  of  the  Commissioner,  be  de- 
ducted, and  when  satisfied  that  a  debt  is  recoverable  in  part,  the 
Commissioner  may  allow  such  debt  to  be  charged  off  in  part. 
It  is  also  specifically  provided  by  the  present  law  that  the  deduc- 
tion for  loss  in  the  case  of  property  destroyed  or  damaged  shall 
be  computed  on  the  basis  of  the  fair  market  price  or  value  of  the 
property  as  of  March  1,  1913,  if  such  property  was  acquired 
prior  thereto.  No  deduction  for  loss  is  allowed  under  the  present 
law  in  the  case  of  the  sale  or  other  disposition  of  stock  or 
securities  where  substantially  identical  property  is  acquired 
within  30  days  before  or  after  such  sale  or  other  disposition. 
The  net  loss  provision  of  the  1918  Law  is  extended  to  all  taxable 
years  beginning  after  December  31,  1920,  and  the  special  deduc- 
tion allowed  by  the  1918  Law  in  regard  to  losses  in  inventory 
and  from  rebates  is,  of  course,  not  carried  into  the  1921  Law.*^ 
The  1921  Law  also  provides  a  different  basis  for  determining 
loss  from  the  sale  or  other  disposition  of  property  acquired  by 
gift  after  December  31,  1920.-' 

Losses  Sustained  in  Trade.  Under  the  present  and  preceding 
laws  losses  sustained  during  the  taxable  year  and  not  compen- 
sated for  by  insurance  or  otherwise,  may  be  deducted,  in  the 
case  of  individuals,  if  incurred  in  trade  or  business.^"  All  losses 
may  be  deducted  by  corporations.  A  loss  incurred  in  trade  or 
business  must  be  absolute  and  not  a  speculative  or  fluctuating 
valuation  of  a  continuing  investment,  and  must  be  determined 
and  ascertained  to  be  an  actual,  a  completed,  a  closed  transac- 
tion.i^  Thus,  a  loss  may  be  claimed  by  the  owner  of  a  business 
truck  demolished  in  collision  with  a  pleasure  car  provided  that 
the  truck  was  in  use  in  connection  with  the  business  of  the 
taxpayer  at  the  time  of  the  collision,  but  no  deduction  may  be 
claimed  by  the  owner  of  the  pleasure  car  wrecked  in  the  col- 
hsion.i-  If  an  automobile  is  purchased  with  the  intention  of 
using  it  in  a  business  and  it  is  appropriated  to  business  uses  pri- 

8  Revenue  Act  of  1921,  §§204   (b),  214   (a)   4,  5,  6,  7,  and  234   (a)   4,  5. 
©Revenue  Act  of  1921,   §202    (a)    2. 

10  Revenue  Act  of  1921,  §214  (a)  4;  Revenue  Act  of  1918,  §214  (a) 
4;  Reg.  45,  Art.  141. 

11  Reg.  45,  Art.  141 ;  T.  D.  1989.  Depreciation  in  the  value  of  property 
is  treated  as  a  separate  deduction  and  should  not  be  confused  with  loss. 

12  0.  D.  857,  T.  B.  13-21-1351. 


DEDUCTION   OF   LOSSES  623 

marily,  a  loss  sustained  through  its  sale  may  be  deducted,  not- 
withstanding its  occasional  use  for  pleasure  purposes. '■'' 

Losses  Not  Sustained  in  Trade.  Under  the  present  law  and 
under  the  1918  Law  citizens  and  residents  may  deduct  all  losses 
sustained  during  the  taxable  year  and  not  compensated  for  by  in- 
surance or  otherwise,  if  incurred  in  any  transaction  entered  into 
for  profit,  though  not  connected  with  the  trade  or  business.'^ 
It  will  be  noted  that  in  this  provision  the  1918  Law  made  an 
important  departure  from  the  1916  Law  and  there  is  now  per- 
mitted the  deduction  of  all  losses  incurred  in  transactions  entered 
into  for  profit  though  not  connected  with  a  trade  or  business, 
notwithstanding  that  such  losses  may  exceed  the  profits  arising 
from  the  same  class  of  transactions.  The  provision  permitting 
the  deduction  of  losses  incurred  "in  any  transaction  entered  into 
for  profit"  does  not  contemplate  that  a  distinction  shall  be  made 
between  an  investment  in  property  or  securities  with  the  object 
of  deriving  an  income  from  the  capital  employed,  and  an  in- 
vestment which  is  made  for  the  purpose  of  realizing  a  profit  on 
the  resale  of  the  property  or  securities  purchased.^"'  Re- 
turns realized  from  either  the  ownership  or  the  final  dispo- 
sition of  investments,  representing  transactions  entered  into 
for  profit,  but  not  connected  with  the  taxpayer's  business  or 
trade,  are  "profits"  within  the  meaning  of  the  law.^'"' 

Where  a  person  purchases  bonds  for  another,  guaranteeing 
said  bonds  against  any  loss,  and  a  loss  occurs  due  to  subsequent 

13  O.   D.  943,  T.  B.  23-21-1676. 

14  Revenue  Act  of  1921,  §  214  (a)  5;  Revenue  Act  of  1918,  §214  (a)  5. 
Under  the  1916  Law,  a  citizen  was  permitted  to  deduct  the  losses  actually 
sustained  in  transactions  entered  into  for  profit  but  not  connected  with 
his  business  or  trade  only  to  an  amount  not  exceeding-  the  profits  arising 
therefrom.  A  loss  was  required  to  be  actually  sustained  during  the  year 
and  the  total  amount  deductible  could  not  exceed  the  profits  arising  from 
the  same  class  of  transactions.  (Revenue  Act  of  1916,  §5.)  Thus,  an 
individual  making  any  investments  in  property  from  time  to  time  or  spec- 
ulating was  required  to  report  all  gains  from  such  investments  or  spec- 
ulations and  might  offset  against  the  gains  all  losses  sustained  in  similar 
transactions.  He  was  required  to  report  only  the  net  gain  from  such 
transactions  during  the  year,  and  if  the  net  result  for  the  year  of  a  series 
of  such  transactions  was  a  loss,  he  was  not  entitled  to  offset  the  loss  against 
his  income  from  trade  or  business.  Prior  to  the  1916  Law  it  was  held  by 
the  Treasury  Department  that  an  individual  was  required  to  report  all 
income  from  transactions  not  incurred  in  trade,  but  was  not  entitled  to 
deduct  any  of  the  losses.  (T.  D.  2135.)  See  also  L.  O.  1061,  T.  B.  14-21- 
1547. 

ir.O.  D.  138,  T.  B.  4-19-218. 

ifi  L.  O.  1061,  T.  B.  14-21-1547,  decided  under  the  1916  Law. 


624  FEDERAL    INCOME    TAX 

insolvency  of  the  corporation  issuing  same,  and  the  guarantor 
makes  good  the  loss,  the  same  is  not  deductible  unless  such  loss 
occurs  in  trade  or  business  or  in  a  transaction  entered  into  for 
profit.i^  Where  borrowed  money  is  stolen  from  the  borrower 
and  the  amount  has  been  borrowed  for  use  in  a  business  deal,  the 
borrower  may  deduct  the  amount  borrowed  with  interest  paid 
thereon  as  a  loss,  but  any  amounts  expended  in  apprehending 
the  thief  are  regarded  as  a  personal  expense.''^  The  department 
has  allowed  as  a  deductible  loss  an  amount  paid  by  a  taxpayer  to 
compromise  a  suit  growing  out  of  his  actions  while  serving  as 
a  director  of  a  bank,  on  the  theory  that  if  acting  as  director 
he  was  not  engaging  in  trade  or  business;  it  was  at  least  a 
transaction  entered  into  for  profit.i^ 

Losses  Connected  With  Residential  Property.  Where  a 
taxpayer  sells  his  residence  at  a  loss  because  of  the  acceptance 
of  a  business  proposition  necessitating  his  removal  to  another 
part  of  the  country,  the  loss  is  not  a  loss  "incurred  in  his  business 
or  trade"  within  the  meaning  of  the  Revenue  Act  of  1916,  as 
amended.^'^  A  loss  sustained  by  an  individual  from  the  sale  of 
residential  property  was  held  to  be  deductible  under  the  Revenue 
Act  of  1918,  which  is  similar  in  its  provisions  in  this  connection 
to  the  present  law,  if  the  property  was  purchased  or  constructed 
by  him  with  a  view  to  its  subsequent  sale  for  pecuniary  profit. 
The  intent  in  purchasing  or  constructing  the  property  is  a  ques- 
tion of  fact  determinable  in  each  case  by  evidence  which  should 
be  submitted  with  the  return.  If  the  residential  property  be  held 
by  the  purchaser  out  of  use  or  under  tenancy  and  be  subsequently 
sold,  there  would  seem  little  room  for  question  that  the  transac- 
tion was  ''entered  into  for  profit"  and  that  the  loss,  if  any,  is  a 
proper  deduction  in  determining  net  income.  If,  on  the  other 
hand,  the  property  is  occupied  by  the  purchaser  as  his  home  dur- 
ing the  whole  or  a  great  portion  of  the  period  of  his  ownership, 
a  strong  presumption  is  raised  that  the  property  was  purchased 
for  his  personal  use  as  a  residence ;  that  the  transaction  was  not 
"entered  into  for  profit"  within  the  meaning  of  the  statute.  This 
presumption  will  not  be  overcome  by  his  self-serving  declaration, 
uncorroborated,  that  his  purpose  was  otherwise. 

An  individual  claiming  deduction  for  loss  incurred  in  the  sale 
of  residential  property  should  attach  to  his  return  an  affidavit 

17  0.  D.  241,  T.  B.  13-19-420. 
IS  0.  D.  571,  T.  B.  27-20-1040. 

19  0.  D.  1091,  T.  B.  45-21-1908. 

20  A.  R.  R.  96,  T.  B.  19-20-918.  The  ruling  of  'the  Treasury  Department 
was  similar  under  the  1918  Law.     (Reg.  45,  Art.  141;  T.  D.  2972). 


DEDUCTION   OF  LOSSES 


625 


stating  the  facts  as  to  the  purpose  and  use  of  the  property  in 
connection  with  which  loss  is  claimed  and  his  intent  in  purchasing 
it,  and  his  affidavit  should  be  supported  by  other  evidence  show- 
ing his  intent  when  he  entered  into  the  transaction.-^ 

The  subletting  of  an  apartment  by  a  tenant  on  account  of 
being  required  to  make  his  residence  in  another  city,  is  held 
not  to  be  a  "transaction  entered  into  for  profit."  Therefore, 
any  loss  sustained  through  such  transaction  is  not  deductible 
from  gross  income.-- 

LOSSES  FROM  SALE  OF  PROPERTY  ACQUIRED  BY  GiFT,  BEQUEST, 

Devise  or  Descent.    A  loss  sustained  from  the  sale  of  property 
acquired  by  gift,  bequest,  devise,  or  descent  (whenever  property 
so  acquired  is  as  a  matter  of  fact  acquired  for  purposes  of  profit) 
is  a  deductible  loss  from  gross  income.     Ordinary  investment 
property  so  acquired  is  to  be  treated  as  having  been  acquired  for 
purposes  of  profit  unless  the  conduct  of  the  recipient  furnishes 
evidence  to  the  contrary .-•'-    Where  a  person  gives  property  away 
or  i3  divested  thereof  by  death,  no  realization  of  loss  results 
therefrom.-^    In  general,  the  measure  of  loss  from  sales  of  such 
property  is  determined  in  accordance  with  the  rules  for  determin- 
ing gain  or  loss  from  sales  stated  elsewhere.-'    The  cost  of  such 
property  is  its  value  as   of  the  date   when   acquired.     In   the 
case  of  property  acquired  by  gift  after  December  31,  1920,  how- 
ever, the  basis  for  determining  loss  will  be  the  same  as  that  which 
it  would  have  in  the  hands  of  the  donor  or  the  last  preceding 
owner  by  whom  it  was  not  acquired  by  gift.-" 

Trade  or  Business.  Under  the  1916  Law,  the  term  "trade"  and 
the  term  "business"  were  defined  as  synonymous  terms  and  to  be, 
"That  which  occupies  and  engages  the  time,  attention  and  labor 
of  any  one  for  the  purpose  of  livelihood,  profit,  or  improvement ; 
that  which  is  his  personal  concern  or  interest ;  employment,  regu- 
lar occupation,  but  it  is  not  necessary  that  it  should  be  his  sole 
occupation  or  employment."  The  doing  of  a  single  act  incident- 
ally or  of  necessity  not  pertaining  to  the  particular  business  of 
the  person  doing  the  same  will  not  be  considered  engaging  in  or 

21  Reg.  45,  Art.  141,  as  amended  by  T.  D.  2972;  0.  780,  T.B.  1-19-51; 
A.  R.  R.  249,  T.  B.  35-20-1168,  modified  by  A.  R.  R.  604,  T.  B.  32-21-1760. 

22  O.  D.  42,  T.  B.  1-19-59. 

23  T.  B.  R.  34,  T.  B.  10-19-357. 

24  T.  D.  2972,  amending  Reg.  45,  Art.  141. 
2r.  See  Chapter  17. 

20  Revenue  Act  of  1921,  §202  (a)  2.  See  Chapter  17  for  a  discussion 
of  this  subject.  See  also  paragraphs  in  this  chapter  on  "Measure  of  Loss' 
and  "Property  acquired  by  gift  under  1918  Law". 


626  FEDERAL    INCOME    TAX 

carrying  on  business.^"  "In  trade,"  as  used  in  the  1916  Law,  is 
held  to  mean  the  trade  or  trades  in  which  the  person  making  the 
return  is  engaged ;  that  is,  in  which  he  has  hivested  money,  other- 
wise than  for  the  purpose  of  being  employed  in  isolated  trans- 
actions, and  to  which  he  devotes  at  least  a  part  of  his  time  and 
attention.  A  person  may  be  engaged  in  more  than  one  trade  and 
may  deduct  losses  incurred  in  all  of  them  under  this  provision 
of  the  law,  provided  that  in  each  trade  the  above  requirements 
are  met.-^  Losses  on  stocks,  grain,  cotton,  etc.,  may  also  be  de- 
ducted under  this  provision  by  a  person  engaged  in  the  trade  to 
which  buying  or  selling  thereof  are  incident  as  a  part  of  the 
business,  as  by  a  member  of  a  stock,  grain  or  cotton  exchange,-^ 
but  neither  the  investment  of  money  in  the  stock  of  a  company 
nor  employment  by  the  company  in  any  official  capacity  makes  the 
business  of  the  company  the  trade  of  the  investor  or  employee.-^*' 

-'TT.  D.  1989. 

-'8  Black  V.  Bolen,  268  Fed.  427;  T.  D.  2090. 

^  T.  D.  2090. 

30  T.  D.  2135.  The  definition  of  "trade  or  business"  discussed  in  the 
text  above  has  now  lost  considerable  importance  in  view  of  the  provision 
(Revenue  Act  of  1921,  §214  (a)  5;  Revenue  Act  of  1918,  §214  (a)  5) 
that  losses  incurred  in  any  transaction  entered  into  for  profit  may  be  de- 
ducted even  though  such  losses  exceed  the  profits  arising  from  the  same 
class  of  transactions.  Under  the  1916  Law,  it  will  be  noted,  the  Treasury 
Department  adopted  an  extremely  narrow  construction  of  the  words 
"business  or  trade,"  a  construction  which  has  been  the  subject  of  con- 
siderable criticism  and  which  operated  to  the  detriment  of  every  person  in- 
vesting or  speculating  in  property.  Congress  has  now  seen  fit  to  remedy 
the  injustice  involved  in  this  narrow  construction  by  permitting  the  de- 
duction of  all  losses  in  transactions  entered  into  for  profit  even  though  they 
may  exceed  the  profits  arising  from  the  same  transactions.  Consequently 
the  definitions  of  "trade  or  business"  discussed  in  the  text  above  are  no 
longer  so  important  except  in  cases  arising  under  the  1916  and  1913  Laws. 
In  Bryce  v.  Keith,  257  Fed.  133,  arising  under  the  1913  Law,  the  Court 
has  adopted  a  broader  construction  of  the  term  "trade"  than  the  Treas- 
ury Department.  In  this  case  it  was  held  that  loss  of  the  value  of  cor- 
porate stock,  acquired  by  numerous  transfers  of  property  to  the  corporation 
and  payment  of  corporate  debts,  transactions  carried  on  for  a  considerable 
period,  complicated  in  character  and  involving  large  sums  of  money  so 
that  they  must  have  required  much  time  and  attention,  was  a  loss  incurred 
in  trade. 

In  Mente  v.  Eisner,  266  Fed.  161,  arising  under  the  1913  Law,  the 
majority  opinion  approved  the  Treasury  Department's  rather  narrow  con- 
struction of  the  word  "trade".  In  this  case  the  plaintiff"  whose  regular 
business  was  manufacturing  jute  bags  and  bagging,  cotton  bags,  etc., 
suffered  losses  in  dealing  in  futures  on  the  Cotton  Exchange  and  was 
not  permitted  to  deduct  such  losses  on  the  theory  that  they  were  isolated 
transactions  outside  the  regular  business  of  the  taxpayer.  Manton,  J., 
dissents  in  a  long  opinion  on  the  general  ground  that  the  statute  contained 


DEDUCTION   OF  LOSSES  627 

The  losses  which  were  limited  by  this  provision  of  the  1916  Law 
were  those  incurred  in  transactions  involving  sales  or  dealings 
in  property.  The  law  seemed  clearly  to  make  a  distinction  be- 
tween such  losses  and  losses  arising  from  fires,  storms,  ship- 
wreck, or  other  casualty,  and  from  theft. 

Losses  Must  Be  Sustained  During  Year.  The  1916  Law  pro- 
vided in  the  case  of  individuals  that  the  loss  must  be  ''actually 
sustained  during  the  year"  and  in  the  case  of  corporations  that 
the  loss  must  be  "actually  sustained  and  charged  off  within  the 
year.""''  The  Revenue  Acts  of  1918  and  1921  omit  the  word 
"actually"  in  the  case  of  individuals  and  the  words  "actually" 
and  "and  charged  off"  in  the  case  of  corporations.  The  treasury 
department  held,  under  the  1918  Law,  that  a  loss  to  be  deductible 
must  be  an  absolute  loss,  actually  sustained  and  ascertained  dur- 
ing the  taxable  year  for  which  the  deduction  is  sought  to  be 
made.  It  must  be  determined  and  ascertained  upon  an  actual,  a 
completed,  a  closed  transaction.  Losses  sustained  from  the  sale 
or  dealing  in  real  or  personal  property  growing  out  of  the  owner- 
ship or  use  of,  or  interest  in,  such  property  will  not  be  deductible 
at  all  unless  they  are  ascertained,  determined  and  fixed  as  abso- 
lute in  the  above  sense  within  the  taxable  year  in  which  the  de- 
duction is  sought  to  be  made.-'-  The  amount  to  be  deducted  as  a 
loss  should  have  in  it  no  element  of  "depreciation"  or  "allowance 
for  wear  or  tear"  or  "compensation  from  insurance  or  otherwise." 
The  amount  is  to  be  an  absolute  and  complete  loss  which  has  been 

no  distinction  between  a  regular  dealer  on  the  Exchange  and  a  person 
who  dealt  casually  on  the  Exchange;  that  though  the  principal  business  of 
plaintiff  was  bagging,  his  transactions  on  the  Cotton  Exchange  were 
nevertheless  "in  trade."  The  plaintiff  in  this  case  does  not  appear  to 
have  spent  so  much  time  in  the  Cotton  Exchange  transactions  as  did  the 
plaintiff  in  the  Bryce  Case  (Bryce  v.  Keith,  257  Fed.  133)  in  the  transac- 
tions involved  in  that  case.  In  a  case  coming  before  the  Department  under 
the  1916  Law,  as  amended,  an  attorney  invested  in  stock  of  a  corporation. 
Certain  of  his  clients  hearing  of  the  attorney's  investment  made  similar 
investments  and  the  attorney  in  order  to  protect  his  clients,  as  well  as  to 
save  his  practice  from  injury,  contracted  expenses  in  investigating  the 
condition  of  the  corporation,  made  advances  to  the  corporation  and  took 
an  active  part  in  its  management.  The  entire  transaction  resulted  in  a 
loss  to  the  attorney,  but  it  was  held  that  the  transaction  was  a  purely 
commercial  one,  in  no  sense  professional  and  not  connected  with  his  bus- 
iness or  trade  and  therefore  not  deductible.  (A.  R.  R.  398,  T.  B.  8-21-1464). 
See  also  A.  R.  R.  242,  T.  B.  33-20-1131;  A.  R.  R.  249,  T.  B.  35-20-1168, 
modified  by  A.  R.  R.  604,  T.  B.  32-21-1760  and  A.  R.  R.  404,  T.  B.  10-21-1495. 

•"51  Revenue  Act  of  1916,  §  12   (a). 

•5-  Reg.  45,  Art.  141 ;  T.  D.  2005.  See,  however,  the  special  rules  at  the 
end  of  this  chapter. 


628  FEDERAL    INCOME    TAX 

actually  sustained.-'^^  The  above  general  principles  that  losses  to 
be  deductible  must  be  actually  sustained  and  determined  and 
ascertained  upon  completed  transactions  will  still  be  applicable 
under  the  present  law,  but  there  is  now  allowed  more  latitude  as 
to  the  year  in  which  they  may  be  deducted.  The  general  rule  is 
still  that  losses  must  be  deducted  in  the  year  in  which  sustained, 
but  they  may  now  be  deducted  in  a  year  other  than  that  in  which 
sustained  if,  in  the  opinion  of  the  Commissioner,  the  deduction 
thereof  in  such  other  taxable  period  will  more  clearly  reflect  the 
income."^  In  explanation  of  this  new  provision  it  is  stated  in  the 
report  of  the  finance  committee  of  the  senate  that  "losses  occur- 
ing  in  one  year  are  frequently  not  determined  or  sustained  until 
another  year,  depending  upon  court  decision  or  the  clearing  up  of 
uncertainty.  To  permit  more  elastic  treatment  of  such  losses,  in 
the  interests  of  justice  to  the  taxpayer,  it  is  provided  that  certain 
losses  shall  not  be  deducted  as  of  the  taxable  year  in  which 
sustained,  if  in  the  opinion  of  the  Commissioner  they  should 
be  accounted  for  as  of  a  different  period.""'"' 

The  following  ruling  has  been  made  under  the  1921  Law :  An 
embezzlement  or  a  shipwreck  may  occur  in  1921  but  not  become 
known  until  1922  and  in  such  a  case  income  may  be  more  clearly 
reflected  by  accounting  for  the  loss  as  of  1922  rather  than  of 
1921.  If  a  taxpayer  desires  to  account  for  a  loss  as  of  a  period 
other  than  the  one  in  which  actually  sustained,  he  must  attach 
to  his  return  a  statement  setting  forth  his  request  for  considera- 
tion of  the  case  by  the  Commissioner,  together  with  a  complete 
statement  of  the  facts  upon  which  he  relies.  However,  in  his 
income  tax  return  he  may  deduct  the  loss  only  for  the  taxable 

33  T.  D.  2005.  Under  the  1916  Law,  in  the  case  of  corporations,  the 
loss  might  not  be  deducted  unless  it  was  actually  sustained  during  the 
year  and  charged  off  on  the  books.  It  was  held  that  a  corporation  was  not 
entitled  to  a  deduction  for  a  loss  unless  charged  off  on  the  books  of  the 
corporation  before  such  deduction  was  allowed.  The  statute  was  not  to 
be  construed  as  requiring  that  losses  be  charged  off  within  the  taxable 
year.  It  was  sufficient  that  they  were  charged  off  before  they  were  allowed 
as  deductions.  Consequently  at  the  time  of  an  examination  of  a  corporation 
it  was  given  an  opportunity  to  reopen  its  books  and  charge  off  losses 
which  it  had  actually  sustained  during  the  taxable  year.  (A.  R.  R.  377, 
T.  B.  5-21-1415;  Letter  from  treasury  department  dated  June  25,  1918; 
I.  T.  S.  1918,  113599.)  This  rule  seemed  to  apply  with  equal  force  in  the 
case  of  an  individual  who  kept  books,  but  one  who  did  not  keep  books  was 
not  thereby  deprived  by  the  law  of  the  right  to  claim  a  loss,  except  in  the 
case  of  worthless  debts. 

3i  Revenue  Act  of  1921,  §§214  (a)   6  and  234   (a)   4. 

35  Report  of  Committee  on  Finance  to  accompany  the  Revenue  Bill  of 
•1921,  p.  14;  T.  D.  3261. 


DEDUCTION   OF  LOSSES  629 

year  in  which  actually  sustained.  Upon  the  audit  of  the  return 
the  Commissioner  will  decide  whether  the  case  is  within  the  ex- 
ception provided  by  the  statute;  if  not  within  the  exception  the 
loss  will  be  allowed  only  as  of  the  taxable  year  in  which  sus- 
tained The  allowance  of  a  deduction  for  a  loss  in  a  year  other 
than  the  one  in  which  sustained  is  entirely  within  the  discretion 
of  the  Commissioner  and  he  will  consider  exercising  this  dis- 
cretion only  in  exceptional  cases.  A  shrinkage  in  the  value  of 
the  taxpayer's  stock  in  trade,  as  reflected  in  his  inventory,  is  not 
such  a  loss  as  is  contemplated  by  the  provision  of  the  statute 
authorizing  the  Commissioner  to  allow  the  deduction  of  a  loss 
for  a  taxable  year  other  than  the  one  in  which  sustained. 

The  following  rulings  on  this  subject  were  made  under  the 
1918  Law     If  a  mother  is  bona  fide  indebted  to  her  son  and  dis- 
charges the  obligation  by  transferring  stock  to  him,  any  excess 
of  the  cost  of  the  stock  over  the  amount  of  the  debt  and  unpaid 
interest  is  a  deductible  loss.    This  payment  of  a  valid  indebted- 
ness is  equivalent  to  a  sale  in  constituting  a  closed  and  completed 
transactiofi.^«    Under  New  York  state  laws,  a  safe-deposit  com- 
pany is  required  to  wait  two  years  before  opening  any  safe- 
deposit  box  for  nonpayment  of  rent.     The  fact  that  no  rental 
is  paid  during  these  years  and  it  is  impossible  of  collection  was 
held  not  to  permit  the  company  to  take  a  deduction  of  an  amount 
equal  to  the  rental  value  of  any  deposit  box  which  it  by  law 
was  prevented  from  opening,  unless  the  company's  books  were 
kept  on  an  accrual  basis  and  such  amount  had  actually  been 
accrued.     That  a  taxpayer  might  derive  greater  profits  if  it 
were  not  for  restrictions  placed  upon  his  activities  by  federal 
or  state  laws  has  no  bearing  on  his  returns  for  federal  income 
tax  purposes.3-    a  taxpayer  was  held  to  sustain  no  deductible 
loss  by  reason  of  a  drop  in  the  rate  of  exchange  where  he  had 
remitted  certain  sums  of  cash  to  his  London  representative  to  be 
used  in  purchasing  raw  material  and  where,  at  the  end  of  the 
year,  the  purchases  had  not  been  made  and  the  rate  of  exchange 
was  lower  than  at  the  time  the  exchange  was  purchased.- 

Losses  of  Capital.  What  the  law  contemplates  as  a  deduction 
is  the  loss  of  capital, ■'»  either  by  the  sale  of  property  or  by  the 

36  0.  D.  555,  T.  B.  25-20-1015. 
S7  O.  D.  486,  T.  B.  18-20-899. 

38  0.  D.  940,  T.  B.  23-21-1672. 

39  It  is  interesting  to  note  that  under  the  Civil  War  Income  Tax  Laws, 
losses  of  capital  were  not  deductible.  (See  letter  from  treasury  depart- 
ment dated  June  8,  1865,  2  Int.  Rev.  Rec.  36.) 


630  FEDERAL    INCOME    TAX 

destruction  or  disappearance  of  property.  It  is,  therefore,  im- 
material in  what  year  the  capital  was  created  so  long  as  the 
loss  is  sustained  in  the  taxable  year.  All  losses  to  be  deductible, 
if  not  sustained  in  trade  or  business,  must  result  from  transac- 
tions entered  into  for  profit,^'*  or  must  be  losses  of  property  aris- 
ing from  fires,  storms,  shipwreck,  or  other  casualty  or  from 
theft.  It  has  been  held  that  a  distribution  of  dividends  by  a 
corporation,  whether  from  capital  or  from  surplus,  is  not  a 
deductible  loss.^^  The  question  of  whether  certain  payments, 
may  be  deducted  as  losses  or  treated  as  capital  expenditures  is 
discussed  in  another  chapter.^- 

Losses  of  Income.  Loss  of  income  is  not,  generally  speaking, 
a  proper  deduction.  If,  for  instance,  a  debtor  defaults  in  pay- 
ment of  interest,  or  a  corporation  fails  to  pay  a  regular  dividend, 
or  an  employer  fails  to  pay  commissions  or  salaries,  the  amount 
of  such  items  may  not  be  deducted  from  other  income  during  the 
year,  as  the  income  is  reduced  by  the  mere  fact  that  such  sums 
are  not  included.  If,  however,  the  taxpayer  has  reported  any 
such  amounts  as  income  for  the  taxable  year,  or  a  preceding 
year,  as  might  be  done  in  the  case  of  taxpayers  reporting  on  a 
basis  other  than  that  of  actual  receipts  and  disbursements,  the 
subsequent  failure  to  collect  the  amounts  so  entered  on  the  books 
may  be  treated  as  a  loss  when  it  is  determined  that  the  amount  is 
not  collectible.^'^ 

Measure  of  Loss.  In  the  case  of  the  sale  of  assets  the  loss  will  be 
the  difference  between  the  cost  thereof  less  depreciation  sustained 
since  acquisition  and  the  price  at  which  sold  or  disposed  of.  How- 
ever, the  loss  which  is  deductible  in  the  case  where  such  property 
was  acquired  before  March  1,  1913,  and  where  its  fair  market 
value  on  that  date  was  less  than  the  cost  thereof,  is  the  difi'erence 
between  such  value  (less  depreciation)  and  the  price  at  which 
sold  or  disposed- of.  No  loss  is  recognized  in  the  case  of  property 
sold  at  less  than  cost  minus  depreciation,  but  for  more  than  its 

■1"  Under  the  1916  Law  it  seemed  that  a  deductible  loss  need  not  necessarily 
be  one  connected  with  the  business  or  trade  of  an  individual,  except  in  the 
case  of  losses  resulting  from  sales  or  dealings  in  property,  in  which  case 
it  was  expressly  provided  that  such  losses  must  be  incurred  in  his  trade 
or  business.  The  Revenue  Act  of  1918  and  the  present  law  seem  to  intend 
that  losses  resulting  from  such  sales  or  dealings  may  be  deducted  not 
only  when  connected  with  his  trade  or  business,  but  when  not  so  connected, 
if  in  transactions  entered  into  for  profit. 

41  Van  Dyke  v.  Milwaukee,    (Wis.)    150  N.  W.  509. 

42  See  Chapter  21. 

43  This  point  is  discussed  in  the  paragraph  below  on  worthless  debts. 


DEDUCTION   OF  LOSSES  631 

fair  market  value  as  of  March  1,  1913.^^  When  loss  is  claimed 
through  the  destruction  of  property  by  fire,  flood,  or  other  cas- 
ualty, the  amount  deductible  will  be  the  difference  between  the 
cost  of  the  property  and  the  salvage  value  thereof,  after  deduct- 
ing from  such  cost  the  amount,  if  any,  which  has  been  or  should 
have  been  set  aside  and  deducted  in  the  current  year  and  pre- 
vious years  from  gross  income  on  account  of  depreciation  and 
which  has  not  been  paid  out  in  making  good  the  depreciation 
sustained.  Under  the  1918  Law,  in  the  case  of  such  property 
acquired  before  March  1,  1913,  when  the  fair  market  value  as  of 
that  date  was  lower  than  the  cost,  the  deductible  loss  was  the 
difference  between  such  value  and  the  salvage  value  thereof  after 
deducting  from  the  value  as  of  March  1,  1913,  the  amount,  if  any, 
which  had  been  or  should  have  been  set  aside  and  deducted  in 
the  current  year  and  previous  years  from  gross  income  on  ac- 
count of  depreciation  and  which  had  not  been  paid  out  in  making 
good  the  depreciation  sustained.  No  loss  was  recognized  where 
the  salvage  value  was  less  than  the  cost  but  more  than  the  de- 
preciated value  of  such  property  as  of  March  1,  1913.  In  any 
event  the  loss  should  be  reduced  by  the  amount  of  any  insurance 
or  other  compensation  received.^''  The  Revenue  Act  of  1921 
specifically  provides  that  in  case  of  losses  arising  from  de- 
struction of  or  damage  to  property,  where  the  property  so  de- 
stroyed or  damaged  was  acquired  before  March  1,  1913,  the  de- 
duction for  loss  shall  be  computed  upon  the  basis  of  its  fair  mar- 
ket price  or  value  as  of  March  1,  1913.^''  In  the  case  of  prop- 
erty which  should  be  included  in  the  inventory,  the  basis  for  de- 
termining loss  on  the  sale  or  other  disposition  thereof  will  be 
the  last  inventory  value  thereof.^' 

In  a  case  arising  under  the  1909  Law,  the  court  said :  "There 
seems  to  be  no  limitation  provided  in  the  act  as  to  the  amount 
of  deductions  to  be  allowed  for  losses  actually  sustained  from  any 
source  during  the  year,  and  whether  due  to  conditions  of  business, 
the  sale  of  property,  or  anything  else,  and  the  court  must,  there- 
fore, assume  that  the  statute  contemplated  that  the  full  amount 
of  all  losses  sustained  within  the  year  would  be  allowed." ^"^ 

■*4  Revenue  Act  of  1921,  §202  (b);  Reg.  45,  Art.  141,  as  amended  by  T. 
D.  3209,  T.  B.  33-21-1773.  See  Chapter  17  for  criticism  of  method  of  meas- 
uring loss  when  March  1,  1913,  value  is  involved. 

-»•■>  Reg.  45,  Art.  141,  as  amended  by  T.  D.  3209,  T.  B.  33-21-1773. 

^'■■Revenue  Act  of  1921,  §§214  (a)   6  and  234  (a)  4. 

-IT  Revenue  Act  of  1921,  §202    (a)    1;  Revenue  Act  of  1918,  §202   (a)   2. 

48  Connecticut  Mutual  Life  Ins.  Co.  v.  Eaton,  218  Fed.  206.  In  this 
case  the  court  required  the  corporation  to  report  as  income  all  of  its 
profits  and  permitted  it  to  deduct  all  of  its  losses  on  the  sale  of  property 


632  FEDERAL    INCOME    TAX 

Property  Acquired  by  Gift  Under  1921  Law.  The  Revenue 
Act  of  1921  provides  that  in  the  case  of  the  sale  or  other  dis- 
position of  property,  real,  personal  or  mixed,  acquired  by  gift 
after  December  31,  1920,  the  basis  for  determining  loss  shall  be 
the  same  as  that  which  it  would  have  in  the  hands  of  the  donor 
or  the  last  preceding  owner  by  whom  it  was  not  acquired  by  gift. 
If  the  facts  necessary  to  determine  such  basis  are  unknown  to 
the  donee,  the  Commissioner  is  required,  if  possible,  to  obtain 
such  facts  from  such  donor  or  last  preceding  owner,  or  any  other 
person  cognizant  thereof.  If  the  Commissioner  finds  it  impossible 
to  obtain  such  facts,  the  basis  will  be  the  value  of  such  property 
as  found  by  the  Commissioner  as  of  the  date  or  approximate 
date  at  which,  according  to  the  best  information  the  Com- 
missioner is  able  to  obtain,  such  property  was  acquired  by  such 
donor  or  last  preceding  owner.  In  the  case  of  such  property  ac- 
quired by  gift  on  or  before  December  31,  1920,  the  basis  for  as- 
certaining gain  or  loss  from  a  sale  or  other  disposition  thereof 
will  be  the  fair  market  price  or  value  of  such  property  at  the 
time  of  such  acquisition.^'* 

Losses  from  Sales  of  Property.  The  most  frequent  deductions 
for  losses  are  claimed  as  a  result  of  the  sale  of  property.  In  such 
cases  the  loss  occurs  when  the  selling  price  is  less  than  the  cost. 
This  is  the  converse  of  gain  from  the  sale  of  property  which  is 
discussed  in  a  preceding  chapter.-'^  The  cost  of  the  property  is 
determined  in  the  same  manner  whether  the  transaction  results 
in  a  loss  or  a  gain  and  the  same  rules  apply  with  respect  to  prop- 
erty acquired  prior  to  March  1,  1913.  Where  a  taxpayer  in- 
herited an  undivided  interest  in  a  piece  of  property  and  sold 
his  interest  to  his  sisters  for  an  amount  less  than  the  value  at 
which  it  was  appraised  for  inheritance  tax,  the  sale  price  being 
approximately  one-third  less  than  the  price  which  it  was  es- 
timated that  the  property  would  have  brought  at  a  forced  sale, 
it  has  been  held  that  the  difference  between  the  fair  market  value 
of  the  property  at  the  date  of  acquisition  and  the  selling  price 
(with  proper  adjustments  for  depreciation  and  improvements) 
does  not  under  the  facts  in  the  case  represent  a  loss  properly 

during  the  year,  regardless  of  the  fact  that  some  of  the  property  was 
purchased  prior  to  the  incidence  of  the  tax,  it  appearing  that  the  result 
would  be  the  same  as  if  the  gains  and  losses  had  been  prorated  as  then 
required  by  the  treasury  department. 

40  Revenue  Act  of  1921,  §  202    (a)    2. 

50  See  Chapter  17. 


DEDUCTION   OF  LOSSES  633 

deductible  from  gross  income,  but  is  rather  in  the  nature  of  a 
gift  to  his  sisters.''^ 

Sale  of  Stock  or  Securities.  A  corporation  sustains  no  de- 
ductible loss  from  the  sale  of  its  own  stock.''-  Where  a  contract- 
ing company  assigned  certificates  of  indebtedness  of  a  state  to 
a  bank,  under  an  agreement  with  the  bank  for  advancing  money 
to  pay  the  operating  expenses  of  the  company,  the  company  also 
paying  the  bank  a  discount  on  the  face  of  the  certificates  in  ad- 
dition to  the  accrued  interest  on  the  funds  advanced,  such  dis- 
count has  been  held  deductible  as  a  loss  on  the  sale  of  the 
securities.''"  Under  the  1918  Law  it  was  held  that  if  a  taxpayer 
made  actual  bo7ia  fide  sale  of  securities  at  a  loss  in  1918,  the  loss 
was  deductible  even  though  the  taxpayer  repurchase  the  se- 
curities in  the  succeeding  year  at  the  same  price  for  which  they 
were  sold.  However,  the  burden  of  proof  would  be  on  the  tax- 
payer to  show  that  the  sale  was  not  fictitious.^^  The  danger  of 
loss  of  revenue  to  the  government  inherent  in  transactions  of 
this  kind  has  now  been  guarded  against  in  the  Revenue  Act  of 
1921  which  provides  that  no  deduction  will  be  allowed  for  any 
loss  claimed  to  have  been  sustained  in  any  sale  or  other  dis- 
position of  shares  of  stock  or  securities  made  after  November 
23,  1921,  where  it  appears  that  within  thirty  days  before  or 
after  the  date  of  such  sale  or  other  disposition  the  taxpayer 
has  acquired  (otherwise  than  by  bequest  or  inheritance)  sub- 
stantially identical  property,  and  the  property  so  acquired  is 
held  by  the  taxpayer  for  any  period  after  such  sale  or  other 
disposition.  If  such  acquisition  is  to  the  extent  of  part  only  of 
substantially  identical  property,  then  only  a  proportionate  part 
of  the  loss  will  be  disallowed. '''^  Where  no  deduction  is  allowed 
for  a  loss  or  a  part  thereof  under  the  above  provision,  that  part 
of  the  property  acquired  with  relation  to  which  such  loss  is 
disallowed  will,  for  the  purpose  of  determining  subsequent  gain 
or  loss,  be  treated  as  taking  the  place  of  the  property  sold  or 
disposed  of.'^'' 

51  O.  D.  847,  T.  B.  12-21-1516. 

52  Reg.  45,  Art.  563,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767. 

53  0.  D.  999,  T.  B.  34-21-1778. 

54  0.  D.  373,  T.  B.  3-20-689. 

55  Revenue  Act  of  1921,  §§  214  (a)  5  and  234  (a)  4.  The  question  of  what 
will  constitute  "substantially  identical  property"  has  not  yet  been  ruled 
upon.  It  would  seem  that  where  common  stock  is  sold,  and,  within  the 
prescribed  period,  the  taxpayer  acquires  preferred  stock  or  bonds  of  the 
same  corporation  or  stock  or  bonds  of  another  corporation,  such  property 
should  not  be  regarded  as  "substantially  identical  property." 

5<!  Revenue  Act  of  1921,  §202   (d)   3. 


634  FEDERAL    INCOME    TAX 

Losses  from  Exchanges  of  Property.  Under  the  1918  Law, 
where  property  was  exchanged  for  other  property,  the  property 
received  in  exchange  was  treated,  for  the  purpose  of  determining 
any  loss  to  the  taxpayer,  as  the  equivalent  of  cash  to  the  amount 
of  its  fair  market  value,  if  any."'"  If  the  property  received  in 
exchange  had  no  fixed  value  or  definitely  ascertainable  market 
value,  it  would  be  difificult  to  determine  the  amount,  if  any,  of 
loss  in  the  transaction  and  it  seems  that  no  loss  could  be 
claimed  by  the  taxpayer.  The  Revenue  Act  of  1921  provides 
that  on  an  exchange  of  property,  real,  personal  or  mixed,  for 
any  other  such  property,  no  gain  or  loss  will  be  recognized  un- 
less the  property  received  in  exchange  has  a  readily  realizable 
market  value,  but  even  if  the  property  received  in  exchange  has 
a  readily  realizable  market  value  no  gain  or  loss  will  be  recog- 
nized (1)  when  any  such  property  held  for  investment,  or  for 
productive  use  in  trade  or  business  (not  including  stock-in- 
trade  or  other  property  held  primarily  for  sale),*  is  exchanged 
for  property  of  a  like  kind  or  use,  or  (2)  when  a  person  trans- 
fers any  property,  real,  personal  or  mixed,  to  a  corporation, 
and  immediately  after  the  transfer  is  in  control  of  such  cor- 
poration, or  (b)  two  or  more  persons  transfer  any  such  property 
to  a  corporation,  and  immediately  after  the  transfer  are  in 
control  of  such  corporation,  and  the  amounts  of  stock,  securi- 
ties, or  both,  received  by  such  persons  are  in  substantially  the 
same  proportion  as  their  interests  in  the  property  before  such 
transfer.  For  the  purposes  of  this  paragraph,  a  person  is,  or 
two  or  more  persons  are,  "in  control"  of  a  corporation  when 
owning  at  least  80  per  centum  of  the  voting  stock  and  at  least 
80  per  centum  of  the  total  number  of  shares  of  all  other  classes 
of  stock  of  the  corporation.  Where  property  is  exchanged  for 
other  property  and  no  gain  or  loss  is  recognized  as  above,  the 
property  received  will,  for  the  purpose  of  determining  sub- 
sequent gain  or  loss,  be  treated  as  taking  the  place  of  the  prop- 
erty exchanged  therefor."'^  The  rules  for  determining  loss  in 
the  case  of  exchanges  of  stock  or  securities  are  set  forth  in  the 
following  paragraphs. 

Exchange  of  Stock  Under  the  1918  Law.  The  Revenue  Act  of 
1918  •"'"  provided  that  "when  in  connection  with  the  reorganiza- 
tion, merger  or  consolidation  of  a  corporation  a  person  receives 
in  place  of  stock  or  securities  owned  by  him  new  stock  or  se- 

57  Revenue  Act  of  1918,  §202   (b). 

ss  Revenue  Act  of  1921,  §  202.     See  Chapter  17. 

59  Revenue  Act  of  1918,  §202    (b). 


DEDUCTION   OF  LOSSES  635 

curities  of  no  greater  aggregate  par  or  face  value,  no  gain  or 
loss  shall  be  deemed  to  occur  from  the  exchange,  and  the  new 
stock  or  securities  received  shall  be  treated  as  taking  the  place 
of  the  stock,  securities,  or  property  exchanged."  Where  in 
such  an  exchange  a  person  received  for  his  stock  or  securities, 
new^  stock  or  securities  of  a  greater  par  or  face  value  then  a  gain 
was  presumed  and  a  method  was  provided  for  determining  the 
amount  of  such  gain.''"  No  provision  was  made  for  determining 
and  allowing  the  deduction  of  a  loss  when  the  new  stock  or  se- 
curities received  were  of  less  par  or  face  value  than  those  ex- 
changed. It  was  expressly  stated  in  the  law,  as  quoted  above, 
that  where  the  new  stock  or  securities  received  were  of  no 
greater  par  or  face  value  than  those  exchanged  no  gain  or  loss 
should  be  deemed  to  occur  from  the  exchange.  Where  in  a 
case  of  merger,  stockholders  of  one  corporation  exchanged  their 
stock  for  stock  of  the  corporation  resulting  from  the  merger 
and  received  a  par  value  less  than  the  par  value  of  the  old 
stock,  it  was  held  under  the  1916  Law^  that  the  transaction  con- 
stituted a  sale  for  income  tax  purposes,  and  that  a  deduction 
might  be  claimed  for  any  loss,  measured  by  the  difference  be- 
tween the  value  of  the  old  stock  on  March  1,  1913,  (or  the  cost, 
if  purchased  subsequent  to  that  date)  and  the  value  at  which 
the  same  stock  was  given  in  exchange  for  stock  of  the  company 
resulting  from  the  merger.''^ 

Exchange  of  Stock  Under  the  1921  Law.  The  Revenue  Act  of 
1921  has  departed  from  the  somewhat  arbitraiy  basis  for  de- 
termining losses  in  such  transactions  provided  by  the  1918  Law. 
It  is  now  provided  that  no  gain  or  loss  will  be  recognized  when 
in  the  reorganization  of  one  or  more  corporations  a  person  re- 
ceives in  place  of  any  stock  or  securities  owaied  by  him,  stock 
or  securities  in  a  corporation  a  party  to  or  resulting  from  such 
reorganization.  The  word  "reorganization,"  as  used  in  this 
paragraph,  includes  a  merger  or  consolidation  (including  the 
acquisition  by  one  corporation  of  at  least  a  majority  of  the  voting 
stock  and  at  least  a  majority  of  the  total  number  of  shares  of  all 
other  classes  of  stock  of  another  corporation,  or  of  substantially 
all  the  properties  of  another  corporation),  recapitalization,  or 

'10  Revenue  Act  of  1918,  §202   (b). 

•■'1  Letter  from  treasury  department  dated  March  9,  1917;  L  T.  S.  1918, 
^1305;  A.  R.  R.  435,  T.  B.  13-21-1528.  See  Chapter  17.  Under  the  1916 
Law  such  losses  were  permitted  to  be  deducted  in  the  case  of  individuals 
cnly  to  the  extent  that  they  did  not  exceed  gains  from  other  similar  transac- 
tions during  the  year. 

<!-' Revenue  Act  of  1921,  §202    (c)    2. 


636  FEDERAL   INCOME   TAX 

mere  change  in  identity,  form,  or  place  of  organization  of  a 
corporation,  (however  effected.)  ^-  In  such  cases  the  stock  or 
securities  received  in  exchange  will  be  treated  as  taking  the 
place  of  the  stock  or  securities  exchanged  therefor  for  the  pur- 
pose of  determining  subsequent  gain  or  loss  from  their  sale 
or  other  disposition.*'^"  However,  in  the  case  of  an  exchange  of 
stock  or  securities  for  other  stock  or  securities  in  a  transaction 
other  than  those  outlined  above,  a  deductible  loss  may  arise  if 
the  stock  or  securities  received  in  exchange  have  a  readily 
realizable  market  value. 

Dividends  Paid  in  Property.  Where  in  1917  a  corporation  de- 
clared a  cash  dividend  and  distributed  in  payment  thereof  certain 
securities  theretofore  held  in  its  treasury,  it  has  been  held  that 
if  the  net  value  of  the  securities  at  the  date  of  distribution  was 
less  than  their  cost  the  taxpayer  has  sustained  a  deductible  loss, 
provided  that  in  such  distribution  the  market  value  of  the  securi- 
ties as  at  the  date  of  the  dividend  was  used.  At  the  date  of  the 
dividend  the  corporation  parted  with  title  to  these  securities  and 
thus  closed  the  transactions  in  them.*'"* 

Bonds  Purchased  Above  Par.  Where  bonds  have  been  pur- 
chased above  par  it  seems,  under  the  present  law,  that  no  deduc- 
tion can  ordinarily  be  made  for  the  loss  of  the  amount  of  the 
premium  until  the  bonds  are  either  sold  in  the  market  before 
maturity,  or  until  the  principal  sum  is  received  at  the  time  of 
maturity.  In  either  case  the  loss  will  be  the  difference  between 
the  amount  paid  and  the  amount  received.  Where,  however,  a 
taxpayer  reports  on  a  basis  other  than  of  actual  receipts  and  dis- 
bursements it  seems  that  this  sum  may  properly  be  deducted  in 
proportionate  amounts  each  year  as  amortization. ^^ 

Losses  from  Fires,  Storms,  Shipwreck  and  Other  Casualty.  The 
law  expressly  provides,  in  the  case  of  individuals,  that  the  loss 
arising  from  fires,  storms,  shipwrecks,  or  other  casualty,  or 
theft,  may  be  deducted  in  the  year  in  which  the  loss  is  sus- 
tained.'^'''  Under  the  present  law,  but  not  under  the  1918  Law, 
such  losses  may  be  deducted  in  a  year  other  than  the  one  in 
which  sustained,  if  in  the  opinion  of  the  Commissioner,  income 

63  Revenue  Act  of  1921,  §  202  (d)   1. 

64  A.  R.  R.  435,  T.  B.  13-21-1528. 

65  This  was  also  the  case  under  the  1916  Law.  Under  the  1909  Law  it 
was  held  that  where  bonds  were  purchased  at  a  rate  above  par  a  pro- 
portionate amount  of  the  premium  might  be  deducted  each  year  on  account 
of  amortization  (T.  D.  1727).  See  Van  Dyke  v.  Milwaukee,  (Wis.)  150 
N.  W.  509. 

66  Revenue  Act  of  1918,  §214    (a)    6. 


DEDUCTION   OF  LOSSES  637 

will  be  more  clearly  reflected.''"  This  kind  of  loss  is  allowed  to 
corporations  without  specific  mention,  as  with  respect  to  corpora- 
tions all  losses  are  deductible.  In  the  case  of  nonresident  aliens 
the  law  permits  the  deduction  of  all  such  losses  of  property 
within  the  United  States.'"'^  In  the  case  of  foreign  corporations 
such  deductions  are  alloM'ed  only  if  and  to  the  extent  that  they 
are  connected  with  income  arising  from  a  source  within  the 
United  States ;  and  the  proper  apportionment  and  allocation  of 
such  deductions  with  respect  to  sources  of  income  within  and 
without  the  United  States  must  be  determined  under  rules  and 
regulations  prescribed  by  the  Commissioner  with  the  approval 
of  the  Secretary.""'  In  all  cases  the  law  provides  that  the  de- 
duction may  be  made  only  when  such  losses  are  not  compensated 
for  by  insurance  or  otherwise.  The  intent  seems  to  be  to  per- 
mit a  deduction  of  the  losses  to  the  extent  that  the  taxpayer  is 
not  compensated  by  insurance  or  otherwise.  If  he  is  com- 
pensated for  part  of  such  loss,  he  may  deduct  the  part  for  which 
he  is  not  so  compensated.  In  claiming  a  loss  due  to  the  destruc- 
tion of  property  the  salvage  value  of  the  property  must  be  con- 
sidered as  a  partial  compensation  to  be  deducted  from  or  not 
included  in  the  amount  claimed  as  a  deduction.  The  value  of  the 
property  at  the  time  of  the  loss  is  not  intended  to  be  the  measure 
of  the  loss.  The  measure  of  loss  will  be  determined  in  ac- 
cordance with  the  rules  set  forth  in  a  former  paragraph."" 

The  term  "other  casualty"  is  held  to  embrace  losses  arising 
through  the  action  of  natural  physical  forces  and  which  occur 
suddenly,  unexpectedly,  and  without  design  of  the  one  suffering 
the  loss."^  A  loss  sustained  through  the  freezing  and  bursting 
of  the  water  pipes  in  a  residence  during  the  absence  of  the  oc- 
cupant has  been  held  deductible  as  a  loss  from  "other  casualty.""^ 
The  following  have  been  held  not  deductible  as  losses  from  "other 
casualty":  (1)  a  lost  ring,  the  owner  being  in  doubt  as  to 
whether  it  was  stolen;""  (2)  a  loss  sustained  by  reason  of  the 
damage  to  a  pleasure  automobile  due  to  an  accident  attributable 

«' Revenue  Act  of  1921,  §§214   (a)   6  and  234   (a)   4.  - 

C8  Revenue  Act  of  1921,  §214   (a)   6;  Revenue  Act  of  1918,  §214   (a)    6. 

«9  Revenue  Act  of  1921,  §234   (b)  ;  Revenue  Act  of  1918,  §234   (b). 

"0  See  paragraph  "Measure  of  Loss",  supra. 

71  0.  D.  526,  T.  B.  22-20-969. 

'2  0.  D.  1076,  T.  B.  43-21-1885. 

7»0.  D.  526,  T.  B.  22-20-969.  Of  course  if  the  owner  of  the  ring  can 
establish  the  fact  that  it  was  stolen,  the  loss  will  be  one  arising  from 
"theft". 


638  FEDERAL   INCOME   TAX 

to  the  icy  condition  of  the  streets;^*  (3)  amounts  expended  in 
defending  a  suit  for  damages  alleged  to  have  been  caused  by 
the  negligent  operation  of  an  automobile  owned  and  operated  for 
personal  convenience ; "^  (4)  an  amount  paid  by  a  taxpayer  as 
damages  on  account  of  injuries  sustained  by  reason  of  the  plain- 
tiff's tripping  over  a  v^ire  stretched  along  the  curb  in  front  of 
the  taxpayer's  residence.'''*'' 

A  taxpayer's  personal  residence  located  on  a  beach  was  dam- 
aged by  a  storm,  which  washed  away  part  of  the  foundation 
and  so  undermined  the  building  as  to  render  its  destruction 
certain  if  it  was  not  immediately  removed.  In  removing  the 
building  to  a  safer  location  it  was  further  damaged.  The  damage 
caused  by  the  direct  action  of  the  storm  and  by  the  removal  to 
avoid  further  probable  damage  is  held  to  have  arisen  from  storm 
and  deductible  from  gross  income  as  a  loss.  If  the  building  was 
moved  to  prevent  further  loss  from  the  storm  in  question,  the  ex- 
pense of  moving  it  is  also  deductible  as  a  loss ;  but  if  it  was  moved 
to  prevent  probable  losses  from  future  storms,  the  expense  of 
moving  it  is  regarded  as  a  capital  expenditure  and  should  be 
added  to  the  cost  of  the  building  in  computing  profit  in  the 
event  of  its  sale,  since  the  removal  to  a  safer  locality  pre- 
sumably increased  its  value.'''' 

Losses  Arising  from  Theft.  The  following  rulings  were  made 
under  the  1918  Law :  A  loss  incurred  by  a  corporation  through 
the  embezzlement  of  its  funds  is  an  allowable  deduction  from 
gross  income  for  the  year  in  which  the  embezzlement  occurs; 

74  0.  D.  629,  T.  B.  33-20-1132.  This  ruling  seems  a  questionable 
interpretation  of  the  statute.  The  statute  provides  for  a  deduction  of 
losses  not  connected  with  the  trade  or  business  "if  arising  from  fires, 
storms,  shipwreck,  or  other  casualty  or  from  theft,  *  *  *."  It  would 
seem  that  the  words  "other  casualty"  are  broad  enough  to  include  a  loss 
due  to  icy  condition  of  streets.  The  word  "casualty"  has  been  defined  by 
the  courts  as  follows :  "An  accident  or  casualty,  according  to  common  under- 
standing, proceeds  from  an  unknown  cause  or  is  an  unusual  effect  of 
a  known  cause.  Either  may  be  properly  said  to  occur  by  chance  and 
unexpectedly."  (Chicago,  St.  Louis,  etc.,  R.  Co.  v.  Pullman  Co.,  139  U.  S. 
79.)  The  only  justification  for  the  ruling  is  the  limitation  of  the  word 
"casualty"  by  reference  to  the  words  immediately  preceding  it  (see  U. 
S.  V.  11501  Lbs.  of  Celluloid,  82  Fed.  627)  but  this  is  not  a  cast  iron  rule 
and  has  been  disregarded  in  the  construction  of  the  clause  "all  other  gains 
and  profits  derived  from  any  source  whatever"  contained  in  the  Virginia 
Income  Tax  Law  (see  Commonwealth  v.  Werth,  116  Va.  604,  82  S.  E. 
695).  This  clause  is  very  similar  to  the  omnibus  clause  used  in  section  213 
(a)  of  the  Revenue  Act  of  1918  and  213   (a)  of  the  1921  Law. 

75  A.  R.  R.  444,  T.  B.  12-21-1527. 

76  0.  D.  779,  T.  B.  4-21-1409. 

77  O.  D.  698,  T.  B.  43-20-1259. 


639 

DEDUCTION   OF   LOSSES 


tHe  «.e  onhe  discover^^f  ^J::^^  r^^^  toZ 

able  deduction  from  gross  ''"^TJlnofZl^nriUes  and  the 
was  made  by  the  badors  for  the  .eturn  "ft^^^^-  ^^^_ 

replacement  made  by  the  company^       vv  _^_ 

fered  a  lo-/'^.™XTh7crrt"„  m9  that  notsu'rance  could 
irrLCed^tVltrhl  to.be  deductible  In  .OH,  the 
,ear  in  which  it  was  --^-"^^-^^^^^.^r  the  present  law  to 
pe^nlltt  rhTrct::nsn:  ^^  .n  years  -.  than  those  .n 
which  sustained  if  such  procedure  will  more  cleaily  reflect 

'"voluntary  Destruction  of  Property.  Loss  due  to  the  voluntary 
.raTr demolition  o-M  bunding,  ---7. .^  - 
machinery    equipment    etc     inc  den    to  .^^^^^_  .^  ^ 

ments  has  been  ^eW  to  be  dedu  ub^  8^^^  ^^  ^^^^  p^^p. 

,.„,    .,,    »„.    ....      O.    «,   T,    «.  *..-!...      !«   <-...-.-."..   - 

Losses,"  infra.  ^  the  time  of  the  embez- 

79  A.  R.  R.  269,  T.  B.  40-20-1221  ^^  ^h^^  ^^^^  ^^  ^^,  be  determined,  for 
zlement  the  amount  of  the  loss  to  '^^^'^rof  ZLZiti.s  at  the  date  of 
it  was  controlled  by  the  -f^f^f.^^L  the  company  might  have  been 
demand  by  the  owners.     The  ^!^^"^^^f  ^ould  have  sustained 

waived  by  the  clients  and  1"/^?^^  c^se  the  comp     Y  ^^.^^^^  ^^  ^^_ 

no  loss.     Furthermore,  the  liability  of  the  company  ^^^  ^^ 

count  of  the  loss  of  the  property  held  ^  ^.^^^^^  ^'^.^^rbailment  for  mutual 
have  been  contested,  the  -^P^^  „^«"^,  ^^  "/.l^.f  i:";elation  to  the  subject- 
benefit  it  is  held  to  the  exercise  ^J^^^^J^^^J^^^jX  negligence.  (New  York 
„.atter  thereof  and  is  -^P^^^f  ^^«.f  ^  f,!  ^kTey  v.  New  York,  139  Fed. 
cent.  R.  Co.  V.  Lockwood,  ^/^  J/^  ;f  ^^'.f  ^Fed.  711;  Smith  v.  British 
807;  Fairmont  Coal  Co.  -  ^  -s  etc  ^^,^  ^^^^^^^^  ^^  ^^^ 
Steamship  Co.,  1^3  i'ea.  i<o.;      ^  i  K^i^ilitv      The  right  of  action  of 

•         stet,'^";J^."Ur  Zf-Z^r^r^^-  ..  33o!  woo.  V. 
Latta,  3  Mont.  9;  Brown  v.  Cook,  9  John.  361.) 
so  A.  R.  R.  542,  T.  B.  26-21-1705. 
SI  Revenue  Act  of  1921,  §§214   (a)  6  and  234  (a)  4. 


640  FEDERAL   INCOME   TAX 

year  prior  to  its  destruction.  When  a  taxpayer  buys  real  estate, 
upon  which  is  located  a  building  which  he  proceeds  to  raze,  with 
a  view  to  erecting  thereon  another  building,  it  will  be  considered 
that  the  taxpayer  has  sustained  no  deductible  loss  by  reason  of 
the  demolition  of  the  old  building  and  no  deductible  expense  on 
account  of  the  cost  of  such  removal,  the  value  of  the  real  estate, 
exclusive  of  old  improvements,  being  presumably  equal  to  the 
purchase  price  of  the  land  and  building  plus  the  cost  of  remov- 
ing the  useless  building.*^-  A  taxpayer  sustains  no  deductible  loss 
in  the  demolition  of  80  per  cent  of  his  building  for  the  purpose 
of  reconstruction.  The  amount  expended  is  an  investment  of 
capital  and  should  be  considered  as  a  part  of  the  cost  of  re- 
construction.'^'^ 

Where  a  taxpayer  purchased  improved  real  estate  adjoining 
his  plant,  intending  to  sell  the  houses  thereon  and  have  them  re- 
moved but  found  that  owing  to  fire  regulations  the  houses  could 
not  be  removed  and  was  obliged  to  sell  them  for  a  very  small 
sum,  it  has  been  held  that  since  the  property  was  purchased 
primarily  for  the  enlargement  of  the  plant  and  not  with  the 
view  of  selling  it  for  profit,  and  inasmuch  as  the  fire  regulations 
were  existent  at  the  time  the  property  was  purchased,  the  houses 
in  fact  were  worth  only  their  salvage  value  when  purchased,  re- 
gardless of  what  it  was  thought  they  were  worth.  The  amount 
paid  for  the  property,  including  the  buildings,  less  the  salvage 
value  of  the  buildings,  represents  the  amount  actually  paid  for 
the  land.  As  the  land  has  not  been  sold  or  otherwise  disposed 
of,  the  gain  or  loss  from  the  transaction,  if  any,  has  not  been 
determined.  No  deductible  loss  was  sustained  from  the  sale  of 
the  buildings.'^^ 

Loss  of  Useful  Value.  When  through  some  change  in  business 
conditions  the  usefulness  in  the  business  of  some  or  all  of  the 
capital  assets  is  suddenly  terminated,  so  that  the  taxpayer  dis- 
continues the  business  or  discards  such  assets  permanently  from 
use  in  such  business,  he  may  claim  as  a  loss  for  the  year  in  which 
he  takes  such  action  the  difi'erence  between  the  cost,  or,  if  ac- 
quired prior  to  March  1,  1913,  the  cost  or  fair  market  price  or 
value  as  of  that  date,  whichever  is  lower,  of  any  assets  so  dis- 
carded (less  any  depreciation  sustained)  and  its  salvage  value 
remaining.  This  exception  to  the  rule  requiring  a  sale  or  other 
disposition  of  property  in  order  to  establish  a  loss  requires  proof 

82  Reg.  45,  Art.  142;  Reg.  33  Rev.,  Arts.  155  and  156.  See  Reg.  33,  Art. 
127. 

83  0.  D.  773,  T.  B.  2-21-1387. 
S4  0.  D.  1031,  T.  B.  37-21-1816. 


DEDUCTION  OF  LOSSES  641 

of  some  unforeseen  cause  by  reason  of  which  the  property  has 
been  prematurely  discarded,  as,  for  example,  where  an  increase 
in  the  cost  of  or  other  change  in  the  manufacture  of  any  product 
makes   it   necessary   to   abandon   such   manufacture,   to   which 
special  machinery  is  exclusively  devoted,  or  where  new  legisla- 
tion directly  or  indirectly  makes  the  continued  profitable  use  of 
the  property  impossible.     This  exception  does  not  extend  to  a 
case  where  the  useful  life  of  property  terminates  solely  as  a  re- 
sult of  those  gradual  processes  for  which  depreciation  allowances 
are  authorized.     It  does  not  apply  to  inventories  or  to  other 
ihan  capital  assets.     The  exception  applies  to  buildings  only 
when    they    are    permanently    abandoned    or    permanently    de- 
voted to  a  radically  different  use,  and  to  machinery  only  when 
its  use  as  such  is  permanently  abandoned.     Any  Icfss  to  be  de- 
ductible under  this  exception  must  be  charged  off  on  the  books 
and  fully  explained  in  returns  of  income.^'    Such  a  loss  m  useful 
value  may  not  be  based  on  the  book  value  of  assets  where  this 
book  value   represents   a   writing   up   of  appreciation   in  then- 
value.    The  loss  in  useful  value  must  be  based  on  cost  or  value  as 
of  March  1,  1913.«''  . 

Where  on  account  of  rearranging  a  lease  on  property  occupied 
by  a  corporation  a  large  portion  of  the  furniture  and  fixtures 
became  useless  and  were  torn  out,  it  has  been  held  that  the 
corporation  mav  deduct  the  amount  of  such  loss.  Such  a  loss 
is  a  loss  of  useful  value  and  may  not  be  deducted  by  the  tax- 
payer as  depreciation.'^'  Where  it  appears  that  material  error 
has  been  made  in  an  estimate  of  the  mineral  contents  of  a  mine 
by  reason  of  the  discovery  of  a  rock  fault,  it  has  been  held  that 
«uch  discovery  does  not  give  rise  to  a  deductible  loss  of  useful 
value.    A  new  estimate  may  be  made  and  the  capital  remaining 

85  Reg  45,  Art.  143;  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767.  Under 
the  Hawaiian  Law,  which  does  not  make  any  provision  for  a  deduction  to 
cover  obsolescence,  it  has  been  held  that  no  deduction  may  be  taken  to  cover 
the  value  of  mills,  buildings,  and  a  railroad  discarded  on  account  of  the 
erection  of  a  larger  mill  at  a  diflferent  location  and  the  construction  of  a 
different  railroad  connected  therewith.  This  transaction  was  ^jeW  not  to 
be  deductible  either  as  a  loss  or  an  expense  and  it  was  also  held  that  the 
provision  that  "no  deduction  shall  be  made  for  any  amount  paid  out  for  new 
buildings,  permanent  improvements  or  betterments  made  to  increase  the 
value  of  any  property  or  estate,"  did  not  imply  that  deduction  might  be 
made  for  all  amounts  so  paid  out  which  did  not  in  fact  increase  the  value 
of  the  property.  (Haw.' Commercial,  etc.,  Co.  v.  Tax  Assessor.  14  Haw. 
601,  687.) 

so  A.  R.  R.  556,  T.  B.  37-21-1817. 

87  A.  R.  R.  469,  T.  B.  16-21-1579. 


642  FEDERAL  INCOME  TAX 

may  be  recovered  thereafter  through  depletion  in  the  year  or 
years  of  continued  operation.^^  The  department  has  also  denied 
the  claim  of  an  ice  company  for  a  loss  of  useful  value  of  a  dam 
constructed  to  make  a  lake  from  which  ice  was  cut  where  the 
company  voluntarily  abandoned  the  ice  business,  but  apparently 
the  claim  was  denied  because  of  the  department's  belief  that 
the  dam  still  had  substantial  value  and  because  there  was  no 
evidence  of  a  "determinable  and   determined"   loss.'^^ 

Cost  of  Drawings,  Models  and  Patterns.  Expenditures  made 
for  designs,  drawings,  patterns  or  models  representing  work 
of  an  experimental  nature  should  be  treated  as  a  capital  dis- 
bursement and  not  as  an  expenditure  if  the  designs,  drawings, 
patterns  or  models  prove  to  be  satisfactory  and  result  in  the 
production  of  salable  goods.  If,  however,  they  prove  to  be  un- 
satisfactory and  have  no  asset  value,  the  expenditure  may  be 
charged  off  as  a  loss  incident  to  running  the  business  and  as 
such  deducted  from  gross  income,  provided  that  the  taxpayer 
taking  credit  for  such  expenditures  in  the  income  tax  return 
makes  a  full  and  complete  explanation  with  respect  to  the 
same.^o  If  designs,  drawings,  patterns,  or  models  result  in  the 
production  of  goods  which  prove  to  be  salable  for  a  certain  length 
of  time  and  then  become  obsolete  and  can  not  be  sold,  the  amount 
expended  for  such  designs,  drawings,  patterns,  or  models,  less 
any  amounts  previously  claimed  as  depreciation  with  respect  to 
the  same  or  as  a  return  of  capital,  may  when  charged  off,  .be  in- 
cluded in,  and  deducted  as  a  loss  incident  to  running  the  business, 
provided  full  and  complete  information  is  reported  in  a  manner 
satisfactory  to  the  Commissioner.^i 

Amounts  Paid  to  Make  Up  Profits  of  Another  Corporation 
Under  Agreement.  Contracts  guaranteeing  the  payment  of  divi- 
dends or  interest  of  one  corporation  by  another  are  frequently 
made  between  corporations  having  close  business  relations. 
Whether  or  not  amounts  paid  under  such  contracts  or  guaran- 
tees may  be  deducted,  as  a  loss  or  as  an  expense  of  doing  busi- 
ness, by  the  paying  corporation  has  not  been  determined  by  the 
courts  in  this  country.  In  England  such  payments  have  been 
held  properly  deductible  as  sums  expended  for  the  purpose  of 
trade.92    jf  the  payment  is  made  under  an  enforceable  contract, 

88  A.  R.  R.  431,  T.  B.  12-21-1521. 

89  A.  R.  R.  498,  T.  B.  20-21-1639. 

90  Reg.  33  Rev.,  Arts.  175,  176. 

91  Reg.  33  Rev.,  Art.  177. 

92  Moore  v.  Stewarts  &  Lloyds  (1906),  8  Eraser  1129.  In  this  case  it  was 
observed  that  the  question  was  one  of  fact  rather  than  of  law.    One  company 


DEDUCTION   OF  LOSSES  643 

there  seems  to  be  no  reason  why  the  amount  should  not  be  de- 
ducted either  as  loss  or  expense.  This  question  would  seem 
under  the  1918  Law  and  the  present  law  to  be  covered  in  many 
cases  by  the  provision  for  the  making  of  a  consolidated  return 
by  affiliated  corporations.^^ 

Shrinkage  in  Securities  and  Stocks.  A  person  possessing  se- 
curities such  as  stocks  and  bonds,  can  not  deduct  from  gross 
income  any  amount  claimed  as  a  loss  on  account  of  the  shrinkage 
in  value  of  such  securities  through  fluctuation  of  the  market  or 
otherwise.  The  loss  allowable  in  such  cases  is  that  actually  suf- 
fered when  the  securities  mature  or  are  disposed  of.  In  the  case 
of  banks  or  other  corporations  which  are  subject  to  supervision 
by  state  or  federal  authorities,  and  which  in  obedience  to  the 
orders  of  such  supervisory  officers  charge  off  as  losses  amounts 
representing  an  alleged  shrinkage  in  the  value  of  property, 
the  amounts  so  charged  off  do  not  constitute  allowable  deduc- 
tions. The  foregoing  applies  only  to  owners  and  investors,  and 
not  to  dealers  in  securities.  However,  if  stock  of  a  corporation 
becomes  worthless,  its  cost,  or,  if  acquired  prior  to  March  1, 
1913,  its  fair  market  value  as  of  that  date,  whichever  is  lower, 
may  be  deducted  by  the  owner  in  the  taxable  year  in  which  the 
&tock  becomes  worthless,  provided  a  satisfactory  showing  of  its 
worthlessness  be  made  as  in  the  case  of  bad  debts.^^ 

It  has  been  held  in  a  recent  case^''  under  the  1909  Law  that 
an  insurance  company,  the  greater  portion  of  whose  assets  con- 
sist of  stocks,  bonds,  and  other  securities,  is  entitled  to  deduct 

entered  into  agreement  with  another  whereby  in  return  for  the  right  to 
nominate  a  majority  of  directors  of  the  second  company  the  first  undertook 
to  pay  to  the  second  such  sums  each  half  year  as  might  be  necessary  to 
make  up  any  deficit  in  the  dividends  on  the  latter's  preferred  shares.  The 
court  said,  "If  the  agreement  was  entered  into  with  a  view  to  profit,  as  I 
think  it  was  *  *  *  then  the  annual  charge  to  the  respondent  company 
is  in  my  view  a  part  of  their  business  outlay  or  expenditure  and  is  not 
subject  to  assessment." 

93  See  Chapter  10. 

94  Reg.  45,  Art.  144,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767;  T.  D. 
2882,  T.  B.  9-19-341;  T.  D.  3261;  letter  from  treasury  department  dated  Au- 
gust 14,  1914;  I.  T.  S.  1918,  Ij  1344;  N.  Y.  Life  Ins.  Co.  v.  Anderson,  257  Fed. 
576.  The  Act  of  June  30,  1864,  as  amended  by  the  Act  of  July  13,  1866,  seems 
to  have  permitted  the  deduction  from  earnings  of  depreciation  in  invest- 
ments in  bonds  and  depreciation  in  stock  in  order  to  arrive  at  the  amount  of 
the  taxpayer's  jyrofits.     (Miami,  etc.,  R.  R.  Co.  v.  U.  S.,  108  U.  S.  277.) 

9o  New  York  Life  Ins.  Co.  v.  Anderson,  263  Fed.  527,  reversing  257  Fed. 
576.  The  soundness  of  this  view  may  be  doubted.  (See  Fink  v.  North- 
western Mutual  Life  Ins.  Co.,  U.  S.  circuit  court  of  appeals,  seventh  circuit, 
June,  1920,  T.  D.  3057,  T.  B.  36-20-1187.  See  the  limiting  definition  of 
depreciation  in  Von  Baumbach  v.  Sargent  Land  Co.,  242  U.  S.  503. 


644  FEDERAL  INCOME   TAX 

the  amount  of  the  market  depreciation  of  such  securities  during 
the  year.  The  court  said  in  part:  "It  is  here  admitted  that 
judged  by  any  standard  famihar  to  business  men,  the  securi- 
ties of  plaintiff  were  worth  at  the  end  of  1910  several  million 
dollars  less  than  they  were  at  the  beginning  of  that  year.  It 
is  further  admitted  that,  not  only  was  it  the  business  custom 
of  plaintiff  to  revalue  its  securities  in  accordance  with  the  mar- 
ket annually,  but  that  such  procedure  was  and  is  a  reasonable 
business  conservatism,  and  a  frequent,  though  not  universal, 
statutory  requirement.  Under  this  taxing  act  the  question  is 
not  strictly  whether  depreciation  in  market  value  is  a  loss,  but 
whether,  when  Congress  specifically  includes  within  'losses  ac- 
tually sustained  within  the  year,  *  *  *  a  reasonable  allow- 
ance for  depreciation  of  property,'  depreciation  does  not  be- 
come a  loss,  no  matter  what  persons  other  than  Congress  may 
think  on  the  subject.  We  have  no  doubt  that  this  loss  in  market 
value  is  depreciation.  The  word  means,  by  derivation  and  com- 
mon usage,  a  'fall  in  value ;  reduction  of  worth' ;  and  it  seems 
to  us  to  require  mention  only  to  prove  that  the  average  citizen, 
for  whom  statutes  are  assumed  to  be  made,  would  judge  depre- 
ciation of  his  own  bonds  by  the  opinion  of  the  public,  however 
thoroughly  convinced  of  the  ultimate  wisdom  of  holding  onto 
what  had  depreciated.  *  *  *  The  plain  inference  is  that  the 
phrase  is  used  in  the  statute  in  a  sense  that  would  be  generally 
understood  in  business  circles,  and  we  hold  that  the  depreciation 
claimed  by  plaintiff  in  its  return  is  used  in  that  sense,  and  should 
have  been  allowed  as  a  deduction." 

No  deduction  may  be  taken  by  a  taxpayer  on  account  of  the 
shrinkage  in  value  of  an  amount  invested  in  foreign  money  due 
to  a  fall  in  the  rate  of  exchange.  The  loss  allowable  in  such  a 
case  is  that  actually  sustained  when  the  investment  is  disposed 
of.^»« 

Transfer  of  Securities  at  Depreciated  Value  to  Corpora- 
tion Formed  for  the  Purpose.  In  a  case  arising  under  the  1917 
Law,  the  stockholders  of  an  industrial  company  owning  certain 
stocks  and  bonds  carried  as  liquid  reserves  for  opportune  pur- 
chases of  material,  established  a  new  corporation  having  the 
same  stockholders  with  the  same  proportionate  stock  holdings. 
The  new  company  then  bought  the  above  stocks  and  bonds  at 
market  prices  which  were  substantially  lower  than  the  cost  of 
market  value  as  of  March  1,  1913,  of  the  securities  of  the  old 
company.    A  small  amount  of  cash  received  from  the  sale  of  its 

i»'i  O.  D.  764,  T.  B.  1-21-1371. 


DEDUCTION  OF  LOSSES 


645 


capital  stock  was  given  by  the  new  company  in  payment  for  the 
securities  and  the  balance  of  the  purchase  price  was  given  in  de- 
mand notes  bearing  Q'A  interest  with  the  same  securities  as  col- 
lateral. The  possession  of  the  securities  was  retained  by  the  old 
corporation  with  a  power  of  sale  in  case  of  default  in  payment  of 
the  notes.  The  new  corporation  had  no  other  assets.  The  treas- 
ury department  first  held  the  whole  transaction  to  be  a  sham  and 
a  subterfuge  to  evade  taxation  with  the  result  that  no  loss  could 
be  deducted  under  the  alleged  sale  of  the  securities  by  the  old 
corporation.-'^ 

This  ruling  was  subsequently  reversed  and  the  separate  en- 
tities of  the  two  corporations  respected,  and  it  was  held  that  the 
.  transfer  of  securities  by  the  old  company  to  the  new  company 
must  be  recognized  as  a  sale  in  which  the  former  suffered  a  de- 
deductible  loss."-^ 

Worthless  Stock.  If  stock  of  a  corporation  becomes  worthless 
its  cost,  or,  if  acquired  prior  to  March  1,  1913,  its  fair  market 
value  as  of  that  date,  whichever  is  lower,  may  be  deducted 
by  the  owner  in  the  taxable  year  in  which  the  stock  was 
ascertained  to  be  worthless  and  charged  off.  The  worthlessness 
must  be  satisfactorily  shown  as  in  the  case  of  bad  debts.  Where 
banks  or  other  corporations  which  are  subject  to  supervision  by 
federal  authorities  (or  to  state  authorities  maintaining  sub- 
stantially equivalent  standards)  in  obedience  to  the  specific 
orders  or  general  policy  of  such  supervisory  officers  charge  off 
stock  as  worthless  or  write  it  down  to  a  nominal  value,  such 
stock  shall,  in  the  absence  of  affirmative  evidence  clearly  es- 
tablishing the  contrary,  be  presumed  for  income  tax  purposes  to 
be  worthless."^ 

Sale  of  Capital  Stock.  Where  the  capital  stock  of  a  corpora- 
tion is  issued  for  less  than  par,  the  amount  of  discount  is  not  an 
allowable  deduction  to  the  corporation.  Such  a  transaction  is 
purely  a  capital  transaction  and  the  income  of  the  corporation  is 
not  directly  decreased  by  reason  of  the  sale  of  the  stock  at  a  price 
less  than  its  par  value.  Neither  is  any  loss  or  gain  reahzed  from 
the  purchase  of  its  own  stock.i'"' 

07  L.  O.  1035  (Rev.),  T.  B.  40-20-1222. 

98  L.  0.  1062,  T.  B.  14-21-1548.  See  Chapter  10  for  a  discussion  of  the 
doctrine  of  corporate  entity  upon  which  this  decision  rested. 

!>!>Reg.  45,  Art.  144,  as  amended  by  T.  D.  3206,  T.  B.  33-21-1767;  T.  D. 
2135;  T.  D.  3261.    See  p.  647  for  a  discussion  of  the  deduction  of  bad  debts. 

lOtt'Reg.  45,  Arts.  563,  542;  T.  D.  2090. 


646  FEDERAL  INCOME  TAX 

Payment  by  Stockholders  of  Loss  of  Corporation.  Assessments 
made  by  a  corporation  on  its  capital  stock  are  regarded  as  an  in- 
vestment of  capital  and  the  amounts  paid  do  not  constitute  al- 
lowable deductions  to  the  stockholders.^'^!  This  rule  was  held  to 
apply  in  a  case  where  a  corporation  showed  a  deficit  at  the  close 
of  the  year  and  the  stockholders  agreed  to  make  it  good  by  the 
payment  of  voluntary  contributions. i*^-  The  surrender  of  stock 
for  the  purpose  of  wiping  out  an  operating  deficit  can  not  b*^ 
made  the  basis  of  a  deduction  in  the  returns  of  the  individual 
stockholders.103  An  assessment  paid  by  a  stockholder  of  a  na- 
tional bank  on  account  of  his  statutory  liability  is  similarly  not 
deductible.  In  such  a  case  the  assessment  under  the  statutes  of 
the  state  impose  upon  the  stockholder  the  necessity  of  an  addi- 
tional capital  expenditure  which  must  be  added  to  the  original 
cost  of  his  stock  and  his  gain  or  loss  can  not  be  determined  until 
this  stock  is  sold  or  otherwise  disposed  of  in  a  closed  transac- 
tion.104 

Shrinkage  or  Deterioration  in  Storage.  Loss  due  to  shrinkage 
or  deterioration  of  produce  in  storage  is  not  allowed  as  a  deduc- 
tion. Such  shrinkage  or  deterioration  is  reflected  in  the  selling 
price  when  the  goods  are  sold  and  correspondingly  reduces  the 
net  income  at  that  time.io^ 

District  Irrigation  Bonds.  District  irrigation  bonds  as  a  rule, 
if  not  always,  are  a  lien  upon  the  real  estate  affected  by  the  irri- 
gation project  and  until  the  corporation  has  taken  such  steps  as 
are  necessary  to  protect  its  rights  and  enforce  the  collection  of 
the  bonds,  it  does  not  appear  that  the  corporation  would  be  war- 
ranted in  writing  out  of  its  assets  and  deducting  from  gross  in- 
come, as  a  loss,  the  face  value,  or  any  other  arbitrarily  ascer- 
tained amount,  representing  a  loss  or  shrinkage  in  the  value  of 
such  bonds.i*^*^  This  ruling  was  made  under  the  1B13  Law  and  is 
now  subject  to  the  new  provisions  of  the  1921  Law  that  losses 
may  in  some  cases  be  deducted  in  years  other  than  those  in  which 
sustained. 

Losses  of  Oil  and  Gas.  Losses  of  oil  and  gas  are  of  two  kinds : 
(a)  Those  which  are  unforeseen  or  unavoidable,  such  as  losses 
sustained  through  fire  or  accident;  and  (b)  losses  that  are  an- 

101  T.  D.  2090.  ^ 

102  Letter  from  treasury  department  dated  February  21,  1916;  I.  T.  S. 
1918,  111291. 

103  0.  D.  216,  T.  B.  11-19-378. 

104  A.  R.  R.  588,  T.  B.  30-21-1744. 

105  Reg.  45,  Art.  145;  T.  D.  2153. 

106  T.  D.  2152. 


DEDUCTION   OF  LOSSES  647 

ticipated  and  recognized  as  unavoidable  under  operating  condi- 
tions, such  as  evaporation  of  oil  in  storage,  ordinary  leakage,  re- 
finery losses,  etc.  Usually  the  latter  class  are  indeterminate  as  to 
amount  and  are  absorbed  either  implicitly  or  explicitly  in  cur- 
rent operating  expenses  or  in  cost  of  the  oil  or  gas.  Indeter- 
minate losses  may  not  be  deducted  from  gross  income.^"'^  If  a 
taxpayer  purchases  royalty  interests  in  tracts  of  oil  land  (not 
including  title  to  the  land  itself)  and  such  interests  prove  worth- 
less, as  evidenced  by  all  wells  drilled  proving  dry  or  failing  after 
producing  very  small  quantities  of  oil,  the  loss  sustained  is  an 
allowable  deduction  from  gross  income. ^"s 

Reserves  for  Losses.  Reserves  to  take  care  of  anticipated  or 
probable  losses  are  not  a  proper  deduction. i"'J  On  the  other  hand, 
losses  sustained  during  the  year  may  be  deducted  although  made 
good  out  of  a  fund  which  has  been  accumulated  as  an  insurance 
reserve  by  the  taxpayer.^^o  The  Revenue  Act  of  1921  contains  a 
new  provision  permitting  the  deduction  of  a  reasonable  addition 
to  a  reserve  for  bad  debts.^^^  Amounts  set  aside  by  canners  of 
perishable  food  products  as  a  reserve  against  which  to  charge 
losses  due  to  climatic  and  other  natural  conditions  producing 
shortage  of  the  raw  products,  are  not  deductible  in  computing 
net  income.112 

Reserves  for  Cash  Discounts.  It  has  been  held  under  the  1918 
Law  that  a  corporation  keeping  its  accounts  on  an  accrual  basis 
will  not  be  permitted  to  deduct  from  gross  income  a  sum  in  an- 
ticipation of  the  amount  the  corporation  may  be  required  to  allow 
as  cash  discount  on  accounts  due  and  payable  in  the  succeeding 
year.  But  any  amounts  so  allowed  in  the  succeeding  year  before 
the  return  is  filed  may  be  deducted  from  gross  sales  for  the  pre- 
vious taxable  year.ii'^ 

Worthless  Debts.  The  Revenue  Act  of  1918  provided  that  in- 
dividuals and  corporations  might  deduct  debts  ascertained  to  be 
worthless  and  charged  off  within  the  taxable  year.i^^  The  Rev- 
enue Act  of  1921  contains  the  same  provision  and  in  addition  per- 
mits the  deduction,  in  the  discretion  of  the  Commissioner,  of  a 
reasonable  addition  to  a  reserve  for  bad  debts  and  authorizes  the 

107  Manual  for  Oil  and  Gas  Industry. 

108  O.  D.  375,  T.  B.  3-20-691. 

100  Reg.  33  Rev.,  Art.  166;  T.  D.  2161. 

110  Reg.  33,  Art.  122. 

111  Revenue  Act  of  1921,  §§214   (a)    (7)   and  234    (a)    (5). 

112  T.  B.  R.  13,  T.  B.  3-19-187. 

113  O.  D.  146,  T.  B.  4-19-228. 

114  Revenue  Act  of  1918,  §§214   (a)   7  and  234  (a)  5. 


648  FEDERAL   INCOME   TAX 

Commissioner,  when  satisfied  that  a  debt  is  recoverable  only  in 
part,  to  allow  such  debt  to  be  charged  off  in  part.""'  It  should  be 
remembered  that  the  following  discussion  is  in  the  light  of  rul- 
ings made  under  the  1918  Law  and  that  the  deduction  of  amounts 
for  bad  debts  under  the  present  law  will  be  subject  to  the  addi- 
tional provisions  above  stated.  For  the  purpose  of  deduction  as 
losses,  debts  are  divided  into  two  classes,  (a)  those  which  rep- 
resent to  the  creditor  a  return  of  capital  and  (b)  those  which  rep- 
resent unpaid  income.  The  former  may  be  deducted  regardless 
of  when  the  debt  became  due  and  payable,  but  the  latter,  such 
as  uncollected  wages,  salaries,  rents,  interest  and  similar  items 
of  taxable  income,  may  not  be  deducted,  if  the  debt  became  due 
on  or  after  March  1,  1913,  unless  the  amount  thereof  has  been 
reported  as  income ;  but  if  the  debt  became  due  and  payable  prior 
to  March  1,  1913,  it  may  be  deducted  in  any  event."''  The  losses 
which  may  be  deducted  are  losses  of  capital ;  income  on  which  the 
tax  has  been  assessed  assumes  the  status  of  capital,  and  income 
which  became  due  and  payable  before  the  incidence  of  the  tax  is 
capital  to  the  taxpayer,  although  it  may  be  received  thereafter. 
The  mere  failure  to  receive  income  does  not  warrant  a  deduction, 
as  the  omission  of  such  amounts  operates,  in  itself,  as  a  reduc- 
tion of  tax.  If  a  taxpayer  computes  his  income  upon  the  basis  of 
valuing  his  notes  or  accounts  receivable  at  their  fair  market 
value  when  received,  which  may  be  less  than  their  face  value, 
the  amount  deductible  for  bad  debts  in  any  case  is  limited  to 
such  original  valuation.  In  the  case  of  debts  existing  prior  to 
March  1,  1913,  only  their  value  on  that  date  may  be  deducted 
upon  subsequently  ascertaining  them  to  be  worthless.  An  ac- 
count merely  written  down  or  a  debt  recognized  as  worthless 
prior  to  the  beginning  of  the  taxable  year  is  not  deductible."' 
Only  the  difference  between  the  amount  received  in  distribution 
of  the  assets  of  a  bankrupt  and  the  amount  of  the  claim  may  be 
deducted  as  a  bad  debt.  The  difference  between  the  amount  re- 
ceived by  a  creditor  of  a  decedent  in  distribution  of  the  assets 
of  the  decedent's  estate  and  the  amount  of  his  claim  may  be  con- 
sidered a  worthless  debt.  A  purchaser  of  accounts  receivable 
which  can  not  be  collected  and  are  consequently  charged  off  the 
books  as  bad  debts  is  entitled  to  deduct  them,  the  amount  of  de- 
ns Revenue  Act  of  1921,  §§214  (a)  7  and  234  (a)  5. 
lie  T.  D.  2224. 
in  Reg.  45,  Art.  151. 


DEDUCTION   OF  LOSSES  649 

auction  to  be  based  upon  the  price  he  paid  for  them  and  not  upon 

their  face  value.i^^  .  •      ^    at      v, 

A  taxpayer  indorsed  the  notes  of  a  corporation  prior  to  March 
1   1913-  the  notes  became  due  prior  to  that  date,  the  corporation 
being  insolvent  at  the  time  they  fell  due  and  ever  since.    The  tax- 
payer obtained  extensions  of  the  notes  from  time  to  time  in  the 
name  of  the  corporation,  endorsed  the  new  notes  and  paid  install- 
ments of  principal  and  interest  in  1917,  1918  and  1919      At  no 
time  had  he  become  primarily  liable  on  the  notes  nor  had  he  ever 
given  any  written  agreement  to  make  such  payments,     it  was 
held  that  he  suffered  no  actual  loss  until  he  made  the  first  pay- 
ment in  liquidation  of  the  principal  and  interest  thereon.    \^'hen 
each  payment  was  made  it  created  a  debt  in  his  favor  from 
the  makers  of  the  notes,  which   debt  was  at  the   time  it  was 
created  definitely  known  to  be  worthless.    Each  additional  pay- 
ment created  an  additional  debt  and  the  taxpayer  was  allowed  to 
deduct  in  each  year  the  amount  of  his  payments  on  the  notes.   • 

A  transaction  in  which  the  majority  stockholder  of  a  corpora- 
tion   to  whom  the  corporation  was  heavily  indebted,  agreed  to 
take  as  payment  the  free  assets  of  the  company  and  to  assume 
its  liabilities  other  than  its  bonded  indebtedness  is  considered  a 
cancellation  of  the  debt  and  any  loss  sustained  by  the  majority 
stockholder  is  deductible  only  in  the  return  for  the  year  when  the 
transaction  took  place,  and  not  when  the  assets  were  disposed  of 
subsequently.    The  measure  of  the  loss  would  be  the  difference 
between  the  liabihties  assumed,  including  the  debt  to  the  ma- 
jority stockholder,  and  the  value  of  the  assets  at  the  time  re- 
ceived by  him.^-"  ,    . ,    ,  ^    u  a 
A  certain  taxpayer  was  notified  by  his  bank  that  a  note  had 
gone  to  protest  and  that  he,  as  one  of  the  indorsers,  was  liable 
for  the  payment  thereof.    In  order  to  defend  a  relative  who  had 
forged  the  indorsement,  the  taxpayer  gave  the  bank  another  note 
of  the  same  face  value.    The  taxpayer  made  arrangements  with 
his  relative  whereby  the  relative  was  to  pay  the  amount  ot  the 
note  on  the  installment  plan.     The  relative,  however,  made  no 
payments  in  the  year  1919  and  payment  could  not  be  enforced 
since  he  had  no  assets.    During  that  year  the  taxpayer  paid  the 
note  in  full  to  the  bank  and  deducted  as  a  bad  debt  for  the  year 
1919  the  difference  between  the  amount  paid  the  bank  and  the 

lis  Reg.  45,  Alt.  152. 

iw  A.  R.  R.  479,  T.  B.  38-21-1837. 

i-'o  A.  R.  R.  30,  T.  B.  9-20-772. 


650  FEDERAL  INCOME   TAX 

amount  by  which  he  had  been  reimbursed  by  his  relative.  It  has 
been  held  that  the  amount  deducted  is  allowable  since  it  repre- 
sented a  debt  due  from  the  relative  and  not  a  gift  to  him.^-^ 

Must  Be  Charged  Off  on  Books.  The  Revenue  Act  of  191S 
and  the  Revenue  Act  of  1921  both  expressly  provide  that  in  the 
case  of  both  individuals  and  corporations  worthless  debts  must 
have  been  "charged  off"  in  the  year  in  which  they  are  claimed 
as  a  deduction.!"  j^  1919,  a  corporation  purchased  notes  from 
a  merchant  and  advanced  sums  of  money  to  him  on  bills  of  sale. 
In  January,  1920,  it  developed  that  the  notes  were  forged  and  the 
bills  of  sale  were  fraudulent.  The  losses  were  charged  off  the 
books  on  March  12,  1920.  It  was  held  that  the  losses  are  deduc- 
tible as  bad  debts  rather  than  other  losses  in  the  taxable  year 
1920,  when  they  were  ascertained  to  be  worthless  and  charged 
off,  regardless  of  when  they  actually  became  worthless.^^^ 

When  Debts  May  Be  Considered  Worthless.  The  follow- 
ing discussion  will  be  subject  to  the  provision  of  the  present  law 
permitting  the  deduction  of  so  much  of  a  debt  as  is  ascertained 
to  be  worthless  when  the  Commissioner  is  satisfied  that  the  debt 
is  recoverable  only  in  part.  To  determine  whether  or  not  a  debt 
is  worthless  it  is  not  essential  that  an  unsatisfied  judgment  shall 
exist  or  a  judicial  determination  be  reached  or  that  the  bad  debt 
or  account  shall  be  proved  worthless  by  legal  proceedings.  Be- 
fore a  deduction  will  be  allowed  the  taxpayer  must,  however,  not 
only  be  satisfied  that  the  debt  or  account  is  worthless,  but  must 
be  able  to  satisfy  the  Commissioner  or  collector  that  the  accounts 
charged  off  were  definitely  determined  at  the  time  to  be  worth- 
less and  that  they  had  not  been  recognized  as  worthless  or  with- 
out value  prior  to  the  beginning  of  the  year  for  which  the  return 
is  made.i2^  Bankruptcy  may  or  may  not  be  an  indication  of  the 
worthlessness  of  a  debt,  and  actual  determination  of  worthless- 
ness  in  such  a  case  is  sometimes  possible  before  and  at  other 
times  only  when  a  settlement  in  bankruptcy  shall  have  been  had. 
Where  a  taxpayer  ascertained  a  debt  to  be  worthless  and  charged 
it  off  in  one  year,  the  mere  fact  that  bankruptcy  proceedings  in- 
stituted against  the  debtor  are  terminated  in  a  later  year  con- 
firming the  conclusion  that  the  debt  is  worthless  will  not  author- 
ize shifting  the  deduction  to  such  later  year.i^s     Where  an  in- 

121  O.  D.  934,  T.  B.  22-21-1663. 

122  Revenue  Act  of  1918,  §§  214  (a)  7  and  234  (a)  5;  Revenue  Act  of  1921, 
§§214  (a)  7  and  234   (a)   5. 

123  0.  D.  604,  T.  B.  30-20-1090. 

124  Reg.  33  Rev.,  Art.  151;  Reg.  45,  Art.  151. 

125  Reg.  45,  Art.  151. 


DEDUCTION   OF   LOSSES  651 

debtedness  is  claimed  and  contested  and  a  settlement  is  had  by 
way  of  compromise  whereby  an  amount,  less  than  the  debt 
claimed,  is  accepted  in  full  payment  and  satisfaction  of  the  debt, 
the  difference  between  the  amount  paid  and  that  claimed  is  not 
allowable  as  a  deduction  for  worthless  debts.  If  the  settlement 
in  compromise  consists  of  a  promise  to  pay  an  amount  less  than 
the  debt  claimed,  an  accord  and  satisfaction  is  established  and 
the  amount  promised  to  be  paid  forms  the  basis  of  a  new  trans- 
action. Upon  the  breach  of  this  promise  the  question  will  arise 
as  to  the  deductibility  of  the  new  amount  only.^-'^  Whenever  the 
debtor  is  legally  discharged  from  his  obligation  either  by  the  run- 
ning of  the  statute  of  limitations,  by  bankruptcy  proceedings,  by 
accord  and  satisfaction,  by  formal  release,  or  by  any  other 
method,  it  seems  that  the  creditor  may  claim  the  amount  of  loss 
sustained  as  a  deduction.  As  indicated  by  the  ruling  above,  it 
may  be  possible  under  other  conditions  to  deduct  the  amount  of 
a  debt  but  the  circumstances  must  be  such  as  to  indicate  beyond 
doubt  that  the  debt  can  not  be  collected.  Where  all  of  the  sur- 
rounding and  attendant  circumstances  indicate  that  a  debt  is 
worthless  and  uncollectible  and  that  legal  action  to  enforce  pay- 
ment would  not  in  all  probability  result  in  the  satisfaction  on 
execution  of  a  judgment,  a  showing  of  these  facts  will  be  suffi- 
cient showing  of  the  worthlessness  of  the  debt  for  purposes  of 
deduction. ^-'^  A  mere  voluntary  forgiveness  of  the  debt  would  not 
make  the  amount  thereof  an  allowable  deduction,  since  such  vol- 
untary action  on  the  part  of  the  creditor  would  be  tantamount  to 
a  gift. 

126  Reg.  33  Rev.,  Art.  8;  O.  D.  297,  T.  B.  24-19-564.  The  regulation  cited 
reversed  the  Treasury  Department's  previous  ruling  that  the  unpaid  portion 
of  a  compromised  debt  might  be  claimed  as  a  deduction. 

127  Reg.  45,  Art.  151;  Reg.  33  Rev.,  Art.  8;  U.  S.  v.  Mayer,  26  Fed.  Cas. 
No.  15,  753.  In  U.  S.  v.  Frost,  25  Fed.  Cas.  No.  15,172,  a  prosecution  for 
making  a  false  income  tax  return  for  the  year  1866,  the  court  made  the 
following  observation  regarding  the  provision  of  the  statute  permitting  the 
deduction  of  w^orthless  debts:  "The  language  is,  'ascertained  to  be  w^orth- 
less'.  By  whom  or  how?  The  law  is  silent  on  this  important  point,  and  there- 
fore there  must  be  a  discretion  given  to  the  person  making  his  returns,  and 
if  that  discretion  is  used  fairly  and  honestly  there  would  seem  to  be  no  just 
ground  of  complaint.  It  certainly  can  scarcely  be  contended  that  every 
debt  must  be  ascertained  to  be  worthless  by  a  suit  at  law,  or  in  equity,  for 
that  would  be  impracticable,  and  therefore  such  cannot  be  the  meaning  of 
the  law.  It  is  undoubtedly  very  difficult  to  lay  down  any  rule  of  universal 
application  to  this  class  of  cases,  and  yet  the  want  of  precision  in  the  law 
may  have  led  to  this  prosecution,  and  may  lead  to  others,  and,  perhaps,  on 
the  whole,  it  would  be  better  to  give,  by  law,  a  clearer  and  simpler  definition 
than  now  exists  of  the  terms  'gains,  profits  and  income'." 


652  FEDERAL   INCOME   TAX 

Where  a  taxpayer  extends  the  time  of  payment  of  a  note  he  is 
not  allowed  at  such  time  to  deduct  the  difference  between  the 
face  value  of  the  note  and  its  fair  market  value  as  a  bad  debt.  The 
debt  has  not  at  the  time  it  is  extended  been  determined  worth- 
less and  charged  off.^-"^  It  is  not  necessary,  however,  that  a  bad 
debt  be  evidenced  by  a  "closed  and  completed"  transaction.  Thus, 
where  a  company  which  had  on  deposit  a  ^um  of  money  with  a 
bank  which  failed  in  1918,  wrote  off  and  deducted  as  a  bad  debt 
one-half  this  amount  on  the  basis  of  information  from  the  re- 
ceiver that  only  one-half  such  indebtednesy  would  be  recovered 
in  liquidation,  it  has  been  held  that  this  was  a  proper  deduction 
by  the  company,  since  at  no  time  after  the  failure  of  the  bank 
was  there  any  doubt  that  a  loss  had  been  suffered  and  since  the 
company  relied  upon  the  best  information  obtainable  and  not 
upon  its  own  judgment  and  since  the  subsequent  distribution  and 
liquidation  confirmed  the  correctness  of  the  statement  of  the  re- 
ceiver.^-" Under  the  1918  Law  a  taxpayer  would  not  be  per- 
mitted a  deduction  for  a  bad  debt  even  where  in  the  year  in  which 
such  deduction  was  claimed  there  was  evidence  that  a  substantial 
part  of  the  debt  would  not  be  recovered  and  although  from  his 
knowledge  of  conditions  existing  he  was  justified  in  believing 
that  in  the  event  of  foreclosure  his  loan  would  result  in  a  loss.^""^ 
Under  the  present  law  it  would  seem  that  a  deduction  for  so 
much  of  the  debt  as  can  be  shown  to  be  worthless  would  be  de- 
ductible. It  has  been  held  that  where  the  Supreme  Court  of  a 
state  in  1919  affirmed  the  judgment  of  a  lower  court  rendered  in 
a  prior  year,  holding  that  a  bank  could  not  recover  on  certain 
notes,  the  bank  may  deduct  the  amount  of  the  loss  in  1919,  the 
final  judgment  of  the  Supreme  Court  fixing  the  time  when  the 
debt  was  ascertained  to  be  worthless. ^-'^ 

Effect  of  War  Conditions  on  Deduction  of  Debts.  Debts 
due  by  one  belligerent  state  to  the  citizens  of  another  state  are  not 
extinguishable  by  war.  Consequently,  a  taxpayer  having  an  out- 
standing claim  against  the  German  government,  dating  before 
the  war,  would  not  be  justified  in  charging  the  amount  of  the 
claim  as  a  loss  when  war  was  declared  between  the  United  States 
and  the  German  government. i"-  Where  as  a  result  of  the  Cuban 
moratorium  certain  accounts  receivable  due  from  customers  in 
Cuba  prior  to  the  close  of  1920  were  uncollectible  at  the  close  of 

t-'S  O.  D.  979,  T.  B.  30-21-1742. 
1-^9  A.  R.  R.  352,  T.  B.  52-20-1362. 

130  A.  R.  R.  365,  T.  B.  0-21-1432. 

131  O.  D.  965,  T.  B.  27-21-1713. 

132  A.  R.  M.  31,  T.  B.  9-20-771. 


DEDUCTION  OF  LOSSES  653 

that  year,  it  has  been  held  that  no  deduction  could  be  taken  there- 
for until  it  had  been  ascertained  that  the  accounts  were  worth- 
less and  charged  off  on  the  books.  There  was  at  the  end  of  1920 
no  means  of  ascertaining  what  portion  of  these  accounts  was 
good  and  what  portion  worthless.  The  fact  that  the  moratorium 
made  the  debts  uncollectible  on  their  due  dates  did  not  lead  to  the 
conclusion  that  nothing  would  ever  be  realized  on  them.^-'"' 

Deposits  in  Russian  Banks.  Bank  deposits  in  Russian 
banks  can  not  be  considered  as  worthless  for  the  purpose  of 
claiming  a  deductible  loss  in  a  return  for  the  taxable  year  1919. 
Russian  rubles  in  the  form  of  bank  deposits  were  sold  during  the 
latter  months  of  1919,  which  would  indicate  that  they  were  not 
at  that  time  worthless. ^-"'^  It  has  also  been  held  that  where  a  tax- 
payer owned  Russian  rubles  deposited  in  Russian  banks  and 
offered  these  deposits  for  sale  in  1920  but  could  find  no  market 
for  them,  no  deductible  loss  is  sustained  unless  he  can  submit 
evidence  that  the  banks,  in  which  the  deposits  in  question  were 
made,  had  lost  their  identity  as  banking  institutions  or  that  they 
had  been  taken  over  by  the  Soviet  Government  and  their  funds 
requisitioned,  confiscated  or  dissipated. i"'-''  Where,  however,  a 
taxpayer  purchased  credits  on  Russian  banks  and  it  appeared 
that  all  efforts  to  communicate  with  the  Russian  banks  had 
proved  futile,  the  New  York  bank  from  which  the  credits  were 
purchased  having  been  informed  by  the  state  department  that 
there  were  no  postal  facilities  with  Petrograd,  and  the  New  York 
bank's  Swedish  correspondent  having  been  unable  to  communi- 
cate with  the  Russian  banks  and  information  from  other  sources 
indicating  that  the  assets  of  the  Russian  banks  had  been  taken 
over  and  dissipated  by  the  Russian  Soviet  Republic,  other  infor- 
mation indicating  that  the  banks  had  been  looted  by  the  revolu- 
tionists, the  amounts  paid  for  the  credits  were  permitted  to  be 
deducted  as  a  worthless  debt  in  1918.  Even  though  a  stable  Rus- 
sian government  should  fulfill  international  obligations  and  re- 
store the  ruble  to  a  normal  parity  of  exchange,  such  action  would 
not  necessarily  affect  the  Russian  banks  against  which  the  credits 
were  issued.^-"' 

Foreclosure  of  Mortgages.  Where  mortgaged  or  pledged 
property  is  sold,  in  the  manner  prescribed  by  law  to  satisfy  the 
debt  secured,  for  less  than  the  debt,  and  the  mortgagee  or 
pledgee  at  that  time  or  thereafter  ascertains    that    the    por- 

133  0.  D.  891,  T.  B.  17-21-1594. 
i-'54  O.  D.  535,  T.  B.  23-20-986. 
135  O.  D.  923,  T.  B.  21-21-1649. 
iw  A.  R.  M.  64,  T.  B.  27-20-1041. 


654  FEDERAL  INCOME   TAX 

tion  of  the  indebtedness  remaining  unsatisfied  after  such  sale  is 
uncollectible,  and  charges  it  off,  he  may  deduct  such  amount  as 
a  bad  debt  for  the  taxable  year  in  which  it  is  ascertained  to  be 
worthless  and  charged  off.  Accrued  interest  may  be  included  as 
part  of  the  deduction  only  when  it  has  previously  been  returned 
as  income.i^^  This  ruling  modifies  the  former  rule  that  where  a 
mortgagee  bought  in  the  mortgaged  property,  the  difference  be- 
tween the  purchase  price  and  the  indebtedness  was  not  allow- 
able as  a  bad  debt.  The  determination  of  loss  in  such  case  was 
deferred  until  the  property  was  disposed  of. 

A  mortgage  is  a  security  for  a  debt  or  obligation  and  an  inci- 
dent thereto;  a  debt  or  obligation  of  some  kind  is  an  essential 
element  of  a  mortgage.^^^  ^  second  mortgage  is  a  mortgage 
without  intervening  liens  between  it  and  the  first  mortgage.^^^ 
A  creditor  whose  debt  is  secured  by  a  mortgage  has  two  remedies 
— one  in  personam  for  his  debt,  and  the  other  in  rem  to  subject 
the  mortgaged  property  to  its  payment. i^*^  Where  a  mortgage  is 
given  to  secure  the  payment  of  a  debt,  the  creditor  may  pursue 
his  remedy  either  on  the  mortgage  or  on  the  evidence  of  the  debt, 
or  on  both  concurrently.^^!  Where  the  proceeds  of  a  foreclosure 
sale  are  not  sufficient  to  satisfy  the  mortgage  debt,  the  mort- 
gagee may  thereafter  maintain  an  action  at  law  against  the 
person  liable  for  such  deficiency.!^-  Since  the  mortgagee  may 
maintain  an  action  against  the  mortgagor  for  the  amount  of  the 
debt,  it  is  not  sufficient,  in  order  to  deduct  the  amount  as  a  bad 
debt,  that  he  show  only  a  failure  of  the  security,  as  the  mort- 
gagor may  be  solvent  and  the  debt  collectible;  but  he  also  must 
show  that  legal  action  against  the  mortgagor  resulted  in  no  re- 
covery, or  that  such  action  would  in  all  probability  not  result  in 
the  satisfaction  of  execution  on  a  judgment.  If  the  debt  existed 
prior  to  March  1,  1913,  only  its  value  on  that  date  may  be  de- 
ducted upon  subsequently  ascertaining  it  to  be  worthless.^^^ 

Worthless  Securities.  Where  bonds  purchased  before 
March  1,  1913,  depreciated  in  value  between  the  date  of  purchase 
and  that  date,  and  were  in  a  later  year  ascertained  to  be  worth- 
less and  charged  off,  the  owner  is  entitled  to  a  deduction  in  that 
year  equal  to  the  value  of  the  bonds  on  March  1,  1913.     Bonds 

137  Reg.  45,  Art.  153,  as  amended  by  T.  D.  3265;  Reg.  33  Rev.,  Art.  8. 
13S  Carrol  v.  Tomlinson,  192  111.  398,  61  N.  E.  484. 

139  Appeal  of  Green,  97  Pa.  342. 

140  Silvey  v.  Axley,  118  N.  C.  959,  23  S.  E.  933. 

141  Ober  V.  Gallagher,  93  U.  S.  199. 

142  Shepherd  v.  May,  115  U.  S.  505. 

143  0.  D.  687,  T.  B.  42-20-1244. 


DEDUCTION  OF  LOSSES  655 

purchased  since  Februray  28,  1913,  when  ascertained  to  be  worth- 
less, may  be  treated  as  bad  debts  to  the  amount  actually  paid 
for  them,  but  not  exceeding  their  amortized  value  if  purchased 
at  a  premium.  Bonds  of  an  insolvent  corporation  secured  only  by 
a  mortgage  from  which  on  foreclosure  nothing  is  realized  for  the 
bondholders  are  regarded  as  ascertained  to  be  worthless  not  later 
than  the  year  of  the  foreclosure  sale,  and  no  deduction  for  a  bad 
debt  is  allowable  in  computing  a  bondholder's  income  for  a  sub- 
sequent year.  To  authorize  a  deduction  for  a  bad  debt  on  ac- 
count of  notes  held  prior  to  March  1,  1913,  their  value  on  that 
date  must  be  established. ^^^  Because  of  disturbed  political  con- 
ditions in  Russia  there  is  little  hope  that  bonds  of  the  Imperial 
Internal  Russian  4  per  cent,  loan  of  1894  will  be  redeemed.  A 
holder  of  such  bonds  which  were  purchased  in  1916,  who  was  un- 
successful in  finding  a  market  for  them  during  the  year  1919,  was 
held  to  be  entitled  to  a  deduction  from  his  gross  income  for  that 
year  to  the  extent  of  the  amount  actually  paid  for  them,  provided, 
however,  that  such  amount  was  charged  off  the  taxpayer's  ac- 
counts for  the  year  1919  and  a  corresponding  reduction  made  in 
his  surplus  account.!^'' 

Reserves  for  Bad  Debts  and  Charging  Off  Bad  Debts  in  Part 
Under  1921  Law.  The  following  rulings  were  issued  as  this  book 
was  going  to  press:  The  1921  Law  changes  the  previous 
practice  in  two  particulars — 1st,  by  recognizing  a  reserve  for 
bad  debts,  and  2nd,  allowing  a  debt  to  be  charged  off  in  part. 
Under  this  provision,  bad  debts  may  be  treated  in  either  of  two 
ways;  (1)  by  a  deduction  from  income  in  respect  of  debts  ascer- 
tained to  be  worthless  in  whole  or  in  part,  or  (2)  by  a  deduction 
from  income  of  an  addition  to  a  reserve  for  bad  debts.  For  the 
year  1921  taxpayers  may,  regardless  of  their  previous  practice, 
elect  either  of  these  two  methods  and  will  be  required  to  continue 
the  use  in  later  years  of  the  method  so  elected  unless  permission 
to  change  to  the  other  method  is  granted  by  the  Commissioner. 

Where  all  the  surrounding  and  attending  circumstances  in- 
dicate that  the  debt  is  worthless,  either  wholly  or  in  part,  the 
part  thereof  which  is  worthless  and  charged  off  or  written  down 
to  a  nominal  amount  on  the  books  of  the  taxpayer  will  be  allowed 
as  a  deduction  in  computing  net  income.  There  should  ac- 
company the  return  a  statement  showing  the  propriety  of  any 
deduction  claimed  for  bad  debts.  No  deduction  will  be  allowed 
for  the  part  of  a  debt  ascertained  to  be  worthless  and  charged 

144  Reg.  45,  Art.  154. 

145  O.  D.  748,  T.  B.  50-20-1343. 


656  FEDERAL  INCOME   TAX 

off  prior  to  January  1,  1921,  unless  and  until  the  debt  is  ascer- 
tained to  be  totally  worthless  and  is  finally  charged  off  or  is 
charged  down  to  a  nominal  amount,  or  the  loss  is  determined 
in  some  other  manner  by  a  closed  and  completed  transaction. 
Before  a  taxpayer  may  charge  off  and  deduct  a  debt  in  part, 
he  must  ascertain  and  be  able  to  demonstrate,  with  a  reason- 
able degree  of  certainty,  the  amount  thereof  which  is  uncol- 
lectible. Any  amount  subsequently  received  on  account  of  a  bad 
debt  previously  charged  off  in  whole  or  in  part,  and  allowed 
as  a  deduction  for  income  tax  purposes,  in  excess  of  the  amount 
not  charged  off,  must  be  included  in  gross  income  for  the  tax- 
able year  in  which  received.  In  determining  whether  a  debt  is 
worthless  in  whole  or  in  part  the  Commissioner  will  consider  all 
pertinent  evidence,  including  the  value  of  the  collateral,  if  any, 
securing  the  debt  and  the  financial  condition  of  the  debtor.  Par- 
tial deductions  will  be  allowed  with  respect  to  specific  debts  only. 

Taxpayers  who  have,  prior  to  1921,  maintained  reserve  ac- 
count for  bad  debts  may  deduct  a  reasonable  addition  to  such 
reserves  in  lieu  of  a  deduction  for  specific  bad  debt  items.  Tax- 
payers who  have  not  heretofore  maintained  such  reserve  ac- 
counts may  now  elect  to  do  so  and  in  such  case,  must  proceed  to 
determine  the  amount  of  the  reserve  that  should  reasonably  have 
been  set  up  as  at  December  31,  1920  (which  may  not  be  de- 
ducted in  computing  net  income),  and  in  respect  of  1921  and  sub- 
sequent years,  may  add  a  reasonable  addition  to  such  reserve 
and  deduct  the  amount  in  computing  taxable  net  income.  Where 
a  reserve  account  is  maintained,  debts  ascertained  to  be  worth- 
less in  whole  or  in  part  should  be  charged  against  the  reserve 
and  not  deducted  from  income.  What  constitutes  a  reasonable 
addition  to  a  reserve  for  bad  debts  must  be  determined  in  the 
light  of  the  facts  and  will  vary  as  between  classes  of  business 
and  with  conditions  of  business  prosperity.  A  taxpayer  using 
the  reserve  method  should  make  a  statement  in  his  return  show- 
ing the  volume  of  his  charge  sales  (or  other  business  trans- 
actions) for  the  year  and  the  percentage  of  the  reserve  to  such 
amount,  the  total  amount  of  notes  and  accounts  receivable  at 
the  beginning  and  close  of  the  taxable  year,  and  the  amount  of 
the  debts  which  have  been  ascertained  to  be  wholly  or  partially 
worthless  and  charged  against  the  reserve  account  during  the 
taxable  year. 

Where  banks  or  other  corporations  which  are  subject  to 
supervision  by  federal  authorities  (or  by  state  authorities  main- 
taining   substantially    equivalent    standards)     in    obedience    to 


DEDUCTION   OF  LOSSES  657 

the  specific  orders  or  in  accordance  with  the  general  policy  of 
such  supervisory  officers,  charge  off  debts  in  whole  or  in  part, 
such  debts  will,  in  the  absence  of  affirmative  evidence  clearly 
establishing  the  contrary,  be  presumed,  for  income  tax  pur- 
poses, to  be  worthless  or  recoverable  only  in  part,  as  the  case 
may  be. 

Accrued  interest  may  be  included  as  part  of  the  deduction  for 
bad  debts  only  when  it  has  previously  been  returned  as  income. 

A  taxpayer  (other  than  a  dealer  in  securities)  possessing 
debts  evidenced  by  bonds  or  other  similar  obligations  can  not  de- 
duct from  gross  income  any  amount  merely  on  account  of  market 
fluctuation.  Where  a  taxpayer  ascertains,  however,  that  due, 
for  instance,  to  the  financial  condition  of  the  debtor  or  condi- 
tions other  than  market  fluctuation,  he  will  recover  upon  ma- 
turity none  or  only  a  part  of  the  debt  evidenced  by  the  bonds 
or  other  similar  obligations  and  is  able  to  so  demonstrate  to 
the  satisfaction  of  the  Commissioner,  he  may  deduct  in  com- 
puting net  income  the  uncollectible  part  of  the  debt  evidenced 
by  the  bonds  or  other  similar  obligations. 

Where  mortgaged  or  pledged  property  is  lawfully  sold 
(whether  to  the  creditor  or  other  purchaser)  for  less  than  the 
amount  of  the  debt,  and  the  mortgagee  or  pledgee  ascertains  that 
the  portion  of  the  indebtedness  remaining  unsatisfied  after  such 
sale  is  wholly  or  partially  uncollectible,  and  charges  it  off,  he 
may  deduct  such  amount  as  a  bad  debt  for  the  taxable  year  in 
which  it  is  ascertained  to  be  wholly  or  partially  worthless  and 
charged  off.  Where  a  taxpayer  buys  in  mortgaged  or  pledged 
property  for  the  amount  of  the  debt,  no  deduction  will  be  allowed 
for  any  part  of  the  debt.  Gain  or  loss  is  realized  when  the 
property  bought  in  is  sold  or  disposed  of.^^'"' 

Loss  Due  to  Adverse  Judgment.  Any  amount  paid  pursuant  to 
a  judgment  or  otherwise  on  account  of  damages  for  personal  in- 
juries, patent  infringement,  or  otherwise,  is  deductible  from 
gross  income  when  the  claim  is  put  in  judgment  or  paid,  less  any 
amount  of  such  damages  as  may  have  been  compensated  for  by 
insurance  or  otherwise. ^-i'''  Where  a  taxpayer  sold  a  farm  and  the 
purchaser  later  sued  him  for  damages  alleging  misrepresenta- 
tions, and  judgment  was  given  for  the  plaintiff  and  paid  by  the 
taxpayer  in  1919,  it  has  been  held  that  the  amount  paid  as  dam- 
ages may  be  deducted  in  1919  since  it  appeared  that  the  damages 

145a  T.  D.  3262. 

i^f-Reg.  45,  Art.  111.  See  Chapter  33  for  a  further  discussion  of  this 
subject. 


658  FEDERAL  INCOME  TAX 

paid  grew  out  of  a  sale  made  in  the  course  of  the  taxpayer's  regu- 
lar business. 14^  In  a  case  where  a  corporation  was  sued  for  in- 
fringing a  trade  name  covering  a  period  ending  in  1912,  and  judg- 
ment was  obtained  against  it  in  1916,  the  treasury  department 
held  that  the  amount  of  this  judgment  should  be  prorated  over  the 
period  ending  in  1912  according  to  the  income  of  each  year.  The 
part  found  by  this  method  to  be  applicable  to  the  income  of  the 
corporation  for  the  period  of  1909  to  1912  would  be  referable  to 
those  years,  but  no  part  of  this  sum  would  be  deductible  as  a  loss 
in  the  return  of  income  for  1916.  The  same  corporation 
also  paid,  in  1916,  an  additional  sum,  as  consideration 
for  dismissal  of  a  pending  suit  for  interest  on  the  above 
judgment  from  the  date  of  the  decision  of  the  court  to  the  date 
of  payment  and  for  the  unrestrained  use  of  the  trade  name  in 
question.  It  was  held  by  the  treasury  department  that  if  this 
amount  could  be  segregated  between  interest  and  use,  it  might 
be  prorated  the  same  as  in  the  other  case,  for  the  period  subse- 
quent to  1912,  and  such  part  thereof  as  would  be  found  applicable 
to  the  1916  income  would  be  deductible  under  the  heading  of  busi- 
ness expense  and  interest  respectively.  If  no  segregation  could 
be  made  the  entire  amount  might  be  treated  as  business  ex- 
pense.148  The  language  of  the  present  and  1918  Laws  differ 
from  that  of  preceding  laws  in  that  they  permit  the  deduction 
of  losses  sustained  during  the  taxable  year,  whether  charged  off 
or  not,  and  seems  to  imply  that  the  loss  shall  be  deducted  from 
the  net  income  of  the  year  in  which  it  was  sustained  notwith- 
standing the  ascertainment  thereof  through  an  adverse  judg- 
ment in  a  subsequent  year,  unless  the  deduction  thereof  in  an- 
other year  will  more  clearly  reflect  income.i^^  If  on  suit  for 
damages  the  amount  recovered  is  less  than  the  damage  sus- 
tained or  less  than  an  amount  necessary  to  make  good  the  dam- 
age, the  difference  between  the  actual  amount  of  damage  sus- 
tained and  the  amount  recovered  will  be  deductible  as  a  loss  by 
the  judgment  creditor  or  prevailing  party .i'^'^ 

Recoveries  on  Losses.  All  the  statutory  provisions  regarding 
the  deduction  of  losses  limit  the  deductible  losses  to  those  "not 
compensated  for  by  insurance  or  otherwise''.^^!     Where  a  loss 

147  0.  D.  978,  T.  B.  29-21-1734. 

148  Letter  from  treasury  department  dated  February  9,  1917;  L  T.  S. 
1918,  If  1427.  '        '] 

149  See  Revenue  Act  of  1918,  §§  214  (a)  4,  5,  6,  and  234  (a)  4. 

150  Reg.  33  Rev.,  Art.  94. 

151  Revenue  Act  of  1921,  §§214  (a)  4,  5,  6  and  234  (a)  4;  Revenue  Act 
of  1918,  §§  214  (a)  4,  5,  6  and  234  (a)  4.    See  also  Chapter  33. 


DEDUCTION  OF  LOSSES  659 

occurs  in  one  taxable  period,  and  compensation  therefor,  or  re- 
covery thereon,  in  whole  or  in  part,  occurs  in  a  subsequent  tax- 
able period  the  question  arises  whether  the  amount  of  the  com- 
pensation or  recovery  is  taxable  as  income  in  the  year  received  or 
is  to  be  applied  in  reduction  of  the  original  loss  through  the  me- 
dium of  amended  returns.  The  rulings  on  this  point  under  the 
1918  Law  are  indicated  in  the  following  paragraphs. 

EMBEZZLEMENTS  RECOVERED.  A  loss  incurred  by  a  corporation 
through  embezzlement  is  an  allowable  deduction  from  gross  m- 
come  for  the  year  in  which  the  embezzlement  occurred.  Where 
the  embezzlement  is  not  discovered  in  the  taxable  year  but  is 
later  discovered  and  admitted  by  the  embezzler,  a  part  of  the 
money  being  promptly  recovered,  the  amount  so  recovered  tends 
to  diminish  the  amount  of  allowable  deductions  on  account  of  the 
embezzlement  for  the  year  in  which  the  embezzlement  occurred, 
and  is  ordinarily  not  returnable  as  income  in  the  year  when  re- 
ceived.i5-  If  fidelity  insurance  is  recovered,  it  should  be  treated 
as  indicated  in  the  next  paragraph. 

INSURANCE  RECEIVED  IN  SUBSEQUENT  YEAR.  Where  embezzle- 
ment by  a  bonded  employee  occurs,  there  is  no  loss  as  to  the 
amount  of  insurance  recoverable  even  though  it  is  not  received 
in  the  same  taxable  period.  The  claim  against  the  bonding  com- 
pany is  considered  the  equivalent  of  cash.^^^^  When  an  insured 
loss  occurs  in  one  taxable  year  and  the  insurance  is  not  recovered 
during  that  year  the  taxpayer  should  compute  his  loss  by  de- 
ducting from  the  total  loss  the  estimated  amount  of  the  recov- 
erable insurance.  The  loss  so  determined  should  be  deducted 
from  the  taxpayer's  gross  income  of  the  year  in  which  the  loss 

isi"  O   845   T   B.  6-19-279,  modifying  Solicitor's  memorandum  698;  U.S.  v. 
Cleveland    Cinn.,  Chicago  &  St.  Louis  Ry.  Co.,   U.  S.  Dist    Ct.,  So.  Dist. 
OhTo   Feb'ruary  23,  1916  (not  reported).   In  the  last  --tioned  case  pr..-^to 
1909   covering   a  period   of  several  years,  the  treasurer  of  the   defendant 
rway  company  had  embezzled  a  large  sum  of  money,  but  the  embezzle- 
::e;t  Ls  not  dlcovered  until  the  year   1909.     The   defendant  c  auned   a 
deduction  of  this  amount  from  its  gross  mcome  under  the  Act  of  August 
5    1909,  which,  like  the  present  statute,  limited  the  deductions  on  account  of 
losses  to  those  "actually  sustained  during  the  year."    The  court  said:      ihe 
Zeot  the  discovery  of  a  loss  bears  no  relation  to  the  date  the  Joss  wa 
sustained.     The  loss  was  sustained  when  the  theft  occurred,  although  the 
defendant  did  not  know  at  the  time  of  the  depletion  of  its  assets     As  each 
embezzlement  occurred,  the  defendant  was  poorer  to  the  extent  of  it.     It 
^hen  sustained  a  loss.     One  of  the  definitions  of  'sustamed'  -    und-go 
As  each  embezzlement  occurred,  the  defendant  underwent  the  loss  of  that 
much  money.    It  is  clear  that  the  defendant  is  not  entitled  co  the  deduction 
claimed."     See,  however,  T.  D.  3261  under  the  1921  Law. 
153  0.  845,  T.  B.  6-19-279;  0.  D.  165,  T.  B.  6-19-273. 


660  FEDERAL   INCOME   TAX 

was  sustained.  If  subsequent  events  demonstrate  that  this  esti- 
mate was  substantially  incorrect,  an  amended  return  should  be 
filed  correcting  the  mi s take. ^"'-^ 

Net  Losses  Under  the  1918  Law.  The  Revenue  Act  of  1918 
contained  a  new  provision  for  the  allowance  of  certain  "net 
losses."  When  used  in  connection  with  this  provision  of  the  1918 
Law,  the  term  "net  loss"  referred  only  to  net  losses  resulting 
from  either  (1)  the  operation  of  any  bushiess  regularly  carried 
on  by  the  taxpayer,  or  (2)  the  bona  fide  sale  by  the  taxpayer  of 
plant,  buildings,  machinery,  equipment  or  other  facilities,  con- 
structed, installed  or  acquired  by  the  taxpayer  on  or  after  April 
6,  1917,  for  the  production  of  articles  contributing  to  the  prose- 
cution of  the  recent  war ;  and  when  so  resulting  meant  the  excess 
of  the  deductions  allowed  by  law  (excluding  in  the  case  of 
corporations  amounts  received  as  dividends  from  a  corporation 
taxable  upon  its  net  income,  and  amounts  received  as  dividends 
from  a  personal  service  corporation  out  of  earnings  or  profits 
upon  which  income  tax  had  been  imposed)  over  the  sum  of  the 
gross  income  plus  any  interest  received  free  from  income  or 
excess-profits  taxes.  The  amount  of  net  loss  claimed  must  have 
represented  an  actual  net  loss  over  and  above  all  income,  including 
tax-free  income.  Such  losses  were  allowable  only  in  respect  of 
a  taxpayer  having  a  taxable  year  beginning  after  October  31, 
1918,  and  ending  prior  to  January  1,  1920,  and  after  one  claim 
had  been  allowed  no  further  claim  would  be  considered.  It  was 
further  provided  that  the  benefit  of  the  provisions  respecting  the 
allowance  of  net  losses  might  be  allowed  to  the  members  of  a 
partnership  and  the  beneficiaries  of  an  estate  or  trust  under  reg- 
ulations prescribed  by  the  Commissioner  with  the  approval  of 
the  secretary. I-"'-"' 

A  corporation  whose  taxable  year  was  not  included  in  the 
period  between  October  31,  1918,  and  January  1,  1920,  was  no! 

154  T.  B.  R.  55,  T.  B.  18-19-482. 

155  Revenue  Act  of  1918,  204;  Reg.  45,  Art.  1601.  The  following  state- 
ment contained  in  the  Senate  Committee  report  upon  the  Revenue  Act  of 
1918,  throws  additional  light  upon  §  204  of  the  statute  providing  :-or  the 
deduction  of  net  losses:  "One  of  the  most  important  provisions  inserted  by 
the  committee  is  quite  new  to  our  tax  laws.  At  the  present  time  no  recog- 
nition is  given  to  net  losses;  that  is,  if  in  any  year  the  losses  and  expenses 
of  a  taxpayer  exceed  his  gross  income  the  excess  (or  in  other  words,  the 
net  loss)  can  not  be  carried  over  into  the  next  year.  For  purposes  of  tax- 
ation the  settlement  must  be  made  upon  the  basis  of  each  year's  business  by 
itself.  The  chief  merit  of  the  present  plan  is  its  simplicity  of  administration. 
But  it  does  not  adequately  recognize  the  exigencies  of  business,  and,  under 
our  present  high  rates  of  taxation,  may  often  result  in  grave  injustice." 


DEDUCTION   OF  LOSSES  661 

entitled  to  the  relief  afforded  by  the  1918  Law  net  loss  provision. 
Consequently  a  corporation  doing  business  on  a  fiscal-year  basis 
might  not  allocate  its  net  loss  and  deduct  the  amount  appor- 
tioned to  that  part  of  its  fiscal  year  falhng  within  the  period 
October  31,  1918,  to  January  1,  1920. ^•"''■'  A  corporation  which  had 
previously  operated  as  a  partnership  incorporated  on  June  30, 
1919.  The  accounting  period  of  the  partnership,  as  well  as  that  of 
the  corporation,  was  a  calendar  year.  During  the  calendar  year 
1918  the  partnership  earned  a  net  income,  and  during  the  period 
from  January  1  to  June  29,  1919,  it  suffered  a  net  operating  loss. 
The  corporation  also  suffered  a  net  operating  loss  during  the 
period  from  June  30  to  December  31,  1919.  It  was  held  that  since 
neither  the  net  operating  loss  sustained  by  the  partnership  nor 
the  net  operating  loss  suffered  by  the  corporation  was  a  loss  for 
a  full  taxable  year,  neither  organization  was  entitled  to  deduct 
the  amount  of  its  net  loss  from  the  net  income  for  either  the  pre- 
ceding or  succeeding  taxable  year.^"''  If  a  taxpayer  changed  his 
accounting  period  in  such  manner  that  the  period  from  the  close 
of  his  previous  taxable  year  to  the  close  of  his  newly  established 
taxable  year  fell  between  October  31,  191S,  and  January  1,  1920, 
and  he  sustained  a  net  loss  during  such  fractional  year  period,  he 
was  not  entitled  to  the  relief  provided  by  the  net  loss  provision 
of  the  Revenue  Act  of  1918,  since  the  net  loss  sustained  was  not 
for  a  full  taxable  year  as  provided  by  the  Act.^''''  A  company 
which  earned  a  large  income  during  the  fiscal  year  ending  Sep- 
tember 30,  1918,  and  which  suffered  a  net  loss  during  the  year 
ending  September  30,  1919,  was  not  permitted  to  change  its  ac- 
counting period  for  1918  to  the  calendar  year  basis  so  as  to  be 
allowed  to  deduct  the  above  net  loss  from  taxable  income  for  the 
calendar  year  1918.  The  accounting  period  ending  September  30, 
1918,  for  which  the  large  tax  liability  had  accrued  and  the 
method  of  accounting  employed  during  that  period  were  accom- 
plished facts  which  could  not  be  changed  by  the  Commissioner.'"''' 
Claim  for  Allowance  of  Net  Loss.  A  taxpayer  having  such 
a  net  loss  might  file  a  claim  on  form  46  with  his  return  of  in- 

i-'*iO.  D.  511,  T.  B.  21-20-947. 

I-"'"  O.  D.  855,  T.  B.  13-21-1529.  If,  however,  the  organization  is  qualified 
and  elects  to  take  advantage  of  the  provisions  of  section  330  of  the  Revenue 
Act  of  1918  and  article  933  of  Regulations  45,  it  is  then  entitled  to  seek 
relief  under  the  "net  loss"  provision  of  the  statute  by  applying  the  total 
net  operating  loss  sustained  during  the  entire  year  1919  against  the  net 
income  of  the  year  1918  and  applying  the  excess,  if  any,  of  the  1919  loss 
over  1918  net  income  against  the  net  income  of  the  year  1920. 

^■>x  O.  D.  445,  T.  B.  15-20-841. 

I't'  T.  D.  3044,  T.  B.  30-20-1087. 


662  FEDERAL   INCOME   TAX 

come  for  the  taxable  year  1919.  Such  claim  was  required  to 
contain  a  concise  statement  setting  forth  the  amount  of  the  loss 
sustained,  in  accordance  with  the  accompanying  return,  the  na- 
ture of  the  loss,  the  amount  of  the  taxpayer's  net  income  for  the 
taxable  year  1918,  the  taxes  paid  by  him  with  respect  thereto, 
and  all  pertinent  facts  necessary  to  enable  the  Commissioner  to 
determine  the  allowability  of  the  claim. i^*^ 

Allowance  of  Net  Loss.  The  amount  allowed  by  the  Com- 
missioner in  respect  of  any  such  claim  was  deducted  from  the  net 
income  for  the  taxable  year  1918  and  the  income  and  the  war- 
profits  and  excess-profits  taxes,  if  any,  for  such  year  were  re- 
computed accordingly.  Any  amount  found  to  be  due  him  was 
credited  or  refunded  to  the  taxpayer.  In  any  case  in  which  it 
was  found  by  the  Commissioner  that  such  net  loss  was  in  excess 
of  the  net  income  of  such  preceding  taxable  year,  the  taxpayer 
might  carry  forward  the  amount  of  such  excess  and  claim  it  as  a 
deduction  in  computing  net  income  for  the  succeeding  taxable 
year.i"!  If  a  taxpayer  suffered  a  net  loss  for  any  taxable  year 
beginning  after  October  31,  1918,  and  ending  prior  to  January  1, 
1920,  and  had  no  net  income  for  the  preceding  taxable  year,  the 
entire  amount  of  the  loss  was  deductible  in  computing  net  income 
for  the  succeeding  taxable  year.^'J-  There  was  no  provision  in 
the  law  whereby  income  received  in  a  year  subsequent  to  1920 
might  be  reduced  on  account  of  a  loss  sustained  for  any  taxable 
year  beginning  after  October  31,  1918,  and  ending  prior  to 
January  1,  1920.i«3 

Net  Losses  Under  the  1921  Law.  The  1921  Law  has  extended 
the  limited  relief,  afforded  by  the  1918  Law,  to  taxpayers  having 
net  losses  in  any  taxable  year  beginning  after  December  30, 
1920.  The  term  "net  loss"  when  used  in  this  connection  means 
only  net  losses  resulting  from  the  operation  of  any  trade  or 
business  regularly  carried  on  by  the  taxpayer  (including  losses 
sustained  from  the  sale  or  other  disposition  of  real  estate,  ma- 
chinery, and  other  capital  assets,  used  in  the  conduct  of  such 
trade  or  business),  and  when  so  resulting  means  the  excess  of 
the  deductions  allowed  by  the  law  over  the  sum  of  the  follow- 
ing: (1)  the  gross  income  of  the  taxpayer  for  the  taxable 
year,  (2)  the  amount  by  which  the  interest  received  free  from 
income  tax  exceeds  so  much  of  the  interest  paid  or  accrued 

160  Reg.  45,  Art.  1602. 

161  Reg.  45,  Art.  1603. 

162  0.  D.  431,  T.  B.  14-20-823. 

163  O.  D.  860,  T.  B.  14-21-1539. 


DEDUCTION   OF  LOSSES  663 

within  the  taxable  year  on  indebtedness  as  is  not  allowed  to  be 
deducted  from  gross  income,  (3)  the  amount  by  which  the 
deductible  losses  not  sustained  in  such  trade  or  business  exceed 
the  taxable  gains  or  profits  not  derived  from  such  trade  or 
business,  (4)  amounts  received  as  dividends  and  allowed  as  a 
deduction,  and  (5)  so  much  of  the  depletion  deduction  allowed 
with  respect  to  any  mine,  oil  or  gas  well  as  is  based  upon  dis- 
covery value  in  lieu  of  cost. 

If  for  any  taxable  year  beginning  after  December  31,  1920, 
it  appears  upon  the  production  of  evidence  satisfactory  to  the 
Commissioner  that  any  taxpayer  has  sustained  a  net  loss,  the 
ii mount  thereof  will  be  deducted  from  the  net  income  of  the 
taxpayer  for  the  succeeding  taxable  year;  and  if  such  net  loss 
is  in  excess  of  the  net  income  for  such  succeeding  taxable  year, 
the  amount  of  such  excess  will  be  allowed  as  a  deduction  in  com- 
puting the  net  income  for  the  next  succeeding  taxable  year ;  the 
deduction  in  all  cases  to  be  made  under  regulations  prescribed 
by  the  Commissioner  with  the  approval  of  the  Secretary. 

The  benefit  of  the  net  loss  provision  will  be  allowed  to  the 
members  of  a  partnership  and  the  beneficiaries  of  an  estate  or 
trust,  and  to  insurance  companies  (other  than  mutual  insurance 
companies)  under  regulations  prescribed  by  the  Commissioner 
with  the  approval  of  the  Secretary. 

If  it  appears,  upon  the  production  of  evidence  satisfactory  to 
the  Commissioner,  that  a  taxpayer  having  a  fiscal  year  beginning 
in  1920  and  ending  in  1921  has  sustained  a  net  loss  during  such 
fiscal  year,  such  taxpayer  will  be  entitled  to  the  benefits  of  the 
net  loss  provision  in  respect  to  the  same  proportion  of  such 
net  loss  which  the  portion  of  such  fiscal  year  falling  within  the 
calendar  year  1921  is  of  the  entire  fiscal  year. 

The  following  rulings  were  made  under  the  1918  Law  but 
would  seem  to  be  applicable  under  the  present  law.  A  net  oper- 
ating business  loss  in  1919  occasioned  by  floods  is  a  net  loss.^'"'^ 
A  1918  loss  due  to  the  failure  and  liquidation  of  two  corpora- 
tions in  which  an  individual  owns  stock  is  not  a  net  loss,  but  is 
merely  a  loss  on  securities. i"''  An  individual  who  sustained  a  net 
loss  for  a  taxable  year  beginning  after  October  31,  1918,  and 
ending  prior  to  January  1,  1920,  with  respect  to  his  share  of 
partnership  earnings  is  not  entitled  to  the  relief  provided  by  the 
net  loss  provision  of  the  Revenue  Act  of  1918  unless  he  has 

i«i^  O.  D.  367,  T.  B.  3-20-681. 
165  O.  D.  380,  T.  B.  4-20-703. 


664  FEDERAL   INCOME   TAX 

sustained  a  net  loss  for  such  taxable  year  with  respect  to  his 
entire  income  derived  from  all  sources  during  that  year.!*"''^ 

Special  Provision  of  1918  Law  Concerning  Losses  in  Inventory 
and  from  Rebates.  The  Revenue  Act  of  1918  contained  a  new 
provision  regarding  losses  sustained  after  the  close  of  the  tax- 
able year  1918.  This  relief  provision  applied  only  to  certain 
losses,  which,  while  actually  sustained  after  1918,  were  at- 
tributable to  that  year.  The  provision  was  inserted  in  the  1918 
Law  in  the  belief  that  prices  would  fall  rapidly  after  1918.  It 
was  provided  that  a  taxpayer  might  file,  at  the  time  of  filing 
return  for  the  taxable  year  1918^  a  claim  in  abatement  based  on 
the  fact  that  he  had  sustained  a  substantial  loss  (whether  or 
not  actually  realized  by  sale  or  other  disposition)  resulting  from 
any  material  reduction  (not  due  to  temporary  fluctuation)  of 
the  value  of  the  inventory  for  such  taxable  year,  or  from  the 
actual  payment  after  the  close  of  such  taxable  year  of  rebates  in 
pursuance  of  contracts  entered  into  during  such  year  upon  sales 
made  during  such  year.  In  such  case  payment  of  the  amount 
of  the  tax  covered  by  the  claim  was  not  required  until  the  claim 
was  decided,  but  the  taxpayer  was  required  to  accompany  his 
claim  with  a  bond  in  double  the  amount  of  the  tax  covered  by 
the  claim,  with  sureties  satisfactory  to  the  Commissioner,  condi- 
tioned for  the  payment  of  any  part  of  such  tax  found  to  be  due, 
with  interest.  If  any  part  of  such  claim  was  disallowed,  the 
remainder  of  the  tax  due,  on  notice  and  demand  by  the  col- 
lector, was  required  to  be  paid  by  the  taxpayer  with  interest  at 
the  rate  of  one  per  centum  per  month  from  the  time  the  tax 
would  have  been  due  had  no  such  claim  been  filed.  If  it  was 
shown  to  the  satisfaction  of  the  Commissioner  that  such  sub- 
stantial loss  had  been  sustained,  then  in  computing  the  income 
tax  the  amount  of  such  loss  was  deducted  from  the  net  income. 
Where  no  such  claim  was  filed,  but  it  was  shown  to  the  satisfac- 
tion of  the  Commissioner  that  during  the  taxable  year  1919  the 
taxpayer  had  sustained  a  substantial  loss  of  the  character  above 
described,  the  amount  of  such  loss  was  deducted  from  the  net 
income  for  the  taxable  year  1918  and  the  income  tax  imposed 
for  such  year  was  redetermined  accordingly.  Any  amount 
found  to  be  due  to  the  taxpayer  upon  the  basis  of  such  redeter- 
mination was  credited  or  refunded  to  the  taxpayer.^''"  These 
deductions  might  be  secured  by  two  methods,  either  by  a  claim 

iWi  O.  D.  430,  T.  B.  14-20-822. 

Km  Revenue  Act  of  1918,  §§214  (a)   12,  234  (a)   14. 


DEDUCTION   OF  LOSSES  665 

in  abatement  or  by  a  claim  for  refund,  and  could  not  be  entered 
upon  the  regular  return.'''^ 

In  a  case  in  which  a  corporation,  engaged  in  manufacturing 
patent  flours,  sold  during  1918  large  (juantities  of  Hour  manu- 
factured from  substitutes  in  accordance  with  regulations  issued 
by  the  food  administration  and  abolished  upon  the  cessation  of 
hostilities,  which  flour  the  corporation  took  back  in  the  first 
six  months  of  1919  and  resold,  the  treasury  department  has  held 
that  the  difference  between  the  amount  of  returned  flour  and 
the  amount  thereof  resold  and  the  inventoiy  thereof  remaining 
could  not  be  deducted  as  a  loss  in  inventory  or  from  rebates. 
It  did  not  appear  in  this  case  whether  there  was  an  actual  loss 
sustained  by  this  taxpayer  through  the  resale  of  these  goods 
below  cost  of  manufacture,  or  whether  the  so-called  "loss"  was 
merely  a  reduction  in  the  amount  of  profit  that  would  have  been 
made  if  the  goods  had  not  been  taken  back  from  the  jobbing 
houses;  but  this  had  no  material  effect  upon  the  case.  Whether 
or  not  the  taxpayer  accepted  the  return  of  such  goods  in  1919 
appears  to  have  been  a  matter  entirely  at  its  own  option  and  if, 
as  a  matter  of  business  prudence  and  expediency,  it  decided  so 
to  do,  the  resulting  loss,  if  any,  was  due  to  its  owm  act  and  by  its 
own  election  in  1919,  and  w^as  held  not  to  be  such  a  loss  as  can 
be  properly  charged,  under  the  law,  against  the  profits  of  the 
year  1918.i'"» 

Loss  IN  Inventory.  Inventory  losses  were  allowable  either 
(a)  where  goods  included  in  an  inventoiy  at  the  end  of  the 
taxable  year  1918  were  sold  at  a  loss  during  the  su'cceeding  tax- 
able year,  or  (b)  where  such  goods  remained  unsold  throughout 
the  taxable  year  1919  and  at  its  close  had  a  then  market  value 
(not  resulting  from  a  temporary  fluctuation)  materially  below 
the  value  at  w^hich  they  were  inventoried  at  the  end  of  the  tax- 
able year  1918.  No  deduction  was  allowable  for  losses  of  an- 
ticipated profits  or  for  losses  not  substantial  in  amount,  nor  for 
physical  damage  or  obsolescence  occurring  in  the  taxable  year 
1919.  If,  for  example,  the  inventory  contained  discontinued  off 
colors  in  broken  lots  and  the  salable  colors  had  been  disposed  of 
and  the  stock  broken  before  the  close  of  the  taxable  year  1918, 
the  element  of  obsolescence  if  definitely  determined  should  have 


Ids  Reg.  45,  Art.  261;  Telegram  from  Treasury  Department  dated  March 
3,  1918;  I.  T.  S.  1919,  ^  3276.  Copies  of  inventories  were  not  required  to 
be  filed  with  the  return  but  taxpayers  should  retain  for  a  period  of  not 
less  than  five  years  all  original  inventory  sheets  and  all  papers  which  would 
have  any  bearing  on  a  claim  for  loss  in  inventories  (including  sales  slips). 
(I.  T.  S.  1919,  ^3358). 


666  FEDERAL  INCOME  TAX 

been  taken  into  account  in  both  the  inventory  made  at  the  close 
of  the  taxable  year  1918  and  that  made  at  the  close  of  the  tax- 
able year  1919.  If  it  was  impossible  to  get  the  market  value 
for  such  colors  in  broken  stocks,  the  taxpayer  would  be  required 
to  await  the  sale  of  such  broken  stocks  in  order  to  determine  the 
loss  involved;  but  in  most  instances  a  reasonable  and  fair  esti- 
mate of  the  market  value  could  be  made.  If  the  salable  colors 
were  disposed  of  after  the  close  of  the  taxable  year  1918,  the 
accompanying  obsolescence  in  the  remaining  stock  took  place 
in  the  year  1919  and  the  deduction  should  have  been  taken  not  as 
a  loss  in  inventory  but  as  obsolescence  occurring  in  the  taxable 
year  1919.^™  In  determining  whether  goods  included  in  an 
inventory  at  the  end  of  the  taxable  year  1918  had  been  sold 
during  the  succeeding  taxable  year,  and  whether  loss  had  re- 
sulted therefrom,  sales  of  goods  made  in  the  taxable  year  1919 
were  deemed  to  have  been  made  from  the  inventoried  stock  of 
1918  until  such  inventoried  stock  was  exhausted.^'^i  All  goods 
where  title  had  actually  passed  to  the  taxpayer  were  required  to 
be  included  in  the  inventory,  and  as  a  result  thereof  were  eligible 
for  consideration  in  any  claim  in  abatement.  It  was  necessary 
that  title  should  have  passed  to  the  taxpayer  in  1918,  and  goods 
merely  ordered  for  future  delivery  and  for  which  no  transfer  of 
title  had  been  effected,  were  excluded.  Where  a  taxpayer's  fiscal 
year  ended  on  November  30,  1919,  and  inventory  was  taken  on 
that  date,  the  claim  in  abatement  could  only  apply  to  goods  which 
were  the  property  of  the  taxpayer  up  to  that  date,  but  no  claim 
could  be  made  on  any  materials  which  had  become  the  property 
of  the  taxpayer  between  December  1  and  31,  inclusive,  of  that 
year.i"-  Where  a  claim  for  inventory  loss  was  finally  allowed, 
the  net  income  for  1919 — as  established  by  usual  accounting 
methods — would  be  correspondingly  higher  as  reported  in  the 
return  for  the  taxable  year  1919.  In  other  words,  the  item  of 
loss  which  would  normally  find  its  way  into  1919  operating  ac- 
counts was  thrown  back  against  1918  income.  It  was  recom- 
mended that  the  accounting  records  of  the  taxpayer  be  not 
changed  but  that  any  adjustment  of  inventories  be  recorded  in 
distinct  accounts  supported  by  adequate  detailed  schedules.     In 

109  A.  R.  R.  155,  T.  B.  26-20-1028. 

170  I.  T.  S.  1919,  H  3363.  Much  of  the  text  of  this  and  the  following  para- 
graphs on  losses  in  inventory  is  based  upon  the  published  answers  of  the 
Advisory  Board  to  a  series  of  questions  submitted  by  the  Southern  Whole- 
sale Drygoods  Association  in  May,  1919. 

171  Reg.  45,  Art.  263. 

172  1.  T.  S.  1919,  M3360,  3361;  see  Reg.  45,  Art.  1581. 


DEDUCTION   OF  LOSSES  667 

arriving  at  the  net  operating  profits  for  any  year,  the  income, 
excess  and  war-profits  taxes  to  be  paid  on  such  profits  were  not 
taken  into  consideration.  Such  taxes,  therefore,  were  theoretic- 
ally paid  out  of  surplus  for  the  year.  If  at  a  subsequent  date 
any  of  such  taxes  were  refunded,  they  should  not  have  been 
recorded  in  the  operating  accounts,  but  should  have  been  credited 
directly  to  surplus. i""' 

The  above  provision  of  the  1918  Law  permitting  taxpayers  to 
file  at  the  time  of  making  returns  for  the  taxable  year  1918, 
claims  in  abatement  based  on  losses  in  inyentoiy  due  to  material 
reduction  in  the  value  of  the  inventory  only  operated  to  relieve 
the  taxpayer  from  payment  of  tax  at  that  time.  The  fact  that 
when  the  return  for-  1918  was  filed  the  value  of  the  inventory 
might  be  substantially  lower  than  at  the  close  of  1918  was  not 
conclusive  that  his  claim  in  abatement  would  be  allowed.  The 
inventoi*y  loss  contemplated  was  for  the  full  taxable  year  1919. 
The  fractional  part  of  the  year  (January  1,  1918,  to  the  time  of 
filing  the  return  for  1918)  did  not  determine  a  gain  or  loss  for 
the  period  of  taxation.  The  question  whether  a  loss  in  inventory 
which  could  be  thrown  back  into  1918  had  been  sustained  could 
not  be  finally  determined  until  the  close  of  1919. ^"^ 

A  company  which  earned  a  large  income  during  the  fiscal 
year  ending  September  30,  1918,  and  which  suffered  a  net  loss 
during  the  year  ending  September  30,  1919,  because  of  certain 
non-cancellable  contracts  for  the  future  delivery  of  materials 
which  were  not  completed  for  delivery  prior  to  the  termina- 
tion of  the  fiscal  year  ending  September  30,  1918,  the  value 
of  this  material  having  been  greatly  decreased  as  a  result 
of  the  signing  of  the  armistice  on  November  11,  1918,  has  been 
held  not  to  be  entitled  to  a  deduction  for  inventor^'  loss.  The 
company  did  not  own  the  material  on  September  30,  1918,  but 
had  only  a  contract  for  its  purchase.  Such  material  was  not 
properly  included  in  its  inventory  for  such  taxable  period  nor 
was  the  amount  due  under  the  contract  for  the  material  entered 
on  the  books  during  such  period  as  a  liability.  In  other  words, 
the  loss  suflFered  was  not  a  loss  "resulting  from  any  material 
reduction  *  *  *  of  the  value  of  the  inventory  for  such 
taxable  year."  The  phrase  "substantial  loss  of  the  character 
above  described"  does  not  enlarge  the  definition  of  inventory 
losses  contained  in  the  earlier  part  of  the  subdivision  of  the 
statute  authorizing  the  deduction  of  such  losses. i"''     Goods  or- 

173  I,  T.  S.  1919,  ^  3369. 

1"4  A.  R.  R.  487,  T.  B.  18-21-1609. 

i"5  T.  D.  3044,  T.  B.  30-20-1087. 


668  FEDERAL   INCOME   TAX 

dered  in  1918  and  delivered  in  1919,  where  title  had  not  passed 
until  subsequent  to  the  close  of  the  taxable  year  1918,  could  not 
be  included  in  the  1918  inventory,  and  any  loss  realized  upon 
such  transactions  were  losses  of  the  taxable  year  1919. i^'' 

An  inventory  loss  could  not  be  proven  by  evidence  showing 
that  a  loss  had  been  sustained  in  respect  of  a  part  of  the  in- 
ventory, without  showing  that  the  amount  of  the  loss  for  which 
the  claim  was  filed  had  not  been  offset  by  profits  made  on  the 
remainder  of  the  inventory.  The  term  ''temporary  fluctuation," 
means  a  fluctuation  in  prices,  which  does  not  develop  into  a 
steady  settled  market.^'^ 

In  fixing  the  cost  of  the  manufactured  articles  inventoried, 
all  of  the  costs  of  manufacture  applicable  to  the  particular 
article  might  be  taken  into  consideration,  but  no  claim  would 
be  allowed  for  speculative  or  anticipated  profits.  No  claim 
should  have  been  made  for  the  loss  of  an  anticipated  profit  on 
labor  or  material  used  in  producing  the  articles. ^''^ 

An  established  loss  through  reduction  after  the  close  of  the 
taxable  year  1918  in  the  value  of  liquor  inventoried  at  the  close 
of  that  year  and  remaining  unsold  at  the  close  of  the  taxable 
year  1919  constituted  an  allowable  deduction.  The  lack  of 
market  for  and  lack  of  rnarket  value  of  the  liquor  was  required 
to  be  established. 1'^^ 

Shrinkage  in  inventory  values  sustained  during  1919  by  a 
partnership  business  which  prior  to  November  4,  1918,  was 
operated  as  a  corporation  might  not  be  taken  as  a  deduction 
from  the  net  income  of  the  corporation  for  the  taxable  year 
1918,  even  though  the  individual  partners  were  stockholders  of 
the  former  corporation.^'^" 

In  the  case  of  a  taxpayer  making  a  return  for  a  fiscal  year 
beginning  of  1917  and  ending  in  1918,  the  provisions  relating 
to  loss  in  inventory,  apply  to  the  computation  of  the  tax  under 

IT'-T.  B.  R.  15,  T.  B.  5-19-251. 

t77T.  B.  M.  52,  T.  B.  12-19-52;  A.  R.  R.  291,  T.  B.  43-20-1260.  The  rule 
stated  in  the  text  above  that  an  inventory  loss  could  not  be  sustained  except 
with  reference  to  the  entire  inventory  could  hardly  have  been  intended 
to  supersede  the  requirement  that  inventories  must  be  valued  at  "cost  or 
market  whichever  is  lower".  In  other  words  appreciation  in  value  of 
part  of  the  inventory,  where  such  appreciation  raised  the  market  value 
of  such  part  above  cost,  would  not  be  entirely  offset  against  the  depreciated 
part  of  the  inventory  if  goods  were  valued  at  "cost  or  market  whichever 
is  lower". 

ns  O.  D.  47,  T.  B.  1-19-64. 

!"!»  O.  D.  390,  T.  B.  5-20-717. 

ISO  0.  D.  263,  T.  B.  17-19-471. 


DEDUCTION   OF  LOSSES  669 

the  Revenue  Act  of  1916  and  .the  Revenue  Act  of  1917  at  the 

1917  rates,  as  well  as  to  the  computation  under  the  1918  Act 

at  the  1918  rates.^^^  .  .u     ^       ki 

Loss  FROM  REBATES.  Where  after  the  close  of  the  taxable 
year  1918  rebates  were  bona  fide  paid  in  pursuance  of  con- 
tracts entered  into  during  such  year  upon  sales  made  durmg 
such  year,  the  net  income  for  that  year  might  be  reduced  by 
the  deduction  of  the  amount  of  such  rebates  actually  paid.  No 
such  deduction  would  be  allowed  unless  the  profits  from  such 
sales   had  been   included   in   the   income   for  the  taxable  year 

1918  i'^-    In  cases  where  rebates  were  made  on  sales  reported  m 
the  1918  return  of  income,  a  separate  schedule  was  required  to 
be  submitted  and  the  total  thereof  might  be  included  in  the 
taxpayer's   claim   in   abatement.     This    schedule    should    have 
been  prepared  in  such  manner  as  to  reflect:    (a)    the  date  ot 
each  rebate;  (b)  the  name  and  address  of  each  party  securing 
the  benefit  thereof;    (c)    a   description  of  the  goods;    (d)    the 
quantities;  (e)  the  sales  value  of  each  item;  and  (f)  the  amount 
rebated.     Rebates  made  during  the  taxable  year  1919  on  sales 
made  during  such  year  (provided  the  goods  to  which  the  rebate 
applied   were   included    in   the   inventory   at   the   close   of   the 
taxable  year  1918)   were  considered  as  an  adjustment  of  sales 
values  in   arriving  at  the  loss  on   inventories  for  the  taxable 
year  1918.     This  item  could  not  go  in  the  rebate  claim,  but  the 
rebate  might  be  considered  in  determining  the  sale  price  for  the 
purpose  of  determining  an  inventori)  loss.     It  must  be  under- 
stood that  rebates  made  on  goods  acquired  and  sold  subsequent 
to  the  end  of  the  taxable  year  1918  could  not  be  considered  in 
any  manner  as  a  1918  inventory  loss.^^- 

Rebates  actually  paid  after  the  close  of  the  taxable  year, 
other  than  those  paid  in  pursuance  of  contracts  entered  into 
during  such  year  upon  sales  made  during  such  year,  were  not 
allowable  deductions.i^^  Rebates  made  during  1919  on  account 
of  defective  goods  purchased  in  1918  were  not  of  the  class  re- 
ferred to  in  this  provision  of  the  statute  and  could  not,  there- 
fore, be  included  in  a  claim  for  abatement  or  refund  filed  under 
such  provisions.!^'     A  written  contract  was  not  necessary  in 

181 T   B   R    10    T   B   3-19-193. 

182  Reg   45,  Art.  262.     This  provision  does  not  apply  to  rebates  made  in 
1918  on  191?' shipments.     (A.  R.  M.  136,  T.  B.  31-21-1754). 
is:i  I.  T.  S.  1919,  V\  3364,  3365. 
1S4  A.  R.  M.  4,  T.  B.  28-19-614. 
185  0.  D.  382,  T.  B.  4-20-705. 


670  FEDERAL  INCOME  TAX 

order  that  a  taxpayer  might  take  advantage  of  the  above  relief 
provision.  It  was  sufficient  that  there  should  have  been  an 
oral  contract  or  a  contract  implied  from  the  usages  and  customs 
of  the  trade  in  general.^'^'^ 

Loss  Where  Goods  Were  Sold  in  1919.  Where  goods  in- 
cluded in  the  inventory  at  the  end  of  the  taxable  year  1918  were 
sold  during  the  succeeding  taxable  year,  the  loss  which  might 
be  deducted  from  net  income  for  the  taxable  year  1918  was  the 
amount  by  which  the  value  at  which  the  goods  sold  were  in- 
cluded in  the  inventory  exceeded  the  actual  selling  price  minus  a 
reasonable  allowance  for  selling  expenses  and  for  manufacturing 
expenses,  if  any,  incurred  in  the  taxable  year  1919  and  at- 
tributable to  such  goods.187 

Loss  Where  Goods  Were  Not  Sold  in  1919.  Where  goods 
included  in  the  inventory  at  the  end  of  the  taxable  year  1918 
were  not  sold  during  the  succeeding  taxable  year,  the  loss  which 
might  be  deducted  from  net  income  for  the  taxable  year  1918 
was  the  amount  by  which  the  net  income  for  such  year  would  be 
reduced  if  the  inventory  were  redetermined  and  such  goods 
taken  at  their  market  value  (ignoring  mere  temporary 
fluctuations  of  value)  at  the  end  of  the  taxable  year  1919.^^^ 

Method  op  Computing  Loss  in  Inventory.  Loose-leaf 
ledgers  were  recommended,  whereby  control  could  be  secured 
of  each  classification  or  lot  of  goods  upon  which  claim  was  to 
be  made.  Therein  should  have  been  recorded  quantities  and  val- 
ues as  returned  on  the  inventory  at  the  close  of  the  taxable  year 
1918 ;  and  there  should  have  been  recorded  in  summary  form 
each  day  or  week,  the  quantities  sold  and  the  values  thereof, 
and  all  items  of  sales  should  have  been  carried  forward, 
according  to  established  classification  adopted  by  the  taxpayer, 
to  the  time  when  the  quantities  as  reported  in  the  inventory 
were  accounted  for.  At  the  time  of  filing  the  return  of  income 
in  1919  the  taxpayer  was  permitted  to  compute  his  loss  from 
sales  to  that  date,  by  deducting  from  the  total  sales  a  reasonable 
and  proportionate  allowance  for  operating  or  selling  expense. 
The  net  result  ascertained  was  to  be  deducted  from  the  inventory 
value  of  the  goods  included  in  the  1918  inventory  sold  to  that 
date,  and  the  resultant  loss  brought  down.     The  taxpayer  was 

186  A.  R.  R.  590,  T.  B.  31-21-1753. 

187  Reg.  45,  Art.  264.  The  Ti-easury  Department  first  held  that  such  loss 
could  not  include  selling  expenses,  deductible  during  the  taxable  year  in 
which  the  sale  is  made.  See  Telegram  from  Treasury  Department  dated 
March  3,  1919;  I.  T.  S.  1919,  113276. 

18S  Reg.  45,  Art.  265. 


DEDUCTION  OF  LOSSES  671 

then  to  reduce  the  balances  remaining  unsold  to  then  market 
value,  and  add  the  loss  thus  ascertained  from  sales.  The  sum 
tQtal  of  these  computations  would  represent  the  total  loss  upon 
which  the  amount  of  tax  to  be  claimed  in  abatement  should  be 
computed  and  this  amount  was  deductible  from  the  unpaid  in- 
stallments of  the  tax,  provided,  a  proper  bond  was  furnished. 
Should  any  goods  unsold,  upon  which  claim  in  abatement  had 
been  filed  at  the  time  of  filing  the  return,  to  be  disposed  of  by  sale 
at  a  subsequent  time  within  the  taxable  year  1919,  the  taxpayer 
was  to  continue  to  record  the  sales  effected,  deducting  therefrom 
the  proportionate  cost  of  operating  or  selling  expense.  The  gain 
or  loss  would  then  be  ascertained  by  computing  the  difference 
between  the  adjusted  sales  values  and  the  inventory  value  estab- 
lished at  the  time  of  filing  the  claim  in  abatement.  If  at  the  close 
of  the  taxable  year  1919  there  remained  any  commodity  unsold, 
the  taxpayer  could  adjust  the  inventory  value  to  the  market  price 
(ignoring  mere  temporary  fluctuations  in  price  or  value) ,  at  the 
close  of  the  taxable  year  and  compute  the  amount  of  gain  or  loss. 
Such  gain  or  loss  would  be  combined  with  the  gain  or  loss  on 
sales  between  the  time  of  fihng  the  return  and  the  close  of  the 
taxable  year  1919.  If  it  was  shown  that  the  taxpayer  had  sus- 
tained a  loss  additional  to  that  shown  in  the  claim  in  abatement 
a  claim  for  refund  should  have  been  made  on  Form  46  for  the 
amount  of  tax  overpaid.  Should  it  be  shown  that  the  amount 
deducted  in  the  claim  in  abatement  at  the  time  of  filing  the  re- 
turn for  the  taxable  year  1918  was  in  excess  of  the  tax  based 
upon  actual  losses  sustained  throughout  the  taxable  year  1919, 
the  taxpayer  was  required  to  remit  to  the  collector  the  addi- 
tional amount  of  tax  involved  with  interest  at  the  rate  of  I'^o 
per  month  from  the  time  of  filing  the  return  until  the  date  of 
filing  the  final  adjustment  of  taxes  for  the  taxable  year  1918  on 
account  of  inventory  losses.^^*^ 

ISO  See  I.  T.  S.  1919,  H  3359. 

The  following  is  an  example  of  the  computation  above  outlined : 

Assume  an  inventory  at  December  31,  1918,  200,000  yds. 

at  15c $30,000 

Assume  sales,  between  January  1,  1919,  and  June  1,  1919, 

100,000  yds.  at  12^c $12,500 

Cost  of  manufacturing  or  selling  based  upon  data  ascer- 
tained from  1918  operations,  say  in  this  case  of  15%  of 
sales  values   1,875 

Net  proceeds  from  sales $10,625 

The  inventory  cost  at  15c  per  yd.  amounted  to 15,000 

Net  loss  upon  which  tax  can  be  claimed  in  abatement 4,375 


i\T2  l^'I'lDKltAI.    INCOMI'l    TAX 

('liAlMS.  Claims  in  abalcnuMil  could  he  (ilcd  with  the  collector 
on  KoiMu  17  when  the  r(>ltirM  for  tlio  taxable  year  IDIH  was  made. 
Where  the  taxpayer  had  liled  his  return,  hut  the  total  amouid 
of  tax  had  not  been  collected,  a  claim  in  abatement  was  consid- 
ered if  liled  before,  or  within  ten  days  aftei-  the  mailinjf  of  the 
collector's  notice  and  demand  on  I'orm  17.'""  (Maims  for  refund 
to  cover  the  loss  in  IDIS  inventory,  ascertained  at  the  clos(>  of  the 
taxable  year  IDM),  were  recjuired  to  be  liled  within  a  reasonabU* 
time.  There  was,  however,  no  time  limit  fixed  by  law  within 
wliich  such  claims  must  be  Died  (except  the  general  statute  of 
limitations  applying  l<>  all  claims  for  refund)  and  therefore,  the 
slatem(>nt  emanating  from  the  advisory  board  that  such  claims 

Assumi'  thai  tho  nmrlicl.  i)rir(>  at  .Iiiiio  1,  IDIS)  (on  the  as- 
siinipMoii  that  tlu>  taxpayer  will  prepare  his  elaim  on 
June  I,  iJilluM-  than  delay  until  June  15,  l!)l!»),  on  this 
class  of  ^i■()()(ls  was  I  lie.  There  would  remain  unsold  at 
that  lime  iOO.OIH)  yds.  orijjinally  in\iM\toried  at  IHe  to  he 
reduced  to  I'Jc  or  at  a  loss  of  Mc  per  yd.  an'jrt'efi'atinn'.  .  .  .  l\,()()0 

Total  ainouid  upon  which  tax  could  he  claimed  in  ahate- 
nient  at  the  time  of  lilinjr  tlu>  return  on  oi'  hidore  .lune  1, 
ISM  I),  would  he   $7,375 

Now,  hetween  ,Iuni<  I.  lidil,  and  Deceinher  .'U ,  li)ll),  as- 
sume that  the  l.ixpayer  sells  50,000  yds.  at  a  price  of  15c 
per  yard,  amount  of  sale  would  he 7,500 

IK'ducliniv  therefrom  operntiuK  oi  selling'  expense  at  the 
same  rate  of  15',;  (or,  if  nsceiiainahle.  the  adjusted  i)er- 
centaye  for  1910)    1,125 

Net    proceeds   fi'om  sale    $(').;{75 

('ost  of  this  material   ,is  adjusted   at    June    1,    IOI!>,  on    the 

hasis  of   iL'i-   per  y<l O.OOO 

(lain  on  these  transactions ,$l?75 

I'"urther,  assume  (hat  the  i-emjiininj;'  50,000  yards  were  un- 
sold at  the  close  of  the  taxahle  year  i;»i;».  and  that  the 
market  iirice  had  risen  to  1 7c  per  yd.,  the  taxpayer 
would,  in  this  ease,  have  to  readjust  his  inveidmy  \-.ilue 
to  the  17c  hasis,  and  at'coui\t  for  the  ek-menl  oi'  ai)pre- 
ciation.  in  this  case  (5c  pvr  yd.  over  adjusted  li^.^ure  as 
of  .hnie   n    2,600 

Total    ^'ains    2,875 

Adjusted  U)ss  upon  wiiieh  tax  is  to  hi'  ahated  or  re- 
funded, as  the  case  may  he $1,500 

I'"M-etter  from  treasury  di'i)arlment  dated  Aujrust  0,   1010;   1.  T.  S.   1021, 
11  1027. 


DEDUCTION   OV   LOHSKS  ^>7'^ 

.should  1m"  lilcd  within  thirty  (hiy.s  al'tcr  Iho  close  of  the  taxabh" 
yuar  I '.Ml),  must   he  considoml  us  dimtory  and  not  mandatory. 
Kach  claim  was  rcciuircd  to  coidain  a  concise  statement  of  the 
amount  of  the  loss  sustained  and  the  basis  upon  which  it  had  been 
computed,  together  with  all  pertinent  facts  necessary  to  enable 
the  Cominissioner   to  determine   the   allowability   of   the   claim. 
The  amount  allowed  by  the  Commissioner  in  respect  of  any  such 
claim  was  deducted   Irom   the  net  income   lor  the  taxable  year 
11) IH  and  the  taxes  recom|)uted   accordinRly.     Any  excess  paid 
over  the  tax  due  was  credited  or  refimded  to  the  taxpayer,     in 
computinjf  income  for  the  taxabl.'  year  I'.H'.l  lli.-  opening  inven- 
tory was  reciuired  to  be  properly  adjusted   by   the   taxpayer  in 
respect  of  any  claim  allowed  for  the  year   IDIH.""     Two  claims 
miRht  be  tiled,  one  at  time  of  (ilin^  the  return,  and  one  adjusting 
the  entire  claim  for  ioHSes  at  the  close  of  the  taxable  year  11)11). 
Tht!  tirst  would  represent  a  claim   in  abatement;  the  second,  a 
claim  for  reftmd.     It  was  possible  tliat  an  additional  amount  (ff 
tax  iniKht  become  due  from  the  taxpayer  with   interest  at  the 
rate  of   I'-    |)('i'  month   from  the  time  of  makinjf  the  deduction 
until    the   time   of   (ilinK   the    hnal    statement,    which    would    be 
brought  about  by  the  fact  that,  in  the  disposition  of  unsold  goods 
as  to  the   ID  IS  inventory  after  the  tiling  of  the  original  return, 
and  th(!  claim  in  abatement,  gains  might  result  from  subse(iuent 
sales.     It  would  therefore  be  necesHary  for  the  taxpayer  to  pre- 
pare a  statement  which  would  fully  retlect  the  corrected  amount 
„f  any  claim  to  which  he  might  be  entitle<l  for  losses  in  inventory 
of  11) IS,  and  this  statement  should  delinitcly  embrace  the  total 
anioiml  of  inventory  value  as  recorded  on  the  books  of  the  tax- 
payer at  the  end  of  the  taxable  year    IDIS.  and  be  cai)able  of 
j)roper  audit.'"-     Taxpayers  were  reijuired  to  tile  with  the  orig- 
inal claim  an. I  at  the  close  of  the  taxable  year  ll»ll»  summarized 

I'.'i  Ki'jf.  in.  Art.  *2(;(i.  Willie  tt.c  liivv  and  (he  regulations  slate  tliat,  elaims 
i„  ulmlcnient  shoul.i  be  Hied  wi.en  ti.e  reln.n  for  tlu-  l,axal)Ie  year  of  IIHK 
is  ma.le.  the  treasury  (lei)ar(ment  lias  rule.!  tl.at,  laxpuycrs  may  file  a  claim 
for  abatement,  based  on  revaluation  of  invi-ntorii'H  at  the  time  of  (ilmk'  re- 
turn, (.r  any  time  thereafter  .lurin«  IIH1».  This  does  not  preclude  the  tux- 
jmyer  from  lilin>f  an  amended  claim  durin^c  H'll),  but  after  one  claim  has 
been  allowe<l.  no  further  claim  may  be  ma.le.  (Telegram  fn)m  treasury 
department  dated  April  :\,  IIMK;  i.  T.  S.  llMi),  H-TJiH.) 

iir.Jl.  T.  S.  lt)2l,  11  !(!:{(•..  The  following  is  an  illustration  of  an  outlino 
to  l>e  use.i  in  makinjf  final  statement  of  a.ljustment  at  the  close  of  the  tax- 
nl.le  year  llMK.  This  is  based  ujion  the  illustration  Riven  above  which 
„ppli..s  to  OIK-  it.-m  .)r  inv.-ntory  only,  but  it  must  be  understood  that  the 
(inal  slatem.-nt  r.d'erre.l  to  herein,  must  c.v.-r  the  entir..  invent.. ry  value 
as  at  the  end  of  the  taxable  year  1J)1H: 


674  FEDERAL   INCOME   TAX 

statements  covering  all  adjustments  involved.  To  conform  to 
good  accounting  practices,  the  taxpayer  should  have  considered 
these  summaries  in  the  light  of  controlling  accounts  and  the  sum 
totals  thereof  should  have  .equalled  the  total  inventories  main- 
tained in  detail  by  the  taxpayer.  Claims  for  losses  in  inventories 
of  the  taxable  year  1918  should  have  embraced  all  items  in  the 
taxpayer's  inventory  so  that  gains  made  in  any  sales  of  certain 
items  or  classes  would  be  used  to  offset  losses  in  others  and  the 
net  result  as  to  the  entire  inventory  determined.  Thus  if  the 
final  computation  showed  a  net  gain  over  all  inventory  items 
sold,  no  claim  for  loss  in  any  particular  item  or  items  could 
be  sustained.!'*'^ 

Claims  of  Partnerships.  A  claim  in  abatement  arising  from 
a  loss  in  1918  partnership  inventory  was  required  to  be  made 
by  each  individual  partner  as  to  his  distributive  share  of  recom- 
puted net  income.  To  this  claim  should  have  been  attached  the 
Statement  of  the  partnership  showing  the  loss  in  inventory  sup- 
ported in  the  same  manner  as  such  claims  were  supported  by 
corporations  and  individuals.  The  statement  filed  as  to  the 
partnership  as  a  whole  was  used  by  the  department  for  the  pur- 
poses of  record  and  verification  and  any  adjustments  which 
might  be  found  necessary  would  be  spread  pro  rata  over  the 
claims  of  the  individuals.  At  the  close  of  the  taxable  year  1919 
a  properly  authorized  member  of  the  partnership  should  have 
compiled  the  final  statement  of  adjustment  in  accordance  with 

Quantity  Value 

1.  Inventory  close  of  taxable  year  1918 200,000  $30,000 

2.  Sales  from  1918  inventory  during  taxable  year  1919.  .150,000  20,000 

3.  Less  deductions  from  sales  for  selling  expenses 3,000 

4.  Net  sales  proceeds    (Item  2  value  less  Item  3) 17,000 

5.  Balance  of  1918  inventory  on  hand  at  close  of  taxable 

year    (Quantity  Item  1  less   Item  2) 50,000  8,500 

(Value  priced  at  market  close  taxable  year  1919) 

6.  Net   sales   proceeds    and    balance   of   inventory 25,500 

(Item  4  plus  Item  5,  values) 

7.  Loss    (Item   1    value   less   Item   6) 4,500 

8.  Gain     


9.  Amount  of  claim  in  abatement  or  for  refund  filed ....  $  7,375 

In  this  illustration  an  excessive  claim  in  abatement  of  tax  based  upon  a 
loss  of  inventory  values,  amounting  to  $2,875,  is  assumed.  Tax  upon  this 
amount  w^ith  interest  at  one  per  cent  per  month  between  the  date  of  making 
the  deduction  and  final  statement  will  be  assessed  in  this  case.  Should 
the  taxpayer  elect  not  to  file  a  claim  in  abatement  at  the  time  of  filing  his 
return,  but  rather  to  wait  until  the  end  of  the  taxable  year  1919,  then,  in 
that  case,  but  one  claim  would  be  filed. 

193  L  T.  S.  1921,  ^1640;  0.  D.  186,  T.  B.  8-19-323. 


DEDUCTION   OF  LOSSES  675 

the  methods  previously  outlined,  attaching  thereto  the  propor- 
tionate amounts  of  adjustment  affecting  each  individual  mem- 
ber of  the  partnership.  On  the  determination  of  the  net  result, 
each  individual  partner  should  have  filed  a  claim  for  refund  (if 
any  refund  was  due),  or  in  the  event  that  the  claim  in  abate- 
ment was  in  excess  of  the  actual  losses  sustained,  each  individual 
would  remit  to  the  collector  of  his  district,  his  share  of  the  addi- 
tional amount  of  tax  ascertained  from  the  adjusted  statement, 
with  interest  at  the  rate  of  V/v  per  month  from  the  original  due 
dates  of  the  tax.i"^  Each  partner  was  required  to  furnish  a 
separate  bond  in  the  requisite  amount.^"'"' 

Disposition  of  Claims.    A  claim  for  loss  resulting  from  re- 
bates paid  or  from  actual  sales  could  be  decided  as  soon  as  prac- 
ticable after  it  had  been  filed.    A  claim  for  loss  in  inventory  not 
realized  by  sale  could  be  decided  only  after  the  close  of  the  tax- 
able year  1919  upon  the  basis  of  any  permanent  reduction  in  the 
level  of  market  values  which  had  occurred  during  such  year  from 
the  inventory  values  taken  at  the  close  of  the  taxable  year  1918. 
Not  later  than  thirty  days  after  the  close  of  the  taxable  year 
1919  a  taxpayer  who  had  filed  either  a  claim  in  abatement  or  a 
claim  for  refund,  or  both,  was.  required  to  submit  to  the  Commis- 
sioner a  descriptive  statement  showing  the  quantity  and  kind  of 
all  goods  included  in  the  1918  inventory  which  had  been  (a)  sold 
at  a  loss  in  the  taxable  year  1919,  (b)  sold  at  a  profit  during  the 
taxable  year  1919,  or  (c)  not  sold  or  otherwise  disposed  of  dur- 
ing the  taxable  year  1919,  together  with  such  other  information 
in  respect  of  such  goods  as  the  Commissioner  might  require.    A 
claim  filed  with  the  return  for  a  loss  not  then  realized  by  sale 
was  passed  upon  in  the  light  of  any  sales  thereafter  made  during 
the  taxable  year  1919.     A    claim    filed    with    the    return    was 
authorized  for  the  purpose  of  allowing  the  taxpayer  to  utilize, 
where  justified,  a  preliminary  allowance  for  inventory  losses  and 
not  to  provide  a  deduction  essentially  different  from  that  taken 
by  way  of  a  claim  filed  at  the  end  of  the  taxable  year  1919.1'"' 
Effect  of  Claim  in  Abatement.    In  the  case  of  a  claim  m 
abatement  filed  with  a  return,  payment  of  the  amount  of  the  tax 
covered  thereby  was  required  until  the  claim  was  decided,  pro- 
vided the  taxpayer  filed  therewith  a  bond    on    form    1124    in 
double  the  amount  of  the  tax  covered  by  the  claim,  conditioned 
for  the  payment  of  any  part  of  such  tax  found  to  be  due  with 

IM  I.  T.  S.  1921,  H  1643. 
105  o    D.  218,  T.  B.  11-19-380. 

]!»!Rep     45,    Art.    267.      No    claim    would    he    allowed    unless    the    above 
information  was  fully  supplied.     (A.  R.  R.  554,  T.  B.  30-21-1745). 


676  FEDERAL   INCOME   TAX 

interest  at  the  rate  of  12  per  cent,  per  annum.  The  filing  of  this 
bond  was  not  a  condition  precedent  to  the  consideration  of  the 
claim  for  abatement  on  its  merits,  but  was  merely  a  condition 
precedent  to  securing  immunity  from  collection  during  the 
pendency  of  the  claim.  The  bond  was  required  to  be  executed 
by  a  surety  company  holding  a  certificate  of  authority  from  the 
secretary  as  an  acceptable  surety  on  federal  bonds  and  was  sub- 
ject to  the  approval  of  the  Commissioner.  If  abatement  of  any 
part  of  the  tax  covered  by  such  a  claim  was  denied,  then  such 
part  was  required  to  be  paid  by  the  taxpayer  with  interest  at 
the  rate  of  12  per  cent  per  annum  from  the  original  due  date  of 
the  tax.197 

Liberty  or  Other  Bonds  as  Security.  In  case  the  claimant, 
in  accordance  with  the  provisions  contained  in  the  Revenue  Act 
of  1918,1^8  elected  to  offer,  in  lieu  of  the  surety  or  sureties  pro- 
vided for  on  Form  1124,  United  States  Liberty  bonds  or  other 
bonds  of  the  United  States  as  security  he  could  execute  in  dupli- 
cate a  bond  and  agreement  on  Form  1124a.  The  original  was 
to  accompany  the  United  States  bonds  oflTered  as  security ;  the 
duplicate  was  to  be  forwarded  by  the  collector  with  the  abate- 
ment claim  to  the  Commissioner,  If  such  bond  and  agreement 
was  executed  by  a  corporation  a  duly  certified  copy  of  the  resolu- 
tion of  the  board  of  directors,  authorizing  the  execution,  was  also 
required.  The  United  States  Liberty  bonds  or  other  bonds  of 
the  United  States,  offered  as  security,  had  to  be,  in  par  value, 
not  less  than  the  amount  of  the  penal  sum  of  the  bond  executed 
on  Form  1124a,  which  had  to  be  in  double  the  amount  of  the  tax 
covered  by  the  abatement  claim.  The  bonds  so  offered  as  security 
were  delivered  to  the  Commissioner  at  the  obligor's  risk  and  ex- 
pense. Registered  bonds  so  offered  as  security  were  registered 
in  the  name  of  the  obligor  and  duly  assigned  to  the  Commissioner 
at  or  before  the  date  of  deposit  with  the  Commissioner.  The 
Commissioner  issued  a  receipt  in  duplicate  for  United  States 
bonds  so  deposited  with  him  as  security,  the  original  of  the  re- 
ceipt being  given  to  the  obligor,  and  the  duplicate  retained  by  the 
Commissioner  for  his  files.  Bonds  of  the  United  States  were  re- 
turned to  the  obligor  as  soon  as  the  security  for  the  performance 
of  such  penal  bond  was  no  longer  necessary.  Registered  bonds 
were  re-assigned  to  the  owner  when  the  liability  was  cancelled.^^^ 

197  Reg.  45,  Art.  268;   A.  R.  R.  331,  T.  B.  48-20-1323. 
398  Revenue  Act  of  1918,  H  1320. 
199  T.  D.  2925. 


DEDUCTION   OF  LOSSES  677 

Where  Liberty  bonds  were  deposited  as  collateral,  as  provided 
when  a  claim  for  abatement  for  a  loss  in  inventory  was  filed, 
coupons  representing-  one  year's  interest  might  be  detached  from 
the  bonds  prior  to  depositing  them  as  collateral  on  Form  1124.^" 

-'<'«'  O.  D.  193,  T.  B.  8-19-336. 


CHAPTER  26 

DEDUCTION  OF  ALLOWANCE  FOR  DEPRECIATION,  OBSOLESCENCE  AND 

AMORTIZATION 

The  Revenue  Act  of  1921  has  introduced  no  substantial 
changes  with  respect  to  allowances  for  depreciation,  obsolescence- 
and  amortization.  The  only  change  in  regard  to  depreciation 
deductions  is  a  statutory  enactment  of  the  former  departmental 
practice  that  depreciation  deductions  must  be  based  on  the  fair 
market  price  or  value  as  of  March  1,  1913,  of  property  acquired 
prior  thereto.  The  amortization  provision  remains  substantially 
the  same,  certain  definite  dates  being  inserted  now  that  the  war 
has  been  officially  terminated.  In  the  case  of  individuals  the  Rev- 
enue Act  of  1921  permits  a  reasonable  allowance  for  the  exhaus- 
tion, wear  and  tear  of  property  used  in  the  trade  or  business  of 
an  individual,  including  a  reasonable  allowance  for  obsolescence. ^ 
In  the  case  of  nonresident  aliens,  and  certain  citizens  taxed  as 
nonresident  aliens,-  the  deduction  for  depreciation  or  ob- 
solescence is  permitted  if  and  to  the  extent  that  it  is  connected 
with  income  arising  from  sources  within  the  United  States ;  and 
the  proper  apportionment  and  allocation  of  the  deduction  with 
respect  to  sources  of  income  within  and  without  the  United 
States  is  determined  under  rules  and  regulations  prescribed  by 
the  Commissioner  with  the  approval  of  the  Secretary.'^  In  the 
case  of  corporations,  the  allowance  is  also  for  the  exhaustion, 
wear  and  tear  of  property  used  in  the  trade  or  business,  in- 
cluding a  reasonable  allowance  for  obsolescence,*  limited  in  the 
case  of  a  foreign  corporation,  and  certain  domestic  corporations 
taxed  as  foreign  corporations,"^  as  above  indicated  in  the  case  of 
nonresident  aliens."  It  must  be  borne  in  mind  that  the  al- 
lowance for  depreciation  or  obsolescence  does  not  include  any 
element  of  a  mere  reduction  in  market  value  not  resulting  from 
exhaustion,  wear  and  tear  or  obsolescence.     The  proper  allow- 

1  Revenue  Act  of  1921,  §214  (a)  8.  This  statutory  enactment  of  the 
former  departmental  practice  was  made  to  remove  all  doubt  as  to  whether 
depreciation  df  property  acquired  before  March  1,  1913,  should  be  based  on 
cost  or  value  on  that  date  in  view  of  the  cases  of  Goodrich  v.  Edwards, 
41  Sup.  Ct.  Rep.  390,  and  Walsh  v.  Brewster,  41  Sup.  Ct.  Rep.  392. 

2  See  Revenue  Act  of  1921,  §  262. 

3  Revenue  Act  of  1921,  §214   (b). 

■i  Revenue  Act  of  1921,  §  234    (a)    7. 

5  See  Revenue  Act  of  1921,  §262. 

6  Revenue  Act  of  1921,  §234   (b). 

678 


DEPRECIATION,  OBSOLESCENCE   AND  AMORTIZATION  679 

ance  for  such  depreciation  of  any  property  used  in  the  trade  or 
business  is  that  amount  which  should  be  set  aside  for  the  taxable 
year  in  accordance  with  a  consistent  plan  by  which  the  ag^'e- 
gate  of  such  amounts  for  the  useful  life  of  the  property  in  the 
business  will  suffice,  with  the  salvage  value,  at  the  end  of  such 
useful  life  to  provide  in  place  of  the  property,  its  cost,  or  its  value 
as  of  March  1,  1913,  if  acquired  by  the  taxpayer  before  that  dateJ 
The  new  provisions  of  the  Revenue  Act  of  1918  and  continued 
in  the  present  law  for  the  deduction  of  a  reasonable  allowance 
for  obsolescence  and  amortization  are  treated  in  this  chapter  in 
addition  to  the  subject  of  depreciation  of  property  used  in  the 
trade  or  business  of  a  taxpayer.  Depreciation  in  the  case  of 
farmers  is  discussed  elsewhere  in  this  book.^ 

Depreciation  Under  Preceding  Income  Tax  Laws.    As  pointed 
out  in  the  preceding  paragraph  the  1918  Law  contained  pro- 
visions similar  to  those  of  the  present  law  respecting  deprecia- 
tion, obsolescence  and  amortization.     The  1909  Law"    allowed 
the  deduction  of  all  losses  including  a  reasonable  allowance  for 
depreciation  of  property,  if  any.     The  1913  Law  allowed  as  a 
deduction  in  the  case  of  individuals  i"  "a  reasonable  allowance 
for  the  exhaustion,  wear  and  tear  of  property  arising  out  of  its 
use  or  employment  in  the  business,"  and  in  the  case  of  corpora- 
tions "  all  losses  "including  a  reasonable  allowance  for  deprecia- 
tion by  use,  wear  and  tear  of  property,  if  any."    The  1916  Law 
allowed  to  individuals  ^-  a  deduction  of  "a  reasonable  allowance 
lor  the  exhaustion,  wear  and  tear  of  property  arising  out  of  its 
use  or  employment  in  the  business  or  trade,"  and  to  corpora- 
tions i^  a  deduction  of  all  losses  "including  a  reasonable  allow- 
ance for  the  exhaustion,  wear  and  tear  of  property  arising  out  of 
its  use  or  employment  in  the  business  or  trade."    It  is  important 
to   note  the   difference   in   phraseology   between   these   various 
provisions  in  consulting  any  case  decided  under  preceding  laws 
as  an  authority  under  the  present  law. 

Depreciable  Property.  The  necessity  for  a  depreciation  allow- 
ance arises  from  the  fact  that  certain  property  used  in  the  busi- 
ness gradually  approaches  a  point  where  its  usefulness  is  ex- 
hausted.    The  allowance  should  be  confined  to  property  of  this 

7  Reg.    45,   Art.    IGl. 

8  See   Chapter   7. 

9  Act  of  August  5,  1909,  §  38. 

10  Act  of  October  3,  1913,  §  B. 

11  Act  of  October  3,  1913,  §  G  (b). 

12  Revenue  Act  of  1916,  §§5   (a),  6   (a). 

13  Revenue  Act  of  1916,  §  12. 


680  FEDERAL   INCOME  TAX 

nature.i^  In  the  case  of  tangible  property,  it  applies  to  that 
which  is  subject  to  wear  and  tear,  to  decay  or  decline  from 
natural  causes,  to  exhaustion,  and  to  obsolescence  due  to  the  nor- 
mal progress  of  the  art  or  to  becoming  inadequate  to  the  growing 
needs  of  the  business.  It  does  not  apply  to  inventories  or  to 
stock  in  trade;  nor  to  land  apart  from  the  improvements  or 
physical  development  added  to  it.^^  It  does  not  apply  to  bodies 
of  minerals  which  through  the  process  of  removal  suffer  deple- 
tion, other  provision  for  this  being  made  in  the  statute  by  way 
of  an  allowance  for  depletion. i*^  Property  kept  in  repair  may, 
nevertheless,  be  the  subject  of  a  depreciation  allowance.!^  The 
deduction  of  an  allowance  for  depreciation  is  limited  to  property 
used  in  the  taxpayer's  trade  or  business.  No  such  allowance 
may  be  made  in  respect  of  automobiles  or  other  vehicles  used 
chiefly  for  pleasure,  a  building  used  by  th'e  taxpayer  solely  as 
his  residence,  nor  in  respect  of  furniture  or  furnishings  therein, 
personal  effects,  or  clothing;  but  properties  and  costumes  used 
exclusively  in  a  business,  such  as  a  theatrical  business,i^  may  be 
the  subject  of  a  depreciation  allowance.^^  Since  the  full  life  of 
radium  has  been  scientifically  estimated  at  such  an  extended 
period  and  since  no  appreciable  depreciation  results  from  its  con- 
tinued use  as  a  therapeutic  agent,  the  depreciation  occurring 
during  the  lifetime  of  any  individual  owner  is  practically 
negligible.  It  is  held,  therefore,  that  radium  which  is  used  as  a 
therapeutic  agent  is  not  subject  to  depreciation  and  its  cost  must 
be  treated  as  a  capital  expenditure.-'* 

Depreciation  of  Automobile  Used  in  Business.  Deprecia- 
tion may  be  claimed  on  an  automobile  where  it  can  be  shown  that 
the  taxpayer,  in  order  to  earn  his  salary,  is  responsible  for 
certain  duties  and  that  the  automobile  is  owned  and  used  by  him 

14  Deductions  for  depreciation  may  not  be  taken  where  the  assets  are  of 
a  more  or  less  permanent  character  such  as  additions  to  the  plant  of  a 
title  abstract  company   (O.  D.  1018,  T.  B.  36-21-1799). 

15  See  paragraph  on  real  estate  below. 

16  See  Chapter  28. 

17  See  p.  689. 
IS  See  p.  682. 

19  Reg.  45,  Art.  162;  Reg.  33  Rev.,  Art.  159;  T.  D.  2153;  T.  D.  2005. 
Depreciation  as  an  allowable  deduction  in  ascertaining  net  incomes  for  the 
purpose  of  the  income  tax  is  not  to  be  confused  with  the  deduction  for  loss. 
See  Chapters  21  and  22  as  to  certain  expenditures  which  should  be  deducted 
as  business  expense  rather  than  capitalized  and  depreciated. 

20  O.  D.  837,   T.  B.  10-21-1496. 


DEPRECIATION,  OBSOLESCENCE  AND  AMORTIZATION  681 

in  the  performance  of  such  duties. -^  A  member  of  a  local  draft 
board  who  used  his  automobile  for  travel  on  business  in  con- 
nection with  the  work  of  the  board  was  not  allowed  to  deduct  any 
amount  representing  wear  and  tear  of  the  automobile  or  main- 
tenance expense,  the  automobile  being  used  for  his  personal 
convenience  and  not  by  reason  of  official  necessity  since  such 
members  when  traveling  under  competent  orders  were  allowed 
actual  traveling  expenses  plus  a  per  diem  of  $4.-- 

Loss  IN  Rental  Value  of  Buildings.  Under  the  1916  Law 
and  prior  laws  the  deduction  on  account  of  depreciation  could 
not  include  any  allowance  for  an  estimated  loss  due  to  lessening 
of  rental  value,  nor  could  the  computation  of  the  deduction  be 
influenced  by  the  changed  environment  after  a  period  of  years, 
nor  by  its  lack  of  adaptability  to  the  use  originally  intended,  nor 
to  any  other  outside  influence  afl'ecting  its  value.  But  under  the 
present  law  and  the  1918  Law  it  would  seem  that  these  factors  of 
obsolescence  may  be  given  weight  in  calculating  the  deprecia- 
tion of  office  buildings,  apartment  houses  and  other  structures. 
However,  the  regulations  appear  still  to  hold  to  the  old  rule.--^ 

Real  Estate.  Real  estate,  as  such,  and  as  distinct  from  the 
improvements  thereon,  is  not  reduced  in  value  by  reason  of  wear 
and  tear  and  an  allowance  for  depreciation  in  the  case  of  real 
estate  does  not  apply  to  the  ground.  The  allowance  is  intended 
to  measure  the  decline  in  the  value  of  the  improvements  due  to 
the  wear  and  tear  thereof.-^  In  determining  the  cost  of  real 
estate  upon  which  depreciable  property  is  located,  it  frequently 
occurs  that  no  segregation  is  made  of  the  cost  of  buildings  as 
separate  and  distinct  from  the  cost  of  the  ground  upon  which 
such  buildings  stand.  In  such  cases  where  the  actual  cost  of 
the  buildings  or  improvements  at  the  time  they  were  taken  over 
by  the  taxpayer  can  not  be  definitely  determined,  it  will  be  suffi- 
cient, for  the  purpose  of  determining  the  rate  of  depreciation  to 
be  used  in  computing  the  amount  deductible  from  gross  income, 
to  estimate  the  actual  value  at  the  time  acciuired,  of  buildings  or 
improvements  if  acquired  after  March  1,  1913,  or  the  fair  market 
price  or  value  as  of  that  date,  if  the  property  was  acquired  prior 
to  March  1,  1913.-"' 

Leases.  In  the  case  of  a  lease  held  by  the  original  lessee, 
who  acquired  it  prior  to  March  1,  1913,  without  any  payment 

21  A.  R.  R.  551,  T.  B.  26-21-1707. 

22  0.  D.  363,  T.  B.  2-20-673. 

23  Cohen  v.  Lowe,  234  Fed.  474;  Reg.  33  Rev.,  Art.  162;  Reg.  45,  Art.  166. 

24  Reg.  45,  Art.  162;  Reg.  33  Rev.,  Art.  162;  T.  D.  2152;  T.  D.  2137. 
2.'-.  Reg.  33  Rev.,  Art.  163;  T.  D.  2137;  T.  D.  2152. 


682  FEDERAL  INCOME   TAX 

other  than  a  stipulated  annual  rent,  the  presumption  is  that  the 
lease  had  no  value  as  at  March  1,  1913.  Under  this  presumption 
there  is  no  basis  for  a  depreciation  deduction.  This  presumption 
can  be  overcome  only  by  evidence  showing  conclusively  that  the 
lease  had  a  value  as  of  March  1,  1913,  for  depreciation  purposes. 
There  is  no  prescribed  method  by  which  the  value  of  a  lease  as 
of  March  1,  1913,  in  excess  of  its  presumptive  value  as  at  that 
date  may  be  established.  The  burden  is  upon  the  taxpayer  to 
establish  the  basis  for  depreciation  to  the  satisfaction  of  the 
Commissioner.26 

Wearing  Apparel.  If  costumes  purchased  by  actors  and 
actresses  are  used  exclusively  in  the  production  of  a  play  and 
are  not  adapted  for  occasional  personal  use,  and  are  not  so  used, 
deduction  may  be  claimed  on  account  of  such  depreciation  in 
their  value  as  occurs  during  the  year  on  account  of  wear  and 
tear  arising  from  their  use  in  the  production  of  a  play,  or  a  loss 
may  be  claimed  if  they  become  obsolete  at  the  close  of  the  pro- 
duction.2"  The  cost  of  naval  uniforms  has  been  held  to  be  a 
personal  expense  and  no  deduction  for  depreciation  in  their 
value  will  be  allowed  to  naval  officers.-'^ 

Merchandise.  Depreciation  does  not  apply  to  inventories  or 
to  stock  in  trade.^^ 

Intangible  Property.  Intangibles,  the  use  of  which  in  the 
trade  or  business  is  definitely  limited  in  duration,  may  be  the 
subject  of  a  depreciation  allowance.  Examples  are  patents  and 
copyrights,  licenses,  and  franchises.  Intangibles,  the  use  of 
which  in  business  or  trade  is  not  so  limited,  will  not  usually  be  a 
proper  subject  of  such  allowance.  If,  however,  an  intangible 
asset  acquired  through  capital  outlay  is  known  from  experience 
to  be  of  value  in  the  business  for  only  a  limited  period,  the 
length  of  which  can  be  estimated  from  experience  with  reason- 
able certainty,  such  intangible  asset  may  be  the  subject  of  a  de- 
preciation allowance,  provided  the  facts  are  fully  shown  in  the 

26  0.  D.  720,  T.  B.  45-20-1292. 

27  Reg.  45,  Art.  162;  Reg.  33  Rev.,  Art.  8;  T.  D.  2090.  See  Reg.  45,  Art. 
143,  if  loss  is  claimed. 

28  A.  R.  R.  594,  T.  B.  32-21-1761. 

29  Reg.  45,  Art.  162.  It  has  been  held  under  previous  laws  that  deprecia- 
tion computed  on  total  invoice  cost  of  merchandise  in  stock  is  not  an  allow- 
able deduction,  except  that  if  any  portion  of  the  merchandise  in  stock 
is  unsalable  by  reason  of  obsolescence  or  damage,  a  depreciation  deduction 
not  in  excess  of  the  decline  in  value  during  the  taxable  year  will  be  al- 
lowed.    (Reg.  33  Rev.,  Art.  169.) 


DEPRECIATION,  OBSOLESCENCE  AND  AMORTIZATION  68S 

tha,-Mn  t.i  the  satisfaction  of  tlie  Commissioner.™ 

'T\  ri't^ion    01  d  pit  at  on  „"y  be  taken  on  all  such  prop- 

taxpayer's  return  for  the  year  m  which  its  worthlessness 

'"  De7ekiation  allowance  for  patent  or  copyright,     in 

The  Allowance  should  be  computed  by  an  apportionment  of  the 

S  ",,'1'""...,  ->  "<  ■!»-;"'■■  «-i»i"«""  "«*"•  ■'- 

tornev's  fees,  etc.,  actually  paid.'" 

If  kcornoration  purchased  a  patent  and  paid  for  it  in  stock 

:e^rriU:fatt  et-r  of  tt^urchase.  Depreciation  of  a  patent 
can  be  taken  on  the  basis  of  the  fair  market  value  as  of  Ma  ch 
1  1913  only  when  affirmative  and  satisfactoi-y  evidence  o  such 
vklue  is  offered.  Such  evidence  should  whenever  P^ac  leab'e  be 
lulmi  ed  with  the  return.  If  the  patent  becomes  obsolete  puo 
oi™  expiration  such  proportion  of  the  amount  o"  -b.ch  ts 
depreciation  may  be  based  as  the  number  of  years  of  its  remain- 
fn^  Me  bears  to  the  whole  number  of  years  intel■^■enlng  be  ween 

he  date  w*en  it  was  acquired  and  the  date  when  it  legaUy  ex- 
pires may  be  deducted,  if  permission  so  to  do  is  ^Pec'fica  V  s  - 
cmedTrom  the  Commissioner.    Owing  to  the  difficulty  of  allocat- 

ni  to  "particular  year  the  obsolescence  of  ^  P^'ten     such  pei 

mfssion  will  be  granted  only  if  -^"^-'Z^t^rf^Ty^l^^e 
dence  that  the  obsolescence  occurred  in  the  year  foi  «b'ch  the 
return  is  made  is  submitted  to  the  Commissioner.    The  fact  that 

:i«Reg.  4B,  Art.  10,3;  T.  D.  2929;   Repr.  33  Rev.,  Art.  KB;  T.  D.  2152; 

T    D.  2137. 

31  0    D.  344,  T.  B.  30-19-640. 

lo  A    p    R    'i3')    T    B.  .50-20-1349. 

»Reg   45    Art.'lT,7;  A.  R.R.mT.B.  44-21-1893. 


684  FEDERAL   INCOME   TAX 

depreciation  has  not  been  taken  in  prior  years  does  not  entitle 
the  taxpaj^er  to  deduct  in  any  taxable  year  a  greater  amount  for 
depreciation  than  would  otherwise  be  allowable."'^  Where  an 
individual  has  invented  certain  apparatus  and,  after  securing 
United  States  patents  thereon,  assigned  such  patents  to  a  foreign 
corporation  under  an  agreement  by  which  he  retained  40%  in- 
terest in  profits  therefrom,  legal  title  to  the  patents  passing  to 
the  corporation  subject  to  the  agreement  mentioned  and  his  in- 
terest being  recognized  by  the  corporation  and  by  the  United 
States  licensees  under  the  patents,  the  department  has  held  that 
the  agreement  should  be  recognized  as  giving  the  individual  a  de- 
preciable interest  in  the  patents.  The  value  of  each  patent  as  at 
March  1,  1913,  should  be  segregated  and  the  depreciation  allow- 
able thereon  determined  on  the  basis  of  its  own  life  instead  of 
using  as  a  basis  the  average  life  of  all  the  patents  and  the  value 
of  all  the  patents  in  bulk.  Of  the  total  depreciation  allowable 
for  any  year,  60  7^  is  deductible  in  the  return  of  the  company  and 
40%  in  the  individual's  return.-^j  An  author  may  not  value  a 
copyright  as  of  March  1,  1913,  by  estimating  the  future  royalties 
for  the  remaining  life  of  the  copyright  and  capitalizing  the 
amount  of  such  estimated  royalties.^'' 

Terms  of  Patents  and  Trade-Marks.  The  following  schedule 
of  the  terms  of  patents  and  trade-marks  in  various  countries 
has  been  published  by  the  treasury  department  for  the  informa- 
tion of  taxpayers:^' 

Country.  Term  of  Patent.  Term  of  Trade-mark. 

Great    Britaiu...      10  years.     Extended  from  14  years  14  years  renewable. 

by  act  of  Parliament,  1919. 

France    5,  10,  or  15  years  from  filing  of  ap-  15  years  renewable. 

plication. 

Germany    15  years  from  next  day  after  filing  10  years  renewaljle. 

Russia  ' 15    years 1  to  10. 

Canada     18    years General   unlimited ;    special   25 

years  renewable. 

Australia     14    years 14  years  renewable. 

Austria     15    years 10  years  renewable. 

Switzerland    10  years  for  chemical  process 20  years  renewable. 

15   years   from   filing 

Sweden    15   years   from   filing 10  years  renewable. 

Denmark    15    years 10  years  renewable. 

United    States ...      17    years 20  years  renewable. 

34  Reg.  45,  Art.  167;  A.  R.  M.  95,  T.  B.  47-20-1312;  T.  B.  R.  59,  T.  B. 
20-19-506. 

•■i">A.   R.  M.  34,  T.  B.  10-20-779. 

36  0.  D.  966,  T.  B.  27-21-1721. 

3T0.  D.  721,  T.  B.  45-20-1293.  The  duration  of  patent  rights  in  Great 
Britain  was  extended  from  14  to  16  years  in  1919  (see  9,  and  9  and  10,  Geo. 
V.  c.  80,  Chitty,  Annual  Statutes  1919,  p.  423).  No  corresponding  change 
seems  to  have  been  made  with  respect  to  trade-marks.  Important  patent 
legislation  is  now  pending  in  France  which  will  radically  change  the  exist- 
ing law  if  passed.  The  only  actual  change  in  duration  of  patents  and  trade- 
marks since  1909  in  the  countries  named  seems  to  have  been  in  Great 
Britain  as  indicated  above. 


DEPRECIATION,  OBSOLESCENCE  AND  AMORTIZATION  685 

Depreciation  of  Drawings  and  Models.  A  taxpayer  who 
has  incurred  expenses  in  his  business  for  designs,  drawings,  pat- 
terns, models,  or  work  of  an  experimental  nature  calculated  to 
result  in  improvement  of  his  facilities  or  his  product,  may  at  his 
option  deduct  such  expenses  from  gross  income  for  the  taxable 
year  in  which  they  are  incurred  or  treat  such  articles  as  a  capital 
asset  to  the  extent  of  the  amount  so  expended.  In  the  latter 
case,  if  the  period  of  usefulness  of  any  such  asset  may  be  es- 
timated from  experience  with  reasonable  accuracy,  it  may  be 
the  subject  of  depreciation  allowances  spread  over  such  esti- 
mated period  of  usefulness.  The  facts  must  be  fully  shown  in 
the  return  or  prior  thereto  to  the  satisfaction  of  the  Commis- 
sioner. Except  for  such  depreciation  allowances  no  deduction 
may  be  made  against  any  sum  so  set  up  as  an  asset  except  on  the 
sale  or  other  disposition  of  such  assets  at  a  loss  or  on  proof  of  a 
total  loss  thereof."'"'  Where  no  appraisal  has  been  made  on  or 
about  March  1,  1913,  the  value  of  drawings,  models,  tracings 
and  patterns  as  of  that  date  may  be  ascertained  by  taking  the 
reproduction  cost  on  March  1,  1913,  determined  from  data  in  the 
possession  of  the  taxpayer  less  depreciation  from  original  ac- 
quisition."-'-^ 

Capital   Sum   Returnable   Through    Depreciation    Allowances. 

The  capital  sum  to  be  replaced  by  depreciation  allowances  is  the 
cost  of  the  property  in  respect  of  which  the  allowance  is  made, 
except  that  in  the  case  of  property  acquired  by  the  taxpayer 
prior  to  March  1,  1913,  the  capital  sum  to  be  replaced  is  the  fair 
market  value  of  the  property  as  of  that  date.^'*  In  the  absence 
of  proof  to  the  contrary,  it  will  be  assumed  that  such  value  as 
of  March  1,  1913,  is  the  cost  of  the  property  less  depreciation  up 
to  that  date.^^  To  this  sum  should  be  added  from  time  to  time 
the  cost  of  improvements,  additions,  and  betterments,^-  the  cost 
of  which  is  not  deducted  as  an  expense  in  the  taxpayer's  return, 
and  from  this  sum  should  be  deducted  from  time  to  time  the 

SB  Reg.  45,  Art.  168. 

3»A.  R.  R.  272,  T.  B.  40-20-1223. 

•to  Revenue  Act  of  1921,  §§  214  (a)  8  and  234  (a)  7.  It  was  hold  in  early 
rulings  that  depreciation  could  only  be  claimed  on  the  basis  of  cost  whether 
or  not  the  property  was  acquired  prior  to  March  1,  1913  (T.  D.  2446), 
but  a  later  ruling?  recognized  the  principle  of  claiming  depreciation  on  the 
value  as  of  March  1,  1913,  if  the  property  was  acquired  prior  thereto  (T. 
D.  2754,  August  23,  1918).  Depreciation  must  be  based  on  actual  cost 
and  not  on  estimated  cost  as  shown  by  a  contract  (0.  D.  1019,  T.  B.  36-21- 
1800). 

41  T.  D.  2754. 

•iS  As  to  incidental  repairs  see  below. 


686  FEDERAL   INCOME   TAX 

amount  of  any  definite  loss  or  damage  sustained  by  the  property 
through  casualty,  as  distinguished  from  that  gradual  exhaustion 
of  its  utility  which  is  the  basis  of  the  depreciation  allowance. 
In  the  case  of  the  acquisition  after  March  1,  1913,  of  a  combina- 
tion of  depreciable  and  non-depreciable  property  for  a  lump 
price,  as,  for  example,  land  and  buildings,  the  capital  sum  to  be 
replaced  is  limited  to  that  part  of  the  lump  price  which  repre- 
sents the  value  of  the  depreciable  property  at  the  time  of  such 
acquisition.^3  The  replacement  value  of  property  can  not  be 
substituted  for  the  cost  of  the  property  as  the  cost  of  replacement 
at  a  time  some  years  in  the  future  is  a  speculative  figure  which 
can  not  be  used  as  a  basis  for  determining  an  annual  deprecia- 
tion charge.  The  depreciation  charge  will  replace  the  amount 
of  the  original  capital  outlay,  which  may  be  more  or  less  than 
adequate  to  replace  the  item  to  which  it  applies.  If  less  than 
adequate,  new  capital  must  be  provided  from  surplus  or  other- 
wise to  effect  the  replacement.^^ 

Where  the  lessee  of  real  property  erects  buildings,  or  makes 
permanent  improvements  which  become  part  of  the  realty  and 
income  or  loss  has  been  returned  by  the  lessor  as  a  result  thereof, 
the  capital  sum  to  be  replaced  by  depreciation  allowances  is  held 
to  be  the  same  as  though  no  such  buildings  had  been  erected  or 
such  improvements  made.^"*  Where  a  corporation  was  liquidated 
and  its  assets  transferred  to  a  partnership  organized  by  its 
stockholders,  the  allowance  for  depreciation  will  be  based  on  the 
cost  of  the  property  to  the  partners.  The  fair  market  value  of 
the  assets  as  of  the  date  of  liquidation  of  the  corporation  will  be 
held  to  be  the  cost  of  the  assets  to  the  stockholders,  who  as 
partners,  turned  them  over  to  the  partnership.  Such  fair  market 
value  as  of  the  date  of  liquidation  divided  by  the  estimated  life 
of  the  assets  from  that  date  will  constitute  the  annual  deprecia- 
tion allowance  of  the  partnership.^''  Where  ships  in  process  of 
construction  under  contract  were  requisitioned  by  the  Shipping 
Board,  completed,  and  then  reconveyed  to  the  company  from 
which  they  were  requisitioned  for  an  amount  in  excess  of  the 
contract  price  of  the  ships,  it  has  been  held  that  the  entire  cost 
of  the  ships  is  a  capital  expenditure  recoverable  by  allowances 
for  depreciation,  and  that  the  excess  of  the  cost  over  the  con- 
tract price  is  not  deductible  as  a  loss  or  a  business  expense.^'' 

4.''>  Reg.  45,  Art.  164. 

44  O.  D.  283,  T.  B.  21-19-524. 

43  Reg.  45,  Art.  164,  as  amended  by  T.  D.  3062,  T.  B.  37-20-1198. 

4C0.  D.  639,  T.  B.  34-20-1148. 

47  0.  D.  851,  T.  B.  12-21-1520. 


DEPRECIATION,  OBSOLESCENCE  AND  AMORTIZATION  687 

Method  of  Computins   Depreciation   Allowance.     The  capital 

sum  to  be  replaced  by  the  depreciation  allowance  should  be 
charged  off  over  the  useful  life  of  the  property  either  in  equal 
annual  installments  or  in  accordance  with  any  other  recognized 
trade  practice,'^  such  as  an  apportionment  of  the  capital  sum 
over  units  of  production.  Whatever  plan  or  method  of  apportion- 
ment is  adopted  must  be  reasonable  and  should  be  described  in 
the  return.^''  The  term  "useful  life"  is  interpreted  to  mean  the 
period  of  time  over  which  an  asset  may  be  used  for  the  purpose 
for  which  it  was  acquired.  In  the  case  of  a  new  building,  this 
period  starts  at  the  time  the  building  is  completed  and  capable 
of  being  used.  Buildings  under  construction  are  not  subject  to 
a  depreciation  allowance  for  income-tax  purposes."" 

Where  in  1914  the  United  States  government  took  over  a 
certain  business  from  a  corporation  and  held  it  until  March, 
1920,  at  which  time  it  was  returned  to  private  ownership  and 
in  1919  the  government  paid  to  the  corporation  a  sum  of  money 
representing  earnings  from  1914  to  April  6,  1917,  and  in  1920 
paid  a  further  sum  as  rental  from  April  6,  1917,  to  March,  1920, 
it  has  been  held  that  as  there  is  no  authority  in  the  law  for  off- 
setting against  income  received  in  one  year  losses  sustained  in 
a  prior  year  by  reason  of  depreciation,  only  such  depreciation 
as  has  been  sustained  during  the  taxable  periods  covered  by  the 
returns  may  be  claimed.''' 

MODIFICATION  OF  METHOD  OF  COMPUTING  DEPRECIATION  AL- 
LOWANCE. If  it  develops  that  the  useful  life  of  the  property 
has  been  underestimated,  the  plan  of  computing  depreciation 
should  be  modified  and  the  balance  of  the  cost  of  the  property,  or 
its  fair  market  value  as  of  March  1,  1913,  not  already  provided 
for  through  a  depreciation  reserve  or  deducted  from  book  value, 
should  be  spread  over  the  estimated  remaining  life  of  the  prop- 
erty. No  modification  of  the  method  should  be  made  on  account 
of  changes  in  the  market  value  of  the  property  from  time  to 
time,  such  as,  on  the  one  hand,  loss  in  rental  value  of  buildings 
due  to  deterioration  of  the  neighborhood,  oi',  on  the  other,  ap- 

■is  Claiming  depreciation  in  accordance  with  any  practice  other  than 
that  of  dividing  the  cost  by  the  useful  life  of  the  property  is  first  recog- 
nized in  this  ruling. 

40  Reg.  45„  Art.  165. 

•"'<'  O.  D.  845,  T.  B.  11-21-1510.  An  interesting  question  is  presented  as  to 
when  depreciation  may  first  be  taken  in  the  case,  for  instance,  of  a  plant 
the  construction  of  which  extends  over  a  long  period  of  time.  It  seem- 
clear  that  depreciation  may  be  taken  on  any  units  of  the  plant  from  the 
moment  they  are  put  in  use. 

51  0.  D.  948,  T.  B.  24-21-1687. 


688  FEDERAL  INCOME  TAX 

preciation  due  to  increased  demand.  The  conditions  affecting 
such  market  vakies  should  be  taken  into  consideration  only  so 
far  as  they  affect  the  estimate  of  the  useful  life  of  the  property .5- 
Inasmuch  as  under  the  provisions  of  the  Income  Tax  Acts  in 
effect  prior  to  the  Revenue  Act  of  1918  deductions  for  ob- 
solescence of  property  were  not  allowed  except  as  a  loss  for 
the  year  in  which  the  property  was  sold  or  permanently 
abandoned,  a  taxpayer  may  for  1918  and  subsequent  years  re- 
vise the  estimate  of  the  useful  life  of  any  property  so  as  to  allow 
for  such  future  obsolescence  as  may  be  expected  from  experience 
to  result  from  the  normal  progress  of  the  art.''"^ 

Annual  Allowances  Measured  by  Life  of  Property.  The  annual 
allowance  may  be  determined  by  dividing  the  cost  by  the  prob- 
able number  of  years  constituting  the  life  of  the  property,  the 
result  being  the  amount  which  may  be  deducted  annually.  The 
life  of  the  property  necessarily  depends  upon  its  character,  the 
use  to  which  it  is  put  and  the  conditions  under  which  it  is  used. 
These  elements  being  taken  into  consideration,  taxpayers  are 
expected,  as  a  result  of  experience  and  observation,  to  approx- 
imate very  closely  the  number  of  years  constituting  the  life  of 
the  property .5*  If,  after  property  has  been  used  for  a  certain 
purpose,  it  is  put  to  another  use  by  which  it  deteriorates  more 
rapidly  the  allowance  for  depreciation  may  be  increased  accord- 
ingly. In  estimating  the  life  of  the  property  it  is  assumed  that 
the  owner  will  make  such  repairs  and  renewals  as  are  necessary 
to  prevent  undue  deterioration.  In  the  case  of  a  building,  for 
instance,  depreciation  is  to  be  based  upon  the  life  of  the  building 
with  regard  to  the  number  of  years  the  building  will  remain  in 
a  condition  to  be  useful  for  the  purpose  for  which  it  was  con- 
structed and  is  used,  not  merely  the  number  of  years  it  will 
stand  without  being  condemned  and  torn  down.  In  determining 
the  life  of  the  building  it  is  assumed  that  the  owner  will  keep  it 
in  good  repair.'^s 

Where  a  taxpayer  by  order  of  an  insurance  company  is  obliged 
to  replace  boilers,  it  has  been  held  that  the  undepreciated  cost 
of  the  old  boilers,  less  their  salvage  value,  may  be  taken  as  a 
loss  for  the  taxable  year  in  which  the  old  boilers  were  scrapped. 
The  available  supply  of  timber  for  the  taxpayer's  mill  in  the 
above  case  is  estimated  to  last  five  years.  The  new  boilers  upon 
exhaustion  of  the  timber  supply  in  that  region  will  be  worth  in 

52  Reg.  45,  Art.  166;  Reg.  33  Rev.,  Art.  165. 

53  Reg.  45,  Art.  166,  as  amended  by  T.  D.  3061,  T.  B.  37-20-1192. 

54  T.   D.   2152. 

55  Cohen  v.  Lowe,  234  Fed.  474. 


DEPRECIATION,  OBSOLESCEN'CE   AND  AMORTIZATION  689 

a  new  location  considerably  less  than  the  cost  of  removal  and 
will,  therefore,  be  scrapped.  The  cost  of  the  new  boilers,  less 
salvage  value,  may  be  recovered  by  annual  deductions  spread 
over  the  five-year  period.  Proper  adjustment  must  be  made  in 
the  year  the  timber  supply  is  exhausted  and  the  mill  abandoned 
for  any  overestimate  of  the  timber  supply,  or  on  the  other  hand, 
any  underestimate  of  the  salvage  value  of  the  boilers.  All  bases 
for  depreciation  must  be  fully  described  in  the  schedules  at- 
tached to  the  returns  and  the  facts  submitted  must  substantiate 
the  depreciation  claimed."''' 

INCIDENTAL  REPAIRS  TO  PROPERTY  ON  WHICH  DEPRECIATION  IS 

Claimed.  Depreciation  is  not  to  be  confused  with  ordinar>'  re- 
pairs. It  is  intended  to  cover  the  estimated  lessening  in  value 
of  the  original  property,  if  any,  due  to  exhaustion,  wear  and  tear, 
decay,  or  gradual  decline  from  natural  causes,  inadequacy,  ob- 
solescence, etc.,  which  at  some  time  in  the  future  will  require  the 
abandonment  or  replacement  of  the  property  in  spite  of  ordinary 
current  repairs."  Ordinary  incidental  repairs  which  keep  the 
property  in  an  operating  condition  should  not  be  charged  to  de- 
preciation reserve;  their  cost  should  be  charged  to  expense.  A 
building  or  a  piece  of  machineiy  or  other  equipment,  as  a 
whole,  may  deteriorate  in  value  and  usefulness  by  reason  of 
wear  and  tear  regardless  of  the  fact  that  certain  minor  com- 
ponent parts  may  be  renewed,  restored  or  replaced.  The  depre- 
ciation deduction  contemplates  the  creation  of  a  fund  that  will 
renew,  restore  or  replace  the  original  property,  when  it  has 
become  worn  out  or  exhausted,  regardless  of  the  renewal  and 
restoration  of  parts  that  may  have  been  made  in  the  meantime. 
Hence,  in  addition  to  the  depreciation  deduction,  the  expense  of 
incidental  repairs  which  do  not  add  to  the  value  of  the  property, 
but  merely  keep  it  in  operating  condition,  and  arrest  deteriora- 
tion, should  be  deducted  as  expense  in  the  year  in  which  the  re- 
pairs are  made."'^  Thus,  the  lessee  of  a  street  railway,  required 
under  the  lease  to  return  the  leased  property  at  the  expiration 
of  the  lease  in  as  good  condition  as  when  received,  may  not  take 
deductions  for  depreciation."''* 

Renewals  to  Property.  It  is  possible  in  some  instances  that 
worn  out  parts  of  a  machine  or  similar  equipment  may  be  re- 
newed, one  after  another,  until  the  original  machine  or  equip- 

5fiO.  D.  871,  T.  B.  15-21-1562. 

57  San  Francisco  Co.  v.  Scott,  253  Fed.  854. 

58  Reg.  45,  Art.  103.  Letter  from  treasury  department  dated  September 
19,  1916;  L  T.  S.  1918,  111467;  Reg.  33  Rev..  Art.  131. 

50  0.  D.  ,1014,  T.  B.  35-21-1794. 


690  FEDERAL  INCOME   TAX 

merit  is  swallowed  up  in  the  renewed  parts.  The  machine  or 
equipment  is  then  in  as  good  operating  condition  as  it  was  orig- 
inally. In  such  cases,  if  the  cost  of  renewed  parts  is  charged  to 
operating  expense,  no  deduction  on  account  of  depreciation 
fhould  be  claimed  as  to  such  machine  or  equipment.  And  on  the 
other  hand,  if  a  reserve  is  set  up  to  cover  property  which  may 
be  renewed  or  restored  part  by  part  until  the  whole  is  renewed, 
the  cost  of  the  renewed  part  should  be  charged  to  the  deprecia- 
tion reserve  fund  and  not  to  expense.'''^ 

It  has  been  held  under  the  1909  Law  that  a  railway  company 
was  not  entitled  to  deduct  an  amount  for  depreciation  where  by 
reason  of  repairs,  renewals  and  replacements  the  company  "had 
made  good  the  normal  amount  of  depreciation"  and  at  the  end 
of  the  years  in  question  the  road  was  in  normal  condition  to 
carry  on  its  business.  It  was  held  that  the  condition  of  the  road 
as  a  whole  should  be  looked  to  and  while  there  had  been  de- 
preciation in  various  units  of  the  property,  this  depreciation 
was  offset  by  the  repairs,  renewals  and  replacements  which  main- 
tained the  road  throughout  the  years  in  question  in  fully  as  good 
condition  and  at  fully  as  great  intrinsic  value  as  at  the  be- 
ginning of  the  respective  years.**! 

Additions  and  Betterments.  Amounts  expended  in  additions 
and  betterments  or  for  furniture  and  fixtures,  which  constitute 
an  increase  in  capital  investment  and  add  to  the  value  of  the 
assets,  are  not  a  proper  deduction  as  expense,  but  such  expendi- 
tures when  capitalized  may  be  extinguished  through  annual  de- 
preciation deductions,  which  latter  deductions  will  be  computed 
upon  the  basis  of  the  cost  and  probable  life  of  the  property .''- 

Rate  of  Depreciation.  The  annual  allowance  for  depreciation, 
is  required  by  law  to  be  "reasonable."  No  fixed  rates  are  pre- 
scribed. The  rule  which  has  been  established  contemplates  that 
the  taxpayer  may  determine  his  annual  deduction  by  dividing 
the  cost  of  the  property  or  the  fair  market  price  or  value  as  of 
March  1,  1913,  if  acquired  prior  thereto,  by  the  probable  number 
of  years  constituting  its  life,  in  the  manner  indicated  above,  the 
result  being  the  amount  which  may  be  deducted  annually .^'^    De- 

'>(>  Letter  from  treasury  department  dated  September  19,  1916;  I.  T.  S. 
1918,  111467. 

01  Nashville,  Chattanooga  &  St.  Louis  Ry.  Co.  v.  U.  S.,  269  Fed.  351. 

•■'-•Reg.  45,  Art.  164;  Reg.  33  Rev.,  Art.  132. 

<«Reg.  45,  Art.  161;  Reg.  33  Rev.,  Art.  162;  T.  D.  2152.  A  collector  who 
told  taxpayers  in  his  district  that  the  amount  of  depreciation  on  frame  build- 
ings was  limited  to  3%,  and  in  case  of  brick  buildings  to  2%,  was  informed 
by  the  Commissioner  that  while  these  rates  might  not  be  far  from  a  reason- 


DEPRECIATION,  OBSOLESCENCE  AND  AMORTIZATION  BA 1 

preciation  may  also  be  claime.l  in  aecrciance  with  ^^  "^^^  r^^^^^ 
ognized  trade  practice,  such  as  an  apportionment  of  the  capital 
sum  over  units  of  production."* 

DEPRECIATION  OF  APARTMENT  HOUSES.  In  the  case  01  an  apart- 
ment house  the  court  has  held  that  where  the  government  al- 
tow^d  3  of  the  cost  as  annual  depreciation,  the  burden  was  on 
the  owner  to  Tow  that  this  amount  was  too  small,  the  court  con- 
siderinff  the  rate  to  be  reasonable  in  this  case.'" 

DEPRECirTiON  OF  STEAMERS.    In  a  case  involving  the  deprecia- 
lion  ot  aXamer  it  has  been  conceded  that  5' ;  of  the  book  value 
her^f  whTcn^uUl  contemplate  a  life  of  20  years,  was  a  r«>- 
sonXle  deduction.'"-'    In  the  case  of  some  ships  constructed  du.ng 
the trr  there  seems  to  be  a  tendency  to  allow  even  a  greater  .ate 
of  depre  iation  on  the  theory  that  the  useful  life  will  be  less  than 
tweny  years     Three  per  cent,  has  been  held  to  be  a  reasonable 
aUowance  for  depreciation  of  bulk  freight  steamships  on  the 
Creat  Lakes    however,  when  due  to  peculiar  conditions,  it  can 
be  definitely  determined  that  the  established  rate  of  deprecation 
wilt  no  be  sufficient  to  return  all  of  the  capital  -v-  ed  a   at  th 
date  of  acquisition  or  March  1,  1913,  whichever  is  latei,  by    he 
fme  thriessel  will  be  rendered  ^-^'^  ^-eTZ:  Zo^n 
remilar  rate  to  cover  obsolescence  may  be  allowed.    The  amouiu 
If  afs  adl^t  on  must  be  determined  upon  the  basis  of  the  fact. 
t  each  particular  case-that  is,  the  type  of  the  vessel  in  que.s- 
ton  the  fi  ness  for  possible  use  in  other  lines  of  transporta  ion. 
and'the  date  when  it  can  be  definitely  foreseen  that  she  wiU  be 
no  longer  commercially  useful  in  this  particular  line  of  traffic. 
This  ™      do^s  not  n^essarily  apply  to  steamers  engaged  in 

.should  not  be  considered  as  the     l'">t'     "^'"^  '  ,    „„,^  „,.  less  than 

eonstitutin,  '--e  Me  0^  the  b.,W,n.  ...       ^^^^^^^.^^  „„,  ,,,  ,.,,. 
the  figures  stated.     (Letter  t»o""J'^^;  J^       \,  ^^  ^  telephone  com- 

I.  T.  S.  1918,  ^  1496.)      It  has  been  held  jj^^  ^"^^^j;  ^^^^  ^   ,He  plant 
pany  that  the  average  life  of  the  co.b.ned  ele- -  ^^^^  \.,,,,.,,,e 

is  about  14  years  and   that  the  ^^^e  «i   Q  P  ^  ^^,.,^^,1  Tel.  &  Tel. 

against  the  value  of  the  plant  as  a  whole  is  7  /r.     (Cumbei 
Co.  V.  Louisville,  187  Fed.  637,  654.) 

•14  Reg.  45,  Art.  165.     See  note  48. 

or.  Cohen  v.  Lowe,  234  Fed.  474. 

rr,  San  Francisco  Co.  v.  Scott,  2.53  Fed.  8o4. 

•w  A.  R.  R.  27,  T.  B.  9-20-773. 


692  FEDERAL   INCOME   TAX 

the  proper  annual  rate  of  depreciation  on  steam  schooners  en- 
gaged in  the  coastwise  lumber  trade  is  5%,  based  upon  an  ex- 
pected life  of  20  years/''* 

Extraordinary  Depreciation.  When  delicate  machinery 
designed  for  the  manufacture  of  a  certain  product  is  used  in 
manufacturing  a  product  of  much  coarser  materials  for  which 
use  it  is  not  fitted,  and  is  operated  at  a  heavy  overload  of  its 
normal  capacity,  the  owner  is  entitled  to  deduct  from  gross 
income  an  amount  representing  extraordinary  depreciation.*^'-^ 
Where  physical  equipment  of  oil  wells  is  subjected  to  deprecia- 
tion from  sulphur  water  in  coal  mines  in  the  immediate  vicinity, 
it  has  been  held  that  this  condition  is  abnormal  and  a  deprecia- 
tion rate  of  10%  was  allowed.™ 

Factories  Running  Night  Shifts.  When  machinery  and 
equipment  are  operated  more  than  the  usual  number  of  working 
hours,  a  greater  rate  of  depreciation  may  be  applied  in  determin- 
ing the  annual  exhaustion,  wear  and  tear  sustained  than  would 
be  permitted  in  the  case  of  machinery  normally  operated  only 
eight  or  nine  hours  a  day.  No  definite  rulings  have  been  made 
as  to  the  amount  by  which  depreciation  may  be  increased  on 
this  account.  Each  case  is  considered  in  connection  with  all  the 
facts  and  figures  relative  thereto. 'i 

Annual  Allowance  Must  Be  Charged  Off  on  Books.  A  depre- 
ciation allowance,  in  order  to  constitute  an  allowable  deduction 
from  gross  income,  must  be  charged  off.  The  particular  manner 
in  which  it  shall  be  charged  off  is  not  material,  except  that  the 
amount  measuring  a  reasonable  allowance  for  depreciation  must 
be  either  deducted  directly  from  the  book  value  of  the  assets  or 
preferably  credited  to  a  depreciation  reserve  account,  which 
must  be  reflected  in  the  annual  balance  sheet.  A  journal  entry 
alone  is  not  sufficient.'^-  The  allowances  should  be  computed  and 
charged  off  with  express  reference  to  specific  items,  units  or 
groups  of  property,  each  item  or  unit  being  considered  separately 
or  specifically  included  in  a  group  with  others  to  which  the  same 
factors  apply.  The  taxpayer  should  keep  such  records  as  to  each 
item  or  unit  of  depreciable  property  as  will  permit  the  ready 
verification  of  the  factors  used  in  computing  the  allowance  for 

08  A.  R.  R.  279,  T.  B.  42-20-1245. 
60  A.  R.  R.  45,  T.  B.  16-20-862. 

70  A.  R.  R.  570,  T.  B.  37-21-1818. 

71  Letter  from  treasury  department  dated  July  12,  1918;  I.  T.  S.  1921, 
11  1486. 

7ii  Letter  from  treasury  department  dated  May  18,  1916;  I.  T.  S.  1918, 
T11591. 


DEPRECIATION.   OBSOLESCENCE   AND  AMORTIZATION  693 

••J 

each  year  for  each  item,  unit  or  group. '•=  This  charging  off  of 
the  depreciation  allowance  is  required  in  order  to  insure  that  the 
returns  of  the  taxpayer  are  in  accord  with  his  books  of  account 
and  in  order  that  error  and  fraud  with  respect  to  the  facts  may 
be  prevented.  The  statute  is  not,  however,  to  be  considered  as 
requiring  that  depreciation,  depletion  and  other  losses  be 
charged  off  within  the  taxable  year.  It  is  sufficient  that  they  are 
charged  off  before  they  are  allowed  as  deductions.  Consequently 
the  taxpayer  may  at  any  time  reopen  his  books  and  charge  off 
depreciation  which  he  actually  sustained  during  the  taxable  year. 
If  the  books  are  reopened  for  this  purpose,  corresponding  cor- 
rections must  be  made  in  the  other  book  entries  and  if  for  any 
reason  the  facts  do  not  warrant  such  other  charges  it  will  bo 
held  that  the  depreciation  can  not  be  charged  off  and  therefore 
can  not  be  allowed  as  a  deduction.  For  example,  if  by  reason 
of  a  distribution  of  earnings  there  is  nothing  from  which  to 
credit  a  reserve  for  depreciation  no  allowance  for  depreciation 
can  be  credited  to  a  depreciation  resen-e  account.''  It  has 
been  held,  however,  that  in  computing  the  taxable  net  income  of 

73  Reg.  45,  Art.  169 ;  letter  from  treasury  department  dated  September  19, 
1916;  I.  T.  S.  1918,  111467;  Reg.  33,  Art.  130;  Reg.  33  Rev.,  Art.  159;  letter 
from  treasury  department  dated  February  12,  1915;  I.  T.  S.  1918,  T;  1526. 
Neither  the  1909  Law  nor  the  1913  Law  required  that  in  order  to  secure  a 
deduction  for  depreciation  the  amount  claimed  should  be  written  off.  It  was, 
nevertheless,  held  by  the  treasury  department  that  a  depreciation  deduction. 
in  order  to  be  allowable  must  be  so  entered  upon  the  books  of  a  corporation 
as  to  constitute  a  liability  against  its  assets.  (Letter  to  collectors  dated 
August  27,  1914;  L  T.  S.  1918,  ^  1483.)  In  a  later  ruling  it  was  held  that, 
under  these  acts  the  writing  off  of  depreciation  would  not  be  insisted  upon 
in  the  adjustment  of  returns  filed  for  the  years  1909  to  1915  inclusive.  (T.  D. 
2481,  dated  April  10,  1917.)  In  the  meantime  the  courts  had  held,  under  the 
1909  Law,  that  the  contention  that  no  allowance  for  depreciation  could  be 
claimed  unless  entered  on  the  books  of  the  company,  recorded  from  time  to 
time,  was  without  force  (U.  S.  v.  Nipissing  Mines  Co.,  202  P^ed.  803  reversed 
in  part  on  jurisdictional  grounds,  206  Fed.  431)  and  that  the  fact  that  a 
deduction  was  incorrectly  carried  on  the  books  in  surplus  account  did  not 
justify  the  government  in  disallowing  it.  (Forty-Fort  Coal  Co.  v.  Kirken- 
dall,  233  Fed.  704.)  The  Supreme  Court  of  the  United  States  declined,  in 
Strattons'  Independence  v.  Howbert,  (231  U.  S.  399)  to  answer  the  question 
as  to  whether  or  not  a  book  entry  was  necessary,  since  the  question  was  not 
properly  brought  before  the  court  in  that  case. 

"^  Letter  from  treasury  department  dated  June  25,  1919;  I.  T.  S.  1918, 
^i2115;  A.  R.  R.  377,  T.  B.  5-21-1415.  The  1916  Law  did  not  expressly  re- 
quire individuals  to  enter  on  their  books  the  annual  allowance  for  depre- 
ciation but  with  respect  to  domestic  corporations  it  expressly  provided  that 
all  losses,  including  the  allowance  for  depreciation,  must  be  "charged  off" 
within  the  year.  Revenue  Act  of  1916,  §§  5  (a),  6  (a),  12  (a).  12  (b).  As 
to  foreign  corporations  the  law  was  silent. 


694  FEDERAL   INCOME   TAX 

a  corporation,  it  can  not  be  denied  a  deduction  on  account  of  de- 
preciation actually  sustained  and  charged  off,  even  though  after 
paying  dividends  there  remains  an  amount  of  surplus  and  earn- 
ings insufficient  to  cover  depreciation ;  and  that  in  such  case  the 
book  value  of  the  assets  must  be  reduced  by  an  amount  equal  to 
the  difference  between  the  amount  of  the  depreciation  actually 
sustained  and  charged  off  and  the  amount  of  the  earnings  and 
surplus  available  for  depreciation  at  the  end  of  the  taxable 
period.'''^ 

Reserves  for  Depreciation.  In  early  rulings  it  was  held  that 
depreciation  set  up  on  the  books  and  deducted  from  gross  in- 
come could  not  be  used  for  any  purpose  other  than  making  good 
the  loss  sustained  by  reason  of  the  wear  and  tear  or  exhaustion 
of  the  property ;  and  that  if  any  portion  of  the  depreciation  set 
up  was  diverted  to  any  purpose  other  than  making  good  the  loss 
sustained  by  reason  of  such  depreciation  the  amount  would  be 
disallowed.  It  was  also  held  that  the  investment  of  deprecia- 
tion reserve  funds  in  additions,  betterments  and  improvements 
was  not  contemplated  by  the  law.'^*''  The  present  ruling  holds 
that  the  allowance  for  depreciation  is  to  be  credited  to  an  ap- 
propriate reserve  account  and  be  carried  as  a  liability  against 
the  assets,  to  the  end  that  when  the  total  of  these  credits  equals 
the  capital  investment  account  no  further  deductions  will  be 
allowed.  There  is  no  requirement  of  law  that  the  funds  repre- 
sented by  these  reserve  liabilities  shall  be  held  intact  or  remain 
idle  against  the  day  when  they  may  be  used  in  making  good  the 
depreciation  of  the  property  with  respect  to  which  the  deduction 
is  claimed,  or  in  restoring  the  capital  investment  in  the  depleted 
assets.  The  depreciation  reserve  may  be  invested  in  assets  of 
any  kind." 

Closing  Depreciation  Account  as  to  Any  Item.  If  the  use  of 
any  property  in  the  business  is  permanently  discontinued,  al- 
though no  sale  or  other  disposition  of  the  property  has  taken 

75  A.  R.  M.  112,  T.  B.  10-21-1497. 

70  Reg.  33,  Arts.  132  and  133;  T.  D.  2137. 

77  T.  D.  2481.  It  was  stated  in  Revised  Regulations  No.  33  as  follows: 
"Depreciation  set  up  on  the  books  and  deducted  from  gross  income  can  not 
be  used  for  any  purposes  other  than  in  making  good  the  loss  sustained  by 
reason  of  the  wear  and  tear  of  the  property  with  respect  to  which  it  is 
claimed.  If,  however,  an  investment  is  made  in  extensions,  additions,  or 
betterments  of  the  company's  own  property,  representing  a  part  or  the  whole 
of  the  credit  balance  of  the  depreciation  reserve  account,  such  investment 
will  not  be  considered  a  misuse  or  diversion  of  the  depreciation  deduction 
otherwise  allowable."  (Reg.  33  Rev.,  Art.  164.)  The  language  used  in  the 
text  above  seems,  however,  to  be  a  sounder  statement  of  the  law. 


DEPRECIATION,  OBSOLESCENCE  AND  AMORTIZATION 


G95 


place,  a  determination  of  any  gain  or  loss  may  be  made;  Ijut  any 
deduction  in  respect  of  any  loss  thereon  must  be  disclosed  .n  the 
taxpayer'*^  retun,  for  the  year  in  which  the  determmat.on  is 
made  and  a  full  statement  of  the  facts  and  the  basis  »P""  -h.^h 
the  computation  is  calculated  must  be  attached  to  the  return. 
UponTsale  or  other  disposition  of  the  property,  the  considei^- 
tion  received  should  be  compared  with  the  amount  of  the  est - 
mated  salvage  value  used  in  computing  the  gam  or  loss  as  above 
rrovTded,  and  the  amount  of  the  difference  should  be  treated  a 
a  gain  oi'  loss,  as  the  case  may  be,  of  the  year  m  which  the  sale 
or  other  disposition  took  place."     Where  a  taxpayer  engaged 
in  distilling  has  claimed  a  deduction  for  loss  in  1917  due  to  the 
abandonment  of  the  business  through  operation  ot  law  part  o 
such  loss  being  disallowed  by  the  department  but  a  subsequent 
sale  in  1918  conclusively  establishing  the  reasonableness  of  the 
deduction  it  has  been  ruled  that  the  taxpayer  may  be  allowed  to 
deduct  for  1917  the  amount  claimed,  his  1918  deduction  being 
correspondingly  reduced.'-^ 

Obsolescence.    The  Revenue  Act  of  1921,  like  the  former  law, 
provides  that  the  deduction  permitted  to  individuals  <"•  ^'Poy^" 
tions  for  the  exhaustion,  wear  and  tear  of  property  used  m  t.ade 
or  business,  may  include  "a  reasonable  ^-"o-^"-.^*- ."''if  ;; 
cence  "^    Obsolescence  is  that  loss  which  occurs  m    espect  ol 
tangible  property  from  the  changes  due  to  the  normal  progress 
of  the  Jt  in  wJch  such  property  may  be  used,  or  to  becoming 
inadequate  to  the  growing  needs  of  the  b"«'™ss,  >    This  defini. 
tion  however,  seems  to  be  incomplete  and  does  not  take  into  con- 
sideration classes  of  property  such  as  buildings,  which  may  be- 
come obsolete  for  the  purposes  for  which  they  were  er  e  ed     A 
taxoaver  who  in  computing  depreciation  allowances  in  letuu  , 
for  yeai  prior  to  1918  has  not  taken  ordinary  obsolescence  into 
ons'derat^n  may,  for  the  year  1918  and  -b-^l-f  J--',    ^ 
vise  the  estimate  of  the  useful  life  of  any  property  so  as  to  allo« 
for  such  t'ture  obsolescence  as  may  be  expected  fron,  experience 
to  result  from  the  normal  progress  of  the  art  or  the  grown,,, 
needs  of  the  business.s- 

78  Reg.  45,  Art.  170. 

:L'l;^er„  ".^"^"u  (a,  S  a,„.  .3.  U.  .  H.enue  A.  „I  I.S, 

'''.V:M  7nZ!%:.  Chaple,.  ...  .■...•  a  ,i..us.o„  of  "I-o..  ot  Usetu, 

Value." 

82  Reg.  45,  Art.  166. 


696  FEDERAL  INCOME   TAX 

No  amount  may  be  charged  off  in  any  year  in  anticipation  of 
obsolescence  of  a  building  which  may  become  obsolete  5  or  10 
years  later.  However,  a  certain  amount  of  obsolescence  may  be 
claimed  from  the  time  that  it  becomes  certain  that  at  a  definite 
future  date  the  building  will  be  obsolete.  The  figure  represent- 
ing obsolescence  should  be,  approximately,  the  difference  be- 
tween the  fair  market  value  of  the  building  as  of  March  1,  1913, 
or  its  cost  if  acquired  after  that  date,  less  depreciation,  and  the 
estimated  salvage  value.  This  obsolescence  should  be  spread 
over  the  period  from  the  time  such  obsolescence  becomes  certain 
until  the  building  becomes  obsolete  and  should  be  claimed  in 
those  years.  For  instance,  the  fair  market  value  of  a  building 
March  1,  1913,  was  $30,000.  Its  depreciated  value  December 
31,  1918,  was  represented  by  $18,000,  and  its  estimated  salvage 
value  will  be  $5,000  in  1920.  At  that  time  (December  31,  1918) 
it  was  definitely  determined  and  certain  that  in  1920  the  build- 
ing would  have  to  be  torn  down  and  rebuilt,  due  to  its  inade- 
quacy to  meet  the  growing  needs  of  the  industry  it  housed.  The 
difference  between  the  depreciated  value  December  31,  1918, 
namely,  $18,000,  and  its  estimated  salvage  value  of  $5,000,  rep- 
resents obsolescence.  This  amount  of  $13,000  should  be  spread 
over  the  years  covering  the  period  1919  and  1920  and  deductions 
claimed  accordingly  for  those  years.  In  cases  where  obsolescence 
is  claimed  it  must  be  supported  by  facts  which  will  enable  the 
Commissioner  to  determine  whether  such  claim  is  proper  and 
allowable.^'^ 

It  has  been  held  that  a  shipbuilding  company  is  not  entitled  to 
a  deduction  for  obsolescence  of  its  plant  where  it  sells  such  plant 
at  less  than  its  book  value  because  of  failure  to  obtain  ship- 
building contracts.  In  the  case  in  which  this  ruling  was  made, 
the  company  had  owned  shipbuilding  plants  for  many  years  and 
during  1917  and  1918  had  greatly  enlarged  its  plants  for  the 
purpose  of  building  ships  for  the  United  States  Shipping  Board. 
After  the  war  the  company  found  itself  unable  to  obtain  con- 
tracts and  sold  its  plants  at  a  loss.  Proper  allowance  had  been 
taken  in  its  returns  for  amortization  of  its  war  facilities.  The 
loss  actually  sustained  should  be  deducted  as  a  loss  arising  from 
sale  and  would  be  reflected  in  the  company's  return  for  the  tax- 
able year  in  which  the  property  was  sold.^* 

83  O.  D.  381,  T.  B.  4-20-704. 

84  0.  D.  753,  T.  B.  51-20-1353. 


DEPRECIATION,  OBSOLESCENCE  AND  AMORTIZATION  697 

In  1910  the  docks  and  the  larger  harbors  along  the  Great 
Lakes  were  greatly  enlarged  and  improved  so  that  only  vessels 
of  10,000  tons  capacity  or  larger  could  be  conveniently  or  eco- 
nomically accommodated.  As  a  result  of  this  condition  the 
larger  and  newer  type  of  vessels  could  carry  freight  at  a  cheaper 
rate  than  the  5,000  ton  vessels  previously  generally  in  use  and 
began  at  that  time  to  displace  the  smaller  types.  A  great  num- 
ber of  these  smaller  vessels  built  in  1910  were  abandoned  by  the 
end  of  1921.  Their  salvage  value  was  estimated  at  20'  i .  Since 
prior  to  the  Act  of  1918,  there  was  no  provision  in  the  Income 
Tax  Acts  for  deduction  on  account  of  loss  due  to  obsolescence 
and  obsolescence  was  only  taken  care  of  by  an  allowance  for 
"loss  of  useful  value"  deductible  only  in  the  year  in  which  the 
property  was  sold  or  permanently  abandoned,  it  has  been  held 
that  any  loss  on  the  5,000  ton  vessels  due  to  obsolescence  should 
be  spread  over  the  period  from  1910  to  the  date  of  abandonment 
and  that  only  that  portion  of  such  obsolescence  which  accrued 
subsequent  to  January  1,  1918,  can  be  taken  in  returns  for  1918 
and  subsequent  years.  Any  further  loss  not  taken  care  of  by 
depreciation  and  obsolescence  and  not  compensated  for  by  insur- 
ance or  otherwise,  may  be  taken  in  the  year  in  which  the  vessels 
are  sold  or  scrapped.^^ 

Obsolescence  Under  1916  Law.  The  position  taken  by  the 
treasury  department  under  the  1916  Law  was  that  obsolescence 
was  not  contemplated  by  the  provision  of  the  law  relating  to 
depreciation,  and  that  no  other  provision  of  the  law  permitted 
an  annual  allowance  with  respect  thereto,  since  neither  the  time 
when  property  may  become  obsolete  nor  the  loss  when  the  stage 
of  obsolescence  is  reached,  can  be  determined  in  advance  with 
any  degree  of  certainty .'^•^  The  deduction  for  depreciation  was 
limited  to  the  creation  of  a  reserve  fund,  out  of  which  the  loss 
due  to  use,  wear,  and  tear  might  be  compensated.  It  was  not 
considered  possible  to  determine  in  advance  when  a  piece  of  ma- 
chinery, equipment  or  even  a  building  would  become  obsolete 

85  Sol.  Op.  114,  T.  B.  31-21-1752. 

so  In  earlier  rulingrs,  the  treasury  department  held  that  depreciation  ap- 
plied to  intangible  property,  subject  to  wear  and  tear,  exhaustion  or  obso- 
lescence (Reg.  33,  Art.  129;  T.  D.  2005;  T.  D.  2077;  T.  D.  2090).  In  San 
Francisco  Co.  v.  Scott,  253  Fed.  854,  a  case  arising  under  the  1909  Law, 
which  permitted  the  deduction  of  "losses  ♦  *  *  including  a  reasonable 
allowance  for  depreciation,  if  any,"  the  court  held  that  depreciation,  as  used 
in  that  law,  was  intended  to  cover  the  estimated  lessening  in  value  of  the 
original  property,  if  any,  due  to  wear  and  tear,  decay  or  gradual  decline 
from  natural  causes,  inadequacy,  and  "obsolescence." 


698  FEDERAL  INCOME  TAX 

and  the  treasury  department  held  that  since  obsolescence  could 
not  be  anticipated,  an  annual  deduction  would  not  be  permitted 
to  provide  therefor.'^''  Losses  on  account  of  obsolescence  of  phys- 
ical property  were  permitted  under  the  1916  Law,  however,  as  a 
deduction  under  the  heading  of  loss,  provided  their  amount  had 
been  recorded  in  the  books  following  the  condemnation  and  with- 
drawal from  use  of  the  obsolete  property.  The  amount  o7  obso- 
lescence was  ascertained  by  deducting  from  the  cost  of  the  prop- 
erty the  sum  of  (a)  the  total  amount  that  had  been  previously 
deducted  on  account  of  the  depreciation  of  the  property,  and  (b) 
its  residuary  value  at  the  time  of  obsolescence,  or  (c)  the  amount 
received  from  the  sale  of  the  property.  The  obsolescence  deduc- 
tion could  not  include  the  accumulated  depreciation  applicable  to 
prior  years.^^  If  no  depreciation  had  been  charged  off  on  ac- 
count of  the  property  in  respect  of  which  obsolescence  was 
claimed  from  the  gross  income  of  prior  years,  the  amount  allow- 
able as  a  deduction  for  the  year  in  which  the  property  became 
obsolete  was  ascertained  by  deducting  from  the  cost  of  the  prop- 
erty the  sum  of  (a)  its  residuary  value  and  (b)  an  amount  equal 
to  the  depreciation  actually  sustained  during  the  prior  period, 
which  might  have  been  deducted  when  computed  at  the  rate  ap- 
plicable to  the  same  or  similar  property.  The  amount  of  depre- 
ciation thus  arrived  at,  as  applicable  to  former  years,  might  be 
made  the  basis  of  amended  returns,  and  a  claim  for  a  refund  of 
taxes  overpaid,  by  reason  of  the  fact  that  no  depreciation  deduc- 
tion was  claimed  in  such  years,  might  be  made.'^^ 

Obsolescence  of  Intangible  Property.  Obsolescence  is  not 
ordinarily  applicable  in  the  case  of  intangibles,  but  will  be  al- 
lowed in  exceptional  cases,  as  in  the  case  of  the  discontinuance 
of  a  going  business  because  of  the  exhaustion  of  its  source  of 
supply,  where  the  cost  of  the  good  will,  or  its  value  as  of  March 
1,  1913,  if  acquired  prior  to  that  date,  can  be  definitely  shown 
and  the  period  of  its  obsolescence  determined  with  reasonable 
accuracy.  To  sustain  a  claim  for  deduction  for  obsolescence  of 
good  will,  it  must  be  shown  that  the  good  will  will  be  of  no  value 
at  the  close  of  an  approximately  definite  period,  and  that  the 
taxpayer  will  be  forced  to  discontinue  the  business  and  be  unable 
to  continue  in  any  similar  business.  An  allowance  for  obsoles- 
cence of  good  will  will  be  made  only  in  connection  with  such  good 

87  Letter  from  treasury  department  dated  September  19,  1916;  I.  T.  S. 
1918,  U  1467. 

88  Reg.  33  Rev.,  Art.  178. 

89  Reg-.  33  Rev.,  Arts.  162  and  179. 


DEPRECIATION,  OBSOLESCENCE   AND  AMORTIZATION  699 

will  as  is  assignable,  as  distinguished  from  good  will  attaching 
to  individuals  owning  or  conducting  a  business,  or  to  the  premises 
at  which  it  is  or  was  conducted;  and  no  allowance  for  obsoles- 
cence will  be  granted  in  any  case  where,  in  connection  with  the 
operation  of  the  business,  the  good  will  will  be  valuable  in  an- 
other business  after  the  termination  of  the  business  in  which  the 
taxpayer  is  engaged.  A  corporation  engaged  in  the  business  of 
sampling  ores  is  entitled  to  a  deduction  for  obsolescence  not  only 
of  its  plant  and  equipment,  but  for  value  of  good  will  existing 
and  having  a  definitely  established  value  as  of  March  1.  1913,  or 
acquired  thereafter  by  capital  outlay,  if  it  can  be  shown  that  the 
plant  and  equipment  will  be  useless  and  the  good  will  of  no  value 
at  the  close  of  an  approximately  definite  period  by  i'eason  of  ex- 
haustion of  the  ores  on  which  its  business  depends.'"'  An  in- 
ventor of  a  war  device,  which  undoubtedly  had  a  large  value  on 
January  1,  1918,  when  the  war  was  on  in  full  force,  has  been  held 
not  entitled  to  claim  a  deduction  for  depreciation  and  obsolescence 
based  on  the  value  of  the  intangible  property  as  of  that  date  and 
on  December  31,  1918,  after  the  signing  of  the  armistice,  when 
it  is  claimed  it  had  a  very  small  value.''' 

Obsolescence  in  the  Case  of  Distillers,  Dealers  in  Liquor,  etc.  It 
was  first  ruled  by  the  treasury  department  that  a  reasonable 
allowance  for  obsolescence  of  good  will,  trade-marks  and  trade 
brands,  the  value  of  which  has  been  impaired  or  destroyed  by 
prohibition  legislation,  might  be  taken  by  distillers  and  dealers  in 
liquor  against  earnings  between  November  21,  1918,  the  date 
upon  which  the  Agricultural  Appropriation  Act,  providing  for 
war-time  prohibition  was  enacted,  and  July  1,  1919,  the  date  upon 
which  war-time  prohibition  became  effective.  The  latter  date 
was  subsequently  changed  to  January  16,  1920.  as  stated  below. 
To  sustain  a  claim  for  a  deduction  for  obsolescence  in  respect  of 
good  will,  trade-marks,  or  trade  brands,  the  taxpayer  must  show 

!"'  O.  D.  472,  T.  B.  17-20-884. 

'•'I  T.  B.  M.  39.  T.  B.  7-19-291.  It  is  not  clear  whether  obsolescence  was 
disallowed  in  this  case  on  the  ground  that  the  cost  of  the  patents,  or  their 
fair  market  value  on  March  1,  1913,  did  not  exceed  their  value  at  the  end 
of  1918,  their  value  having  merely  appreciated  during  the  war,  or  on  the 
ground  that  the  ending  of  the  war  failed  definitely  to  pi-ove  their  obsolescence. 
It  would  seem  that  obsolescence  of  patents  should  be  allowed  in  many  caser, 
as  a  result  of  the  ending  of  the  war  if  it  can  be  definitely  shown  that  as  a 
result  thereof  substantial  contracts  were  cancelled  or  the  patents  otherwise 
lost  their  value  in  whole  or  in  part  at  the  time  of  the  armistice.  In  other 
words,  while  the  ending  of  the  war  might  not  per  se  constitute  sufficiently 
tangible  proof  of  the  obsolescence,  there  might  well  be  accompanying  circum- 
stances which  would  prove  obsolescence  beyond  any  doubt. 


700  FEDERAL  INCOME   TAX 

that  the  value  of  the  property  in  question  was  destroyed  not  later 
than  June  30,  1919,  and  that  he  is  not  continuing  in  any  similar 
trade  or  business.  An  allowance  will  be  made  only  in  respect  of 
such  assets  as  are  assignable  as  distinguished  from  those  at- 
taching to  the  individuals  owning  or  conducting  the  business  or 
to  the  premises  at  which  it  is  being  or  has  been  conducted.  No 
allowance  for  obsolescence  will  be  made  in  any  case  where,  in 
connection  with  the  operation  of  his  previous  business,  the  tax- 
payer has  developed  a  good  will,  trade-mark,  or  trade  brand  that 
is  valuable  in  continuing  a  lawful  business  after  June  30,  1919.^- 

An  allowance  for  obsolescence  of  intangible  assets  (trade- 
marks, trade  brands,  etc.)  of  a  corporation  engaged  in  the  whole- 
sale and  retail  liquor  business  will  not  be  permitted  in  1917  if 
the  corporation  had  a  considerable  volume  of  sales  in  1918  show- 
ing that  the  intangible  assets  had  some  value  on  December  31, 
1917,  even  though  they  may  have  shrunk  considerably  in  value 
by  that  date.""  Deductions  from  gross  income  on  account  of  de- 
preciation or  obsolescence  of  intangibles,  such  as  good  will,  trade- 
marks, and  trade  brands,  allowed  distillers  and  dealers  in  liquors, 
are  also  applicable  to  brewers.^^  Property  consisting  of  a  plant, 
including  equipment  for  the  manufacture  of  beer  bottles,  which 
because  of  restrictions  and  regulations  by  the  United  States  gov- 
ernment on  the  brewery  industry  can  not  be  sold  and  in  conse- 
quence the  factory  had  to  be  closed,  has,  to  the  extent  the  prop- 
erty or  plant  was  constructed  for  the  manufacture  of  beer  bottles 
and  is  not  suited  or  adapted  for  any  other  purpose  without  re- 
construction, become  obsolete.  The  corporation  to  that  extent 
is  entitled  to  a  deduction  for  obsolescence.  So  much  of  the 
shrinkage  in  value  of  the  plant,  if  any,  as  is  not  thus  due  to 
obsolescence  can  not  be  claimed  as  a  deduction  for  loss  until  the 
property  is  sold  or  becomes  worthless  and  the  loss  is  definitely 
ascertained.'*^ 

The  values  will  be  based  on  those  as  at  March  1,  1913,  if  the 
good  will,  trade-marks,  or  trade  brands  were  acquired  or  estab- 
lished prior  to  that  date,  or  at  the  actual  cost  thereof,  if  acquired 
subsequent  to  February  28,  1913.  Information  helpful  in  es- 
tablishing the  values  would  be  of  the  following  general  character: 
A.  Where  the  good  will,  trade-marks,  or  trade  brands  were  ac- 
quired prior  to  March  1,  1913:  (1)  The  nature  of  business 
(whether  distillers,  wholesalers,  or  retailers,  or  a  combination 

92  0.  D.  818,  T.  B.  8-21-1465;  O.  D.  1001,  T.  B.  34-21-1780. 

93  A.  R.  R.  185,  T.  B.  29-20-1076. 

94  O.  D.  298,  T.  B.  24-19-565. 

95  0.  D.  125,  T.  B.  3-19-190. 


DEPRECIATION,   OBSOLESCENCE  AND  AMORTIZATION  701 

thereof).     (2)   Date  of  foundation  of  business  and  whether  or- 
ganized as  an  individual,  partnership,  or  corporation.    Also  date 
and  particulars  of  each  change  in  the  ownership  or  form  of  or- 
ganization of  the  business,  such  as  the  admission  or  retirement 
of  a  partner  or  partners;  the  incorporation  of  a  company  and  of 
each  reorganization  thereof.     (3)  In  respect  to  the  trade-marks 
or  trade  brands  for  which  a  deduction  is  claimed:     (a)  The  date 
established  and  by  whom,     (b)  The  date  of  acquisition  by  the 
present  owners,     (c)  The  price  paid  therefor  and  whether  paid 
in  cash  or  stock;  if  the  latter,  state  the  basis  of  the  valuation 
on  which  the  purchase  price  was  determined,     (d)  For  each  year 
from  1900  or  the  date  of  the  establishment  of  the  trade-mark  or 
trade  brand,  if  subsequent  to  that  year,  to  1919,  inclusive:     (I) 
Annual  sales  (quantity  and  amount).     (II)  The  gross  profit  on 
sales  (i  e    the  difference  between  the  selling  price  and  the  cost 
price  of  the  merchandise  sold).     (HI)   The  total  expenses  and 
losses  of  the  business  which,  when  deducted  from  the  gross 
profit  on  sales,  will  produce-(IV)  The  net  income     Where  the 
records  permit,  the  sales  and  gross  profit  on  sales  should  be  sub- 
mitted for  each  class  of  merchandise  sold  and,  if  possible,  for 
each  trade-mark  or  trade  brand  in  respect  of  which  a  deduction 
is  claimed.     (V)  The  amount  of  capital  invested  in  the  busmess 
(i.  e.,  capital  or  capital  stock  and  paid  in  or  earned  surplus  and 
undivided  profits)  as  at  the  beginning  of  each  year,    /^lyf^^ 
amount  included  in  the  invested  capital  at  the  begmning  of  the 
period  in  respect  of  good  will,  trade-marks,  or  trade  brands  and 
the  date  and  amount  of  each  subsequent  addition  to  the  good  wil, 
trade-marks,  or  trade  brands,     (e)   Full  details  of  each  offer  to 
purchase  any  of  the  trade-marks  or  trade  brands,  setting  foith 
in  particular  the  date  of  each  offer,  by  whom  and  on  whose  be- 
half made:  the  amount  of  each  offer,  and  whether  payable  in  cash 
or  stock;  and  the  date  or  dates  on  which  the  purchase  P^ice  wa^ 
proposed  to  be  paid,  and  the  amounts  to  be  paid  on  each  such  date. 
(4)  Where  a  deduction  is  claimed  in  respect  of  good  will,  as  dis- 
tinct from  trade-marks  or  trade  brands,  the  following  infoi^a- 
tion  should  be  submitted:  (a)  The  date  of  acquisition   and  fiom 
whom  acquired,     (b)  The  amount  paid  therefor  and  whether  paid 
in  cash  or  in  stock.    If  the  latter,  state  the  basis  of  the  valuation 
on  which  the  purchase  price  was  arrived  at.     (O  For  each  year 
from  1900  or  the  date  of  acquisition,  if  subsequent  to  that  >ear, 
to  1919,  inclusive.     (I)  The  annual  sales  of  the  business  (quantity 
and  amount)   classified,  if  possible,  as  to  the  various  kinds  of 
merchandise  sold.     (II)  Gross  profit  on  each  class  of  merchandise 
sold   or  if  the  records  do  not  disclose  the  information,  the  gross 


702  FEDERAL   INCOME   TAX 

profit  of  the  business  as  a  whole.  (Ill)  Total  yearly  expenses 
and  losses  of  the  business  which,  when  deducted  from  the  gross 
profit  on  sales,  will  produce — (IV)  The  net  income  from  the  busi- 
ness. (V)  The  amount  of  capital  invested  in  the  business  (i.  e., 
capital  or  capital  stock  and  paid  in  or  earned  surplus  and  un- 
divided profits),  as  at  the  beginning  of  each  year.  (VI)  The 
amount  included  in  invested  capital  at  the  beginning  of  the  period 
in  respect  of  good  will  and  the  date  and  amount  of  each  subse- 
quent addition  to  good  will,  trade-marks  or  trade  brands,  (d) 
Full  details  of  each  offer  to  purchase  the  good  will,  setting  forth 
in  particular  the  date  of  each  offer ;  by  whom  and  in  whose  behalf 
made;  the  amount  of  each  offer  and  whether  payable  in  cash  or 
in  stock,  and  the  date  or  dates  on  which  the  purchase  price  was 
proposed  to  be  paid,  and  if  on  more  than  one  date,  the  amount 
payable  on  each  such  date.  B.  Where  good  will,  trade-marks  or 
trade  brands  were  acquired  subsequent  to  February  28,  1913: 
(1)  Dates  of  acquisition  of  good  will  or  of  each  trade-mark  or 
trade  brand.  (2)  From  whom  acquired.  (3)  Purchase  price  of 
good  will  or  of  each  trade-mark  or  trade  brand.  (4)  Whether 
purchased  for  cash  or  stock ;  if  the  latter,  state  the  basis  of  the 
valuation  on  which  the  purchase  price  was  arrived  at.  Similar 
information  to  that  suggested  in  A — 3d,  and  3e,  and  in  A — 4 
should  also  be  furnished  for  each  of  the  five  years  prior  to  the 
date  of  acquisition,  and  for  each  year  thereafter  up  to  and  includ- 
ing the  year  1919.  C.  In  the  case  of  good  will,  trade-marks  and 
trade  brands  acquired  prior  to  March  1,  1913,  a  statement  should 
be  submitted  showing  the  development  of  prohibition  and  local 
option  laws  within  the  territory  of  the  taxpayer  during  the  five 
years  preceding  March  1,  1913.  Such  statement  should  show 
each  prohibition  or  local  option  law  enacted  by  any  state  or  other 
governmental  unit  within  the  business  territory  of  the  taxpayer, 
and  should  also  state  the  unsuccessful  efforts  at  such  legislation 
during  such  period.^^ 

An  extension  of  the  period  set  forth  above  against  the  earnings 
of  which  the  obsolescence  might  be  taken  as  a  deduction  was 
later  granted  and  the  treasury  department  has  now  ruled  that  in 
arriving  at  the  taxable  income  for  the  first  taxable  year  ending 
on  or  after  January  31,  1918,  the  obsolescence  fully  accrued  on 
that  date  is  to  be  allowed  as  a  deduction  in  computing  the  in- 
come subject  to  taxation  under  the  Revenue  Act  of  1918,  plus 
a  further  deduction  of  such  proportion  of  the  remaining  value  of 

96  Letter  from  treasury  department  dated  June  21,  1919;  L  T.  S.  1921, 
U  1461. 


DEPRECIATION,   OBSOLESCENCE   AND  AMORTIZATION  703 

the  intangible  assets  as  the  interval  between  January  31,  1918, 
and  the  end  of  the  taxable  year  bears  to  the  total  inten'al  be- 
tween January  31,  1918,  and  January  16,  1920,  (unless  at  an 
earlier  date  the  taxpayer  discontinues  his  business,  in  which  case 
such  earlier  date  will  mark  the  close  of  the  period),  and  that  for 
any  taxable  year  following  the  taxable  year  just  referred  to  a 
deduction  in  respect  of  the  value  of  such  intangible  assets  on 
January  31,  1918,  based  upon  a  ratable  distribution  will  be  per- 
missible. It  is  the  opinion  of  the  treasury  department  that  the 
ratification  of  the  eighteenth  amendment  in  the  month  of  Janu- 
ary, 1918,  by  the  states  of  Massachusetts,  Maryland,  and  Ken- 
tucky, was  the  first  definite  indication  that  the  prohibition 
amendment  would  be  ratified  by  the  requisite  number  of  state 
legislatures,  and  therefore  that  on  January  31,  1918,  a  comput- 
able portion  of  the  cost  of  good  will,  trade-marks,  trade  brands, 
or  the  value  thereof,  on  March  1,  1913,  if  acquired  prior  thereto 
(excluding  any  intangibles  acquired  since  that  date,  the  expendi- 
tures of  which  were  deductible  and  had  been  deducted  in  com- 
puting income  for  tax  purposes)  had  become  obsolescent.  On 
January  31,  1918,  the  intangible  assets  had  an  actual  value,  viz.: 
the  then  present  value  of  the  income  to  be  derived  therefrom  be- 
tween that  date  and  January  16,  1920,  or  at  an  earlier  date  should 
the  taxpayer  discontinue  his  business  prior  thereto.  This  value 
as  stated  above  should  be  distributed  ratably  over  the  period 
from  January  31,  1918,  to  January  16,  1920  (unless  at  an  earlier 
date  the  taxpayer  discontinues  his  business,  in  which  case  such 
earlier  date  will  mark  the  close  of  the  period) .  The  excess  of  the 
cost  of  the  intangibles  or  the  value  thereof,  on  March  1,  1913,  if 
acquired  prior  thereto  (subject  to  the  exclusions  mentioned 
above),  over  the  value  thereof,  as  of  January  31,  1918,  deter- 
mined as  outlined  above,  will  represent  the  amount  of  obsoles- 
cence that  was  fully  accrued  on  January  31,  1918.''' 

Obsolescence  of  Vineyards.  Where  vineyards  planted  to  wine 
grapes  appear  to  be  rendered  useless  for  profitable  operation  as 
vineyards  through  the  enactment  of  prohibition  legislation,  but 
the  owners  continue  to  cultivate  them  in  the  hope  that  some  new 
and  profitable  use  for  the  crop  may  be  found,  a  reasonable  de- 
duction for  obsolescence  may  be  claimed.  There  being  at  the 
time  this  ruling  was  made  no  data  available  upon  which  a  de- 
termination of  what  constitutes  a  reasonable  deduction  may  be 
made,  a  tentative  deduction  of  one-half  the  loss  which  would  re- 

f»"  Letter  from  treasury  department  dated  August  19,  1919;  I.  T.  S.  1921, 
111468;   T.  B.  R.  44,  T.  B.  15-19-445. 


704  FEDERAL   INCOME   TAX 

suit  from  the  total  abandonment  of  the  property  for  vineyard 
purposes  was  allowed  in  the  return  for  the  year  in  which  the 
legislation  was  enacted,  subject  to  adjustment  when  the  success 
or  failure  of  the  experiment  shall  have  been  satisfactorily  estab- 
lished. Where  vineyards  devoted  to  the  growing  of  wine  grapes 
are,  as  a  result  of  prohibition  legislation,  abandoned  as  vineyards 
and  the  vines  and  improvements  incidental  solely  to  grape  grow- 
ing are  junked  and  the  land  employed  in  other  uses,  the  loss 
directly  resulting  may  be  deducted  in  determining  the  net  income 
of  the  owner,  care  being  taken  to  exclude  from  the  deduction  the 
value  of  any  improvements,  such  as  installation  of  drainage  or 
irrigation,  fencing,  breaking  up  of  the  soil,  and  similar  improve- 
ments which,  while  incidental  to  the  planting  of  the  vineyard, 
tend  to  permanently  improve  the  ground  for  other  uses.  The 
allowance  for  obsolescence  will  be  distributed  over  the  period 
elapsing  between  the  passage  of  the  prohibition  measure  and  the 
date  when  abandonment  occurs.  In  general,  no  deduction  for 
obsolescence  or  obsoleteness  is  allowable  in  the  case  of  land,  but 
in  exceptional  cases,  where  the  loss  of  usefulness  through  prohi- 
bition legislation  is  so  great  that  the  land  practically  becomes 
worthless,  the  taxpayer  may,  upon  proper  showing,  be  allowed 
a  reasonable  reduction  on  that  account  for  the  land  as  well  as  for 
the  vines  and  improvements.  In  this  case  the  cost  or  value  used 
as  the  basis  of  such  deduction  for  obsolescence  or  obsoleteness 
may  properly  include  the  value  of  any  improvements  which  when 
made  were  regarded  as  permanently  improving  the  land  and 
which  have  not  heretofore  been  charged  off  as  expenses.  In  the 
case  where  the  entire  deduction  is  claimed  in  a  single  year  by  rea- 
son of  actual  abandonment  on  account  of  obsolescence  of  land, 
vines,  and  improvements,  the  amount  of  such  deduction  will  be 
the  difference  between  the  value  on  March  1,  1913,  if  acquired 
prior  to  that  date,  or  the  cost,  if  acquired  on  or  after  that  date, 
and  the  salvage  or  junk  value,  taking  into  account  any  deduc- 
tions or  obsolescence  previously  allowed.  Where  a  reasonable 
allowance  for  obsolescence  is  claimed  before  actual  abandonment, 
to  be  spread  over  a  period  of  two  or  more  years,  care  must  be 
taken  to  eliminate  from  the  sum  used  as  the  basis  of  the  allow- 
ance any  general  decrease  in  the  value  of  real  estate  due  to  other 
causes,  such  decrease  being  deductible  only  when  definitely  de- 
termined through  sale.  Any  return  of  income  from  vineyard 
property  in  which  a  deduction  is  claimed  as  a  result  of  obsoles- 
cence must  be  accompanied  by  an  affidavit  setting  forth  fully  the 


DEPRECIATION,  OBSOLESCENCE  AND  AMORTIZATION  705 

facts  necessary  to  a  determination  of  the  loss  properly  chargeable 
to  obsolescence  under  the  rules  above  stated.'*^ 

Amortization.  The  1916  Law  made  no  provision  for  amorti- 
zation of  plants  or  equipment  acquired  for  government  contract 
work.  That  law  allowed  the  taxpayer  only  ordinary  depreciation 
due  to  exhaustion,  wear  and  tear,  without  considering  the  ele- 
ments of  amortization  or  obsolescence."''  The  Revenue  Act  of 
1918,  however,  provided  that,  (a)  in  the  case  of  buildings,  ma- 
chinery, equipment  or  other  facilities  constructed,  erected,  in- 
stalled or  acquired  on  or  after  April  6,  1917,  for  the  production 
of  articles  contributing  to  the  prosecution  of  the  war  with  Ger- 
many, and  (b)  in  the  case  of  vessels  constructed  or  acquired  on 
or  after  April  6,  1917,  for  the  transportation  of  articles  or  men 
contributing  to  the  prosecution  of  the  war  with  Germany,  there 
shall  be  allowed  a  reasonable  deduction  for  the  amortization  of 
such  part  of  the  cost  of  such  facilities  or  vessels  as  has  been  borne 
by  the  taxpayer.  This  allowance  might  not  again  include  any 
amount  otherwise  allowed  under  the  Revenue  Act  of  1918  or  pre- 
vious laws  as  a  deduction  in  computing  net  income.  At  any  time 
within  three  years  after  the  termination  of  the  recent  war  with 
Germany,  as  fixed  by  proclamation  of  the  President,  the  Commis- 
sioner might,  and  at  the  request  of  the  taxpayer  was  obliged  to, 
re-examine  the  return  and  if  he  then  found,  as  a  result  of  the 
appraisal  or  from  other  evidence,  that  the  deduction  originally 
allowed  for  amortization  was  incorrect,  the  income  tax  and  war- 
profits  and  excess-profits  taxes  for  the  year  or  years  affected, 
was  required  to  be  redetermined,  and  the  amount  of  tax  upon 
such  redetermination,  if  any,  paid  upon  notice  and  demand  by 
the  collector.  The  amount  of  tax  overpaid,  if  any,  was  required 
to  be  credited  or  refunded  to  the  taxpayer.'^"'  The  1921  Law 
contains  the  same  provision  except  that  the  deduction  will  be 

OSO.  862,  T.  B.  8-19-320,  modifying  O.  D.  102,  T.  B.  2-19-150.  and  super- 
seding T.  B.  M.  18,  T.  B.  4-19-219. 

«9  Letter  from  treasury  department  dated  January  4,  1919;  I.  T.  S.  1918, 
^{3716.    See  p.  697  for  a  discussion  of  obsolescence  under  the  1916  Law. 

100  Revenue  Act  of  1918,  §§214  (a)  9,  234  (a)  8.  The  Committee  on 
Appeals  and  Review  is  of  the  opinion  that  Congress  in  using  the  phrase  "at 
any  time  within  three  years  after  the  termination  of  the  present  war"  in- 
tended to  place  a  limitation  only  upon  the  latest  date  before  which  the  con- 
templated redetermination  must  be  made  and  that  it  was  not  the  purpose 
of  Congress  to  place  a  limitation  upon  the  cnrlicst  date  at  which  such  re- 
determination might  be  undertaken.  Taxpayers,  therefore,  need  not  await 
the  formal  termination  of  the  war,  but  may  present  to  the  Commissioner 
their  claim  for  a  redetermination  at  any  time  prior  to  three  years  after  such 
termination.     (A.  R.  M.  10,  T.  B.  31-19-646.) 


706  FEDERAL  INCOME   TAX 

allowed  "for  any  taxable  year  ending  before  March  3,  1924  (if 
claim  therefor  was  made  at  the  time  of  filing  return  for  the 
taxable  year  1918,  1919,  1920,  or  1921)",  and  the  words  "before 
March  31,  1924"  are  inserted  in  place  of  the  words  "within  three 
years  after  the  termination  of  the  present  war."  The  rulings 
indicated  in  the  following  paragraphs  were  made  under  the  amor- 
tization provision  of  the  1918  Law,  and  should  be  followed  under 
the  present  law. 

Claims  Must  Be  Differentiated  in  Return.  Claims  for 
amortization  must  be  unmistakably  differentiated  in  the  return 
from  all  other  claims  for  wear,  tear,  obsolescence,  and  loss.  No 
such  claim  will  be  allowed  unless  it  is  reflected  in  any  accounts 
submitted  by  the  taxpayer  to  stockholders  and  in  any  credit 
statements  by  the  taxpayer  to  banks,  and  is  given  full  effect  on 
his  financial  books  of  account.  If  government  or  other  contracts 
taken  by  the  taxpayer  contained  recognition  of  amortization  as 
an  element  in  the  cost  of  production,  copies  of  such  contracts 
must  be  filed  with  the  taxpayer's  return,  together  with  a  state- 
ment and  description  of  any  sums  received  on  account  of  amorti- 
zation and  the  basis  upon  which  they  were  determined. 

Effect  Upon  Invested  Capital.  In  any  case  in  which  an 
allowance  has  been  made  for  amortization  of  cost,  the  taxpayer 
will  not  be  allowed  to  restore  to  his  invested  capital  for  the  pur- 
pose of  the  excess-profits  tax  any  portion  of  the  amount  covered 
by  such  allowance.!"^!  Where  a  taxpayer  in  filing  his  returns  for 
the  years  1916  and  1917,  claimed  a  deduction  for  amortization  to 
the  same  extent  as  claimed  in  his  Munition  Manufacturers'  Tax 
returns  and  was  allowed  this  deduction  by  the  department,  it  has 
been  held  that  he  might  file  amended  returns  for  the  years  af- 
fected, excluding  therefrom  as  deductions  the  charges  for  amor- 
tization as  originally  filed  and  that  the  deductions  thus  excluded 

might  be  allowed  as  additions  to  the  invested  capital  of  the  tax- 
payer.i'^2 

Scope  of  Provision  for  Amortization.  All  allowances  made 
to  a  taxpayer  by  a  contracting  department  of  the  government, 
or  by  any  other  contractor,  for  amortization  or  fall  in  the  value 
of  property,  whether  such  allowances  were  made  as  a  part  of  the 
price  of  the  product  or  in  settlement  of  claims  arising  out  of  the 
cancellation  or  termination  of  contracts,  must  be  included  in 
gross  income.    All  payments  arising  out  of  the  settlement  of  such 

101  Reg.  45,  Art.  186.  For  definition  of  tlie  term  "government  contract" 
see  Reg.  45,  Art.  1510,  and  Chapter  43. 

102  A.  R.  R.  349,  T.  B.  52-20-1367. 


DEPRECIATION,   OBSOLESCENCE  AND  AMORTIZATION  707 

claims  must  be  included  in  the  accrued  income  of  the  taxable  year 
in  which  such  cancellation  or  termination  (whether  formal  or  in- 
formal) occurred.  The  amount  of  amortization  to  be  allowed  as 
a  deduction  from  gross  income,  for  the  purpose  of  the  tax,  should 
be  computed  in  accordance  with  the  rule  set  forth  in  this  and  the 
following  paragraphs,  pursuant  to  which  the  deduction  must  be 
made,  and  not  upon  the  basis  of  any  amounts  contractually  or 
otherwise  determined. ^"•'^ 

DEPRECIATION  OF  AMORTIZED  PROPERTY.  The  allowance  for 
amortization  will  be  inclusive  of  all  depreciation  during  the 
amortization  period  on  proper.ty  subject  to  amortization.  Depre- 
ciation will  be  allowed,  beginning  at  the  close  of  the  amortiza- 
tion period,  upon  property  the  cost  of  which  has  been  partly 
amortized.  Depreciation  on  partly  amortized  property  will  be 
based  on  the  value  of  such  property  after  the  amortization  allow- 
ance has  been  deducted.  Property  which  has  been  amortized  to 
its  scrap  value  will  not  further  be  subject  to  depreciation. i"* 

Property  the  Cost  of  Which  May  Be  Amortized.  The  tax- 
payer may  deduct  from  gross  income  a  reasonable  allowance  for 
amortization ;  such  deduction  not  to  be  in  excess  of  the  cost  of 
buildings,  machinery,  equipment,  or  other  facilities  constructed, 
erected,  installed,  or  acquired  on  or  after  April  6,  1917,  for  the 
production  of  articles  contributing  to  the  prosecution  of  the 
recent  war,  or  of  vessels  constructed  or  acquired  on  or  after 
such  date  for  the  transportation  of  articles  or  men  contributing 
to  the  prosecution  of  the  recent  war.  In  the  case  of  property 
the  construction,  erection,  installation  or  acquisition  of  which 
was  commenced  before  April  6,  1917,  and  completed  subsequent 
to  that  date,  amortization  will  be  allowed  with  respect  only  to 
that  part  of  the  cost  incurred  on  or  after  April  G,  1917,  and  which 
was  properly  entered  on  the  books  of  the  taxpayer  on  or  after 
that  date.^"''  Machinery,  equipment  or  other  facilities  erected  or 
acquired  on  or  after  April  6,  1917,  for  the  production  or  manu- 
facture of  sugar  are  considered  as  contributing  to  the  prosecu- 
tion of  the  war  and  the  cost  may,  therefore,  be  amortized.'""''  A 
claim  for  amortization  on  additional  facilities  acquired  and  built 
by  a  railroad  subsequent  to  April  6,  1917,  to  meet  the  additional 
demands  upon  such  road  arising  out  of  the  prosecution  of  the  war 
has  been  denied  on  the  ground  that  it  was  not  within  the  pro- 
ws Reg.  45,  Art.  181,  as  amended  by  T.  D.  3123,  T.  B.  6-21-1439. 
lO-iReg.  45,  Art.  182,  as  amended  by  T.  D.  3123,  T.  B.  6-21-1439. 
105  Rep.  45,  Art.  183,  as  amended  by  T.  D.  3123,  T.  B.  6-21-1439. 
100  O.  D.  259,  T.  B.  16-19-464. 


708  FEDERAL   INCOME   TAX 

vision  of  the  1918  Law.io7  Yet  the  word  "facilities"  is  very  broad, 
unless  it  is  limited  as  a  general  term  to  the  same  class  as  the 
special  terms  immediately  preceding.io^  The  term  "articles  con- 
tributing to  the  prosecution"  of  the  war  is  also  very  general. 
Rulings  made  by  the  War  Industries  Board  should  be  helpful  in 
determining  whether  articles  fell  within  this  classification. 

Cost  Which  May  Be  Amortized.  The  total  amount  subject 
to  amortization  will  be  the  difference  between  the  original  cost 
of  the  property  if  constructed,  erected,  installed  or  acquired  on 
or  after  April  6,  1917;  or  if  acquired  partly  before  and  partly 
after  April  6,  1917,  then  that  part  of  the  cost  incurred  on  or  after 
April  6,  1917,  and  properly  entered  on  the  books  of  the  taxpayer 
on  or  after  that  date,  less  any  amounts  deducted  for  deprecia- 
tion, losses,  etc.,  prior  to  January  1,  1918,  and  the  value  of  the 
property  on  either  of  the  bases  indicated  below : 

1.  In  the  case  of  property  useful  to  the  taxpayer  only  during 
the  period  of  its  operation  as  a  war  facility  and  which  has  been 
sold  or  permanently  discarded,  or  which  will  be  sold  or  perma- 
nently discarded  before  March  3,  1924,  the  value  will  be  the 
actual  sale  price  or  estimated  fair  market  value  as  of  the  date 
when  the  property  was  or  will  be  permanently  discarded,  such 
fair  market  value  to  be  re-established  at  and  as  of  the  time  of 
the  investigation  by  engineers  of  the  Bureau  of  Internal  Revenue. 

2.  In  the  case  of  property  not  included  in  (1)  above,  the  value 
will  be  the  estimated  value  to  the  taxpayer  in  terms  of  its  actual 
use  or  employment  in  his  going  business ;  such  value  to  be  not  less 
than  the  sale  or  salvage  value  of  the  property:  Provided,  hoiv- 
cver,  That  for  the  purposes  of  returns  made  in  1919,  the  pre- 
liminary estimate  of  the  amount  of  such  amortization  shall  not, 
in  any  case,  have  exceeded  25%  of  the  cost  of  the  property.  In 
the  determination,  by  engineers  of  the  Bureau  of  Internal  Rev- 
enue, of  the  proper  amortization  allowance,  the  estimated  value 
to  the  taxpayer  of  the  property  in  terms  of  its  actual  use  or  em- 
ployment in  his  going  business,  will  be  as  of  the  time  of  such 
determination.  In  the  final  determination,  the  amount  of  the 
amortization  allowance  will  be  ascertained  upon  the  basis  of 
stable  post  war  conditions  under  regulations  to  be  promulgated 
when  these  conditions  become  apparent. 

Special  record  of  all  property  falling  in  (1)  above,  must  be  pre- 

lOT  L.  O.  1074,  T.  B.  45-21-1909.  Congress  recognized  that  the  language 
first  used  was  not  broad  enough  to  embrace  transportation  facilities  and 
fjroadened  the  section  only  in  so  far  as  to  include  vessels  (Report  of  Senate 
Committee  on  Finance,  dated  December  6,  1918). 

K'S  See  Chapter  47. 


DEPRECIATION,  OBSOLESCENCE  AND  AMORTIZATION  709 

served  by  the  taxpayer,  and  the  Commissioner  must  be  promptly 
notified  (a)  if,  after  having  been  in  good  faith  permanently  dis- 
carded or  dismantled,  property  shall  in  any  case  be  restored  to 
use  because  of  conditions  not  foreseen  or  anticipated  at  the  time 
it  was  discarded;  or  (6)  of  the  selling  price,  if  sold.'"'-' 

109  Reg.  45,  Art.  184,  as  amended  by  T.  D.  2859  and  further  amended  by 
T.  D.  3123,  T.  B.  6-21-1439.  It  is  to  be  noted  that  the  original  ruling  of  the 
treasury  department  in  this  connection  read  as  follows:  "The  total  amount 
to  be  extinguished  by  amortization  is  the  difference  between  the  original 
cost  to  the  taxpayer  of  the  property  and  its  value  to  the  taxpayer  at  the 
close  of  the  amortization  period  (a)  for  sale  or  (b)  for  use,  immediate  or 
prospective,  as  part  of  the  plant  or  equipment  of  a  going  business,  which- 
ever value  is  the  larger,  less  any  amounts  otherwise  deducted  or  deductible 
for  wear,  tear,  obsolescence  and  loss.  In  the  case  of  property  constructed  or 
the  installation  of  which  was  commenced  before  April  6,  1917,  and  com- 
pleted subsequent  to  that  date  amortization  will  be  allowed  with  respect 
only  to  the  cost  incurred  on  or  after  April  6,  1917."  It  was  then  ruled: 
"In  the  case  of  other  property  the  basis  is  the  estimated  reproduction  cost 
as  of  April,  1919,  of  such  property  in  its  then  condition.  In  the  final  de- 
termination such  cost  will  be  ascertained  under  stable  postwar  conditions, 
without  reference  to  such  date."  The  present  regulation,  as  well  as  the 
regulation  as  promulgated  by  T.  D.  2859,  more  justly  carries  out  the  intent 
of  the  statute  to  allow  a  deduction  because  of  expenditures  made  during 
war  time  which  would  not  have  been  made  under  peace  conditions,  for  the 
reason  that  the  normal  business  of  the  taxpayer  would  not  have  required 
increased  facilities.  Senator  Simmons  in  discussing  this  provision  in  the 
senate,  February  11,  1919,  said:  "I  can  answer  the  senator  generally  by 
saying  that  if  by  reason  of  the  investment  of  his  profits  in  an  extension  of 
his  yards  he  has  constructed  a  plant  which  was  necessary  in  time  of  war  to 
meet  the  demands  which  were  made  upon  him  at  that  time  for  production, 
but  which  after  the  termination  of  the  war  has  depreciated  in  value  because 
not  needed ;  in  that  case,  under  the  amortization  provision  he  will  be  allowed 
to  amortize  to  the  full  extent  of  the  depreciation  value.  Of  course,  if  there 
is  salvage  he  would  be  allowed  to  amortize  only  down  to  the  salvage  value." 
(Congressional  Record,  February  17,  1919,  p.  3774.)  Under  the  rule  estab- 
lished by  the  regulation  last  quoted  "reproduction  cost"  as  of  April,  1919, 
which  in  most  cases  would  exceed  the  cost  of  property  to  be  amortized  was 
taken  as  a  temporary  basis,  final  determination  being  postponed  until 
"stable  postwar  conditions"  arrived.  In  order,  therefore,  to  have  secured 
present  relief  by  virtue  of  the  amortization  provision  of  the  statute  by  ex- 
tinguishing amortization  by  the  difference  between  "salvage  value"  and 
original  cost,  the  taxpayer  must  have  permanently  discarded  property  be- 
fore December  15,  1919  (or  the  last  installment  date).  The  injustice  of 
taking  "salvage  value"  in  one  case  and  "reproduction  cost"  in  another  may 
be  illustrated  by  the  case  of  the  taxpayer  who  had  purchased  two  machines 
and  discarded  one  of  them,  and  another  taxpayer  who  had  purchased  one 
machine  of  a  capacity  equivalent  to  the  capacity  of  the  two  machines  of  the 
first  taxpayer.  Under  the  last  quoted  rule,  the  former  would  immediately 
obtain  the  benefit  of  the  amortization  provision  and  the  latter  would  not 
have  obtained  it  until  the  problematical  time  when  "stable  postwar  condi- 
tions" return,  if  ever.     This  came  close  to  being  arbitrary  discrimination. 


710  FEDERAL  INCOME   TAX 

In  any  case  where  a  taxpayer  has  deducted  on  account  of 
amortization  an  amount  in  excess  of  the  preKminary  estimate  of 
25%  of  the  cost  of  property  and  it  is  found  upon  consideration 
that  he  is  entitled  to  an  amount  exceeding  25%  of  the  cost  of 
the  property,  but  less  than  the  amount  originally  deducted,  the 
5%  penalty  and  1%  interest  on  account  of  negligence  has  been 
held  due  on  account  of  amortization  claimed  but  disallowed  in  the 
return  for  1918.  In  the  event  that  the  case  is  reopened  within  a 
period  of  three  years  and  an  additional  amount  of  amortization 
allowed,  the  penalty  and  interest  will  not  attach  to  the,  amount 
of  tax  based  on  the  additional  allowance  granted.  In  other  words, 
penalty  and  interest  should  attach  only  to  such  amount  of  tax  as, 
upon  final  settlement,  is  found  to  have  been  due  to  the  govern- 
ment and  not  paid  at  the  time  of  filing  return  by  reason  of  the 
taxpayer's  disregard  of  the  regulations.^!*^ 

Amortization  Period.  The  amortization  allowance  will  be 
spread  in  proportion  to  the  net  income  (computed  without  benefit 
of  the  amortization  allowance)  between  January  1,  1918  (or  if 
the  property  was  acquired  subsequent  to  that  date,  January  1st  of 
the  year  in  which  acquired) ,  and  either  of  the  following  dates : 

(a)  If  the  claim  is  based  on  (1)  of  the  preceding  paragraph, 
the  date  when  the  property  was  or  will  be  sold  or  permanently 
discarded  as  a  war  facility;  or  (b)  if  the  claim  is  based  on  (2)  of 
the  preceding  paragraph,  the  actual  or  estimated  date  of  cessa- 
tion of  operation  as  a  war  facility. 

All  taxpayers  claiming  an  allowance  for  amortization  should 
compute  (or,  to  the  extent  that  accurate  computations  can  not 
be  made,  should  estimate)  the  amount  of  their  net  income  for 
the  period  between  January  1,  1918,  and  the  dates  specified  above, 
and  should  also  compute  (or  estimate  as  above)  that  part  thereof 
properly  assignable  to  each  of  the  calendar  years  falling  within 
the  amortization  period ;  and  the  amount  of  income  so  computed 
or  estimated  will  be  the  basis  for  apportioning  the  amounts  of 
amortization  applicable  to  each  of  the  calendar  years  affected. 

110  A.  R.  M.  24,  T.  B.  3-20-692.  This  25%  limitation  upon  the  amount 
which  might  be  deducted  in  1919  returns  is  hardly  supported  by  a  statute 
prescribing  a  "reasonable"  deduction,  unless  in  the  particular  case  25% 
is  a  reasonable  deduction.  The  above  ruling  recognizes  the  tentative  quality 
of  the  25%'  limitation,  and  makes  that  limitation  simply  a  penalty  upon 
honest  as  well  as  fraudulent  calculations  of  the  deduction  in  1919  returns. 
In  effect  it  was  an  attempt  to  induce  conservative  calculations.  It  hardly 
seems  fair,  if  technically  permissible,  to  assess  a  penalty  upon  honest  over- 
estimates, made  at  a  time  when  the  difficulty  of  making  any  estimate  hardly 
needs  statement.  For  cases  that  a  regulation  in  conflict  with  the  statute  is 
invalid,  see  Chapter  47. 


DEPRECIATION,   OBSOLESCENCE  AND  AMORTIZATION  711 

Taxpayers  reporting  on  the  fiscal  year  basis  should  (a)  in  all  com- 
putations based  upon  1918  rates  for  fiscal  years  ending  in  1918 
and  1919,  use  the  amount  of  such  allowance  apportioned  to  the 
calendar  year  1918;  (b)  in  all  computations  based  upon  1919 
rates  for  a  year  beginning  in  1918  and  ending  in  1919,  use  the 
amount  of  such  allowance  apportioned  to  the  calendar  year  1919; 
and  (c)  in  all  computations  for  subse(iuent  fiscal  years,  use  the 
number  of  twelfths  of  the  allowance  apportioned  to  each  calendar 
year  falling  within  such  fiscal  year  that  there  are  months  of  such 
calendar  year  falling  within  such  fiscal  year.''^  A  claim  for 
amortization  applicable  to  the  portion  of  the  calendar  year  1918 
covered  by  the  return  of  the  taxpayer  for  the  taxable  year  1918 
should  be  included  in  such  return  and  if  such  amortization  is  not 
claimed  therein  it  may  not  be  taken  in  the  return  covering  the 
taxable  year  1919.  The  return  for  the  taxable  year  1919  should 
provide  only  for  the  proper  amortization  applicable  to  such  tax- 
able year  ascertained  in  accordance  with  the  above  provisions. 
However,  in  cases  where  it  was  impracticable  to  determine  ac- 
curately the  amortization  during  the  calendar  year  1919,  any  re- 
turns made  during  such  period  should  include  amortization  allow- 
ances tentatively  determined  in  accordance  with  this  and  the  pre- 
ceding paragraphs.  Returns  made  for  the  taxable  year  1918,  in 
cases  where  the  taxpayers  are  entitled  to  amortization  claims 
should  include  such  claims  ascertained  as  above  provided,  and  if 
subsequently  the  amortization  as  finally  determined  differs  essen- 
tially from  the  amount  claimed  in  the  returns  filed,  then  amended 
returns  should  be  made.^'- 

Redetermination  OF  Amortization  Allowance.  Re- 
determination of  the  deduction  allowed  on  account  of  amortiza- 
tion may,  or  at  the  request  of  the  taxpayer  must,  be  made  by 
the  Commissioner  at  any  time  within  three  years  after  the  ter- 
mination of  the  recent  war  (March  3,  1924),  and  if  as  a  result  of 
an  appraisal  or  from  other  evidence  it  is  found  that  the  deduc- 
tion originally  allowed  was  incorrect,  the  amount  of  tax  due  for 
each  taxable  year  during  the  amortization  period  will  be  adjusted 
by  additional  assessment  or  by  refund. ^^•''' 

Sale  of  Amortized  Property.  In  the  case  of  the  bona  fide 
sale  of  amortized  property  before  three  years  from  the  termina- 
tion of  the  war,  the  sale  price  thereof  will  be  considered  as  re- 
flecting the  correctness  or  incorrectness  of  the  amortization  al- 

111  Reg.  45,  Art.  185,  as  amended  by  T.  D.  3123,  T.  B.  6-21-1439. 

112  Letter  from  treasury  department  dated  June  9,  1919;  I.  T.  S.  1919, 
If  3391. 

113  Reg.  45,  Art.  187. 


712  FEDERAL  INCOME  TAX 

lowance  made,  due  allowance  being  made  for  depreciation  sus- 
tained since  the  close  of  the  amortization  period.""* 

Information  to  Be  Furnished  by  Taxpayer.  The  taxpayer's 
claim  for  amortization  must  be  complete  and  comprehensive  in 
all  respects.  The  Commissioner  will  not  entertain  claims  which 
do  not  clearly  set  forth  full  data  with  respect  to  the  property 
which  it  is  desired  to  amortize.  To  assist  the  taxpayer  in  com- 
piling this  information  the  Commissioner  has  prepared  Guide 
Form  1007-M,  which  explains  in  detail  the  manner  in  which 
claims  for  amortization  should  be  presented.  A  copy  of  this 
guide  form  will  be  furnished  to  the  taxpayer  upon  application  to 
the  Commissioner.115 

114  Reg.  45,  Art.  188,  as  amended  by  T.  D.  3123,  T.  B.  6-21-1439. 

115  Reg.  45,  Art.  189;  T.  D.  3123,  T.  B.  6-21-1439. 


CHAPTER  27 

DEPLETION — IN  GENERAL 

The  Revenue  Act  of  1921  contains  a  provision  for  the  deduc- 
tion of  an  allowance  for  depletion  in  the  case  of  mines,  oil  wells, 
gas  wells  or  any  other  natural  deposits  and  timberJ  The  same 
allowance  is  permitted  to  individuals  as  to  corporations  and  is 
permitted  to  nonresident  aliens  or  foreign  corporations  with  re- 
spect to  property  located  in  the  United  States.  Depletion  is  the 
loss  sustained  through  the  progressive  removal  or  exhaustion  of 
natural  resources,  such  as  a  mineral  deposit  or  timber  supply. - 
Depletion  allowances  are  made  because  mineral  deposits  and  tim- 
ber supplies  are  exhaustible  and  because  each  unit  removed  re- 
duces the  amount  recoverable,  and  hence  the  value  of  the  proj)- 
erty.  The  depletion  provisions  of  the  1918  Law  was  identical  with 
that  of  the  present  law,  except  that  it  did  not  contain  the 
limitation  prescribed  by  the  Revenue  Act  of  1921  in  regard  to 
depletion  based  on  discovery  values."'  The  1916  Law  provided 
for  an  allowance  for  depletion  in  the  case  of  mines,  oil  and  gas 
wells."* 

That  law  provided,  in  the  case  of  oil  and  gas  wells,  a  reason- 
able allowance  for  actual  reduction  in  flow  and  production,  and  in 
the  case  of  mines  a  reasonable  allowance  not  to  exceed  the  mar- 
ket value  in  the  mine  of  the  product  thereof  which  had  been 
mined  and  sold  during  the  year  for  which  the  return  and  com- 
putation were  made.  The  present  law  does  not  limit  the  de- 
duction for  depletion  in  the  same  way,  but  permits  a  reason- 
able allowance  according  to  the  peculiar  conditions  of  each  case. 
The  1916  Law,  the  1918  Law  and  the  present  law  permit  the  al- 
lowance for  depletion  to  be  based  upon  the  value  of  the  property 
as  of  March  1,  1913,  or  the  cost,  if  the  property  has  been  ac- 
quired since  that  date.     The   1916  Law  made  no   reference  to 

1  Revenue  Act  of  1921,  §214    (a)    1,  234    (a)    9. 

-  This  is  forcibly  stated  in  the  latest  Manual  of  the  Oil  and  Gas  In- 
dustry (p.  17)  as  follows:  "These  reserves  are  wasting  assets  from  the 
moment  production  begins,  for  the  reason  that  there  is  no  recuperation  or 
rehabilitation  of  any  part  or  portion  that  has  been  removed  from  the 
rock  containing  them.  They  are  gone  forever  so  far  as  human  needs  are 
concerned.  The  only  way  to  meet  the  increased  requirements  of  industry 
is  to  exhaust  separate  reserves  rapidly  and  discover  new  sources  of  supply." 

"See  Revenue  Act  of  1918,  §§214  (a)   10  and  234   (a)   9. 

•♦Revenue   Act  of   ]91(i,   §§5,  G  and   12. 

713 


714  FEDERAL  INCOME   TAX 

lessees  and  the  treasury  department  ruled  thereunder  that  a 
lessee  could  claim  no  depletion  with  respect  to  the  value  of  the 
natural  deposit  on  March  1,  1913.-'^  The  present  law  provides 
that  in  the  case  of  leases  the  deduction  shall  be  equitably  ap- 
portioned between  the  lessor  and  the  lessee.  With  respect  to  de- 
pletion the  treasury  department  has  ruled  as  stated  in  the  fol- 
lowing paragraphs."  These  rulings,  while  made  under  the  1918 
Law,  will  be  equally  applicable  under  the  present  law. 

Depletion  of  Mines,  Oil  and  Gas  Wells;  Depreciation  of  Im- 
provements.' The  Revenue  Act  of  1921^  provides  that  taxpayers 
shall  be  allowed  as. a  deduction  in  computing  net  income  in  the 
case  of  natural  deposits  a  reasonable  allowance  for  depletion 
of  mineral  and  for  depreciation  of  improvements.  The  pro- 
visions of  the  statute  and  the  rules  stated  in  this  and  the  follow- 
ing paragraphs  do  not  apply  to  or  affect  the  regulations  covering 
invested  capital,  losses,  and  accounting  methods.  The  essence 
of  these  provisions  of  the  statute  is  that  the  owner  of  mineral 
deposits,  whether  freehold  or  leasehold,^  shall  within  the  limi- 
tations prescribed,  secure  through  an  aggregate  of  annual  de- 
pletion and  depreciation  deductions  the  return  of  either  (a)  his 
capital  invested  in  the  property,  or  (6)  the  value  of  his  property 
on  the  basic  date,  plus  subsequent  allowable  capital  additions, 
but  not  including  land  values  for  purposes  other  than  the  ex- 
traction of  minerals.  Operating  owners,  lessors,  and  lessees, 
whether  corporations  or  individuals,  are  entitled  to  deduct  an  al- 
lowance for  depletion  and  depreciation,  but  a  stockholder  in 
a  mining  or  oil  or  gas  corporation  is  not  allowed  such  deduc- 
tions. 

Definition  of  Terms.  When  used  in  this  and  the  following 
chapters : 

(a)  The  term  "basic  date"  indicates  the  date  of  valuation,  i.  e., 
March  1,  1913,  in  the  case  of  property  acquired  prior  thereto,  the 
date  of  acquisition  in  the  case  of  property  acquired  on  or  after 
March  1,  1913,  or  the  date  of  discovery,  or  within  30  days  there- 
after, in  the  case  of  discovery. 

5  See  paragraph  "Rule  as  to  Lessees  under  Prior  Laws,"  p.  728. 

6  This  chapter  gives  only  the  general  rules  with  respect  to  depletion. 
The  special  rules  with  respect  to  mines,  oil  and  gas  wells,  and  timber 
are  given  in  the  chapters  following. 

7  Reg.  45,  Art.  201. 

8  §§214   (a)    10  and  234   (a)   9. 

9  Under  the  1916  Law  no  allowance  for  depletion  was  permitted  in  the 
case  of  a  lessee,  but  the  lessee  was  permitted  to  claim  "depreciation"  on 
the  actual  bonus  or  other  cost  incurred  in  acquiring  and  developing  prop- 
erty.   (See  p.  728.) 


DEPLETION— IN  GENERAL  ^^^ 


(M   The  "fair  market  value"  of  a  property  is  that  amount 
Ji    .  loM  induce  a  wilUng  seller  to  sell  and  a  -  l-^^,b;^>-J^ 
v,.,-„      Whpre  there  has  been  no  sale  and  the  fan  marKei 

""i^he  basic  date  s  to  be  used,  such  value  will  be  determined 
value  at  thebas.cdate.sroo.  ^^^^^^^  .^  ^^^  .^ 

IZ  Torur^'Sn^XTat  the  sale  value  of  the  property  at 


*;'rA  "mineral  property"  or  "property"  is  the  oil  or  .as  we,, 
■     ,  V       th„  mineral  plant,  development,  and  surface  value  of 
;;:  "and"  The^Xof'a  mineral  property  is  the  combined  value 

°^"rTCineraTdeposit••  refers  to  "mine.-als  only,"  such  as 
the  '  oret  only-M'the  case  of  a  mine,  to  the  "oil  only"  .n  the  case 

an  Operatmg  Ownci.'-    In  the  case  oi        J^      ,iu-„uirh  depletion 
the  capital  remaining  in  any  ^^f  ^f  °\^' "Z^'!  "^e  of  hi  prop- 

hereof. 

11  Reg.  45,  Art.  201. 

12  Reg.  45,  Art.  202.                   ,   •      j     „„     nil  nhvsical     property.      Tho 
..Depreciation     fo^\J^^,;:^'-:^,,Z^::^  af  distinguished   fro.   de- 

"physical   property     as  to   which  d  1  ^.^  ^^^^^  ^^^  .^^^^^^^.^  ,^ 

pletion,  should  be  ^^^";'.^^^^"  '^'  '^''     ^64  )     Depletion  applies  only  to  the 
merated  elsewhere  in  this  book.     (See  p.J^04.i 
loss  due  to  exhaustion  of  the  natural  resource. 


716  FEDERAL   INCOME   TAX 

whether  legally  allowable  or  not/^  from  the  basic  date  to  the 
taxable  year,  and  minus  (d)  the  value  of  the  land  at  the  basic 
date  for  other  purposes  than  mineral  production.^"'  The  capital 
recoverable  through  depletion  is  the  total  capital  remaining  less 
the  sum  recoverable  through  depreciation. 

Capital  Recoverable  Through  Depletion  Allowance  in  Case  of 
Lessee.!*'  (a)  In  the  case  of  a  lessee,  the  capital  remaining  in  any 
year  recoverable  through  depletion  and  depreciation  deductions 
is  (1)  the  value  as  of  the  basic  date  of  the  lessee's  equity  in  the 
property  plus  (2)  subsequent  allowable  capital  additions  but 
minus  (3)  depletion  and  depreciation  sustained,  whether  legally 
allowable  or  not,  from  the  basic  date  to  the  taxable  year.  The 
capital  recoverable  through  depletion  is  the  total  capital  re- 
maining less  the  sum  recoverable  through  depreciation. 

(b)  The  value  of  the  equities  of  lessor  and  lessee  must  be  com- 
puted separately,  but,  when  determined  as  of  the  same  basic  date, 
may  together  never  exceed  the  value  at  that  date  of  the  prop- 
erty in  fee  simple. 

(c)  The  value  of  a  lessee's  equity,  if  acquired  prior  to  March 
1,  1913,  is  the  value  of  his  interest  in  the  mineral  as  of  that  date. 

(d)  The  value  of  a  lessee's  equity  in  a  proven  mineral  property 
acquired  on  or  after  March  1,  1913,  is  its  cost. 

(e)  The  value  of  a  lessee's  equity  in  a  discovery  on  or  after 
March  1,  1913,  is  the  fair  market  value  at  date  of  discovery  or 
within  30  days  thereafter,  of  his  equity  in  the  mineral  discov- 
ered. 

Where  a  taxpayer  made  claim  under  the  placer  mining  laws  to 
public  land,  which  was  withdrawn  by  executive  order  prior  to 
completion  of  valid  location  (and  prior  to  March  1,  1913),  and 
later  (subsequent  to  March  1,  1913),  operated  the  land  under 
agreement  with  the  secretary  of  the  interior,  or  lease  from  the 
government,  he  is  not  entitled  to  a  depletion  deduction  based  upon 
the  value  of  his  claim  as  of  March  1,  1913,  but,  under  the  provi- 

14  It  is  to  be  noted  that  the  ruling  contemplates  that  depletion  must  be 
taken  consistently  from  year  to  year  and  more  depletion  than  is  allocated 
to  the  production  of  one  year  cannot  be  taken  by  reason  of  the  fact  that  less 
has  been  deducted  in  a  past  year  than  could  have  been  properly  allocated 
to  such  past  year.  The  depletion  which  has  or  should  have  been  taken 
must  be  based  upon  the  same  cost  or  fair  market  value  and  is  subtracted 
w^hether  or  not  it  (or  any  part  thereof)  has  been  allowed  under  earlier 
laws.     T.  B.  R.  4,  T.  B.  1-19-53. 

!•">  That  is,  in  the  case  of  an  owner  the  value  of  the  surface  of  the  land 
should  not  be  considered  as  a  part  of  the  value  of  the  natural  deposit. 

ifi  Reg.  45,  Art.  203.     See  T.  D.  3089,  T.  B.  47-20-1313. 


DEPLETION — IN  GENERAL  717 

sions  of  the  Revenue  Acts  of  1918  and  1921,  he  is  entitled  to  a 
depletion  deduction  based  upon  the  discovery  value  as  to  dis- 
coveries made  subsequent  to  the  acquisition  of  the  lease  or  leases 
from  the  government. '' 

Bonuses.  Bonuses  constitute  a  part  of  the  cost  of  the  lease- 
hold. Any  annual  or  periodical  rents  or  flat  royalties  (as  in  the 
case  of  gas  wells)  supplementing  the  bonuses  or  other  amount 
paid  for  the  lease  at  the  time  of  acquisition  may  be  charged  to 
cost  of  leasehold  until  the  property  reaches  the  operating  stage 
and  will  fonn  part  of  the  capital  returnable  through  deductions 
for  depletion. ^'^  Under  an  option  to  purchase,  or  so-called  "bond 
and  lease"  agreement,  providing  for  the  payment  of  royalties 
on  ore  mined  and  for  the  payment  at  stated  times  of  the  amounts 
necessary  to  bring  the  total  amounts  paid  to  certain  specific  sums, 
and  giving  an  option  to  the  purchaser  to  take  title  to  the  property 
upon  the  payment  of  a  specified  amount  upon  which  the  royalties 
and  deficiency  payments  are  credited  as  part  of  the  purchase 
price,  it  has  been  held  that  the  additional  sums  paid  to  make  up 
the  amounts  of  the  several  installments  when  due  are  capital 
investments  in  the  nature  of  bonuses  and  are  recoverable  through 
deductions  for  depletion  computed  upon  the  total  sum  of  such 
additional  payments  to  the  end  of  the  taxable  year.  Where  the 
option  is  forfeited,  the  capital  sum  remaining  to  be  recovered  is 
deductible  as  depletion  in  the  year  in  which  the  forfeiture  oc- 
curs.^^ 

Capital  Recoverable  Through  Depletion  in  Case  of  Lessor.-" 
(a)  In  the  case  of  a  lessor,  the  capital  remaining  in  any  year  re- 
coverable through  depletion  and  depreciation  deductions  is  (1) 
the  value  of  his  equity  in  the  property  at  the  basic  date  minus 
(2)  depletion  and  depreciation  sustained,  whether  legally  allow- 
able or  not,  from  the  basic  date  to  the  taxable  year,  plus  (3)  sub- 
sequent allowable  capital  additions,  and  minus  (4)  the  value  of 
the  land  at  the  basic  date  for  other  purposes  than  mineral  pro- 
duction. The  capital  recoverable  through  depletion  is  the  total 
capital  remaining  less  the  sum  recoverable  through  depreciation. 

(b)  The  value  of  the  equities  of  lessor  and  lessee  must  be  com 
puted  separately,  but,  when  deteiTnined  as  of  the  same  basic  date, 
may  together  never  exceed  the  value  at  that  date  of  the  property 
in  fee  simple. 

I'Sol.  Op.   118,  T.  B.  36-21-1801. 

18  Manual  for  the  Oil  and  Gas  Industry,  p.  20. 

1«  Sol.  Op.  86,  T.  B.  4-21-1406. 

20  Reg.  45,  Art.  204.     See  T.  D.  3089,  T.  B.  47-20-1313. 


718  FEDERAL  INCOME  TAX 

(c)  The  value  of  the  lessor's  equity  in  the  case  of  a  mineral 
property  not  under  lease  on  March  1,  1913,  but  subsequently 
leased,  is  the  en  bloc  value  of  the  mineral  in  the  ground  on  March 
1,  1913,  and  will,  in  the  absence  of  satisfactory  evidence  to  the 
contrary,  be  presumed  not  to  exceed  the  value  as  of  March  1, 
1913,  of  the  royalties  to  be  expected  under  the  lease. 

(rf)  The  value  of  a  lessor's  equity  in  a  mineral  property  under 
lease  March  1,  1913,  for  the  entire  operating-  life  of  the  mineral 
deposits  is  the  value  as  of  March  1,  1913,  of  the  royalties  and 
other  payments  to  be  expected  under  the  terms  of  the  lease  in 
effect  on  that  date. 

(e)  The  value  of  a  lessor's  equity  iji  a  mineral  property  under 
lease  for  a  portion  of  its  operating  life  is  the  value  as  of  March 
1,  1913,  of  the  royalties  expected  from  the  mineral  to  be  ex- 
tracted during  the  life  of  the  existing  lease  plus  the  estimated 
en  bloc  value  of  the  mineral  remaining  at  its  expiration,  which, 
in  the  absence  of  satisfactory  evidence  to  the  contrary,  will  be 
presumed  not  to  exceed  the  value  as  of  March  1,  1913,  of  royal- 
ties which  could  have  been  expected  as  at  that  date  from  the  re- 
maining mineral. 

(/)  The  value  of  a  lessor's  equity  in  a  mineral  property  when 
acquired  on  or  after  March  1,  1913,  is  its  cost. 

(g)  The  value  of  a  lessor's  equity  in  a  discovery  on  or  after 
March  1,  1913,  is  the  fair  market  value  at  the  date  of  discovery, 
or  within  30  days  thereafter,  of  his  equity  in  the  mineral  dis- 
covered. 

Determination  of  Cost  of  Deposits.  In  any  case  in  which  a 
depletion  or  depreciation  deduction  is  computed  on  the  basis  of 
the  cost  or  price  at  which  any  mine,  mineral  deposit,  mineral 
rights,  or  leasehold  was  acquired,  the  owner  or  lessee  will  be  re- 
quired to  show  that  the  cost  or  price  at  which  the  property  was 
bought  was  fixed  for  the  purpose  of  a  bona  fide  purchase  and 
sale,  by  which  the  property  passed  to  an  owner,  in  fact  as  well  as 
in  form,  other  than  the  vendor.^i     No  fictitious  or  inflated  cost 

21  That  is,  owners  of  a  natural  deposit  will  not  be  allowed  to  base  de- 
pletion on  a  greater  value  by  reason  of  incorporating  or  re-incorporating 
where  the  change  of  ownership  is  one  of  form  and  not  substance.  The 
treasury  department  has  uniformly  insisted,  however,  upon  the  impo- 
sition of  an  income  tax  upon  transferrors  of  property  to  a  corporation, 
even  if  the  beneficial  ownership  remains  the  same  (See  Chapter  17). 
This  practice  has  been  rendered  impossible  under  the  present  law,  but 
under  the  1918  and  prior  laws  it  would  seem  clear  that  the  transfer  of 
property  by  an  individual  to  a  corporation,  or  by  one  corporation  to 
another,  in  exchange  for  stock,  will  establish  a  new  cost  measured  by  the 
market  value  of  the  stock  at  the  date  of  the  transaction.     In  other  words, 


DEPLETION — IN  GENERAL  719 

or  price  will  be  permitted  to  form  the  basis  of  any  calculation  of 
a  depletion  or  depreciation  deduction,  and  in  detennining  whether 
or  not  the  price  or  cost  at  which  any  purchase  or  sale  was  made 
represented  the  actual  market  value  of  the  property  sold,  due 
weight  will  be  given  to  the  relationship  or  connection  existing 
between  the  person  selling  the  property  and  the  buyer  thereof:- 
Determination  of  Fair  Market  Value  of  Mineral  Property.  A 
deteiTni nation  of  the  fair  market  value  of  a  property  (or  the  tax- 
payer's interest  therein)  is  required: 

(a)   In  connection  with  the  computation  of  depletion  allow- 
ances:   (1)  As  of  March  1,  1913,  in  the  case  of  properties  ac- 
quired prior  to  that  date;  (2)  At  the  date  of  discovery  or  within 
30  days  thereafter  in  the  case  of  mines,  oil  and  gas  wells,  dis- 
covered by  the  taxpayer  on  or  after  March  1,  1913,  and  not  ac- 
quired as  the  result  of  purchase  of  a  proven  tract  or  lease,  where 
the  fair  market  value  of  the  property  is  disproportionate  to  the 
cost;  (3)  As  of  the  date  of  conveyance  or  acquisition,  if  subse- 
quent to  March  1,  1913,  in  the  case  of  property  paid  for  with  stock 
of  a  corporation,  the  value  of  the  stock  representing  "cost"  of  the 
properties,  and  such  stock  value  being  frequently  only  possible  of 
calculation  by  reference  to  the  value  of  the  assets  it  represents ; 
(b)  In  connection  with  invested  capital:     (1)  In  computing  the 
amount  which  may  be  included  in  paid-in  surplus,  as  of  date  of 
conveyance  or  acquisition,  where  tangible  property  has  been  con- 
veyed to  a  corporation  by  gift  or  at  a  value  accurately  established 
or  definitely  known  as  at  date  of  conveyance  clearly  and  substan- 
tially in  excess  of  the  cost  or  of  the  par  value  of  the  stock  or 
shares  paid  therefor;  (2)  In  computing  the  amount  which  must 
be  deducted  from  capital  and  surplus  as  of  the  date  of  conveyance 
or  acquisition  in  order  to  limit  invested  capital  to  the  actual  cash 
value  of  tangible  property,  other  than  cash,  bo7m  fide  paid  in  for 
stock  or  shares;  (c)  In  connection  with  the  computation  of  profit 
and  loss  from  sale  of  capital  assets  in  the  case  of  properties :  (See 
Chapter  17)  ;  (1)  As  of  March  1,  1913,  in  the  case  of  properties 
acquired  prior  to  that  date;  and  (2)  As  of  the  date  of  acquisition, 
in  order  to  ascertain  "cost"  in  the  case  mentioned  in   (a)    (3) 
above.     (3)  As  of  the  date  of  the  transaction,  where  the  prop- 
such  new  corporation  becomes  an  "owner  in  fact  as  well  as  in  form,  other 
than    the    vendor".      Congress    expressly    provided     that     such     transfers 
should  not  affect  invested  capital    (Revenue   Act  of   1918,   §331;   Revenue 
Act  of   1917,   §  208)    but  these   provisions  obviously  have  no   reference  to 
the  "capital  sum"  for  purposes  of  depletion  or  depreciation. 
22  Reg.  45,  Art.  205. 


720  FEDERAL  INCOME  TAX 

erty  is  sold  for  stock  of  a  closely  held  corporation  having  no 
other  property,  in  order  to  ascertain  "Selling  price"  (not  under 
1921  Law) . 

The  treasury  department  has  ruled  as  follows:  (a)  Where 
the  fair  market  value  of  property  at  a  specified  date  in  lieu  of 
the  cost  thereof  is  the  basis  for  depletion  and  depreciation  de- 
ductions, such  value  must  be  determined,  subject  to  approval 
or  revision  by  the  Commissioner,  by  the  owner  of  the  property 
in  the  light  of  the  conditions  and  circumstances  known  at  that 
date,  regardless  of  later  discoveries  or  developments  in  the  prop- 
erty or  in  methods  of  extraction  and  treatment  of  the  mineral 
product.-^  The  value  sought  should  be  that  established  assuming 
a  transfer  between  a  willing  seller  and  a  willing  buyer  as  of  that 
particular  date.  The  Commissioner  will  lend  due  weight  and  con- 
sideration to  any  and  all  factors  and  evidence  having  a  bearing 
on  the  market  value,  such  as  cost,  actual  sales  and  transfers  of 
similar  properties,  market  value  of  stock  or  shares,  royalties 
and  rentals,  value  fixed  by  the  owner  for  purposes  of  capital 
stock  tax,  valuation  for  local  or  state  taxation,  partnership  ac- 
countings, records  of  litigation  in  which  the  value  of  the  property 
was  in  question,  the  amount  at  which  the  property  may  have  been 
inventoried  in  probate  court,  disinterested  appraisals  by  approv- 
ed methods,  such  as  the  present  value  method  and  other  factors. 

(5)  To  determine  the  fair  market  value  of  a  mineral  property 
by  the  present  value  method,  the  essential  factors  must  be  de- 
termined for  each  deposit  included  in  the  property.  The  factors 
are  (1)  the  total  quantity  of  mineral  in  terms  of  the  principal  or 
customary  unit  (or  units)  paid  for  in  the  product  marketed,  (2) 
the  average  quality  or  grade  of  the  mineral  reserves,  (3)  the  ex- 
pected percentage  of  extraction  or  recovery  in  each  process  or 
operation  necessary  for  the  preparation  of  the  crude  mineral  for 
market,  (4)  the  probable  operating  life  of  the  deposit  in 
years,  (5)  the  unit  operating  cost,  i.  e.,  cost  of  production  ex- 
clusive of  depreciation  and  depletion,  (6)  expected  average  sell- 
ing price  per  unit  during  the  operating  life,  and  (7)  the  rate  of 
profit  commensurate  with  the  risk  for  the  particular  deposit. 
When  the  deposit  has  been  sufficiently  developed  these  factors 
may  be  determined  from  past  operating  experience.  In  the  ap- 
plication of  factors  derived  from  past  experience  full  allowance 
should  be  made  for  probable  future  variations  in  the  rate  of  ex- 
haustion, quality  or  grade  of  the  mineral,  percentage  of  recov- 

23  See  Sol.  Op.  80,  T.  B.  5-21-1418. 


DEPLETION — IN  GENERAL  721 

ery,  costs  of  production,  and  selling  price  of  the  product  market- 
ed during  the  expected  operating  life  of  the  mineral  deposit. 

(c)  Mineral  deposits  for  which  these  factors  may  not  be  de- 
termined with  reasonable  accuracy  from  past  operating  expe- 
rience may,  with  the  approval  of  the  Commissioner,  be  valued 
in  a  similar  manner;  but  the  factors  must  be  deduced  from  con- 
current evidence  such  as  the  general  type  of  the  deposit,  the 
characteristics  of  the  district  in  which  it  occurs,  the  habit  of  the 
mineral  deposits  in  the  property  itself,  the  intensity  of  mineral- 
ization, the  rate  at  which  additional  mineral  has  been  disclosed  by 
exploitation,  the  stage  of  the  operating  life  of  the  property,  and 
other  evidence  tending  to  establish  a  reasonable  estimate  of  the 
required  factors. 

{d)  Mineral  deposits  of  different  grades,  locations,  and  prob- 
able dates  of  extraction  in  a  mineral  property  must  be  valued 
separately.  The  mineral  content  of  the  deposit  should  be  deter- 
mined in  accordance  with  the  rules  stated  in  the  following  chap- 
ters. In  estimating  the  average  grade  of  the  developed  and  pro- 
spective mineral,  account  should  be  taken  of  probable  increases 
or  decreases  as  indicated  by  the  operating  histor>\  The  rate  of 
exhaustion  of  a  mineral  deposit  should  be  detennined  with  due 
regard  to  the  limitations  imposed  by  plant  capacity,  by  the  char- 
acter of  the  deposit,  by  the  ability  to  market  the  mineral  product, 
by  labor  conditions,  and  by  the  operating  program  in  force  or 
definitely  adopted  at  the  basic  date  for  future  operations.  The  op- 
erating life  of  a  mineral  deposit  is  that  number  of  years  neces- 
sary for  the  exhaustion  of  both  the  developed  and  prospective 
mineral  content  at  the  rate  determined  as  above.  The  operating 
cost  comprises  all  current  expense  of  producing,  preparing,  and 
marketing  the  mineral  product  sold,  exclusive  of  federal  income, 
war-profits,  and  excess-profits  taxes,  allowable  capital  addi- 
tions,-^ and  deductions  for  depreciation  and  depletion,  but  in- 
cluding cost  of  repairs  and  replacements  necessary  to  maintain 
the  plant  and  equipment  at  its  rated  capacity  and  efl!iciency.  This 
cost  of  repairs  and  replacements  is  not  to  be  confused  with  the 
depreciation  deduction  by  which  the  cost  or  value  of  plant  and 
equipment  is  returned  to  the  taxpayer  free  from  tax.  In  general 
no  estimates  of  these  factors  will  be  approved  by  the  Commis- 
sioner which  are  not  supported  by  the  operating  experience  of 
the  property  or  which  are  derived  from  different  and  arbitrarily 
selected  periods. 

24  See  Reg.   45,  Art.  222. 


722  FEDERAL  INCOME   TAX 

(e)  The  product  of  the  number  of  units  of  mineral  recoverable 
in  marketable  form  by  the  difference  between  the  selling  price 
and  the  operating  cost  per  unit  is  the  total  expected  operating 
profit.  The  value  of  each  mineral  deposit  is  then  the  total  ex- 
pected operating  profit  from  that  deposit  reduced  to  a  present 
value  as  of  the  basic  date  at  the  rate  of  interest  commensurate 
with  the  risk  for  the  operating  life,  and  further  reduced  by  the 
value  at  the  basic  date  of  appreciable  assets  and  of  the  capital 
additions,  if  any,  necessary  to  realize  the  profits.^s 

Revaluations  of  Mineral  Deposits  Not  Allowed.-^  No  revalua- 
tion of  a  property  whose  value  as  of  the  basic  date  has  been  de- 
termined and  approved  will  be  allowed  during  the  continuance 
of  the  ownership  under  which  the  value  was  so  determined  and 
approved,  except  in  the  case  of  discovery .27  The  value  as  of  the 
basic  date  may,  however,  be  corrected  when  a  virtual  change 
of  ownership  of  part  of  the  property  results  as  the  outcome  of 
litigation,  and  may  be  redistributed  (a)  when  a  revision  of  the 
number  of  units  of  mineral  in  the  property  has  been  made  in 
accordance  with  the  rules  set  forth  elsewhere ^s  in  this  book,  and 
(b)  in  case  of  the  sale  of  a  part  of  the  property,  between  the  part 
sold  and  part  retained. 

Computation  of  Deduction  for  Depletion  of  Mineral  Deposits. 
(a)  Depletion  attaches  to  the  annual  production  "according  to 
the  peculiar  conditions  of  each  case"  and  when  the  depletion  ac- 
tually sustained,  whether  legally  allowable  or  not,  from  the  basic 
date,  equals  the  cost  or  value  on  the  basic  date  plus  subsequent 
allowable  capital  additions,  no  further  deduction  for  depletion 
will  be  allowed  except  in  consequence  of  added  value  arising 
through  discovery  or  purchase. 

(b)  When  the  value  of  the  property  at  the  basic  date  has 
been  determined,  depletion  for  the  taxable  year  is  determined  by 
dividing  the  value  remaining  for  depletion  by  the  number  of  units 
of  mineral  to  which  this  value  is  applicable,  and  by  multiplying 
the  unit  value  for  depletion,  so  determined,  by  the  number  of 
units  sold  within  the  taxable  year.  In  the  selection  of  a  unit 
for  depletion  preference  must  be  given  to  the  principal  or  cus- 
tomary unit  or  units  paid  for  in  the  product  sold.^^ 

Limitation  Upon  Depletion  Based  on  Discovery  Value.  Under 
the  1921  Law  a  new  provision  is  inserted,  placing  a  limitation  on 

25  Reg.  45,  Art.  206. 

26  Reg.  45,  Art.  207. 

27  For  a  definition  of  discovery,  see  pages  758  and  760. 

28  See  pages  000  and  000. 

29  Reg.  45,  Art.  210. 


DEPLETION — IN  GENERAL  723 

the  depletion  deduction  when  based  upon  discovery  vahie.  ll  i.s 
now  provided  that  the  depletion  allowance  based  on  discovery 
value  shall  not  exceed  the  net  income,  computed  without  allow- 
ance for  depletion,  from  the  property  upon  which  the  discovery 
is  made,  except  where  such  net  income  so  computed  is  less  than 
the  depletion  allowance  based  on  cost  or  fair  market  value  as  of 
March  1,  1913.""  The  purpose  of  this  provision  has  been  stated 
to  be  "in  order  to  make  it  certain  that  the  depletion  deduction 
when  based  upon  discovery  value  shall  not  be  permitted  to  offset 
cr  cancel  profits  derived  by  the  taxpayer  from  a  separate  and 
distinct  line  of  business."  ='1 

Adjustments  of  Accounts  Based  on  Bonus  or  Advanced  Roy- 
alty, (a)  Where  a  lessor  receives  a  bonus  or  other  sum  in  ad- 
dition to  royalties,  such  bonus  or  other  sum  is  to  be  regarded  as  a 
return  of  capital  to  the  lessor,  but  only  to  the  extent  of  the  capital 
remaining  to  be  recovered  through  depletion  by  the  lessor  at  tho 
date  of  lease.  If  the  bonus  exceeds  the  capital  remaining  to  be 
recovered,  the  excess  and  all  the  royalties  thereafter  received 
will  be  income  and  not  depletable.  If  the  bonus  is  less  than  the 
capital  remaining  to  be  recovered  by  the  lessor  through  depletion, 
the  difference  may  be  recovered  through  depletion  deductions 
based  on  the  royalties  thereafter  received.  The  bonus  or  other 
sum  paid  by  the  lessee  for  a  lease  made  on  or  after  March  1, 
1913,  will  be  his  value  for  depletion  as  of  date  of  acquisition. 

(b)  Where  the  owner  has  leased  a  mineral  property  for  a  term 
of  years  with  a  requirement  in  the  lease  that  the  lessee  shall  ox- 
tract  and  pay  for,  annually,  a  specified  number  of  tons,  or  other 
agreed  units  of  measurement,  of  such  mineral,  or  shall  pay,  an- 
nually, a  specified  sum  of  money  which  shall  be  applied  in  pay- 
ment of  the  purchase  price  or  royalty  per  unit  of  such  mineral 
whenever  the  same  shall  thereafter  be  extracted  and  removed 
from  the  leased  premises,  the  value  in  the  ground  to  the  lessor, 
for  purposes  of  depletion,  of  the  number  of  units  so  paid  for  in 
advance  of  extraction  will  constitute  an  allowable  deduction  from 
the  gross  income  of  the  year  in  which  such  payment  or  payments 
shall  be  made ;  but  no  deduction  for  depletion  by  the  lessor  may 
be  claimed  or  allowed  in  any  subsequent  year  on  account  of  the 
extraction  or  removal  in  such  year  of  any  mineral  so  paid  for  in 
advance  and  for  which  deduction  has  once  been  made. 

30  Revenue  Act  of  1921,  §§214  (a)  10  ami  234  (a)  9.  This  is  the  one 
respect  in  which  the  depletion  provision  of  the  present  law  differs  from 
the  corresponding   provision   of  the   1918   Law. 

31  See  Report  of  Senate  Finance  Committee  on  tho  Revenue  Bill  of  1921, 

p.  15. 


724  FEDERAL   INCOME   TAX 

(c)  If,  for  any  reason,  any  such  mineral  lease  is  terminated 
or  abandoned  before  the  mineral  which  has  been  paid  for  in  ad- 
vance has  been  extracted  and  removed,  and  the  lessor  repossesses 
the  leased  property,  the  lessor  must  adjust  his  capital  accounts 
by  restoring  to  the  capital  sum  of  the  property  the  depletion  de- 
ductions made  in  prior  years  on  account  of  royalties  on  mineral 
paid  for  but  not  removed,  and  his  income  account  must  be  ad- 
justed so  as  to  include  the  amount  so  restored  to  capital  sum  as 
income  of  the  year  such  lease  is  terminated  or  the  property  re- 
possessed, and  the  tax  thereon  paid. 

(d)  Upon  the  expiration,  termination,  or  abandonment  of  a 
lease,  without  the  removal  of  any  or  all  of  the  mineral  con- 
templated by  the  lease,  the  lessor  will  be  required  to  restore 
to  capital  account  so  much  of  the  bonus  received  and  deducted 
from  capital  recoverable  through  depletion  as  is  in  excess  of 
the  actual  depletion  or  loss  in  value  sustained  as  a  result  of  the 
operations  under  the  lease  and  the  corresponding  amount  will  be 
income  for  the  year  in  which  the  lease  expires,  terminates,  or  is 
abandoned/'- 

Depletion  and  Depreciation  Account  on  Books.  Every  tax- 
payer claiming  and  making  a  deduction  for  depletion  and  de- 
preciation of  mineral  property  must  keep  accurate  ledger  ac- 
counts in  which  shall  be  charged  fair  market  value  as  of  March 
1,  1913,  or  within  30  days  after  the  date  of  discovery,  or  the 
cost,  as  the  case  may  be,  (a)  of  the  mineral  deposit,  and  (b)  of 
the  plant  and  equipment  together  with  subsequent  allowable 
capital  additions  to  each  account.  These  accounts  should  there- 
after be  credited  annually  with  the  amounts,  whether  legally 
allowable  or  not,  of  the  depreciation  and  depletion  sustained,  or 
the  amount  of  the  depreciation  and  depletion  sustained  shoula 
be  credited  to  depletion  and  depreciation  reserve  accounts  to  the 
end  that  when  the  sum  of  the  credits  for  depletion  and  deprecia- 
tion equals  the  value  or  cost  of  the  property,  plus  subsequent  al- 
lowable capital  additions,  no  further  deduction  for  depletion  and 
depreciation  with  respect  to  the  property  will  be  allowed.^-^ 

32  Reg.  45,  Art.  215. 

3S  Reg.  45,  Art.  216.  Because  of  the  fact  that  depreciation  and  deple- 
tion deductions  are  applied  against  different  capital  sums,  which  are 
usually  returnable  at  different  rates,  it  is  essential  that  these  accounts  be 
kept  separately;  that  is,  the  cost  or  value  of  physical  property  subject  to 
depreciation  with  deductions  for  depreciation  enter  into  one  account;  the 
cost  or  value  of  the  property  (exclusive  of  physical  property),  together 
with  additions  for  such  development  costs  as  have  not  been  charged  to 
current  operating  expenses,  enter  into  a  separate  account  against  which 
depletion  may  be  charged. 


DEPLETION — IN  GENERAL  725 

Rule  Under  the  1909  Law.  The  Act  of  August  5,  19U9,  did  not 
pi()\  ide  for  deductions  from  gross  income  on  account  of  depletion 
of  natural  resources.  The  fact  that  revenues  derived  from  oper- 
ating mines  resulted  to  some  extent  in  exhaustion  of  the  capital 
established  under  that  law  no  ground  for  the  deduction  from 
gross  income  of  the  value  of  the  ore  extracted.'-*  Lessors  could 
claim  no  deduction  from  royalties  with  respect  to  depletion.-'"' 
Lessees  were  allowed  to  claim  a  deduction  of  a  proportionate 
amount  of  the  cost  of  the  lease,  but  not  of  the  value  of  the  deposit 
at  the  incidence  of  the  tax.-''"'  Although  the  treasury  department 
prescribed  rulings  for  determining  depletion  under  the  1909 
Law-"  such  rulings  were  not  authorized  by  the  statute,  and  a 
corporation  which  had  claimed  depletion  thereunder  could  not 
claim  that  the  treasury  department  was  estopped  by  such  regu- 
lations from  assessing  the  tax  without  the  benefit  of  any  depletion 
under  that  law.-'"'^ 

Rule  Under  the  1913  Law.  The  1913  Law  allowed  the  tax- 
payer to  deduct  from  the  gross  income  of  the  taxable  year  on 
account  of  depletion  of  natural  deposits  an  amount  not  to  exceed 
5V'  of  the  gross  value  of  the  output  of  the  ore  at  the  mine  during 
the  year."'"  The  term  "gross  value  at  the  mine"  was  held  to  mean 
in  the  case  of  a  coal  mine  the  market  value  of  the  prepared 
coal  at  the  mine  where  such  value'  is  established  by  actual  sales 
at  the  mine;  and,  where  the  market  value  is  established  at 
some  place  other  than  the  mine,  the  price  for  which  the  coal 
is  sold  less  transportation  charges.^"  The  law  did  not  require 
that  the  charge  for  depletion  of  natural  deposits  must  actually 
be  set  up  on  the  books  of  the  taxpayer  in  order  to  constitute 
an  allowable  deduction.  It  was  first  held  that  such  an  entry 
must  be  made  in  order  to  obtain  the  benefit  of  the  allowance,-*' 
but  it  was  later  held  that  failure  to  write  off  depletion  would 
not  result  in  a  disallowance  of  the  deduction.^-  It  is  now  held 
that:  "An  operating  owner  will  determine  the  amount  which  he 
is  entitled  to  deduct  in  his  return  as  depletion  by  adding  to  the 
amount  paid  for  the  deposit  or  to  its  fair  market  value  as  of 

3-t  Stratton's  Independence  v.  Howbert,  231  U.  S.  399. 

^r)Von  Baumbach  v.  Sargeant  Land  Co.,  242  U.  S.  ri03. 

3«Biwabik  Mining  Co.  v.  U.  S.,  247  U.  S.  116. 

37  T.  D.  1675. 

ssGoldfield  Consolidated  Mines  Co.  v.  Scott,  247  U.   S.  126. 

S!»  Act  of  October  3,  1913,  1j  B  and  TI  G. 

40  S.   1365,  T.   B.   18-20-900. 

41  Letter   from    treasury    department   dated    May    18,    1916. 

42  T.  D.  2481. 


726  FEDERAL   INCOME   TAX 

March  1,  1913,  if  acquired  prior  thereto,  such  costs  of  develop- 
ment since  that  date,  as  have  not  been  deducted  as  expenses  on 
his  returns,  and  by  dividing  the  resultant  sum  by  the  number  of 
units  in  the  mine  estimated  as  of  the  time  of  its  acquisition  or  as 
of  March  1,  1913,  if  acquired  prior  thereto,  thereby  determining 
the  per  unit  cost  or  value.  The  taxpayer  is  then  entitled  to  de- 
duct as  depletion  for  the  years  1913,  1914  and  1915  the  product 
of  the  per  unit  cost  or  value  multiplied  by  the  number  of  units 
produced  within  the  year,  provided  such  amount  does  not  exceed 
5  per  cent,  of  the  gross  value  of  the  output  for  the  year  at  the 
mine."^'^  Under  the  1913  Law  and  under  the  1916  Law  a  lessor 
is  permitted  a  depletion  allowance  which  is  computed  like  that  of 
an  operating  owner,  except  that  where  a  mine  was  leased  before 
March  1,  1913,  the  allowance  for  depletion  in  favor  of  the  lessor 
is  based  not  on  the  fair  market  value  of  the  ore  or  mineral  in  place 
as  of  March  1,  1913,  but  on  the  lessor's  interest  therein  on  that 
date.« 

Rule  as  to  Mine  Under  the  1916  Law.  Under  the  1916  Law  an 
operating  owner  is  entitled  to  a  reasonable  allowance  for  de- 
pletion, limited  in  the  case  of  mines  to  the  market  value  in  the 
mine  of  the  product  thereof  mined  and  sold  during  the  year, 
not  exceeding  in  the  aggregate  the  capital  originally  invested,  or 
in  case  of  purchase  made  prior  to  March  1,  1913,  the  fair  market 
value  as  of  that  date.  In  a  case  arising  under  the  1916  Law  the 
price  at  which  property  was  offered  for  sale  on  May  1,  1914,  has 
been  accepted  as  the  fair  market  value  of  mining  property  on 
March  1,  1913,  in  the  absence  of  evidence  showing  a  change  in 
value  between  these  two  dates.*^  In  order  that  a  taxpayer  may 
have  the  benefit  of  the  authorized  deduction  for  depletion,  the 
amount  claimed  must  actually  be  charged  off  on  his  books  before 
the  allowance  can  be  granted.^'''    An  operating  owner  will  deter- 

43  Extract  from  circular  entitled  "Schedule  for  Depletion — 1909-1917," 
issued  by  the  treasury  department.  Mines  and  Minerals  Section,  1919. 

44  Id.  But  since  the  courts  have  held  that  a  lessee  acquires  no  interest 
in  the  mineral  deposits  in  place,  but  only  the  privilege  of  entering  upon 
the  premises  and  mining  and  removing  such  deposits,  it  would  seem  that 
the  lessor's  interest  in  a  deposit  as  of  March  1,  1913,  was  not,  for  the  pur- 
pose of  claiming  depletion  under  the  1913  and  1916  Laws,  diminished  by 
I'eason  of  a  lease  existing  on  that  date. 

45  S.  1365,  T.  B.  18-20-900. 

46  The  amount  need  not  however  be  written  off  in  the  taxable  year.  It 
is  sufficient  if  the  amount  is  charged  off  before  being  allowed  as  a  deduction. 
Consequently  at  the  time  of  an  examination  of  a  corporation  it  is  allowed 
to  reopen  its  books  and  charge  off  depletion  actually  sustained  for  any 
taxable  year  during  which  the  1916  Law  was  in  effect.     If,  however,  the 


DEPLETION — IN  GENERAL  727 

mine  the  amount  which  he  is  entitled  to  deduct  as  depletion  by 
adding  to  the  amount  paid  for  the  ore  or  mineral  or  to  its  fair 
market  value  as  of  March  1,  1913,  if  acquired  prior  thereto,  such 
costs  of  development  since  that  date  as  have  not  been  deducted  as 
expenses,  and  by  dividing  the  resultant  sum  by  the  number  of 
units  in  the  mine  estimated  as  of  the  time  of  its  acquisition  or  as 
of  March  1,  1913,  if  acquired  prior  thereto,  thereby  determining 
the  per  unit  cost  or  value.  The  taxpayer  is  then  entitled  to  deduct 
as  depletion  for  the  year  1916  and  subsequent  years  the  product 
of  the  per  unit  cost  or  value  multiplied  by  the  number  of  units 
produced  within  the  year.  However,  when  the  aggregate  of  such 
deductions  shall  equal  the  cost  or  fair  market  value  as  of  March 
1,  1913,  plus  the  amount  subsequently  expended  in  developing  the 
property  which  had  not  been  deducted  as  an  expense,  the  tax- 
payer will  be  entitled  to  no  further  deductions.^' 

In  a  case  arising  under  the  1916  Law,  a  taxpayer  leased  min- 
eral property  in  1910  for  a  royalty  of  20  cents  a  ton  for  a  period 
of  10  years.  In  1913  it  was  determined  that  the  property  was 
very  valuable  and  had  a  large  tonnage  of  ore  which  would  extend 
its  life,  at  the  probable  rate  of  extraction,  until  1940.  In  1920 
he  renewed  the  lease  for  the  life  of  the  mine  for  a  royalty  of 
$1.00  per  ton.  It  was  ruled  that  the  value  of  the  taxpayer's 
interest  as  of  March  1,  1913,  in  the  ore  in  the  mine  was  the 
present  worth,  as  of  that  date,  of  his  royalties  of  20  cents  per 
ton,  obtained  by  multiplying  the  royalty  per  ton  by  the  number 
of  tons  probable  extraction  by  the  lessee  and  discounting  the 
product  for  the  remaining  life  of  the  lease,  plus  the  value  of  the 
ore  which  would  be  left  in  the  mine  at  the  termination  of  the 
lease.  The  fair  market  value  of  the  ore  in  the  mine  as  of  March 
1,  1913,  having  been  determined,  "a  reasonable  allowance"  for 
depletion  under  such  lease  was  the  then  present  worth  of  his 
royalties,  provided  this  did  not  exceed  such  fair  market  value. 
Upon  the  renewal  of  the  lease  in  1920  for  the  remaining  life  of 
the  mine,  the  taxpayer's  interest  in  the  capital  sum  would  again 
be  represented  by  the  royalties  stipulated  to  be  paid,  capitali'ied 

facts  do  not  warrant  the  opening  of  the  books  and  charging'  off  depletion 
for  any  past  year,  it  \vill  not  be  allowed  as  a  deduction.  Thus,  for 
example,  if  all  the  earnings  of  a  year  have  been  distributed  and  there  is 
nothing  from  which  to  credit  a  reserve  for  depletion  no  allowance  for  de- 
pletion can  be  credited  to  a  reserve  account  or  permitted  as  a  deduction. 
(Letter  from  treasury  department  dated  June  25,  1918;  I.  T.  S.  1919, 
^2119.) 

47  Extract   from   circular    entitled   "Schedule   for   Depletion— 1909-1917," 
issued  by  the  treasury  department.  Mines  and  Minerals  Section,  1919. 


728  FEDERAL  INCOME  TAX 

and  discounted  as  above,  and  its  present  worth  divided  by  the 
estimated  mineral  content  of  the  mine  at  the  date  of  the  lease 
would  equal  the  unit  of  depletion  which,  multiplied  by  the  num- 
ber of  tons  extracted  in  any  year,  would  give  the  allowable  de- 
duction for  depletion  for  such  year,  provided  always  that  such 
deduction  does  not  exceed  the  value  as  of  March  1,  1913,  of  the 
ore  extracted  during  such  year.^s 

Rule  as  to  Lessees  Under  Prior  Laws.  As  mining  leases  are 
held  not  to  convey  the  mineral  deposits  in  place,  but  only  the 
privilege  of  entering  upon  the  premises  and  mining  and  remov- 
ing such  deposits,  under  none  of  the  Acts  of  1909,  1913,  or  1916 
is  a  lessee  entitled  to  deduction  from  income  on  account  of  de- 
pletion. But  under  the  provisions  of  the  Acts  of  1909,  1913, 
and  1916,  authorizing  the  deduction  from  gross  income  of  the 
ordinary  and  necessary  expenses  of  the  business,  including  rent- 
als, the  lessee  may  deduct  royalties  paid  as  such  necessary  ex- 
penses, and  in  the  event  that  he  paid  a  lump  sum  for  his  lease, 
such  sum  may  be  considered  as  rent  paid  in  advance  and,  to- 
gether with  the  cost  of  development  not  deducted  as  expenses, 
may  be  divided  by  the  estimated  number  of  units  in  the  mine  as 
of  the  date  of  acquisition  in  order  to  determine  the  expense  per 
unit  for  the  purpose  of  deduction.  The  lessee  is  then  entitled  to 
deduct  as  expense  the  product  of  the  per  unit  expense  multiplied 
by  the  number  of  units  produced  within  the  year.  If  the  lessee 
is  unable  to  determine  the  proper  amount  based  upon  investment 
in  accordance  with  the  method  outlined  above,  he  may  deduct 
in  his  return  the  pro  rata  portion  of  the  amount  expended  for 
the  lease  and  for  development  based  upon  the  life  of  the  lease.^^ 

In  a  case^o  arising  under  the  1916  Law  it  appeared  that  the 
Mohawk  Mining  Company  on  February  7,  1905,  acquired  a  min- 
ing lease  upon  a  tract  of  land  in  Minnesota,  paying  $81,250  there- 
for and  agreeing  to  pay  a  royalty  of  $0.25  per  ton  as  the  ore  was 
mined  and  removed  from  the  premises.  Immediately  thereaftei' 
the  mining  company  entered  into  possession  of  the  leased  proper- 
ty and  opened  a  mine,  spending  a  large  sum  of  money  in  sinking 

48  Sol.  Op.  80,  T.  B.  5-21-1418. 

49  Extract  from  circular  entitled  "Schedule  for  Depletion — 1909-1917  " 
issued  by  the  Treasury  Department,  Mines  and  Minerals  Section,  1919. 

•")0  Mohawk  Mining  Co.  v.  Weiss,  U.  S.  Dist.  Ct.,  No.  D.  of  Ohio,  I.  T.  S. 
1919,  par.  3635.  The  case  was  submitted  to  the  Circuit  Court  of  Appeals  on 
February  9,  1920,  and  this  court  reversed  the  lower  court  on  March  2,  1920. 
The  opinion  was  corrected  and  refiled  on  June  15,  1920.  The  Court  ren- 
dered a  further  opinion  on  June  15,  1920,  on  a  petition  for  a  rehearing. 
(See  254  Fed.  502.) 


DEPLETION — IN  GENERAL  729 

shafts,  driving  entries,  etc.  On  March  1,  1913,  there  were  1,106,- 
389  tons  of  ore  in  the  mine,  of  an  agreed  value  of  $0.49875  per 
ton,  considering  the  entire  deposit  en  bloc.  The  value  of  the 
lease  on  March  1,  1913,  was  $275,214.26.  The  term  was  suffi- 
cient to  enable  the  lessee  to  mine  out  all  the  ore.  In  its  1916  and 
1917  returns  the  mining  company  deducted  allowances  for  de- 
pletion—$46,096.61  in  1916  and  $66,467  in  1917,  such  depletion 
being  at  the  rate  of  $0.24875  per  ton  on  the  ore  removed  in  such 
years.  Of  these  amounts  the  Commissioner  allowed  a  deduction 
in  1916  and  1917  at  the  rate  of  $0.04  per  ton  on  the  ore  removed 
in  such  years,  it  being  agreed  that  such  amount,  when  applied 
to  all  the  ore  known  to  be  in  the  mine  in  1905,  would  free  from 
tax  the  $81,250  originally  paid  for  the  lease  by  the  mining  com- 
pany. The  disallowance  of  any  further  depletion  was  based 
solely  on  the  ground  that  the  mining  company  was  not  the 
owner  of  the  ore  or  mine  content,  but  was  only  the  lessee  or 
contractor."'^  In  reversing  the  decision  of  the  district  court  per- 
mitting an  allowance  for  depletion  and  reversing  the  Commis- 
sioner, the  circuit  court  of  appeals  relied  almost  entirely  upon  a 
decision  of  the  United  States  Supreme  Court  under  the   1909 

51  The  Court  said:  "We  cannot  conceive  any  substantial  distinction  as 
applied  to  a  mine  between  that  depreciation  or  allowance  for  capital  assets 
consumed  which  was  sought  by  mine  owners  under  the  earlier  acts,  and  that 
depletion  which  was  expressly  allowed  by  the  amendment  of  1916.  From 
every  point  of  view,  this  kind  of  depreciation  or  aUoJvance  was  depletion  and 
this  allowed  depletion  is  depreciation  or  diminution  of  capital  and  when  the 
question  or  right  to  the  allowance  arises  as  between  fee  owner  and  lessee, 
it  can  make  no  difference  whether  the  claimed  allowance  is  called  by  one 
name  or  by  the  other.  In  U.  S.  v.  Biwabik  Co.,  247  U.  S.  116  (arising  under 
the  Act  of  1909),  it  was  ruled,  after  full  consideration,  that  under  a  lease 
practically  identical  with  the  Mohawk  lease  now  involved,  the  nature  of  the 
interest  held  by  the  lessee  was  not  such  as  to  permit  it  to  claim  the  allow- 
ance, but  that  the  contingencies  which  attended  the  character  of  the  lessee's 
interest  barred  it  from  claiming  that  its  capital  assets  had  been  diminished. 
It  is  true  that  the  question  whether  the  mining  of  ore  could  be  considered 
depreciation  in  any  event  was  underlying,  and  that  this  question  has  been 
completely  removed  by  the  amendment  of  1916,  but  the  Supreme  Court  did 
not  rest  its  conclusion  at  all  upon  the  definition  of  depreciation."  ( Original 
opinion  as  revised.)  "In  the  Biwabik  case,  the  lessee  was  not  heard  to  say 
that  his  capital  assets  had  been  consumed  by  his  mining  operations,  and  we 
interpret  that  decision  as  resting  in  an  essential  degree  on  the  idea  that  the 
natui'e  of  the  lessee's  title  forbade  him  to  make  this  claim.  We  can  not 
read  the  decisions  of  the  supreme  court  as  having  determined  that  the 
exhaustion  of  ore  reserves  is  so  inherently  a  business  loss  rather  than  an 
impairment  of  capital,  that  a  statutory  grant  of  the  right  to  deduct  for 
depletion  on  that  account  will  reach  a  case  which  has  been  adjudged  not 
to  involve  the  diminution  of  capital  assets.     We  think  the  substantial  prin- 


730  FEDERAL  INCOME   TAX 

law.s2  In  this  case  the  defendant  acquired  a  leasehold  in  certain 
ore  producing  properties  in  Minnesota  from  which  it  mined  ore 
from  that  date  to  and  including  the  year  1910.  This  lease  was 
acquired  by  payment  to  the  prior  lessee  of  the  sum  of  $612,000 
in  addition  to  contracting  to  pay  a  royalty  of  $0.30  per  ton  upon 
ore  mined.  In  its  1910  return  the  defendant  deducted  the  sum 
of  $265,372.08  "to  cover  realization  of  unearned  increment." 
The  amount  of  this  deduction  was  arrived  at  by  multiplying  the 
number  of  tons  of  ore  mined  during  the  year  by  $0.4875,  which 
was  the  market  value  of  the  ore  in  place  on  January  1,  1909.  The 
district  court  held  that  the  deduction  could  not  be  allowed  since 
the  lease  was  not  a  conveyance  of  the  ore  in  place,  but  was 
merely  a  grant  of  the  privilege  of  entering  upon  the  premises 
and  mining  and  removing  the  ore.  This  court  allowed,  however, 
the  deduction  of  the  sum  of  $0.03885  per  ton,  which  represented 
an  allowance  of  part  of  the  cost  of  $612,000  calculated  upon  a 
per  unit  basis.  This  decision  of  the  district  court  was  reversed 
by  the  circuit  court  of  appeals. '"^  The  Supreme  Court,  however, 
repudiating  the  construction  of  its  earlier  opinions  placed  upon 
such  opinions  by  the  circuit  court  of  appeals,  held  that  the  de- 
fendant was  not  entitled  to  the  depletion  claimed.  The  Supreme 
Court  did  not  pass  upon  the  propriety  of  the  deduction  of  $.03885 
per  ton  allowed  by  the  district  court  as  the  government  had 
taken  no  writ  of  error  as  to  this  partial  deduction.  This  de- 
cision of  the  United  States  Supreme  Court  must  be  considered 
in  the  light  of  the  prior  decisions  of  the  Supreme  Court  upon  the 
question  of  depletion  under  the  1909  law''^  and  also  in  the  light 
of  other  contemporary  decisions  holding  that  in  determining 
net  income  under  the  1909  Law  arising  from  the  conversion  of 

ciples  established  by  the  decisions  are  that  both  the  royalty  received  by  the 
fee  owner  and  the  sums  received  by  the  operating  lessee  above  the  cost  of 
operation  are  income;  that  the  statutory  reduction  for  'depletion'  cannot  be 
twice  credited,  once  to  the  fee  owner  and  one  to  the  lessee;  and  that  the 
exemption  belongs  of  right  to  the  fee  owner."  (On  petition  for  rehearing.) 
In  the  case  under  consideration  this  gives  the  fee  owner  a  depletion  allow- 
ance of  $.49875  per  ton  although  his  royalty  under  the  contract  is  only  $.25 
per  ton.  The  contention  of  the  lessee,  however,  was  not  that  each  should 
claim  an  allowance  of  $.49875  per  ton  but  that  such  aggregate  value  per  ton 
on  the  deposit  en  bloc  should  be  shared  by  lessor  and  lessee. 

52  U.  S.  v.  Biwabik  Mining  Co.,  247  U.  S.  116. 

53  Biwabik  Mining  Co.  v.  U.  S.,  242  Fed.  9. 

5-i  Stratton's  Independence  v.  Howbert,  231  U.  S.  399;  Von  Baumbach  v. 
Sargent  Land  Co.,  242  U.  S.  503.  The  decision  in  Goldfield  Consolidated 
Mines  v.  Scott,  247  U.  S.  126,  was  made  on  the  same  day  as  the  Biwabik 
decision  and  reiterates  the  force  and  effect  of  the  other  cases  cited,  adding 
nothing  material  to  the  discussion  of  the  principles  involved. 


DEPLETION — IN  GENERAL  731 

ihe  capital  assets  of  a  taxpayer  acquired  before  January  1,  1909, 
there  might  be  deducted  from  the  gross  proceeds  of  the  conver- 
sion an  amount  sufficient  to  restore  the  capital  value  existing 
on  December  31,  1908."'  The  essential  substance  of  the  first  of 
the  decisions  on  depletion-"'"  was  that  (1)  the  proceeds  of  ores 
mined  by  a  corporation  from  its  own  premises  constitute  in- 
come under  the  1909  Law,  and  (2)  a  corporation  is  not  entitled 
under  that  law  to  deduct  the  value  of  such  ore  in  place  before 
it  is  mined,  from  such  income.  The  former  of  these  two  con- 
clusions was  based  upon  the  consideration  that  the  1909  Law 
was  not  an  income  tax  law,  but  imposed  an  excise  tax  on  cor- 
porations engaged  in  business  measured  by  net  income  as  defined 
in  the  act.  The  mining  company,  being  within  the  taxing  clause 
and  not  within  the  exempting  clause,  was  taxable  upon  net  in- 
come as  defined  in  the  act.  Thus,  it  seems,  the  income  used  as 
a  measure  of  the  1909  tax,  according  to  the  Supreme  Court, 
need  not  necessarily  be  true  net  income  and  may  include  amounts 
which,  properly  speaking,  are  return  of  capital,  in  a  business 
that  theoretically  or  practically  involves  a  wasting  capital, 
especially  when  such  income  is  easy  of  ascertainment  and  simply 
applied  in  practice. 

In  the  next  case"  involving  depletion  the  Supreme  Court 
held  that  (1)  so-called  royalties  received  by  the  owners  of  lands 
leased  for  mining  purposes  were  income  within  the  meaning  of 
the  1909  Law  and  (2)  the  resulting  exhaustion  of  ore  body  was 
not  an  element  to  be  considered  in  determining  the  reasonable 
depreciation  allowed  as  a  deduction  by  the  1909  Law.  The  for- 
mer of  these  decisions  was  based  upon  an  analysis  of  the  mining 
leases  involved  and  a  citation  of  numerous  Minnesota  cases  to 
the  effect  that  such  leases  did  not  constitute  a  sale  of  any  part 
of  the  land  or  ore  in  place.  The  second  decision  was  based  upon 
a  strict  interpretation  of  the  word  "depreciation,"  which  was 
held  not  sufficiently  broad  to  include  "depletion." 

Clearly,  at  the  time  the  Biwabik  case  was  decided,  an  owner 
was  not  entitled  to  any  allowance  for  depletion  under  the  1909 
Law,  whether  the  mine  was  operated  by  him  or  he  was  a  lessor. 
All  the  Biwabik  case  decided  was  that  a  lessee  could  not  have  an 
allowance  to  which  a  lessor  was  not  entitled.  The  decision  put 
the  lessor  and  the  lessee  on  an  equality,  and  was  a  necessary 

:"' Doyle  V.  Mitchell  Bros.,  247  U.  S.  179;  Hays  v.  Gauley  Mountain  Coal 
Co.,  247  U.  S.  189;  Lynch  v.  Turrish,  247  U.  S.  221;  U.  S.  v.  Cleveland,  etc.; 
Ry.  Co.,  247  U.  S.  195. 

•"''■•  Stratton's  Independence  v.  Ilowbert,  231  U.  S.  399. 

"H  Von  Baumbach  v.  Sargent  Land  Co..  242  U.  S.  503. 


732  FEDERAL  INCOME   TAX 

corollary  of  the  two  prior  decisions  of  the  court.  The  real  reason 
why  an  allowance  for  depletion  was  denied  to  the  lessee  mining 
company  in  the  Biwabik  case  was  that  the  statute  contained  no 
provision  permitting  such  depletion  to  any  one,  under  the  head 
of  depreciation  or  otherwise. 

It  seems  that  in  the  Mohawk  mining  case  the  circuit  court 
of  appeals  misconstrued  the  Biwabik  case.  The  circuit  court 
of  appeals'  understanding  of  the  essence  of  the  Biwabik  decision 
is  indicated  by  its  statement  that  "the  nature  of  the  interest  held 
by  the  lessee  was  not  such  as  to  permit  it  to  claim  the  allow- 
ance" and  that  the  "nature  of  the  lessee's  title  forbade  him  to 
make  this  claim."  This  is  not  true.  If  the  lessee  had  had  the 
title  of  the  lessor,  he  would  have  been  entitled  to  no  depletion. 
No  one  was  entitled  to  depletion.  The  nature  of  a  mining  prop- 
erty, not  "the  nature  of  the  lessee's  title,"  prohibited  the  deduc- 
tion, under  the  1909  Law. 

This  misapprehension  is  probably  based  upon  the  language 
of  the  Supreme  Court,  reading  as  follows:  "The  lessee  takes 
from  the  property  the  ore  mined,  paying  for  the  privilege  so 
much  per  ton  for  each  ton  removed.  He  has  this  right  or  priv- 
ilege under  the  form  of  lease  here  involved  so  long  as  he  sees 
fit  to  hold  the  same  without  exercising  the  privilege  of  cancella- 
tion herein  contained.  He  is,  as  we  held  in  the  Sargent  Land 
Co.  case,  in  no  legal  sense  the  purchaser  of  the  ore  in  place." 
But  this  language  appears  not  to  have  been  the  basis  of  the 
decision  but  a  mere  restatement  of  the  rule  that  the  kind  of  lease 
involved  did  not  constitute  pro  tanto  a  purchase.  The  statement 
immediately  follows  the  criticism  of  the  circuit  court  of  appeals' 
statement  to  this  effect. 

It  was  perhaps  necessary  to  reiterate  this  point  since  on  the 
same  day-''^  of  the  Biwabik  decision  the  Supreme  Court  also 
decided  other  cases  which  held  that  upon  the  conversion  of 
capital  assets  a  taxpayer  was  entitled  to  deduct  from  the  pro- 
ceeds received  the  value  of  assets  at  the  date  of  the  incidence 
of  the  tax.5^  If  the  kind  of  lease  involved  had  been  such  as  to 
effect  a  sale  or  conversion  of  capital  assets  or  ore  in  place,  the 
lessor  (but  not  the  lessee)  would  have  been  entitled  to  what 
would  have  amounted  to  a  depletion  deduction.  But  this  would 
not  necessarily  have  helped  the  lessee  since,  even  if  the  lease 
had  effected  a  conversion  of  capital  assets  or  sale  of  ore  in  place, 
the  lessee  would  merely  have  assumed  the  position  of  an  owner 

58  May  20,  1918. 

50  Doyle  V.  Mitchell  Bros.,  247  U.  S.  179;  U.  S.  v.  Cleveland,  etc.,  Ry.  Co.. 
247  U.  S.  195;  Hays  v.  Gauley  Mountain  Coal  Co.   247  U.  S.  189. 


DEPLETION — IN  GENERAL  733 

who  had  already  been  denied  depletion.  The  lease  would  not 
have  effected  a  sale  by  him;  it  would  have  meant  a  purchase 
by  him. 

The  Revenue  Act  of  1913  and  that  of  1916,  allow  depletion."" 
Under  both  statutes  the  department  has  held  that  depletion  is 
allowed  only  to  the  owner.  But  the  lessee  is  allowed  a  deduction 
to  provide  for  the  amortization  of  his  capital  investment  in  the 
property,  and  such  deduction  may  be  measured  annually  in  the 
same  manner  as  depletion  is  measured — by  production,  or  may  be 
measured  by  the  life  of  the  lease.  No  deduction  has  been  allowed 
for  the  value  of  a  lease  on  March  1,  1913,  in  excess  of  the  capital 
investment  on  that  date.  A  very  serious  question  arises  in  this 
connection,  which  the  Mohawk  case  does  not  settle,  namely,  if  the 
lessee  had  a  lease  on  March  1,  1913,  possessed  of  a  fair  market 
value,  how  is  he  to  separate  that  value  from  his  receipts  in  order 
not  to  be  taxed  on  what  was  capital  at  the  incidence  of  the  tax, 
Mnd  on  which  he  can  not  be  taxed  in  the  case  of  a  sale  under  the 
decisions  of  the  Supreme  Court.''^ 

In  the  case  of  mines  the  lessee  has  been  held  in  the  cases 
heard  by  the  Supreme  Court  not  to  be  the  purchaser  of  any  ore 
in  place.  Not  being  the  purchaser,  the  lessee  is  not  owner  and 
the  statute  seems  to  limit  depletion  to  property  owned  by  the 
taxpayer.  Under  the  theory  that  leases  do  not  effect  a  sale  of 
ore  in  place,  the  property  of  the  lessee  is  not  the  ore  but  the 
contract  permitting  its  extraction.  It  is  intangible,  not  tangible 
property,  and  any  allowance  to  the  lessee  must  be  based  upon 
the  theory  that  such  intangible  property  or  contract  right  is 
exhausted  by  its  use  or  employment  in  the  lessee's  business  or 
trade. 

c<^  The  1913  Law  permitted  the  deduction  of  "a  reasonable  allowance  for 
the  exhaustion,  wear  and  tear  of  property  arising  out  of  its  use  or  employ- 
ment in  the  business  not  to  exceed,  in  the  case  of  mines,  5  per  centum  of 
the  gross  value  at  the  mine  of  the  output  for  the  year  for  which  the  com- 
putation is  made."  (Act  of  October  3,  1913,  G  (b).)  The  Revenue  Act  of 
1916  provided  for  the  deduction  in  the  case  of  individuals  "(a)  in  the  case 
of  oil  and  gas  wells  a  reasonable  allowance  for  actual  reduction  in  flow  and 
production  to  be  ascertained  not  by  the  flush  flow,  but  by  the  settled  pro- 
duction or  regular  flow;  (b)  in  the  case  of  mines  a  reasonable  allowance  for 
depletion  thereof  not  to  exceed  the  market  value  in  the  mine  of  the  product 
thereof,  which  has  been  mined  and  sold  during  the  year  for  which  the 
return  and  computation  are  made,  *  *  *"  (Revenue  Act  of  1910,  Sections 
5,  6  and  12). 

fii  See  Doyle  v.  Mitchell,  247  U.  S.  179;  Lynch  v.  Turrish.  247  U.  S.  221; 
note  distinction,  however,  in  Lynch  v.  Hornby,  247  U.  S.  339. 

fi2  See  Reg.  33,  Rev.  Art.  171. 


734  FEDERAL  INCOME  TAX 

It  is  possible  that  mineral  deeds  or  leases  of  land  situated  in 
states  other  than  Minnesota  may  be  held  to  constitute  a  sale  of 
minerals  in  place,  in  which  case  a  different  conclusion  as  to  the 
rights  of  lessor  and  lessee  under  the  1909  Law  might  follow  and 
also  a  different  conclusion  under  the  1913  and  1916  Laws  as 
to  lessees. 

The  regulations  issued  under  the  1916  Law  provided  that  "the 
deduction  in  the  case  of  a  lessee  (of  a  mine)  will  be  limited 
to  an  amount  equal  to  the  capital  actually  invested  in  the  lease, 
without  regard  to  value  as  of  March  1,  1913,  or  any  other 
date."*"'-  Under  this  regulation  it  has  been  held  that  where  a 
corporation  organized  for  the  purpose  takes  over  a  mining 
lease,  issuing  its  entire  capital  stock  to  the  individual  owners 
of  the  lease  in  proportion  to  their  respective  interests  therein, 
the  "capital  actually  invested  in  the  lease"  is  represented  by 
the  fair  market  value  of  the  stock  so  issued/*^ 

Depletion  for  Past  Years  Not  Allowed  Under  Present  Law. 
Where  under  the  act  of  October  3,  1913,  or  of  September  8,  1916, 
a  taxpayer  has  not  been  allowed  to  make  a  deduction  for  the  full 
amount  of  his  depletion,  the  amount  of  such  deficiency  can  not  be 
carried  forward  and  deducted  in  any  later  year.  Depletion  at- 
taches to  each  unit  of  mineral  or  other  property  removed,  and  a 
taxpayer  should  make  proper  provision  therefor  in  computing  his 
net  income.  Under  the  Revenue  Acts  of  1918  and  1921  the 
amount  recoverable  through  depletion  will  be  the  cost,  or  the 
value  as  of  March  1,  1913,  or  within  30  days  of  the  date  of  dis- 
covery, as  the  case  may  be,  less  proper  allowance  for  the  mineral 
or  other  property  removed  prior  to  January  1,  1918.^'^ 

63  0.  1033,  T.  B.  20-20-938. 

04  Manual  for  the  Oil  and  Gas  Industry,  p.  45. 


CHAPTER  28 

DEPLETION  OF  MINES 

The  provision  of  the  law  permitting  the  deduction  of  an 
allowance  for  depletion  in  the  case  of  mines,  oil  wells,  gas  wells, 
or  any  other  natural  deposits  and  timber,  has  been  set  forth 
and  discussed  generally  in  the  preceding  chapter.  It  is  shown 
in  that  chapter  that  this  allowance  is  based  (a)  upon  cost,  if 
acquired  after  February  28,  1913,  or  (b)  upon  the  fair  market 
value  as  of  March  1,  1913,  if  acquired  prior  thereto,  or  (c) 
upon  the  fair  market  value  within  thirty  days  after  the  date 
of  discovery  in  the  case  of  mines  discovered  by  the  taxpayer 
after  February  28,  1913,  where  the  fair  market  value  is  seriously 
disproportionate  to  the  cost.  As  shown  in  the  preceding  chapter, 
the  Revenue  Act  of  1921  limits  the  depletion  deduction  when  based 
on  discovery  value  and  provides  that  such  deduction  shall  not  ex- 
ceed the  net  income,  computed  without  allowance  for  depletion, 
from  the  property  on  which  discovery  is  made.  Subject  to  any 
changes  occasioned  by  this  limitation  the  regulations  issued  under 
the  1918  Law  remain  applicable.  The  depletion  allowance  is  per- 
mitted to  operating  owners,  lessors  and  lessees,  and  the  capital 
recoverable  through  the  depletion  allowance  in  the  case  of  each 
and  the  rules  with  respect  to  the  apportionment  of  the  de- 
duction between  lessor  and  lessee  are  discussed  in  the  same 
chapter. 1  In  general,  the  allowance  for  depletion  is  ascertained 
by  multiplying  the  number  of  mineral  units  extracted  from  a 
mine  each  year  by  the  unit  value.  The  unit  value  is  ascertained 
by  dividing  cost,  or  value  as  of  March  1,  1913,  or  within  30 
days  after  discovery,  by  the  number  of  mineral  units  in  the 
property  as  of  the  date  of  acquisition  or  valuation.-  The  pre- 
ceding chapter  should  be  consulted  for  the  rulings  regarding  de- 
pletion generally;  certain  special  rules  relating  specifically  to 
mines  are  set  forth  below.-"^ 

Determination  of  Mineral  Contents  of  Mine.  Every  taxpayer 
claiming  a  deduction  for  depletion  for  a  given  year  will  be  re- 
quired to  estimate  or  determine  with  respect  to  each  separate 

iReg.  45,  Art.  201. 

2  Reg.  45,  Art.  210. 

3  Many  of  the  rules  stated  in  the  next  chapter  with  regard  to  the  oil  and 
gas  industry  have  a  general  application  and  should  be  consulted  for  addi- 
tional information. 

735 


736  FEDERAL  INCOME   TAX 

property  the  total  units  (tons,  pounds,  ounces,  or  other  measure) 
of-  mineral  products  reasonably  known  or  on  good  evidence  be- 
lieved to  have  existed  in  the  ground  on  the  basic  date,  accord- 
ing to  the  method  current  in  the  industry  and  in  the  light  of 
the  most  accurate  and  reliable  information  obtainable.  Pref- 
erence must  be  given  in  the  selection  of  a  unit  of  estimate  to 
the  principal  unit  (or  units)  paid  for  in  the  product  marketed. 
The  estimate  of  the  recoverable  units  of  the  mineral  products  in 
the  property  for  the  purposes  of  valuation  and  depletion  should 
include  as  to  both  quantity  and  grade  (a)  the  ores  and  minerals 
"in  sight,"  "blocked  out,"  "developed,"  or  "assured,"  in  the  usual 
or  conventional  meaning  of  these  terms  in  respect  to  the  type  of 
the  deposit,  and  (b)  "probable"  or  "prospective"  ores  and  miner- 
als (in  the  corresponding  sense),  that  is,  ores  and  minerals  that 
are  believed  to  exist  on  the  basis  of  good  evidence,  although  not 
actually  known  to  occur  on  the  basis  of  existing  development; 
but  "probable"  or  "prospective"  ores  and  minerals  may  be  com- 
puted, for  purposes  of  this  valuation,  (c)  as  to  quantity,  only  in 
case  they  are  extensions  of  known  deposits  or  new  bodies  or 
masses  whose  existence  is  indicated  by  geological  or  other  evi- 
dence to  a  high  degree  of  probability,  and  (d)  a§  to  grade,  of 
such  richness  only  as  accords  with  the  best  indications  available,^ 
Where  a  taxpayer  discovered  that  a  coal  vein  on  his  property 
was  lacking  to  the  extent  of  certain  acreage  by  reason  of  the 
discovery  in  1917  of  a  rock  fault,  it  has  been  held  that  he  is  not 
entitled  to  loss  under  the  heading  of  "loss  of  useful  value,"  but 
be  may  revise  his  estimate  of  recoverable  ore  and  the  capiUil 
remaining  may  be  recovered  by  depletion  deductions  in  subse- 
quent years.  If  the  mining  operation  of  this  property  was  dis- 
continued entirely  in  the  taxable  year,  the  deduction  for  deple- 
tion should  be  taken  in  that  year  so  that  the  return  of  capital 
may  be  complete.^ 

Statement  to  be  Attached  to  Return  Where  Depletion  or  De- 
preciation of  Mineral  Property  is  Claimed.  To  the  return  of 
every  taxpayer  claiming  a  deduction  for  depletion  or  deprecia- 
tion there  should  be  attached  a  statement  setting  forth  with 
respect  to  each  mineral  property  (1)  whether  the  taxpayer  is  a 
fee  owner,  lessor,  or  lessee;  (2)  the  date  of  acquisition,  and  if 
under  lease  its  exact  terms  and  date  of  expiration;  (3)  the  cost 
of  the  property  stating  the  amount  paid  to  each  vendor  with  his 
name  and  address;  (4)  the  basic  date  at  which  the  property  i? 

4  Reg.  45,  Art.  208. 

5  A.  R.  R.  431,  T.  B.  12-21-1521. 


DEPLETION    OF    MINES  737 

valued;  (5)  the  value  of  the  property  on  the  basic  date  with  a 
statement  of  the  precise  method  by  which  it  was  determined;  (6) 
the  value  of  the  surface  of  the  land  for  purposes  other  than 
mineral  production;  (7)  the  estimated  number  of  units  of  miner- 
al at  the  basic  date,  with  an  explanation  of  the  method  used  in 
the  estimation,  and  an  average  analysis  which  will  indicate  the 
quality  of  the  mineral  valued;  (8)  the  number  of  units  sold 
during  the  year  for  which  the  return  is  made;  (9)  the  gross  and 
net  income  derived  from  the  sale  of  mineral;  (10)  the  amounts 
deducted  for  depletion;  (11)  the  amounts  sustained  on  account 
of  depletion  or  on  account  of  depreciation  stated  separately  from 
the  basic  date  to  the  taxable  year;  and  (12)  any  other  data  which 
will  be  helpful  in  determining  the  reasonableness  of  the  deduc- 
tions claimed  in  the  return.  To  tht  return  of  every  taxpayer 
claiming  a  deduction  for  depletion  in  respect  of  (1)  property  in 
which  he  owns  a  fractional  interest  only  or  (2)  a  leasehold,  or 
(3)  property  subject  to  lease  there  should  also  be  attached  a 
statement  setting  forth  the  name  and  address  and  the  precise 
nature  of  the  holding  of  each  person  interested  in  the  property, 
and  every  lessor  is  required  to  attach  to  his  return  an  affidavit 
stating,  as  of  the  date  of  filing  the  return,  whether  the  lease  in- 
volved is  still  in  effect  during  the  year  covered  by  the  return, 
and  if  not  still  in  effect  when  it  was  terminated  and  for  what 
reason  and  whether  the  lessor  has  repossessed  the  property.'' 

Discovery  of  Mines.  To  entitle  a  taxpayer  to  a  valuation  of  his 
property  for  the  purpose  of  depletion  allowances,  by  reason  of  the 
discovery  of  a  mine  on  or  after  March  1,  1913,  the  discovery 
must  be  made  by  the  taxpayer  after  that  date  and  must  result 
in  the  fair  market  value  of  the  property  becoming  dispropor- 
tionate to  the  cost.  The  fair  market  value  of  the  property  will 
be  deemed  to  have  become  disproportionate  to  the  cost  when  the 
newly  discovered  mine  contains  mineral  in  such  quantity  and 
of  such  quality  as  to  afford  a  reasonable  expectation  of  return 
to  the  taxpayer  of  an  amount  materially  in  excess  of  the  capital 
expended  in  making  such  discovery  plus  the  cost  of  future  de- 
velopment, equipment,  and  exploration. 

A  mine  may  be  said  to  be  discovered  when  (1 )  there  is  found  a 
natural  deposit  of  mineral,  or  (2)  there  is  disclosed  by  drilling 
or  exploration,  conducted  above  or  below  ground,  a  mineral  de- 
posit not  previously  known  to  exist  and  so  improbable  that  it 
had  not  been,  and  could  not  have  been,  included  in  any  previous 
valuation  for  the  purpose  of  depletion,  and  which  in  either  case 

CReg.  45,  Art.  217. 


738  FEDERAL  INCOME  TAX 

exists  in  quantity  and  grade  sufficient  to  justify  commercial  ex- 
ploitation. The  discovery  must  add  a  new  mine  to  those  previ- 
ously known  to  exist  and  can  not  be  made  within  a  proven  tract 
or  lease  as  defined  below. 

In  determining  whether  a  discovery  entitling  the  taxpayer  to  a 
valuation  has  been  made,  the  commissioner  will  take  into  ac- 
count the  peculiar  conditions  of  each  case ;  but  no  discovery,  for 
the  purposes  of  valuation,  will  be  allowed  as  to  ores,  or  minerals, 
such  as  extension  of  known  ore  bodies,  that  have  been  or  should 
have  been  included  in  "probable"  or  "prospective"  ore  or  miner- 
al, or  in  any  other  way  comprehended  in  a  prior  valuation,  nor 
as  of  date  subsequent  to  that  v/hen,  in  fact,  discovery  was  evi- 
dent, when  delay  by  the  taxpayer  in  making  claim  therefor  has 
resulted  or  will  result  in  excessive  allowances  for  depletion. 

The  value  of  the  property  claimed  as  a  result  of  a  discovery 
must  be  the  fair  market  value,  as  defined  in  the  preceding  chap- 
ter, based  on  what  is  evident  within  thirty  days  after  the  com- 
mercially valuable  character  and  extent  of  the  discovered  de- 
posits of  ore  or  mineral  have  with  reasonable  certainty  been 
established,  determined,  or  proved.  After  a  bona  fide  discovery 
the  taxpayer  must  adjust  his  capital  and  depletion  accounts  in 
accordance  with  the  rules  stated  in  the  preceding  chapter  and 
must  submit  such  evidence  as  to  establish  his  right  to  a  revalu- 
ation, covering  the  conditions  and  circumstances  of  the  discov- 
ery and  the  size,  character,  and  location  of  the  discovered  de- 
posit of  mineral,  the  value  of  the  property  at  the  prior  basic 
date,  the  cost  of  discovery,  and  its  development,  equipment  and 
exploitation,  its  value  and  the  particular  method  used  in  the 
determination. 

In  the  case  of  a  mine,  a  "proven  tract  or  lease"  includes,  but 
is  not  necessarily  limited  to,  the  mineral  deposits  known  to  exist 
in  any  known  mine  at  the  date  as  of  which  such  mine  was  valued 
for  purposes  of  depletion,  and  all  extensions  thereof,  including 
"probable"  and  "prospective"  ores  considered  as  a  factor  in  the 
determination  of  their  value  or  cost.^ 

A  taxpayer  is  not  entitled  to  a  new  valuation  for  depletion  in 
a  known  mine;  a  discovery  can  not  be  made  of  any  "probable" 

7  Reg.  45,  Art.  219.  The  term  "discovery"  has  been  defined  in  a  number 
of  cases  relating  to  the  location  of  mining  claims,  but  the  word  "discovery" 
as  used  in  this  statute  is  not  used  in  the  sense  employed  in  Revised  Statutes 
§  2320,  under  which  section  it  has  been  held  that  a  sufficient  "discovery"  to 
justify  a  location  on  public  lands  need  not  be  a  discovery  that  the  ground 
contains  mineral  in  sufficient  quantities  to  pay.  See  Words  and  Phrases 
Volume  3,  p.  2094. 


DEPLETION    OF    MINES  739 

or  "prospective"  ores  which  had  been  or  could  have  been  in 
eluded  in  the  previous  valuation,  and  the  regulations  do  not 
recognize  a  discovery  for  the  purpose  of  depletion  as  the  result 
of  improved  processes  of  treatment  of  ores  making  commercially 
valuable  ores  which  were  theretofore  valueless.  If  bodies  of 
zinc  ore  not  theretofore  known  to  exist  were  discovered  within 
the  meaning  of  the  regulations,  the  fact  that  the  explorations 
were  stimulated  by  recent  improvements  in  metallurgy  which 
made  them  commercially  valuable  for  the  first  time  would  not 
bar  a  claim  for  discovery,  and  if  the  original  valuations  of  the 
taxpayer  were  based  upon  estimates  of  recoverable  units,  which 
included  only  the  ores  in  sight  and  blocked  out,  the  properties 
may  be  revalued  as  of  the  basic  date  and  the  depletion  rate  deter- 
mined accordingly  .8 

Allowable  Capital  Additions  in  Case  of  Mines.  All  expendi- 
tures for  development,  rent,  and  royalty  in  excess  of  receipts 
from  minerals  sold  should  be  charged  to  capital  account  recover- 
able through  depletion,  while  the  mine  is  in  the  development 
stage.  Thereafter  any  development  which  adds  value  to  the 
mineral  deposit  beyond  the  current  year  should  be  carried  as  a 
deferred  charge  and  apportioned  and  deducted  as  operating  ex- 
pense in  the  years  to  which  it  is  applicable. 

All  expenditures  for  plant  and  equipment  should  be  charged 
to  capital  account  recoverable  through  depreciation,  while  the 
mine  is  in  the  development  state.  Thereafter  the  cost  of  major 
items  of  plant  and  equipment  should  be  capitalized  but  the  cost 
of  minor  items  of  equipment  and  plant,  necessary  to  maintain 
the  normal  output,  and  the  cost  of  replacement  may  be  charged 
to  current  expense  of  operation.^  All  expenditures  by  a  mining 
company  for  prospecting  and  development  for  the  purpose  of 
enlarging  the  business  or  continuing  it  beyond  its  present  limits 
must  be  charged  to  capital  account.^" 

Accumulated  Depletion.  A  lessor  of  mining  property  who 
waived  his  right  to  royalties  for  several  years  on  account  of  the 
fact  that  the  mine  was  operated  at  a  loss,  and  received  all  of 
the  royalties  in  the  year  1917,  may,  if  he  has  submitted  returns 
for  those  years  on  a  cash  receipts  and  payments  basis,  deduct 
from  the  income  received  in  1917  such  depletion  allowance  as 
appertains  to  that  income.^i 

8  A.  R.  M.  124,  T.  B.  19-21-1620. 

9  Reg.  45,  Art.  222. 

10  O.  D.  314,  T.  B.  26-19-589. 

11  A.  R.  M.  17,  T.  B.  2-20-674. 


CHAPTER  29 

DEPLETION  OF  OIL  AND  GAS  WELLS 

The  provisions  of  the  Revenue  Act  of  1921  permitting  the  de- 
duction of  an  allowance  for  depletion  in  the  case  of  mines,  oil 
wells,  gas  wells,  or  other  natural  deposits  and  timber,  has  been 
set  forth  and  discussed  generally  in  another  chapter. i  This  al- 
lowance is  based  (a)  upon  cost,  if  acquired  after  February  28, 
1913,  or  (b)  upon  the  fair  market  value  as  of  March  1,  1913,  if 
acquired  prior  thereto,  or  (c)  upon  the  fair  market  value  within 
30  days  after  the  date  of  discovery  in  the  case  of  mines  discov- 
ered by  the  taxpayer  after  February  28,  1913,  where  the  fair 
market  value  is  materially  disproportionate  to  the  cost.  The 
depletion  provision  of  the  Revenue  Act  of  1918  was  identical  with 
that  of  the  present  law  except  that  the  present  law  contains  the 
following  limitation:  ''Such  depletion  allowance  based  on  dis- 
covery value  shall  not  exceed  the  net  income,  computed  without 
allowance  for  depletion,  from  the  property  upon  which  the  dis- 
covery is  made,  except  where  such  net  income  so  computed  is  less 
than  the  depletion  allowance  based  on  cost  or  fair  market  value 
as  of  March  1,  1913."-  The  essence  of  the  depletion  provision 
is  that  the  owner  of  mineral  deposits,  whether  leasehold  or  free- 
hold, shall  secure  through  an  aggregate  of  annual  depletion  and 
depreciation  deductions  the  amount  indicated  in  (a),  (b),  or  (c), 
whichever  applies  to  his  particular  case,  plus  in  any  case  the  sub- 
sequent cost  of  plant  and  equipment  (less  salvage  value)  and 
underground  and  overground  development,  which  is  not  charge- 
able to  current  operating  expense,  but  not  including  land  values 
for  purposes  other  than  the  extraction  of  minerals.-^ 

"Capital  Sum."  The  term  "capital  sum"  is  used  in  this  chapter 
to  denote  the  total  amount  recoverable  to  the  taxpayer  by  means 
of  depletion,  depreciation,  and  obsolescence  allowances.  Both  "cost 
of  property"  and  "cost  of  development,"  in  so  far  as  they  have 
not  been  decreased  by  allowable  deductions,  are  chargeable  to  cap- 
ital sum  and  are  returnable  through  the  several  allowable  deduc- 

1  Revenue  Act  of  1918,  §§214  (a)  10,  234  (a)  9. 

2  Revenue  Act  of  1921,  §   214  (a)    (10)  and  §234   (a)    (9). 

3  Reg.  45,  Art.  201.  It  has  seemed  necessary  for  the  clearer  understanding 
of  this  chapter  to  repeat  some  of  the  rules  stated  in  Chapter  27;  where 
possible,  however,  this  has  been  avoided.  Reference  is  made  to  that  chapter 
for  definitions  of  various  terms  used  herein. 

f^ 

740 


DEPLETION  OF  OIL  AND  GAS  WELLS  741 

tions.  Structures  and  equipment  may  also  be  included  in  capital 
assets  and  are  returnable  through  depreciation.  In  the  case  of  re- 
valuations as  of  March  1,  1913,  or  within  30  days  of  a  discovery 
by  the  taxpayer  made  subsequent  to  February  28,  1913,  the  value 
thus  established  plus  consequent  costs  not  otherwise  deducted  be- 
comes the  total  of  "capital  sum."  This  revaluation,  however,  does 
not  affect  the  invested  capital.  Development  costs  (except  the  cost 
of  physical  property)  may  be  deducted  as  an  expense  in  the  year 
in  which  they  are  paid  out  or  at  the  option  of  the  taxpayer  may 
be  charged  to  capital  sum.  Election  once  made  under  this  option 
is  final  and  will  control  the  returns  for  all  subsequent  years.-* 

Cost  of  Property.  Cost  of  property  includes  all  amounts  (in 
cash  or  its  equivalent)  paid  for  and  incident  to  the  establishment 
of  title  and  acquisition  of  the  lease  or  fee,  as  the  case  may  be, 
such  as — purchase  price  of  lease  or  fee ;  purchase  price  of  physi- 
cal property ;  salaries  or  commissions  paid  to  brokers  or  agents ; 
fees  to  geologists,  attorneys,  surveyors,  etc.,  for  examination  and 
defense  of  title,  establishing  boundaries,  etc.,  state  and  county 
fees  for  recording  and  legalizing  transfers,  and  all  other  pay- 
ments made  in  acquiring  and  establishing  title  to  the  properties.'' 

Cost  of  Development.  Cost  of  development  comprises  all 
payments  made  for  and  incident  to  the  drilling  of  wells,  such  as 
for  (1)  physical  property;  (2)  geological  and  other  surveys,  made 
subsequent  to  acquisition;  (3)  roads;  (4)  water  supplies;  (5) 
hauling;  (6)  wages;  (7)  drilling;  (8)  shooting;  (9)  overhead 
charges  (incident  to  drilling  of  wells);  (10)  fuel;  and  (11)  all 
other  similar  expenditures. *' 

"Capital  Sum"  and  "Invested  Capital."  The  term  Capital  Sum 
is  applied  to  the  total  amount  returnable  to  the  taxpayer  through 
depletion,  depreciation,  and  obsolescence  allowances.  It  is  to  be 
clearly  distinguished  from  the  term  "invested  capital,"  which  is 
the  basis  for  the  determination  of  war-profits  credits  and  excess- 
profits  credits  of  corporations.  It  has  no  necessary  relation  to 
the  "invested  capital."  It  may  represent  the  investment  of  funds 
belonging  to  the  taxpayer,  or  the  investment  of  borrowed  funds, 
which  have  no  relation  to  invested  capital;  under  the  provisions 
of  the  law  and  regulations,  the  capital  sum  may  include  amounts 
based  upon  the  right  of  yaluation  as  of  March  1,  1913,  or  within 
30  days  after  the  discovery  of  oil  or  gas  by  the  taxpayer.  Where 
such  valuations  are  allowable,  they  have  no  application  to  in- 

4  Manual  for  the  Oil  and  Gas  Industry,  p.  10. 

5  Manual  for  the  Oil  and  Gas  Industry,  p.  9. 

6  Manual  for  the  Oil  and  Gas  Industry,  p.  10. 


742  FEDERAL  INCOME   TAX 

vested  capital,"  and  may  not  be  used  for  any  purpose  other  than 
as  a  basis  for  depletion,  depreciation,  and  obsolescence,  or  as  a 
basis  upon  which  to  determine  the  gain  or  loss  arising  from  the 
sale  or  surrender  of  property  acquired  prior  to  March  1,  1913. 
With  respect  to  any  allowance  for  amortization  the  basis  is  the 
cost  of  property  acquired  after  April  5,  1917,  and  no  amount  may 
be  added  on  account  of  revaluation  for  discovery.  Neither  may 
any  revaluation  on  account  of  discovery  be  used  in  determining 
gains  or  losses  on  the  sale  of  mineral  properties. "^ 

Capital  Recoverable  Through  Depletion  Deduction  in  Case  of 
an  Operating  Owner.  In  the  case  of  an  operating  owner  in  fee, 
the  capital  remaining  in  any  year  recoverable  through  depletion 
and  depreciation  deductions  is  (a)  the  cost  or  value  of  the  prop- 
erty at  the  basic  date  plus  (b)  subsequent  allowable  capital  addi- 
tions and  minus  (c)  depletion  and  depreciation  sustained, 
whether  legally  allowable  or  not,  from  the  basic  date  to  the  tax- 
able year,  and  minus  (d)  the  value  of  the  land  at  the  basic  date 
for  other  purposes  than  mineral  production.  The  capital  recover- 
able through  depletion  is  the  total  capital  remaining  less  the  sum 
recoverable  through  depreciation.  Where  depletion  deductions 
for  former  years  have  or  should  have  been  taken  these  amounts 
are  to  be  subtracted  from  the  capital  sum  returnable  through 
depletion  deductions.  In  no  case  may  the  amount  returnable 
through  deductions  for  depletion  include  items  against  which  de- 
preciation is  being  charged ;  that  is,  the  cost  (or  value)  of  physi- 
cal property  may  not  be  included,  since  it  is  returnable  through 
depreciation  deductions.^ 

Capital  Recoverable  Through  Depletion  Deduction  in  the  Case 
of  Lessee,  (a)  In  the  case  of  a  lessee,  the  capital  remaining  in 
any  year  recoverable  through  depletion  and  depreciation  deduc- 
tions is  (1)  the  value  as  of  the  basic  date  of  the  lessee's  equity 
in  the  property  plus  (2)  subsequent  allowable  capital  additions 
but  minus  (3)  depletion  and  depreciation  sustained,  whether 
legally  allowable  or  not,  from  the  basic  date  to  the  taxable  year. 
The  capital  recoverable  through  depletion  is  the  total  capital  re- 
maining less  the  sum  recoverable  through  depreciation. 

(b)  The  value  of  the  equities  of  lessor  and  lessee  must  be 
computed  separately,  but,  when  determined  as  of  the  same  basic 
date,  may  together  never  exceed  the  value  at  that  date  of  the 
property  in  fee  simple. 

7  Except  as  indicated  in  Reg.  45,  Art.  844  (2). 

8  Manual  for  the  Oil  and  Gas  Industry,  p.  29.     See  Chapter  2. 

9  Reg.  45,  Art.  202 ;  Manual  for  the  Oil  and  Gas  Industry,  p.  20. 


DEPLETION  OF  OIL  AND  GAS  WELLS  743 

(c)  The  value  of  a  lessee's  equity,  if  acquired  prior  to  March 
1,  1913,  is  the  value  of  his  interest  in  the  mineral  as  of  that  date. 

(d)  The  value  of  a  lessee's  equity  in  a  proven  mineral  property 
acquired  on  or  after  March  1,  1913,  is  its  cost. 

(e)  The  value  of  a  lessee's  equity  in  a  discovery  on  or  after 
March  1,  1913,  is  the  fair  market  value  at  date  of  discovery  or 
within  30  days  thereafter,  of  his  equity  in  the  mineral  discov- 
ered.'" 

Capital  Recoverable  Through  Depletion  Deduction  in  the  Case 
of  Lessor,  (a)  In  the  case  of  a  lessor,  the  capital  remaining  in 
any  year  recoverable  through  depletion  and  depreciation  deduc- 
tions is  (1)  the  value  of  his  equity  in  the  property  at  the  basic 
date  minus  (2)  depletion  and  depreciation  sustained,  whether 
legally  allowable  or  not,  from  the  basic  date  to  the  taxable  year, 
plus  (3)  subsequent  allowable  capital  additions,  and  minus  (4) 
the  value  of  the  land  at  the  basic  date  for  other  purposes  than 
mineral  production.  The  capital  recoverable  through  depletion 
is  the  total  capital  remaining  less  the  sum  recoverable  through 
depreciation. 

(b)  The  value  of  the  equities  of  lessor  and  lessee  must  be 
computed  separately,  but,  when  determined  as  of  the  same  basic 
date,  may  together  never  exceed  the  value  at  that  date  of  the 
property  in  fee  simple. 

(c)  The  value  of  the  lessor's  equity  in  the  case  of  a  mineral 
property  not  under  lease  on  March  1,  1913,  but  subsequently 
leased,  is  the  en  bloc  value  of  the  mineral  in  the  ground  on  March 
1,  1913,  and  will  in  the  absence  of  satisfactory  evidence  to  the 
contrary,  be  presumed  not  to  exceed  the  value  as  of  March  1, 
1913,  of  the  royalties  to  be  expected  under  the  lease. 

(d)  The  value  of  a  lessor's  equity  in  a  mineral  property  under 
lease  March  1,  1913,  for  the  entire  operating  life  of  the  mineral 
deposits  is  the  value  as  of  March  1,  1913,  of  the  royalties  and 
other  payments  to  be  expected  under  the  terms  of  the  lease  in 
effect  on  that  date. 

(e)  The  value  of  a  lessor's  equity  in  a  mineral  property  under 
lease  for  a  portion  of  its  operating  life  is  the  value  as  of  March 
1,  1913,  of  the  royalties  expected  from  the  mineral  to  be  ex- 
tracted during  the  life  of  the  existing  lease  plus  the  estimated  en 
bloc  value  of  the  mineral  remaining  at  its  expiration,  which,  in 
the  absence  of  satisfactory  evidence  to  the  contrary,  will  be  pre- 
sumed not  to  exceed  the  value  as  of  March  1,  1913,  of  royalties 

10  Reg.  45,  Art.  203;  A.  R.  R.  570,  T.  B.  37-21-1818. 


744  FEDERAL  INCOME   TAX 

which  could  have  been  expected  as  at  that  date  from  the  remain- 
ing mineral. 

(f )  The  value  of  a  lessor's  equity  in  a  mineral  property  when 
acquired  on  or  after  March  1,  1913,  is  its  cost. 

(g)  The  value  of  a  lessor's  equity  in  a  discovery  on  or  after 
March  1,  1913,  is  the  fair  market  value  at  the  date  of  discovery, 
or  within  30  days  thereafter,  of  his  equity  in  the  mineral  dis- 
covered.^^ 

Determination  of  Cost  of  Deposits.  The  cost  of  oil  and  gas 
properties  is  determined  in  accordance  with  the  rules  set  forth 
in  another  chapter.^- 

Fair  Market  Value  of  Oil  or  Gas  Properties.  The  determina- 
tion of  the  fair  market  value  of  an  oil  or  gas  property  (or  the 
taxpayer's  interest  therein)  and  the  rules  and  tests  and  evidence 
bearing  on  the  determination  of  market  value  are  set  forth  in 
another  chapter.^-'  No  revaluation  of  property  will  be  permitted, 
as  stated  more  fully  in  the  same  chapter. 

Determination  of  Quantity  of  Oil  in  Ground.  In  the  case  of 
either  an  owner  or  lessee  it  will  be  required  that  an  estimate,  sub- 
ject to  the  approval  of  the  Commissioner,  shall  be  made  of  the 
probable  recoverable  oil  contained  in  the  territory  with  respect 
to  which  the  investment  is  made  as  of  the  time  of  purchase,  or  as 
of  March  1,  1913,  if  acquired  prior  to  that  date,  or  within  30  days 
after  the  date  of  discovery,  as  the  case  may  be.  The  oil  reserves 
must  be  estimated  for  all  undeveloped  proven  land  as  well  as  pro- 
ducing land.  If  information  subsequently  obtained  clearly  shows 
the  estimate  to  have  been  materially  erroneous,  it  may  be  revised 
with  the  approval  of  the  Commissioner.^^  The  estimate  of  prob- 
able recoverable  oil  in  the  ground  is  fundamentally  necessary  if  a 
reasonable  deduction  for  depletion  is  to  be  calculated,  and,  while 
it  may  be  impossible  to  determine  exactly  the  future  production 
of  a  well  or  tract,  it  has  been  found  possible  to  predict  future  pro- 
ductions with  a  comparatively  narrow  limit  of  error.  The  result 
of  analysis  of  a  great  volume  of  production  records  has  led  to  the 
development  of  the  method  suggested  in  the  following  para- 
graph.^-^ 

Method  of  Estimating  Recoverable  Reserves.  The  tax- 
payer may  estimate  his  recoverable  reserves  by  any  methods 

11  Reg.  45,  Art.  204. 

12  See  page  718. 

13  See  Chapter  27.    See  also  Chapter  17. 

14  Reg.  45,  Art.  209. 

15  Manual  for  the  Oil  and  Gas  Industry,  p.  29. 


DEPLETION  OF  OIL  AND  GAS  WELLS  745 

that  can  be  shown  to  be  well  founded,  but  in  all  cases  the  data 
upon  which  such  estimate  was  based  must  be  submitted,  with  a 
description  of  the  method  employed  and  a  resume  of  the  calcula- 
tions. The  treasury  department  does  not  prescribe  any  particular 
method  of  estimating  recoverable  reserves,  but  various  methods, 
applicable  to  a  wide  variety  of  conditions  have  been  suggested  by 
the  treasury  department.^*' 

These  methods  may  be  summarized  as  follows : 

1.  Plotting  the  record  of  production  of  individual  wells,  or, 
lacking  such  detailed  information,  the  average  production  per 
well  for  each  tract. 

2.  Deriving  from  these  graphical  records  an  average  or  com- 
posite production  decline  curve  for  the  district. 

3.  Estimating  from  the  last  year's  average  production  per  well 
the  probable  future  production,  based  on  the  average  production 
decline  curve,  or  a  future  production  curve  derived  from  the  pro- 
duction decline  curve. 

4.  Ascertaining  probable  total  future  production  of  producing 
wells  by  multiplying  average  future  production  per  well  by  the 
number  of  wells  producing  at  the  end  of  the  year. 

5.  Estimating  the  probable  future  production  of  undeveloped 
proven  land  on  the  basis  of  nearby  production,  making  due  allow- 
ance for  the  decline  in  pressure  due  to  the  extraction  of  oil  from 
the  pool. 

Computation  of  Allowance  for  Depletion  of  Oil  Wells.  The 
method  of  computing  the  depletion  allowance  has  been  given  in 
a  previous  chapter  as  applicable  to  all  natural  resources.^"  In 
general,  the  allowance  for  depletion  of  oil  wells  is  ascertained  by 
multiplying  the  number  of  mineral  units  extracted  from  a  well 
each  year  by  the  unit  value.  The  unit  value  is  ascertained  by 
dividing  cost,  or  value  at  the  basic  date  remaining  for  depletion, 
by  the  number  of  barrels  of  oil  or  units  of  gas  to  which  this  di- 
minished cost  or  value  is  applicable.is  Each  barrel  of  oil  or  unit 
extracted  and  marketed  must,  before  a  profit  can  be  realized,  pay 
not  only  its  proportionate  share  of  the  operating  expense  and 
deductions  for  depreciation  and  obsolescence  of  physical  property, 
but  also  must  pay  its  proportionate  share  of  capital  sum  return- 
able through  depletion  allowances.  This  proportionate  share  of 
capital  sum  returnable  through  depletion  allowances,  which  each 
unit  of  oil  or  gas  must  pay,  is  iinit  cost.    Unit  cost  is  obtained  by 

16  See  Manual  for  the  Oil  and  Gas  Industry. 

17  See  page  722. 

18  Reg.  45,  Art.  210.     For  a  full  statement  of  this  rule,  see  Chapter  27. 


746  FEDERAL  INCOME  TAX 

dividing  the  capital  sum  returnable  through  depletion  by  the 
"estimated  recoverable  reserve"  at  the  beginning  of  the  taxable 
year.  The  recoverable  reserves  used  in  deriving  the  unit  cost 
should  be  the  taxpayer's  share  only.  The  depletion  deduction  is 
computed  by  multiplying  the  unit  cost  by  the  number  of  units 
produced  during  the  taxable  year.i^ 

19  The  following  illustration  shows  the  effect  of  the  rule  stated   in  the 
text: 

A,  a  lessee,  has  an  oil  lease  in  which  his  original  investment  (ex- 
clusive of  value  of  physical  property)  was $20,000 

Development  cost    (exclusive  of  cost  of   physical   property)    not 

otherwise    deducted 80,000 

Capital  returnable  through  depletion  allowance $100,000 

Estimated   gross   recoverable   reserves   at    end   of   taxable    year 

barrels   400,000 

Gross  production  during  taxable  year barrels. .  . .  100,000 

Gross  reserves  oil  at  beginning  of  year do 500,000 

Lessee's  share  (I) do 437,500 

Lessor's  share   ( i ) do 62,500 

Total    do 500,000 

Therefore  unit  cost  for  lessee  isll^MCK),  ^^^  ^^^  barrel $0.2285 

437,500 

Lessee's   share   of  production   during  year   is   I   of  100,000,   or, 

barrels     87,500 

A's  depletion  allowance  for  the  taxable  year  is,  therefore,  87,500 

X  $0.2285    $19,993.75 

B,  the  owner  in  fee  of  the  property,  had  invested $40,000 

Of  which  the  value  of  the  land  exclusive  of  oil  rights  represents  25,000 

The  investment  in  the  oil  deposit  is $15,000 

B's  unit  cost  is,  therefore,  ilM^> ,  or,  per  barrel $0.24 

'   62,.500  '       '  *^ 

Lessor's  share  of  production  is  §  of  100,000  barrels,  or 12,500 

And  his  depletion  allowance  for  the  same  year  is  12,500  x  $0.24,  or  $3,000 

The  above  example  presupposes  that  B  leased  his  land  without  bonus. 

Any  amount  received  by  a  lessor  as  bonus  for  an  oil  and  gas  lease  on  the 
property  would  reduce  his  capital  sum  by  that  amount. 

Illustration : 

The  lessor's  (B's)  investment  in  the  deposit  is $15,000 

He  receives  as  bonus  5,000 

His  net  investment  in  the  deposit  is,  therefore $10,000 

He  sells  a  one-half  interest  in  his  royalty  for $6,000 

As  this  half  cost  him 5,000 

His  profit  is   $1,000 


DEPLETION  OF  OIL  AND  GAS  WELLS  747 

Revised  Estimate  of  Reserves.  If  proper  additions  are 
made  to  the  capital  account  represented  by  the  original  cost  or 
value  of  the  property,  or  circumstances  make  advisable  a  revised 
estimate  of  the  number  of  mineral  units  in  the  ground,  a  new 
unit  value  for  purposes  of  depletion  may  be  found  by  dividing  the 
capital  account  at  the  end  of  the  year,  less  deductions  for  deple- 
tion to  the  beginning  of  the  taxable  year  v^hich  have  or  should 
have  been  taken,  by  the  number  of  units  in  the  ground  at  the 
beginning  of  the  taxable  year.  This  number,  unless  a  revision 
of  the  original  estimate  has  been  made,  v^ill  equal  the  number 
of  units  in  the  ground  at  the  date  of  original  acquisition  or  valua- 
tion less  the  number  extracted  prior  to  the  taxable  year.  If, 
hovv^ever,  a  recalculation  is  made,  the  number  of  units  at  the  be- 
ginning of  the  year  v^^ill  be  the  sum  of  the  gross  production  of 
the  year  and  the  estimated  mineral  reserves  in  the  property  at 
the  end  of  the  year.  If  a  certain  proportionate  part  of  the  les- 
see's capital  returnable  through  depletion  deductions  is  deducted 
in  a  given  year  the  same  proportion  of  the  lessor's  capital  sum 
returnable  through  depletion  will  be  deducted.-" 

Computation  of  Allowance  for  Depletion  of  Gas  Wells.  On  ac- 
count of  the  peculiar  conditions  surrounding  the  production  of 
natural  gas  it  will  be  necessary  to  compute  the  depletion  allow- 
ance for  gas  properties  by  methods  suitable  to  the  particular 
cases  in  question  and  acceptable  to  the  Commissioner.  Usually 
the  depletion  of  natural  gas  properties  should  be  computed  on 
the  basis  of  decline  in  closed  or  rock  pressure,  taking  into  ac- 
count the  effects  of  water  encroachment  and  any  other  modifying 
factors.  The  gas  producer  will  be  expected  to  compute  the  de- 
pletion as  accurately  as  possible  and  submit  with  his  return  a 
description  of  the  method  by  which  the  computation  was  made. 
The  following  formula,  in  which  the  units  of  gas  are  pounds  per 
square  inch  of  closed  pressure,  is  recommended:  The  quotient 
of  the  capital  account  recoverable  through  depletion  allowances 
to  the  end  of  the  taxable  year  divided  by  the  sum  of  the  pressures 
at  the  beginning  of  the  year  plus  the  sum  of  initial  pressures  of 

And  is  subject  to  tax  as  income. 

His  capital  sum  remaining  is $5,000 

If  he  had  sold  a  one-half  interest  in  his  royalty  for 4,000 

He  would  have  sustained  a  loss  of $1,000 

and  should  deduct  this  amount  from  gross  income  as  a  loss  in  computing  his 
tax. 

20  Manual  for  the  Oil  and  Gas  Industry,  p.  30. 


748  FEDERAL  INCOME  TAX 

new  wells  and  less  the  sum  of  the  pressures  at  the  time  of  ex- 
pected abandonment  (which  quotient  is  the  unit  cost)  multiplied 
by  the  sum  of  the  pressures  at  the  beginning  of  the  taxable  year 
plus  the  sum  of  the  initial  pressures  of  new  wells  and  less  the 
sum  of  the  pressures  at  the  end  of  the  tax  year  equals  the  deple- 
tion allowance.-i  The  above  methods  are  more  fully  discussed  in 
the  following  paragraphs. 

Details  of  Production  or  the  Performance  Record  of  the 
Well  or  Property.  As  a  general  rule  the  demand  on  a  natural 
gas  property  is  a  variable  factor.  In  certain  fields,  however,  the 
demand  from  some  wells  has  from  the  beginning,  or  for  consid- 
erable periods,  been  greater  than  the  supply,  so  that  the  amount 
of  gas  marketed  per  well  may,  as  in  the  case  of  oil,  show  a  regu- 
lar decline,  which  will  be  indicative  of  the  total  amount  that  the 
well  may  be  expected  to  produce,  and  also  the  rate  of  production. 
Even  where  the  demand  does  not  greatly  exceed  the  supply,  the 
amount  and  rate  of  past  production  may  in  certain  cases  throw 
light  on  the  future  of  the  well  or  property.- 

Decline  in  Open-Flow  Capacity.  Where  data  are  available 
the  decline  in  open-flow  capacity  indicates  in  a  general  way  the 
rate  of  exhaustion  of  the  gas  field.  The  relationship  is  not  at  all 
close  and  varies  from  field  to  field  and  from  well  to  well.  Also  for 
most  gas  wells  accurate  data  on  decline  in  open-flow  capacity  are 
not  available.  Nevertheless  it  is  probable  that  for  certain  prop- 
erties this  method  will  have  value,  for  with  rare  exceptions  the 
production  of  gas  from  a  well  leads  to  a  decline  in  its  capacity, 
and  the  fraction  produced  is  roughly  proportional  to  the  decline.--^ 

Comparison  with  Life  History  of  Similar  Wells  or  Prop- 
erties Particularly  Those  Now  Exhausted  or  Nearing  Ex- 
haustion. Where  no  other  data  are  available  the  rate  of  de- 
pletion of  a  gas  well  or  property  may  be  approximated  by  compar- 
ison with  a  neighboring  well  or  property  that  has  reached  a  later 
stage  in  life.  Particularly  is  this  applicable  in  a  district  where 
many  gas  wells  have  become  exhausted.  For  example,  in  a  region 
where  wells  produce  during  a  period  of  8  to  12  years,  or  an  aver- 
age of  10  years,  a  10  per  cent,  deduction  will  be  a  rough  approxi- 
mation of  the  rate  of  depletion.^^ 

Size  of  Reservoir  and  Pressure  of  Gas,  or  the  Pore-Space 
Method.     For  some  properties  the  pore-space  method  may  be 

21  Reg.  45,  Art.  211;  Manual  for  the  Oil  and  Gas  Industry,  p.  32. 

22  Manual  for  the  Oil  and  Gas  Industry,  p.  32. 

23  Manual  for  the  Oil  and  Gas  Industry,  p.  32. 

24  Manual  for  the  Oil  and  Gas  Industry,  p.  32. 


DEPLETION  OF  OIL  AND  GAS  WELLS  749 

best  for  estimating  underground  supplies  of  natural  gas  and  for  a 
good  many  it  will  furnish  additional  evidence  of  value.  The 
method  would  be  ideal  if  the  average  percentage  of  pore-space, 
the  extent  and  thickness  of  the  sand,  and  the  pressure  of  the  gas 
could  be  accurately  ascertained.  In  computing  the  reserves  of  an 
individual  property  by  this  method  the  migratory  character  of 
gas  must  be  considered  and  the  production  and  behavior  of  ad- 
jacent properties  taken  into  account.  The  factors  that  make  the 
method  difficult  to  apply  are  difficulty  of  accurately  ascertaining 
the  thickness  of  pay,  limits  of  pool,  percentage  of  pore-space,  the 
effect  of  encroaching  water  and  oil,  and  the  quantity  of  gas  re- 
maining when  commercial  production  is  no  longer  possible.  Take, 
for  example,  a  pool  where  there  is  no  encroachment  by  water. 
Suppose  that  the  pore-space  is  25  per  cent.,  the  thickness  of  the 
pay  20  feet,  and  the  extent  of  the  pool  10  square  miles,  or  roughly 
280,000,000  square  feet.  The  volume  of  the  reservoir  would  be 
1,400,000,000  cubic  feet,  and  the  amount  of  gas  in  the  sand  could 
be  readily  computed  by  taking  into  account  the  closed  pressure 
of  the  wells.23 

Other  Indications  of  Depletion.  Additional  evidence  of 
decreasing  supply  of  natural  gas  in  the  ground  is  commonly  ob- 
servable in  the  behavior  of  the  wells  and  the  provision  that  must 
be  made  for  transporting  the  gas  to  market.  Observations  on 
minute  pressures  show  more  or  less  progressive  change  as  the 
wells  become  older  and  an  increasing  amount  of  gas  is  drawn 
from  the  ground.  Line  pressures  and  pressures  at  compressing 
stations  are  also  likely  to  show  a  progressive  change  in  the  same 
direction.  The  appearance  of  water  or  oil  in  a  gas  well  or  in 
neighboring  gas  wells  may  be  a  very  significant  symptom  of  the 
approaching  termination  of  the  life  of  the  well.  The  clogging  of 
gas  wells  by  paraffin,  salt,  or  other  deposits  may  demand  modi- 
fication of  depletion  estimates.-'' 

Closed-Pressure  Method.  Because  of  its  general  applica- 
bility, the  closed-pressure  method  is  by  far  the  best  method  of 
estimating  the  depletion  of  gas  properties.  Unfortunately,  ac- 
curate closed-pressure  data  have  not  been  kept  for  all  properties 
or  perhaps  even  for  the  majority  of  properties,  but  the  rock  pres- 
sure in  most  pools  is  known  or  is  ascertainable  with  a  fair  degree 
of  accuracy,  and  the  information  drawn  from  the  pressure  de- 
cline is,  with  the  exception  of  a  few  fields,  not  subject  to  profound 
modification  because  of  factors  whose  value  can  not  be  appraised. 

sr)  Manual  for  the  Oil  and  Gas  Industry,  p.  33. 
20  Manual  for  the  Oil  and  Gas  Industry,  p.  33. 


750  FEDERAL  INCOME  TAX 

The  basis  of  this  method  is  Boyle's  law.  According  to  this  law 
of  physics,  if  gas  is  pumped  into  a  vessel  until  the  pressure  is  200 
pounds  and  then  is  drawn  off  until  the  pressure  is  100  pounds, 
the  size  of  the  vessel  remaining  fixed,  and  ignoring  for  the  mo- 
ment atmospheric  pressure,  it  may  be  concluded  that  one-half  of 
the  gas  has  been  drawn  out  of  the  vessel.  If  an  underground  gas 
reservoir  of  fixed  dimensions  is  tapped  by  wells  and  the  pressure 
is  found  to  be  a  thousand  pounds,  and  then  if  the  gas  is  drawn 
off  through  the  wells  until  the  gas  pressure  in  the  pool  is  lowered 
to  100  pounds,  we  may  infer  that  about  nine-tenths  of  the  supply 
of  gas  has  been  exhausted.-" 

''Unit  Cost"  as  Applied  to  Natural  Gas.  Although,  as  a 
rule,  the  number  of  cubic  feet  of  gas  under  a  tract  can  not  be  sat- 
isfactorily estimated  and  the  quantity  that  will  be  marketed  is 
even  less  definite,  the  "unit  cost  method"  can  be  used  by  re- 
garding pounds  of  closed  pressure  as  units,  for  the  actual  quan- 
tity of  gas  underground  commonly  varies  with  the  decline  in 
pressure  and  the  relative  quantity  at  the  beginning  and  end  of  the 
tax  year  and  at  the  time  of  abandonment,  is,  in  the  lack  of  better 
information,  usable  for  tax  purposes.-^ 

Corrections  and  Refinements  of  Closed-Pressure  Method. 
Several  corrections  and  more  or  less  important  refinements  are 
made  in  applying  this  method  to  the  computation  of  depletion, 
and  it  should  be  borne  in  mind  that  it  does  not  afford  data  on 
the  amount  of  gas  originally  in  the  pool  or  at  any  later  specified 
time,  but  only  the  fraction  of  the  gas  that  has  been  removed  from 
its  natural  reservoir  and  the  fraction  remaining  in  that  reservoir. 
Perhaps  the  most  important  of  these  corrections  arises  out  of  the 
fact  that  the  size  of  the  reservoir  does  not  remain  fixed  but  be- 
comes smaller  as  the  gas  is  drawn  and  water  or  oil  advances  into 
a  part  of  the  space  formerly  occupied  by  the  gas.  The  pressure  is 
thus  prevented  from  declining  at  a  rate  propbrtionate  to  the 
amount  of  gas  drawn  from  the  pool.  The  correction  on  account  of 
water  or  oil  encroachment  is  difficult  to  make,  because  of  the  lack 
of  data  to  determine  the  extent  of  the  encroachment.  However, 
in  a  good  many  pools,  after  a  study  of  the  distribution  of  wells 
that  have  been  "drowned  out"  and  the  history  of  water  troubles 
in  similar  near-by  pools,  it  is  possible  to  make  allowance  for 
water  or  oil  encroachment  which  will  more  or  less  closely  approx- 
imate the  facts. 

27  Manual  for  the  Oil  and  Gas  Industry,  p.  33. 

28  Manual  for  the  Oil  and  Gas  Industry,  p.  34. 


DEPLETION  OF  OIL  AND  GAS  WELLS  751 

Another  refinement  applicable  to  the  computation  of  depletion 
of  natural  gas  by  the  closed-pressure  method  is  based  upon  the 
fact  that  even  where  there  is  no  encroachment  of  water  or  oil  the 
depletion  is  not  precisely  represented  by  the  gauge  readings, 
though  the  errors  are  generally  so  small  that  they  may  be  ig- 
nored. For  example,  where  the  pressure  declines  from  1,000  to 
500  pounds,  the  gas  is  not  exactly  half  gone,  for  the  reason  that 
the  pressures  referred  to  are  gauge  readings  and  to  each  should 
be  added  the  pressure  of  the  atmosphere — for  most  fields  about 
14.4  pounds  to  the  square  inch.     The  fraction  remaining  in  the 

ground  then  becomes  . 

1014.4 

Account  should  also  be  taken  of  the  pressure  at  which  wells 
are  abandoned  in  the  field  or  district. 

If  wells  can  not  be  operated  with  profit  after  the  pressure  has 
declined  to  25  pounds  gauge  reading  (39.4  pounds  absolute) ,  then 
the  percentage  of  recoverable  gas  remaining  when  the  pressure 
has  declined  from  1,000  to  500  pounds  gauge  reading  is  not  one- 
half  of  even  the  fraction    ''        but    ^'.     The  difference  in  the 

1014.4  '.»T.". 

fraction  where  pressures  of  several  hundred  pounds  are  involved 
is  not  great  and  scarcely  worth  considering  in  view  of  the  other 
errors  which  are  certain  to  aflfect  the  result.  However,  after  the 
pressure  has  declined  to  a  low  figure,  the  matter  of  correcting  the 
fraction  becomes  of  considerable  injportance.  Thus,  if  the  pres- 
sure of  abandonment  is  4  pounds  gauge  reading  and  during  the 
year  the  average  closed  pressure  of  a  pool  has  declined  from  10 
pounds  to  5  pounds  gauge  reading,  five-sixths  instead  of  one-half 
of  the  recoverable  gas  has  been  withdrawn. 

Still  another  refinement  that  has,  as  a  rule,  more  theoretical 
than  practical  value  may  be  worthy  of  consideration  in  certain 
instances.  This  arises  out  of  the  fact  that  the  gases  do  not  ex- 
pand precisely  as  the  pressure  decreases,  and  that  even  if  the 
size  of  the  natural  reservoir  remains  fixed  the  pressure  does  not 
decline  in  exact  proportion  to  the  amount  of  gas  removed.  The 
difference  amounts  to  only  a  few  per  cent,  and  is  greatest  for 
high  pressures.  In  the  decline  from  1,000  to  500  pounds  per 
square  inch  the  gas  expands  several  per  cent,  more  than  would 
be  calculated  by  a  strict  application  of  Boyle's  law,  and  in  a  de- 
cline from  1,500  pounds  to  1,000  pounds  the  departure  is  still 
greater.  The  correction  varies  from  field  to  field  because  of  the 
different  constitution  of  the  gases,  though  since  most  natural 
gases  consist  largely  of  methane  the  variations  on  account  of 
differences  in  gases  are  not  great. 


752  FEDERAL  INCOME   TAX 

A  fourth  detail  of  refinement  arises  out  of  the  fact  that  o. 
the  average  more  gas  is  marketed  for  50  pounds  of  decline  in 
pressure  after  the  pressure  has  reached  100  pounds  or  less  than 
an  equal  decline  while  the  pressure  is  high,  as,  for  example,  1,000 
pounds  per  square  inch.  Also  the  expense  of  marketing  gas  after 
the  pressure  has  become  low  is  greater  than  when  it  was  high, 
largely  because  of  the  necessity  of  installing  compressors  to  push 
the  gas  through  the  pipe  lines  to  the  consumers.  These  two  con- 
siderations have  a  tendency  to  balance  each  other  and,  with  cer- 
tain exceptions,  will  not  be  of  sufficient  importance  to  warrant 
an  attempt  to  apply  the  corrections.-^ 

Method  of  Gauging.  In  using  the  closed-pressure  method  of 
estimating  depletion,  the  method  of  gauging  is  of  vital  impor- 
tance and  in  many  fields  is  not  carried  out  with  sufficient  care. 
Care  should  be  taken  to  make  sure  that  the  gauge  is  accurate, 
testing  it  before  and  after  attaching  it  to  the  well.  If  it  must  be 
transported  far  or  is  subject  to  much  jolting  in  transportation, 
a  gauge  tester  should  be  taken  along  and  used  at  the  well.  Care 
should  also  be  taken  to  empty  the  well  of  oil  and  water  by  pump- 
ing, blowing,  or  siphoning  before  attaching  the  gauge,  for  any 
liquid  in  the  hole  will  lower  the  closed  pressure  reading.  The 
well  should  be  closed  long  enough  to  allow  the  pressure  to  build 
up  to  its  maximum.  The  length  of  time  necessary  for  this  pur- 
pose varies  a  great  deal  from  field  to  field  and  well  to  well.  The 
well  should  remain  closed  until  the  pressure  will  not  build  up 
more  than  1  per  cent,  in  10  minutes.  Ordinarily,  24  hours  will  be 
sufficient  for  this  purpose,  but  for  some  wells  several  days  or  even 
a  longer  period  will  be  required,  owing  to  the  slowness  of  equali- 
zation of  pressure  in  the  sand.-"'^ 

Apportionment  of  Depletion  Among  Various  Sands.  Where 
more  than  one  sand  under  a  property  is  yielding  gas,  the  problem 
arises  as  to  how  to  weigh  or  evaluate  the  decline  in  pressure  in 
the  different  sands.  Suppose  there  is  a  very  good  gas  sand  in 
which  the  pressure  declines  from  600  to  300  pounds  during  the 
year,  and  a  very  poor  sand  in  which  the  pressure  declines  from 
800  to  750.  The  depletion  sustained  is  not  indicated  by  the  aver- 
age decline  in  pressure  but  is  more  nearly  proportionate  to  the 
decline  in  the  good  sand.  If  accurate  figures  on  capacities  of 
wells  are  obtainable,  it  will  be  possible  to  make  a  fairly  accurate 
weighting  of  the  pressure  declines,  or  if  facts  indirectly  indicat- 
ing capacity  of  individual  wells  are  obtainable  some  light  may  be 

29  Manual  for  the  Oil  and  Gas  Industry,  p.  34. 

30  Manual  for  the  Oil  and  Gas  Industry,  p.  35. 


DEPLETION  OF  OIL  AND  GAS  WELLS  753 

thrown  on  the  question.  But,  as  a  general  rule,  it  is  necessary  to 
average  the  decline  of  wells  drawing  from  different  sands  as 
though  they  were  drawing  from  the  same  sand/'^^ 

Season  for  Testing  Wells  for  Closed  Pressure.  For  many 
fields  summer  or  early  fall  readings  furnish  the  best  indication 
of  decline  in  closed  pressure.  It  is  therefore  recommended  that 
such  readings  be  taken  regularly  and  consistently.  Summer  or 
fall  readings  are  of  especial  value  because  these  seasons  for  most 
fields  are  at  the  end  of  a  period  during  which  the  wells  have  not 
been  subject  to  heavy  draft,  and  hence  are  in  best  condition  to 
accurately  reflect  the  pressure  of  the  gas  in  the  underground  pool 
or  reservoir.  If  pressures  of  all  wells  or  representative  wells  are 
observed  regularly  and  carefully  in  summer  or  early  fall,  these 
readings  may  in  many  cases  be  applied  direct  to  the  end  of  the 
taxable  year,  though  in  some  cases  it  may  be  possible  and  desir- 
able to  estimate  the  pressures  at  the  end  of  the  taxable  year  from 
pressures  observed  at  other  times.  Obviously,  it  will  not  be  pos- 
sible to  test  the  pressures  of  all  wells  at  the  exact  end  of  the  tax- 
able year. 

If  in  one  part  of  a  tract  a  gas  well  is  brought  in  at  a  pressure 
of  1,000  pounds  and  during  the  remainder  of  the  taxable  year  the 
pressure  declines  to  700  pounds,  the  rough  inference  may  be 
drawn  that  three-tenths  of  the  gas  has  been  taken  from  the  tract 
and,  subject  to  corrections  in  certain  cases,  three-tenths  of  the 
capital  returnable  through  depletion  may  be  charged  off.  Sup- 
pose that  some  time  in  the  next  taxable  year  a  gas  well  is  com- 
pleted on  another  part  of  the  tract  and  that  its  initial  pressure  is 
800  pounds.  If  by  the  end  of  the  year  the  pressure  of  this  well 
has  declined  to  700  pounds  while  the  pressure  of  the  first  well  has 
dropped  to  500  pounds,  the  fraction  of  the  capital  account  re- 
turnable through  depletion  the  second  year  is  proportional  to  the 
average  decline  in  pressure,  assuming  that  there  are  no  water 
troubles  or  other  noteworthy  complications.  The  average  of  700 
and  800  is  750  and  the  average  of  500  and  700  is  600.  The  differ- 
ence or  average  decline  in  pounds  or  units  of  gas  is  150,  and  this 
represents  a  decline  of  20  per  cent,  from  750.  It  will  be  noted 
that  the  exact  date  of  completion  of  the  new  well  does  not  enter 
the  computation  and  it  is  treated  as  though  it  were  finished  at 
the  beginning  of  the  year.  The  rate  of  decline  within  the  year  is 
of  little  consequence,  the  main  consideration  being  the  amount  of 
decline  for  the  whole  year.  If  the  year's  decline  occurred  within 
a  month,  or  even  a  week,  it  is  treated  the  same  as  though  it  were 

31  Manual  for  the  Oil  and  Gas  Industry,  p.  36. 


754  FEDERAL   INCOME   TAX 

spread  over  the  entire  year.  Abandoned  wells  may  be  regarded 
as  fully  depleted  and  their  pressure  counted  as  zero  in  computing 
depletion.  Consider  the  wells  just  described  and  assume  that 
in  the  third  year  a  third  well  is  brought  in  and  one  of  the  old  wells 
is  abandoned.  Suppose  the  pressure  at  the  first  well  declined 
from  500  pounds  to  about  zero  and  the  well  is  abandoned,  the 
second  well  to  300  pounds  and  the  third  to  600.  The  pressure  of 
the  two  old  wells  at  the  beginning  of  the  year  and  of  the  new 
one  at  its  completion  averaged  600  pounds,  and  the  average  of  the 
three  at  the  end  of  the  year  was  300.  The  depletion  indicated  is 
50  per  cent,  of  the  remaining  capital  account.  It  is  suggested 
that  the  capital  sum  at  the  beginning  of  each  year  be  treated  as 
100  per  cent,  for  the  average  pressure  at  the  beginning  of  the 
year  and  the  average  decline  during  the  year  will  then  furnish  a 
readily  usable  basis  for  computing  the  depletion  allowance.  The 
amount  of  gas  in  the  ground  is,  as  a  rule,  to  be  regarded  as  lim- 
ited to  the  proven  territory  so  that  as  new  wells  are  drilled  and 
the  territory  is  enlarged,  or  new  gas-bearing  sands  are  discov- 
ered, the  denominator  of  the  fraction  indicating  depletion  varies 
from  year  to  year.-^^ 

Formula.''-"  The  following  discussion  is  offered  for  the  use  of 
those  who  prefer  to  use  a  formula  in  computing  the  depletion  al- 
lowance.   Perhaps  the  simplest  formula  may  be  written: 

X 

— X2;=depletion  allowance. 

y 

In  this  formula  x  stands  for  the  capital  sum  to  the  end  of  the 
year;  y  is  the  total  future  pressure  decline  or  the  sum  of  the 
pressures  at  the  beginning  of  the  tax  year  +  the  sum  of  the 
initial  pressures  of  new  wells  —  the  sum  of  the  pressures  at  the 
time  of  expected  abandonment ;  z  is  the  pressure  decline  during 
the  year  as  obtained  by  adding  to  the  sum  of  the  pressures  at  the 
beginning  of  the  year  the  sum  of  the  initial  pressures  of  any  new 
wells  completed  during  the  year  and  subtracting  the  sum  of  the 
pressures  at  the  end  of  the  year.  The  formula  may  also  be  writ- 
ten as  follows : 

32  Manual  for  the  Oil  and  Gas  Industry,  p.  36. 

33  Manual  for  the  Oil  and  Gas  Industry,  p.  37. 


DEPLETION  OF  OIL  AND  GAS  WELLS  755 

Capital  sum  to  end  of  tax  year     Sum  of  pressures 

X     at  beginning  of 

Sum  of  the  pressures  at  be-         tax  year  +  sum 
ginning  of  year  +  the  sum  of         of  pressures  of  =  Depletion 
initial  pressures  of  new  wells  new    wells    —      allowance. 

—  sum  of  pressures  at  time  of  sum    of    pres- 

expected  abandonment.  sures  at  end  of 

tax  year. 
Gas  Well  Pressure  Records  to  Be  Kept.  Beginning  with  1919 
closed  pressure  readings  of  representative  wells,  if  not  of  all 
wells,  must  be  carefully  made  and  kept.  In  order  to  standardize 
pressure  readings  the  well  should  remain  closed  until  the  pres- 
sure does  not  build  up  more  than  1  per  cent,  of  the  total  pressure 
in  10  minutes.  Ordinarily  24  hours  will  suffice  for  this  purpose, 
but  some  wells  will  need  to  remain  closed  for  a  longer  period.  If 
there  is  any  water  in  the  well  it  should  be  blown  or  pumped  off 
before  the  well  is  closed.  A  closed  pressure  reading  of  a  gas  well 
which  has  been  producing,  or  is  near  gas  wells  that  have  been  pro- 
ducing, is  lower  than  the  actual  pressure  of  the  gas  in  the  reser- 
voir by  an  amount  depending  on  the  well's  location  with  refer- 
ence to  other  producing  wells  and  the  length  of  time  it  has  been 
closed  in.  It  is  necessary  to  record  the  length  of  time  the  well 
has  been  closed  and  to  show  how  the  pressure  built  up  during  this 
period.  Successive  readings  will  indicate  the  point  at  which  the 
pressure  becomes  approximately  stationary,  that  is,  the  point  at 
which  the  closed  pressure  approaches  as  nearly  as  possible  the 
maximum  pressure  which  would  be  shown  if  all  wells  in  the  pool 
were  closed  for  several  months.  The  length  of  time  required 
varies  with  the  character  of  the  sand,  position  of  the  packer,  the 
location  of  the  well  with  reference  to  other  wells,  the  limits  of  the 
pool,  and  other  factors.  The  depth  of  the  well,  diameter  of  tub- 
ing, and  line  pressure  when  the  well  was  shut  off,  should  be 
noted.  Since  readings  at  the  exact  end  of  the  taxable  year  will 
ordinarily  not  be  available,  the  pressure  of  that  date  may  be  ob- 
tained by  interpolation  or  extrapolation.  In  certain  cases  read- 
ings taken  regularly  in  September  or  some  other  month  may  be 
applicable  to  the  end  of  the  taxable  year.  As  a  general  rule 
September  closed  pressure  readings  furnish  the  best  indication 
of  depletion  and  it  is  recommended  that  such  readings  be  made 
with  regularity  and  care.  Where  interpolated  or  extrapolated 
readings  are  used  the  data  from  which  they  are  obtained  should 
be  given.  Gauges  should  be  of  appropriate  capacity  and  should 
be  frequently  tested.    A  record  should  be  kept  of  the  number  of 


756  FEDERAL  INCOME   TAX 

gauges,  date  each  was  tested,  names  of  men  testing,  and  other 
significant  details.^-^ 

Computation  of  Depletion  Allowance  Where  Quantity  of  Oil  or 
Gas  Uncertain.  If  by  reason  of  the  youth  of  the  field,  the  re- 
stricted production,  or  for  any  other  cause,  it  is  not  possible  to 
determine  with  any  degree  of  certainty  the  quantity  of  oil  or  gas 
in  a  property,  it  will  be  necessary  to  make  a  tentative  estimate 
which  will  apply  until  production  figures  are  available  from 
which  an  accurate  estimate  may  be  made,^-^ 

Computation  of  Depletion  Allowance  for  Combined  Holdings 
of  Oil  and  Gas  Properties.  The  recoverable  oil  belonging  to  the 
taxpayer  should  be  estimated  for  each  property  separately.  The 
capital  account  for  each  property  includes  the  cost  or  value,  as 
the  case  may  be,  of  the  oil  or  gas  lease  or  rights  plus  all  inci- 
dental costs  of  development  not  charged  as  expense  nor  return- 
able through  depreciation.  The  unit  value  of  the  recoverable 
oil  or  gas  for  each  property  is  the  quotient  obtained  by  dividing 
the  capital  account  recoverable  through  depletion  for  each 
property'  by  the  estimated  number  of  units  of  recoverable  oil 
or  gas  on  that  property.  This  unit  for  each  separate  property 
multiplied  by  the  number  of  units  of  oil  or  gas  produced  within 
the  year  by  the  taxpayer  upon  such  property  will  determine 
the  amount  which  may  be  deducted  for  depletion  from  the 
gross  income  of  that  year  for  that  property.  The  total  allow- 
ance for  depletion  of  all  the  oil  or  gas  properties  of  the  tax- 
payer will  be  the  sum  of  the  amounts  computed  for  each 
property-  separately:  Provided,  That  in  the  case  of  gas  prop- 
erties the  depletion  allowance  for  each  pool  may  be  computed  by 
using  the  combined  capital  account  returnable  through  depletion 
of  all  the  tracts  of  gas  land  owned  by  the  t-axpayer  in  the  pool 
and  the  average  decline  in  rock  pressures  of  all  the  taxpayer's 
wells  in  such  pool  in  the  established  formula.  The  total  allowance 
for  depletion  in  the  gas  properties  of  the  taxpayer  will  be  the 
sum  of  the  amounts  computed  for  each  pool.-^^ 

Statement  to  Be  Attached  to  Return  Where  Depletion  of  Oil 
or  Gas  is  Claimed.  To  each  return  made  by  a  person  owning  or 
operating  oil  or  gas  properties,  there  should  be  attached  a  state- 
ment showing  for  each  property  the  following  information,  which 
may  be  given  in  form  of  a  table,  if  desired,  by  taxpayers  owning 
more  than  one  property  : 

^  Reg.  45,  Art.  212. 
35  Reg.  45,  Art.  213. 

3«Reg.  45,  Art.  214.  For  the  formula  referred  to  see  Reg.  45,  Art.  211; 
T.  D.  3065,  T.  B.  38-20-1204. 


DEPLETION  OF  OIL  AND  GAS  WELLS  757 

(a)  the  fair  market  value  oi  me  proi>erty  (exclusive  of  ma- 
chinery-, equipment,  etc.,  and  the  value  of  the  surface  rights)  as 
of  March  1,  1913,  if  acquired  prior  to  that  date;  or  the  fair  mar- 
ket value  of  the  property  within  30  days  after  the  date  of  dis- 
covery-;  or  the  actual  cost  of  the  property,  if  acquired  subse- 
quentlj"  to  February  28,  1913,  and  not  covered  by  the  foregoing 
clause ;  ^ 

(b)  how  the  fair  market  value  was  ascertained,  if  the  prop- 
ert\-  came  under  the  first  or  second  head  under  (a) ; 

(c)  the  estimated  quantity  of  oil  or  gas  in  the  property  at  the 
time  that  the  value  or  cost  was  determined; 

(d)  the  name  and  address  of  the  i)erson  making  the  estimate 
and  the  manner  in  which  this  estimate  was  made,  including  a 
summarj-  of  the  calculations ; 

(e)  the  amount  of  capital  applicable  to  each  unit  (this  being 
found  by  dividing  the  value  or  cost,  as  the  case  may  be,  by  the 
estimated  number  of  units  of  oil  or  gas  in  the  property  at  the 
time  the  value  or  cost  was  determined )  ; 

(f )  the  quantity  of  oil  or  gas  produced  during  the  year  for 
which  the  return  is  made  (in  the  case  of  new  properties  it  is 
desirable  that  this  information  be  furnished  by  months )  ; 

(g)  the  number  of  acres  of  producing  and  proven  oil  or  gas 
land; 

(h)  the  number  of  wells  producing  at  the  beginning  and  end 
of  the  taxable  year ; 

(i)  the  date  of  completion  of  wells  finished  during  the  tax- 
able year ; 

(j)  the  date  of  abandonment  of  all  weUs  abandoned  during  the 
taxable  year ; 

(k)  a  property-  map  showing  the  location  of  the  property 
and  of  the  producing  and  abandoned  wells,  dry  holes,  and  proven 
oil  and  gas  lands ; 

(1)  the  average  gravity  of  the  oil  produced  on  the  tract ; 

(m)  the  number  of  pay  sands  and  average  thickness  of  each 
pay  sand  or  zone  on  the  property : 

(n)  the  average  depth  to  the  top  of  each  of  the  different  pjay 
sands; 

(o)  any  data  regarding  change  in  oi)erating  conditions,  such 
as  flooding,  use  of  compressed  air.  vacuum,  shooting,  etc,  which 
have  a  direct  effect  on  the  production  of  the  property : 

(p)  the  monthly  or  annual  production  of  individual  wells  and 
the  initial  daily  production  of  new  wells  (this  is  highly  desir- 
able information  and  should  be  furnished  wherever  possible) ; 
(q)    (for  the  first  year  in  which  the  above  information  is  filed 


758  FEDERAL  INCOME  TAX 

for  a  property  which  was  producing  prior  to  the  taxable  year 
covered  by  the  above  statement  the  following  information  must 
be  furnished)  annual  production  of  the  tract  or  of  the  individual 
wells,  if  the  latter  information  is  available,  from  the  beginning 
of  its  productivity  to  the  beginning  of  the  taxable  year  for  which 
the  return  was  filed;  the  average  number  of  wells  producing 
during  each  year;  and  the  initial  daily  production  of  each  well; 
and 

(r)  any  other  data  which  will  be  helpful  in  determining  the 
reasonableness  of  the  depletion  production.-''^ 

Maps.  Maps  that  accompany  records  and  delineate  property 
boundaries  must  be  sufficiently  extended  to  show  the  position 
of  property  in  relation  to  section,  township,  and  range  lines,  or 
in  areas  of  metes  and  bounds  survey,  the  relation  to  two  or 
more  established  lines,  of  either  township  or  district.  On  some 
part  of  the  map  should  be  recorded  the  name  of  the  state,  county, 
township  or  district,  name  of  the  owner,  operator  and  (or)  lessee 
of  the  property,  scale  of'  map,  and  date  of  survey,  and  points 
of  the  compass.  It  will  be  to  the  advantage  of  every  taxpayer 
to  assist  the  department  in  compiling  complete  statistics  of  all 
development  that  has  taken  place,  and  maps  submitted  should 
show  location  of  all  wells  that  have  ever  been  drilled  on  a  given 
property.  The  character  of  each  well  should  be  indicated  by 
appropriate  symbols.  Where  wells  have  been  drilled  by  another 
company  or  individual  it  is  advisable  to  distinguish  such  wells 
by  some  symbol  or  abbreviation,  explaining  the  symbol  in  a 
marginal  note.  When  a  taxpayer  has  filed  adequate  maps  with 
the  Commissioner  he  may  be  relieved  of  filing  further  maps  of 
the  same  properties,  providing  all  additional  information  neces- 
sary for  keeping  the  maps  up  to  date  is  filed  each  year.  This 
includes  records  of  dry  holes  as  well  as  producing  wells,  together 
with  logs,  depth,  and  thickness  of  sands,  location  of  new  wells, 
etc.  By  "production"  is  meant  the  production  of  oil  or  gas  be- 
longing to  the  taxpayer.  In  those  leases  where  no  account  is 
kept  of  the  oil  or  gas  used  for  fuel,  the  net  production  will  neces- 
sarily be  that  remaining  after  the  fuel  used  in  the  property  has 
been  taken  out.  In  cases  ^f  this  kind  an  estimate  of  the  fue^ 
used  from  each  tract  should  be  given  for  each  year."^8 

Discovery  of  Oil  and  Gas  Wells.  The  discovery  clause  of  the 
statute  provides  that  taxpayers  who  discover  oil  and  gas  wells 
on  or  after  March  1,  1913,  may,  under  the  circumstances  therein 

37  Reg.  45,  Art.  218. 

38  Manual  for  the  Oil  and  Gas  Industry,  p.  43. 


DEPLETION  OF  OIL  AND  GAS  WELLS  759 

prescribed,  determine  the  fair  market  value  of  such  property  at 
the  date  of  discovery  or  within  30  days  thereafter  for  the  pur- 
pose of  ascertaining  allowable  deductions  for  depletion.  Before 
such  valuation  may  be  made  the  statute  requires  that  two  con- 
ditions precedent  be  satisfied,  (1)  that  the  fair  market  value  of 
such  property  (oil  and  gas  wells)  on  the  date  of  discovery,  or 
within  30  days  thereafter,  became  materially  disproportionate 
to  the  cost,  by  virtue  of  the  discovery,  and  (2)  that  such  oil  and 
gas  wells  were  not  acquired  as  the  result  of  purchase  of  a  proven 
tract  or  lease.-''-'  The  discovery  value  when  obtained  in  accordance 
with  the  rules  set  forth  below  is,  in  the  case  of  a  lease,  to  be 
equitably  apportioned  between  the  lessor  and  lessee.-**^'  The  dis- 
covery clause  was  inserted  to  protect  the  prospector  or  "wildcat- 
ter" who  goes  into  an  unknown  field  and  overcoming  hazards  of 
the  business  discovers  a  new  and  valuable  deposit  of  oil  or 
gas,  and  by  so  doing  increases  the  value  of  his  holdings  to  such 
an  extent  that  their  value  at  the  time  of  the  discovery  or  within 
30  days  thereafter  is  materially  disproportionate  to  their  cost. 
The  discovery  may  refer  to  the  opening  up  of  a  new  pool  or  field 
or  it  may  refer  to  the  tapping  of  a  new  and  previously  unknown 
sand  or  zone  in  an  old  pool  or  field.  The  benefits,  however,  will 
accrue  solely  to  the  holdings  of  the  taxpayer  actually  making 
the  discovery.  And  it  will  effect  him  only  in  so  far  as  he  is  able 
to  prove  that  his  discovery  was  bona  fide,  and  that  it  has  so  in- 
creased the  value  of  his  holdings  as  to  make  it  materially  dis- 
proportionate to  the  cost.^i  Unless  the  taxpayer  proves  to  the 
satisfaction  of  the  Commissioner  that  his  so-called  discovery 
well  has  opened  up  an  entirely  new  pool  or  structure  or  a  new 
sand  or  zone  in  the  particular  pool  or  structure  in  which  the  oper- 
ation takes  place,  this  law  will  not  apply  to  (a)  any  tract  or 
lease  any  part  of  which  was  proven  or  producing  prior  to  the 
date  of  (the  alleged)  discovery,  (b)  nor  to  any  tract  or  lease 
within  the  proven  limits  of  any  well-recognized  oil  or  gas  pool  or 
field,  (c)  nor  to  such  wells  as  are  drilled  immediately  in  advance 
of  producing  wells,  (d)  or  on  the  edge  of  proven  territory. 
Neither  will  it  apply  to  the  tract  or  lease  of  any  other  than  the 
taxpayer  making  the  bona  fide  discovery. - 

39  Reg.  45,  Art.  220,  as  amended  by  T.  D.  2956,  Dec.  2,  1919.  This 
Treasury  Decision  substantially  modifies  the  former  ruling  of  the  Treas- 
ury Department.     See  also  T.  D.  3089,  T.  B.  47-20-1313. 

•lit  Manual  for  the  Oil  and  Gas  Industry,  p.  20. 

■41  Manual  for  the  Oil  and  Gas  Industry,  p.  45;  T.  D.  3089,  T.  B.  47-20-1313. 

42  Manual  for  the  Oil  and   Gas  Industry,  p.  45. 


760  federal  income  tax 

Discovery — Proven  Tract  or  Lease — Property  Dispropor- 
tionate Value.  (1)  For  purposes  of  the  discovery  clauses  of 
the  Revenue  Acts  of  1918  and  1921,  an  oil  or  gas  well  may  be  said 
to  be  discovered  when  there  is  either  a  natural  exposure  of  oil  or 
gas,  or  a  drilling  that  discloses  the  actual  and  physical  presence  of 
oil  or  gas  in  quantities  sufficient  to  justify  commercial  exploita- 
tion. Quantities  sufficient  to  justify  commercial  exploitation  are 
deemed  to  exist  when  the  quantity  and  quality  of  the  oil  or  gas 
so  recovered  from  the  well  are  such  as  to  afford  a  reasonable 
expectation  of  at  least  returning  the  capital  invested  in  such 
well  through  the  sale  of  the  oil  or  gas,  or  both,  to  be  derived 
therefrom. 

(2)  A  proven  tract  or  lease  may  be  a  part  or  the  whole  of  a 
proven  area.  A  proven  area  will  be  presumed  to  be  that  portion 
of  the  productive  sand  or  zone  or  reservoir  included  in  a  square 
surface  area  of  160  acres  having  as  its  center  the  mouth  of  a 
well  producing  oil  or  gas  in  commercial  quantities.  In  other 
words,  a  producing  well  will  be  presumed  to  prove  that  portion 
of  a  given  sand,  zone  or  reservoir  which  is  included  in  an  area 
of  160  acres  of  land,  regardless  of  private  boundaries.  The  cen- 
ter of  such  square  area  will  be  the  mouth  of  the  well,  and  its 
sides  must  be  parallel  to  the  section  lines  established  by  the 
United  States  system  of  public  land  surveys  in  the  district  in 
which  it  is  located.  Where  a  district  is  not  covered  by  the 
United  States  land  surveys,  the  sides  of  said  area  must  run  north 
and  south,  east  and  west. 

So  much  of  a  taxpayer's  tract  or  lease  which  lies  within  an 
area  proven  either  by  himself  or  by  another  is  "a  proven  tract 
or  lease"  as  contemplated  by  the  statute,  and  the  discovery  of  a 
well  thereon  will  not  entitle  such  taxpayer  to  revalue  such  well 
for  the  purpose  of  depletion  allowances,  unless  the  tract  or  lease 
had  been  acquired  before  it  became  proven.  And  even  though 
a  well  is  brought  in  on  a  tract  or  lease  not  included  in  a  proven 
area  as  above  defined,  nevertheless  it  may  not  entitle  the  owner 
of  the  tract  or  lease  in  which  such  w^ell  is  located  to  revaluation 
for  depletion  purposes,  if  such  tract  or  lease  lies  within  a  com- 
pact area  which  is  immediately  surrounded  by  proven  land,  and 
the  geologic  structural  conditions  on  or  under  the  land  so  in- 
closed may  reasonably  warrant  the  belief  that  the  oil  or  gas  of 
the  proven  areas  extends  thereunder.  Under  such  circumstances 
the  entire  area  is  to  be  regarded  as  proven  land. 

(3)  The  "property"  which  may  be  valued  after  discovery  is 
the  "well."  The  "well"  is  the  drill  hole,  the  surface  necessary 
for  the  drilling  and  operation  of  the  well,  the  oil  or  gas  content 


DEPLETION  OF  OIL  AND  GAS  WELLS  7G1 

of  the  particular  sand,  zone  or  reservoir  (limestone,  breccia, 
crevice,  etc.)  in  which  the  discovery  was  made  by  the  drilling 
and  from  which  the  production  is  drawn,  to  the  limit  of  the  tax- 
payer's private  bounding-  lines,  but  not  beyond  the  limits  of  the 
proven  area. 

(4)  A  taxpayer  to  be  entitled  to  revalue  his  property 
after  March  1,  1913,  for  the  purpose  of  depletion  allowances 
must  make  a  discovery  after  said  date  and  such  discovery 
must  result  in  the  fair  market  value  of  the  property  becoming 
disproportionate  to  the  cost.  The  fair  market  value  of  the 
property  will  be  deemed  to  have  become  disproportionate  to  the 
cost  when  the  output  of  such  well  of  oil  or  gas  affords  a  reason- 
able expectation  of  returning  to  the  taxpayer  an  amount  ma- 
terially in  excess  of  the  cost  of  the  land  or  lease  if  acquired  since 
March  1,  1913,  or  its  fair  market  value  on  March  1,  1913,  if 
acquired  prior  thereto,  plus  the  cost  of  exploration  and  develop- 
ment work  to  the  time  the  well  was  brought  in.'"* 

Private  Bounding  Lines.  The  "private  bounding  lines," 
mentioned  in  subdivision  (3)  of  the  previous  paragraph,  refer 
to  the  exterior  limit  of  a  coritinuoiis  tract  held  under  lease  or 
teases  or  in  fee  by  the  taxpayer.    To  illustrate: 

A  company  has  leases  upon  the  S.  E.  quarter  of  the  N.  W. 
quarter  of  section  10.  The  company  holds  this  land  under  five 
separate  leases  from  different  fee  owners.  A  well  is  brought 
in  upon  the  land,  conceded  to  be  a  discoveiy  well,  subsequent 
to  the  acquiring  of  the  leases  by  the  company,  and  so  located  as 
to  include  the  entire  40  acres  of  the  company  in  the  proven  area. 
The  property  to  be  valued  is  the  drill  hole,  the  surface  necessary 
for  the  drilling  and  operation  of  the  well,  the  oil  or  gas  content 
of  this  particular  sand,  zone,  or  reservoir,  in  which  the-  discov- 
ery was  made,  to  the  limits  of  the  entire  40  acres  held  by  the 
company.  If  the  "private  bounding  lines"  were  interpreted  to 
mean  the  boundaries  of  each  lease,  it  would  enable  the  company 
to  value  one  well  subsequently  brought  in  upon  each  of  the  five 
leases. 

Wells  drilled  upon  a  proven  tract  which  has  already  been 
re-valued  upon  discoveiy  have  no  significance  upon  the  value 
previously  given  the  "property."  But  wells  brought  in  upon  a 
proven  area  still  further  extend  the  proven  area.    To  illustrate: 

^•■'•Reg:.  45,  Art.  220a,  as  amended  by  T.  D.  2956;  Manual  for  the  Oil  and 
Gas  Industry,  p.  43.  The  same  evidence  as  required  under  "Determination 
of  fair  market  value,"  must  be  submitted  by  the  taxpayer  to  substantial'.^ 
the  value  which  he  sets  up  as  of  date  of  the  discovery,  or  within  30  days 
thereafter,  in  the  cases  under  discussion. 


762  FEDERAL  INCOME  TAX 

A  company  owns  an  acreage  of  land  upon  which  a  discovery 
well  is  brought  in,  all  of  the  proven  area  being  included  in  the 
acreage.  The  company,  for  the  .purpose  of  ascertaining  allow- 
able deductions  for  depletion,  determines  the  fair  market  value 
of  the  "well,"  i.  e.  (1)  the  drill  hole,  (2)  the  surface  necessary 
for  the  drilling  and  operation  of  the  well,  and  (3)  the  oil  or 
gas  content  of  the  particular  sand,  zone,  or  reservoir,  in  which 
the  discovery  was  made  by  the  drilling,  and  from  which  the 
production  is  drawn.  The  great  increase  in  value,  of  course, 
is  from  item  (3),  the  oil  or  gas  content  of  the  sand,  zone,  or 
reservoir.  If  the  company  were  allowed  to  value  other  wells 
brought  in  upon  this  proven  area,  it  would  in  fact  be  valuing 
the  same  oil  and  gas  content  of  the  sand,  zone  or  reservoir, 
which  had  previously  been  valued  and  upon  which  depletion  was 
being  taken.  Such  a  result  would  be  distinctly  contrary  to  the 
statute.  However,  the  bringing  in  of  other  wells  upon  this 
proven  area,  still  further  extends  the  proven  area  to  the  extent 
provided  by  law,  and  wells  brought  in  upon  an  area  so  proven 
can  not  be  revalued  unless  the  land  was  acquired  before  proven. 

If  a  well  should  be  drilled  in  the  corner  of  a  quarter  section 
of  land  owned  by  the  taxpayer,  to  be  able  to  value  the  portion  of 
the  quarter  section  not  proven  by  the  well,  it  would  be  necessary 
for  other  wells  to  be  brought  in  upon  the  area  not  proven  by  the 
first  well.44 

Proof  of  Discovery  of  Oil  and  Gas  Wells.  In  order  to 
meet  the  requirements  of  the  discovery  clause  of  the  statute  to 

44  0.  D.  527,  T.  B.  22-20-970.  It  is  difficult  to  see  the  authority  in  the 
statute  or  any  ground  in  equity  for  this  ruling  insofar  as  it  precludes 
the  taxpayer  from  revaluing  acreage  beyond  the  limits  of  the  area  proven 
by  the  first  well  by  means  of  a  well  drilled  in  such  proven  area.  The  effect 
of  the  ruling  is  (1)  to  preclude  a  purchaser  from  claiming  discovery  value 
on  the  extended  area  proven  beyond  the  limits  of  the  original  tract  by  addi- 
tional wells  drilled  within  those  limits  on  the  ground  that  such  extended 
area  is  "a  proven  tract  or  lease"  within  the  meaning  of  the  law,  and  (2)  to 
deny  the  right  of  the  taxpayer  to  re-value  the  same  extended  area  on  the 
ground  that  as  to  him  such  extended  area  is  not  "proven"  until  discovery  is 
actually  made  outside  the  limits  of  the  original  tract.  There  seems  to  be  a 
valid  reason  for  (1),  but,  if  so,  (2)  is  clearly  inconsistent.  The  ruling,  as  it 
now  stands,  limits  the  application  of  the  mathematical  formula  of  a  proven 
tract  or  lease  according  to  the  interest  of  the  government.  If  the  formula  is 
to  be  applied  at  all,  it  would  seem  only  reasonable  to  apply  it  without  dis- 
crimination. It  is  not  difficult  to  conceive  of  cases  in  which,  on  account  of 
geological  or  operating  conditions,  a  taxpayer  would  drain  the  acreage  out- 
side the  original  tract  without  being  able  economically  to  drill  outside 
such  tract. 


DEPLETION  OF  OIL  AND  GAS  WELLS  763 

the  satisfaction  of  the  Commissioner,  the  taxpayer  will  be  re- 
quired, among  other  things,  to  submit  the  following  with  his 
return : 

(a)  A  map  of  convenient  scale,  showing  the  location  of  the 
tract  and  discovery  well  in  question  and  of  the  nearest  producing 
well,  and  the  development  for  a  radius  of  at  least  three  miles 
from  the  tract  in  question,  both  on  the  date  of  discovery  and  on 
the  date  when  the  fair  market  value  was  set. 

(b)  A  certified  copy  of  the  log  of  the  discovery  well,  showing 
the  location,  the  date  drilling  began,  the  date  of  completion  and 
beginning  of  production,  the  formations  penetrated,  the  oil,  gas, 
and  water  sands  penetrated,  the  casing  record,  including  the 
record  of  perforations,  and  any  other  information  tending  to 
show  the  condition  of  the  well  and  the  location  of  the  sand  or 
zone  from  which  the  oil  or  gas  is  produced  on  the  date  the  dis- 
covery was  claimed. 

(c)  A  sworn  record  of  production  clearly  proving  the  com.- 
mercial  productivity  of  the  discovery  well. 

(d)  A  sworn  copy  of  the  records,  showing  the  cost  of  the 
property;  and 

(e)  A  full  explanation  of  the  method  of  determining  the  value 
on  the  date  of  discovery,  or  within  30  days  thereafter,  supported 
by  satisfactory  evidence  of  the  fairness  of  this  value.^"' 

Charges  to  Capital  and  to  Expense  in  the  Case  of  Oil  and  Gas 
Wells.  Such  incidental  expenses  as  are  paid  for  wages,  fuel, 
repairs,  hauling,  etc.,  in  connection  with  the  exploration  of  the 
property,  drilling  of  wells,  building  of  pipe  lines,  and  devel- 
opment of  the  property  may  at  the  option  of  the  taxpayer  be 
deducted  as  an  operating  expense  or  charged  to  the  capital 
account  returnable  through  depletion.  If  in  exercising  this 
option  the  taxpayer  charges  these  incidental  expenses  to  capital 
account,  in  so  far  as  such  expense  is  represented  by  physical 
property,  it  may  be  taken  into  account  in  determining  a  reason- 
able allowance  for  depreciation.  The  cost  of  drilling  nonpro- 
ductive wells  may  at  the  option  of  the  operator  be  deducted  from 
gross  income  as  an  operating  expense  or  charged  to  capital 
accounts  returnable  through  depletion  and  depreciation  as  in 
the  case  of  productive  wells.  An  election  once  made  under  this 
option  will  control  the  taxpayer's  retunis  for  all  subsequent 
years.-*"  Casinghead-gas  contracts  have  been  construed  to  be 
tangible  assets  and  their  cost  may  be  added  to  the  capital  account 

•l-JReg.  45,   Art.   221,   as   amended   by  T.   D.   2956. 

4fiA.  R.  M.  110,  T.  B.  10-21-1498;  0.  D.  796,  T.  B.  6-21-1434. 


764  FEDERAL   INCOME   TAX 

returnable  through  depletion,  following  the  rate  set  by  the  oil 
wells  from  which  the  gas  is  derived,  or,  if  the  life  of  the  contract 
is  shorter  than  the  reasonable  expectation  of  the  life  of  the  wells 
furnishing  the  gas,  the  capital  invested  in  the  contract  may  be 
written  off  through  yearly  allowances  equitably  distributed  over 
the  life  of  the  contract.  All  oil  produced  during  the  taxable 
year,  whether  sold  or  unsold,  must  be  considered  in  the  com- 
putation of  the  depletion  allowance  for  the  taxable  year.  In 
computing  net  income  all  oil  in  storage  at  the  beginning  and 
at  the  end  of  the  taxable  year  must  be  inventoried  at  cost,  that 
is,  unit  cost  plus  lifting  cost.  Where  deductions  for  depreciation 
or  depletion  have  either  on  the  books  of  the  taxpayer  or  in  his 
returns  of  net  income  been  included  in  the  past  in  expense  or 
other  accounts,  rather  than  specifically  as  depreciation  or  deple- 
tion or  where  capital  expenditures  have  been  charged  to  expense 
in  lieu  of  depreciation  or  depletion,  a  statement  indicating  the 
extent  to  which  this  practice  has  been  carried  should  accompany 
the  return .47 

Depreciation  of  Improvements  in  the  Case  of  Oil  and  Gas 
Wells.  Both  owners  and  lessees  operating  oil  or  gas  properties 
will,  in  addition  to  and  apart  from  the  deduction  allowable  for 
the  depletion  or  return  of  capital,  be  permitted  to  deduct  a  rea- 
sonable allowance  for  depreciation  of  physical  property,  such  as 
machinery,  tools,  equipment,  pipes,  etc.,  so  far  as  not  in  conflict 
with  the  option  exercised  by  the  taxpayer  under  the  preceding 
paragraph.  The  amount  deductible  on  this  account  shall  be 
such  an  amount  based  upon  its  cost  or  fair  market  value  as  of 
March  1,  1913,  equitably  distributed  over  its  useful  life  as  will 
bring  such  property  to  its  true  salvage  value  when  no  longer 
useful  for  the  purpose  for  which  such  property  was  acquired. 
Accordingly,  where  it  can  be  shown  to  the  satisfaction  of  the 
Commissioner  that  the  reasonable  expectation  of  the  economic 
life  of  the  oil  or  gas  deposit  with  which  the  property  is  connected 
is  shorter  than  the  normal  useful  life  of  the  physical  property, 
the  amount  annually  deductible  for  depreciation  may  for  such 
property  be  based  upon  the  length  of  life  of  the  deposit.'*^ 

Physical  Property.  Physical  property  is  defined  as  all  equip- 
ment having  an  inventory  or  salvage  value  and  subject  to  re- 

47  Reg.  45,  Art.  223.  It  has  been  held  that  a  subsidiary  company  is 
bound  by  the  election  made  by  its  parent  or  holding  company  in  charging 
development  and  exploitation  expenses  to  operating  expenses  and  may 
not  capitalize  such  expenses  after  such  election.  (0.  D.  1002,  T.  B.  34-21- 
1781). 

48  Reg.  45,  Art.  225.     See  Chapter  26  for  a  discussion  of  depreciation. 


DEPLETION  OF  OIL  AND  GAS  WELLS  765 

moval  from  the  property,  such  as  buildings,  bridges,  and  power 
plants,  derricks,  casings,  drilling  equipment  (cable  and  rotary), 
and  pumping  equipment,  including  engines,  boilers,  tubing,  and 
rods;  flow  lines,  and  connections  on  wells,  tanks  attached  to 
wells',  and  other  tankage  of  steel,  wood,  or  concrete;  cleaning  and 
pulling  equipment;  salt-water  equipment;  refineries,  treating 
and  reducing  plants,  including  casinghead  gas  plants;  telegraph 
and  telephone  lines,  pipe  lines  and  tank  cars,  and  all  other 
equipment  used  in  the  production,  reduction,  conservation,  or 
transportation  of  oil  and  gas  or  their  products.''' 

ESTIMATES  OF   DEPRECIATION   OF    PHYSICAL   PROPERTY.      Some 

percentages  and  tables  used  in  the  estimation  of  depreciation  of  oil 
and  gas  property  and  intended  as  a  suggestion  for  the  guidance  of 
the  taxpayer  in  calculating  his  just  tax  have  been  prepared  by 
the  department."^"    The  percentages  and  tables  are  neither  maxi- 
mum nor  minimum  rates.    They  are  not  to  be  applied  hnUscrim- 
hiatelij  to  specific  property,  and  the  bureau  is  in  no  way  com- 
mitted to  accept  allowances  based  upon  them.    Every  claim  for 
deduction  must  be  accompanied  by  a  detailed  statement  of  the 
facts  upon  which  such  claim  is  based.    Each  class  of  equipment 
is  shown  in  detail  and  as  a  class,  with  the  suggestion  that  an 
average  life  of  the  class  be  used  rather  than  the  life  of  any  indi- 
vidual part.     The  average  years  of  useful  life  of  the  various 
classes  is  shown  in  the  summary  sheet  and  a  suggestion    for 
charging  out  annual  percentages  to  conform  to  the  depreciation 
as  it  actually  occurs.     It  must  be  borne  in  mind  that  it  is  not 
possible  to  make  standard  rules  or  formulae  to  cover  all  condi- 
tions in  this  business.    Although  different  rates  may  reasonably 
be  applied  in  different  parts  of  the  country,  the  average  rates  for 
each  locality  are  not  given  by  the  treasury  department,  as  it  is 
believed  that  the  variation  of  such  rates  from  the  general  aver- 
age is  so  slight  as  to  be  practically  negligible  in  most  instances. 
Whenever  the  life  of  the  property  is  materially  shorter  than 
that  called  for  in  this  schedule,  a  special  rate  may  be  claimed, 
or  the  differences  may  be  made  up  by  replacements  chargeable 
to  the  maintenance  accounts.     In  the  case  of  some  of  the  Gulf 
coast  districts,  portions  of  the  pipe  lines  are  eaten  out  in  five 
or   six  years.     These   repairs   are   rightly   a   replacement   and 
chargeable  to  maintenance  or  operating  accounts.^i 

Depletion   and   Depreciation  of  Oil  and   Gas  Wells  in   Years 
Before  1916.    If  upon  examination  it  is  found  that  in  respect  of 

•t!>  Manual  for  the  Oil  and  Gas  Industry,  p.  9. 

T'"  These  percentages  and  tables  are  shown  in  the  Oil  and  Gas  Manual. 

•"•1  Manual  for  the  Oil  and  Gas  Industry,  p.  59. 


766  FEDERAL  INCOME  TAX 

the  entire  drilling  cost  of  wells,  including  physical  property  and 
incidental  expenses,  between  March  1,  1913,  and  December  31, 
1915,  a  taxpayer  has  been  allowed  a  reasonable  deduction  suffi- 
cient to  provide  for  the  elements  of  exhaustion,  wear  and  tear, 
and  depletion,  it  will  not  be  necessary  to  reopen  the  returns  for 
years  prior  to  1916  in  order  to  show  separately  in  these  years 
the  portions  of  such  deduction  representing  depletion  and  depre- 
ciation, respectively.  Such  separation  will  be  required  to  be 
made  of  the  reserves  for  depreciation  at  January  1,  1916,  and 
proper  allocation  between  depreciation  and  depletion  must  be 
maintained  after  that  date.  In  any  case  in  which  it  is  found 
that  the  deductions  taken  between  March  1,  1913,  and  December 
31,  1915,  are  not  reasonable,  amended  returns  may  be  required 
for  these  years.^^ 

52  Reg.  45,  Art.  226. 


CHAPTER  30 

DEPLETION  OF  TIMBER 

The  provision  of  the  Revenue  Act  of  1921  permitting  the 
deduction  of  an  allowance  for  depletion  in  the  case  of  mines, 
oil  v^ells,  gas  wells,  or  other  natural  deposits  and  timber,  has 
been  set  forth  and  discussed  generally  in  another  chapter.^  The 
same  allowance  was  permitted  under  the  1918  Law,  and  the  regu- 
lations issued  under  that  law  remain  still  applicable.  The  allow- 
ance is  based  (a)  upon  cost,  if  acquired  after  February  28,  1913, 
or  (b)  upon  the  fair  market  value  as  of  March  1,  1913,  if  ac- 
quired prior  thereto.  The  essence  of  this  provision  is  that  the 
owner  of  timber  property,  whether  it  be  a  leasehold  or  a  freehold, 
shall  secure  through  an  aggregate  of  annual  depletion  and  de- 
preciation deductions  a  return  of  the  amount  of  capital  invested 
by  him  in  the  property,  or  in  lieu  thereof  an  amount  equal  to  its 
fair  market  value  as  of  March  1,  1913,  plus  in  any  case  the  sub- 
sequent cost  of  plant,  equipment  and  development  which  is  not 
chargeable  to  current  operating  expenses,  but  not  including  cut- 
over  land  values.-'  The  allowance  is  permitted  to  operating  own- 
ers, lessors  and  lessees,  and  the  capital  recoverable  through  the 
depletion  allowance  in  the  case  of  each  and  the  rules  with  respect 
to  the  apportionment  of  the  deduction  between  lessor  and  lessee 
are  also  set  forth  generally  in  another  chapter.-"  The  cost  of  tim- 
ber property  is  determined  in  accordance  with  the  rules  laid 
down  in  the  same  chapter.^   Certain  special  rules  specifically  re- 

1  See  Chapter  27. 

2  Reg.  45,  Art.  227.  Prior  to  the  1918  law  the  statute  did  not  provide  for 
depletion  of  timber  lands,  but  the  treasury  department  prescribed  rulings 
under  which  a  deduction  could  be  taken  from  gross  receipts  or  made  through 
a  charge  in  the  cost  c^f  manufacturing  the  timber  into  lumber.  These  rul- 
ings were  practically  to  the  same  effect  as  those  discussed  in  this  chapter. 

•"i  See  Chapter  27.  It  has  been  held  that  since  a  licensee  of  Crown  Timber 
Limits  in  the  Province  of  Quebec  has  no  proprietary  interest  in  the  timber, 
but  only  a  right  to  enter  upon  the  lands  and  cut  and  remove  timber  there- 
from upon  the  payment  of  the  prescribed  dues  and  charges,  his  status 
is  solely  that  of  lessee  and  that  the  bonus  paid  by  him  for  the  privilege  of 
obtaining  the  license  or  the  value  of  the  license  on  March  1,  1913,  if  the 
license  was  granted  prior  to  that  date,  constitutes  his  entire  depletable 
interest.  (L.  L.  1055,  T.  B.  49-20-1334;  see  also  A.  R.  M.  Ill,  T.  B.  9-21- 
1480.) 

■*  This  chapter  should  be  consulted  in  connection  with  the  rules  discussed 
in  this  chapter.  Many  of  the  rules  stated  in  Chapter  29  on  oil  and  gas 
wells  have  a  more  general  application  and  should  be  consulted  also. 

767 


768  FEDERAL   INCOME   TAX 

lating  to  the  depletion  allowance  in  the  case  of  timber  are  set 
forth  below. 

Determination  of  Fair  Market  Value  of  Timber.  Where  the 
fair  market  value  of  the  property  at  a  specified  date,  in  lieu  of 
the  cost  thereof,  is  the  basis  for  depletion  and  depreciation  de- 
ductions, such  value  must  be  determined,  subject  to  approval  or 
revision  by  the  commissioner  upon  audit,  by  the  owner  of  the 
property  in  the  light  of  the  most  reliable  and  accurate  informa- 
tion available  with  reference  to  the  condition  of  the  property 
as  it  existed  at  that  date,  regardless  of  all  subsequent  changes, 
such  as  changes  in  surrounding  circumstances,  in  methods  of 
exploitation,  in  degree  of  utilization,  etc.  The  value  sought  will 
be  the  selling  price  assuming  a  transfer  between  a  willing 
seller  and  a  willing  buyer  as  of  the  particular  date.  Such  factors 
as  the  following  will  be  given  due  consideration:  (a)  Character 
and  quality  of  the  timber  as  determined  by  species,  age,  size, 
condition,  etc.;  (b)  the  quantity  of  timber  per  acre,  the  total 
quantity  urider  consideration,  and  the  location  of  the  timber  in 
question  with  reference  to  other  timber;  (c)  accessibility  of  the 
timber  (location  with  reference  to  distance  from  a  common 
carrier,  the  topography  and  other  features  of  the  ground  upon 
which  the  timber  stands  and  over  which  it  must  be  transported 
in  process  of  exploitation,  the  probable  cost  of  exploitation,  and 
the  climate  and  the  state  of  industrial  development  of  the  local- 
ity) ;  and  (d)  the  freight  rates  by  common  carrier  to  important 
markets.  The  timber  in  question  will  be  valued  on  its  own 
merits,  and  not  on  the  basis  of  general  averages  for  regions; 
however,  the  value  placed  upon  it,  taking  into  consideration  such 
factors  as  those  mentioned  above,  will  be  consistent  with  that 
of  the  other  timber  in  the  region.  The  commissioner  will  give 
due  weight  and  consideration  to  any  and  all  facts  and  evidence 
having  a  bearing  on  the  market  value,  such  as  cost,  actual  sales 
and  transfers  of  similar  properties,  the  margin  between  the  cost 
of  production  and  the  price  realized  for  timber  products,  market 
value  of  stock  or  shares,  royalties  and  rentals,  value  fixed  by  the 
owner  for  the  purpose  of  the  capital  stock  tax,  valuation  for 
local  or  state  taxation,  partnership  accountings,  records  of  liti- 
gation in  which  the  value  of  the  property  has  been  involved,  the 
amount  at  which  the  property  may  have  been  inventoried  and  /  or 
appraised  in  probate  or  similar  proceedings,  disinterested  ap- 
praisals by  approved  methods,  and  other  factors.  For  depletion 
purposes  the  fair  market  value  at  a  specified  date  may  not  in- 
clude any  part  of  the  value  of  the  land.-^ 

5  Reg.  45,  Art.   234. 


DEPLETION    OF   TIMBER  769 

Determination  of  Quantity  of  Timber.  Each  taxpayer  claim- 
ing or  expecting  to  claim  a  deduction  for  depletion  is  required 
to  estimate  with  respect  to  each  separate  timber  account  the 
total  units  (feet  board  measure  log  scale,  cords,  or  other  units) 
of  timber  reasonably  known  or  on  good  evidence  believed  to 
have  existed  on  the  ground  on  March  1,  1913,  or  on  the  date  of 
acquisition  of  the  property,  as  the  case  may  be.  This  estimate 
must  state  as  nearly  as  possible  the  number  of  units  which 
would  have  been  found  present  by  a  careful  estimate  made  on 
the  specified  date  with  the  object  of  determining  100' c  of  the 
quantity  of  timber  which  the  area  would  have  produced  on  that 
date  if  all  the  merchantable  timber  had  been  cut  and  utilized  in 
accordance  with  the  standards  of  utilization  prevailing  in  that 
region  at  that  time.  If,  subsequently,  during  the  ownership  of 
the  taxpayer  making  the  return,  as  the  net  result  of  the  growth 
of  the  timber,  of  changes  in  standards  of  utilization,  of  losses 
not  otherwise  accounted  for,  of  abandonment  of  timber,  and  /  or 
of  errors  in  the  original  estimates,  there  are  found  to  remain 
on  the  ground,  available  for  utilization,  more  or  less  units  of 
timber  than  remain  in  the  timber  account  or  accounts,  a  new 
estimate  of  the  recoverable  units  of  timber  (but  not  of  the  cost 
or  the  fair  market  value  at  a  specified  date)  must  be  made, 
and,  when  made,  will  thereafter  constitute  a  basis  for  deple- 
tion.6 

Computation  of  Allowance  for  Depletion  of  Timber  for  Given 
Year.  The  allowance  for  depletion  of  timber  in  any  taxable  year 
should  be  based  upon  the  number  of  units  of  timber  felled 
during  the  year  and  the  unit  value  of  the  timber  in  the  timber 
account  or  accounts,  pertaining  to  the  timber  cut.  The  unit 
value  of  the  timber  for  a  given  timber  account  in  a  given  year 
should  be  the  quotient  obtained  by  dividing  (a)  the  total  num- 
ber of  units  of  timber  on  hand  in  the  given  account  at  the  be- 
ginning of  the  year  plus  the  number  of  units  acquired  during 
the  year  plus  (or  minus)  the  number  of  units  required  to  be 
added  (or  deducted)  by  way  of  correcting  the  estimate  of  the 
number  of  units  remaining  available  in  the  account  into  (b)  the 
total  fair  market  value  as  of  March  1,  1913  (and  /  or  cost),  of 
the  timber  on  hand  at  the  beginning  of  the  year,  plus  the  cost 
of  the  number  of  units  acquired  during  the  year,  plus  proper 
additions  to  capital.  The  amount  of  the  deduction  for  depletion 
in  any  taxable  year  with  respect  to  a  given  timber  account  will 
be  the  product  of  (a)  the  number  of  units  of  timber  cut  from 
the  given  account  during  the  year  multiplied  by   (b)   the  unit 

6  Reg.  45,  Art.  235. 


770  FEDERAL  INCOME   TAX 

value  of  the  timber  for  the  given  account  for  the  year.  Those 
taxpayers,  who  keep  their  accounts  on  a  monthly  basis,  may,  at 
their  option,  keep  their  depletion  accounts  on  a  monthly  basis, 
in  which  case  the  amount  deductible  on  account  of  depletion 
for  a  given  month  will  be  determined  in  the  manner  outlined 
above  for  a  given  year.  The  total  amount  of  the  deduction 
for  depletion  in  any  taxable  year  will  be  the  sum  of  the  amounts 
deductible  for  the  several  timber  accounts. 

The  depletion  of  timber  takes  place  at  the  time  the  timber 
is  felled.  Since,  however,  it  is  not  ordinarily  practicable  to 
determine  the  quantity  of  timber  immediately  after  felling, 
depletion,  for  purposes  of  accounting,  will  be  treated  as  tak- 
ing place  at  the  time,  when,  in  the  process  of  exploitation,  the 
quantity  of  timber  is  first  definitely  determined.''' 

In  the  case  of  timber  land  acquired  prior  to  March  1,  1913, 
depletion  may  be  based  on  the  average  value  on  that  date  of 
all  timber  located  in  a  single  operation  unit.  In  other  words, 
the  average  value  may  be  determined  independently  for  each 
separate  operation  unit.  A  separate  operation  unit  should  in- 
clude all  timber  which  should  logically  be  manufactured  at  a 
single  definite  mill  site.^ 

Revaluation  of  Timber  Not  Allowed.  In  the  case  of  timber 
acquired  prior  to  March  1,  1913,  the  fair  market  value  as  of 
that  date  should,  when  determined  and  approved  by  the  com- 
missioner, be  the  basis  for  determining  the  depletion  deduction 
for  each  year  during  the  continuance  of  the  ownership  under 
which  the  fair  market  value  of  the  timber  was  fixed,  and  dur- 
ing such  ownership  there  may  be  no  redetermination  of  the  fair 
market  value  of  the  timber  for  such  purpose.  However,  the 
unit  market  (or  cost)  value  of  the  timber  will  subsequently 
be  changed  if  from  any  cause  such  unit  market  (or  cost)  value 
if  continued  as  a  basis  of  depletion,  shall  upon  evidence  satis- 
factory to  the  commissioner  be  found  inadequate  or  excessive 
for  the  extinguishment  of  the  cost,  or  fair  market  value  as  of 
March  1,  1913,  of  the  timber.^ 

Charges  to  Capital  and  to  Expense  in  the  Case  of  Timber.  In 
the  case  of  a  timber  property  held  for  future  operation  by  an 
owner  having  no  substantial  income  from  the  property  or  from 
other  sources,  all  expenditures  for  administration,  protection, 
and  other  carrying  charges  prior  to  production  on  a  normal 
basis  must  be  charged  to  capital  account;  after  such  a  property 

7  Reg.  45,  Art.  229. 

8  0.  D.  43,  T.  B.   1-19-60. 
3  Reg.  45,  Art.  230. 


DEPLETION    OF   TIMBER  771 

is  on  a  normal  production  basis  such  expenditures  should  be 
treated  as  current  operating  expenses.  In  case  a  taxpayer,  who 
has  a  substantial  income  from  other  sources,  owns  a  timber 
property  which  is  not  yet  on  a  normal  production  basis,  he  may, 
at  his  option,  charge  such  expenditures  with  respect  to  such 
timber  property  to  capital,  or  treat  them  as  current  operating  ex- 
penses, but  whichever  system  is  adopted  must  be  followed  until 
permission  to  change  to  the  other  system  is  secured  from  the 
commissioner.  In  the  case  of  timber  operations  all  expenditures 
prior  to  production  for  plants,  improvements,  and  equipment, 
and  thereafter  all  major  items  of  plant  and  equipment  must  be 
charged  to  capital  account  for  purposes  of  depreciation.  After  a 
timber  operation  has  been  developed  and  equipped  and  has 
reached  its  normal  output  capacity,  the  cost  of  additional  minor 
items  of  equipment  and  the  cost  of  replacement  of  minor  items 
of  worn-out  and  discarded  plant  and  equipment  may  be  charged 
to  current  operating  expenses,  unless  the  taxpayer  elects  to  write 
off  such  expenditures  through  charges  for  depreciation;  how- 
ever, the  method  adopted  must  be  followed  consistently  from  year 
to  year.io 

Aggregating  Timber  and  Land  for  Purposes  of  Valuation  and 
Accounting.  With  a  view  to  logical  and  reasonable  valuation  of 
timber,  the  taxpayer  must  include  his  timber  in  one  or  more 
accounts.  In  general,  each  such  account  should  include  all  of 
the  taxpayer's  timber  which  is  located  in  one  "block,"  a  "block" 
being  an  operation  unit  which  includes  all  of  the  taxpayer's  tim- 
ber which  would  logically  go  to  a  single  given  point  of  manufac- 
ture. In  those  cases  in  which  the  point  of  manufacture  is  at 
a  considerable  distance  or  in  which  the  logs  or  other  products  will 
probably  be  sold  in  a  log  or  other  market,  the  "block"  may  be 
a  logging  unit  which  includes  all  of  the  taxpayer's  timber  which 
would  logically  be  removed  by  a  single  logging  development.  In 
exceptional  cases,  provided  there  are  good  and  substantial  rea- 
sons, and  subject  to  approval  or  revision  by  the  commissioner 
on  audit,  the  taxpayer  may  divide  the  timber  in  a  given  "block" 
into  two  or  more  accounts,  e.  g.,  timber  owned  on  February  28, 
1913,  and  that  purchased  subsequently,  may  be  kept  in  separate 
accounts,  or  timber  owned  on  February  28,  1913,  and  the  timber 
purchased  since  that  date  in  several  distinct  transactions  may 
be  kept  in  several  distinct  accounts,  or  individual  tree  species 
or  groups  of  tree  species  may  be  carried  in  distinct  accounts,  or 
special  timber  products  may  be  carried  in  distinct  accounts,  or 
"blocks"  may  be  divided  into  two  or  more  accounts  based  on  the 

10  Reg.  45,  Art.  231. 


772  FEDERAL  INCOME  TAX 

character  of  the  timber  and  /  or  its  accessibility,  or  scattered 
tracts  may  be  included  in  separate  accounts.  When  such  a  divi- 
sion is  made  a  proper  portion  of  the  total  value  or  cost,  as  the 
case  may  be,  should  be  allocated  to  each  account. 

The  timber  accounts  mentioned  in  the  preceding  paragraph 
may  not  include  any  part  of  the  value  or  cost,  as  the  case  may 
be,  of  the  land.  In  a  manner  similar  to  that  prescribed  in  the 
foregoing  part  of  this  paragraph  the  land  in  a  given  "block" 
may  be  carried  in  a  single  land  account  or  may  be  divided  into 
two  or  more  accounts  on  the  basis  of  its  character  and  /  or  ac- 
cessibility. When  such  a  division  is  made,  a  proper  portion  of 
the  total  value  or  cost,  as  the  case  may  be,  will  be  allocated  to 
each  account. 

The  total  value  or  total  cost,  as  the  case  may  be,  of  land  and 
timber  should  be  equitably  allocated  to  the  timber  and  land  ac- 
counts, respectively. 

Each  of  the  several  land  and  timber  accounts  carried  on  the 
books  of  the  taxpayer  must  be  definitely  described  as  to  their 
location  on  the  ground  either  by  maps  or  by  legal  descriptions. 

For  good  and  substantial  reasons,  to  be  approved  by  the  com- 
missioner, or  as  required  by  the  commissioner,  the  timber  or 
the  land  accounts  may  be  readjusted  by  dividing  individual  ac- 
counts, by  combining  two  or  more  accounts,  or  by  dividing  and 
recombining  accounts.!^ 

Timber  Depletion  and  Depreciation  Accounts  on  Books.  Every 
taxpayer  claiming  or  expecting  to  claim  a  deduction  for  depletion 
and  /  or  depreciation  of  timber  property  (including  plants,  im- 
provements, and  equipment  used  in  connection  therewith)  must 
keep  accurate  ledger  accounts  in  which  should  be  charged  the 
fair  market  value  as  of  March  1,  1913,  or  the  cost,  as  the  case 
may  be,  of  (a)  the  property,  and  (b)  the  plant,  improvements, 
and  equipment,  together  with  such  amounts  subsequently  ex- 
pended for  the  administration,  protection,  and  other  carrying 
charges,  or  development  of  the  property  or  additions  to  plant  and 
equipment  as  are  not  chargeable  to  current  operating  expenses. 
In  such  accounts  there  should  be  set  up  separately  the  quantity 
of  timber,  the  quantity  of  land,  and  the  quantity  of  other  re- 
sources, if  any,  and  a  proper  part  of  the  total  value  or  cost  should 
be  allocated  to  each.  These  accounts  should  be  credited  with 
the  amount  of  the  depreciation  and  depletion  deductions  claimed 
and  allowed  each  year,  or  the  amount  of  the  depreciation  and 
depletion  should  be  credited  to  depletion  and  depreciation  reserve 
accounts,  to  the  end  that  when  the  sum  of  the  credits  for  deple- 

11  Reg.  45,  Art.  236. 


DEPLETION    OF   TIMBER  773 

tion  and  depreciation  equals  the  value  or  cost  of  the  property, 
plus  the  amount  added  thereto  for  administration,  protection, 
and  other  carrying  charges,  or  development  or  for  additional 
plant  and  equipment,  less  salvage  value  of  the  physical  property, 
no  further  deduction  for  depletion  and  depreciation  will  be 
allov^ed.i- 

Information  to  He  Furnished  by  Taxpayer  Claiming  Depletion 
of  Timber.  To  the  return  of  the  taxpayer  claiming  a  deduction 
for  depletion  or  depreciation  or  both  there  must  be  attached  a 
map  and  statement  (Form  T  [timber])  for  the  taxable  year 
covered  by  the  income  tax  return.  Form  T  (timber)  requires 
the  following:  (a)  Map  showing  timber  and  land  acquired, 
timber  cut,  and  timber  and  land  sold ;  (b)  description  of,  cost  of, 
and  terms  of  purchase  or  lease  of,  timber  and  land  acquired; 
(c)  proof  of  profit  or  loss  from  sale  of  capital  assets ;  (d)  descrip- 
tion of  timber  with  respect  to  which  claim  for  loss,  if  any,  is 
made;  (e)  record  of  timber  cut;  (f)  changes  in  each  timber 
account  as  the  result  of  purchase,  sale,  cutting,  re-estimate,  or 
loss ;  (g)  changes  in  the  physical  property  accounts  as  the  result 
of  addition  to  or  deductions  from  capital  and  depreciation;  (h) 
operation  data  with  respect  to  raw  and  finished  materials  handled 
and  inventoried;  (i)  unit  production  costs;  and  (j)  any  other  data 
which  will  be  helpful  in  determining  the  reasonableness  of  the 
depletion  and  /  or  depreciation  deductions  claimed  in  the  return. 
Similar  information  is  required  for  certain  years  prior  to  the 
1919  taxable  year  from  those  taxpayers  who  have  not  already 
furnished  it.  The  specific  nature  of  the  information  required 
for  the  earlier  years  is  given  in  detail  in  "Form  T — General 
Forest  Industries  Questionnaire  for  the  Years  Prior  to  1919."  ^-"^ 

l2ReR.  45,   Art.  237. 
13  Reg.  45,  Art.  233. 


CHAPTER  31 

NORMAL  TAX  CREDITS — PERSONAL  EXEMPTION 

Net  income  is  ascertained  by  subtracting  the  allowable  deduc- 
tions from  the  gross  income  of  the  taxpayer.  The  net  income 
so  ascertained  is  subject  to  the  surtax  if  the  taxpayer  is  an 
individual,  or  to  excess-profits  taxes  if  the  taxpayer  is  a  cor- 
poration, but  for  the  purposes  of  the  normal  tax  of  individuals 
and  the  income  tax  of  corporations,  certain  items  of  income  may 
be  credited  against  net  income  as  above  ascertained.  These  cred- 
its are:  (a)  such  items  of  income  as  are  included  in  gross  income 
but  are  not  subject  to  normal  tax  in  the  case  of  individuals  or 
income  tax  in  the  case  of  corporations  (i.  e.,  certain  dividends, 
and  interest  on  certain  obligations  of  the  United  States)  ;  (b) 
the  personal  exemption  and  credit  for  dependents  in  the  case  of 
individuals  and  the  amount  of  the  war-profits  and  excess-profits 
taxes  in  the  case  of  corporations  plus  $2,000  in  the  case  of 
domestic  corporations  only,i  and  only  if  the  net  income  of  such 
corporation  is  $25,000  or  less.  Under  the  1918  Law  all  domestic 
corporations  were  allowed  a  specific  credit  of  $2,000.^  A  foreign 
corporation  is  allowed  the  same  credits  as  a  domestic  corporation 
other  than  the  sum  of  $2,000,  under  both  the  1918  and  1921 
Laws.3 

Credit  of  Dividends  Under  1918  Law.  For  the  purpose  of  the 
normal  tax  only  there  might  be  credited  against  net  income  the 
amount  received  as  dividends  from  a  corporation  taxable  upon 
its  net  income  and  amounts  received  as  dividends  from  a  per- 
sonal service  corporation  out  of  earnings  or  profits  upon  which 
income  tax  had  been  imposed.^  The  dividends  included  in  the 
above  provision  of  law  were  those  received  from  corporations 
other  than  foreign  corporations  having  no  income  from  sources 
within  the  United  States.^  The  normal  tax  did  not  apply  to  div- 
idends, regardless  of  the  amount  of  such  dividends,  received 

1  Revenue  Act  of  1921,  §§  216,  236. 

2  Revenue  Act  of  1918,  §  236. 

3  Reg.  45,  Art.  591.  For  a  discussion  of  the  specific  credit  and  the  credit 
of  war-profits  and  excess-profits  taxes  allowed  to  corporations  see  Chapter 
10. 

4  Revenue  Act  of  1918,  §216  (a).  Such  dividends  when  received  by  a 
corporation  were  an  allowable  deduction.  (Revenue  Act  of  1918,  §  234  (a) 
6.) 

•TReg.  45,  Art.  301. 

774 


NORMAL    TAX    CREDITS — PERSONAL    EXEMPTION  775 

I'rom  a  foreign  corporation  taxable  upon  income  from  sources 
within  the  United  States,  however  small  such  hicome  might  be/' 
Credit  of  Dividends  Under  the  1921  Law.  Under  the  present 
law  there  is  allowed  as  a  credit  against  the  normal  tax  the 
amount  received  as  dividends  (1)  from  a  domestic  corporation 
other  than  a  corporation  80  7o  or  more  of  the  gross  income  of 
which  (computed  without  the  benefit  of  this  provision)  for  the 
three  year  period  immediately  preceding  the  close  of  the  taxable 
year  (or  for  such  part  of  such  period  immediately  preceding  the 
close  of  such  taxable  year  as  may  be  applicable)  was  derived 
from  sources  within  a  possession  of  the  United  States  and  if, 
in  the  case  of  such  corporation,  50%  or  more  of  its  gross  income 
(computed  without  the  benefit  of  this  provision)  for  such  period 
or  such  part  thereof  was  derived  from  the  active  conduct  of  a 
trade  or  business  within  a  possession  of  the  United  States,  and 
(2)  from  a  foreign  corporation  when  it  is  shown  to  the  satisfac- 
tion of  the  Commissioner  that  more  than  50%  of  the  gross  in- 
come of  such  foreign  corporation  for  the  three-year  period  end- 
ing with  the  close  of  its  taxable  year  preceding  the  declaration 
of  such  dividends  (or  for  such  part  of  such  period  as  the  cor- 
poration has  been  in  existence)  was  derived  from  sources  v;ithin 
the  United  States  as  defined  by  the  statute."  Dividends  of  a  for- 
eign corporation  whose  income  from  sources  within  the  United 
States  was  absorbed  by  deductions  allocable  to  this  country 
might  be  applied  as  a  credit  against  net  income  by  the  stock- 
holders of  such  corporation.  The  American  stockholders  of  a 
foreign  corporation  whose  entire  income  from  sources  within 
the  United  States  consisted  of  dividends  from  a  corporation  tax- 
able upon  its  net  income  under  the  Revenue  Act  of  1918  were 
entitled  to  credit  for  purposes  of  the  normal  tax  for  the  dividends 
received  from  such  corporation.^  Where  a  town  owned  prac- 
tically all  of  the  common  stock  of  a  corporation  organized  to 
furnish  it  with  water,  light,  power  and  heat,  no  dividends  being 
paid  thereon,  the  preferred  stock  to  be  redeemed  as  soon  as  pos- 

•' Letter  from  treasury  department  dated  June  9,  1919;  L  T.  S.  1921, 
11 1661.  T.  B.  M.  21,  T.  B.  5-19-252.  The  credit  of  dividends  received  from 
foreign  corporations  taxable  on  income  from  sources  within  the  United 
States  applied  equally  to  the  Revenue  Acts  of  191G,  1917,  and  1918.  The 
same  credit  v^^as  allow^ed  to  corporations  under  the  Revenue  Act  of  1917,  for 
the  purpose  of  the  4%  war  income  tax  imposed  by  §  4  of  that  act,  but  not 
for  the  purpose  of  the  2%  tax  imposed  by  §  10  (a).  Revenue  Act  of  1916,  as 
amended  by  the  Revenue  Act  of  1917.     (O.  D.  383,  T.  B.  4-20-706.) 

7  Revenue  Act  of  1921,  §§216  (a),  262  and  217.  Such  dividends  are  al- 
lowed to  corporations  as  a  deduction  (Revenue  Act  of  1921,  §234  (a)  6). 

8L.  O.  1054,  T.  B.  47-20-1314. 


776  FEDERAL  INCOME   TAX 

sible  out  of  earnings,  after  which  the  plant  becomes  the  property 
of  the  town,  the  corporation  is  held  to  be  exempt  from  income 
tax  and  dividends  received  by  the  preferred  stockholders  might 
not,  therefore,  be  credited  against  net  income.'' 

Credit  of  Interest.  Both  the  Revenue  Act  of  1921  and  the 
Revenue  Act  of  1918  provide  that  in  the  case  of  individuals,  for 
the  purpose  of  the  normal  tax  only,  there  may  be  taken  as  a 
credit  against  net  income  the  amount  received  as  interest  upon 
obligations  of  the  United  States  and  bonds  issued  by  the  War 
Finance  Corporation,  which  is  included  in  gross  income. i"  In 
the  case  of  corporations  such  amount  may  be  taken  as  a  credit 
against  net  income  for  purposes  of  income  tax.^^  Consequently 
as  to  individuals,  the  normal  tax  does  not  apply  to  interest  on 
any  obligations  of  the  United  States  and  in  the  case  of  corpora- 
tions no  income  tax  is  imposed  on  any  interest  received  upon 
obligations  of  the  United  States  or  bonds  of  the  War  Finance 
Corporation.i- 

Personal  and  Specific  Exemptions.  The  1918  Law  provided 
that  for  the  purpose  of  the  normal  tax  there  might  be  taken  as 
a  credit  against  net  income  in  the  case  of  a  single  person,  a  per- 
sonal exemption  of  $1,000,  or  in  the  case  of  the  head  of  a  family 
or  a  married  person  living  with  husband  or  wife,  a  personal 
exemption  of  $2,000.i-^  Under  the  present  law  a  single  person 
is  allowed  a  personal  exemption  of  $1,000.  In  the  case  of  the 
head  of  a  family,  or  a  married  person  living  with  husband  or 
wife,  a  personal  exemption  of  $2,500  is  allowed,  unless  the  net 
income  is  in  excess  of  $5,000,  in  which  case  the  personal  exemp- 
tion is  $2,000.  It  is  further  provided  that  in  no  case  shall  the 
reduction  of  the  personal  exemption  from  $2,500  to  $2,000 
operate  to  increase  the  tax  which  would  be  payable  if  the  exemp- 
tion were  $2,500,  by  more  than  the  amount  of  the  net  income  in 
excess  of  $5,000.^^  Suppose,  for  example,  a  taxpayer  married 
and  living  with  his  wife,  but  having  no  dependents,  with  a  net 
income  of  $5,010,  The  income  subject  to  the  normal  tax  would 
be  $3,010  ($5,010  — $2,500),  and  the  tax  thereon  at  4%  would 
be  $100.40.  But  the  reduction  of  the  exemption  from  $2,500  to 
$2,000  may  not  operate  to  increase  the  tax  by  more  than  the 
amount  of  the  net  income  in  excess  of  $5,000,  which  in  this  case 

9  O.  D.  328,  T.  B.  28-19-612. 

10  Revenue  Act  of  1921,  §  216  (b)  ;  Revenue  Act  of  1918,  §  216  (b). 

11  Revenue  Act  of  1918,  §  236  (a). 

12  Reg.  45,  Arts.  301,  591. 

13  Revenue  Act  of  1918,  §  216  (c). 

14  Revenue  Act  of  1921,  §  216  (c). 


NORMAL    TAX    CREDITS — PERSONAL    EXEMPTION  777 

is  $10.  The  tax  payable  would  be,  therefore,  $110.40.  A  hus- 
band and  wife  living  together  receive  but  one  personal  exemp- 
tion of  $2,000,  or  $2,500  as  the  case  may  be,  against  their  aggre- 
gate net  income;  and  in  case  they  make  separate  returns,  the 
personal  exemption  may  be  taken  by  either  or  divided  between 
them.'"'  In  the  case  of  domestic  corporations  only,  there  is 
allowed,  for  purposes  of  income  tax,  under  the  present  law,  a 
specific  credit  of  $2,000,  if  the  net  income  is  $25,000  or  less. 
Applying  the  same  principle  as  in  the  case  of  individuals,  the 
tax  may  not  exceed  the  tax  which  would  be  payable  if  the  $2,000 
credit  were  allowed,  plus  the  amount  of  the  net  income  in 
excess  of  $25,000.i"  A  specific  credit  of  $2,000  was  allowed  to  all 
domestic  corporations  under  the  1918  Law.^"  Under  the  1918 
Law,  the  personal  exemption  was  allowed  in  all  cases  to  citizens 
and  residents ;  a  nonresident  alien  might  secure  the  personal 
exemption  in  certain  cases  and  on  certain  conditions-i*^  Under 
the  present  law  nonresident  alien  individuals  and  certain  citi- 
zens who  are  taxed  only  on  income  from  sources  within  the 
United  States  are  allowed  a  personal  exemption  of  $1,000.^"  The 
personal  exemption  may  be  said  to  be  an  arbitraiy  sum  allowed 
for  personal  living  and  family  expenses,  which  are  not  otherwise 
deductible.-" 

Head  of  Family.  A  head  of  a  family  is  a  person  who  ac- 
tually supports  and  maintains  in  one  household  one  or  more  in- 
dividuals who  are  closely  connected  with  him  by  blood  relation- 
ship, relationship  by  marriage,  or  by  adoption,  and  whose  right 
to  exercise  family  control  and  provide  for  these  dependent  in- 
dividuals is  based  upon  some  moral  or  legal  obligation.  The 
head  of  a  family  may  be  a  single  or  married  person,  a  widow, 
widower,-'  brother,  sister,  or  other  relative  by  blood,  marriage 
or  adoption.  A  widower  who  maintains  a  home  and  supports 
his  daughter  therein  is  held  to  be  the  head  of  a  family,  notwith- 
standing that  the  daughter  is  over  18  years  of  age,   receives 

'•■'Revenue  Act  of  1921,  §210  (c)  ;  Revenue  Act  of  1918,  §216  (c). 

1'' Revenue  Act  of  1921,  §236   (c). 

17  Revenue  Act  of  1918,  §236   (c). 

i"^  See  page  782. 

!!•  Revenue  Act  of  1921,  §  216  (e). 

-^  S.uch  expenses  are  expressly  stated  not  to  be  deductible.  See  Revenue 
Act  of  1921,  §215  (a).  See  Revenue  Act  of  1918,  §215  (a).  See  also 
Revenue  Act  of  1916,  §5  (a).  The  exemption  under  the  1918  Law  of 
$3,500  of  the  compensation  received  by  persons  in  active  service  in  the 
military  or  naval  forces  was  in  addition  to  the  personal  exemption  and 
credit  for  dependents   (0.  D.  123,  T.  B.  3-19-184). 

21  Reg.  45,  Art.  302:  T.  D.  2427;  T.  D.  2692;  Reg.  33  Rev.,  Art.  14. 


778  FEDERAL  INCOME  TAX 

nominal  income  from  other  sources,  and  is  neither  physically 
nor  mentally  incapable  of  self-support.-^  In  order  to  meet  the 
test  of  actual  support  and  maintenance  the  benefactor  must  con- 
tribute more  than  half  of  the  support  and  maintenance.  A 
taxpayer  who  merely  supplies  means  of  support  additional  to 
the  chief  support  of  the  beneficiary,  is  not  the  head  of  a 
family.23 

In  the  absence  of  continuous  actual  residence  together,  whether 
or  not  a  person  with  dependent  relatives  is  a  head  of  a  family 
within  the  meaning  of  the  statute  must  depend  on  the  character 
of  the  separation.  If  a  father  is  absent  on  business  or  at  war, 
or  a  child  or  other  dependent  is  away  at  school  or  on  a  visit, 
the  common  home  being  still  maintained,  the  additional  exemp- 
tion applies.  If,  moreover,  through  force  of  circumstances  a 
parent  is  obliged  to  maintain  his  dependent  children  with  rela- 
tives or  in  a  boarding  house  while  he  lives  elsewhere,  the  ad- 
ditional exemption  may  still  apply.  If,  however,  without  neces- 
sity the  dependent  continuously  makes  his  home  elsewhere,  his 
benefactor  is  not  the  head  of  a  family,  irrespective  of  the  ques- 
tion of  .support.2-t 

Where  a  widow  has  a  child  over  18  years  of  age  who  is  away 
from  home  attending  school,  the  child  having  separate  income  in 
excess  of  $1,000  a  year  but  insuflficient  to  pay  half  the  cost  of 
its  support,  the  balance  being  contributed  by  the  mother,  who 
maintains  the  home,  the  child  having  made  a  return  claiming 
an  exemption  of  $1,000,  the  widow  is  considered  the  head  of  a 
family,  and  is  entitled  to  a  personal  exemption  of  $2,000  in 
making  her  return.  The  fact  that  a  child  under  such  cir- 
cumstances has  separate  income  or  receives  support  from  other 
sources  does  not  preclude  the  parent  from  claiming  exemption 
as  head  of  a  family,  provided  the  child  is  in  a  material  degree 
dependent  on  the  parent  for  support.^^  A  daughter  who  actually 
supports  her  dependent  mother  elsewhere  than  in  her  own  home, 
by  reason  of  the  fact  that  she  is  unable  to  earn  enough  to  sup- 
port them  both  in  the  mother's  place  of  abode  or  to  defray 
their  joint  expenses  in  the  daughter's  place  of  employment,  is 
properly  classifiable  as  head  of  a  family.^^  A  father  is  entitled 
to  the  personal  exemption  as  the  head  of  a  family  if  he  is 
maintaining  a  home  for  daughters  on  the  last  day  of  the  year 

22  0.  D.  422,  T.  B.  13-20-1809. 

23  O.  D.  775,  T.  B.  3-21-1397. 

24  Reg.  45,  Art.  302;  T.  D.  2427;  T.  D.  2692;  Reg.  33  Rev.,  Art.  14. 

25  0.  D.  474,  T.  B.  17-20-886. 

26  0.  D.  665,  T.  B.  38-20-1205, 


NORMAL    TAX    CREDITS — PERSONAL    EXEMPTION  779 

and  furnishing  more  than  half  their  support,  even  if  under  the 
terms  of  a  separation  agreement  with  his  wife  the  daughters 
may  be  living  with  the  wife  on  the  last  day  of  the  year.-"  A 
resident  alien  with  children  abroad  is  not  the  head  of  a  family.-"^ 

Husband  and  Wife.  In  the  case  of  a  married  man  or  mar- 
ried woman  the  joint  exemption  replaces  the  individual  exemp- 
tion only  if  the  man  lives  with  his  wife  or  the  woman  lives  with 
her  husband.  In  the  absence  of  continuous  actual  residence  to- 
gether, whether  or  not  a  man  or  woman  has  a  wife  or  husband 
living  with  him  or  her  within  the  meaning  of  the  statute  must 
depend  on  the  character  of  the  separation.  If  merely  occasionally 
and  temporarily  a  wife  is  away  on  a  visit  or  a  husband  is  away 
on  business,  the  joint  home  being  maintained,  the  additional 
exemption  applies.  The  unavoidable  absence  of  a  wife  or  hus- 
band at  a  sanatorium  or  asylum  on  account  of  illness  does  not 
preclude  claiming  the  exemption.  If,  however,  the  husband 
voluntarily  and  continuously  makes  his  home  at  one  place  and 
the  wife  hers  at  another,  they  are  not  living  together  for  the 
l)urpose  of  the  statute,  irrespective  of  their  personal  relations. 
A  resident  alien  with  a  wife  residing  abroad  is  not  entitled  to 
the  joint  exemption.-^  Unavoidable  absence  of  a  wife,  due  to  the 
war,  did  not  preclude  a  husband  from  claiming  the  joint  per- 
sonal exemption.-'"  The  separation  of  a  husband  and  wife  due 
to  the  fact  that  the  husband  has  been  declared  mentally  in- 
competent and  confined  in  an  institution  for  treatment,  is  held 
to  be  temporary  in  character  and  consequently  without  effect  in 
so  far  as  the  joint  personal  exemption  is  concerned.-^i  A  resident 
alien  with  a  wife  and  children  living  abroad  is  not  entitled  to 
the  personal  exemption  of  a  married  person  or  head  of  a  family, 
but  is  entitled  to  a  credit  of  $400  for  each  dependent  child  under 
18  years  of  age  or  incapable  of  self-support.^'- 

Credit  FOR  Dependents.  A  taxpayer  receives  a  credit  of 
$400  for  each  person  (other  than  husband  or  wife),  whether 
related  to  him  or  not  and  whether  living  with  him  or  not,  de- 
pendent upon  and  receiving  his  chief  support  from  the  taxpayer, 
provided  the  dependent  is  either  (a)  under  eighteen  or  (b)  in- 
capable of  self-support  because  defective.     The  credit  is  based 

27  0.  D.  754,  T.  B.  51-20-1354. 

28  Reg.  45,  Art.  302;  T.  D.  2427;  T.  D.  2692;  Reg.  33  Rev.,  Art.  14. 

29  Reg.  45,  Art.  303;  T.  D.  2692. 

30  O.  D.  357,  T.  B.  1-20-657. 

31  O.  D.  603,  T.  B.  30-20-1089. 

32  0.   D.   640,   T.   B.   34-20-1149.      This   credit   for   dependents   was   $200 
under  the  1918  Law. 


780  FEDERAL   INCOME   TAX 

upon  actual  financial  dependency  and  not  mere  legal  dependency. 
It  may  accrue  to  a  taxpayer  who  is  not  the  head  of  a  family. 
Eut  a  father  whose  children  receive  half  or  more  of  their  sup- 
port from  a  trust  fund  or  other  separate  source  is  not  entitled 
to  the  credit."'"^  The  credit  for  each  dependent  was  $200  under 
the  1918  Law.3^  An  American  citizen  may  claim  the  credit  for 
dependents  irrespective  of  the  nationality  or  place  of  residence 
of  the  dependents.-'^^  If  a  husband  and  wife  both  contribute  to 
the  support  of  a  dependent,  such  credit  must  be  taken  by  the 
one  contributing  the  chief  support  and  may  not  be  divided  be- 
tween them.^'*^ 

Date  Determining  Exemption.  The  status  of  the  taxpayer, 
on  the  last  day  of  his  taxable  year,  determines  his  right  to  a 
personal  exemption  and  to  a  credit  for  dependents.  If  then  he 
is  the  head  of  a  family,  the  personal  exemption  of  $2,000  or 
$2,500  as  the  case  may  be,  may  be  taken.  If  then  he  is  the  chief 
support  of  a  dependent  who  is  under  eighteen  years  of  age  or 
incapable  of  self-support  because  mentally  or  physically  defec- 
tive, the  credit  of  $400  may  be  taken.  But  an  unmarried  in- 
dividual or  a  married  individual  not  living  with  husband  or 
wife,  who  during  the  taxable  year  has  ceased  to  be  the  head  of  a 
family  or  to  have  dependents,  is  entitled  only  to  the  personal 
exemption  of  $1,000  allowed  a  single  person.  A  husband  and 
wife  living  together  at  the  end  of  the  taxable  year  may  receive 
but  one  personal  exemption  of  $2,000  or  $2,500,  divisible  as  they 
please,  against  their  aggregate  net  income.  If  an  individual  dies 
during  the  taxable  year,  his  executor  or  administrator  in  making 
a  return  for  him  is  entitled  to  claim  his  full  personal  exemption 
according  to  his  status  at  the  time  of  his  death.  If  a  husband 
or  wife  so  dies  and  the  joint  personal  exemption  is  used  by  the 
executor  or  administrator  in  making  a  return  for  the  decedent, 
an  undiminished  personal  exemption  according  to  the  status  of 
the  survivor  at  the  end  of  the  taxable  year  may  be  claimed  in 
the  survivor's  return.  If  a  taxpayer  makes  a  return  for  a  period 
other  than  a  taxable  year,  the  last  day  of  such  period  is  treated 
as  the  last  day  of  the  taxable  year  for  the  purposes  of  the  above 
discussion.     The  foregoing  rules  were  followed  by  the  depart- 

33  Revenue  Act  of  1921,  §216  (d)  ;  Reg.  45,  Art.  304;  0.  D.  797,  T.  B. 
6-21-1436.  Prior  to  the  1918  Law,  this  exemption  was  limited  to  dependent 
children.  (But  see  A.  R.  R.  551,  T.  B.  26-21-1707,  where  it  was  granted  to 
an  uncle.). 

3-1  Revenue  Act  of  1918,  §  216  (d). 

35  0.  D.  139,  T.  B.  4-19-220. 

30  O.  D.  776,  T.  B.  3-21-1398. 


NORMAL    TAX    CREDITS — PERSONAL    EXEMPTION  781 

ment  under  the  1918  Law  but  they  are  now  embodied  in  the 
1921  Statute;'" 

Credits  to  Nonresident  Individuals  Under  the  1921  Law.  Non- 
resident alien  individuals  and  citizens  taxed  only  on  income  from 
sources  within  the  United  States  are  allowed,  for  purposes  of 
the  normal  tax,  the  same  credit  for  dividends  and  interest  on 
obligations  of  the  United  States  and  bonds  issued  by  the  War 
Finance  Corporation  as  is  allowed  to  citizens  and  residents. 
They  are  allowed,  however,  a  personal  exemption  of  only  $1,000 
and  no  credit  for  dependents,-'"^  The  1918  Law,  which  allowed  the 
personal  exemption  and  credit  for  dependents  to  nonresident 
alien  individuals  if  the  country  in  which  the  nonresident  alien 
resided  allowed  the  same  credits  to  citizens  of  the  United  States, 
was  found  very  difficult  to  administer  and  the  above  simpler 
provision  of  the  present  law  is  the  result."'-' 

Credits  to  Nonresident  Alien  Individual  Under  the  1918  Law. 
Under  the  1918  Law,  a  nonresident  alien  individual,  similarly  to 
a  citizen  or  resident,  was  entitled  for  the  purpose  of  the  normal 
tax  to  credit  dividends  from  domestic  or  resident  foreign  cor- 
porations, interest  on  obligations  of  the  United  States,  a  per- 
sonal exemption,  and  $200  for  each  dependent,  except  that,  if 
he  was  a  citizen  or  subject  of  a  country  which  imposed  an  in- 
come tax,  a  personal  exemption  or  credit  for  dependents  was 
allowed  him  only  if  such  country  allowed  a  similar  credit  to 
citizens  of  the  United  States  not  residing  in  such  country  or  if  no 
tax  was  levied  on  citizens  of  the  United  States  not  residing  in 
such  country  on  income  from  such  country.^"  "If  such  country 
allows  a  similar  credit"  meant  if  such  country  in  imposing 
its  income  tax  allowed  a  personal  exemption  or  a  credit  for  de- 
pendents, as  the  case  might  be,  and  allowed  it  without  dis- 
crimination to  citizens  of  the  United  States  not  residing  in  such 
country.  "Country"  included  within  its  meaning  any  foreign 
sovereign  state  or  self-governing  colony  (for  example,  the  Do- 
minion of  Canada),  but  did  not  include  a  foreign  municipality 

•  37  Revenue  Act  of  1921,  §216  (f)  ;  Reg.  45,  Art.  305;  O.  D.  105,  T.  B. 
2-19-154;  0.  D.  775,  T.  B.  3-21-1397.  In  the  instructions  appearing  on  the 
forms  of  individual  returns  for  1918  there  first  appeared  a  statement  in- 
dicating that  the  personal  exemption  should  be  prorated  if  there  was  a 
change  in  the  status  of  the  taxpayer  during  the  year,  but  the  treasury  de- 
partment receded  from  this  position  prior  to  March  15,  1919. 

3s  Revenue  Act  of  1921,  §  216. 

3ft  Report  of  Senate  Finance  Committee  on  the  Revenue  Bill  of  1921,  dated 
September  26,  1921. 

40  Revenue  Act  of  1918,  §  216  (d)  ;  letter  from  treasury  department  dated 
May  1,  1919;  L  T.  S.  1919,  113324. 


782  FEDERAL  INCOME   TAX 

(for  example,  Montreal)  unless  itself  a  sovereign  state  (for  ex- 
ample, Hamburg).^!  To  satisfy  the  requirement  of  a  similar 
credit  it  was  not  necessary  that  the  personal  exemption  or  credit 
for  dependents,  as  the  case  might  be,  should  be  the  same  as  that 
allowed  by  the  United  States  statute.^-  Where  a  country  im- 
posed an  income  tax  but  did  not  levy  a  tax  on  income  derived 
from  sources  therein  by  citizens  of  the  United  States,  a  citizen 
of  such  country  who  was  a  nonresident  of  the  United  States 
was  entitled  to  claim  the  credits  for  personal  exemption  and  for 
dependents.^3  The  status  as  to  residence  of  an  alien  individual 
on  the  last  day  of  his  taxable  year  determined  his  right  to  be 
treated  as  a  resident  or  as  a  nonresident  for  such  year.^^ 

The  right  of  a  nonresident  alien  to  personal  exemption  and 
credit  for  dependents  was  contingent  primarily  on  his  citizen- 
ship. For  example,  a  native-born  Russian,  especially  one  who 
had  been  living  in  the  United  States  for  a  number  of  years, 
would  still  be  regarded  by  this  country  as  a  citizen  of  Russia. 
This  was  rebuttable,  however,  by  evidence  of  citizenship  in 
Poland ;  and  if  an  individual  had  in  fact  become  a  citizen  of  the 
new  state,  inasmuch  as  Poland  was  not  included  in  the  coun- 
tries enumerated  below,  it  would  be  necessary  for  him  to  comply 
with  the  above  requirements  as  to  proof  to  the  Commissioner  in 
order  to  secure  the  benefit  of  the  exemptions  provided.^^ 

When  Nonresident  Alien  Individual  Entitled  to  Per- 
sonal Exemption  Under  the  1918  Law.  The  following  is  an 
incomplete  list  of  countries  which  either  imposed  no  income  tax 
or  in  imposing  an  income  tax  allowed  both  a  personal  exemption 
and  a  credit  for  dependents  which  satisfied  the  similar  credit 
requirement  of  the  statute:  Albania,  Argentina,  Armenia,  Ba- 
hama Islands,  Barbadoes,  Basutoland,  Bechuanaland  Protector- 
ate, Belgium,  Bermuda,  Bolivia,  Bosnia,  Brazil,  British  Guiana, 
British  Honduras,  Bulowina,  Bulgaria,  Canada,  Carinthia,  Car- 
niola,  Ceylon,  Chile,  China,  Cuba,  Cyprus,  Czecho-Slovakia,  in- 
cluding Bohemia,  Moravia  and  Slovakia;  Dalmatia,  Denmark, 
Ecuador,  Egypt,  Falkland  Islands,  Fiji  Islands,  France,  Galicia, 
Gambia,  Germany  (Act  of  March  29,  1920),  Gibraltar,  Gold 
Coast,  Goritz,  Gradisca,  Greece,  Grenada,  Guatemala,  Herze- 
govina, Hongkong,  Hungary,  Istria,  Jamaica,  Kenya,  Lithuania, 
Lower   Austria,   Luxemberg,    Malay   States,   Malta,    Mauritius, 

41  Reg.  45,  Art.  382. 

42  Reg.  45,  Art.  306. 

43  S.  969,  T.  B.  2-19-153. 

44  Reg.  45,  Art.  306. 

45  O.  D.  346,  T.  B.  30-19-642. 


NORMAL    TAX    CREDITS — PERSONAL   EXEMPTION  783 

Mexico,  Montenegro,  Montserrat,  Morocco,  Newfoundland,  Nic- 
aragua, Nigeria,  Northern  Rhodesia,  Norway,  Nyasaland  Pro- 
tectorate, Palestine,  Panama,  Paraguay,  Persia,  Peru,  Porto 
Rico,  Portugal,  Roumania,  Russia  (including  Poles  owing  al- 
legiance to  Russia),  St.  Helena,  St.  Kitt  Nevis,  Salsburg,  Santo 
Domingo,  Serbia,  Siam,  Sierra  Leone,  Silesia,  Somaliland  Pro- 
tectorate, Spain,  Styria,  Swaziland,  Switzerland,  Syria,  Trieste, 
Tyrol,  Uganda  Protectorate,  Union  of  South  Africa,  Upper  Aus- 
tria, Venezuela,  Virgin  Islands  (Brit.),  Weihaiwei,  Western 
Pacific  Islands,  Zanzibar  Protectorate.  The  following  is  an  in- 
complete list  of  countries  which  in  imposing  an  income  tax  al- 
lowed a  personal  exemption  which  satisfied  the  similar  credit  re- 
quirement of  the  statute,  but  did  not  allow  a  credit  for  depen- 
dents :  Austrian  Poland,  Bachka,  Banat  of  Temesvar,  Croatia, 
Finland,  India,  Italy,  Prussian  Poland,  Salvador,  Slavonia, 
Straits  Settlements  (since  January  1,  1920),  Transylvania.  The 
following  is  an  incomplete  list  of  countries  which  in  imposing  an 
income  tax  did  not  allow  to  citizens  of  the  United  States  not  re- 
siding in  such  country  either  a  personal  exemption  or  a  credit 
for  dependents  and,  therefore,  failed  entirely  to  satisfy  the 
similar  credit  requirement  of  the  statute:  Australia,  Costa 
Rica,  Dutch  Guiana,  Great  Britain  and  Ireland,  Japan,  the 
Netherlands,  New  Zealand,  Sweden,  Trinidad.  The  former 
names  of  certain  of  these  territories  are  here  used  for  con- 
venience, in  spite  of  an  actual  or  possible  change  in  name  or 
sovereignty.  A  nonresident  alien  individual  who  was  a  citizen 
or  subject  of  any  countiy  in  the  first  list  was  entitled  for  the 
purpose  of  the  normal  tax  to  such  credit  for  a  personal  exemp- 
tion and  for  dependents  as  his  family  status  might  warrant. 
If  he  was  a  citizen  or  subject  of  any  country  in  the  second  list 
he  was  entitled  to  a  credit  for  personal  exemption,  but  to  none 
for  dependents.  If  he  was  a  citizen  or  subject  of  any  country 
in  the  third  list  he  was  not  entitled  to  credit  for  either  a  per- 
sonal exemption  or  for  dependents.  If  he  was  a  citizen  or  a  sub- 
ject of  a  country  which  is  in  none  of  the  lists,  then  to  secure 
credit  for  either  a  personal  exemption  or  for  dependents  he 
was  required  to  prove  to  the  satisfaction  of  the  Commissioner 
that  his  countiy  did  not  impose  an  income  tax  or  that  in  im- 
posing an  income  tax  it  granted  the  similar  credit  required  by 
the  statute.'*'^     In  order  that  a  nonresident  alien  might  prove 

46  Reg.  45,  Art.  307,  as  amended  by  T.  D.  2970;  O.  D.  466,  T.  B.  16-20- 
864;  O.  D.  437,  T.  B.  14-20-831;  O.  D.  581,  T.  B.  28-20-1056;  0.  D.  300,  T.  B. 
24-19-567;  0.  D.  547,  T.  B.  24-20-1004;  O.  D.  322,  T.  B.  27-19-603;  0.  D. 
548,  T.  B.  24-20-1005;   0.  D.  364,  T.  B.  2-20-675;  O.  D.  605,  T.  B.  30-20- 


784  FEDERAL  INCOME   TAX 

that  his  country  satisfied  the  similar  credit  requirement  of  the 
law,  he  should  have  submitted  to  the  Commissioner  a  copy 
of  the  income  tax  laws  of  his  native  country,  or  an  official  com- 
munication from  an  accredited  diplomatic  representative  of  such 
country,  showing  that  the  country  imposed  no  income  tax,  or  in 
doing  so  granted  similar  credits  required  by  statute.^'^ 

Allowance  of  Credits  to  Non-Resident  Alien  Individual 
Under  the  1918  Law.  The  benefit  of  the  credits  allowed  against 
net  income  for  the  purpose  of  the  normal  tax  might  not  be  re- 
ceived by  a  nonresident  alien  by  filing  a  claim  with  the  with- 
holding agent,  but  only  by  claiming  them  upon  filing  a  return  of 
income,  with  two  exceptions  as  indicated  in  the  two  paragraphs 
next  following.^s 

Personal  Exemption  of  Nonresident  Aliens  Under  1918 
Law.  In  case  a  nonresident  alien  was  entitled  to  personal  ex- 
emption and  credits  for  dependents  and  his  gross  income  from 
sources  in  the  United  States,  including  bond  interest,  did  not 
exceed  his  personal  exemption  and  credits  for  dependents,  a  cer- 
tificate. Form  lOOlB,  was  required  to  be  executed  and  filed  with 
the  withholding  agent,  if  any  part  of  the  gross  income  was  de- 
rived from  interest  upon  bonds  of  a  domestic  corporation  which 
contained  a  tax-free  covenant  clause.  The  certificate  might  be 
filed  with  the  withholding  agent  at  the  end  of  the  calendar  year 
but  not  later  than  February  first  of  the  succeeding  year  and  all 
such  certificates  were  required  to  be  attached  to  the  annual  list 
return,  Form  1013.  The  amount  of  tax  due  from  the  withhold- 
ing agent  as  shown  by  Form  1013,  might  be  reduced  by  2%  of 
the  aggregate  amount  of  interest  payments  made  to  the  non- 
1091;  O.  D.  350,  T.  B.  31-19-648;  O.  D.  630,  T.  B.  33-20-1133;  O.  D.  765,  T.  B. 
1-21-1372;  0.  D.  766,  T.  B.  1-21-1373;  O.  D.  777,  T.  B.  3-21-1399;  O.  D. 
820,  T.  B.  8-21-1467;  0.  D.  894,  T.  B.  17-21-1597;  O.  D.  895,  T.  B.  17-21- 
1598;  O.  D.  906,  T.  B.  19-21-1622;  O.  D.  981,  T.  B.  30-21-1746;  O.  D.  935, 
T.  B.  22-21-1664;  O.  D.  1003,  T.  B.  34-21-1782;  O.  D.  1004,  T.  B.  34-21-1783; 
O.  D.  1022,  T.  B.  36-21-1804;  O.  D.  1054,  T.  B.  40-21-1854;  O.  D.  1055, 
T.  B.  40-21-1855;  0.  D.  1125,  T.  B.  49-21-1961;  0.  D.  1126,  T.  B.  49-21-1962. 
In  the  case  of  Greece  and  Germany  the  personal  exemption  and  credit  for 
dependents  were  allowable  only  for  1919  and  1920  respectively.  The  fore- 
going provisions  apply  only  to  1918  and  subsequent  years  and  have  no  ap- 
plication for  the  year  1917.  (0.  D.  301,  T.  B.  24-19-568).  They  apply  to 
1918,  however,  and  in  cases  where  an  excess  of  tax  has  been  paid  for  the 
year  1918,  due  to  the  official  data  not  having  been  received  by  the  Commis- 
sioner in  regard  to  personal  exemption,  claims  for  refund  on  Form  No.  46 
should  be  filed  with  the  collector  to  whom  the  income  tax  was  paid.  (0.  D, 
391,  T.  B.  5-20-718). 

47  O.  D.  253,  T.  B.  15-19-446. 

48  Revenue  Act  of  1918,  §  217;  Reg.  45,  Arts.  311  and  316. 


NORMAL    TAX    CREDITS — PERSONAL    EXEMPTION  785 

resident  alien  upon  tax-free  covenant  bonds  during  the  calendar 
year,  and  the  amount  of  tax  represented  by  the  certificates, 
payment  of  which  was  assumed  on  monthly  list  return,  Form 
1012,  would  not  be  included  in  the  assessment  against  the 
withholding  agent.  The  certificate  might  be  filed  only  by  a 
citizen  or  subject  of  the  countries  enumerated  in  a  preceding 
paragraph  as  satisfying  the  similar  credit  requirement  of  the 
statute.  In  case  tax  in  excess  of  a  nonresident  alien's  tax 
liability  had  been  withheld  from  interest  upon  bonds  which  did 
not  contain  a  tax-free  covenant  clause,  the  nonresident  alien 
should  have  filed  or  caused  to  be  filed  with  the  collector  a  return 
of  his  gross  income  from  all  sources  within  the  United  States, 
accompanied  by  a  claim  for  refund  on  Form  46.^'' 

Allowance  of  Personal  Exemption  to  Nonresident  Alien 
Employee.  A  nonresident  alien  employee,  provided  he  was  en- 
titled to  credit  for  a  personal  exemption  or  for  dependents  or 
both,  might  claim  the  benefit  of  such  credit  by  filing  with  his 
employer  Form  1115  duly  filled  out  and  executed  under  oath. 
On  the  filing  of  such  claim  the  employer  should  have  examined 
it.  If  on  such  examination  it  appeared  that  the  claim  was  in 
due  fonn,  that  it  contained  no  statement  which  to  the  knowledge 
of  the  employer  was  untrue,  that  such  employee  on  the  face  of 
the  claim  was  entitled  to  credit,  and  that  such  credit  had  not 
yet  been  exhausted,  such  employer  need  not  until  such  credit 
was  in  fact  exhausted  withhold  any  tax  from  payments  of  salary 
or  wages  made  to  such  employee.  Every  employer  with  whom 
affidavits  of  claim  on  Form  1115  were  filed  by  employees  was 
required  to  presei^'e  such  affidavits  until  the  following  calendar 
year,  and  was  then  required  to  file  them,  attached  to  his  annual 
withholding  return  on  Form  1042  (revised),  with  the  collector 
on  or  before  March  1.  In  case,  however,  when  the  following 
calendar  year  arrived  such  employer  had  no  withholding  to  re- 
turn, he  was  required  to  forward  all  such  affidavits  of  claim 
directly  to  the  Commissioner  (Sorting  Division),  with  a  letter 
of  transmittal,  on  or  before  March  15.  Where  any  tax  was 
withheld,  the  employer  in  every  instance  should  show  on  the 
pay  envelope  or  should  furnish  some  other  memorandum  showing 
the  name  of  the  employee,  the  date  and  the  amount  withheld. 
This  rule  applied  only  to  payments  of  compensation  by  an  em- 
ployer to  an  employee.""*^ 

-«!>  Rejr.  4;'),  Art.  363  (a)  ;  T.  D.  2920. 
50  Reg.  45,  Art.  316. 


CHAPTER  32 

CREDIT  FOR  TAXES 

The  Revenue  Act  of  1918  was  the  first  American  income  tax 
law  to  recognize  and  provide  against  the  double  taxation  of  in- 
come of  an  individual  or  corporation  deriving  income  from 
sources  within  the  United  States  and  another  country.  There- 
tofore, a  citizen  of  the  United  States  doing  business,  for  ex- 
ample, in  Canada  had  been  taxed  upon  the  net  income  arising 
from  that  business  by  Canada  and  upon  the  same  net  income  by 
the  United  States.  Under  the  1918  Law  and  the  present  law  a 
taxpayer  in  such  a  position  is  allowed  to  deduct  from  the  total 
tax  found  to  be  due  on  his  entire  net  income  the  amount  of  tax 
(with  certain  limitations  imposed  by  the  1921  Law)  paid  to 
Canada  on  the  income  arising  in  that  country.  The  Revenue 
Act  of  1921  provides  that  the  credit  for  taxes  will  not  be  al- 
lowed in  the  case  of  certain  citizens  taxable  under  that  law  only 
on  income  from  sources  within  the  United  States.  A  limitation 
on  the  amount  of  credit  for  taxes  is  also  imposed  by  the  present 
law.  It  is  provided  that  in  no  case  may  the  amount  of  credit 
for  taxes  exceed  the  same  proportion  of  the  tax,  against  which 
such  credit  is  taken,  which  the  taxpayer's  net  income  (computed 
without  deduction  for  any  income,  war-profits  and  excess-profits 
taxes  imposed  by  any  foreign  country  or  possession  of  the 
United  States)  from  sources  without  the  United  States  bears  to 
his  entire  net  income  (computed  without  such  deduction)  for 
the  same  taxable  year.i  Certain  other  minor  changes  made  by 
the  present  law  are  indicated  in  the  following  paragraphs.  The 
privilege  of  taking  credit  for  taxes  paid  to  foreign  countries 
and  to  possessions  of  the  United  States  is  extended  to  the  follow- 
ing classes  of  taxpayers  and  to  the  extent  indicated  below. 

Definition.  "Amount  of  taxes  paid  during  the  taxable  year" 
means  taxes  proper  (no  credit  being  given  for  amounts  repre- 
senting interest  or  penalties)  paid  or  accrued  during  the  tax- 
able year  on  behalf  of  the  taxpayer  claiming  credit.  "Foreign 
country"  includes  within  its  meaning  any  foreign  sovereign 
state  or  self-governing  colony  (for  example,  the  Dominion  of 
Canada),  but  does  not  include  a  foreign  municipality  (for  ex- 
ample, Montreal)  unless  itself  a  sovereign  state  (for  example, 
Hamburg) .    It  is  held  to  mean  the  composite  whole  made  up  of 

1  Revenue  Act  of  1921,  §  222   (a)  5; 

786 


CREDIT    FOR    TAXES  787 

all  the  subdivisions  of  a  foreign  state  subject  to  the  same  central 
control.  Each  of  the  subdivisions,  in  this  sense,  is  not  a  "coun- 
tiy"  but  a  part  of  a  ''country."  The  Province  of  British 
Columbia,  therefore,  does  not  come  within  the  meaning  of  the 
term  "foreign  country."-  "Any  possession  of  the  United  States" 
includes,  among  others,  Porto  Rico,  the  Philippines  and  the 
Virgin  Islands.** 

Citizens  of  the  United  States.  In  the  case  of  a  citizen  of  the 
United  States,  whether  resident  or  non-resident,  the  basis  of  the 
credit  for  taxes  under  the  1918  Law  was  the  amount  of  any 
income,  war-profits  and  excess-profits  taxes  paid  or  accrued  dur- 
ing the  taxable  year  to  any  foreign  country  upon  income  derived 
from  sources  therein,  or  to  any  possession  of  the  United  States.-* 
The  1921  Law  omits  the  words  "upon  income  derived  from 
sources  therein."''  Under  the  1918  Law  a  tax  paid  by  a  citizen  of 
the  United  States  to  the  government  of  France  and  imposed  on 
an  amount  fixed  at  seven  times  the  rent  of  his  residence  in 
France  (whether  because  he  actually  received  no  income  or  in- 
suflftcient  income  from  France) ,  was  considered  not  to  have  been 
imposed  on  income  from  sources  therein.*^  If  the  taxpayer's 
books  are  kept  on  an  accrual  basis  and  his  returns  are  so  ren- 
dered, the  credit  for  taxes  paid  to  a  foreign  country  is  limited 
to  taxes  accrued  in  the  taxable  year  for  which  the  return  is 
rendered."^ 

Resident  Aliens.  In  the  case  of  an  alien  resident  of  the  United 
States  the  basis  of  the  credit  for  taxes  under  the  1918  Law  was 
as  follows:  (a)  the  amount  of  any  income,  war-profits  and 
excess-profits  taxes  paid  or  accrued  during  the  taxable  year  to 
any  possession  of  the  United  States;  (b)  the  amount  of  any 
such  taxes  paid  or  accrued  during  the  taxable  year  to  the  coi?n- 
try  of  which  he  is  a  citizen  or  subject  upon  income  derived  from 
sources  therein,  if  such  country,  in  imposing  such  taxes,  allows 
a  similar  credit  to  citizens  of  the  United  States  residing  in  such 
country.^  Under  the  present  law  he  is  allowed  the  credit  in- 
cluded in  (a)  above  and  also  the  amount  of  any  such  taxes  paid 
during  the  taxable  year  to  any  foreign  country,  if  the  foreign 

2  O.  D.  1050,  T.  B.  39-21-1844. 
SReg.  45,  Art.  382. 

4  Revenue  Act  of  1918,  §222    (a);   Reg-.   45,  Art.  381. 

5  Revenue  Act  of  1921,  §  222    (a)   2. 

6  0.  D.  1093,  T.  B.  45-21-1911.  Such  a  tax  would,  however,  be  a  proper 
deduction.     See  O.  D.  317,  T.  B.  26-20-593. 

■7  0.  982,  T.  B.  7-20-743. 

8  Revenue  Act  of  1918,  §222  (a)  2,  3;  Reg.  45,  Art.  381. 


788  FEDERAL  INCOME  TAX 

country  of  which  he  is  a  citizen  or  subject,  in  imposing  such 
taxes,  allows  a  similar  credit  to  citizens  of  the  United  States 
residing  in  such  country.'-^ 

Countries  Satisfying  Similar  Credit  Requirement.  The 
following  is  an  incomplete  list  of  the  countries  which  satisfy  the 
similar  credit  requirement  stated  in  the  preceding  paragraph: 
Bulgaria,  Canada,  Italy,  Newfoundland,  Salvador.  The  follow- 
ing is  an  incomplete  list  of  the  countries  which  do  not  satisfy  the 
similar  credit  requirement  of  the  statute:  Argentina,  Bahama, 
Belgium,  Bermuda,  Bolivia,  Bosnia,  Brazil,  Chile,  China,  Costa 
Rica,  Ecuador,  Egypt,  Finland,  France,  Great  Britain  and  Ire- 
land, Guatemala,  Herzegovina,  India,  Jamaica,  Japan,  Monte- 
negro, Morocco,  New  Zealand,  Nicaragua,  Panama,  Paraguay, 
Persia,  Peru,  Portugal,  Roumania,  Santo  Domingo,  Serbia,  Siam, 
Straits  Settlements,  since  January  1,  1920,  Sweden,  Switzerland, 
Venezuela.  The  former  names  of  certain  of  these  territories  are 
here  used  for  convenience  in  spite  of  the  actual  or  possible 
change  in  the  name  or  sovereignty.  A  resident  of  the  United 
States  who  is  a  citizen  or  subject  of  any  country  in  the  first 
list  is  entitled,  for  the  purpose  of  the  total  tax  due  to  the  United 
States,  to  a  credit  for  the  amount  of  any  income,  war-profits  and 
excess-profits  taxes  paid  or  accrued  during  the  taxable  year  to 
any  foreign  country.  If  he  is  a  citizen  or  subject  of  any  country 
in  the  second  list  he  is  not  entitled  to  such  credit.  If  he  is  a 
citizen  or  subject  of  a  country  which  is  in  neither  list,  then  to  se- 
cure the  desired  credit,  he  must  prove  to  the  satisfaction  of  the 
Commissioner  that  his  country  satisfies  the  similar  credit  re- 
quirement of  the  statute.!*^  Under  the  1918  Law  a  citizen  of  any 
country  in  the  first  list  could  only  take  a  credit  for  such  taxes 
pafd  to  such  country  and  not  to  any  foreign  country. 

Nonresident  Aliens.  No  credit  for  taxes  is  allowed  to  a  non- 
resident alien  under  either  the  present  law  or  the  1918  Law.^^ 

Citizens  of  Possessions,  Residing  in  the  United  States.  Citi- 
zens of  possessions  of  the  United  States  residing  in  the  United 
States  are  allowed  a  credit  of  any  income,  war-profits  and  ex- 
cess-profits taxes  paid  during  the  taxable  year  to  any  possession 

9  Revenue  Act  of  1921,  §  222   (a)   2,  3. 

10  T.  D.  3060,  T.  B.  36-20-1186,  revoking  T.  D.  3028,  T.  B.  24-20-1008, 
and  adding  Reg.  45,  Art.  385.  See  also  0.  D.  580,  T.  B.  28-20-1056;  O.  D. 
393,  T.  B.  5-20-720;  O.  D.  424,  T.  B.  13-20-813;  O.  D.  499,  T.  B.  19-20-922; 
O.  D.  1125,  T.  B.  49-21-1961. 

11  See  Revenue  Act  of  1921,  §222;  Revenue  Act  of  1918,  §222. 


CREDIT    FOR    TAXES  789 

of  the  United  States.^-'  The  same  credit  was  allowed  to  such  tax- 
payers under  the  1918  Law.^^ 

Fiscal  Year  in  Case  of  Individuals.  If  a  taxpayer  claiming 
credit  for  taxes  makes  a  return  for  a  fiscal  year  beginning  in 
1920  and  ending  in  1921,  the  credit  for  the  entire  fiscal  year 
will  notwithstanding  any  other  provision  of  the  statute  be  de- 
termined under  the  provisions  set  forth  in  the  preceding  para- 
graphs, and  the  Commissioner  is  authorized  to  disallow,  in 
whole  or  in  part,  any  such  credit  which  he  finds  has  already  been 
taken  by  the  taxpayer.^^ 

Domestic  Corporations.  In  the  case  of  a  domestic  corporation 
(one  created  or  organized  in  the  United  States)  the  credit  for 
taxes  is  the  amount  of  any  income,  war-profits  and  excess-profits 
taxes  paid  during  the  taxable  year  to  any  foreign  country  or  to 
any  possession  of  the  United  States.''^  The  same  credit  was  al- 
lowed under  the  1918  Law,  except  that  in  the  case  of  taxes  paid 
to  a  foreign  country  they  must  have  been  paid  upon  'income 
derived  from  sources  therein."^'*  The  tax  imposed  by  the  Re- 
public of  Cuba  on  all  corporations  operating  sugar  plantations 
therein,  is  based  on  production,  not  on  income,  and  is  in  the  na- 
ture of  an  excise  tax.  Domestic  coiiDorations  may  not  credit  the 
amount  of  such  taxes  against  the  total  tax  due  the  United 
States.'^  Certain  domestic  corporations,  taxable  only  upon  in- 
come from  sources  within  the  United  States,  are  treated  as 
foreign  corporations.^^  The  limitation  on  the  amount  of  credit 
that  may  be  taken  is  the  same  as  in  the  case  of  individuals.'-' 

Foreign  Corporations.  No  credit  for  taxes  is  allowed  to  a 
foreign  corporation  notwithstanding  that  it  may  have  established 
its  principal  business  in  this  country.-" 

Domestic  Corporations  Owning  Stock  of  Foreign  Corporations. 
Under  the  1921  Law,  a  domestic  corporation  which  owns  a 
majority  of  the  voting  stock  of  a  foreign  corporation  from  which 
it  receives  dividends  (not  deductible  under  the  law)  in  any  tax- 
able year  will  be  deemed  to  have  paid  the  same  proportion  of 
any  income,  war-profits,   or  excess-profits  taxes  paid  by  such 

1^  Revenue  Act  of  1921,  §222   (a)  2. 

1"!  Revenue  Act  of  1918,  §222    (a)    2;  Reg.  45,  Art.   1132. 

H  Revenue   Act  of   1921,   §222    (d). 

i-'>  Revenue  Act  of  1921,  §  238. 

It;  Revenue  Act  of  1918,  §238    (a);   Reg.  45,  Art.  611. 

17  0.  D.  372,  T.  B.  3-20-688. 

1'^  Revenue  Act  of  1921,  §238   (f). 

I't  Revenue  Act  of  1921,  §  238.     See  ^  000. 

-'•See  Revenue  Act  of  1921,  §238;  Revenue  Act  of  1918,  §238. 


790  FEDERAL  INCOME   TAX 

foreign  corporation  to  any  foreign  country  or  to  any  possession 
of  the  United  States,  upon  or  with  respect  to  the  accumulated 
profits  of  such  foreign  corporation  from  which  such  dividends 
were  paid,  which  the  amount  of  such  dividends  bears  to  the 
amount  of  such  accumulated  profits.  The  credit  for  taxes  al- 
lowed to  any  domestic  corporation  under  this  paragraph,  how- 
ever, may  in  no  case  exceed  the  same  proportion  of  the  taxes 
against  which  it  is  credited,  which  the  amount  of  such  dividends 
bears  to  the  amount  of  the  entire  net  income  of  the  domestic 
corporation  in  which  such  dividends  are  included.  The  term 
''accumulated  profits"  when  so  used  in  reference  to  a  foreign  cor- 
poration, means  the  amount  of  its  gains,  profits,  or  income  in 
excess  of  the  income,  war-profits,  and  excess-profits  taxes  im- 
posed upon  or  with  respect  to  such  profits  or  income;  and  the 
Commissioner  with  the  approval  of  the  secretary  is  given  full 
power  to  determine  from  the  accumulated  profits  of  what  year  or 
years  such  dividends  were  paid;  treating  dividends  paid  in  the 
first  sixty  days  of  any  year  as  having  been  paid  from  the  ac- 
cumulated profits  of  the  preceding  year  or  years  (unless  to  his 
satisfaction  shown  otherwise),  and  in  other  respects  treating 
dividends  as  having  been  paid  from  the  most  recently  ac- 
cumulated gains,  profits,  or  earnings.  In  the  case  of  a  foreign 
corporation,  the  income,  war-profits,  and  excess-profits  taxes  of 
which  are  determined  on  the  basis  of  an  accounting  period  of 
less  than  one  year,  the  word  "year"  as  used  in  this  paragraph 
will  be  construed  to  mean  such  accounting  period.-^ 

Credit  for  Taxes  Allowed  Under  1918  Law.  A  domestic 
corporation  which  owned  a  majority  of  the  voting  stock  of  a 
foreign  corporation  was  entitled,  under  the  1918  Law,  to  credit 
its  income,  war-profits  and  excess-profits  taxes  with  any  income, 
war-profits  or  excess-profits  taxes  paid  (but  not  including  taxes 
accrued)  by  such  foreign  corporation  during  the  taxable  year 
to  any  foreign  country  or  to  any  possession  of  the  United 
States  upon  income  derived  from  sources  without  the  United 
States  in  an  amount  equal  to  the  proportion  which  the  amount 
of  any  dividends  (not  deductible  from  gross  income)  received 
by  such  domestic  corporation  from  such  foreign  corporation 
during  the  taxable  year  bore  to  the  total  taxable  income  of  such 
foreign  corporation  upon  or  with  respect  to  which  such  taxes 
were  paid.  But  in  no  case  might  the  amount  of  the  credit  for 
such  taxes  exceed  the  amount  of  the  dividends  on  the  stock  of 
the  foreign  corporation  received  by  the   domestic  corporation 

21  Revenue  Act  of  1921,  §238   (e). 


CREDIT    FOR    TAXES  791 

during  the  taxable  year  (and  not  deductible  from  gross  income). 

A  domestic  corporation  seeking  such  credit  was  required  to 
comply  with  the  provisions  of  law  applicable  to  credits  for  taxes 
already  paid.-- 

Members  of  Partnerships.  If  an  individual  is  a  member  of  a 
partnership  he  is  entitled  to  his  proportionate  share  of  any  in- 
come, war-profits  and  excess-profits  taxes  paid  or  accrued  dur- 
ing the  taxable  year  by  the  partnership  to  any  foreign  country 
or  to  any  possession  of  the  United  States.  The  law  does  not  ap- 
pear to  make  any  distinction  between  domestic  or  foreign  part- 
nerships, but  it  has  been  ruled  under  the  1918  Law  that  if  the 
member  of  a  partnership  was  a  resident  alien  he  was  entitled 
to  the  credit  only  "if  such  country,  in  imposing  such  taxes,  allows 
a  similar  credit  to  citizens  of  the  United  States  residing  in  such 
country."-'^ 

Beneficiaries  of  Estates  or  Trusts.  Beneficiaries  of  estates  or 
trusts  are  entitled  to  their  proportionate  shares  of  such  taxes 
of  the  estate  or  trust  paid  during  the  taxable  year  to  a  foreign 
country  or  to  any  possession  of  the  United  States.  If  the  ben- 
eficiary is  a  resident  alien  he  is  limited  in  the  same  manner  as  a 
resident  alien  member  of  a  partnership.-^ 

Massachusetts  Trusts.  Massachusetts  trusts  were  regarded 
as  associations  within  the  meaning  of  the  Revenue  Act  of  1918. 
In  a  case  in  which  the  shareholders  of  a  Massachusetts  trust 
owning  and  operating  large  properties  in  a  foreign  country  re- 
ceived very  low  salaries  and  no  dividends  in  1920,  so  that  their 
credit  for  income  taxes  paid  to  the  foreign  country  exceeded 
their  income  taxes  due  to  the  United  States,  it  was  held  that 
the  trust  could  take  no  credit  against  its  income  tax  due  to  the 
United  States  and  thus  secure  the  benefit  of  a  credit  for  taxes 
paid  on  the  identical  income  upon  which  income  tax  to  the 
United  States  had  accrued,  for  the  reason  that  in  the  foreign 
country  the  income  tax  was  not  imposed  upon  an  association 
as  a  separate  entity  but  upon  the  beneficiaries,  so  that  the  taxes 
paid  to  the  foreign  country  were  the  taxes  of  such  beneficiaries 
and  not  the  association.-^ 

-•■i  Revenue  Act  of  1918,  §240;  Reg.  45,  Art.  636.  In  accordance  with 
Reg.  45,  Art.  611,  the  form  to  be  used  was  Form  1118  instead  of  Form 
1116. 

23  Revenue  Act  of  1921,  §222  (a)  4;  Revenue  Act  of  1918,  §222;  Reg. 
45,  Art.  381. 

24  Revenue  Act  of  1921,  §222  (a)  4;  Revenue  Act  of  1918,  §222;  Reg. 
45,  Art.  381. 

25  A.  R.  R.  643,  T.  B.  42-21-1872. 


792  FEDERAL  INCOME  TAX 

Conditions  of  Allowance  of  Credit.  The  following  rulings  were 
made  under  the  1918  Law:  When  credit  is  sought  for  income, 
war-profits  or  excess-profits  taxes  paid  other  than  to  the  United 
States,  the  income  tax  return  of  the  taxpayer  must  be  ac- 
companied by  a  form,26  carefully  filled  out  with  all  the  informa- 
tion there  called  for  and  with  the  calculations  of  credits  there 
indicated,  and  duly  signed  and  sworn  to  or  affirmed.  When 
credit  is  sought  for  taxes  already  paid,  the  form  must  have  at- 
tached to  it  the  receipt  for  each  such  tax  payment.  When  credit 
is  sought  for  taxes  accrued,  the  form  must  have  attached  to  it 
the  return  on  which  each  such  accrued  tax  was  based.  This  re- 
ceipt or  return  so  attached  must  be  either  the  original,  a  dupli- 
cate original,  a  duly  certified  or  authenticated  copy,  or  a  sworn 
copy.  In  case  only  a  sworn  copy  of  a  receipt  or  return  is  at- 
tached, there  must  be  kept  readily  available  for  comparison  on 
request  the  original,  a  duplicate  original  or  a  duly  certified  or 
authenticated  copy.-'^ 

In  a  case  in  w^hich  a  domestic  partnership  leased  certain 
patents  to  a  British  licensee  for  a  fixed  royalty,  the  British  Gov- 
ernment requiring  the  licensee  to  withhold  and  pay  to  it  a  British 
income  tax  on  the  royalty  payments,  the  partners,  in  order  to 
obtain  credit  for  such  tax  paid  to  the  British  Government,  were 
instructed  to  attach  to  the  partnership  return  a  claim  for  credit 
on  Form  1118,  modified  throughout  by  substituting  the  word 
"partnership"  for  the  word  "corporation."  In  lieu  of  the  re- 
quired receipt  or  return,  a  copy  of  the  receipt  issued  to  the 
British  licensee  duly  attested  by  the  president  of  the  British 
licensee  was  accepted.  The  individual  members  of  the 
partnership  were  required  to  attach  Form  1116  to  their  in- 
dividual returns,  accompanied  by  a  copy  of  the  receipt  issued  to 
the  British  licensee  and  a  copy  of  the  attesting  affidavit  made 
by  the  president  of  the  British  licensee.-'^  Where  under  a  foreign 
income  tax  law  corporations  are  required  to  withhold  a  fixed 
percentage  of  the  total  amount  of  dividends  paid  to  the  stock- 
holders in  this  country,  such  tax  being  withheld  in  a  lump  sum, 
although  imposed  upon  the  individual  stockholders,  the  amounts 
withheld  not  being  itemized  by  the  foreign  government,  in  lieu 
of  the  individual  tax  receipts  required  to  be  attached  to  Form 
1116,  the  taxpayer  may  attach  to  the  return  on  Form  1116  his 
affidavit  showing  the  number  of  shares  held  during  the  year, 

26  Form  1116  for  individuals  or  Form  1118  for  corporations. 

27  Reg.  45,  Art.  383;  See  0.  D.  809,  T.  B.  7-21-1450. 

28  O.  D.  583,  T.  B.  28-20-1059. 


CREDIT    FOR    TAXES  'i'93 

whether  or  not  any  of  the  shares  held  by  him  were  acquired  or 
sold  during-  the  year,  giving  dates  and  number  of  shares  so 
acquired  or  sold;  the  total  number  of  shares  outstanding  on 
which  the  dividend  was  declared,  regardless  of  whether  the 
dividend  was  paid  to  citizens  of  the  United  States  or  other 
governments;  and  the  total  dividends  paid  or  accrued  on  such 
shares  during  the  year,  and  attach  to  and  make  a  part  of  such 
affidavit  a  certified  copy  of  the  tax  receipts  from  the  foreign 
tax  collector  showing  the  payment  of  the  tax  en  bloc,  with  copies 
of  any  other  documents  which  he  may  have  that  will  serve  to 
corroborate  the  facts  set  forth  in  such  affidavit.  The  amount  of 
the  credit  claimed  should  be  computed  by  dividing  the  total  tax 
withheld  by  the  total  number  of  shares  of  the  corporation  out- 
standing and  multiplying  this  result  by  the  number  of  shares 
held  during  the  entire  year.  In  the  event  that  any  of  the  shares 
were  acquired  or  disposed  of  during  the  year,  an  adjustment 
should  be  made  showing  the  amount  of  taxes  properly  allocated 
to  the  dividends  received  after  acquisition  or  before  disposition 
of  the  stock.-"'* 

When  credit  is  claimed  by  an  American  bank  for  the  amount 
of  tax  withheld  from  interest  on  bank  deposits  and  paid  to  a 
foreign  government  by  a  foreign  bank,  there  should  be  attached 
to  and  filed  with  Form  1118,  an  affidavit  from  the  foreign  with- 
holding agent.  The  affidavit  should  set  forth  the  title  of  the 
statute  under  which  such  withholding  was  required,  the  amount 
of  interest  accrued  to  the  American  bank  and  the  amount  of  tax 
withheld  and  paid  to  the  foreign  government.-"^" 

In  the  case  of  a  credit  sought  for  a  tax  accrued  but  not  paid, 
the  Commissioner  may  require  as  a  condition  precedent  to  the 
allowance  of  credit  a  bond  from  the  taxpayer  in  addition  to  the 
above  form.  If  such  a  bond  is  required,  the  prescribed  form  "-^ 
should  be  used  for  it.  It  should  be  in  such  penal  sum  as  the  Com- 
missioner may  prescribe,  and  will  be  conditioned  for  the  payment 
by  the  taxpayer  of  any  amount  of  tax  found  due  upon  any  re- 
determination of  tax  made  necessary  by  such  credit  proving  in- 
correct, with  such  further  conditions  as  the  Commissioner  may 
require.  This  bond  should  be  executed  by  the  taxpayer,  his 
agent  or  representative,  as  principal,  and  by  sureties  satisfactory 
to  and  approved  by  the  Commissioner.=^- 

liOO.  D.  232,  T.  B.  12-19-407. 
:!o  o.  D.  671,  T.  B.  39-20-1213. 

:5l  Form  1117  for  individuals  or  Form  1119  for  corporations. 
S2Reg.   45,   Art.   383;    see   also   Art.   Gil    as  to   corporations.      Domestic 
corporations  claiming  credit  for  taxes  paid  by  a  foreign  subsidiary  were 


794  FEDERAL  INCOME  TAX 

Redetermination  of  Tax  When  Credit  Proves  Incorrect.     In 

case  credit  has  been  given  for  taxes  accrued,  or  a  proportionate 
share  thereof,  and  the  amount  that  is  actually  paid  on  account  of 
such  taxes,  or  a  proportionate  share  thereof,  is  not  the  same  as 
the  amount  of  such  credit,  or  in  case  any  tax  payment  credited 
is  refunded  in  whole  or  in  part,  the  taxpayer  must  immediately 
notify  the  Commissioner.  The  Commissioner  will  thereupon  re- 
determine the  amount  of  the  income  tax  of  such  taxpayer  for 
the  year  or  years  for  which  such  incorrect  credit  was  granted. 
The  amount  of  tax,  if  any,  due  upon  such  redetermination  must 
be  paid  by  the  taxpayer  upon  notice  and  demand  by  the  collector. 
The  amount  of  tax,  if  any,  shown  by  such  redetermination  to 
have  been  overpaid  will  be  credited  against  any  income,  war- 
profits  or  excess-profits  taxes,  or  installment  thereof,  then  due 
from  such  taxpayer  under  any  other  return,  and  any  balance  of 
such  amount  will  be  immediately  refunded  to  him.^^ 

Fiscal  Year  in  Case  of  Corporations.  If  a  domestic  corporation 
makes  a  return  for  a  fiscal  year  beginning  in  1920  and  ending  in 
1921,  the  credit  for  the  entire  fiscal  year  will,  notwithstanding 
any  provision  of  the  statute,  be  determined  in  accordance  with 
the  provisions  stated  in  the  preceding  paragraphs,  and  the 
Commissioner  is  authorized  to  disallow,  in  whole  or  in  part,  any 
such  credit  which  he  finds  has  already  been  taken  by  the  tax- 
payer 


34 


permitted  to  avail  themselves  of  subdivision  (a)  of  this  ruling,  but  not 
(b)  as  credit  might  be  claimed  only  with  respect  to  taxes  paid  (not  those 
accrued)  by  foreign  subsidiaries. 

33  Revenue  Act  of  1921,  §§222    (b),  238    (b)    and  252;   Revenue  Act  of 
1918,  §§222   (b),  252;  Reg.  45,  Art.  384. 

34  Revenue  Act  of  1921,  §238   (d). 


CHAPTER  33 

METHODS  AND  PERIODS  OF  ACCOUNTING 

Net  income  must  be  computed  with  respect  to  a  fixed  period. 
Usually  that  period  is  the  taxable  year  which  is  the  time  unit  for 
the  purpose  of  the  tax.^  It  must  also  be  computed  with  respect 
to  a  definite  method  of  accounting.  It  is  provided  that  net  in- 
come shall  be  computed  upon  the  basis  of  the  taxpayer's  annnal 
accounting  period  (fiscal  year  or  calendar  year  as  the  case  may 
be) ,  in  accordance  with  the  method  of  accounting  regularly  em- 
ployed in  keeping  the  books  of  such  taxpayer;  but  if  no  such 
method  of  accounting  has  been  so  employed,  or  if  the  method 
employed  does  not  clearly  reflect  the  income,  the  computation 
must  be  made  upon  such  basis  and  in  such  manner  as  in  the 
opinion  of  the  Commissioner  does  clearly  reflect  the  income.  If 
the  taxpayer's  annual  accounting  period  is  other  than  a  fiscal 
year,  or  if  the  taxpayer  has  no  accounting  period  or  does  not 
keep  books,  the  net  income  must  be  computed  on  the  basis  of  the 
calendar  year.- 

This  provision  is  designed  to  secure  returns  of  income  upon 
the  same  basis  as,  and  in  accord  with,  the  books  of  the  reporting 
taxpayers,  whenever  these  books  are  kept  in  accordance  with 
valid  accounting  practices ;  and  facilitates  the  preparation  of 
returns  by  the  taxpayer  by  lessening  the  necessity  for  readjust- 
ment, and  the  verification  of  returns  by  revenue  agents  and  in- 
spectors, who  will  henceforth  be  able  to  compare  figures  more 
readily. 

Basis  of  Actual  Receipts.  Taxpayers  who  (a)  employ  no  spe- 
cific method  of  accounting  in  keeping  their  books,  (b)  employ  a 
method  of  accounting  which  does  not  clearly  reflect  the  income, 
or  (c)  keep  their  books  upon  the  basis  of  actual  receipts  and  dis- 
bursements, will  compute  their  net  income  under  both  the  present 
and  the  1918  Law  upon  the  basis  of  actual  receipts  and  disburse- 
ments; that  is,  such  taxpayers  will  report  as  gross  income  only 

1  Reg.  45,  Arts.  22,  1533. 

2  Revenue  Act  of  1921,  §  212;  Revenue  Act  of  1918,  §  212.  This  provision 
extends  to  all  taxpayers  the  privilege  of  reporting  income  upon  the  basis  of 
book  entries,  a  privilege  accorded  in  some  respects  by  the  1916  Law  only  to 
partnerships  and  corporations,  at  the  same  time  chan^'ing  the  privilege  into 
a  requirement.     (Revenue  Act  of  1916,  §§8  (g),  13  (a),  13  (d).) 


795 


796  FEDERAL   INCOME  TAX 

items  actually  or  constructively  received  in  cash  or  its  equiva- 
lent, and  as  deductions  only  items  paid  in  cash  or  its  equivalent.-* 

Reporting  Income  Upon  Accrual  Basis.  The  requirement  that 
income  be  reported  and  deductions  taken  upon  the  accrual  basis 
is  confined  to  taxpayers  who  (a)  keep  books,  and  (b)  employ  a 
method  of  accounting  clearly  reflecting  their  income.  If  such  tax- 
payers employ  a  method  of  accounting  according  to  which  items, 
both  of  income  and  liability,  are  set  up  when  they  accrue,  or  are 
incurred,  they  are  required  to  use  this  method  of  accounting  as  a 
basis  for  their  returns  of  income.  Mercantile  corporations  are 
required  to  file  returns  upon  the  accrual  basis.  When  such  cor- 
porations carry  a  substantial  stock  of  merchandise,  the  inven- 
tories of  the  stock  on  hand  at  the  beginning  and  end  of  the  tax- 
able year  must  be  included  in  the  computation  and  determination 
of  net  income  for  that  period ;  when  a  business  is  carried  on 
mainly  through  sales  on  credit  no  return  of  income  for  a  taxable 
year  is  accurate  and  complete  without  considering  the  accounts 
receivable,^  The  accrual  method  does  not  apply  to  dividends 
which  must  invariably  be  reported  for  the  year  in  which  they 
are  unqualifiedly  made  subject  to  the  demand  of  the  stock- 
holder,5 

Reporting  Deductions  Upon  Accrual  Basis,  It  is  to  be 
noted  that  both  receipts  and  liabilities  must  be  entered  upon  the 
same  basis  if  the  income  of  a  taxpayer  is  to  be  clearly  reflected. 
When  the  accrual  basis  is  used  for  the  computation  of  net  in- 
come, items  of  gross  income  and  deductions  are  both  accounted 
for  upon  the  accrual  basis.  Unless  all  items  of  gross  income  and 
all  deductions  are  treated  with  reasonable  consistency,  a  method 
of  accounting  will  not  be  regarded  as  clearly  reflecting  income," 
The  statute  uses  the  words  "paid  or  incurred,"  or  the  words 
"paid  or  accrued"  in  connection  with  many  of  the  deductions 
specified  and  it  is  also  provided  that  the  term  "paid"  for  the  pur- 
pose of  the  deductions  and  credits  allowed  by  the  income  tax 
means  "paid  or  accrued"  or  "paid  or  incurred"  and  that  the  terms 
"paid  or  incurred"  and  "paid  or  accrued"  shall  be  construed  ac- 
cording to  the  method  of  accounting  upon  the  basis  of  which  net 
income  is  computed,'^ 

3  Revenue  Act  of  1921,  §§  212,  232;  Revenue  Act  of  1918,  §§  212,  232. 

4  A.  R.  R.  217,  T.  B.  32-20-1115. 

5  Revenue  Act  of  1921,  §  201  (e) . 

6  Reg.  45,  Art.  23. 

7  Revenue  Act  of  1921,  §§200,  214  (a),  234  (a);  Revenue  Act  of  1918, 
§§200,  214  (a),  234  (a).  This  subject  is  more  fully  covered  in  succeeding 
paragraphs.     See  also  Chapter  21. 


METHODS   AND   PERIODS    OF   ACCOUNTING  797 

Accrued  Charges.  If  book  entries  represent  an  actual  ex- 
pense or  element  of  cost  in  the  production  of  the  income  of  the 
year,  their  amount  is  properly  deductible,  even  though  they  have 
not  been  actually  disbursed  in  cash  or  its  equivalent,  provided 
they  constitute  a  liability  against  the  assets  of  the  taxpayer  and 
provided  further  that  the  income  is  also  returned  upon  an  ac- 
crued basis.  If  in  the  course  of  its  business,  a  corporation  credits 
the  accounts  of  individuals,  firms  or  corporations  with  any  ex- 
penses, interest,  rentals,  wages,  etc.,  due  them,  thereby  making 
them  subject  to  the  personal  drawings  of  such  creditors,  or  if 
expenses  actually  incurred  are  vouchered  in  definite  amounts,  and 
if  the  amounts  so  credited  or  vouchered  are  expenses  incurred 
concurrently  with  and  in  the  production  of  the  income  of  the 
year,  they  may  be  deducted  therefrom.  The  deduction  of  any 
accrued  charges  which  if  paid  in  cash  or  otherwise  would  not  be 
deductible  is  not  permitted.^ 

Methods  of  Accounting.  Approved  standard  methods  of  ac- 
counting will  ordinarily  be  regarded  as  clearly  reflecting  income.'* 
It  is  recognized  that  no  uniform  method  of  accounting  can  be 
prescribed  for  all  taxpayers,  and  the  law  contemplates  that  each 
taxpayer  shall  adopt  such  forms  and  systems  of  accounting  as  are 
in  his  judgment  best  suited  to  his  purpose.  Each  taxpayer  is  re- 
quired by  law  to  make  a  return  of  this  true  income.  He  must, 
therefore,  maintain  such  accounting  records  as  will  enable  him  to 
do  so.  Among  the  essentials  are  the  following:  (1)  In  all  cases 
in  which  the  production,  purchase  or  sale  of  merchandise  of  any 
kind  is  an  income-producing  factor  inventories  of  the  merchan- 
dise on  hand  (including  finished  goods,  work  in  process,  raw 
materials  and  supplies)  should  be  taken  at  the  beginning  and  end 
of  the  year  and  used  in  computing  the  net  income  of  the  year ;  (2) 
expenditures  made  should  be  properly  classified  as  between  capi- 
tal and  income,  that  is,  expenditures  for  items  of  plant,  equip- 
ment, etc.,  which  have  a  useful  life  extending  substantially 
beyond  the  year  should  be  charged  to  a  capital  account  and  not 
to  an  expense  account;  and  (3)  in  any  case  in  which  the  cost  of 
capital  assets  is  being  recovered  through  deductions  for  depreci- 
ation, depletion  or  obsolescence  any  expenditure  (other  than  or- 
dinary repairs)  made  to  restore  the  property  or  prolong  its  useful 
life  should  be  charged  against  the  property  account  or  the  ap- 
propriate reserve  and  not  against  current  expenses.^'* 

RReg.  33  Rev.,  Art.  126;  T.  D.  2433;  T.  D.  2625. 
»  Reg.  45,  Art.  2l 
10  Reg.  45,  Art.  24. 


798  federal  income  tax 

Inconsistent  Bases  not  Permissible  in  Same  Return. 
Where  a  taxpayer  has  income  from  several  sources,  including 
interest  on  securities,  royalties  on  books,  profits  of  a  partner- 
ship maintaining  its  books  on  a  cash  basis,  and  income  from  a 
publishing  business,  he  must  report  his  income  on  a  cash  and 
disbursement  basis,  even  though  the  books  of  the  publishing 
business  are  kept  on  the  accrual  basis-^^ 

When  Items  Should  Be  Reported.  One  of  the  most  perplexing 
difficulties  arising  under  a  law  which  imposes  a  tax  upon  income 
with  respect  to  a  definite  or  fixed  period  of  time  is  the  question 
when,  under  a  given  set  of  circumstances,  an  item  of  income  or 
a  particular  deduction  should  be  reported.  The  time  as  of  which 
any  item  of  gross  income  or  any  deduction  is  to  be  accounted  for 
must  be  determined  in  the  light  of  the  fundamental  rule  that  the 
computation  must  be  made  in  such  manner  as  clearly  reflects 
the  taxpayer's  income.  If  the  method  of  accounting  regularly 
employed  by  him  in  keeping  his  books  clearly  reflects  his  income, 
it  is  to  be  followed  with  respect  to  the  time  as  of  which  items  of 
gross  income  and  deductions  are  to  be  accounted  for.^-  The  es- 
sence of  this  rule  is  that  gross  income  should  ordinarily  be  re- 
ported in  the  taxable  year  in  which  received  by  the  taxpayer, 
unless  he  keeps  his  accounts  upon  the  accrual  basis,  in  which 
event  items  should  be  reported  as  accrued,  according  to  recog- 
nized accounting  practices.  The  application  of  this  rule  raises 
some  of  the  most  intricate  problems  connected  with  the  income 
tax.  It  is  only  possible  to  suggest  some  of  these  problems  in  this 
chapter  and  to  indicate  the  more  or  less  tentative  answers  so  far 
given  to  them  by  the  treasury  department  and  the  courts.  Many 
of  the  principles  involved  are  hardly  formulated;  the  subject  is 
new;  and  the  department  is  still  feeling  its  way.  There  may  be 
doubt  as  to  the  proper  recipient  of  income,  a  doubt  which  can 
possibly  only  be  resolved  by  litigation.  An  item  of  income  may 
be  received  in  a  conditional  sense,  subject  to  a  claim  for  its  re- 
turn. On  the  other  hand,  uncertainty  may  surround,  not  the 
recipient  but  the  amount  of  income  arising  from  a  particular 
transaction,  and  there  may,  of  course,  be  doubt  both  as  to  the 
recipient  and  the  amount  of  income.  The  transaction  producing 
income  may  be  of  a  contingent  character.  Cash  or  its  equiva- 
lent may  be  received  by  a  taxpayer  by  virtue  of  a  contract,  the 
operation  of  which  extends  over  a  period  of  years,  so  that  in  the 
early  years,  and  perhaps  not  until  final  consummation,  will  the 

11  O.  D.  777,  T.  B.  29-20-1731. 

12  Reg.  45,  Art.  221. 


METHODS   AND   PERIODS   OF   ACCOUNTING  799 

character  of  the  payment  received  at  the  outset  be  definitely 
ascertained.  Again,  an  item  of  income  may  be  received-  in  a 
year  in  which  nothing  connected  with  its  production  has  trans- 
pired ;  it  may  be  the  result  of  activities  or  processes  anticipating 
the  taxable  year  by  many  years.  Commercial  transactions  con- 
stantly involve  transfers  of  property  and  payments  of  money 
the  exact  definition  of  which  is  contingent  and  dependent  upon 
the  future ;  the  parties  themselves  may  not  know,  and  it  may  be 
impossible  for  them  to  know,  how  the  transaction  will  result. 
The  determination  of  contract  rights  and  the  settlement  of  busi- 
ness disputes  frequently  take  place  years  after  the  efforts  and 
activities  and  processes  to  which  they  relate.  Finally,  the  tax- 
payer may  discover  for  the  first  time  in  one  year  a  gain  or  loss 
which  in  fact  has  occurred  in  a  prior  year. 

These  considerations  affect  not  only  gross  income  but  also  the 
charges  incident  to  the  production  thereof.  Deductions  should 
be  taken  when  payment  of  charges  is  made  or  when  charges 
accrue,  as  the  case  may  be.  As  a  general  rule,  the  statutory 
deductions  are  expenditures,  other  than  capital  expenditures, 
connected  icith  the  production  of  income.^^  The  artificiality 
of  the  taxable  year  as  a  unit  of  time  will  often,  if  strictly  ad- 
hered to,  result  in  the  reporting  of  deductions  in  one  year  which 
are  connected  with  another  year's  income.  Technically,  they 
should  be  reported,  so  far  as  possible,  in  the  same  period  with 
the  income  with  which  they  are  connected.  It  is,  however,  utterly 
impracticable  to  proceed  in  all  cases  upon  the  theory  that  losses 
and  expenses  must  be  charged  against  the  income  of  the  year  m 
which  the  operation  occurred  giving  rise  to  the  losses  and  ex- 
penses.!^ This  would  mean  that  ''the  administration  of  the  tax- 
ing acts  would  be  an  interminable  accounting  proposition." 

Throughout  this  discussion  the  distinction  between  the  con- 
structive receipt  and  the  accrual  of  income  must  be  kept  m  mind. 
The  manner  in  which  income  may  be  constructively  received  is 
described  in  another  chapter.!-^  stated  briefly,  income  is  con- 
structively received  when  it  is  credited  to  the  account  of  or  set 
apart  without  restriction  for  a  taxpayer  so  that  it  may  be  drawn 
upon  by  him  at  any  time.'^'  The  basic  theory  underlying  the  idea 
of  constructive  receipt  is  that  the  reduction  of  income  to  physical 

13  Reg.  45,  Art.  21. 

14  S    983,  T.  B.  3-19-188. 

15  See  Chapter  14.    The  attempt  in  this  chapter  is  not  to  define  income  as 
in  Chapter  14  but  to  discuss  the  question  token  is  income  to  be  reported. 

10  Reg.  45,  Art.  53. 


800  FEDERAL  INCOME   TAX 

possession,  being  a  process  to  a  large  extent  or  entirely  within 
the  volition  of  the  taxpayer,  should  be  regarded  as  immaterial 
with  respect  to  third  parties  such  as  the  government.  It  is  in 
effect  an  application  of  the  principle  that  equity  regards  that  as 
done  which  ought  to  be  done.  Income  may  accrue  to  a  taxpayer 
without  being  subject  to  his  demand  or  capable  of  being  drawn 
on  or  against  by  him.i^ 

Where  the  Recipient  of  Income  Is  Doubtful.  It  frequent- 
ly happens  that  with  respect  to  a  particular  item  of  income  there 
is  doubt  as  to  the  proper  recipient.  Thus,  where  a  sale  is  made 
and  because  of  claimants  for  commissions  the  seller  is  required 
by  the  purchaser  to  put  a  certain  part  of  the  purchase  price  in 
escrow,  and  thereafter  certain  claimants  are  paid  directly  out  of 
said  funds  in  escrow,  the  seller  is  not  liable  for  income  tax  upon 
any  part  of  the  purchase  price  in  escrow  until  actually  received 
by  him.is  It  has  been  held  that  income  from  oil  royalties  must 
be  returned  in  the  taxable  year  received,  even  though  the  title 
to  the  producing  land  and  interest  in  the  productive  area  are  in 
litigation.  This  is  true  when  the  royalty  payments  are  received 
subsequeyit,  as  well  as  when  they  are  received  prior,  to  the  de- 
termination of  the  litigation.!''     Where  the  United  States  gov- 

17  Reg.  45,  Art.  53. 

18  S.  1315,  T.  B.  6-20-725. 

19  0.  D.  825,  T.  B.  9-21-1477;  O.  D.  1046,  T.  B.  39-21-1839.  If  any  part  of 
the  royalty  income  accounted  for  as  income  m  advance  of  determination  of 
the  litigation  is  ordered  by  the  court  to  be  paid  over  to  another,  any  tax 
previously  paid  thereon  will  be  credited  against  any  income  tax  then  due 
under  any  other  return  of  the  taxpayer,  and  any  balance  of  the  excess  tax 
paid  will  be  refunded  if  proper  claim  for  such  refund  is  made.  These  rulings 
are  not  easy  to  reconcile.  They  both  adopt  the  taxable  year  of  physical 
receipt  as  the  test  of  when  the  payments  should  be  reported.  When  the  title 
to  producing  oil  land  is  in  litigation,  the  royalties  received,  in  advance  of 
determination  of  that  litigation,  therefrom  are  conditionally  received.  The 
taxpayer  may  never  become  legally  entitled  to  them  and  may  have  to  return 
them.  In  contemplation  of  law  his  position  with  regard  to  the  funds  is  not 
different  because  he  actually  received  them  from  what  it  would  be  if  they 
were  deposited  in  court  or  in  escrow  pending  final  determination  of  owner- 
ship. The  distinction  here  is  one  of  responsibility.  If  it  is  eventually  decided 
that  he  is  not  entitled  to  them,  he  has  in  effect  never  received  them.  He 
has  received  a  loan.  If  the  moneys  are  finally  awarded  to  him,  the  date  of 
the  judgment,  or  award,  or  decision  vesting  ovoiership  in  him,  is  the  date 
when  he  may  be  said  to  receive  them  in  any  real  sense.  Before  this  decision 
they  are  not  his  property;  how  then  can  they  be  income  to  him?  This  ruling 
requires  him  to  pay  a  tax  upon  income  conditionally  received,  which  may  be 
taken  from  him,  and  to  seek  to  recover  the  tax  if  it  is  taken  from  him. 
0.  D.  825  is  difficult  to  reconcile  with  the  other  rulings  discussed  in  the  text 
above,  particularly  S.  1315,  T.  B.  6-20-725;  O.  D.  948,  T.  B.  24-21-1687;  0.  D 


METHODS   AND   PERIODS    OF   ACCOUNTING  801 

ernment  took  over  a  business  in  1914,  operating  it  until  1920, 
paying  over  earnings  from  1914  to  1917  in  1919  upon  the  set- 
tlement of  a  dispute  as  to  the  ownership  of  the  corporation,  it 
was  held  that  the  sums  paid  over  in  1919  constituted  income  for 
1919  when  they  were  paid  over  upon  the  settlement  of  the  dis- 
pute.'-*^ 

Income  Conditionally  Received.  Closely  related  to  the 
cases  discussed  in  the  preceding  paragraph  are  those  cases  in 
which  items  of  income  are  received  in  a  conditional  sense,  sub- 
ject to  a  claim  for  their  return.-^  Where  certain  corporations 
collected  commissions  in  excess  of  the  schedule  of  commissions 
sought  to  be  established  by  one  of  the  executive  departments  of 
the  government,  a  restraining  order  was  issued  enjoining  the 
putting  into  effect  of  the  schedule  until  final  determination  of 
the  case.  The  order  required  that  each  of  the  corporations  seek- 
ing relief  should  deposit  with  the  court  such  portion  of  the  com- 
missions collected  by  them  in  excess  of  the  commissions  specified 
in  the  department's  schedule.  It  was  held  that  the  commissions 
so  deposited  need  not  be  returned  as  gross  income  until  the  tax- 
able year  in  which  the  ownership  therein  was  judicially  deter- 
mined.-- When  property  is  sold  by  individuals  who  are  under 
agreement  to  incorporate  at  a  later  date,  the  proceeds  of  the 
sale  being  placed  on  deposit  in  a  bank  in  escrow  under  the  con- 
dition that  the  sale  must  be  ratified  by  the  directors  of  the  cor- 
poration when  organized,  income  accrues  to  the  corporation  at 
the  time  when  the  sale  is  ratified  and  the  funds  in  escrow  are 
made  available  to  the  company.-'^  Where  the  employees  of  a  cor- 
poration subscribe  to  shares  of  its  stock,  title  to  the  stock  re- 
maining in  the  corporation  until  the  stock  is  fully  paid  for,  the 
dividends  being  credited  to  the  account  of  the  employee  as  part 
payment,  such  credits  are  not  income  to  the  employee  until  the 
terms  of  the  agreement  of  subscription  have  been  completed.-* 

Where  the  Amount  of  Income  Is  Doubtful.  The  amount 
of  income  incident  to  a  particular  transaction  may  remain  un- 

980,  T.  B.  30-21-1743,  and  0.  D.  282,  T.  B.  21-19-523.  On  principle  it  is  cer- 
tainly inconsistent  with  the  decision  of  the  court  in  Holbrook  v.  Moore,  T.  B. 
17-21-1592. 

20  O.  D.  948,  T.  B.  24-21-1687.  Here  the  company  kept  its  books  on  a  cash 
receipts  and  disbursements  basis. 

21  An  example  of  such  a  payment  will  be  found  in  0.  D.  19,  T.  B.  1-19-31. 
See  paragraph  "Payments  of  Compensation"  below. 

22  O.  D.  980,  T.  B.  30-21-1743. 

23  O.  D.  282,  T.  B.  21-19-523. 

24  O.  D.  763,  T.  B.  1-21-1370;  0.  D.  791,  T.  B.  6-21-1426.  See  A.  R.  R.  182, 
T.  B.  29-20-1070. 


802  FEDERAL   INCOME   TAX 

determined  for  a  considerable  period  after  the  transaction  from 
which  it  originated.  In  other  words,  a  claim  may  remain  un- 
liquidated for  some  time  after  it  arises.  This  was  particularly- 
true  in  the  period  of  unusual  conditions  prevailing  at  the  close 
of  1918  when  it  was  recognized  that  many  items  of  gross  income 
such  as  claims  for  compensation  under  cancelled  contracts  to- 
gether with  claims  against  contracting  departments  of  the  gov- 
ernment for  amortization  and  other  matters,  while  properly  con- 
stituting gross  income  for  the  taxable  year  1918  were  undecided 
and  not  sufficiently  definite  in  amount  to  be  reported  in  the  orig- 
inal return  for  that  year.^^  All  such  claims  have  been  held  in 
the  final  analysis  to  be  more  or  less  tentative  and  subject  to  re- 
vision and  where  the  full  amount  of  such  claims  has  been  re- 
ported as  income,  the  loss  resulting  from  the  disallowance  of  part 
thereof  can  not  be  classified  with  bad  accounts.-''^  Applying  this 
rule,  it  has  been  held  that  where  a  number  of  carloads  of  coal, 
purchased  on  contracts  entered  into  prior  to  October  30,  1919, 
and  shipped  to  tidewater  for  export,  were  diverted  by  the  Fuel 
Administration  for  the  account  of  the  Railroad  Administration, 
and  settlement  with  the  railroads  receiving  the  coal  remained 
undetermined,  the  railroads  having  remitted  some  on  the  basis 
of  the  maximum  government  price  and  some  on  the  basis  of  the 
cost  price,  the  corporation  owning  the  coal  should  set  up  the  ac- 
counts involved  in  a  "suspense  account"  and  eliminate  them  from 
its  1919  and  1920  returns  pending  final  settlement  when 
amended  returns  might  be  made  for  these  years.^^  But  where 
an  item  is  in  dispute  and  there  is  no  assurance  that  it  will  be 
paid,  it  should  not  be  reported  as  income  until  there  is  an  adju- 
dication that  it  is  due,  or  a  settlement  of  the  dispute.^s  Thus 
an  award  in  the  year  1918  by  a  board  of  arbitration  on  an  un- 
liquidated claim  to  a  portion  of  the  proceeds  arising  out  of  trans- 
actions which  took  place  in  1917,  is  held  to  be  income  for  the 
year  1918  rather  than  1917.2^    The  amount  of  compensation  for 

25  Reg.  45,  Art.  52,  as  amended  by  T.  D.  3247,  T.  B.  48-21-1943.  These 
provisions  are  not  applicable  to  cases  in  which  collections  of  taxpayers  for 
the  year  1920  have  been  postponed  because  of  unusual  conditions  such  as  the 
moratorium  in  Cuba,  there  being  no  question  as  to  the  definiteness  of  the 
obligations  of  purchasers.     (0.  D.  869,  T.  B.  15-21-1559.) 

20  A.  R.  R.  685,  T.  B.  48-21-1948. 

27  0.  D.  816,  T.  B.  8-21-1461.  It  was  also  held  that  the  corporation  should 
attach  to  its  original  1919  and  1920  returns  a  full  statement  of  facts  relative 
to  the  claims.     (See  next  footnote.) 

28  Sol.  Op.  41,  T.  B.  34-20-1159;  0.  D.  642,  T.  B.  34-20-1151. 

29  S.  1335,  T.  B.  8-20-750.  See  O.  D.  591,  T.  B.  29-20-1071;  0.  D.  642,  T.  B. 
34-20-1151.     In  this  case  prior  to  the  award  there  was  doubt  as  to  whether 


METHODS   AND   PERIODS   OF   ACCOUNTING  803 

personal  services  is  frequently  doubtful  as  in  a  case  where  such 
amount  is  largely  in  the  discretion  of  the  employer  or  where  it 
is  contested.-"'" 

Where  the  Transaction  Producing  Income  Is  Contingent. 
Question  as  to  when  an  item  should  be  reported  sometimes  arises 
in  connection  with  exchanges  of  property.  When  is  the  exchange 
a  closed  transaction  ?  Where  in  connection  with  the  reorganiza- 
tion of  a  company  the  stockholder  has  the  right  to  make  an  ex- 
change in  one  year  but  does  not  actually  make  the  exchange 
until  the  following  year,  the  profit  accruing  is  income  in  the  year 
in  which  the  exchange  is  actually  made.^'^  In  a  case  in  which 
holdings  of  stock  in  a  corporation,  including  shares  held  prior  to 
March  1,  1913,  shares  received  as  dividends  after  March  1,  1913, 
and  shares  acquired  by  purchase  after  March  1,  1913,  were  in 
1918  exchanged  for  shares  of  stock  in  several  other  corporations, 
but  owing  to  requirements  of  the  capital  issues  committee,  a 
portion  of  the  stock  to  be  received  was  held  in  trust  during  the 
period  of  the  war,  certificates  of  ownership  being  issued  and  final 
delivery  of  the  stock  being  made  in  1919,  the  treasury  depart- 
ment held  that  the  exchange  constituted  a  closed  transaction 
which  reflected  a  gain  or  loss  in  the  difference  between  the  ag- 
gregate value  of  the  shares  exchanged  and  the  total  market  value 
of  the  securities  received,  and  that  the  date  of  the  exchange  and 
not  the  date  of  complete  delivery  detennined  the  taxable  period 
in  which  such  gain  or  loss  should  be  reported.-"-  A  sale  may  be  of 
a  contingent  character  depending  for  final  consummation  upon 
events  taking  place  in  a  year  following.  Thus,  a  corporation  en- 
gaged in  the  exportation  of  merchandise  made  heavy  shipments 
to  foreign  countries  during  1919.    The  bill  of  lading  in  each  case 

or  not  the  taxpayer  would  receive  anything,  and  the  award  was  regarded 
as  equivalent  to  a  judgment.  The  outcome  of  the  controversy  was  so  un- 
certain that  it  could  not  possibly  have  been  foretold.  The  case  does  not  seem 
entirely  consistent  with  the  coal  case  discussed  in  the  text  above.  In  that 
case  there  seemed  to  be  considerable  doubt  as  to  the  amount  which  the  owner 
of  the  coal  would  receive.  It' is  true,  however,  that  the  corporation  owning 
the  coal  was  practically  certain  of  receiving  something.  These  two  cases 
illustrate  the  difficulty  inherent  in  these  questions  of  when  income  should 
be  reported.  Strictly  speaking,  insofar  as  the  amounts  received  for  the  coal 
were  contingent  and  subject  to  the  possibility  of  not  being  received,  they 
should  have  been  reported  when  the  determination  was  made,  that  the  sums 
were  owing  to  the  taxpayer,  the  amounts  not  in  controversy  being  reportable 
in  the  earlier  years  under  amended  returns. 

30  These  cases  are  discussed  below.     See  paragraph  "Payments  of  Com- 
pensation." 

31  A.  R.  R.  289,  T.  B.  44-20-1274. 

32  0.  D.  480,  T.  B.  18-20-892. 


804  FEDERAL  INCOME  TAX 

was  accompanied  with  a  draft  on  a  bank  located  in  the  city  of 
the  purchaser,  the  understanding  being  that  legal  title  to  the 
goods  should  not  pass  prior  to  the  acceptance  of  the  draft  by  the 
purchaser.  Many  of  the  drafts  so  sent  were  not  accepted  and  the 
goods  were  sold  to  persons  other  than  the  original  purchasers.  In 
numerous  cases  these  rejections  did  not  take  place  until  after 
the  close  of  the  year  1919  and  notice  of  the  nonacceptance  was 
not  received  prior  to  the  filing  of  the  corporation's  1919  return. 
The  corporation  reported  in  its  return  for  1919  the  profits  to  be 
realized  upon  all  such  sales  within  the  year  and  excluded  the 
goods  so  sold  from  its  closing  inventory  for  1919.  This  was  held 
to  be  an  error.  No  part  of  the  profit  to  be  realized  upon  any  par- 
ticular sale  made  in  1919  should  have  been  included  in  the  in- 
come of  the  corporation  for  that  year  if  at  the  end  of  the  year 
the  company  was  not  in  receipt  of  notice  of  the  acceptance  of 
the  draft  accompanying  the  bill  of  lading  for  such  sale.  The 
goods  so  shipped,  but  not  considered  as  having  been  actually 
sold,  because  of  the  nonacceptance  of  the  draft  or  because  of 
the  nonreceipt  of  a  notice  of  the  nonacceptance  of  the  draft 
should  have  been  included  in  the  closing  inventory  for  1919.3^ 
It  is  held  also  that  a  corporation  is  not  required  to  treat  its  con- 
tracts covering  unfilled  and  undelivered  orders  for  its  goods  as 
gross  sales  for  the  year  in  which  an  order  is  taken  and  a  con- 
tract entered  into,  but  that  the  sale  of  the  goods  can  not  be 
properly  considered  as  taking  place  when  the  goods  are  deliv- 
ered to  the  carrier  for  shipment  to  the  buyer,  or  in  those  cases  in 
which  the  purchaser  is  to  call  for  the  goods  at  the  place  of  busi- 
ness of  the  seller,  until  there  is  a  specific  identification  of  the 
goods  manufactured  and  they  are  put  in  a  deliverable  state.^^ 

Payments  the  Character  of  Which  Depends  on  Future 
Development.  Cash  or  its  equivalent  may  be  received  by  a  tax- 
payer by  virtue  of  a  contract,  the  operation  of  which  extends 
over  a  period  of  years  and  the  exact  nature  of  early  payments 
may  remain  doubtful  until  the  contract  is  finally  performed.  Sums 
received  may  prove  ultimately  to  be  a  return  of  capital  or  in- 
come, according  to  future  developments.  For  instance,  a  cor- 
poration assigned  its  principal  asset,  a  mortgage,  to  trustees  in 
trust  for  its  stockholders  and  then  instituted  liquidation  pro- 
ceedings.    The  mortgage  was  payable  in  annual  installments 

33  0.  D.  824,  T.  B.  9-21-1476.  The  question  of  notice  would  seem  to  be 
immaterial  in  this  case;  the  real  question  was:  Was  there  a  sale?  not,  Did 
the  taxpayer  know  whether  or  not  there  was  a  sale  ?  Compare  this  decision 
with  O.  D.  13,  T.  B.  1-19-25. 

34  0.  D.  826,  T.  B.  9-21-1478. 


METHODS   AND    PERIODS   OF   ACCOUNTING  805 

with  interest,  and  the  beneficiaries  were  to  receive  proportionate 
shares  of  the  principal  and  interest  as  paid  to  the  trustees.  The 
trustees  were  to  receive  compensation  in  a  fixed  amount  plus  a 
percentage  of  the  income  received  and  distributed,  and  be  reim- 
bursed for  expenses  incurred  in  connection  with  the  trust.  It 
was  held  that  the  profit  of  the  stockholders  from  the  surrender 
of  their  stock  is  not  definitely  ascertainable,  and  they  need  not 
report  any  amount  as  income  until  the  total  sum  received  in 
liquidation  exceeds  either  the  cost  of  their  stock  or  its  fair  mar- 
ket value  March  1,  1913,  if  acquired  prior  to  that  date."^"' 

Subsequently  Discovered  Gains.  A  taxpayer  some  times 
discovers  for  the  first  time  in  one  year  a  gain  which  has  in  fact 
occurred  in  a  prior  year.  Thus,  adjustments  made  in  accordance 
with  instructions  from  the  Interstate  Commerce  Commission,  in- 
creasing the  income  of  a  railroad  corporation  from  transactions 
in  prior  years  and  taken  up  on  the  books  of  the  corporation  dur- 
ing the  taxable  year  because  necessary  information  was  not  avail- 
able prior  to  that  time,  represent  income  for  the  years  during 
which  the  transactions  took  place  instead  of  the  taxable  year. 
Corrections  should  be  made  by  means  of  amended  returns.^" 
Profit  on  goods  sold  by  a  consignee  is  income  to  the  consignor  for 
the  year  in  which  the  sales  are  made,  even  though  the  consignor 
received  no  notification  of  sale  until  a  subsequent  year.  If  re- 
ported otherwise,  amended  returns  should  be  filed.-"^^ 

Payments  of  Compensation.  The  well  established  rule  that 
compensation  for  personal  services  is  to  be  reported  as  income 
in  the  year  of  receipt,  rather  than  the  year  in  which  the  services 
for  which  the  compensation  is  paid  are  rendered,  is  discussed  in 
full  in  another  chapter,3s  particularly  as  this  rule  is  affected  by 
the  consideration  that  such  services  may  have  been  rendered 
prior  to  March  1,  1913.  This  rule  is  productive  of  many  artificial 
results."^^    It  is  founded,  no  doubt,  upon  the  consideration  that 

35  O.  D.  461,  T.  B.  16-20-874. 

36  0.  D.  9,  T.  B.  1-19-18. 

37  0.  D.  13,  T.  B.  1-19-25.  A  loss  may  likewise  be  discovered  years  after 
it  has  been  sustained.     See  Chapter  25. 

38  See  Chapter  15.  See  also  T.  B.  R.  12,  T.  B.  3-19-178;  A.  R.  R.  182,  T.  B 
29-20-1070;  O.  D.  717,  T.  B.  45-20-1289;  O.  D.  432,  T.  B.  14-20-824;  O.  D 
19,  T.  B.  1-19-31;  O.  D.  512,  T.  B.  21-20-948;  O.  D.  456,  T.  B.  26-21-1700 
Jackson  v.  Smietanka,  267  Fed.  932;  affirmed  Jan.  1921,  T.  B.  14-21-1545 
Holbrook  v.  Moore,  T.  B.  17-21-1592;  Woods  v.  Lewellyn,  252  Fed.  106; 
State  ex  rel.  Houghton  v.  Phelps  (Wis.),  176  N.  W.  217. 

30  Thus  an  amount  received  on  January  1st  is  reported  as  income  for  the 
year  in  which  received  rather  than  the  year  preceding  during  which  the 
services  which  the  payment  represents  were  rendered.     Again,  an  adver- 


806  FEDERAL  INCOME  TAX 

the  recipients  of  salaries  rarely  keep  books  and  consequently  are 
required  to  report  income  upon  the  cash  and  receipts  basis.  But 
it  is  also  founded  in  large  part  upon  the  doctrine  of  constructive 
receipt.  There  seems  to  be  no  valid  reason  under  the  present 
law  (or  the  Revenue  Act  of  1918)  why  a  taxpayer  keeping  satis- 
factory books  of  account  and  employing  a  regular  method  of  ac- 
counting in  keeping  such  books  should  not  report  payments  for, 
compensation  upon  an  accrual  basis.  In  regard  to  such  pay- 
ments, however,  the  distinction  between  accrual  and  constructive 
receipt  is  particularly  important.  It  is  well  established  that 
where  compensation  for  personal  services  is  contested,  the  entire 
amount  thereof  should  be  reported  as  income  in  the  year  in  which 
received.^"  The  same  is  true  if  the  amount  of  compensation  is  in 
the  discretion  of  the  employer  or  of  the  amount  of  compensation 
remains  undetermined  until  the  year  of  payment.^^ 

Allocation  of.  Income  from  Judgments,  Lands  which  are 
received  as  compensation  for  services  in  one  year,  the  title  to 
which  is  disputed  and  in  a  later  day  adjudged  to  be  valid,  con- 
stitute income  to  the  grantee  in  the  former  year.  On  the  other 
hand,  a  person  may  sue  in  one  year  on  a  pecuniary  claim  or  for 
property,  but  money  or  property  recovered  on  a  judgment  there- 
for rendered  in  a  later  year  would  be  income  in  that  year,  as- 
suming that  it  would  have  been  income  in  the  earlier  year  if 
then  received.  This  is  true  of  a  recovery  for  a  patent  infringe- 
ment. Bad  debts  or  accounts  charged  off  subsequently  to  Feb- 
ruary 28,  1913,  because  of  the  fact  that  they  were  determined 
to  be  worthless  which  are  subsequently  recovered,  whether  or  not 
by  suit,  constitute  income  for  the  year  in  which  recovered.^^ 
Where  a  company  in  1912  entered  into  an  agreement  to  sell  oil 

tising  solicitor  is  required  to  report  commissions  in,  the  year  in  which  re- 
ceived, which  he  may  subsequently  be  obliged  to  pay  back  owing  to  failure 
of  payment  for  advertising  (O.  D.  19,  T.  B.  1-19-31).  A  taxpayer  who  had 
been  discharged  from  the  employ  of  a  railroad  company  and  who  was  there- 
after reinstated  and  paid  for  all  time  lost  during  the  period  of  two  years 
has  been  required  to  report  the  amount  so  received  as  income  for  the  year 
in  which  paid  (0.  D.  512,  T.  B.  21-20-948).  "Post  allowances"  made  to 
members  of  diplomatic  and  consular  services  have  been  held  to  be  income 
in  the  year  in  which  received  and  not  the  year  to  which  they  related.  (O.  D. 
997,  T.  B.  34-21-1778). 

40  O.  D.  432,  T.  B.  14-20-824. 

41  O..  D.  717,  T.  B.  45-20-1289,  superseding  O.  D.  460,  T.  B.  16-20-858;  Reg. 
45,  Art.  32.  This  was  true  in  the  case  of  Jackson  v.  Smietanka,  267  Fed. 
932,  affirmed  January,  1921,  T.  B.  14-21-1545.  But  Jackson  kept  no  books 
and  the  decision  might  have  been  placed  on  that  ground. 

42  Reg.  45,  Art.  52,  as  amended  by  T.  D.  3247,  T.  B.  48-21-1943;  Letter 
from  treasury  department  dated   February  11,  1916,  I.  T.   S.   1918,  111211. 


METHODS   AND   PERIODS   OF   ACCOUNTING  807 

to  another  company,  at  90  cents  per  barrel,  delivery  to  extend 
over  two  years,  the  latter  company  to  have  an  option  to  extend 
the  term  of  the  contract  and  to  pay  for  oil  thereafter  delivered 
at  a  price  equal  to  the  highest  contract  price  then  being  paid  by 
any  one  of  four  of  the  largest  purchasing  companies,  and  did 
exercise  such  option  and  dispute  arose  as  to  the  price  to  be  paid, 
the  buying  company  paying  only  50  cents  a  barrel  and  the  selling 
company  claiming  $1.00  a  barrel,  the  price  being  finally  fixed  by 
the  courts  in  1912  at  $1.00  and  the  buying  company  ordered  to 
pay  the  balance  of  50  cents  a  barrel,  it  has  been  held  that  such 
balance  is  income  to  the  buying  company  for  the  year  in  which 
received  and  not  for  the  year  or  years  in  which  the  right  of 
action  accrued.-^-^ 

Allocating  Deductions  to  Income  with  Which  They  Are 
Connected.  A  taxpayer  making  returns  on  an  accrual  basis 
has  the  right  to  deduct  all  authorized  allowances,  whether  paid 
in  cash  or  set  up  as  a  liability,  and  it  follows  that  if  he  does  not 
within  any  year  pay  or  accrue  certain  of  his  expenses,  interest, 
taxes  or  other  charges,  and  makes  no  deduction  therefor,  he  can 
not  deduct  from  the  income  of  the  next  or  any  subsequent  year 
any  amounts  then  paid  in  liquidation  of  the  previous  year's 
liabihties.^^  Many  of  the  principles  governing  the  allocation  of 
deductions  to  the  proper  taxable  period  are  the  necessary  corol- 
laries of  the  rules  governing  the  allocation  of  items  of  income 
to  their  proper  taxable  period.  Generally  speaking,  if  a  payment 
is  income  to  the  recipient,  it  is  deductible,  by  the  payor,  if  at  all, 
in  the  period  as  of  which  it  is  to  be  reported  as  income  by  the 
payor.^''  It  has  been  stated  that  compensation  for  personal 
services  is  generally  to  be  reported  by  the  recipient  as  of  the 
period  during  which  its  amount  is  fixed  and  paid.  The  same 
item  is  usually  to  be  deducted  by  the  taxpayer  as  of  the  same 

For  this  rule  in  the  case  of  bad  debts  charged  off  as  worthless  prior  to  March 
1,  1913,  see  Reg.  45,  Art.  87,  as  amended  by  T.  D.  3206. 

43  Sol.  Op.  11,  T.  B.  34-20-1159.  See  Jackson  v.  Smietanka,  207  Fed.  932; 
T.  D.  2960. 

44  Reg.  45,  Art.  111. 

4'">  This  will  not  be  true  in  all  cases.  Thus  a  receiver  of  a  corporation  may 
deduct  receivers'  and  attorneys'  fees  actually  paid  during  the  year  to  which 
the  return  relates  if  the  books  are  kept  on  the  cash  receipts  and  disburse- 
ments basis;  but  if  the  books  are  kept  on  an  accrual  basis  the  amount  of 
such  fees  accruing  during  the  year  may  be  deducted  even  though  disburse- 
ment is  not  actually  made  until  the  following  year.  (0.  D.  3,  T.  B.  1-19-6). 
In  other  words,  the  same  item  may  be  reported  in  different  taxable  periods 
by  payor  and  payee,  when  the  books  of  the  one  are  kept  on  one  basis  and  the 
books  of  the  other  on  another  basis. 


808  FEDERAL   INCOME   TAX 

period.  Thus,  when  additional  compensation  is  agreed  to  be  paid 
by  a  corporation  to  its  officers  at  a  future  date,  upon  the  hap- 
pening of  certain  contingencies  expected  to  result  from  the  ren- 
dition of  services,  the  amount  of  such  compensation  being  left 
for  future  determination,  the  amount  eventually  paid  is  not  to 
be  treated  as  back  salary  and  allocated  to  the  years  during  which 
the  services  were  rendered,  but  constitutes  a  business  expense 
to  the  corporation  for  the  taxable  year  in  which  the  same  was 
paid.46  Similarly,  it  was  stated  in  discussing  the  subject  of  in- 
come that  where  the  amount  of  an  item  was  unliquidated  or  in 
controversy,  it  should  not  be  reported  upon  final  liquidation  as 
of  the  year  in  which  liquidated  and  paid,  but  should  form  the 
basis  of  amended  returns  for  prior  years,  unless  the  outcome  of 
the  liquidation  or  controversy  was  so  uncertain  that  it  could  not 
possibly  have  been  foretold.^^  Charges  should  likewise  form  the 
basis  of  amended  returns  for  prior  years  unless  the  outcome  of 
the  liquidation  or  controversy  was  so  uncertain  until  final  settle- 
ment that  it  could  not  have  been  known  in  advance.  This  is  illus- 
trated by  the  case  of  a  corporation  which  sold  merchandise,  the 
weight  and  grade  of  which  was  guaranteed  under  contract. 
Under  the  practice  of  the  trade,  when  shipments  failed  to  con- 
form to  specifications,  adjustments  were  made  in  accordance 
with  rules  promulgated  by  certain  trade  associations.  Referring 
to  certain  shipments  made  toward  the  close  of  a  taxable  period 
and  finally  adjusted  after  the  end  of  the  taxable  period,  it  has 
been  ruled  that  if  the  liability  of  the  taxpayer  were  in  question, 
there  would  have  been  no  deductible  loss  until  such  liability  had 
been  actually  determined,  either  by  agreement  or  in  the  courts, 
but  where  such  liability  is  not  in  dispute  and  the  amount  thereof 
is  merely  an  accounting  detail  to  be  determined  under  an  existing 
contract  or  agreement,  and  in  accordance  with  a  clearly  recog- 
nized course  of  procedure,  such  adjustments  are  applicable  to  the 
year  in  which  the  sales  were  made  and  should  be  regarded  more 
truly  as  adjustments  of  the  selling  price  rather  than  as  rebates 
or  allowances.  It  is  held,  however,  that  loss  sustained  as  the 
result  of  the  return  of  defective  goods  in  one  year,  which 
had  been  sold  in  a  prior  year,  is  deductible  only  in  the  year  in 
which  the  goods  were  returned.^^    Where  rental  is  withheld  by 

46  A.  R.  R.  232,  T.  B.  33-20-1130.     See  p.  000. 

47  See  page  805. 

48  A.  R.  R.  275,  T.  B.  42-20-1242;  O.  D.  642,  T.  B.  34-20-1151;  0.  D.  1067, 
T.  B.  42-20-1871.  The  first  of  these  rulings  may  be  theoretically  sound,  but 
it  draws  rather  a  fine  line.  When  is  the  determination  of  liability  under  a 
contract  merely  a  matter  of  accounting  detail  ?     This  question  may  be  an- 


METHODS   AND   PERIODS    OF   ACCOUNTING  809 

a  lessee  and  held  in  reserve,  the  amount  so  retained  is  deductible 
for  the  year  of  withholding,  although  not  paid  in  cash.  Such 
rental  is  a  definite  liability.^''  Where  the  final  outcome  of  a  con- 
troversy is  uncertain,  the  amount  finally  determined  as  a  liability 
should  be  reported  as  of  the  year  of  final  determination.  Where 
a  corporation  in  1919  pays  liquidated  damages  to  be  relieved 
from  the  terms  of  a  contract  w^hich  called  for  the  delivery  of 
merchandise  in  1918  and  1919,  the  loss  so  incurred  is  deductible 
from  gross  income  for  the  year  1919  rather  than  1918.^*^ 

Judgments  Against  Taxpayer.  Any  amount  paid  pursuant 
to  a  judgment  or  otherwise  on  account  of  damages  for  personal 
injuries,  patent  infringement  or  otherwise,  is  deductible  from 
gross  income  when  the  claim  is  put  in  judgment  or  paid,  less  any 
amount  of  such  damages  as  may  have  been  compensated  for  by 
insurance  or  otherwise."'!  The  principle  underlying  this  rule  is 
that  the  loss  or  expense  involved  in  and  culminating  in  a  judg- 
ment can  not  be  properly  set  up  as  liabilities  on  the  books  of  the 
taxpayer  until  they  have  become  known  and  definite,  which  does 
not  happen  in  a  litigated  matter  until  judgment.^^  This  rule  ap- 
plies to  all  amounts  paid  pursuant  to  a  judgment  recovered  in  a 
patent  infringement  suit,  whether  as  "damages"  or  as  ''profits 
turned  over  to  the  patent  owner".-""'-  The  judgment  is  the  adju- 
dication fixing  the  amount  due.  The  report  of  a  master  in  chan- 
cery, appointed  by  an  interlocutory  decree  in  a  suit  for  damages 
for  alleged  infringement  of  a  patent,  assessing  damages  against 
the  taxpayer,  which  report  was  filed  during  the  taxable  year,  but 
was  not  confirmed  until  the  following  year  when  judgment  was 
entered  on  the  report,  can  not  be  regarded  as  a  determination  of 
the  amount  of  the  claim,  and  no  deduction  for  the  taxable  year 
is  permissible  in  regard  to  the  judgment  referred  to.-"'^  The  award 
of  a  board  of  arbitration,  provided  it  is  final,  is  analogous  to  the 

swered  readily  enough  in  some  cases,  but  there  are  many  cases  in  which  the 
whole  question  of  liability  under  a  contract  is  a  matter  of  accounting  detail; 
accounting  details  are  frequently  of  the  most  vital  importance  going  to  the 
question  of  liability  itself,  as  distinguished  from  extent  of  liability.  Account- 
ing details  may  change  a  liability  into  an  asset. 

49  O.  D.  794,  T.  B.  6-21-1430. 

50  S.  983,  T.  B.  3-19-188. 

•■ji  Reg.  45,  Art.  111.  This  subject  is  more  fully  discussed  in  Chapter  25 
on  Losses,  particularly  under  the  paragraph  heading  "Loss  due  to  Adverse 
Judgment." 

32  O.  D.  917,  T.  B.  20-21-1638. 

53  O.  D.  917,  T.  B.  20-21-1638. 

54  S.  923,  T.  B.  1-19-94. 


810  FEDERAL   INCOME  TAX 

judgment  of  a  court;  it  is  a  less  formal,  but  equally  conclusive 
determination  of  the  rights  of  the  parties  involved.^^ 

Reserves  to  Meet  Liabilities.  The  extent  to  which  re- 
serves to  meet  liabilities  are  deductible  is  a  difficult  matter  to 
determine..  The  character  of  the  reserve  is  vital  to  any  consid- 
eration of  the  question.  If  the  reserve  is  for  a  liability  certain  and 
definite  in  amount,  such  as  rent  and  interest  charges  incurred  but 
payable  in  the  future,  it  is  deductible.  Where  pursuant  to  the 
consistent  practice  of  accounting  of  a  corporation,  or  pursuant 
to  the  requirements  of  some  federal,  state  or  municipal  super- 
vising authority,  corporations  set  up  and  maintain  reserves  to 
meet  liabilities,  the  amounts  of  which,  and  the  date  of  payment 
or  maturity  of  which  are  not  definitely  determined  or  determin- 
able at  the  time  the  liabilities  are  incurred,  the  treasury  depart- 
ment permitted  the  amounts  credited  to  such  reserves  to  be  de- 
ducted, under  the  1916  Law,  provided  the  amounts  deductible  on 
account  of  the  reserves  approximated,  as  nearly  as  could  be  de- 
termined, the  actual  amounts  which  experience  had  demonstrated 
would  be  necessary  to  discharge  the  liabilities  incurred  during 
the  year,  for  the  payment  of  which  additions  to  the  reserves  were 
made.  If  it  was  found  that  the  amount  credited  to  any  such  re- 
serve was  in  excess  of  the  reasonable  or  probable  needs  for  which 
the  reserve  was  created,  the  excess  would  be  disallowed  as  a  de- 
duction and  restored  to  income.  In  no  event  are  sinking  funds 
or  other  reserves  set  up  to  meet  additions,  betterments  or  other 
capital  obligations  allowed  as  deductions.  Reserves  to  meet 
losses  contingent  upon  shrinkage  in  values,  losses  from  bad  debts, 
losses  from  capital  investments,  etc.,  are  not  allowable  as  deduc- 
tions, since  such  losses  are  only  deductible  when  definitely  de- 
termined as  a  result  of  a  closed  or  completed  transaction  and 
actually  charged  off.^*^ 

The  distinction  between  the  kind  of  reserves  deductible  and 
nondeductible  under  this  ruling  is  difficult  to  define.  As  in  the 
case  of  other  rulings  discussed  in  this  chapter,  the  attempt  again 
seems  to  be  to  draw  a  line  between  reserves  to  meet  losses  or 

53  See  S.  1335,  T.  B.  8-20-750. 

50  T.  D.  2433.  The  treasury  department  has  always  held,  in  the  case  of 
corporations,  that  it  was  immaterial  whether  deductions,  except  for  taxes 
and  losses,  were  evidenced  by  actual  disbursements  in  cash,  oi-  evidenced  in 
such  other  ways  as  to  properly  acknowledged  by  the  corporate  officers  and 
so  entered  on  the  boo'  of  the  corporation  as  to  constitute  a  liability  against 
the  assets,  except  that  taxes  were  deductible  only  v/hen  actually  paid,  and 
not  merely  entered  as  a  charge,  and  losses  when  actually  sustained  in  the 
year  charged  off. 


METHODS   AND    PERIODS   OF   ACCOUNTING  811 

charges  which  may  or  may  not  eventually  be  payable  at  all,  and 
as  to  which  the  question  of  liability  remains  unsettled,  and  losses 
or  charges  merely  contingent  or  indefinite  as  to  their  amount.''" 
This  is  illustrated  by  a  ruling  in  regard  to  amounts  set  aside  by 
canners  of  perishable  fruit  products  against  which  to  charge 
losses  due  to  climatic  and  other  natural  conditions  producing 
shortage  of  the  raw  products.'''^  The  treasury  department  held 
in  this  connection  that  in  general  the  statute  evidences  a  clear 
intent  to  restrict  within  the  narrowest  limits  deductions  for  ad- 
ditions to  reserves  other  than  the  reserves  of  insurance  com- 
panies required  by  law;  that  it  is  doubtful  even  whether  a  re- 
serve against  an  incurred  but  unpaid  liability  can  be  recognized, 
when  the  liability  is  at  all  indefinite ;  but  there  can  be  little  doubt 
that  a  reserve  against  a  future  loss  is  unrecognized  by  the 
statute,  and  no  doubt  at  all  that  a  reserve  against  fluctuations 
in  future  profits  has  no  standing  of  a  kind  which  would  warrant 
the  deduction  of  additions  thereto  in  computing  net  income  for 
purposes  of  taxation.''^  In  the  light  of  this  distinction  it  is  inter- 
esting to  note  the  ruling  of  the  treasury  department  that  where 
a  reserve  representing  the  estimated  amount  of  claims  which 
will  be  paid  on  account  of  loss  and  damages  to  freight  and  in- 
juries to  persons  is  adjusted  at  the  end  of  the  year  so  that  the 
balance  approximates  as  nearly  as  possible  the  amount  of  the 
claims  actually  outstanding  at  the  close  of  the  year,  such  reserve 
covers  a  contingent  liability  and  is  only  deductible  for  the  year 
when  the  claims  are  put  in  judgment  or  paid/^"  Amounts  paid 
on  account  of  loss  and  damages  to  freight  and  injuries  to  passen- 
gers may  be  regarded  in  one  sense  as  "losses"  and  in  another 

•'"'"This  is  a  shadowy  distinction.  Until  the  amount  of  a  charge  is  deter- 
mined, it  is  never  an  absolute  liability.  The  analysis  of  details  may  reverse 
the  entry. 

"'8  T.  B.  R.  13,  T.  B.  3-19-187. 

-'!)  See  A.  R.  M.  136,  T.  B.  31-21-1754. 

fio  O.  D.  879,  T.  B.  16-21-1578.  Is  the  point  of  this  ruling  the  fact  that  the 
adjustment  of  the  reserves  at  the  close  of  the  year  left  the  reserve  at  an 
amount  which  appi'oximated  the  "claivis"  (as  distinguished  from  the  actual 
liability)  outstanding  at  the  end  of  the  year?  If  in  fact  the  adjustment 
placed  the  reserve  at  an  amount  which  approximated  the  liability  of  the 
company,  according  to  extended  experience,  and  not  the  amount  of  claims 
outstanding  a  portion  of  which  would  never  be  paid,  the  ruling  would  seem 
to  neglect  the  fact  that  such  claims  may  be  reduced,  upon  a  sort  of  actuarial 
basis,  to  a  close  approximation  to  the  amount  of  actual  liability  eventually 
to  be  paid.  In  other  words,  some  of  the  total  number  of  claims  outstanding 
will  never  be  paid ;  the  amounts  of  others  will  be  reduced ;  but  it  is  possible, 
where  the  claims  are  numerous,  to  compute  the  amount  eventually  payable 
with  comparative  certainty. 


812  FEDERAL  INCOME   TAX 

sense  as  more  or  less  fixed  "expenses."  If  regarded  as  losses, 
they  are  not  deductible  until  "sustained."  Each  loss  is  sustained 
if  regarded  separately  when  put  in  judgment  or  paid.^'i  But  the 
losses,  when  regarded  in  bulk,  may  be  said  to  be  sustained  to  the 
extent  of  a  proportion  of  their  total,  based  on  previous  experi- 
ence, when  the  transaction  or  event  upon  which  they  are  founded 
occurs.  Approved  standard  accounting  methods  which  are  in- 
tended to  control  the  reporting  of  income  and  deduction  of 
losses '''-  certainly  dictate  the  allocation  of  such  losses  and 
charges  to  the  year  in  which  they  originate.  Where  embezzle- 
ment by  a  bonded  employee  occurs,  the  claim  against  the  bonding 
company  is  held  the  equivalent  of  cash  and  to  the  extent  of  such 
claim  there' is  no  loss,  even  though  recovery  against  the  bonding 
company  is  postponed  until  the  following  year.  Recoverable  in- 
surance always  reduces  a  loss,  even  though  no  collection  thereon 
is  made  until  a  subsequent  yea.rS>^  If  the  taxpayer  in  such  cases 
is  considered  to  be  in  receipt  of  his  insurance  when  his  loss 
occurs,  even  though  the  insurance  is  not  paid  until  a  later  year, 
it  would  appear  that  the  converse  proposition  must  be  true  and 
the  insurance  company  must  have  suffered  a  loss  in  the  year  of 
embezzlement  and  not  the  year  when  the  insurance  is  paid.  The 
standing  of  a  railroad  or  other  company  subject  to  claims  for 
losses  and  damages  to  freight  and  injuries  to  passengers  is  not 
dissimilar  in  principle  from  the  position  of  the  insurance  com- 
pany. If  the  amounts  of  such  loss  and  damages  are  regarded,  on 
the  other  hand,  as  "ordinary  and  necessary  expenses",  and  owing 
to  their  regularity  and  certainty  there  is  much  to  be  said  for  re- 
garding them  in  this  light,^*^  they  may  be  said  to  be  deductible 
without  reference  to  a  strict  construction  of  the  word  "sus- 
tained", such  as  trading  stamp  reserves  are  now  held  deductible.*^^ 
Again,  in  the  case  of  a  taxpayer  who  sells  automobiles  on  term 
contracts  in  order  to  insure  himself  against  losses  through  em- 

01  The  distinction  is  to  be  noted  between  the  phrase  "losses  sustained 
during  the  taxable  year"  (Revenue  Act  of  1918,  §§  214  (a)  4  and  234  (a) 
4)  and  "losses  actually  sustained  and  charged  off  within  the  year"  (Revenue 
Act  of  1916,  §  12  (a) ).  The  former  phrase  opens  the  door  to  a  more  liberal 
and  reasonable  interpretation  of  the  word  "sustained". 

62  Reg.  45,  Art.  23. 

03  Sol.  Op.  845,  T.  B.  6-19-279;  T.  B.  M.  55,  T.  B.  18-19-482. 

64Brovra  v.  City  of  Corry,  175  Pa.  St.  528,  34  Atl.  854.  The  evidence 
of  such  claims  is  inevitable;  no  railroad  can  be  operated  without  the  cer- 
tain expectation  that  such  claims  must  be  met. 

65  See  Reg.  33  Rev.,  Art.  141,  revised  by  Reg.  45,  Art.  88.  See  also  the 
ruling  in  regard  to  reserves  for  cash  discounts  which  is  not  entirely  con- 
sistent therewith  in  principle   (O.  D.  146,  T.  B.  4-19-228). 


METHODS   AND   PERIODS   OF   ACCOUNTING  813 

bezzlement  of  the  cars  or  confiscation  thereof  by  the  government 
under  the  Volstead  Act,  has  adopted  a  plan  of  carrying  his  own 
insurance,  by  collecting  premiums  from  the  purchasers  under  the 
leases  or  term  contracts  and  placing  the  money  received  into  a 
reserve  fund,  against  which  all  losses  referred  to  are  charged,  it 
has  been  held  that  if  the  taxpayer's  books  are  kept  on  a  cash 
receipts  basis,  all  amounts  received  from  the  so-called  premiums 
in  any  taxable  year  should  be  reported  as  income  in  the  return  of 
the  taxpayer  for  that  year,  or  if  his  books  are  kept  on  the  accrual 
basis,  then  in  the  year  in  which  such  amounts  accrue,  the  losses 
sustained  by  the  taxpayer  being  allowable  deductions  for  the  year 
in  which  such  losses  are  sustained.'''* 

These  rulings  illustrate  the  uncertainty  surrounding  the  en- 
tire subject  of  reserves  to  meet  liabilities  and  the  tentative  state 
of  the  regulations  relating  thereto.  The  subject  is  also  affected 
by  the  new  provision  of  the  Revenue  Act  of  1921  that  losses  may 
be  deducted  in  a  period  other  than  that  in  which  sustained  if 
necessary  in  order  clearly  to  reflect  incomes.''^  This  provision  is 
obviously  a  delegation  of  power  to  the  Commissioner  which  will 
enable  him  to  permit  the  deduction  of  losses  and  reserves  there- 
for, without  the  limitation  imposed  by  the  word  ''sustained." 

Money  Paid  Under  Mistake  of  Fact.  It  not  infrequently 
happens  that  everits  subsequent  to  an  expenditure  prove  it  to  be 
excessive  or  insufficient  in  amount.  The  parties  act  at  the  time 
of  payment  under  a  mistake  of  fact.  For  instance,  during  the 
years  1915,  1916,  and  1917,  a  company  paid  customs  duties  on 
foreign  merchandise  imported,  on  the  basis  of  an  exchange  rate 
in  excess  of  the  rate  prevailing  at  the  time  of  importation.  Dur- 
ing the  year  1919  the  company  received  a  refund  of  the  amount 
so  paid  in  excess  of  the  amount  due,  and  the  question  was  raised 
as  to  whether  the  amount  of  the  refund  was  properly  reported  as 
income  for  1919.  It  was  held  that  the  excess  duties  for  which  a 
refund  was  received  had  been  erroneously  deducted  in  computing 
net  income  for  the  years  1915,  1916,  and  1917,  respectively,  and 
did  not  represent  income  for  the  year  1919.  Accordingly  amended 
returns  for  the  respective  years  should  be  filed.""^ 

Subsequently  Discovered  Charges.  It  has  been  held  that 
liabilities  discovered  subsequently  to  the  close  of  a  taxable  period 
may  not  be  deducted  for  such  taxable  period  even  though  they 
clearly  relate  thereto.    Thus,  an  additional  surtax  imposed  by  the 

66  O.  D.  1106,  T.  B.  47-21-1929. 

67  See  Revenue  Act  of  1921,  §§  214  (a)  6,  234  (a)  4. 

68  0.  D.  741,  T.  B.  49-20-1332. 


814  FEDERAL  INCOME   TAX 

laws  of  Wisconsin  retroactively  for  the  year  1920  has  been  held 
not  to  be  deductible  under  the  federal  law  for  the  calendar  year 
1920,  because  such  surtax  was  not  a  known  liability  when  the 
books  of  the  taxpayers  liable  to  such -tax  were  closed  for  1920. 
Such  surtax  was  held  deductible  in  the  year  in  which  paid  or  in 
which  accrued,  if  the  books  of  the  taxpayers  were  kept  on  an 
accrual  basis/^^ 

Allocation  of  Deductions  to  More  Than  One  Year.  De- 
ductions may  under  certain  conditions  be  ratably  distributed  over 
more  than  one  year  by  a  taxpayer  keeping  accounts  on  the  ac- 
crual basis.  In  the  case  of  a  partnership  keeping  its  books  on  the 
accrual  basis  which  was  required  to  pay  an  injured  employee  a 
sum  in  weekly  installments  extending  over  several  years  it  was 
held  that  the  entire  sum  payable  is  not  such  an  item  as  may  be 
properly  accrued  in  its  entirety  upon  the  books  of  the  partner- 
ship at  the  time  the  award  was  rendered  for  the  purpose  of 
claiming  a  deduction  in  computing  net  income.  Only  the  install- 
ments actually  accrued  by  time  elapsed  whether  paid  or  unpaid  as 
at  the  end  of  the  taxable  year,  are  properly  deductible  in  com- 
puting net  income  for  that  year.™  Again,  the  entire  amount  of 
a  reserve,  set  aside  under  the  Ohio  Workmen's  Compensation 
Law,  which  provides  for  the  payment  of  compensation  in  weekly 
installments  but  which  also  provides  for  the  making  of  an  award 
covering  total  liability  in  death  and  permanent  disability  cases, 
would  be  allocated  to  the  years  in  which  actually  paid  and  may 
not  be  deducted  in  its  entirety  in  the  year  in  which  determined.'''^ 
A  sum  paid  in  1920  by  a  lessee  for  the  privilege  of  securing  a 
lease  to  be  effective  in  1922  is  a  proper  charge  against  the  busi- 
ness of  the  taxpayer  for  the  period  between  the  payment  thereof 
and  the  effective  date  of  the  lease,  and  should  be  apportioned  over 
that  period.'^-  An  amount  paid  by  a  baseball  club  to  another 
baseball  club  as  the  purchase  price  of  a  contract  between  such 
club  and  a  player  covering  the  services  of  the  player  for  a  period 
of  more  than  one  year  is  deductible  from  gross  income  during 
the  life  of  the  contract,  a  proportionate  part  of  the  price  paid 
being  deductible  each  year.'^'^    Where  the  amount  recoverable  or 

69  0.  D.  1118,  T.  B.  48-21-1949.  This  ruling  seems  contrary  to  the  well 
established  principle  that  statutory  deductions  being  expenditures  connected 
with  the  production  of  income  should  be  reported  so  far  as  possible  in  the 
same  period  with  the  income  with  which  they  are  connected.  See  p.  807. 
See  also  footnote  33. 

70  0.  D.  686,  T.  B.  42-20-1243. 

71  0.  D.  992,  T.  B.  33-21-1768. 

72  0.  D.  1013,  T.  B.  35-21-1793. 

73  0.  D.  836,  T.  B.  10-21-1494. 


METHODS   AND   PERIODS   OF   ACCOUNTING  815 

payable  under  a  contract  may  not  be  accurately  estimated  in  ad- 
vance, however,  and  may  vary  in  amount  in  the  several  years  ot 
performance  of  the  contract,  such  amount  may  not  be  amortized 
over  the  life  of  the  contract.'^^ 

Losses.    The  allocation  of  losses  to  the  proper  taxable  period 
is  discussed  in  another  chapter."' 

Changing  Basis  for  Computation  of  Net  Income.  If  a  taxpayer 
should  change  the  method  of  accounting  employed  in  keeping  his 
books  for  the  taxable  year  1919  or  thereafter,  he  must  before 
computing  his  income  upon  such  new  basis  for  purposes  of  taxa- 
tion secure  the  consent  of  the  Commissioner.  Application  for 
permission  to  change  the  basis  of  the  return  must  be  made  at 
least  thirty  davs  in  advance  of  the  date  of  filing  return  and  must 
be  accompanied  by  statement  specifying  the  class  of  items  dif- 
ferently treated  under  the  two  systems  and  specifying  all 
amounts  which  would  be  duplicated  or  entirely  omitted  as  a  result 

of  the  proposed  change.'^  ,,       ,    •        -p 

Doctrine  of  Election.  Where  the  taxpayer  has  the  choice  ot 
using  two  or  more  methods  of  accounting,  each  of  such  methods 
being  permissible  as  an  approved  accounting  practice,  and  adopts 
one  of  these  methods,  he  is  held  to  have  exercised  his  option  and 
he  mav  not  change  his  method,  particularly  where  it  may  have  a 
material  effect  on  his  income  for  the  year  and  distort  his  income 
as  between  different  years.  Thus,  a  wholesale  liquor  dealer  who, 
for  years  prior  to  1918,  exercised  the  option  of  including  excise 
taxes  in  cost  of  merchandise  in  calculating  inventory,  may  not 
amend  such  inventory  and  treat  such  taxes  as  business  expenses 

for  1918."^^  ^     , 

Accounting  Period:  Fiscal  Year.  The  return  of  a  taxpayei  is 
made  and  his  income  computed  for  his  taxable  year  as  a  time  unit 
which  means  his  fiscal  year,  or  the  calendar  year  if  he  has  not 
established  a  fiscal  year.^^^  The  term  fiscal  year  means  an  ac- 
counting period  of  twelve  months  ending  on  the  last  day  of  an> 
month  other  than  December.^o    No  fiscal  year  will,  however,  be 

74  0.  D.  971,  T.  B.  28-21-1723.  k;hh.«" 
7.^  See  Chapter  25.  See  paragraph  above  "Reserves  to  meet  I'^b^liti^^  • 
70  Revenue  Act  of  1921,  §212;  Revenue  Act  of  1918,  §212;  Reg.  45,  Art. 

23    as  amended  by  T.  D.  2873;  0.  D.  1113,  T.  B.  48-21-1921. 

77  A  R  M  121  T  B  16-21-1574.  This  doctrine  of  election  apphes  also 
in  ve^r^rd  to' periods  of  accounting.  See  p.  818.  It  is  applied  in  regard 
to  the   excess-profits   tax    (See   Reg.   45,   Art.   843). 

75  Reg.  45,  Art.  25.  The  taxable  year  1921  is  the  calendar  yeai  Un 
or  any  fiscal  year  ending  during  the  calendar  year  1921. 

70  R^nue  Lt  of  1921.  §  200;  Revenue  Act  of  1918,  §  200.  A  return  re- 
ceived for  a  period  ending  on  any  date  other  than  the  last  day  of  some 


816  FEDERAL  INCOME  TAX 

recognized  unless  before  its  close  it  was  definitely  established  as 
an  accounting  period  by  the  taxpayer  and  the  books  of  such  tax- 
payer were  kept  in  accordance  there  with. ■'^o  ^  taxpayer  having 
an  existing  accounting  period  which  is  a  fiscal  year  within  the 
meaning  of  the  statute  not  only  needs  no  permission  to  make  his 
return  on  the  basis  of  such  a  taxable  year,  but  is  required  to  do 
so,  regardless  of  the  former  basis  of  rendering  returns.  A  person 
having  no  such  fiscal  year  must  make  return  on  the  basis  of  the 
calendar  year.  Except  in  the  cases  of  a  return  for  the  taxable 
year  1918  and  of  a  first  return  for  income  tax,  a  taxpayer  makes 
his  return  on  the  basis  (fiscal  or  calendar  year)  upon  which  he 
made  his  return  for  the  taxable  year  immediately  preceding 
unless,  with  the  approval  of  the  Commissioner,  he  has  changed 
the  basis  of  computing  his  net  income.'^^  The  taxable  year  of  a 
taxpayer  is  either  a  fiscal  year  or  the  calendar  year,  and  all  his 
income  must  be  reported  upon  the  basis  of  the  taxable  year. 
Unless  an  individual  maintains  personal  books  of  account  in 
which  his  income  from  business  and  all  other  sources  is  reflected 
on  the  basis  of  a  fiscal  year,  he  does  not  have  a  fiscal  year  which 
can  be  recognized  as  the  basis  upon  which  his  returns  may  be 
made.^-  Where  a  corporation's  by-laws  are  silent  as  to  its  fiscal 
year  and  it  has  for  a  number  of  years  closed  its  books  twice  each 
year,  once  on  December  31,  but  has  not  "ruled  down"  its  books 
on  that  date  as  on  August  31,  returns  filed  on  the  basis  of  the 
calendar  year  have  been  held  proper  as  a  binding  exercise  of  an 
option  when  they  correctly  reflect  income,  even  though  the  col- 
lections of  the  corporation  were  substantially  confined  to  the 
period  extending  from  September  to  December  and  at  the  August 
closing  of  the  books  every  customer  carried  by  the  corporation 
was  mailed  an  itemized  statement  of  every  transaction  during 
the  preceding  twelve  months  and  this  date  was  used  by  the  cor- 
poration as  one  of  the  dates  for  the  closing  of  its  books,  the 
reason  being  that  the  work  of  getting  out  statements,  etc.,  was 
long  and  tedious  and  could  best  be  handled  during  the  summer 

month  will  not  be  accepted,  unless  it  is  a  "final  return".  (Mimeograph 
letter  to  collectors,  No.  1148.) 

80  Reg.  45,  Art.  25. 

81  Reg.  45,  Art.  25;  A.  R.  R.  391,  T.  B.  8-21-1458.  A.  R.  R.  342,  T.  B. 
50-20-1340.  For  the  rule  governing  the  computation  of  tax  in  the  case 
of  a  taxpayer  with  a  fiscal  year  beginning  in  1918  and  ending  in  1919 
see  Reg.  45,  Art.  1625;  and  in  the  case  of  a  taxpayer  with  a  fiscal  year 
beginning  in  1917  and  ending  in  1918  see  Reg.  45,  Art.  1621-4,  and  O.  D. 
71,  T.  B.  1-19-100. 

82  O.  D.  941,  T.  B.  23-21-1673. 


METHODS   AND   PERIODS   OF   ACCOUNTING  817 

months,  when  the  corporation  had  disposed  of  its  product  and 
the  office  force  was  least  busy."*-^ 

First  Returns.  The  law  makes  no  provision  for  seeking  the 
consent  of  the  Commissioner  to  the  recognition  of  a  fiscal  year, 
unless  the  taxpayer  had  previously  filed  returns  on  a  calendar 
year  basis;  but  implies  rather  that  such  fiscal  period  must  be 
used.  The  Revenue  Act  of  1918  provided^^  that  "if  a  taxpayer 
making  his  first  return  for  income  tax  keeps  his  accounts  on  the 
basis  of  a  fiscal  year  he  shall  make  a  separate  return  for  the 
period  between  the  beginning  of  the  calendar  year  in  which  such 
fiscal  year  ends  and  the  end  of  such  fiscal  year.'"'''  The  first  re- 
turn under  the  Revenue  Act  of  1918  of  a  taxpayer  who  thereto- 
fore made  returns  on  a  basis  different  from  his  accounting  period 
would  necessarily  overlap  his  next  previous  return.  The  first 
taxable  year  of  a  corporation  organized  in  1918  which  established 
a  recognized  fiscal  year  not  ending  in  1918  after  its  organization 
was  its  fiscal  year  ending  in  1919.^*^  A  newly  organized  corpora- 
tion might  file  its  return  on  a  fiscal  year  basis  without  applying 
for  permission  to  do  so,  provided  such  basis  was  definitely  estab- 
lished and  the  books  kept  in  accordance  therewith  prior  to  the 
close  of  the  first  fiscal  year.*^" 

Change  in  Accounting  Period.  If  a  taxpayer  changes  his 
accounting  period,  and  not  merely  his  taxable  year  to  conform 
with  his  existing  accounting  period,  he  must  as  soon  as  possible 
give  to  the  collector  for  transmission  to  the  Commissioner  writ- 
ten notice  of  such  change  and  of  his  reasons  therefor.  The  Com- 
missioner will  not  approve  a  change  of  the  basis  of  computing  net 
income  unless  such  notice  is  given  at  a  time  which  is  both  (a)  at 
least  thirty  days  before  the  due  date  of  the  taxpayer's  return  on 
the  basis  of  his  existing  taxable  year  and  (b)  at  least  thirty  days 
before  the  due  date  of  his  separate  return  for  the  period  between 
the  close  of  the  existing  taxable  year  and  the  date  designated  as 
the  close  of  the  proposed  taxable  year.  If  the  change  in  the  basis 
of  computing  the  net  income  of  the  taxpayer  is  approved  by  the 
Commissioner,  the  taxpayer  will  thereafter  make  his  returns 
upon  the  basis  of  the  new  accounting  period  in  accordance  with 

83  A.  R.   R.   501,  T.  B.  21-21-1646. 

S4  This  provision  is  not  contained  in  the  Revenue  Act  of  1921.  It  was 
an  unnecessary  provision. 

85  Revenue  Act  of  1918,  §§  226  and  232;  Reg.  45,  Art.  25.  The  method 
of  adjusting  the  tax  in  such  case  is  discussed  in  Reg.  45,  Arts.  1621-4. 
§205  of  the   Statute  is  applicable;   §226  has  no  application. 

86  S.  930,  T.  B.  1-19-3. 

87  0.  D.  404,  T.  B.  8-20-740. 


818  FEDERAL  INCOME  TAX 

the  requirements  of  the  statute  discussed  elsewhere.'^'^  A  com- 
pany which  earned  a  large  income  during  the  fiscal  year  ended 
September  30,  1918,  and  suffered  a  net  loss  during  the  year 
ended  September  30,  1919,  will  not  be  permitted  to  change  its 
accounting  period  for  1918  to  the  calendar  year  basis  so  as  to  be 
allowed  to  deduct  the  net  loss  from  1918  income.  The  accounting 
period  for  which  the  tax  liability  had  accrued  and  the  method  of 
accounting  during  that  period  were  accomplished  facts  which 
could  not  thereafter  be  changed  by  the  Commissioner.^^  A  tax- 
payer having  made  a  return  upon  the  basis  of  the  business  year 
best  adapted  to  reflect  his  true  income  should  not  be  permitted 
to  depart  from  that  return  year.^'^  Permission  will  not  be  granted 
to  an  employee  of  a  partnership  (not  a  partner)  receiving  part  of 
his  salary  in  the  form  of  a  share  in  the  profits  of  the  partner- 
ship to  make  his  returns  upon  the  basis  of  the  fiscal  year  of  the 
partnership.^!  Where  a  taxpayer  has  been  permitted  to  change 
his  accounting  period  from  the  calendar  to  a  fiscal  year  and 
renders  a  return  for  the  period  from  January  1  to  the  end  of 
such  fiscal  year,  both  the  normal  tax  and  the  surtax  will  be  com- 
puted^ as  though  the  return  were  filed  for  a  full  twelve-month 
period  after  the  reduction  of  the  exemptions  and  credits.^^  Ap- 
plications for  a  change  in  accounting  period  must  be  made  by  the 
taxpayer  or  his  duly  authorized  attorney  or  agent.^-' 

Fiscal  Years  1920-1921  and  1921-1922.  The  provisions  of  the 
Revenue  Act  of  1918  and  the  Revenue  Act  of  1921  with  regard 
to  fiscal  years  are  substantially  the  same.^^  The  regulations 
issued  under  such  corresponding  provision  of  the  1918  Law  were 
complicated  by  the  fact  that  individuals  were  not  permitted  to 
make  their  1917  returns  on  a  fiscal  year  basis.  Under  the  1921 
Law  it  is  to  be  noted  that  in  calculating  tax  for  a  portion  of  a 
fiscal  year  falling  within  1921,  the  Revenue  Act  of  1921  as  in 
force  on  December  31,  1921,  is  to  be  regarded;  in  calculating  the 
tax  for  a  portion  of  a  fiscal  year  falling  within  1922,  the  Revenue 

S'^Reg.  45,  Art.  26,  as  amended  by  T.  D.  3032,  T.  B.  26-20-1026;  Sol.  Op. 
5,  T.  B.  24-20-996.  "Due  date"  means  original  due  date,  not  the  date 
to  which  an  extension  is  granted.      (O.  D.  205,  T.  B.  10-19-355.) 

89  T.  D.  3044,  T.  B.  30-20-1087;  see  also  A.  R.  R.  391,  T.  B.  8-21-1458; 
A.  R.  R.  342,  T.  B.  50-20-1340. 

90  T.  B.  R.  37,  T.  B.  11-19-370. 

91  O.  D.  696,  T.  B.  43-20-1257. 

92  0.  D.  723,  T.  B.  45-20-1296. 

93  M.  2738,  T.  B.  14-21-1541. 

9-iCf.  Revenue  Act  of  1921,  §205;  Revenue  Act  of  1918,  §205.  Changes 
are  made  necessary,  of  course,  in  the  case  of  personal  service  corporations 
by  the  abolition  of  that  class  of  corporation  as  of  December  31,  1921. 


METHODS   AND   PERIODS    OF   ACCOUNTING  819 

Act  of  1921  as  in  effect  on  January  1,  1922,  is  to  be  regarded. 
The  Revenue  Act  of  1916,  as  amended,  and  the  Revenue  Act  of 

1917,  were  different  laws  from  the  Revenue  Act  of  1918  and  con- 
tained different  provisions  for  1917  and  1918  respecting  gross 
income  and  deductions  and  credits,  as  well  as  rates;  the  Revenue 
Act  of  1918  is  a  different  law  from  the  Revenue  Act  of  1921, 
and  contains  different  provisions  respecting  gross  income  and 
deductions  and  credits,  but  the  rates  are  the  same  for  1920  and 
1921.  On  the  other  hand,  the  provisions  respecting  gross  in- 
come and  deductions  and  credits  were  the  same  in  the  Revenue 
Act  of  1918  for  1918  and  1919,  though  the  rates  imposed  for  the 
two  years  were  different;  in  the  Revenue  Act  of  1921  the  pro- 
visions respecting  gross  income  and  deductions  and  credits  are 
in  general  the  same  for  1921  and  1922,  but  the  rates  imposed  for 
the  two  years  are  different.  Special  complications  will  arise 
under  the  present  law  in  the  case  of  insurance  companies  with 
fiscal  years  other  than  the  calendar  year.  The  regulations  issued 
under  the  1918  Law  are  given  in  the  following  paragraphs;  in 
general  they  should  be  followed  under  the  present  law.  How- 
ever, the  rule  in  the  case  of  an  individual's  fiscal  year  ending  in 
1921  will  correspond  to  the  regulation  issued  under  the  1918  Law 
in  the  case  of  a  corporation  with  a  fiscal  year  ending  in  1918. 

Fiscal  Year  of  Corporation  Ending  in  1918.  The  method 
provided  for  computing  the  tax  for  a  fiscal  year  beginning  in  1917 
and  ending  in  1918  is  as  follows:  (a)  The  tax  attributable  to 
the  calendar  year  1917  is  found  by  computing  the  income  of  the 
taxpayer  and  the  tax  thereon  in  accordance  with  Title  I  of  the 
Revenue  Act  of  1916,  as  amended,  and  Title  I  of  the  Revenue 
Act  of  1917,  as  if  the  fiscal  year  was  the  calendar  year  1917,  and 
determining  the  proportion  of  such  tax  which  the  proportion  of 
the  fiscal  year  falling  within  the  calendar  year  1917  is  of  the  full 
fiscal  year;  (b)  the  tax  attributable  to  the  calendar  year  1918  is 
found  by  computing  the  income  of  the  taxpayer  and  the  tax 
thereon  in  accordance  with  the  present  statute,  as  if  the  fiscal 
year  was  the  calendar  year  1918,  and  determining  the  proportion 
of  such  tax  which  the  portion  of  such  fiscal  year  falling  within 
the  calendar  year  is  of  the  full  fiscal  year;  and  (c)  the  tax  for 
the  fiscal  year  is  found  by  adding  the  tax  attributable  to  the 
calendar  year  1917  and  the  tax  attributable  to  the  calendar  year 

1918.  If  a  corporation  made  its  return  for  the  taxable  year  1917 
on  the  calendar  year  basis  and  for  the  taxable  year  1918  on  a 
fiscal  year  basis,  the  tax  attributable  to  the  calendar  year  1917 
need  not  again  be  computed  and  the  tax  attributable  to  the 


820  FEDERAL  INCOME   TAX 

calendar  year  1918  as  above  computed  will  be  the  tax  of  the  cor- 
poration for  the  portion  of  such  fiscal  year  falling  within  the 
calendar  year  1918.  A  personal  service  corporation  is  not  re- 
quired to  pay  the  tax  attributable  to  the  calendar  year  1918, 
since  for  that  year  it  is  treated  substantially  like  a  partnership 
for  the  purposes  of  taxation.*^'"* 

Deductions  and  Credits  in  the  Case  of  Corporation  Fiscal 
Year  Ending  in  1918.  Net  losses  deductible  from  net  income 
of  the  fiscal  year  under  the  Revenue  Act  of  1918  may  be  deducted 
in  computing  the  tax  attributable  to  the  calendar  year  1917,  as 
well  as  in  computing  the  tax  attributable  to  the  calendar  year 
1918.  In  computing  the  tax  attributable  to  the  calendar  year  1917 
the  net  income  computed  for  the  entire  period  under  Title  I  of  the 
Revenue  Act  of  1916,  as  amended,  and  Title  I  of  the  Revenue 
Act  of  1917,  may  be  credited  with  the  excess-profits  tax  com- 
puted for  the  entire  period  under  Title  II  of  the  Revenue  Act  of 
1917.  In  computing  the  tax  attributable  to  the  calendar  year 
1918  the  net  income  computed  for  the  entire  period  under 
the  present  statute  may  be  credited  with  the  war-profits  and 
excess-profits  tax  computed  for  the  entire  period  under  Title  III 
of  the  Revenue  Act  of  1918  at  the  rates  prescribed  for  1918. 
Amounts  previously  paid  by  the  taxpayer  on  account  of  the  in- 
come tax  for  such  fiscal  year  may  be  credited  towards  the  pay- 
ment of  the  income  tax  imposed  for  such  fiscal  year  by  the 
Revenue  Act  of  1918.  Any  excess  will  be  credited  or  refunded 
to  the  taxpayer.^c 

Fiscal  Year  of  Individual  Ending  in  1918.  Since  under 
the  law  applicable  to  the  calendar  year  1917  individuals  were  not 
permitted  to  make  returns  on  the  fiscal  year  basis,  the  tax  of  an 
individual  for  that  part  of  a  fiscal  year  ending  in  1918  attributable 
to  the  calendar  year  1917  has  already  been  included  in  the  tax 
for  such  calendar  year  and  need  not  ordinarily  again  be  com- 
puted. The  tax  for  that  part  of  the  year  attributable  to  the 
calendar  year  1918  is  found  by  computing  the  income  of  the  tax- 
payer for  the  taxable  year  and  the  tax  thereon  in  accordance  with 
the  Revenue  Act  of  1918  as  if  the  taxable  year  was  the  calendar 
year  1918,  and  determining  the  proportion  of  such  tax  which  the 
portion  of  such  fiscal  year  falling  within  the  calendar  year  is  of 
the  full  fiscal  year.^^ 

95  Reg.  45,  Art.  1622. 

96  Reg.  45,  Art.  1623. 

97  Reg.  45,  Art.  1624. 


methods  and  periods  of  accounting  821 

Fiscal  Year  of  Corporation  or  Individual  Ending  in  1919. 
The  method  provided  for  computing  the  tax  for  a  fiscal  year  be- 
ginning in  1918  and  ending  in  1919  is  as  follows:  (a)  The  tax 
attributable  to  the  calendar  year  1918  is  found  by  computing  the 
income  of  the  taxpayer  and  the  tax  thereon  in  accordance  v^^ith 
the  Revenue  Act  of  1918  as  if  the  fiscal  year  was  the  calendar 
year  1918,  and  determining  the  proportion  of  such  tax  which  the 
portion  of  such  fiscal  year  falling  within  the  calendar  year  is  of 
the  full  fiscal  year;  (b)  the  tax  attributable  to  the  calendar  year 
1919  is  found  by  computing  the  income  of  the  taxpayer  and  the 
tax  thereon  in  accordance  with  the  Revenue  Act  of  1918  as  if  the 
fiscal  year  was  the  calendar  year  1919,  and  determining  the  pro- 
portion of  such  tax  which  the  portion  of  such  fiscal  year  falling 
within  the  calendar  year  is  of  the  full  fiscal  year;  and  (c)  the 
tax  for  the  fiscal  year  is  found  by  adding  the  tax  attributable  to 
the  calendar  year  1918  and  the  tax  attributable  to  the  calendar 
year  1919.'Js 

Personal  Service  Corporations.  It  is  expressly  provided 
by  the  present  law  that  the  amount  of  tax  to  be  paid  by  personal 
service  corporations  with  fiscal  years  ending  in  1922  shall  be  lim- 
ited to  a  tax  for  that  part  of  such  fiscal  years  falling  within  the 
calendar  year  1922.  This  provision  is  rendered  necessary  by  the 
fact  that  personal  service  corporations  were  not  taxable  as  such 
between  January  1,  1918,  and  December  31,  1921.9^ 

9SReg.  45,  Art.  1625. 

99  Revenue  Act  of  1921,  §205  (b). 


CHAPTER  34 

RETURNS  OF  INCOME 

For  the  purpose  of  assessing  the  tax,  a  return  of  income  is 
required,  showing  specifically  the  items  of  gross  income  and  the 
deductions  and  credits  allowed  by  law.  This  chapter  deals  with 
the  general  provisions  relating  to  returns  of  income,  and  does 
not  cover  the  annual  or  special  returns  required  with  respect  to 
withholding  at  the  source,  information  at  the  source  or  other 
matters.  For  a  discussion  of  such  returns  attention  is  directed 
to  chapters  on  the  respective  subjects. 

By  Whom  Filed.  The  1921  Law,  like  the  Revenue  Act  of  1918, 
requires  a  return  of  income  to  be  filed  by  every  individual  having 
a  net  income  for  the  taxable  year  of  $1,000  or  over,  if  single  or 
if  married  and  not  living  with  husband  or  wife,  or  of  $2,000  or 
over,  if  married  and  living  with  husband  or  wife.^  In  addition, 
the  present  law  requires  that  a  return  shall  be  filed  by  every 
individual  having  a  gross  income  for  the  taxable  year  of  $5,000 
or  over,  regardless  of  the  amount  of  his  net  income.-  A  return 
is  required  of  every  fiduciary  ^  (with  the  exception  of  receivers 
appointed  by  authority  of  law  in  possession  of  part  only  of  the 
property  of  an  individual)  or  at  least  one  of  the  joint  fiduciaries 
for  the  individual,  estate  or  trust  for  which  he  acts  (1)  if  the 
net  income  of  such  individual  is  $1,000  or  $2,000  or  the  gross 
income  is  $5,000  ^  as  indicated  above  or  (2)  if  the  net  income 
of  such  estate  or  trust  is  $1,000  or  over  or  if  any  beneficiary 
of  such  estate  or  trust  is  a  nonresident  alien.-'  Minors  are  ex- 
pressly required  to  make  returns.  The  return  of  an  incompetent 
must  be  filed  for  him  by  his  committee.  A  return  is  required 
from  every  partnership  and  from  every  corporation  and  personal 
service  corporation  subject  to  the  tax  regardless  of  whether  or 
not  they  have  been  in  receipt  of  any  income  during  the  taxable 
year.6 

1  Revenue  Act  of  1921,  §223;  Revenue  Act  of  1918,  §223. 

2  Revenue  Act  of  1921,  §  (a)   3. 

3  See  Chapter  6  for  a  definition  of  the  term  "fiduciary". 

4  The  provision  as  to  returns  when  the  gross  income  is  $5,000  was  not 
contained  in  the  1918  Law. 

5  Revenue  Act  of  1921,  §225.  See  Revenue  Act  of  1918,  §225;  Reg.  45 
Art.  421. 

6  Revenue  Act  of  1921,  §§224  and  239;  Revenue  Act  of  1918,  §§224 
and  239. 

822 


RETURNS  OF  INCOME  823 

Individual  Returns.  Every  individual  whose  net  income  as 
defined  in  the  statute  is  $1,000  or  over  for  the  taxable  year  must 
make  a  return  of  income  unless  married  and  living  with  husband 
or  wife,  in  which  case  a  return  must  be  made  if  the  net  income 
is  over  $2,000.  Every  individual  with  a  gross  income  for  the 
taxable  year  of  $5,000  or  over,  must  make  a  return,  regardless 
of  the  amount  of  his  net  income.  Individuals  having  less  than 
the  above  amounts  of  income  may  be  required  to  make  returns 
or  statements  sufficient  to  satisfy  the  Commissioner  that  they 
are  not  liable  to  tax."  The  return  must  be  for  the  taxable  year, 
whether  calendar  or  fiscal.  Whether  or  not  an  individual  is  the 
head  of  a  family  or  has  dependents  is  immaterial  in  determining 
his  liability  to  render  a  return.^  Under  the  1918  Law,  the  in- 
dividual return  was  made  on  Form  1040  (revised),  except  that 
it  might  be  on  Short  FoiTn  1040a  (revised)  where  the  net  in- 
come did  not  exceed  $5,000  and  the  net  income  subject  to  the  nor- 
mal tax,  that  is,  after  applying  the  personal  exemption  and  other 
credits,  did  not  exceed  $4,000.  The  forms  are  provided  by  the 
Commissioner  and  may  be  had  from  the  collectors  of  the  several 
districts. 

Husband  and  Wife.  A  husband  and  wife  living  together 
may  make  a  single  joint  return,  in  which  case  the  tax  will  be 
computed  on  the  aggregate  income.^  If  a  husband  and  wife,  liv- 
ing together,  have  separate  estates,  the  income  from  both  may 
be  reported  in  one  return,  but  under  the  1918  Law  the  amount 
of  income  of  each,  and  the  full  name  and  address  of  both,  was 
required  to  be  shown  in  such  return.  Ordinarily,  the  hus- 
band, as  the  head  and  legal  representative  of  the  household,  and 
general  custodian  of  its  income,  should  make  the  return  of  the 
aggregate  income  of  himself  and  his  wife.  Unless  the  wife  files 
a  separate  return  of  income  or  joins  with  her  husband  in  a  re- 
turn which  sets  forth  her  income  separately,  her  husband  should 
include  in  his  return  the  income  accruing  to  the  wife  from 
services  rendered  by  her  or  the  sale  of  products  of  her  labor. 
If,  however,  the  wife  does  not  disclose  her  income  to  the  husband, 
each  may  make  a  return,  in  which  case  the  personal  exemption 
may  be  divided  between  the  two  in  such  proportions  as  they 
agree  upon.  If  a  husband  and  wife  living  together  have  an 
aggregate  net  income  of  $2,000  or  over,  or  an  aggregate  gross 

7  Revenue   Act   of    1921,   §1307;    Revenue    Act   of    1918,    §1305. 

8  Revenue  Act  of  1921,  §223;  Revenue  Act  of  1918,  §223;  Reg.  45,  Art. 
401. 

9  Revenue  Act  of  1921,  §222    (b). 


824  FEDERAL  INCOME  TAX 

income  of  $5,000  or  over,  a  return  or  returns  are  required.^'' 
If  either  husband  or  wife  separately  had  an  income  equal  to  or  in 
excess  of  $2,000  a  return  was  required  under  the  1918  Law.  If 
the  aggregate  income  of  both  was  $2,000  or  more,  the  treasury- 
department  required  a  return,  although  neither  might  have  an 
income  of  $2,000.1^  The  treasury  department  has  ruled  that  a 
husband  and  wife  living  together  may,  at  their  option,  file 
separate  returns  of  income  or  a  single  joint  return.  If  husband 
and  wife  living  together  file  a  single  joint  return  of  income, 
such  return  is  treated  as  the  return  of  a  taxable  unit  and  the 
income  disclosed  by  the  return  is  subject  to  both  normal  and 
surtax  as  though  the  return  were  that  of  a  single  individual. 
If  a  husband  or  wife  has  allowable  deductions  for  any  taxable 
year  in  excess  of  his  or  her  gross  income  for  such  year,  such  ex- 
cess may,  if  the  husband  and  wife  are  living  together  and  a 
single  joint  return  of  income  is  filed,  be  deducted  from  the  net 
income  of  the  other  spouse  for  the  purpose  of  computing  both 
the  normal  and  surtax.^^  It  was  held  under  the  1918  Law  that 
when  the  net  income  of  one  spouse  was  in  excess  of  $2,000  but 
the  other  had  allowable  deductions  which  if  applied  against  this 
net  income  would  result  in  making  the  figure  representing  the 
aggregate  net  income  of  both  less  than  $2,000,  no  return  need  be 
filed.13  A  net  loss  of  one  spouse  may  be  deducted  from  the  in- 
come of  the  other.i*  Where  husband  and  wife  clearly  indicate 
on  a  single  return  the  net  income  of  each,  such  a  return  does 
not  necessarily  constitute  a  joint  return.  It  is  a  matter  of  intent. 
Having  separated  their  respective  incomes,  in  the  absence  of  a 
showing  to  the  contrary,  the  presumption  is  that  they  intended 
to  file  separate  returns  of  income,  but  that  for  convenience  they 
have  used  one  form.  In  such  case  both  the  normal  and  surtax 
should  be  computed  on  the  separate  income  of  each.  This  pre- 
sumption is,  however,  overcome  if  the  tax  has  been  computed  by 
the  taxpayer  on  the  combined  net  income,  in  which  case,  even 
though  their  incomes  have  been  separated  and  can  be  identified, 
the  return  is  held  to  be  a  joint  return  and  both  the  normal  and 
surtax  will  be  assessed  on  the  basis  of  combined  net  income.^^ 
A  husband  and  wife  may  elect  to  file  a  joint  return  one  year  and 
separate  returns  the  next,  regardless  of  whether  such  election  re- 

10  Revenue  Act  of  1921,  §  222    (b) . 

11  Reg.  45,  Arts.  401,  305.     See  Revenue  Act  of  1921,  §216   (c). 

12  Sol.   Op.  90,  T.  B.  7-21-1452. 

13  O.  D.  1005,  T.  B.  34-21-1784. 

14  Letter   from   treasury  department  dated   February   3,    1921 ;    L    T.    S. 
1921,  H  2720. 

15  0.  D.  960,  T.  B.  26-21-1708. 


RETURNS  OF  INCOME  825 


suits  in  a  benefit  to  them  or  a  benefit  to  the  government.^"  Where 
husband  and  wife  have  filed  separate  returns  m  the  past  they 
are  not  precluded  from  filing  amended  joint  returns,  but  any 
claim  for  refund  or  credit  arising  therefrom  must  be  filed  withm 
the  period  of  limitation  prescribed  by  statute.^'  Where  a  hus- 
band and  wife  file  separate  returns  of  income,  one  of  them  be- 
ing filed  in  time  and  the  other  delinquent,  such  returns  are  not 
supplemental  of  each  other  and  delinquency  must  be  answered  for 
by  the  one  in  connection  with  whose  return  it  occurred.!^ 

Minors      An  individual  under  twenty-one  years  of  age,  or 
under  the  statutory  age  of  majority  where  he  lives,  whatever  it 
may  be,  is  required  to  render  a  return  of  income  if  he  has  a 
net  income  of  his  own  of  $1,000  or  over  or  a  gross  income  of 
$5  000  or  over  for  the  taxable  year.    If  a  minor  has  been  eman- 
cipated by  his  parent,  his  earnings  are  his  own  income,  and  such 
earnings,  regardless  of  amount,  are  not  required  to  be  included 
in  the  return  of  the  parent.    If  the  aggregate  of  the  net  income  of 
a  minor  from  any  property  which  he  possesses,  and  from  any 
funds  held  in  trust  for  him  by  a  trustee  or  guardian,  and  from 
his  earnings  in  case  he  has  been  emancipated,  is  at  least  ^1,0UU, 
or  his  gross  income  is  $5,000,  a  return  as  in  the  case  of  any  other 
individual  must  be  made  by  him,  or  by  his  guardian,  or  some 
other  person  charged  with  the  care  of  his  person  or  property  for 
him      If,  however,  a  minor  has  not  been  emancipated  by  his 
parent    who   appropriates   or  may  appropriate  his   earnings, 
such  earnings,  regardless  of  amount,  are  income  of  the  parent 
and  not  of  the  minor  for  the  purpose  of  the  normal  tax  and 
surtax     In  the. absence  of  proof  to  the  contrary,  a  parent  will 
be  assumed  not  to  have  emancipated  his  minor  child  and  must 
include  in  his  return  any  earnings  of  the  minor.^^     Where  a 

16  0.  D.  968,  T.  B.  27-21-1715. 

17  O.  D.  880,  T.  B.  16-21-1580. 

10  rS  11  ATtltSs,  422  as  amended  by  T.  D.  3110,  T.  B.  2-21-1390. 

At  common  law,  the  age  at  which  an  infant  male  or  female  reaches  full 
majority  is  twenty-one  years.  This  rule  is  still  almost  universal  by  statute 
Tn  the  Le  of  males  but  in  Arkansas,  California  Colorado,  Idaho  Ilhno.s 
Iowa,  Kansas,  Maryland,  Minnesota,  Missouri,  Nebraska,  Nevada,  Noith 
Dakota,  Ohio,  Oregon,  South  Dakota,  Vermont  and  Washington  the  age  oi 
majority  as  to  females,  at  least  for  some  purposes,  has  been  fixed  at  eighteen 
Tars  Married  infants,  male  or  female,  are  considered  adults,  whatever 
their  age,  in  Iowa,  Texas  and  Louisiana.  Married  female  infants  are 
considered  adults,  whatever  their  age,  in  Maryland,  Oregon  and  Texas, 
and  in  Alabama  if  over  eighteen  and  Nebraska  if  over  sixteen  years  of  age. 
A  married  female  infant  is  considered  an  adult  in  Washington,  whatever 
her  age,  provided  her  husband   has   attained   his   legal   majority.     i.man- 


826  FEDERAL   INCOME   TAX 

married  man  has  two  sons  aged  17  and  20,  each  earning  over 
$1,000  per  year  and  both  wholly  dependent  upon  their  father 
who  appropriates  their  entire  earnings,  merely  giving  them 
spending  money  and  carfare  to  take  them  to  and  from  their 
work,  it  has  been  held  that  inasmuch  as  both  are  minors  and 
have  not  been  emancipated,  the  entire  amount  of  their  earnings, 
together  with  his  own  income,  should  be  reported  in  the  father's 
return.-"  Where  a  father  has  made  a  bona  fide  and  absolute 
gift  of  property  to  his  minor  child,  the  income  therefrom  need 
not  be  included  in  the  father's  return  of  gross  income  even 
though  the  father  administers  the  property  and  collects  the  in- 

cipation  is  not  an  exact  term.  (Dunks  v.  Grey,  3  Fed.  862,  865.)  It  is 
to  be  determined  upon  the  peculiar  facts  and  circumstances  of  each  case 
and  is  never  presumed  (Brosius  v.  Barker,  154  Mo.  App.  657;  136  S.  W. 
19).  Emancipation  is  the  relinquishment  by  the  parent  of  control  and 
authority  over  his  child,  conferring  on  the  child  the  right  to  his  earnings 
and  extinguishing  the  parents'  legal  duty  of  support.  (Rounds  Bros.  v. 
McDaniel,  133  Ky.  669;  118  S.  W.  956,  958.)  Emancipation  may  be  com- 
plete or  incomplete.  Complete  emancipation  is  an  entire  surrender  of  all 
the  rights  to  the  care,  custody  and  earnings  of  the  child,  as  w^ell  as  a 
renunciation  of  parental  duties,  and  the  test  to  be  applied  is  the  preser- 
vation or  destruction  of  the  parental  and  filial  relationship.  (Brosius  v. 
Barker,  Supra.)  Emancipation  may  also  be  express  or  implied:  It  is 
express  when  the  parent  voluntarily  agrees  with  the  child,  who  is  able 
to  take  care  of  and  provide  for  himself,  that  he  may  go  from  home,  earn 
his  own  living,  and  control  his  earnings,  or  when  the  father  voluntarily 
transfers  the  custody  and  keeping  of  the  child  to  another.  An  express 
emancipation  cannot  be  renounced  by  the  parent.  An  implied  emancipation 
results  where  the  parent  by  his  acts  or  conduct,  impliedly  consents  that 
the  minor  may  leave  home  and  shift  for  himself;  the  father,  under  these 
circumstances,  however,  being  authorized  to  renounce  the  same  within 
a  reasonable  time.  (Rounds  Bros.  v.  McDaniel,  Supra.)  Living  separately 
from  the  family  does  not  necessarily  establish  a  child's  emancipation. 
(Sherburne  v.  Hartland,  37  Vt.  528.)  The  better  rule  is  that  an  infant 
husband  is  entitled  to  his  own  wages  so  far  as  they  are  necessary  to  the 
support  of  his  wife  and  children,  even  though  he  married  without  the 
consent  of  his  father.  (Commonwealth  v.  Graham,  157  Mass.  73;  See  also: 
Bristor  v.  Chicago  &  N.  W.  Ry.  Co.,  128  Iowa,  479,  104  N.  W.  487;  Alex- 
andria V.  Bethlehem,  16  N.  J.  L.  119;  In  re.  Dunavant,  96  Fed.  542.) 
Although  under  the  common  law  a  father  is  entitled  to  the  services  of  his 
unemancipated  minor  children  (The  Hattie  Law,  14  Fed.  880)  and  to 
money  paid  them  for  such  services  by  others  (Allen  v.  Allen,  60  Mich. 
635,  27  N.  W.  702),  he  is  not  entitled  to  his  children's  income  from  sep- 
arate estates  (Wheeler  v.  St.  Joseph,  31  Kans.  640,  3  Pac.  297;  Hillebrant 
V.  Brewer,  6  Tex.  45;  Grangiac  v.  Arden,  10  Johns.  (N.  Y.)  293;  Boobier 
v.  Boobier,  39  Maine  406;  Mears  v.  Bickford,  55  Maine  528).  When  a 
father  receives  income  from  his  children's  separate  estates  he  must  account 
therefor  as  a  trustee.  See  Darlington  v.  Turner,  202  U.  S.  195. 
20  0.  D.  797,  T.  B.  6-21-1436. 


RETURNS  OF  INCOME  827 

come  for  the  child.  In  such  a  transaction  there  is  no  presump- 
tion that  the  gift  is  or  is  not  bona  fide,  but  the  burden  will  be 
upon  the  father  in  each  case  to  show  that  it  is  an  absolute  gift 
to  the  child.2i 

Incompetents.  A  fiduciaiy  acting  as  the  committee  of  an  in- 
sane person  having  an  income  of  $1,000  or  $2,000,  according  to 
the  marital  status  of  such  person,  or  a  gross  income  of  $5,000, 
must  make  a  return  for  such  incompetent  (under  the  1918  Law 
on  Form  1040  (revised)  or  1040A  (revised),  according  to  the 
amount  of  net  income),  and  pay  the  tax.-- 

Agents.  The  law  provides  that  if  a  taxpayer  is  unable  to 
make  his  own  return,  the  return  shall  be  made  by  a  duly 
authorized  agent,  or  by  the  guardian  or  other  person  charged 
with  the  care  of  the  person  or  property  of  such  taxpayer.-"' 
If  the  return  is  made  by  the  agent,  the  reason  therefor  must 
be  stated.-^  If  the  return  is  made  by  an  agent,  when  by  reason 
of  illness,  absence  or  nonresidence  the  person  liable  for  the  re- 
turn is  unable  to  make  it,  the  agent  assumes  the  responsibility 
for  making  the  return  and  incurs  liability  to  the  specific  penal- 
ties provided  for  erroneous,  false  or  fraudulent  returns.-^  There 
may  be  a  fiduciary  relationship  between  an  agent  and  the  prin- 
cipal, but  the  word  ''agent"  does  not  denote  a  "fiduciary"  for 
purposes  of  the  income  tax.-"  Unless  otherwise  provided,  there- 
fore, the  principal  and  not  the  agent  is  subject  to  the  liability 
under  the  law.-'^  Notice  of  failure  to  make  return  may  be  served 
upon  an  agent.  Upon  such  notice  the  agent  will  be  permitted  to 
file  evidence  with  the  collector  showing  that  the  individual  for 
whom  he  acts  did  not  receive  taxable  income  during  the  year, 
or  that  the  agent  filed  the  return  with  some  other  collector,  as 
provided  by  law.-^ 

Corporation,  Fiduciary  and  Partnership  Returns.  The  subject 
of  returns  by  corporations,  including  new  provisions  regarding 
consolidated  returns  by  aflftliated  corporations  and  the  subject  of 
returns  by  partnerships  and  fiduciaries,  are  discussed  in  previous 
chapters. 29 

21  Sol.  Op.  14,  T.  B.  31-20-1100. 

22  Reg.  45,  Art.  422. 

2"'.  Revenue  Act  of  1921,  §223;   Revenue  Act  of  1918,  §223. 

24  See  Form  1040   (used  under  the  1918  Law). 

25  Reg.  45,  Art.  402. 

26  Reg.  33  Rev.,  Art.  29. 
2TT.  D.  2137. 

28  Reg.  33,  Art.  18. 

29  See  Chapters  10,  8  and  6. 


828  FEDERAL  INCOME  TAX 

Where  Returns  Are  Filed.  Returns  of  income  must  be  deliv- 
ered or  mailed  to  the  collector  for  the  district  of  the  legal  resi- 
dence or  principal  place  of  business  of  the  person  making  the 
return.  Persons  having  no  domicile  or  place  of  business  in  the 
United  States,  and  persons  in  the  military  or  naval  service  of  the 
United  States,  may  file  their  returns  of  income  with  the  collector 
at  Baltimore.'^o  Although  the  law  permits  the  return  to  be  filed 
in  either  one  of  the  two  districts  indicated  above,  the  treasury 
department  desires,  for  administrative  purposes,  that  the  re- 
turn be  filed  in  the  district  in  which  the  individual  resides.^^ 

When  Filed.  Except  in  the  case  of  nonresident  aliens  and  for- 
eign corporations,  returns  of  income  must  be  made  on  or  before 
the  fifteenth  day  of  March  following  the  taxable  year,  except 
that  returns  on  the  basis  of  a  fiscal  year  other  than  the  calendar 
year  must  be  made  on  or  before  the  fifteenth  day  of  the  third 
month  following  the  close  of  the  fiscal  year.  In  the  case  of  non- 
resident aliens  and  foreign  corporations,  returns  of  income  are 
made  on  or  before  the  fifteenth  day  of  June  in  the  case  of  a 
calendar  year  or  on  or  before  the  fifteenth  day  of  the  sixth 
month  following  the  close  of  the  fiscal  year  if  the  taxpayer  re- 
ports on  a  fiscal  year  basis.^^  Under  the  1918  Law  all  returns 
of  income  were  made  on  or  before  the  fifteenth  day  of  the 
third  month  following  the  close  of  the  taxpayer's  taxable  year.^^ 
The  dates  above  indicated  will  be  the  primary  due  dates  for  all  re- 
turns of  income.  Unless  an  extension  of  time  is  obtained,  the 
taxpayer  will  be  held  delinquent  if  his  return  is  not  filed  on  or 
before  the  primary  date  and  will  be  subject  to  the  25%  additional 
tax  and  the  penalties  provided  by  the  law.^*  The  rule  in  regard 
to  the  time  for  filing  returns  upon  the  death  of  a  taxpayer  or  the 
termination  of  a  trust  is  set  forth  elsewhere.^^ 

30  Revenue  Act  of  1921,  §227;  Revenue  Act  of  1918,  §227;  Reg.  45, 
Art.  448. 

31  Letter  from  treasury  department  dated  December  17,  1914 ;  I.  T.  S. 
1918,  ^  596.  The  treasury  department  recognizes  that  the  individual  has 
the  right  to  choose  one  of  two  districts,  where  he  resides  in  one  and  does 
business  in  another,  and  the  filing  in  either  district  will  be  a  proper  com- 
pliance with  the  law.  For  the  year  1913  the  treasury  department  re- 
quested the  filing  of  returns  in  the  district  in  which  the  individual's  prin- 
cipal place  of  business  was  located.  This  threw  an  undue  burden  on  the 
collectors  in  large  cities  and  the  subsequent  ruling  was  made  in  order  to 
remedy  this  condition. 

32  Revenue  Act  of  1918,  §§227  and  241;  Reg.  45,  Art.  441. 

33  Revenue  Act  of  1921,  §§227  (a)  and  241. 

34  R.  S.  3176,  as  amended  by  Revenue  Act  of  1921;  T.  D.  2001;  Reg. 
45,  Art.  441. 

35  See  Reg.  45,  Art.  442.     See  Chapter  6. 


RETURNS  OF  INCOME  ^^9 


LAST  DUE  DATE.  These  words  are  used  to  designate  the  last 
day  upon  which  a  return  is  required  to  be  filed  in  accordance 
'w  h  the  provisions  of  the  law.  or  the  last  day  of  the  penod 
;  ered  hy'an  extension  of  time  granted  by  the  ^""ec  or  or  Com 
mi.sioner/'"  When  the  last  due  date  as  above  defined  fa"-  »"  ^ 
S  nday  or  a  legal  holiday,  the  last  due  dat-vill  be  cons-de-d  the 
day  next  following,  and  the  return  should  be  fi'^'' "°Vf,*;' *!l^,d 
such  following  day,  or,  if  placed  in  the  mails,  .t  should  be  posted 
in  nmole  time  to  reach  the  collector's  office,  under  ordinary 
"amlZg  ofThe  mails,  on  or  before  the  date  on  which  the  return 
as  here  indicated  is  required  to  be  filed.''  •,    •     j  .„ 

MAILING  RETURNS.  If  a  return  is  placed  in  the  mails  in  due 
course  properly  addressed  and  postage  paid,  in  ample  time  to 
reach  the  office  of  the  collector  on  or  before  the  ast  due  date 
no  penalty  will  attach  should  the  return  not  actually  be  received 
bv  such  officer  until  subsequent  to  that  date  Where  a  question 
may  be  raised  as  to  whether  or  not  the  return  was  posted  n 
"mple  time  to  reach  the  collector's  office  on  or  before  the  due 
date  the  envelope  in  which  the  return  was  transmitted  w  11  be 
preserved  by  the  collector  and  forwarded  to  the  Commissioner 

with  the  return."  ^,        .  „  u„ 

Returns  When  Accounting  Period  Changed.    No  return  can  be 
made  for  a  period  of  more  than  twelve  months.    A  separate  re- 
Turn  for  a  f  i^ctional  part  of  a  year  is,  therefore,  required  where- 
ever  there  is  a  change,  with  the  approval  of  the  Commissioner 
in  the  basis  of  computing  net  income,  from  one    "''able  year  to 
another  taxable  year  or,  under  the  1918  Law,  but  not  under  the 
nresent  law,  wherever  a  taxpayer  making  his  first  return  of  in- 
come did  so'on  the  basis  of  a  fiscal  year.»    If  the  change  is  f™ 
calendar  year  to  fiscal  year,  a  separate  return  must  be  made  for 
the  period  between  the  close  of  the  calendar  year  for  which  le- 
turn  was  made  and  the  date  designated  as  the  close  of  the  fisca 
year.     If  the  change  is  from  one  fiscal  year  to  another  fiscal 
year,  a  separate  return  must  be  made  for  the  period  between  the 
close  of  the  former  fiscal  year  and  the  date  designated  as  the 
close  of  the  new  fiscal  year.    If  the  taxpayer  making  his  first 
return  under  the  1918  Law,  kept  his  accounts  on  the  basis  of  a 
fiscal  year,  he  was  required  to  make  a  separate  return  for    he 
period  between  the  beginning  of  the  calendar  year  m  which  such 

36  Reg    45,  Art  447;   Reg  33  Rev.,  Art.  218. 

s-Reg.  45,  Art.  447;  Reg.  33  Rev.,  Art.  219. 

3SReg.  45,  Art.  447;  Reg.  33  Rev.,  Art.  52 

:«)  Revenue  Act  of  1921,  §226;  Revenue  Act  of  1918,  ^22b,  Keg.  40,  ^ 

431. 


830  FEDERAL  INCOME   TAX 

fiscal  year  ended  and  the  end  of  such  fiscal  year.^o  This  re- 
quirement is  omitted  from  the  1921  Law  and  it  would  now  seem 
that  a  taxpayer  with  a  fiscal  year,  and  making  his  first  re- 
turn, should  file  such  return  for  his  full  fiscal  year.  It  is  diffi- 
cult to  see  why  the  1918  Law  required  a  return  for  a  part  of 
a  year  in  such  cases.  An  alien  who  arrived  in  the  United  States 
on  September  1,  1919,  and  who  actually  kept  his  books  of  account 
on  a  fiscal  year  basis  ending  August  31,  was  required  to  render 
a  return  on  the  basis  of  such  fiscal  year.  Notice  that  he  main- 
tains an  accounting  period  for  the  fiscal  year  ending  August  31, 
should  be  given  to  the  collector  for  the  district  in  which  the 
alien  resides.*^  The  requirements  with  respect  to  the  filing  of  a 
separate  return  and  the  payment  of  tax  for  a  part  of  a  year, 
are  the  same  as  for  the  filing  of  a  return  and  the  payment  of  tax 
for  a  full  taxable  year  closing  at  the  same  time.^-  In  the  case  of 
a  return  for  a  period  of  less  than  one  year  the  net  income  should 
be  placed  on  an  annual  basis  by  multiplying  the  amount  thereof 
by  twelve  and  dividing  by  the  number  of  months  included  in 
such  period,  and  the  tax  will  be  such  part  of  a  tax  computed  on 
such  annual  basis  as  the  number  of  months  in  such  period  is  of 
twelve  months."*'^ 

Extension  of  Time.  The  Revenue  Act  of  1921  makes  provision 
in  certain  cases  for  an  extension  of  time  for  filing  returns.  As 
indicated  in  the  following  paragraphs,  such  extensions  may  be 
granted  by  collectors  or  by  the  Commissioner. 

Extension  of  Time  by  Collector.  It  is  important  that  the 
taxpayer  render  before  the  return  due  date  a  return  as  complete 
and  final  as  it  is  possible  for  him  to  prepare.  However,  in 
cases  of  sickness  or  absence,  collectors  are  authorized  to  grant  an 
extension  of  not  exceeding  thirty  days  where,  in  their  judgment, 
such  further  time  is  actually  required  for  the  making  of  an  ac- 
curate return.44  The  application  for  such  extension  must  be 
made  prior  to  the  expiration  of  the  period  for  which  the  exten- 
sion is  required.  Absence  or  sickness  of  one  or  more  officers  of 
a  corporation  at  the  time  the  return  is  required  to  be  filed,  will 
not  be  accepted  as  a  reasonable  cause  for  failure  to  file  the  re- 
turn within  the  prescribed  time,  unless  it  is  satisfactorily  shown 
that  there  were  no  other  principal  officers  available  and  suffi- 

40  Revenue  Act  of  1918,  §  226. 

41  O.  D.  456,  T.  B.  15-20-853. 

42  Revenue  Act  of  1918,  §§226  and  239;  Reg.  45,  Art.  431. 

43  Revenue  Act  of  1921,  §§226   (c)    and  239. 

44  Revised  Statutes  §  3176,  as  amended  by  the  Revenue  Act  of  1921; 
§  1811;  Reg.  45,  Art.  443.     The  1918  Law  was  similar  in  this  respect. 


RETURNS  OF  INCOME  ^^^ 


ciently  informed  as  to  the  affairs  of  the  corporation  to  make  and 
verify  a  return.    Where  a  husband  and  wife  tile  a  joint  return 
and  an  extension  of  time  has  been  granted  to  either  of  them, 
the  benefit  of  the  extension  inures  to  both  and  i    ^^il  be  un- 
necessary for  the  other  party  to  secure  additional  authoiity. 
As  a  condition  of  granting  an  extension  of  time  for  fiUng  a  return 
the  collector  may  require  the  submission  of  a  tentative  i-eturn 
and  estimate  of  the  tax  (under  the  1918  Law  on  t  orm  1040  T  in 
the  case  of  individuals,  or  on  Form  1031  T  in  the  case  of  corpoia- 
tions)   and  the  payment  of  one-fourth  of  the  estimated  amount 
of  tax  -">    Where  a  taxpayer  has  filed  a  tentative  return  and  has 
failed  to  file  a  complete   return  within  the  period  of  the  ex- 
tension requested  by  him  the  complete  return  filed  is  subject  to 
penalties  prescribed  for  delinquency.    Where  a  tentative  return 
has  been  filed  and  no  time  has  been  fixed  within  which  a  com- 
plete return  must  be  filed,  the  collector  may  at  any  time  send 
notice  to  the  taxpayer  to  file  a  complete  return  within  a  period  of 
time  therein  specified  by  him,  and  a  taxpayer  who  fails  to  comply 
with  such  request  will  incur  the  penalties  prescribed  by  statute 
Tor  delinquency  in  filing  a  return.-    Where  the  time  for  filing 
a  return  has  been  extended  by  the  Commissioner  beyond  the 
original  due  date,  or  beyond  a  period  of  extension  granted  by  a 
collector   the  collector  is  without  authority  to  grant  a  further 
extension,  regardless  of  whether  or  not  a  tentative  return  has 

been  filed.^"^  ^        ,  ....       ,^   ,,  ^ 

EXTENSION  OF  TiME  BY  COMMISSIONER.     In  addition  to  the 
limited  extension  of  thirty  days  which  may  be  granted  by  col- 
lectors  the  Commissioner  may  grant  a  reasonable  extension  ot 
time  for  filing  returns  whenever,  in  his  judgment,  good  cause 
exists      He  is  required  to  keep  a  record  of  such  extensions  and 
the  reasons  therefor.    Except  in  the  case  of  taxpayers  who  ai-e 
abroad,  no  such  extension  may  be  for  more  than  six  months..  • 
If  before  the  end  of  a  thirty-day  extension  granted  by  a  collector, 
an  accurate  return  can  not  be  made,  an  appeal  for  a  further  ex- 
tension must  be  made  to  the  Commissioner  with  a  full  recita 
of  the  causes  for  the  delay.     The  Commissioner  will  not  grant 
an  additional  extension  without  a  clear  showing  that  a  complete 
return  can  not  be  made  before  the  end  of  the  thirty-day  period. 

4r,o.  D.  521,  T.  B.  21-20-959. 
4<'.  Reg.  45,  Art.  443. 
4T  T.  D.  2935. 

48  0.  D.  650,  T.  B.  35-20-1171. 

40  Revenue  Act  of  1921.  §227    (a).     The  rule  was  t^e   same  under  the 
1918  Law.     See  Revenue  Act  of  1918,  §  227  (a) ;  Reg.  45,  Art.  445. 


832  FEDERAL  INCOME  TAX 

The  Commissioner  will  grant  no  such  extension  beyond  the 
original  due  date  of  the  third  installment  of  the  tax.  Either  a 
complete  or  a  tentative  return  as  complete  as  possible  and  giving 
a  ground  for  assessment  of  the  tax,  must  be  submitted  on  or 
before  the  due  date  as  extended,  and  the  tax  shown  to  be  due 
must  be  paid  with  the  submission  of  the  return.  If  a  complete 
return  can  not  be  made  at  that  time,  the  facts  must  be  sub- 
mitted to  the  Commissioner  for  such  further  action  as  he  deems 
warranted.  In  exceptional  circumstances  the  taxpayer  may 
apply  originally  to  the  Commissioner  for  an  extension  of  time.^^ 
Extension  of  Time  in  the  Case  of  Persons  Abroad.  Be- 
cause of  the  disturbed  conditions  abroad  and  the  consequent  in- 
terference with  the  usual  channels  of  communication,  an  ex- 
tension of  time  for  filing  returns  of  income  for  1918  and  sub- 
sequent years  and  for  paying  the  tax  was  granted  in  the  case 
of  nonresident  alien  individuals  and  nonresident  foreign  corpora- 
tions, or  their  proper  representatives  in  the  United  States,  and 
of  American  citizens  residing  or  traveling  abroad,  including 
persons  in  military  or  naval  service  on  duty  outside  the  United 
States,  for  such  period  as  might  be  necessary,  not  exceeding 
ninety  days  after  proclamation  by  the  President  of  the  end  of 
the  war  with  Germany.  The  installments  of  tax  actually  due 
must  be  paid  at  the  time  of  filing  the  return  and  the  other  install- 
ments must  be  paid  as  they  fall  due.  In  all  such  cases  an 
affidavit  was  required  to  be  attached  to  the  return,  stating  the 
causes  of  the  delay  in  filing  it,  in  order  that  the  Commissioner 
might  determine  that  the  failure  to  file  the  return  in  time  was 
due  to  a  reasonable  cause  and  not  to  wilful  neglect  and  that  the 
return  was  filed  without  any  unnecessary  delay;  If  the  showing 
justified  the  conclusion  that  the  failure  to  file  the  return  in  time 
was  excusable,  no  penalty  would  be  imposed.  This  extension 
was  granted  as  a  matter  of  general  expediency  to  all  persons 
abroad  owing  income,  war-profits,  and  excess-profits  taxes  to 
the  federal  government  and  was  not  granted  upon  the  request 
of  any  particular  taxpayer.  Accordingly,  in  the  case  of  tax- 
payers who  took  advantage  of  this  general  extension  of  time  for 
the  filing  of  returns  and  the  payment  of  tax  no  interest  will  be 
collected  from  such  taxpayers,  but  where  a  request  was  made  by 
a  taxpayer  and  an  extension  granted  for  other  reasons  by  the 
Commissioner,  interest  will  be  collected  at  the  rate  of  one  half  of 
one  per  centum  per  month  from  the  time  the  tax  would  have 
been  due  if  no  extension  had  been  granted.    This  extension  also 

50  Reg.  45,  Art.  444. 


RETURNS  OF  INCOME  833 

applied  to  domestic  corporations  whose  records  are  kept  and 
business  transacted  abroad.'^  Since  the  President,  on  November 
14,  1921,  proclaimed  the  war  at  an  end,  the  above  extension  will 
expire  on  February  12,  1922."'- 

EXTENSION  OF  TiME  TO  ENEMIES.  An  extension  of  time  was 
granted  for  such  period  as  might  be  necessary,  not  exceeding 
ninety  days  after  proclamation  by  the  President  of  the  end  of 
the  war  with  Germany,  for  filing  returns  of  income  for  1918 
and  subsequent  years  and  for  paying  the  tax  by  or  for  non- 
resident enemies  or  allies  of  enemies,  as  defined  by  section  2  of 
the  Trading  with  the  Enemy  Act  of  October  6,  1917,  not  holding 
licenses  granted  under  the  provisions  of  that  act.  The  whole 
tax  shown  to  be  due  must  be  paid  at  the  time  of  filing  the  re- 
turn. This  extension,  however,  did  not  authorize  any  delay  in 
filing  returns  of  information.  This  extension  was  also  subject 
to  the  condition  that  all  persons  who  on  October  6,  1917,  had,  or 
since  have  had,  or  may  hereafter  have  control  of  any  money  or 
other  property  for  any  such  enemy  or  ally  of  enemy,  or  who,  on 
October  6,  1917,  were,  or  since  have  been,  or  may  hereafter  be 
indebted  to  any  such  enemy  or  ally  of  enemy,  shall  hold  and  de- 
liver all  such  money  and  property  in  all  respects  subject  to  the 
Trading  with  the  Enemy  Act,  and  to  the  orders  of  the  President 
and  the  Alien  Property  Custodian  thereunder,  and  shall  in  due 
course  file  returns  of  income  in  respect  of  all  such  money  and 
property  for  such  period  as  may  elapse  or  have  elapsed  prior  to 
the  actual  delivery  of  such  money  and  property  to  the  Alien 
Property  Custodian.'-'  In  other  words,  if  delivery  was  made  in 
November,  1917,  a  return  should  be  filed  for  the  portion  of  the 
year  1917  elapsing  before  such  delivery,  and  if  delivery  was  in 
March,  1918,  a  return  should  be  filed  for  the  year  1917  and  also 
before  March  1,  1919,  for  such  portion  of  the  year  1918  as  elapsed 
before  such  delivery.'-^  This  extension  will  also  expire  February 
12,  1922. 

51  Reg.  45,  Art.  445,  as  amended  by  T.  D.  2844;  telegram  from  treasury 
department  dated  April  19,  1919;  I.  T.  S.  1919,  T|3312;  0.  809,  T.  B.  2-19- 
160;  O.  D.  443,  T.  B.  14-20-839.  This  general  extension  does  not  affect 
the  liability  to  the  b'A  penalty  of  such  individuals  who  file  returns  before 
the  expiration  of  this  extension  period,  if  they  fail  to  pay  the  tax  due  on 
such  return  within  the  prescribed  time  after  it  was  filed.  (O.  D.  608,  T.  B. 
30-20-1095.) 

r.-'  See  I.  T.  S.  1921,  Ij  3213. 

•'"'SReg.   45,   Art.  446;   T.  D.  2673. 

•'W  Letter  from  treasury  department  dated  May  3,  1918;  I.  T.  S.  1919, 
H 1515. 


834  FEDERAL  INCOME  TAX 

L 
Tentative  Returns.    Prior  to  the  passage  of  the  1916  Law, 

extension  of  time  could  be  granted  only  in  case  of  sickness  or 
absence,  but  the  treasury  department  permitted  foreign  corpora- 
tions and  domestic  corporations  doing  business  in  foreign  coun- 
tries who  were  unable  to  assemble  their  data  on  or  before  the  pri- 
mary due  date,  to  file  tentative  returns,  approximating  as  nearly 
as  possible  the  actual  business  transacted  during  the  year.  Such 
tentative  returns  were  accepted  subject  to  the  substitution  later 
of  true  and  correct  returns  when  the  necessary  data  to  make  the 
same  had  been  received.^^  Under  the  1916  Law  the  Com- 
missioner had  authority  to  grant  unlimited  extension  in  merito- 
rious cases,  thus  making  unnecessary  the  filing  of  tentative  re- 
turns.s*^  Under  the  present  law  the  Commissioner  will  grant  no 
extension  beyond  the  original  due  date  of  the  third  installment  of 
the  tax.  Either  a  complete  or  a  tentative  return  as  complete  as 
possible,  and  giving  the  ground  for  assessment  of  the  tax  must 
be  submitted  on  or  before  the  due  date  as  extended,  and  the  tax 
shown  to  be  due  must  be  paid  with  the  submission  of  the  return. 
If  a  complete  return  can  not  be  made  at  that  time,  the  facts  must 
be  submitted  to  the  Commissioner  for  such  further  action  as  he 
deems  warranted.-''^'''  A  collector,  in  granting  an  extension  of 
time,  may  also  require  the  submission  of  a  tentative  return  and 
payment  of  one-fourth  of  the  estimated  amount  of  tax.^^  jf  ^ 
taxpayer  has  filed  a  tentative  return  for  any  taxable  year  or  has 
paid  any  amount  to  a  collector  on  the  supposition  that  he  will  be 
liable  for  payment  of  t^x,  and  later  finds  that  his  income  was 
insufficient  to  require  a  return,  a  statement  under  oath  to  that 
effect  should  be  filed  in  lieu  of  a  complete  return.  If  the  tax- 
payer desires  to  file  a  claim  for  refund  of  the  amount  erroneously 
paid,  a  complete  return  will  be  required.^'* 

Forms.  The  forms  on  which  the  returns  of  income  are  to  be 
made  are  prescribed  by  the  Commissioner,  and  may  be  had  from 
the  collectors  of  the  several  districts.  The  forms  have  been 
changed  from  time  to  time  and  those  for  1918  contained  much 
new  matter.  The  following  forms  were  prescribed  under  the 
1918  Law.  The  forms  for  use  by  individuals  were  Form  1040 
(revised)  and  Form  1040A  (revised).  The  form  prescribed  for 
use  by  nonresident  aliens  was  Form  1040  C,  whether  filed  by 
the  principal  or  by  an  agent  on  his  behalf.    Separate  forms  were 

55  T.  D.  2137. 

56  T.  D.  2561  and  T.  D.  2581. 

57  Reg.  45,  Art.  443. 

58  Reg.  45,  Art.  444. 

59  O.  D.  347,  T.  B.  30-19-643. 


RETURNS  OF  INCOME  835 

provided  for  use  by  fiduciaries  in  cases  where  the  tax  was  pay- 
able by  the  beneficiaries.  In  such  case  the  form  prescribed  was 
Form  1041  (revised),  A  receiver  in  charge  of  the  business  of 
a  partnership  rendered  return  on  Form  1065  (revised).  In 
other  cases  returns  by  fiduciaries  were  made  on  Form  1040  (re- 
vised) except  that  it  might  be  on  short  Form  1040A  (revised), 
where  the  net  income  did  not  exceed  five  thousand  dollars. 
Partnerships  made  their  returns  on  Form  1065  (revised).  Cor- 
porations, whether  domestic  or  foreign,  made  their  returns  on 
Form  1120.  Form  A  Revised  (mining),  Form  N  (oil  and  gas), 
and  Form  T  (timber)  were  available  for  taxpayers  engaged  in 
the  mining,  oil  or  gas,  or  timber  industries.""  These  forms 
were  prescribed  to  facilitate  the  compilation  and  presentation 
of  certain  information  required  for  the  audit  and  examination 
of  the  returns  of  these  classes  of  taxpayers.  If,  however,  it  was 
more  convenient  to  use  other  methods  of  tabulation,  the  informa- 
tion so  furnished  if  complete  was  accepted  in  lieu  of  these  forms. 
The  information  called  for  by  these  forms  should  be  filed  with 
the  returns  in  complete  detail,  either  on  the  forms  prescribed  or 
in  other  suitable  manner.  This  is  necessary  for  the  reason  that 
depletion  sustained  must  be  taken  into  consideration  in  the  com- 
putation of  invested  capital,  regardless  of  whether  or  not  a  de- 
duction for  it  was  claimed  or  has  been  claimed  for  it  in  the  past 
by  the  taxpayer.  This  requirement  applies  to  individuals  as 
well  as  corporate  taxpayers."^  The  Revenue  Act  of  1921  provides 
for  the  establishment  of  a  "Tax  Simplification  Board"  which, 
among  other  duties,  will  investigate  the  foiTns  used  and  make 
recommendations  for  their  simplification."- 

USE  OF  Prescribed  Forms.  Copies  of  the  prescribed  return 
forms  will  so  far  as  possible  be  furnished  taxpayers  by  collectors. 
Failure  on  the  part  of  any  taxpayer  to  receive  a  blank  form  will 
not,  however,  excuse  him  from  making  a  return.  Taxpayers  not 
supplied  with  the  proper  forms  should  make  application  therefor 
to  the  collector  in  ample  time  to  have  their  returns  prepared, 
verified  and  filed  with  the  collector  on  or  before  the  last  due 
date.  Each  taxpayer  should  carefully  prepare  his  return  so  as 
fully  and  clearly  to  set  forth  the  data  therein  called  for.  Im- 
perfect or  incorrect  returns  will  not  be  accepted  as  meeting  the 
requirements  of  the  statute.  In  lack  of  a  prescribed  form  a  state- 
ment made  by  a  taxpayer  disclosing  his  gross  income  and  the 

<50  A  copy  of  Forms  A,  N  and  T  will  be  found  in  the  appendix  to  the 
1920  edition  of  this  book. 
GIT.  D.  2849. 
02  See  Revenue  Act  of  1921,   §  1327. 


836  FEDERAL   INCOME   TAX 

deductions  therefrom  may  be  accepted  as  a  tentative  return,  and 
if  filed  within  the  prescribed  time  a  return  so  made  will  relieve 
the  taxpayer  from  liability  to  penalties,  provided  that  without 
unnecessary  delay  such  a  tentative  return  is  replaced  by  a  re- 
turn made  on  the  proper  form.""^ 

Verification  of  Returns.  All  income  tax  returns  must  be  veri- 
fied under  oath  or  affirmation  before  an  officer  duly  authorized 
to  administer  oaths  either  by  the  laws  of  the  United  States  or 
by  the  laws  of  the  state  or  territory  where  such  officer  resides.^^ 
The  affidavit  may  be  made  before  the  collector  of  the  district  or 
before  any  officer  authorized  by  law  to  administer  oaths.'^^  Rev- 
enue agents,  inspectors  and  special  employes,""  or  any  clerk  in 
the  office  of  the  collector,"'^  may,  if  commissioned  as  deputy  col- 
lectors, take  the  oaths  of  taxpayers.  If  a  return  is  executed  be- 
fore a  notary  in  a  state  where  the  law  does  not  require  the  notary 
to  use  a  seal,  and  none  is  used,  a  certificate  of  a  clerk  of  court 
or  other  officer  possessing  a  seal,  showing  that  the  notary  is 
duly  commissioned  and  authorized  to  administer  oaths,  should 
be  filed  with  the  Commissioner;  otherwise  the  return  will  not  be 
accepted,""^  unless,  as  may  be  done,  the  collector  waives  this  re- 
quirement in  states  where  jurats  are  accepted  in  the  state  courts 
either  with  or  without  a  seal,  and  without  a  certificate  showing 
authority.'"'  Every  collector,  deputy  collector,  internal  revenue 
agent  and  internal  revenue  officer  assigned  to  duty  under  an  in- 
ternal revenue  agent,  is  authorized  to  administer  oaths  and  to 
take  evidence  touching  any  part  of  the  administration  of  the  in- 
ternal revenue  laws  with  which  he  is  charged,  or  where  such  oaths 
and  evidence  are  authorized  by  law  or  by  regulation  authorized  by 
law  to  be  taken.  Forms  are  properly  executed,  therefore,  when 
sworn  to  and  subscribed  before  a  deputy  collector  instead  of  a 
notary  public.'^"  The  words  "before  an  officer  duly  authorized 
to  administer  oaths  either  by  the  laws  of  the  United  States  or 
by  the  laws  of  the  State,"  with  respect  to  the  verification  of  re- 
turns, signify  an  officer  duly  authorized  to  administer  oaths  gen- 

03  Reg.  45,  Art.  407. 

c-i  Reg.  45,  Art.  406,  as  amended  by  T.  D.  2951.  Under  this  regulation 
a  commissioner  of  deeds  is  authorized  to  administer  an  oath  to  an  income 
tax  return.     T.  D.  2952;  See  U.  S.  v.  Benowitz,  262  Fed.  223. 

fis  Reg.  33,  Art.  22. 

66  T,  D.  2235,  T.  D.  2238. 

67  T.   D.  2293\ 

68  T.  D.  2090. 

69  T.  D.  2174. 

W  R.  S.,  §  3165,  as  amended  by  Revenue  Act  of  1918,  §  1317,  and  by  the 
Revenue  Act  of  1921,  §1311;  O.  D.  761,  T.  B.  52-20-1368. 


RETURNS  OF  INCOME  837 

erally,  rather  than  an  officer  authorized  to  administer  oaths  only 
under  special  circumstances.  Postmasters,  therefore,  while  ad- 
mittedly "duly  authorized  to  administer  oaths  *  *  *  by  the 
laws  of  the  United  States"  in  a  limited  field,  have  no  authority  to 
administer  oaths  in  general,  and,  possessing  no  specific  authority 
for  that  purpose,  can  not  properly  administer  oaths  to  taxpayers 
when  filing  returns  of  income."' 

Verification  Abroad.  An  individual  residing  abroad  may 
acknowledge  his  return  before  any  duly  appointed  officer  of  the 
country  in  which  he  resides,  authorized  to  administer  oaths  and 
use  an  official  seal."-'  Where  a  foreign  notary  or  other  official 
having  no  seal  acts  as  attesting  officer,  the  authority  of  such  at- 
testing officer  should  be  certified  to  by  some  judicial  official  or 
other  proper  officer  having  knowledge  of  the  appointment  and 
official  character  of  the  attesting  officer.  Income  tax  returns  ex- 
ecuted abroad  may  be  attested  free  of  charge  before  United 
States  consular  officers."-'  American  citizens  in  China  executing 
their  income  tax  returns  may,  when  the  services  of  a  notary  are 
not  available,  attach  to  their  returns  Consular  Form  180,  prop- 
erly adapted,  and  made  a  part  of  their  tax  returns."^ 

Verification  in  Army  and  Navy.  Persons  in  the  naval  or 
military  service  of  the  United  States  may  verify  their  returns  be- 
fore any  official  authorized  to  administer  oaths  for  the  purposes 
of  those  services.""' 

Assistance  by  Collectors.  Any  assistance  or  information  which 
may  be  needed  in  connection  with  the  preparing  and  filing  of  in- 
come tax  returns,  is  required  to  be  furnished  by  the  collector 
upon  request.  Questions  regarding  the  tax  will  be  answered 
upon  inquiry  at  the  internal  revenue  offices.  When  questions 
are  directed  to  the  treasury  department  at  Washington  asking 
for  information  which  should  be  supplied  by  collectors,  the  letters 
are  referred  to  the  collectors  for  reply  and  the  writers  are  advised 
accordingly.'*' 

Return  Made  by  Collector.  The  Revenue  Act  of  1921  provides 
that  if  any  taxpayer  fails  to  make  and  file  a  return  or  list  at  the 
time  prescribed  by  law  or  by  regulation  made  under  authority  of 
the  law,  or  makes,  wilfully  or  otherwise,  a  false  or  fraudulent 
return  or  list,  the  collector  or  deputy  collector  must  make  the  re- 

"1  O.  D.  701,  T.  B.  43-20-1263. 

T2T.  D.  2090. 

"-Reg.  45,  Art.  406. 

"4  O.  D.  189,  T.  B.  8-19-327. 

"■■'Reg.  45,  Art.  406;  T.  D.  2534. 

7tiT.  D.  1949;  T.  D.  1956. 


838  FEDERAL  INCOME  TAX 

turn  or  list  from  his  own  knowledge  and  from  such  information 
as  he  can  obtain  through  testimony  or  otherwise.  In  any  such 
case  the  Commissioner  may,  from  his  own  knowledge  and  from 
such  information  as  he  can  obtain  through  testimony  or  other- 
wise, make  a  return  or  amend  any  return  made  by  a  collector 
or  deputy  collector.  Any  return  or  list  so  made  and  subscribed 
by  the  Commissioner,  or  by  a  collector  or  deputy  collector  and 
approved  by  the  Commissioner,  will  be  prima  facie  good  and 
sufficient  for  all  legal  purposes." 

Erroneous  Returns.  Under  previous  laws,  if  a  return  was  im- 
properly prepared,  it  was  returned  by  the  collector  to  the  tax- 
payer for  correction,  and  the  corrected  return  was  accepted  with- 
out penalty,  provided  the  incorrect  return  showing  the  date  of 
its  receipt  accompanied  the  corrected  return,^^  The  latest  rul- 
ing under  the  present  law,  states  than  an  imperfect  or  incor- 
rect return  will  not  be  accepted  as  meeting  the  requirements  of 
the  statute.'''^ 

Understatement  in  Returns.  The  Revenue  Act  of  1921  pro- 
vides that  if  the  collector  or  deputy  collector  has  reason  to  be- 
lieve that  the  amount  of  any  income  returned  is  understated,  he 
is  required  to  give  due  notice  to  the  taxpayer  making  the  re- 
turn to  show  cause  why  the  amount  shown  by  the  return  should 
not  be  increased  and  upon  proof  that  the  amount  was  understated, 
he  may  increase  the  same  accordingly.  Such  taxpayers  may 
furnish  sworn  testimony  to  prove  any  relevant  facts  and  if  dis- 
satisfied with  the  decision  of  the  collector,  may  appeal  to  the 
Commissioner  for  his  decision  under  such  rules  of  procedure  as 
may  be  prescribed  by  the  Commissioner  with  the  approval  of 
the  secretary.  If  a  collector  suspects  that  the  amount  of  any 
income  is  understated  in  a  return,  he  may  on  his  own  initiative 
take  up  the  matter  with  the  taxpayer  and  upon  being  satisfied 
that  the  amount  was  understated,  may  increase  it  accordingly, 
subject  to  the  right  of  the  taxpayer  to  appeal  to  the  Com- 
missioner. The  Commissioner,  however,  without  the  interven- 
tion of  the  collector,  may  exercise  original  jurisdiction  in  cases 
of  understatements  of  other  errors  in  returns.^^ 

77  R.  S.  3176,  as  amended  by  Revenue  Act  of  1921,  §  1311.  The  Revenue 
Act  of  1918  contained  the  same  provision.  See  R.  S.  §  3176  as  amended 
by  §  1317  of  Revenue  Act  of  1918. 

78  Mimeograph  letter  to  Collectors  dated  February  9,  1915;  I.  T.  S.  1919, 
II 1541. 

70  Reg.  45,  Art.  407. 

80  Revenue  Acts  of  1918  and  1921,  §  228;  Reg.  45,  Art.  451. 


RETURNS  OF  INCOME  839 

Amended  Returns.  Where  upon  an  audit  of  a  return  of  an  in- 
dividual, a  fiduciary,  or  a  withholding  agent,  or  as  a  result  of  an 
investigation  made  by  a  revenue  agent,  an  additional  tax  is  as- 
sessed, it  is  not  necessary  to  file  an  amended  return.  Notice  of 
the  additional  assessment  will  be  given  to  the  taxpayer  by  letter 
from  the  Treasury  Department.^!  If  a  taxpayer  discovers  or  de- 
tects expenses  or  liabilities  which  were  due  and  payable  during  a 
preceding  year,  it  is  permissible  for  him  to  make  an  amended  re- 
turn for  the  year  to  which  such  expense  or  liability  applies,  in- 
clude such  expense  in  the  deductions  of  that  year,  and  file  a  claim 
for  refund  for  any  taxes  overpaid  by  reason  of  the  failure  to  de- 
duct such  expenses  or  liabilities  in  the  original  return  of  that 
year.^-  Where  a  corporation  is  called  upon  by  a  revenue  in- 
spector to  make  amended  returns,  the  officers  of  the  corporation 
will  be  given  the  fullest  opportunity  to  make  any  investigation 
they  may  desire  prior  to  signing  such  amended  returns,  provided, 
of  course,  such  investigation  does  not  cover  an  unreasonable 
length  of  time.'^"' 

Notice  of  Failure  to  File  Returns.  The  Revenue  Act  of  1921 
provides  that  whenever  in  the  judgment  of  the  Commissioner 
necessary,  he  may  require  any  person,  by  notice  sensed  upon  him, 
to  make  a  return  or  such  statements  as  he  deems  sufficient  to 
show  whether  or  not  such  person  is  liable  to  tax.*^* 

SI  Mimeograph  letter  No.  1232  to  Collectors;  Reg.  33  Rev.,  Art.  38. 

82  Reg.  33   Rev.,   Art.   128;   Reg.  45,  Art.  23. 

S3  Letter  from  treasury  department  dated  February  2,  1915;  I.  T.  S.  1921, 
^  2080.  In  1915  and  1916  it  was  the  practice  of  the  treasury  department  to 
send  out  a  letter  to  corporations  whenever  items  on  the  return  were  reached, 
concerning  which  more  detailed  information  was  sought,  referring  to  the 
return  and  briefly  requesting  information  regarding  one  or  more  items 
therein.  The  letter  ended  with  a  statement  that  in  the  absence  of  an 
explanatory  affidavit,  at  the  end  of  thirty  days  from  the  date  of  the  letter 
the  entire  amount  of  the  deductions  questioned  would  be  suspended  and  an 
assessment  returned  accordingly.     (I.  T.  S.  1917,  H  1623.) 

f<^  Revenue  Act  of  1921,  §  1307.  The  Revenue  Act  of  1918  contained 
the  same  provision.  See  Revenue  Act  of  1918,  §  1305.  Under  the  1916 
Law,  when  the  collector  possessed  any  information  which  led  him  to  be- 
lieve that  any  person  in  his  district  was  in  receipt  of  income  for  the  year 
and  did  not  make  a  return,  he  was  required  to  serve  a  notice  calling  attention 
to  the  failure  and  to  the  fact  that  penalties  for  failure  had  been  incurred. 
The  notice  also  called  attention  to  the  fact  that  if  the  return  was  not  filed 
within  ten  days  from  the  date  thereof,  the  books  and  papers  of  the  taxpayer 
would  be  examined  and  a  return  prepared  therefrom  as  provided  by  law. 
(Reg.  33,  Art.  196.)  This  notice  was  sent  out  on  form  1045.  For  the 
first  year  of  the  income  tax,  March  1  to  December  31,  1913,  the  collector 
sent  out  an  informal  letter  as  a  preliminary  to  the  formal  notice.  This 
letter  invited  the  taxpayer  to  make  a  return  without  penalty  within  ten 
days  but  the  letter  was  not  used  in  subsequent  years. 


840  FEDERAL  INCOME   TAX 

Inspection  of  Returns  by  the  Public.  The  income  tax  law  is 
specific  and  mandatory  in  the  matter  of  safeguarding  from  pub- 
licity the  information  acquired  by  reason  of  its  requirements  rel- 
ative to  annual  returns  of  income.  The  law  imposes  on  col- 
lectors, deputy  collectors,  agents,  clerks,  or  other  officers  or  em- 
ployees of  the  bureau  of  internal  revenue,  including  internal 
revenue  agents,  a  penalty  of  fine,  imprisonment,  dismissal  from 
office  and  forfeiture  of  right  to  hold  office,  for  making  known 
in  any  manner  not  provided  by  the  law,  the  amount  or  source 
of  income,  or  any  particulars  thereof,  set  forth  or  disclosed  in  a 
return  of  income  by  any  person."^"'  All  internal  revenue  officers 
are  cautioned  to  preserve  as  confidential  all  income  tax  returns."*'' 
The  returns  on  which  assessments  have  been  made  are  filed  in 
the  office  of  the  Commissioner  and  constitute  public  records  and 
are  open  to  inspection  as  such,  but  only  upon  order  of  the  Presi- 
dent and  under  rules  and  regulations  prescribed  by  the  secretary 
and  approved  by  the  President."^"^  It  was  held  that  a  similar 
provision  of  the  1909  Law  permitting  the  inspection  of  returns 
was  not  unconstitutional.'"*"*  The  President  by  an  executive 
order,  dated  January  7,  1920,  directed  that  returns  of  income 
should  be  subject  to  inspection  in  accordance  with  the  follow- 
ing regulations  prescribed  by  the  secretary  of  the  treasury  set 
forth  in  the  following  paragraphs.*^^ 

The  word  "return,"  unless  otherwise  indicated,  includes  in- 
come and  profits  tax  and  also  capital  stock  tax  returns.  Written 
statements  filed  with  the  Commissioner  designed  to  be  sup- 
plemental to  and  to  become  a  part  of  tax  returns  will  be  subject 
to  the  same  rules  and  regulations  as  to  inspection  as  are  the 
returns  themselves.'"'  Except  as  hereinafter  specifically  in- 
dicated, the  Commissioner  may,  in  his  discretion,  upon  written 
application  setting  forth  fully  the  reasons  for  the  request,  grant 
permission  for  the  inspection.  The  application  will  be  con- 
sidered by  the  Commissioner  and  a  decision  reached  by  him 
whether   the   applicant  has   met   the   conditions    imposed   and 

85  R.  S.  3167,  as  amended  by  Revenue  Act  of  1921,  §  1311;  R.  S.  §3167, 
as  amended  by  the  Revenue  Act  of  1918;  Reg.  33  Rev.,  Art.  229;  T.  D. 
2903,  T.  B.  15-19-461. 

86  T.  D.  2135,  T.  D.  1962. 

87  Revenue  Act  of  1921,  §257;  Revenue  Act  of  1918,  §257. 

88  Flint  V.  Stone  Tracy  Co.,  220  U.  S.  107. 

89  T.  D.  2961  and  2962.     See  Reg.  45,  Art.  1091. 

9"  Reg.  45,  Art.  1091.  A  debtor  corporation  may  not  inspect  ownership 
certificates  executed  by  owTiers  of  its  bonds  or  bonds  of  its  subsidiaries 
after  such  certificates  have  been  forwarded  to  the  Commissioner  by  the 
debtor  corporation.      (S.  1301,  T.  B.  6-20-434.) 


RETURNS  OF  INCOME 


841 


whether  the  reasons  advanced  for  permission  to  inspect  are 
sufficient  to  permit  the  inspection.  Such  written  application  is 
not  required  of  the  officers  and  employes  of  the  treasury  depart- 
ment whose  official  duties  require  inspection  of  a  return,  or  of 
the  solicitor  of  internal  revenue.  When  it  becomes  necessary 
for  the  department  to  furnish  returns  or  copies  thereof  for 
use  in  legal  proceedings,  inspection  of  such  returns  or  copies 
that  necessarily  result.s  from  such  use  is  permitted.  Except  as 
indicated  above,  returns  may  be  inspected  only  in  the  office 
of  the  Commissioner  at  Washington.  A  person  who  is  per- 
mitted to  inspect  a  return  may  make  and  take  a  copy  thereof 
or  a  memorandum  of  data  contained  therein.'-'' 

Returns  or  Individuals.     The  return   of  an   individual  is 
open  to  inspection  as  follows:      (a)     By  the  officers  and  em- 
ployees of  the  treasury  department  whose  official  duties  require 
such  inspection  and  by  the  solicitor  of  internal  revenue;  (b)  by 
the  person   who  made  the  return,  or  by  his   duly  constituted 
attorney-in-fact;   (c)   by  the  administrator,  executor  or  trustee 
of  the  taxpayer's  estate,  or  by  the  duly  constituted  attorney-in- 
fact  of  such  administrator,  executor  or  trustee,  where  the  maker 
of  the  return  has  died,"-  and  (d)  in  the  discretion  of  the  Com- 
missioner, by  one  of  the  heirs  at  law  or  next  of  kin  of  such 
deceased  person  upon  showing  that  he  has  a  material  interest 
which  will  be  affected  by  information  contained  in  the  return. 
An    original   letter   with   regard    to   his    return   written   by    a 
decedent  to  the  collector  may  not  be  furnished  to  the  attorneys 
for  the  estate.    A  certified  or  photostatic  copy  may  be,  however, 
be  given  to  them  provided  the  executors  submit  a  copy  of  the 
letters   testamentary    issued   to   them   by   the   court,    together 
with  a  letter  signed  by  them  authorizing  the  attorneys  to  re- 
ceive a  copy  of  the  letter  in  question."'"*     A  joint  return  of  a 
husband  and  wife  will  be  open  to  inspection  (a)  by  the  officers 
and  employees  of  the  treasury  department  whose  official  duties 
require  such  inspection,  and  by  the  solicitor  of  internal  revenue, 
and  (b)  by  either  spouse  for  whom  the  return  was  made,  or  his 
or  her  duly  constituted  attorney,   upon   satisfactory   evidence 
of  such  relationship.''^ 

•■'1  Reg.  45,  Art.   1091. 

niiThe  executor  of  an  estate  may  secure  copies  of  income  tax  returns 
filed  by  the  decedent  upon  submission  to  the  Commissioner  of  a  certified 
copy  of  letters  testamentary  evidencing  his  appointment  as  executor.  (O. 
D.  355,  T.  B.  31-19-654.) 

o;iO.  D.  576,  T.  B.  27-20-1046. 

«-tReg,  45,  Art.   1091. 


842  FEDERAL  INCOME  TAX 

Returns  of  Partnerships.  The  return  of  a  partnership  will 
be  open  to  inspection  (a)  by  the  officers  and  employees  of 
the  treasury  department  whose  official  duties  require  such  in- 
spection and  by  the  solicitor  of  internal  revenue;  and  (b)  by 
any  individual  (or  his  duly  constituted  attorney-in-fact,  or  legal 
representative)  who  was  a  member  of  such  partnership  during 
any  part  of  the  time  covered  by  the  return,  upon  satisfactory 
evidence  of  such  fact.^-^ 

Returns  of  Corporations.  The  return  of  a  corporation 
will  be  open  to  inspection  (a)  by  the  officers  and  employees  of 
the  treasury  department  whose  official  duties  require  such  in- 
spection and  by  the  solicitor  of  internal  revenue;  (b)  upon 
satisfactory  evidence  of  identity  and  official  position,  by  the 
president,  vice-president,  secretary  or  treasurer  of  such  cor- 
poration or  if  none,  its  principal  officer;  and  (c)  by  a  stock- 
holder of  record  owning  one  per  centum  or  more  of  the  out- 
standing stock  of  such  corporations  as  provided  below. 

A  stockholder  of  record  owning  one  per  centum  or  more  of 
the  outstanding  stock  of  a  corporation  may  be  permitted  to  in- 
spect its  return.  Such  permission  will  only  be  granted  upon  an 
application  in  writing  to  the  Commissioner  accompanied  by  an 
affidavit  showing  applicant's  address,  the  name  of  the  corpora- 
tion, the  period  of  time  covered  by  the  return  he  desires  to 
inspect,  and  a  certificate  from  the  officials  of  the  corporation 
or  other  satisfactory  evidence  showing  the  amount  of  the  cor- 
poration's outstanding  capital  stock,  the  number  of  shares 
owned  by  the  applicant,  the  date  when  such  stock  was  acquired, 
and  satisfactory  proof  of  identity.  This  privilege  of  inspection  is 
personal  and  will  be  granted  only  to  the  stockholder.  This  rule  has 
no  application  to  the  return  of  a  corporation  filed  pursuant  to 
the  Revenue  Act  of  1918  or  the  Revenue  Act  of  1921,  specific 
provision,  independent  of  Presidential  regulation,  being  made 
in  those  acts  for  inspection  by  a  stockholder  of  a  return  of  a 
corporation  filed  thereunder.^"  A  bona  fide  stockholder''^  of 
record  owning  one  per  centum  or  more  of  the  outstanding 
stock  of  a  corporation  shall  be  entitled  as  of  right,  upon  mak- 
ing request  of  the  Commissioner,  to  examine  the  annual  income 

95  Reg.  45,  Art.  1091. 

96  Reg.  45,  Art.  1091;  Revenue  Act  of  1921,  §257;  Revenue  Act  of  1918, 
§257. 

97  A  "stockholders  protective  committee,"  to  which  deposited  stock  has 
been  transferred  for  the  purpose  of  safeguarding  the  interests  of  the 
minority  stockholders,  is  not  considered  a  bona  fide  stockholder.  (O.  D. 
273,  T.  B.  18-19-490.) 


RETURNS  OF  INCOME  843 

war-profits,  excess-profits  and  capital  stock  tax  returns  of  such 
corporation  and  of  its  subsidiaries  made  under  the  Revenue 
Act  of  1918  or  the  Revenue  Act  of  1921.  His  request  for  per- 
mission to  examine  such  returns  must  be  made  in  writing  and 
must  be  in  the  form  of  an  affidavit  showing  his  address,  the 
name  of  the  corporation,  the  period  of  time  covered  by  the 
return  he  desires  to  inspect,  the  amount  of  the  corporation's 
outstanding  capital  stock,  the  number  of  shares  owned  by  him, 
the  date  when  he  acquired  them  and  whether  he  has  the  bene- 
ficial as  well  as  the  record  title  to  such  shares.  It  must  also 
show  that  he  has  not  acquired  his  shares  for  the  purpose  of  the 
examination  of  the  income  returns  of  the  corporation.  If  he 
has  acquired  them  for  this  purpose  he  is  not  a  bona  fide  stock- 
holder within  the  meaning  of  the  statute.  The  application  must 
be  supported  by  satisfactory  evidence  showing  that  the  applicant 
is  a  bo)ia  fide  stockholder  of  record  of  the  required  amount  of 
stock  of  the  corporation.  The  supporting  evidence  may  be  partly 
in  the  form  of  a  certificate  signed  by  the  president  or  vice- 
president  of  the  corporation,  and  countersigned  by  the  secre- 
tary under  the  corporate  seal.  Upon  being  satisfied  from  the 
evidence  presented  that  the  applicant  has  fully  met  these  condi- 
tions the  Commissioner  will  grant  the  permission  to  examine 
the  returns  and  set  a  convenient  time  for  the  examination  in 
the  office  of  the  Commissioner.  This  privilege  is  personal  and 
will  be  granted  only  to  the  stockholder,  who  cannot  delegate 
it  to  another. """ 

Inspection  of  Returns  by  Government  Officers.  When  the 
head  of  an  executive  department  (other  than  the  treasury  de- 
partment) or  of  any  other  United  States  government  estab- 
lishment, desires  to  inspect  or  to  have  some  other  officer  or 
employee  of  his  branch  of  the  senice  inspect  a  return  in  con- 
nection with  some  matter  officially  before  him,  the  inspection 
may,  in  the  discretion  of  the  Secretary  of  the  Treasury,  be  per- 
mitted upon  written  application  to  him  by  the  head  of  such 
executive  department  of  other  government  establishment.  The 
application  must  be  signed  by  such  head  and  must  show  in 
detail  why  the  inspection  is  desired,  the  name  and  address  of 
the  taxpayer  who  made  the  return,  and  the  name  and  official 
designation  of  the  one  it  is  desired  shall  inspect  the  return. 
When  the  head  of  a  bureau  or  office  in  the  treasury  department, 
not  a  part  of  the  internal  revenue  bureau,  desires  to  inspect 

'•'■^Revenue  Act  of  1921,  §257;  Revenue  Act  of  1918,  §257;  Reg.  45,  Art. 
1093. 


844  FEDERAL   INCOME   TAX 

a  return  in  connection  with  some  matter  officially  before  him, 
other  than  an  income,  profits  tax  or  corporation  excise  tax 
matter,  the  inspection  rnay,  in  the  discretion  of  the  secretary, 
be  permitted  upon  written  application  to  him  by  the  head  of 
such  bureau  or  office  showing  in  detail  why  the  inspection  is 
desired.  The  reasons  submitted  for  permission  to  inspect  as 
provided  in  this  paragraph  will  be  considered  by  the  secretary 
and  a  decision  reached  by  him  whether  the  reasons  are  suffi- 
cient to  permit  the  inspection.^'' 

Inspection  of  Corporation  Returns  by  State  Officers.  The 
proper  officers  of  a  state  imposing  an  income  tax  are  entitled 
as  of  right  upon  the  request  of  its  governor  to  have  access  to 
the  income  and  profits  tax  returns  of  a  corporation,  associa- 
tion, joint-stock  company  or  insurance  company  or  to  an  abstract 
thereof  showing  its  name  and  income.  Proper  officers  in  this 
connection  are  only  those  officers  of  the  state  who  are  charged 
with  the  enforcement  of  the  state  income  tax  law  and  who 
are  to  use  the  information  gained  by  the  access  only  in  con- 
nection with  such  enforcement.  The  request  or  application  of 
the  governor  must  be  in  writing  signed  by  him  under  the  seal  of 
his  state  and  must  show:  (a)  That  the  state  imposes  an  in- 
come tax.  (b)  The  name  and  address  of  the  corporation,  asso- 
ciation, joint-stock  company,  or  insurance  company  making  the 
returns  to  which  access  is  desired,  (c)  Why  access  is  desired, 
(d)  The  names  and  official  positions  of  the  officers  designated  to 
have  the  access,  (e)  That  such  designated  officers  are  charged 
with  the  enforcement  of  the  state  income  tax  law.  (f)  That 
the  information  to  be  gained  by  the  access  is  to  be  used  only 
in  connection  with  such  enforcement.  The  request  or  applica- 
tion of  the  governor  may  be  addressed  either  to  the  Secretary 
of  the  Treasury  or  to  the  Commissioner  but  should  be  trans- 
mitted to  the  Commissioner  who  will  set  a  convenient  time  for 
the  access  to  the  returns  (or  to  an  abstract  thereof  as  he  may 
determine).  Access  will  be  given  only  in  the  office  of  the 
Commissioner  in  Washington.  The  officers  designated  by  the 
governor  will  not  be  permitted  to  name  another  person  or 
persons  to  examine  the  returns  (or  abstracts)  for  them.  The 
officers  designated  will  be  given  access  only  to  the  returns  of 
those  corporations,  associations,  joint-stock  companies,  or  insur- 
ance companies  organized  or  doing  business  in  their  state.  The 
officers  designated  may  have  access  to  lists  furnished  to  sup- 
plement and  become  a  part  of  the  returns  to  which  they  are 


99 


Reg.  45,  Art.  1091. 


RETURNS  OF  INCOME  845 

given  access.  The  proper  officers,  as  defined  above,  might  have 
access  to  the  capital  stock  tax  returns  filed  under  the  provisions 
of  the  Revenue  Act  of  1918  under  the  same  conditions  prescribed 
above  for  access  to  the  income  and  profits  tax  returns  of  cor- 
porations, associations,  joint-stock  companies,  and  insurance 
companies.  This  right  does  not  extend  to  the  examination  of 
capital  stock  tax  returns  filed  pursuant  to  prior  acts  of 
Congress.'"" 

Furnishing  Copies  of  Returns.  No  specific  provision  is  made 
in  the  statutes  for  furnishing  a  copy  of  an  income  return  to 
any  one.  Authority  to  permit  inspection  does  not  carry  with 
it  authority  to  furnish  a  copy.  Implied  authority  to  furnish 
a  copy  is  contained  in  several  provisions  of  law  constituting 
returns  public  records,  and  in  Sections  161  and  251  R.  S., 
which  confer  upon  the  secretary  of  the  treasury'  broad  power 
to  make  rules  and  regulations  concerning  "custody,  use  and 
preservation  of  the  records,  papers  and  property"  of  the  de- 
partment and  the  enforcement  of  the  internal  revenue  laws. 
Because  of  the  provisions  contained  in  Section  3167  R,  S.,  as 
amended  by  the  Revenue  Act  of  1918  and  by  the  Revenue  Act  of 
1921,  making  it  unlawful  for  any  officer  or  employee  of  the 
United  States  "to  divulge  or  to  make  known  in  any  manner 
whatever  not  provided  by  law  to  any  person  *  *  *  the 
amount  or  source  of  income,  profits,  losses,  expenditures,  or 
any  particular  thereof;  set  forth  or  disclosed  in  any  income  re- 
turn, or  to  permit  any  income  return  or  copy  thereof  or  any  book 
containing  any  abstract  or  particulars  thereof  to  be  seen  or 
examined  by  any  person  except  as  provided  by  law;"  and  also 
unlawful  "for  any  person  to  print  or  publish  in  any  mannei: 
whatever  not  provided  by  law  any  income  return,  or  any  part 
thereof  or  source  of  income,  profits,  losses,  or  expenditures 
appearing  in  any  income  return ;"  a  copy  of  an  income  return 
cannot  be  furnished,  except  as  provided  by  law,  to  any  one  except 
the  person  or  persons  who  made  the  return.  Furnishing  the 
maker  with  a  copy  of  his  return  is  not  a  divulging  of  information 
contained  therein  to  any  person,  within  the  meaning  of  Sec- 
tion 3167  R.  S,,  as  amended.  There  are  numerous  provisions 
in  the  statutes  constituting  the  doing  or  failure  to  do  certain 
things  off"enses  against  the  United  States,  and  providing  for  col- 
lecting unpaid  taxes  by  suits  in  court  and  for  bringing  suits 
to  recover  taxes  and  penalties  wrongfully  collected.     These  pro- 

i<><»  Revenue  Act  of  1921,  §257;  Revenue  Act  of  1918,  §257;  Reg.  45, 
Art.  1092. 


846  FEDERAL  INCOME   TAX 

visions  would  be  of  no  avail  were  it  held  that  the  returns  them- 
selves, or  certified  copies  thereof  provided  for  in  Section  882 
R.  S.,  could  not  be  used  by  the  government  as  evidence  in  such 
litigation  or  in  preparation  for  same.  Manifestly  Congress  did 
not,  when  it  enacted  Section  3167  R.  S.,  intend  to  defeat 
prosecution  and  suits  in  court  for  which  it  has  specifically 
provided.  Income  returns  filed  with  the  department  are  public 
records  of  the  department,  and  public  records  in  the  treasury 
department  are  of  right  available  as  evidence  in  litigation  in 
court  unless  there  is  some  statute  making  it  unlawful  to  use 
them  as  such.^^i  As  therefore  the  use  of  income  returns  or 
copies  thereof  in  connection  with  litigation  in  court,  where  the 
United  States  government  is  interested  in  the  result,  is  pro- 
vided for  by  law,  such  returns  or  copies  may  be  furnished  for 
such  use  without  a  violation  of  the  provisions  of  Section  3167 
R.  S.,  as  amended."'^ 

The  following  rules  and  regulations  have  been  prescribed: 
The  original  income  return  of  an  individual,  partnership,  cor- 
poration, association,  joint-stock  company,  insurance  company, 
or  fiduciary,  or  a  copy  thereof,  may  be  furnished  by  the  Commis- 
sioner to  a  United  States  Attorney  for  use  as  evidence  before  a 
United  States  grand  jury  or  in  litigation  in  any  court,  where 
the  United  States  is  interested  in  the  result,  or  for  use  in  the 
preparation  for  such  litigation,  or  to  an  attorney  connected 
with  the  department  of  justice  designated  to  handle  such  mat- 
ters upon  written  request  of  the  attorney-general,  the  assistant 
to  the  attorney-general,  or  an  assistant  attorney-general. 

When  an  income  return  or  copy  thereof  is  thus  furnished, 
it  must  be  limited  in  use  to  the  purpose  for  which  it  is  fur- 
nished and  is  under  no  condition  to  be  made  public  except 
where  publicity  necessarily  results  from  such  use.  In  case  the 
original  return  is  necessary,  it  shall  be  placed  in  evidence  by 
the  Commissioner  or  by  some  other  officer  or  employee  of  the 
Internal  Revenue  Bureau  designated  by  the  Commissioner  for 
that  purpose,  and  after  it  has  been  placed  in  evidence  it  shall 
be  returned  to  the  files  in  the  office  of  the  Commissioner  in 
Washington.  An  original  return  will  be  furnished  only  in  excep- 
tional cases  and  then  only  when  it  is  made  to  appear  that  the 
ends  of  justice  may  otherwise  be  defeated.    Neither  the  original 

101  Winn  V.  Patterson,  9  Pet.  663,  677;  Evanston  v.  Gunn,  99  U,  S. 
660;  17  Cyc.  306;  Williams  v.  Conger,  125  U.  S.  397,  410;  Iron  Silver  Min. 
Co.  V.  Campbell,  135  U.  S.  286,  298;  Oakes  v.  U.  S.,  174  U.  S.  778;  Texas, 
etc.,  Ry.  Co.  v.  Swearing-en,  196  U.  S.  51,  60. 

302  T.  D.  2962,  T.  B.  4-20-711. 


RETURNS  OF  INCOME  847 

nor  a  copy  of  an  income  return  desired  for  use  in  litigation  in 
court  where  the  United  States  government  is  not  interested  in 
the  result  and  where  such  use  might  result  in  making  public 
the  information  contained  therein  will  be  furnished,  except  as 
otherwise  provided  in  the  next  succeeding  paragraph. 

A  copy  of  an  income  return  may  be  furnished  by  the  Com- 
missioner to  the  person  who  made  the  return  or  to  his  duly 
constituted  attorney,  or  if  the  person  is  deceased,  to  his  execu- 
tor or  administrator ;  or  if  the  entity  is  in  the  hands  of  a  receiver, 
trustee  in  bankruptcy,  guardian  or  similar  legal  custodian,  to 
the  receiver,  trustee  or  other  similar  custodian  upon  written 
application  for  same  accompanied  by  satisfactory  evidence  that 
the  applicant  comes  within  this  provision.  "The  person  who  made 
the  return"  as  herein  used  refers  in  the  case  of  an  individual 
return  to  the  individual  whose  return  is  desired,  and  in  the  case 
of  a  return  of  a  corporation,  association,  joint-stock  company, 
insurance  company  or  fiduciary  to  the  corporation,  association, 
joint-stock  company  or  fiduciary',  a  copy  of  whose  return  is  de- 
sired. A  corporation  may  also  designate  by  proper  action  of 
its  board  of  directors  the  officer  or  individual  to  whom  a  copy 
of  a  return  made  by  the  corporation  may  be  furnished,  and 
upon  sufficient  evidence  of  such  action  and  of  the  identity  of 
the  officer  or  individual,  a  copy  may  be  furnished  to  such  per- 
son. A  copy  of  a  partnership  income  return  will  be  furnished 
to  the  partners  only  in  case  all  the  partners  join  in  the  request 
therefor,  it  matters  not  what  particular  partner  or  officers  of 
the  partnership  made  the  return.  If  the  partnership  has  been 
dissolved  the  members  sunnving  may  be  furnished  a  copy  if 
all  the  members  surviving  join  in  the  request. ^'^'^  Ownership 
certificates  are  filed  as  a  result  of  income  tax  laws  for  the  pur- 
pose of  being  used  in  connection  with  income  tax  returns  and 
are,  therefore,  to  be  treated  as  returns  under  the  regulations 
governing  the  furnishing  of  copies.^"^ 

Statistics  of  Income.  The  Commissioner  will  publish  annually 
a  volume  of  statistics  of  income,  showing,  among  other  things, 
the  distribution  of  income  between  corporations  and  individuals 
and  by  states,  by  classes  and  by  occupations.^"'' 

103  Reg.  45,  Art.  1091   (a),  as  amended  by  T.  D.  3188,  T.  B.  29-21-1739. 
lo-tO.  879,  T.  B.  17-19-473. 

105  Revenue  Act  of  1921,  §258;  Revenue  Act  of  1918,  §258;  Reg.  45, 
Art.  1191. 


CHAPTER  35 

ASSESSMENT,    PAYMENT    AND    COLLECTION    OF    THE    TAX 

While  it  follows  the  methods  inaugurated  by  the  Revenue  Act 
of  1918  for  the  assessment,  payment  and  collection  of  taxes,  the 
Revenue  Act  of  1921  amends  those  methods  in  four  substantial 
respects  and  in  several  minor  details,  as  will  be  indicated  in  this 
chapter.  As  under  the  1918  Law,  it  is  contemplated  that  all 
assessments  shall  be  made  by  the  Commissioner .^  The  tax  is 
payable  in  four  equal  installments ;  the  first  at  the  time  fixed 
for  filing  returns,  the  second,  third  and  fourth  installments  on 
the  15th  days  of  the  third,  sixth  and  ninth  months  respectively 
following  such  date.  This  means,  as  it  did  under  the  1918  Law, 
a  taxpayer  reporting  on  a  calendar  year  basis  (except  non- 
resident aliens  and  nonresident  foreign  corporations)  will  pay 
the  tax  on  or  before  March  15,  June  15,  September  15  and 
December  15,  but  as  the  time  fixed  for  filing  the  returns  of  non- 
resident aliens  and  nonresident  foreign  corporations  is  changed 
by  the  present  law  to  "June  15  (or  the  15th  day  of  the  sixth 
month  following  the  closing  of  the  fiscal  year) ,  such  taxpayers 
will  now  pay  their  tax  in  four  equal  installments  on  June  15, 
September  15,  December  15  and  March  15  (of  the  second  year 
after  the  year  for  which  the  tax  is  paid) .-  If  any  installment 
of  the  tax  is  not  paid  when  due,  the  whole  amount  of  the  tax 
becomes  payable  on  notice  and  demand  by  the  collector.  In 
the  case  of  the  first  installment,  the  instructions  printed  on 
the  return  are  deemed  sufficient  notice  of  the  date  when  the 
tax  is  due  and  sufficient  demand,  and  the  taxpayer's  computa- 
tion of  the  tax  on  the  return  is  deemed  sufficient  notice  of  the 
amount  due.  The  Revenue  Act  of  1921  also  provides  that  in 
the  case  of  each  subsequent  installment,  the  collector  may  within 
30  days,  and  not  later  than  10  days,  before  each  subsequent 
installment  becomes  due,  mail  to  the  taxpayer  notice  of  the 
amount  of  the   installment  and  the  date  on   which  it  is   due, 

1  The  1916  Law  expressly  provided  that  all  assessments  should  be  made 
by  the  Commissioner.  When  an  assessment  was  made  the  amount  thereof 
was  reported  to  the  local  collector,  who  notified  the  taxpayer  on  or  before 
June  1  of  such  amount.  The  tax  became  due  on  the  15th  of  June  but  an 
additional  ten-day  period  of  grace  after  June  15  was  allowed  before  the 
application  of  penalties  or  interest.  (Revenue  Act  of  1916,  §§9  (a)  and 
14  (a).) 

2  Revenue  Act  of  1921,  §§250    (a),  241    (a)   and  227   (a). 

848 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  849 

which  notice  shall  be  sufficient  notice  and  sufficient  demand.-' 
The  amount  of  any  additional  tax  in  excess  of  that  paid  is 
termed  a  "deficiency"  by  the  Revenue  Act  of  1921.  Any  de- 
ficiency must  be  paid  upon  notice  and  demand  by  the  collector, 
together  with  interest  at  the  rate  of  one-half  of  one  per  cent, 
per  month  from  the  time  the  tax  was  due.  If  the  deficiency 
is  due  to  negligence  or  intentional  disregard  of  authorized  rules 
and  regulations  with  knowledge  but  without  intent  to  defraud,  a 
five  per  cent,  penalty  is  added.  If  the  deficiency  is  due  to  fraud 
with  intent  to  evade  the  tax,  a  fifty  per  cent,  penalty  is  added. 
However,  when  any  tax  liability  is  discovered  by  the  Commis- 
sioner upon  examination  of  a  return  made  under  the  Revenue 
Act  of  1916,  the  Revenue  Act  of  1917,  the  Revenue  Act  of  1918, 
or  the  Revenue  Act  of  1921,  the  taxpayer  must  be  notified  of 
such  deficiency  and  given  a  period  of  not  less  than  thirty  days 
in  which  to  file  an  appeal.  Opportunity  for  a  hearing  is  to  be 
granted,  and  when  any  tax  or  deficiency  is  assessed  after  such 
appeal  and  hearing,  no  claim  in  abatement  will  be  entertained. 
This  provision  for  notice  and  appeal  will  not  operate  in  cases 
in  which  the  Commissioner  believes  the  collection  of  the  tax 
due  will  be  jeopardized  by  such  delay.  This  matter  of  procedure 
upon  the  finding  of  new  or  additional  tax  liability  constitutes 
one  of  the  principal  changes  made  by  the  Revenue  Act  of  1921. 
The  other  most  important  changes  are:  (a)  a  provision  giving 
the  Commissioner  discretion  to  extend  the  time  for  the  pay- 
ment of  any  deficiency  (except  where  due  to  negligence  or 
fraud)  where  the  payment  thereof  would  result  in  undue  hard- 
ship to  the  taxpayer;  (b)  the  provision  that  interest  shall 
run  with  respect  to  additional  tax  from  the  time  such  tax  was 
originally  due;  and  (c)  the  provisions  changing  the  several 
periods  of  limitation  upon  the  assessment  and  collection  of  taxes. 
The  new  remedy  provided  by  the  Revenue  Act  of  1918  in  the 
case  of  taxpayers  designing  to  depart  from  the  United  States 
or  to  remove  property  therefrom,  is  amended  in  minor  respects 
and  is  also  made  applicable  to  aliens  departing  from  the  United 
States  whatever  their  design  or  intent.  Some  of  the  amend- 
ments indicated  above  are  made  applicable  to  the  assessment  and 
collection  of  taxes  under  the  Revenue  Act  of  1917  and  the 
Revenue  Act  of  1918,  as  will  be  indicated  in  the  following  para- 
graphs.^ 

•■'  This  provision  substantially  embodies  the  department's  practice  under 
the   1918  Law. 

•»  Revenue  Act  of  1921,  §  250. 


850  FEDERAL  INCOME   TAX 

Suit  to  Restrain  Assessment  or  Collection.  No  suit  for  the  pur- 
pose of  restraining  the  assessment  or  collection  of  any  tax  may 
be  maintained  in  any  court.^  The  constitutionality  of  a  law 
cannot  be  inquired  into  in  an  injunction  suit  against  the  govern- 
ment,*^ but  may  be  in  a  stockholder's  suit  to  enjoin  a  corpora- 
tion from  voluntarily  paying  a  tax  alleged  to  be  unconstitutional^ 
An  injunction  will  not  be  granted  at  the  instance  of  a  stock- 
holder to  restrain  the  officers  of  a  corporation  from  paying  the 
tax,  other  than  voluntarily,  as  that  would,  in  effect,  be  the 
same  as  an  action  to  restrain  the  government.^  Allegations 
that  an  assessment  is  irregular  and  void  do  not  constitute  ground 
for  an  injunction.''  A  bill  in  equity  will  not  lie  to  enjoin  col- 
lection although  the  tax  is  alleged  in  the  bill  to  have  been  illegally 
assessed.io  A  collector  cannot  be  restrained  from  collecting  an 
assessment  by  injunction.!^  It  is  contrary  to  every  principle  of 
equity  jurisprudence  that  the  collection  of  taxes  on  personal 
property  should  be  stayed  by  injunction.12  The  courts  will  not 
interfere  by  a  mandamus  with  the  executive  officers  of  the  gov- 
ernment in  the  exercise  of  their  ordinary  official  duties.^^  In 
matters  which  require  an  executive  officer  to  exercise  judg- 
ment or  discretion  no  rule  will  issue  for  mandamus.^*  The 
inhibition  of  the  Revised  Statutes  i'^  applies  to  all  assessments 
of  taxes,  made  under  color  of  their  offices,  by  internal  revenue 
officers  charged  with  general  jurisdiction  of  the  subject  of  assess- 
ing the  income  tax.  The  remedy  of  a  suit  to  recover  back  the 
tax  after  it  is  paid  is  provided  by  statute,  and  a  suit  to  restrain 
its  collection  is  forbidden.     The  remedy  so  given  is  exclusive, 

5  R.  S.  §  3224.  See  also  §  3226,  as  amended  by  §  1318  of  the  Revenue 
Act  of  1921. 

6  Delaware  R.  R.  Co.  v.  Prettyman,  17  Int.  Rev.  Rec.  99;  Allen  v.  Pull- 
man's Palace  Car  Co.,  139  U.  S.  658;  Dodge  v.  Brady,  240  U.  S.  122. 

7  Pollock  v.  Farmers  Loan  &  Trust  Co.,  157  U.  S.  429;  Flint  v.  Stone- 
Tracy  Co.,  220  U.  S.  107;  Brushaber  v.  Union  Pacific  R.  R.  Co.,  240  U.  S. 
1;  Stanton  v.  Baltic  Mining  Co.,  240  U.  S.  103. 

8  Strauss  v.  Abrast  Realty  Co.,  200  Fed.  327. 

9  Alkan  v.  Bean,  23  Int.  Rev.  Rec.  351. 

10  Snyder  v.  Marks,  109  U.  S.  189;  Dodge  v.  Osborn,  240  U.  S.  118. 

11  State  R.  R.  Tax  cases,  92  U.  S.  575;  Keely  v.  Sanders,  99  U.  S.  441. 

12  Nye  v.  Washburn,  125  Fed.  818. 

13  U.  S.  v.  Black,  128  U.  S.  40.  The  court  in  this  case  followed  an  earlier 
decision  of  Decatur  v.  Paulding  (14  Pet.  497)  and  made  clear  the  distinction 
between  the  mere  ministerial  act  of  the  executive  officer,  which  may  be 
controlled  by  the  courts  by  mandamus,  and  an  act  in  the  performance  of 
which  an  officer  is  vested  with  quasi- judicial  discretion. 

14  Carrick  v.  Lamar,  116  U.  S.  423. 

15  R.  S.  §  3224. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  851 

and  no  other  remedy  can  be  substituted  for  it.     The  system  of 
administrative  measures,  not  judicial,  to  collect  internal  revenue 
taxes,  with  appeals  to  specified  tribunals,  and  suits  to  recover 
back  moneys  illegally  exacted  is  a  system  of  corrective  justice 
intended  to  be  complete,  and  enacted  under  the  right  belong- 
mg  to  the  Government  to  prescribe  the  conditions  on  which  it 
will  subject  itself  to  the  judgment  of  the  courts  in  the  collection 
of  its  revenues.^''     In  a  recent  case  the  question  arose  whether 
or  not  a  suit  against  a  collector  to  cancel  a  sale  to  the  govern- 
ment of  the  taxpayer's  real  estate  to   satisfy  a  tax  assessed 
against  him  was  prohibited  and  whether  or  not  the  word  "re- 
strain," as  above  used,  should  be  construed  in  a  narrow  sense  as 
prohibiting  the  issuance  of  restraining  orders  and  injunctions  or 
in  a  broad  or  liberal  sense  as  applying  to  all  suits  to  hinder  or 
impede  the  collection  of  taxes.     The  court  adopted  the  broader 
and   more  liberal   definition.^'      The  prohibition   of  such   suits 
can  not  be  waived  by  any  officer  of  the  government.i«    Despite 
this  general  rule  receivers,  as  officers  of  the  court,  may,  where 
they  deem  the  property  or  income  from  the  property  in  their 
charge  not  subject  to  the  tax  as  contended  by  collecting  officials, 
apply  to  the  appointing  court  for  instructions  as  to  payment.^'' 
It  has  been   held   that   trustees   liquidating   a   dissolving   cor- 
poration, under  direction  of  the  court  as  provided  by  the  Gen- 
eral Statutes  of  Connecticut-"  are  not  officers    of    such    court 
and  the  court,  under  such  circumstances,  has  no  jurisdiction 
to  pass  on  the  legality  of  an  assessment  of  internal   revenue 
taxes  or  to  issue  an  order  restraining  the  assessment  or  col- 
lection thereof.-i 

Also  despite  this  general  rule,  where  the  collector  is  acting 
without  statutory  authority  and  in  seeking  to  make  an  unwar- 
ranted and  premature  distraint,  his  action  will  be  enjoined  as 
an  unlawful  seizure  of  property  where  irreparable  injury  to 
the  assets  of  an  estate  would  result,  including  the  loss  of  all 
benefit  of  a  period  of  grace  of  180  days  given  for  the  payment 
of  estate  taxes.--    It  has  been  held  in  a  recent  case  that  a  suit 

i<;  Dodge  V.  Osborn,  240  U.  S.  118. 

1"  Gouge  V.  Hart,  250  Fed.  802,  appeal  dismissed  for  want  of  jurisdiction, 
251   U.  S.  542;   Reg.  45,  Art.  1037. 

IS  Reg.  45,  Art.  1037. 

ii»  Scott  V.  Western  Pac.  R.  Co.,  246  Fed.  545.  See  also  U.  S.  v.  Nebraska 
Distilling  Co.,  80  Fed.  285. 

•^0  §§  3447  and  3448. 

-•iWillmann  v.  Walsh,  Supreme  Court  of  Errors  of  Conn.,  T.  D.  3166, 
T.  B.  23-21-1679. 

2-'  Polk  V.  Page,  U.  S.  Dist.  Court,  Dist.  of  Rhode  Island. 


852  FEDERAL  INCOME  TAX 

may  not  be  maintained  to  restrain  the  collection  of  taxes  where 
the  tax  has  been  assessed  against  a  corporation,  which  the 
alleged  stockholders  claim  went  out  of  existence  many  years 
before  by  virtue  of  the  limitation  in  its  charter  limiting  its  cor- 
porate existence  to  20  years.  These  stockholders  claimed  that 
the  assets  of  the  corporation  had  been  taken  over  by  them  as 
partners  and  they  had  tendered  a  partnership  return  which  had 
been  refused  by  the  collector.  The  contention  of  the  partners 
was  that  the  prohibition  against  suits  to  restrain  the  collection 
of  taxes  operates  only  against  the  party  assessed,  in  this  case, 
the  corporation.  The  court,  however,  held  that  the  prohibition 
was  effective  against  all  suits.-"^ 

Time  of  Payment  of  Tax.  Except  as  to  any  taxes  paid  at  the 
source,  the  income  tax  is  ordinarily  paid  in  four  equal  install- 
ments.-'' The  first  installment  is  paid  at  the  time  fixed  by  law 
for  filing  the  return,  the  second,  third  and  fourth  installments  on 
the  15th  days  of  the  third,  sixth  and  ninth  months  respectively 
following  such  date.  There  are  now  four  due  dates  which  are, 
in  the  case  of  citizens  and  residents  and  resident  foreign  cor- 
porations:-" March  15,  June  15,  September  15  and  December  15 
in  the  case  of  taxpayers  reporting  on  the  basis  of  a  calendar  year, 
and  the  15th  days  of  the  third,  sixth,  ninth  and  twelfth  months 
following  the  close  of  the  fiscal  year  of  taxpayers  reporting  on 
the  basis  of  a  fiscal  year  other  than  the  calendar  year.^^  The 
payment  of  the  tax  may  be  made  at  any  time  on  such  due  dates. 
If  payment  is  made  by  mail  the  remittance  should  be  mailed  in 
due  time  to  reach  the  collector  on  the  due  date.  To  accommodate 
those  who  make  payments  after  closing  time  a  niail  box  is  pro- 
vided at  the  cashier's  window  in  the  office  of  the  local  collector 
for  the  deposit  of  such  collections.^^ 

24  Markle  v.  Kirkendall,  267  Fed.  498. 

23  Under  the  1916  Law,  the  Secretary,  under  rules  and  regulations  pre- 
scribed by  him,  was  required  to  permit  taxpayers  to  make  payments  in 
advance  in  installments  of  an  amount  not  in  excess  of  the  estimated  taxes 
which  would  be  due  from  them,  and  upon  determination  of  the  taxes 
actually  due  any  amount  paid  in  excess  was  refunded  as  taxes  erroneously 
collected.  The  Secretary  might  allow  a  credit  against  taxes  so  paid  in 
advance  of  an  amount  not  exceeding  the  rate  of  3%  per  annum.  (Act  of 
October  3,  1917   (Public  No.  50),  §1009;  T.  D.  2622.) 

26  See  p.   853. 

27  Revenue  Act  of  1921,  §250  (a)  ;  Revenue  Act  of  1918,  §  250  (a)  ;  T. 
D.  3136,  T.  B.  11-21-1513.  These  provisions  omit  the  ten-day  period  of 
grace  allowed  under  the  former  law. 

28  T.  D.  1728;  Reg.  45,  Art.  1007. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  853 

Extension  of  Time  for  Payments.  An  unconditional  exten- 
sion of  time  for  filing  a  return  will  postpone  the  date  for  pay- 
ment of  the  first  installment,  but  will  not  postpone  the  date  of 
payment  of  the  other  installments  unless  so  specified  in  each 
case.-"'  In  case  an  extension  is  granted  on  request  of  the  tax- 
payer, interest  at  the  rate  of  one-half  of  one  per  centum  per 
month  is  added  to  the  installment  from  the  date  it  would  have 
been  due  if  no  extension  had  been  granted,  that  is,  the  original 
due  date,  until  the  installment  is  paid.'"' 

Nonresident  Aliens  and  Nonresident  Foreign  Cor- 
porations. The  time  fixed  by  law  for  the  filing  of  returns  by 
nonresident  aliens  and  nonresident  foreign  corporations^*'  re- 
porting on  the  calendar  year  basis  is  now  June  15th;  and  in  the 
case  of  such  taxpayers  reporting  on  the  fiscal  year  basis  the 
time  fixed  for  the  filing  of  returns  is  the  15th  day  of  the  sixth 
month  following  the  close  of  the  fiscal  year.-'-  Therefore,  non- 
resident aliens  and  nonresident  (not  resident)  foreign  corpo- 
rations reporting  on  the  calendar  year  basis  will  pay  the  tax 
in  four  equal  installments  on  June  15,  September  15,  December 
15  and  March  15  (of  the  second  year  after  the  year  for  which 
the  tax  is  paid).  Nonresident  aliens  and  nonresident  foreign 
corporations  reporting  on  a  fiscal  year  basis  will  pay  the  tax  in 
four  equal  installments  on  the  15th  day  of  the  sixth,  ninth, 
twelfth  and  fifteenth  month  following  the  close  of  such  fiscal 
year — which  is  at  the  time  fixed  by  law  for  filing  the  return,  and 
on  the  15th  day  of  the  third,  sixth,  and  ninth  month  thereafter.^*-* 

Effect  of  Failure  to  Pay  Installment.  The  Revenue  Act 
of  1921,  like  the  1918  Law,  provides  that  upon  failure  to  pay 
an  installment  on  time,  all  of  the  tax  remaining  unpaid  becomes 
due  and  payable  upon  notice  and  demand.-'*  It  has  been  held 
that  where  a  taxpayer  pays  on  time  only  a  part  of  an  install- 
ment it  is  the  duty  of  a  collector  within  a  reasonable  time  to  de- 
mand of  him  the  whole  amount  of  the  tax  unpaid.    This  demand 

20  Reg.   45,   Art.   1001. 

■■i<»  Revenue    Act   of    1921,   §250    (a);    Revenue   Act   of   1918,   §250    (a). 

•^1  The  term  "nonresident  foreign  corporation",  as  used  in  this  chapter, 
refers  to  foreign  corporations  with  no  office  or  place  of  business  in  the 
United  States;  resident  foreign  corporations  are  foreign  corporations 
with  such  an  office  or  place  of  business  (See  Revenue  Act  of  1918,  §241 
(a)    ). 

3-' Revenue  Act  of  1921,  §§227   (a)   and  241    (a). 

ss  Revenue    Act  of   1921,   §250    (a). 

34  Revenue  Act  of  1921,  §250  (a)  ;  Revenue  Act  of  1918,  §250  (a)  ;  Reg. 
45,  Art.  1001. 


854  FEDERAL  INCOME   TAX 

is  the  culminating  act  which  makes  the  installment  plan  of  pay- 
ing the  tax  imperative.  What  is  a  reasonable  time  must  be  de- 
termined by  the  facts  and  circumstances  in  each  particular 
case.35  Where  a  taxpayer  filed  a  return  of  income  on  March  14, 
1921,  showing  no  tax  due,  but  attached  to  the  return  a  state- 
ment disclosing  the  fact  that  during  the  year  1920  a  profit  had 
been  derived  from  the  sale  of  capital  assets,  and  immediately 
after  the  United  States  Supreme  Court  decision  holding  such 
profit  to  be  income  sent  to  the  collector  a  check  to  be  credited 
as  the  first  installment  of  his  1920  tax  with  interest  accrued 
through  delay  in  payment,  it  has  been  ruled  that  the  other  in- 
stallments may  not  be  declared  due  and  payable.  Since  his  re- 
turn disclosed  no  tax  liability,  it  could  not  be  held  that  he 
failed  to  pay  an  installment  of  tax  due.^*' 

Advance  Payment  of  Tax.  Income  taxes  may  at  the  option 
of  a  taxpayer  be  paid  in  advance  and  in  a  single  payment  instead 
of  installments,  in  which  case  the  total  amount  must  be  paid  on 
or  before  the  time  fixed  by  law  for  filing  the  return,  or  such  time 
as  extended,  to  wit,  March  15th  or  the  15th  day  of  the  third 
month  following  the  close  of  a  fiscal  year  other  than  the  calendar 
year  as  the  case  may  be.^^ 

Assessment  of  Tax.  When  returns  made  under  the  1918  Law 
were  received  at  the  collectors'  offices,  they  were  examined  and 
listed  before  being  forwarded  to  the  Commissioner,  If  it  ap- 
peared that  the  tax  was  greater  or  less  than  shown  in  the  return, 
it  was  recomputed.  After  checking  the  figures  the  Commis- 
sioner assessed  the  tax  on  the  basis  of  the  collectors'  lists. 
The  collectors  then  sent  out  bills  for  the  taxes,  either  as  com- 
puted by  the  taxpayer  or  as  recomputed.  If  a  taxpayer  be- 
lieved that  he  had  been  overassessed,  he  might  file  a  claim 
for  abatement  or  (after  payment  of  the  tax)  for  a  refund  of  the 
excess.  As  soon  as  practicable  the  returns  were  carefully  audited 
by  accountants  in  the  office  of  the  Commissioner  at  Washington, 
assisted  where  necessary  by  reports  of  the  examination  of  tax- 
payers' books  and  records  made  by  revenue  agents  in  the  field. 
If  error  in  a  return  was  detected,  the  taxpayer  was  notified  ac- 
cordingly and  an  additional  assessment  was  made  against  him 
or  he  was  given  the  opportunity  to  file  a  claim  for  a  refund,  as 
the  case  might  be.^^ 

35  Sol.  Op.  77,  T.  B.  48-20-1326. 

36  0.  D.  961,  T.  B.  26-21-1709. 

37  Revenue  Act  of  1921,  §  250  (a)  ;  Revenue  Act  of  1918,  §  250  (a)  ;  Reg. 
45,  Art.  1001. 

38  Reg.  45,  Art.  1012. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  855 

This  procedure,  so  far  as  it  relates  to  recomputation  and  to 
amounts  paid  in  excess  of  tax  liability,  will  be  retained.  If, 
upon  examination  of  a  return  by  the  Commissioner  and  recom- 
putation of  the  tax  and  installments,  the  amount  paid  exceeds 
what  should  have  been  paid  on  the  basis  of  the  installments  as 
recomputed,  the  excess  so  paid  will  be  credited  against  subse- 
quent installments;  and  if  the  amount  already  paid  exceeds  the 
correct  amount  of  the  tax  such  excess  will  be  credited  or  re- 
funded to  the  taxpayer  in  accordance  with  the  rules  set  forth  in 
another  chapter.'"'  If,  however,  upon  such  examination  of  a  re- 
turn by  the  Commissioner,  the  tax  appears  to  be  greater  than  that 
shown  in  the  return  the  procedure  adopted  by  the  Revenue  Act 
of  1921  differs  materially  from  that  provided  in  the  1918  Law 
and  the  practice  adopted  thereunder.  Any  such  excess  of  the 
amount  due  upon  such  recomputation  over  the  amount  already 
paid  is  termed  a  "deficiency"  by  the  Revenue  Act  of  1921.  It 
is  to  be  noted  that  Interest  on  this  deficiency  is  payable  at  the 
rate  of  one-half  of  one  per  centum.  It  is  due  on  any  such  defi- 
ciency from  the  time  the  tax  was  due,  and  such  deficiency  must 
be  paid  upon  notice  and  demand  by  the  collector.  Penalties 
are  provided  with  regard  to  such  deficiency  and  a  new  pro- 
cedure is  adopted  in  the  Revenue  Act  of  1921  for  the  notification 
of  the  taxpayer  of  the  amount  thereof  and  an  appeal  (with 
hearing)  by  him  with  regard  to  the  amount  of  such  proposed 
additional  tax.  This  subject  is  more  fully  discussed  in  subse- 
quent paragraphs.^" 

Notice  and  Demand  for  Tax.  The  law  provides  ^^  for  five  no- 
tices and  demands  upon  the  taxpayer  by  the  collector.  The  first 
is  a  notice  and  demand  for  the  whole  amount  of  the  tax  unpaid, 
upon  default  in  the  payment  of  any  installment.  The  second  is  a 
notice  and  demand  for  the  difference  between  the  amount  of  tax 
computed  in  the  taxpayer's  return  and  the  amount  recomputed 
by  the  Commissioner,  termed  "deficiency"  under  the  present  law. 
The  third  is  a  notice  and  demand  by  the  collector  under  a  return 
made  pursuant  to  the  revised  statutes.^-  The  fourth  is  a  notice 
and  demand  for  any  tax  remaining  unpaid  after  the  date  when 
it  is  due,  ten  days  after  the  making  of  which  penalties  and 
interest  begin  to  run.     The  fifth  is  the  notice  and  demand  im- 

30  See  Chapter  37. 
^"See  p.  863. 

41  Revenue  Act  of  1918,  §250;  Reg.  45,  Arts.  1001-1012. 

42  R.  S.,  §  3176,  as  amended. 


856  FEDERAL  INCOME   TAX 

puted  to  the  taxpayer  in  respect  of  the  first  installment.^"  Under 
these  provisions  the  treasury  department  sent  out  notice  and 
demand  (called  "Satement  of  Tax  Due")  for  the  tax  (Form 
1123  taking  the  place  of  Form  1-17A)  sufficiently  in  advance 
of  June  15,  September  15  and  December  15  (or  the  corespond- 
ing  dates  in  the  case  of  taxpayers  making  returns  on  the  basis 
of  fiscal  years) ,  to  give  the  taxpayer  ten  days'  notice  and  demand 
before  each  of  such  dates.  In  this  manner,  on  the  15th  days  of 
June,  September  and  December,  the  tax  is  due  and  the  taxpayer 
has  had  a  notice  and  demand  by  the  collector  ten  days  pre- 
viously. If  the  required  installment  was  not  paid  by  such  dates, 
the  penalties  and  interest  provided  by  the  law  attached  and 
Form  1-21A  was  sent  out.^^  In  addition,  the  whole  amount 
of  tax  unpaid  became  due  and  payable  upon  a  further  notice 
and  demand  by  the  collector  in  accordance  with  the  first  of  the 
above  stated  notipes  and  demands.  The  second  and  third  of 
the  above  stated  notices  and  demands  both  referred  to  an  amount 
of  tax  not  computed  by  the  taxpayer,  but  one  computed  by  the 
treasury  department.  The  second  notice  and  demand  was  for 
a  tax  recomputed  by  the  Commissioner  after  his  examination 
of  the  return.  The  third  notice  and  demand  was  for  a  tax 
assessed  after  a  return  made  by  a  collector  or  the  Commissioner 
in  accordance  with  the  revised  statutes.  Both  these  notices  and 
demands  were  for  additional  taxes  or  for  taxes  computed  by 
the  treasury  department  in  the  absence  of  any  computation 
by  the  taxpayer.  In  such  cases,  the  ten-day  period  of  grace 
applied,  or  at  least  no  penalties  attached  until  the  additional  tax 
had  been  demanded.^'*  With  regard  to  the  first  installment  of  the 
tax;  the  statute  provided  that  the  instructions  printed  on  the 
return  shall  be  deemed  sufficient  notice  of  the  date  when  the  tax 
is  due,  and  sufficient  demand,  and  the  taxpayer's  computation  of 
the  tax  on  the  return  shall  be  deemed  sufficient  notice  of  the 
amount  due.^"     If  a  return  was   filed  without  payment  of  at 

43  See  T.  D.  3136,  T.  B.  11-21-1513.  The  first  three  notices  and  demands 
are  covered  respectively  by  subdivisions  (a),  (b)  and  (c)  ;  the  fourth  and 
fifth  by  subdivision    (e)    of  §  250. 

44  T.  D.  2840;   M.  2784,  T.  B.  22-21-1666. 

45  See  "Notice  and  Demand  for  Tax"  (Form  1-17)  and  "Second  Notice 
and  Demand  for  Tax"   (Form  1-21),  used  under  the  1918  Law. 

46  Reading  this  provision  in  connection  with  the  first  sentence  of  sub- 
division (e)  of  §  250,  it  may  be  argued  that  on  March  15th  the  taxpayer 
has  had  sufficient  notice  of  the  date  when  the  tax  is  due  (March  15th)  and 
of  the  amount  of  tax  due,  and  also  sufficient  demand;  that  by  virtue  of  the 
first  sentence  of  subdivision  (e)  the  taxpayer  has  ten  days  after  such  de- 
mand within  which  to  pay  the  tax  without  penalty.     On  the  other  hand, 


ASSESSMENT  AND  PAYMENT  OF   THE  TAX  857 

least  one-fourth  of  the  tax  shown  by  the  return  to  be  due,  it 
was  the  practice  under  the  1918  Law  to  send  a  notice  to  the 
taxpayer  covering  the  correct  amount  of  the  first  installment, 
which  carried  interest  from  the  date  on  which  the  return  should 
have  been  filed  up  to  date  on  which  payment  was  made.  Such 
taxpayer  was  also  sent  a  notice  and  demand  for  the  second, 
third  and  fourth  installments,  and  an  additional  notice  and  de- 
mand if  the  total  was  not  paid  within  ten  days.  Such  tax- 
payer lost  the  privilege  of  paying  the  tax  in  installments.^" 

Changes  Made  By  1921  Law.  The  present  law  provides  for 
the  notices  and  demands  enumerated  in  the  preceding  para- 
graph.^'^  It  contains  the  provision  for  notice  and  demand  in  the 
case  of  the  first  installment  and  provides  that  in  the  case  of  the 
second,  third  and  fourth  installments  the  collector  may,  within 
30  days,  and  not  later  than  10  days,  before  each  such  installment 
becomes  due,  mail  to  the  taxpayer  notice  of  the  amount  of  the 
installment  and  the  date  on  which  it  is  due  for  payment,  which 
notice  of  the  collector  will  be  deemed  sufficient  notice  and  de- 
mand.^'' This  provision  puts  the  practice  of  the  department 
under  the  1918  Law  into  the  statute  and  insures  the  incidence 
of  penalties  and  interest  from  the  due  date  of  each  installment. 
The  notice  and  demand  required  for  the  payment  of  any  defi- 
ciency (the  second  notice  and  demand  referred  to  in  the  preced- 
ing paragraph)  must,  where  the  delay  will  jeopardize  the  col- 
lection of  tax,  await  the  determination  of  the  hearing  and  appeal 
accorded  to  the  taxpayer  upon  the  determination  that  he  owes 
any  tax  not  paid  or  any  deficiency."'" 

Service  of  Notice  and  Demand.  Notice  and  demand  may 
lawfully  be  given  by  mail  and  when  so  given  is  presumed  to  have 
been  received.     The  burden  rests  on  the  taxpayer  to  prove  the 

it  may  be  argued  that  the  words  "sufficient  demand"  are  intended  as  to 
the  first  installment  to  be  paramount  in  effect,  to  the  first  sentence  of  sub- 
division (e)  ;  that  is,  that  the  instructions  printed  on  the  return  constitute 
sufficient  demand  in  the  case  of  the  first  installment  and  that  the  taxpayer 
has  not  ten  days  after  demand  within  which  to  pay  the  tax.  The  former 
of  these  interpretations  would  make  the  first  due  date  March  25th,  and  the 
latter  March  15th.  The  former  seems  to  be  a  more  reasonable  interpre- 
tation of  the  language,  and  the  latter  to  be  more  consistent  with  the 
statute  in  general. 

-I'O.  D.  233,  T.  B.  12-19-408. 

•♦'*  It  also  provides  for  a  notice  and  demand  for  the  payment  of  interest 
and  penalties    (§250   (b)    ). 

4i»  Revenue  Act  of  1921,  §250  (e). 

5ti  See  Revenue  Act  of  1921,  §250    (d). 


858  FEDERAL  INCOME   TAX 

contrary  in  order  to  avoid  the  penalty.^i  The  time  within  which 
the  tax  must  be  paid  runs  from  the  date  of  mailing  the  notice  and 
not  of  its  receipt  by  the  taxpayer.-''-  The  practice  of  the  depart- 
ment in  such  cases  has  been  to  permit  the  taxpayer  to  show,  to 
the  satisfaction  of  the  Commissioner,  that  he  did  not  receive  the 
notice,  and  upon  such  showing  to  give  the  taxpayer  an  opportu- 
nity to  pay  his  taxes  without  penalty.  The  record  of  the  collector 
showing  that  notice  had  been  duly  mailed  is  considered  merely  as 
'prima  facie  evidence  that  the  notice  was  received.-^^  The  date 
appearing  on  the  notice  and  demand,  as  the  last  date  on  which  the 
tax  may  be  paid  without  penalty,  should  be  a  date  ten  days  sub- 
sequent to  the  actual  mailing  of  the  notice  and  not  necessarily  ten 
days  from  the  date  of  the  notice.    The  date  of  mailing  controls.^* 

Notice  and  Demand  to  Absentees.  By  reason  of  absence 
from  their  homes  or  places  of  business  in  foreign  countries  or  in 
the  military  or  other  service  of  the  country  and  the  consequent 
delay  in  receiving  mail,  or  by  reason  of  the  location  of  the  resi- 
dence of  an  individual  or  of  the  office  of  a  corporation  to  which 
the  notice  was  addressed  at  a  distance  from  the  collector's  office, 
it  is  impossible  for  many  persons  to  receive  a  notice  and  demand 
and  to  make  payment  of  the  tax  so  that  such  payment  may  be 
received  by  the  collector  within  the  ten-day  period  following  the 
service  of  notice  and  demand.  In  all  such  cases  it  has  been  the 
practice  for  the  collector  to  enter  on  the  notice  as  the  date  on 
which  the  tax  becomes  due  and  payable  a  date  as  nearly  as  possi- 
ble ten  days  after  the  time  that  the  notice  should  be  received  in 
the  ordinary  course  of  the  mails  by  the  taxpayer.  In  such  cases 
when  it  appears  that  a  remittance  for  the  tax  was  placed  in  the 
mails  within  the  ten-day  period  after  the  date  specified  in  the 
notice,  and  in  cases  where  tardiness  is  occasioned  because  the 
notice  was  not  delivered  in  due  time  by  reason  of  delay  in  the 
mail  and  satisfactory  evidence  of  that  fact  is  furnished,  the  pen- 
alty and  interest  will  not  be  collected.''^ 

Additional  Assessment  Under  1918  and  Prior  Laws  Prior  to 
Enactment  of  Present  Law.  The  1916  Law  provided  ^"^  that  "in 
cases  of  refusal  or  neglect  to  make  a  return  and  in  cases  of  erro- 
neous, false,  or  fraudulent  returns,  the  Commissioner  shall,  upon 

51  U.  S.  V.  General  Inspection  and  Loading  Co.,  204  Fed.  657;  Reg.  45, 
Art.  1007. 

52  Reg.  45,  Art.  1007. 

53  L  T.  S.  1917,  112268;  Reg.  45,  Art  1007. 

54  T.  D.  1659. 

55  Reg.  45,  Art.  1007. 

56  Revenue  Act  of  1916,  §§9  (a),  14   (a). 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  859 

the  discovery  thereof,  at  any  time  within  three  years  after  the 
return  is  due,  or  has  been  made,  make  a  return  upon  information 
obtained  as  provided  for  in  the  law,  or  require  the  necessary  cor- 
rections to  be  made,  and  in  such  cases  the  assessment  made  by 
the  Commissioner  thereon  shall  be  paid  by  the  taxpayer  imme- 
diately upon  notification  of  the  amount  of  such  assessment."-"'^ 
The  same  law  provided:''^  "If  any  person  *  *  *  fails  to 
make  and  file  a  return  or  list  at  the  time  prescribed  by  law,  or 
makes,  willfully  or  otherwise,  a  false  or  fraudulent  return  or  list, 
the  collector  or  deputy  collector  shall  make  the  return  or  list 
from  his  own  knowledge  and  from  such  information  as  he  can 
obtain  through  testimony  or  otherwise.  Any  return  or  list  so 
made  and  subscribed  by  a  collector  or  deputy  collector  shall  be 
prima  facie  good  and  sufllicient  for  all  legal  purposes.  *  *  * 
The  Commissioner  of  Internal  Revenue  shall  assess  all  taxes, 
other  than  stamp  taxes,  as  to  which  returns  or  lists  are  so  made 
by  a  collector  or  deputy  collector."  The  duplication  and  conflict 
of  these  provisions  were  removed  by  the  Revenue  Act  of  1918. 
It  was  provided  by  that  law  :•"'•'  "If  any  person  *  *  *  f^^jjg 
to  make  and  file  a  return  or  Ust  at  the  time  prescribed  by  law 
or  by  regulations  made  under  authority  of  law,  or  makes,  will- 
fully or  otherwise,  a  false  or  fraudulent  return  or  list,  the  col- 
lector or  deputy  collector  shall  make  the  return  or  list  from  his 
own  knowledge  and  from  such  information  as  he  can  obtain 
through  testimony  or  otherwise.  In  any  such  case  tJie  Commis- 
sioner may  from  his  oivn  knowledge  and  from  such  information 
as  he  can  obtain  through  testimony  or  otherwise,  make  a  return 
or  amend  any  rehcm  made  by  a  collector  or  deputy  collector. 
Any  return  or  list  so  made  and  subscribed  by  the  Commissioner 
or  by  a  collector  or  deputy  collector  and  approved  by  the  Com- 
missioner, shall  be  prima  facie  good  and  sufficient  for  all  legal 

•"'"  The  usual  ten  day  period  of  grace,  however,  applied  to  such  assess- 
ments as  well  as  to  the  regular  assessments. 

58  R.  S.,  §3176,  as  amended  by  the  Revenue  Act  of  1916.  Although  the 
Commissioner  had  power  summarily  to  assess  the  tax  upon  discovery  of 
income  which  had  not  been  reported,  yet  if  such  discovery  was  made  prior 
to  the  day  on  which  the  tax  was  due  (June  15th  or  in  the  case  of  the  cor- 
porations filing  for  their  fiscal  year  165  days  after  the  closing  of  the  fiscal 
year)  the  tax  could  not  be  summarily  assessed  but  might  be  paid  at  any 
time  before  the  regular  due  date  with  an  additional  period  of  ten  days 
of  grace.  (T.  D.  2003.)  Where  a  summary  assessment  was  made  after  the 
regular  due  date,  the  tax  was  due  immediately  upon  notice  and  demand 
given  by  the  collector.     (Reg.  33,  Arts.  177  and  184.) 

JJOR.  S.,  §3176,  as  amended  by  the  Revenue  Act  of  1918.  The  amend- 
ment of  this  section  by  the  Revenue  Act  of  1921  is  of  no  consequence. 


860  FEDERAL   INCOME   TAX 

purposes.  *  *  *  The  Commissioner  of  Internal  Revenue  shall 
determine  and  assess  all  taxes  other  than  stamp  taxes,  as  to 
which  returns  or  lists  are  so  made  under  the  provisions  of  this 
section."  The  Revenue  Act  of  1918  also  provided ""  that  "except 
in  the  case  of  false  or  fraudulent  returns  with  intent  to  evade 
the  tax,  the  amount  of  tax  due  under  any  return  shall  be  deter- 
mined and  assessed  by  the  Commissioner  within  five  years  after 
the  return  was  due  or  was  made,  and  no  suit  or  proceeding  for  the 
collection  of  any  tax  shall  be  begun  after  the  expiration  of  five 
years  after  the  date  when  the  return  was  due  or  made.  In  the 
case  of  such  false  or  fraudulent  returns,  the  amount  of  tax  due 
may  be  determined  at  any  time  after  the  return  is  filed,  and  the 
tax  may  be  collected  at  any  time  after  it  becomes  due."  In  ad- 
dition to  removing  the  inconsistency  of  the  two  sections  provid- 
ing for  summary  assessment,  the  two  last  quoted  provisions  make 
three  changes  in  the  law.  In  the  first  place,  the  rule  that  the 
limitation  of  time  was  upon  the  discovery  of  the  error  by  the 
Commissioner  and  not  upon  the  making  of  the  additional  assess- 
ment,"^ was  changed,  and  the  limitation  fixed  upon  the  making 
of  the  assessment."-  In  the  second  place,  the  limitation  itself 
was  extended  from  three  to  five  years. "^  In  the  third  place,  the 
limitation  which  was  held  formerly  to  apply  only  to  summary 
assessments*'^  was  now  expressly  made  also  applicable  to  "suits 
or  proceedings  for  the  collection  of  any  tax.""''  Additional  as- 
sessment might  still  be  made  where  the  erroneous  return  was 
due  to  an  honest  mistake,  and  where  the  mistake  was  not  dis- 
covered until  after  the  tax  had  been  assessed  and  paid  in  the 
regular  course."" 

Five- Year  Limitation  on  Summary  Assessment.  The  1916 
Law  authorized  the  Commissioner  to  make  a  summary  assess- 

<•'<»  Revenue  Act  of  1918,  §250   (d). 

<51  Eliot  Nat.  Bank  v.  Gill,  210  Fed.  933,  affirmed  218  Fed.  600. 

<!2  Revenue  Act  of  1918,   §250    (d). 

63  Compare  Revenue  Act  of  1918,  §250  (d)  with  Revenue  Act  of  1916 
§§9  (a)  and  14  (a). 

f'-t  U.  S.  V.  Minneapolis  Threshing  Mach.  Co.,  220  Fed.  1019. 

•JS  Revenue  Act  of  1918,  §250  (d).  Compare  this  section  with  Revenue 
Act  of  1916,  §§  9  (a)  and  14  (a).     Sol.  Op.  79,  T.  B.  49-20-1337. 

<w  Eliot  National  Bank  v.  Gill,  218  Fed.  600;  Woods  v.  Lewellyn,  252 
Fed.  106.  The  same  words  "false  or  fraudulent"  were  still  used  in  R.  S., 
§  3176,  as  amended  by  the  Revenue  Act  of  1918,  which  were  held  in  the 
above  cases  to  include  returns  honestly  incorrect  and  thus  to  give  the  Com- 
missioner power  to  make  summary  assessments  when  such  returns  had 
been  filed.  They  are  still  used  in  R.  S.,  §  3176,  as  amended  by  the  Revenue 
Act  of  1921. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  861 

ment  of  the  tax  on  undisclosed  income,  if  the  di scorer  1/  was  made 
within  three  years  after  the  return  in  which  such  income  should 
have  been  reported  was  due.*'"  The  assessment  was  not  required 
to  be  made  within  three  years,  so  long  as  the  discoreri/  was  made 
within  that  time.''^  The  three  years'  limitation  in  this  provision 
was  not  a  limitation  upon  the  right  of  the  government  to  sue  for 
unpaid  taxes,  but  was  at  most  a  limitation  upon  the  right  of  the 
collecting  officers  to  make  assessment  and  enforce  the  payment 
by  the  summary  statutory  proceeding.'''  This  three-year  limita- 
tion was  held  still  applicable  after  the  enactment  of  the  Revenue 
Act  of  1918  to  additional  assessments  made  under  the  1909,  the 
1913  and  the  1916  Laws.""  It  might  be  waived  by  a  formal  state- 
ment or  the  filing  of  amended  returns  which  were  held  in  effect 
such'a  waiver.  By  the  Revenue  Act  of  1918  the  period  of  limita- 
tion was  made  five  years  as  to  taxes  assessed  under  the  Revenue 
Act  of  1918 ;  the  limitation  was  upon  the  making  of  the  assess- 
ment, and  was  applicable  to  the  right  of  the  government  to  sue 
as  well  as  to  make  summary  assessment."^   The  limitation  did  not 

<i7  Revenue  Act  of  1916,  §§  9  (a)  and  14  (a). 

•w  Eliot  National  Bank  v.  Gill,  218  Fed.  600;  O.  D.  234,  T.  B.  12-19-409; 
Sol.  Op.  60,  T.  B.  36-20-1189;  Sol.  Op.  92,  T.  B.  13-21-1534;  Sol.  Op.  79, 
T.  B.  49-20-1337.  While  the  government  was  fully  authorized  under  the 
1916  Law  to  recover  taxes  by  suit  upon  discovery  of  liability  to  original 
or  additional  tax  after  the  three-year  period,  the  treasury  department 
preferred  that  the  collection  should  be  made  in  the  ordinary  statutory 
method,  that  is,  as  a  result  of  a  formal  assessment.  In  order  that  this 
might  be  done,  taxpayers  were  requested  to  make  amended  returns  and 
to  execute  waivers  of  the  three-year  statutory  limitation.  In  executing 
such  waiver,  the  taxpayers  forfeited  none  of  their  rights  and  assumed  no 
liability  to  any  penalty  that  might  not  have  been  enforced  against  them 
in  the  absence  of  such  waiver.  If  the  taxpayer,  against  whom  an  additional 
tax  liability  was  discovered  formally  accepted  the  findings  of  the  examining 
officer  and  agreed  voluntarily  to  pay  the  tax,  this  amounted  to  a  waiver 
and  neither  amended  returns  nor  waivers  were  required.  (Mimeograph 
Letter  to  Collectors,  No.  1192.)  There  was  apparently  no  objection  to  a 
taxpayer  signing  a  waiver  where  additional  tax  liability  was  discovered 
after  the  expiration  of  the  three-year  period,  providing  he  did  not  ques- 
tion the  legality  of  the  assessment.  The  result  of  signing  a  waiver  was 
to  compel  him  to  pay  the  tax  under  protest  and  sue  for  its  recovery,  while 
if  a  waiver  was  not  signed,  the  government  became  the  plaintiff  in  an 
action  to  collect  such  tax.  Where  the  limitation  of  the  statute  as  to  assess- 
ment had  run  and  a  written  waiver  of  exemption  from  assessment  was 
given  by  the  taxpayer,  the  ad  valorem  penalty  of  50^/r  addition  to  tax, 
was  not  assessed  for  delinquency  in  filing  a  return.     (Reg.  33  Rev.,  Art.  .52). 

«'U.  S.  V.  Grand  Rapids  &  Indiana  Ry.  Co.,  239  Fed.  153;  Sol.  Op.  79, 
T.  B.  49-20-1337. 

"*'  This  period  has  been  extended  by  the  present  law.     See  p.  862. 

n  Sol.   Op.  79,  T.   B.  49-20-1337.     But  there  is  now  a  limitation  on  the 


862  FEDERAL  INCOME   TAX 

apply,  under  the  1918  Law,  in  the  case  of  false  or  fraudulent  re- 
turns with  intent  to  evade  the  taxJ^ 

Computation  of  Period.  In  computing  the  five  year  period, 
March  15,  the  date  on  which  the  returns  should  have  been  filed, 
or  were  filed  in  due  course,  should  be  excluded.  The  more  modern 
general  rule"^  in  the  interpretation  of  statutes,  where  time  is  to 
be  computed  from  a  particular  day,  is  to  exclude  the  day  thus 
designated  and  to  include  the  last  day  of  the  specified  period.'''^ 
It  has  been  held  under  the  1916  Law  that  an  extension  of  time 
granted  by  the  Commissioner  to  taxpayers  for  filing  their  income 
returns  operates  to  shift  the  due  date  for  filing  returns  to  the 
expiration  of  the  period  of  extension  and  the  three-year  limita- 
tion begins  to  run  from  the  due  date  as  thus  shifted."^ 

Additional  Assessments;  Rules  Established  by  Present* Law. 
Extensive  changes  have  been  made  by  the  Revenue  Act  of  1921 
in  the  rules  discussed  in  the  foregoing  paragraph.  The  provi- 
sions of  the  present  law  may  be  summarized  as  follows : 

(1)  The  statute  of  limitations  upon  the  making  of  assess- 
ments for  any  tax  due  under  any  return  made  under  the  1921 
Law  is  reduced  to  four  years,  the  period  of  limitation  upon  suits 
or  proceedings  for  the  collection  of  taxes  under  the  1918  Law 
being  kept  at  five  years. 

(2)  The  statute  of  limitations  upon  suits  or  proceedings  for 
the  collection  of  taxes  due  under  any  return  made  under  the 
1918  Law  is  retained  at  five  years ;  and  it  is  also  extended  to  all 
prior  income  tax  laws,  and  the  1909  Law.  As  to  these  laws  prior 
to  the  1918  Law  there  had  formerly  been  no  limitation  upon  suits. 

(3)  The  statute  of  limitations  of  five  years  upon  the  making 
of  assessments  for  any  tax  due  under  any  return  made  under  the 
1918  Law,  first  introduced  in  the  1918  Law  and  not  formerly 
applicable  to  taxes  due  under  any  return  made  under  any  other 
law,  is  made  applicable  to  taxes  due  under  any  return  filed  under 
all  income,  excess-profits  and  war-profits  tax  laws,  as  well  as  the 
1909  Law,  unless  both  the  Commissioner  and  the  taxpayer  con- 
sent in  writing  to  a  later  determination,  assessment  and  collec- 
tion of  the  tax ;  the  period  of  limitation  upon  the  making  of  such 
assessments  of  taxes  due  under  laws  prior  to  the  1918  Law  hav- 

right  to  sue  for  taxes  due  under  the  1916  Law,  as  well  as  the  right  to 
make  assessments. 

72  Revenue  Act  of  1918,  §250   (d). 

73  McCullough  V.  Hopper,  47  N.  J.  L.  189. 

74  Eliot  National  Bank  v.  Gill,  218  Fed.  600;  National  Bank  of  Com- 
merce V.  Allen,  223  Fed.  472. 

75  Sol.  Op.  92,  T.  B.  13-21-1534. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  863 

ing  formerly  been  three  years,  but  being  applicable  to  the  dis- 
covery of  error  rather  than  the  assessment  of  additional  tax."" 
(4)  The  statutory  periods  upon  the  making  of  assessments 
do  not  apply  in  the  case  of  (a)  a  false  or  fraudulent  return  with 
intent  to  evade  tax,  (b)  the  failure  to  file  a  required  return,  (c) 
where  tax  must  be  assessed  on  the  final  determination  of  amorti- 
zation deductions,  and  (d)  where  taxes  must  be  assessed  upon  a 
final  determination  of  losses  and  other  deductions  tentatively  al- 
lowed pending  a  determination  of  the  exact  amount  deductible; 
the  amount  of  tax  or  deficiency  in  any  of  these  cases  being  assess- 
able and  collectible  at  any  time,  subject  to  the  right  of  the  tax- 
payer to  a  hearing  and  appeal." 

Income  Received  During  Lifetime  of  a  Decedent.  The 
Revenue  Act  of  1921  also  provides  that  in  the  case  of  income 
received  during  the  lifetime  of  a  decedent  all  taxes  due  thereon 
shall  be  determined  and  assessed  within  one  year  after  written 
request  therefor  by  the  executor,  administrator,  or  other  fidu- 
ciary representing  the  estate  of  such  decedent."^' 

Right  of  Taxpayer  to  Appeal.  The  term  "deficiency,"  as  used 
in  the  present  law,  refers  to  any  amount  of  tax  found  by  the 
Commissioner  to  be  due  in  excess  of  that  paid  by  the  taxpayer 
and  not  carried  by  any  credits  to  which  the  taxpayer  is  entitled. 
The  Revenue  Act  of  1921  contains  an  important  new  provision 
that  if  upon  examination  of  a  return  made  under  the  Revenue 
Act  of  1916,  the  Revenue  Act  of  1917,  the  Revenue  Act  of  1918, 
or  this  act,  a  tax  or  a  deficiency  in  tax  is  discovered,  the  tax- 
payer shall  be  notified  thereof  and  given  a  period  of  not  less  than 
30  days  after  such  notice  is  sent  by  registered  mail  in  which  to 
file  an  appeal  and  show  cause  or  reason  why  the  tax  or  deficiency 
should  not  be  paid.  Opportunity  for  hearing  will  be  granted  and 
a  final  decision  thereon  must  be  made  as  quickly  as  practicable. 
Any  tax  or  deficiency  in  tax  then  determined  to  be  due  will  be 

TO  It  is  well  that  all  statutes  should  run  from  the  making  of  a  return 
to  the  making  of  the  assessment  rather  than  to  the  disco  ve)-y  of  error.  The 
time  when  discovery  is  made  is  not  always  easy  to  fix,  and  is  peculianly 
within  the  knowledge  of  the  party  against  whom  the  statute  would  run. 
It  seems  doubtful,  however,  whether  Congress  may  revive  the  power  of 
the  Commissioner  to  make  assessments  under  the  1916  Law  in  cases  m 
which  the  discovery  was  not  made  within  three  years,  but  in  which  five 
years  have  not  run  since  the  making  of  a  return.  The  power  to  impose 
a  retroactive  tax  would  not  seem  to  support  such  a  provision.  However, 
the  government  still  has  the  power  to  sue  in  such  cases,  and  may  impose  a 
limitation  of  time  upon  that  power. 

77  Revenue  Act  of  1921,  §  250   (d) . 

77a  Id.  ^ 


864  FEDERAL   INCOME   TAX 

assessed  and  paid,  together  with  the  penalty  and  interest,  if  any, 
applicable  thereto,  within  10  days  after  notice  and  demand  by 
the  collector,  and  in  such  cases  no  claim  in  abatement  of  the 
amount  so  assessed  will  be  entertained.  This  provision  does  not 
apply  if  the  Commissioner  believes  that  the  collection  of  the 
amount  due  will  be  jeopardized  by  such  delay  and  in  such  case  he 
may  make  the  assessment  without  giving  such  notice  or  awaiting 
the  conclusion  of  such  hearing."^ 

Final  Determinations  and  Assessments.  Another  new  provi- 
sion introduced  by  the  Revenue  Act  of  1921  is  the  provision  that 
if  after  a  determination  and  assessment  in  any  case  the  taxpayer 
has  without  protest  paid  in  whole  any  tax  or  penalty,  or  accepted 
any  abatement,  credit,  or  refund  based  on  such  determination 
and  assessment,  and  an  agreement  is  made  in  writing  between 
the  taxpayer  and  the  Commissioner,  with  the  approval  of  the 
secretary,  that  such  determination  and  assessment  shall  be  final 
and  conclusive,  and  that  (except  upon  a  showing  of  fraud  or 
malfeasance  or  misrepresentation  of  fact  materially  affecting  the 
determination  or  assessment  thus  made)  (1)  the  case  shall  not 
be  reopened  or  the  determination  and  assessment  modified  by 
any  ofiicer,  employee,  or  agent  of  the  United  States,  and  (2)  no 
suit,  action,  or  proceeding  to  annul,  modify,  or  set  aside  such 
determination  or  assessment  shall  be  entertained  by  any  court 
of  the  United  States.'^ 

Administrative  Review.  It  is  provided  by  the  Revenue  Act  of 
1921  that  in  the  absence  of  fraud  or  mistake  in  mathematical 
calculation,  the  findings  of  facts  in  and  the  decision  of  the  Com- 
missioner upon  (or  in  case  the  secretary  is  authorized  to  approve 
the  same,  then  after  such  approval)  the  merits  of  any  claim  pre- 
sented under  or  authorized  by  the  internal  revenue  laws  shall  not 

'8  Revenue  Act  of  1921,  §250  (b),  (d).  The  purpose  of  this  provision 
is  to  prevent  additional  assessments  made  with  complete  knowledge  of  all 
the  facts  in  the  case,  to  hasten  the  work  of  audit  and  examination  and  to 
secure  prompt  departmental  decisions  in  which  all  questions  shall  be  set- 
tled at  the  same  time.  (Report  of  Senate  Finance  Committee  on  Internal 
Revenue  Bill  of  1921,  p.  20). 

"'*  Revenue  Act  of  1921,  §  1312.  This  provision  is  explained  by  the 
Senate  Finance  Committee  (Report  of  Finance  Committee  on  Internal  Rev- 
enue Bill  of  1921,  p.  31)  as  follows:  "Under  the  present  method  of  pro- 
cedure a  taxpayer  never  knows  when  he  is  through,  as  a  tax  case  may 
be  opened  at  any  time  because  of  a  change  in  ruling  by  the  treasury  depart- 
ment. It  is  believed  that  this  provision  will  tend  to  promote  expedition  in 
the  handling  of  tax  cases  and  certainty  in  tax  adjustment." 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  865 

be  subject  to  review  by  any  other  administrative  officer,   em- 
ployee, or  agent  of  the  United  States."^" 

Extension  of  Time  for  Payment  of  Tax.  The  Revenue  Act  of 
1918  gave  the  Commissioner  no  power  to  extend  the  time  for 
payment  of  any  tax,  even  in  cases  where  it  was  manifestly  to 
the  interest  of  the  government,  as  well  as  the  taxpayer,  to  grant 
such  an  extension.  The  recent  period  of  depression  has  strikingly 
emphasized  the  need  of  such  a  provision,  and  the  Revenue  Act 
of  1921,  recognizing  the  defect  of  the  previous  law  in  this  respect, 
provides  that  in  the  case  of  any  '^deficiency"  (except  where  the 
deficiency  is  due  to  negligence  or  to  fraud  with  intent  to  evade 
tax)  where  it  is  shown  to  the  satisfaction  of  the  Commissioner 
that  the  payment  of  such  deficiency  would  result  in  undue  hard- 
ship to  the  taxpayer,  the  Commissioner  may,  with  the  approval 
of  the  secretary,  extend  the  time  for  the  payment  of  such  defi- 
ciency or  any  part  thereof  for  such  period  not  in  excess  of  18 
months  from  the  passage  of  the  Revenue  Act  of  1921  (November 
23,  1921)  as  the  Commissioner  may  determine.  In  such  case  the 
Commissioner  may  require  the  taxpayer  to  furnish  a  bond  with 
sufficient  sureties  conditioned  upon  the  payment  of  the  deficiency 
in  accordance  with  the  terms  of  the  extension  granted.  There 
will  be  added  in  lieu  of  other  interest  provided  by  law,  as  a  part 
of  such  deficiency,  interest  thereon  at  the  rate  of  two-thirds  of 
1%  per  month  from  the  time  such  extension  is  granted;  except 
where  such  other  interest  provided  by  law  is  in  excess  of  interest 
at  the  rate  of  two-thirds  of  1%  per  month.  If  the  deficiency  or 
any  part  thereof  is  not  paid  in  accordance  with  the  terms  of  the 
extension  granted,  there  shall  be  added  as  part  of  the  deficiency, 
in  lieu  of  other  interest  and  penalties  provided  by  law,  the  sum 
of  5%  of  the  deficiency  and  interest  on  the  deficiency  at  the  rate 
of  1'";  per  month  from  the  time  it  becomes  payable  in  accordance 
with  the  terms  of  such  extension.^i 

The  extension  will  be  granted  only  in  case  the  taxpayer  estab- 
lishes to  the  satisfaction  of  the  Commissioner  that  without  such 
extension  undue  hardship  will  result  to  the  taxpayer.  The  term 
"undue  hardship"  means  more  than  an  inconvenience  to  the  tax- 
payer. It  is  defined  as  meaning  that  substantial  financial  loss  or 
sacrifice  will  result  to  the  taxpayer  from  making  payment  of  the 
deficiency  at  the  due  date.    This  provision  of  the  statute  is  ap- 

80  Revenue   Act  of  1921,  §1313. 

81  Revenue  Act  of  1921,  §  250  (f )  as  to  the  acceptance  of  United  States 
bonds  or  notes  at  par  in  connection  with  the  above  bond;  see  Revenue  Act 
of  1921,  §  1329. 


866  FEDERAL  INCOME  TAX 

plicable  only  to  deficiences  in  taxes  which  have  accrued  or  may- 
accrue  under  the  Revenue  Act  of  1917,  the  Revenue  Act  of  1918, 
or  the  Revenue  Act  of  1921,  and  the  deficiency  referred  to  is  only 
such  deficiency  in  tax  as  is  revealed  on  the  examination  of  an 
income  or  profits  tax  return.  It  has  no  application  to  deficiencies 
in  taxes  other  than  deficiencies  in  income  and  profits  taxes  under 
the  three  acts  named.  Any  application  for  the  extension  must 
be  made  under  oath  on  Form  1127  in  accordance  with  instruc- 
tions printed  thereon  and  must  be  accompanied  by  evidence  show- 
ing that  undue  hardship  to  the  taxpayer  would  result  if  the  ex- 
tension were  refused.  The  extension  will  not  be  granted  on  a 
general  statement  of  hardship,  but  in  each  case  there  must  be 
furnished  a  statement  of  the  specific  facts  showing  what,  if  any, 
financial  loss  or  sacrifice  will  result  if  the  extension  is  not 
granted.  The  application,  with  the  evidence,  must  be  filed  with  the 
collector  who  will  at  once  transmit  it  to  the  Commissioner  with 
his  recommendations  as  to  the  extension.  When  it  is  received 
by  the  Commissioner  it  will  be  examined  and  within  thirty  days 
either  rejected  or  tentatively  approved.  The  application  should, 
wherever  practicable,  contain  a  certified  statement  of  assets  and 
liabilities  of  the  taxpayer.  Where  the  application  is  tentatively 
approved  and  a  bond  is  required  it  must  be  filed  with  the  collector 
within  ten  days  after  the  notification  by  the  Commissioner  that 
a  bond  is  required.  It  must  be  conditioned  for  the  payment  of 
the  deficiency  and  applicable  penalties,  if  any,  and  interest  in 
accordance  with  the  terms  of  the  extension  to  be  granted,  and 
must  be  executed  by  a  surety  company  holding  a  certificate  of 
authority  from  the  Secretary  of  the  Treasury  as  an  acceptable 
surety  on  federal  bonds  and  will  be  subject  to  the  approval  of  the 
Commissioner.^^ 

Interest  on  Delinquent  Taxes.  The  Revenue  Act  of  1921  makes 
an  important  change  in  existing  law  with  regard  to  interest  on 
delinquent  taxes.  Under  the  1918  Law  interest  did  not  usually 
begin  to  run  upon  an  additional  assessment  until  ten  days  after 
notice  and  demand  for  the  payment  thereof.^^     g^t  under  the 

82  Revenue  Act  of  1921,  §250  (h),  T.  D.  3263.  Form  1127  has  not  yet 
been  issued. 

S3  In  the  latest  edition  of  article  1001  of  Regulations  45,  the  department 
asserted  the  right  to  collect  interest  upon  additional  tax  even  in  cases  in 
which  (1)  no  extension  of  time  was  granted,  (2)  no  negligence  (without 
intent  to  defraud)  on  the  part  of  the  taxpayer  was  shown,  and  (3)  when 
a  claim  for  loss  in  inventory  values  was  denied.  This  was  hardly  justified 
by  the  Revenue  Act  of  1918  which  provided  for  the  running  of  interest 
(1) where  an  extension  was  granted,  (2)  where  there  was  such  negligence. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  867 

present  law,  which  terms  an  additional  assessment  a  "deficiency," 
interest  on  an  additional  assessment  runs  at  the  rate  of  6% 
per  annum  "from  the  time  the  tax  was  due  (or,  if  paid  on  the 
installment  basis,  on  the  deficiency  of  each  installment  from  the 
time  the  installment  was  due).'"^  With  this  exception  the  in- 
terest provisions  of  the  present  law  and  the  1918  Law  are  largely 
the  same.  Where  the  time  for  the  payment  of  any  installment 
of  the  tax  is  postponed  at  the  request  of  the  taxpayer,  interest 
at  the  rate  of  6'<  per  annum  is  added  from  the  original  due 
date.^  If  an  understatement  of  the  tax  in  the  return  is  due  to 
the  negligence  "or  the  intentional  disregard  of  authorized  rules 
and  regulations  with  knowledge  thereof,"  of  the  taxpayer,  but 
without  intent  to  defraud,  interest  at  the  rate  of  12 '^r  per  an- 
num is  added  to  the  amount  of  the  deficiency  of  each  installment 
from  the  time  the  installment  was  due,  which  interest  becomes 
due  on  notice  and  demand.^''  If  any  tax  remains  due  and  unpaid 
for  ten  days  after  notice  and  demand  by  the  collector,  or  in  the 
case  of  the  first  installment  as  computed  by  the  taxpayer  remains 
due  and  unpaid  for  ten  days,  interest  at  the  rate  of  12 '7  per 
annum  is  added  from  the  due  date,  except  that  the  interest  on 
any  amount  which  is  the  subject  of  a  bona  fide  claim  for  abate- 
ment filed  within  ten  days  after  notice  and  demand,  where  the 
taxpayer  has  not  had  a  hearing  and  a  decision  on  an  appeal,  is  at 
the  rate  of  6 '7  per  annum,  and  except  that  no  interest  is  added  in 
the  case  of  estates  of  insane,  deceased  or  insolvent  persons.^" 
Under  the  1918  Law  interest  was  to  be  added  in  all  cases  in  which 
the  demand  of  payment  was  made  of  the  taxpayer  personally, 
although  he  subsequently  died,  or  became  insane  or  insolvent, 
so  that  collection  of  the  tax  was  made  from  his  estate  in  the 

and  (3)  where  such  a  claim  was  denied.  Rather,  the  statute  prescribed 
(at  a  point  where  such  interest  should  have  been  provided  for)  that  if 
an  understatement  "is  not  due  to  any  fault  of  the  taxpayer,  there  shall 
be  no  penalty".  This  provision  is  omitted  from  the  1921  Law,  and  it  is 
clear  that  under  that  law  interest  runs  from  the  original  due  date  in  all 
cases  of  additional  taxes,  or  deficiencies. 

84  Revenue  Act  of  1921,  §250  (b).  This  provision  is  natural  in  view 
of  the  new  provision  of  the  1921  Law  that  interest  may  be  recovered  from 
the  government  in  certain  cases.  (Revenue  Act  of  1921,  §1324).  See 
Chapter  37. 

85  Revenue  Act  of  1921,  §250   (a)  ;  Reg.  45,  Art.  1003. 

s«  Revenue  Act  of  1921,  §250  (b)  ;  Reg.  45,  Art.  1003.  The  quoted 
words  were  added  by  the  1921  Law,  but  represent  the  departmental 
definition  of  "negligence"  made  under  the  1918  Law. 

87  Revenue  Act  of  1921,  §250  (e)  ;  Reg.  45,  Art.  1003.  The  provision 
for  a  hearing  and  appeal  are  discussed  on  page  863. 


868  FEDERAL  INCOME  TAX 

hands  of  his  representative.^'^  Under  the  1918  Law  permitting 
the  deduction  of  losses  in  inventory,  if  such  a  loss  or  any  part 
thereof  claimed  was  disallowed,  interest  from  the  original  due 
date  at  the  rate  of  12%  per  annum  was  added  to  the  fax  not 
abated.s'^  When  it  was  found  upon  filing  a  complete  return  that 
the  first  installment  of  tax  was  underestimated  at  the  time  of 
filing  a  tentative  return  under  the  1918  Law,  interest  on  the 
amount  by  which  the  tax  was  underestimated  was  collected, 
irrespective  of  amount.^o  Where  interest  was  collectible  at  the 
rate  of  1%  per  month  from  the  due  date,  interest  was  collected 
for  the  fractional  part  of  a  month,  where  the  tax  is  not  paid 
within  10  days  from  notice  and  demand  for  payment.^^  No 
interest  was  collectible  on  the  difference  between  the  amount  of 
tax  paid  on  the  basis  of  an  original  return  and  that  shown  to 
be  due  by  an  amended  return  if  the  understatement  in  the  orig- 
inal return  was  not  due  to  negligence  of  the  taxpayer.^-  It  has 
been  ruled  by  the  treasury  department  that  interest  collectible 
upon  the  amount  of  tax  due  and  unpaid  ten  days  after  notice  and 
demand  by  the  collector  should  be  computed  only  upon  the 
amount  of  tax  shown  by  the  return  to  be  due  and  not  upon  the  tax 
plus  the  five  per  cent,  penalty .^"^  The  interest  provisions  of  the 
Revenue  Act  of  1918  did  not  apply  to  taxes  for  prior  years.^* 

Suits  for  Collection  of  Taxes.  Prior  to  the  Revenue  Act  of 
1918  none  of  the  statutes  of  limitations,  such  as  the  limitation 
of  three  years  as  to  summary  assessments  contained  in  the  vari- 
ous income  tax  laws,  was  applicable  to  suits  by  the  United  States 
to  recover  unpaid  taxes  or  the  balance  of  any  unpaid  tax,  but  at 
most  was  a  limitation  upon  the  right  of  collecting  officers  to 
make  assessments  and  to  enforce  the  tax  by  summary  statutory 
proceedings.^-^  This  rule  was  changed  by  the  Revenue  Act  of 
1918  and  the  statute  of  limitation  of  five  years  was  made  ap- 
plicable by  that  law  to  suits,  as  well  as  assessments.^^    As  to 

88  Reg.  45,  Art.  1003.  No  reason  appears  for  a  change  in  this  rule  under 
the  1921  Law. 

89  Reg.  45,  Art.  1003. 

60  O.  D.  74,  T.  B.  1-19-106. 
910.  884,  T.  B.  13-19-426. 

92  0.  D.  691,  T.  B.  42-20-1251.  This  rule  is  not  changed  as  stated  at 
the  beginning  of  this  paragraph. 

93  O.  D.  725,  T.  B.  45-20-1298.  The  correctness  of  this  ruling  may  be 
doubted,  since  the  statute  states  that  the  5%  penalty  "shall  be  added  as 
part  of  the  tax". 

94  0.   D.  798,  T.  B.  6-21-1437. 

95  U.  S.  V.  Minneapolis  Threshing  Machine  Co.,  229  Fed.  1019. 

96  Revenue  Act  of  1918,  §250  (d)  ;  Sol.  Op.  79,  T.  B.  49-20-1337;  O. 
833,  T.  B.  4-19-235. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  869 

taxes  which  have  accrued  under  the  1916  Law  and  prior  laws  the 
government,  prior  to  the  enactment  of  the  Revenue  Act  of  1921, 
might  bring  suit,  without  limitation  as  to  time,  whether  the  taxes 
in  question  had  been  assessed  or  not,  and  whether  or  not  they 
were  assessable.  The  only  qualification  upon  this  right  to  resort 
to  a  plenary  suit  in  the  absence  of  an  assessment  was  that  the 
tax  must  be  ascertainable  and  determinable,  on  evidence,  by  a 
court,  and  a  tax  of  fixed  percentage  on  a  subject  or  object  which 
was  so  definitely  described  in  the  statute  that  its  amount  or  value 
could  be  so  ascertained  or  determined,  might  be  recovered  in  an 
action  though  it  had  never  been  fixed  by  an  assessment.  The 
action  by  the  government  to  recover  unpaid  taxes  took  the  form 
of  indebitatus  assumpsit,  or  a  common-law  action  of  debt,-*"  and 
was  brought  in  the  name  of  the  United  States  in  the  district 
within  which  the  liability  to  the  taxes  was  incurred  or  where  the 
party  from  whom  the  taxes  were  due  resided  at  the  time  of  the 
commencement  of  the  action.  Interest  on  the  taxes  sued  for  runs 
from  the  time  the  taxes  were  due,-'"*  According  to  practice  no 
suit  for  the  recovery  of  unpaid  taxes  or  of  any  fine,  penalty  or 
forfeiture  was  commenced  until  the  collector  had  submitted 
to  the  Commissioner  a  full  report  of  all  material  facts  and  cir- 
cumstances in  the  case  and  received  from  him  express  authority 
to  proceed.'*''  The  fact  that  an  additional  assessment  of  taxes 
due  for  1915  was  barred  by  the  statute  of  limitations  was  held 
to  have  no  bearing  on  a  claim  for  the  abatement  of  1916  taxes. 
While  the  law  provided  that  no  sums  may  be  paid  from  the 
treasury  to  any  person  indebted  to  the  United  States,  this  pro- 
vision did  not  apply  to  the  abatement  of  taxes  erroneously 
assessed  for  any  year,  and  the  government  was  obliged  to  pursue 
its  remedy  of  a  suit  for  the  recovery  of  any  amounts  due  in 
1915,  as  it  was  not  justified  in  collecting  taxes  for  1916  which 
were  not  due  for  that  year.^^'^  The  five-year  period  of  limitation 
upon  governmental  suits  to  recover  taxes  (as  distinguished  from 
assessments  first  imposed  by  the  Revenue  Act  of  1918  only  as  to 
taxes  collectible  under  that  law,  is  now  made  applicable  to  the 
collection  by  suit  of  taxes  due  under  all  income,  excess-profits,  or 

97  U.  S.  V.  Nashville,  etc.,  Ry.  Co.,  T.  D.  2697;  U.  S.  v.  Grand  Rapids, 
etc.,  Ry.  Co.  (and  cases  cited)  239  Fed.  153;  U.  S.  v.  Minneapolis  Thresh- 
ing Mach.  Co.,  229  Fed.  .1019;  Dollar  Savings  Bank  v.  U.  S.,  19  Wall. 
227,  86  U.  S.  227;  King  v.  U.  S.,  99  U.  S.  229;  U.  S.  v.  Chamberlin,  219  U. 
S.  250;  U.  S.  V.  Little  Miami  Co.,  1  Fed.  700. 

08  U.  S.  V.  Erie  R.  R.,  106  U.  S.  327. 

0»Reg.  45,  Art.  1008. 

100  A.  R.  M.  56,  T.  B.  23-20-984. 


870  FEDERAL  INCOME  TAX 

war-profits  tax  acts,  as  well  as  the  1909  Law,  which  was  not 
an  income  tax  act,  except  as  to  suits  or  proceedings  begun  at  the 
time  of  passage  of  the  Revenue  Act  of  1921.  This  statutory- 
period  does  not  apply  (1)  in  the  case  of  a  false  or  fraudulent 
return  with  intent  to  evade  tax,  (2)  in  the  case  of  a  failure  to 
file  a  required  return,  and  (3)  in  the  case  of  tax  due  on  account 
of  amortization  deducted  by  the  taxpayer  and  later  disallowed, 
and  (4)  in  the  case  of  tax  due  on  the  final  settlement  of  losses 
and  other  deductions  tentatively  allowed  by  the  Commissioner 
pending  a  determination  of  the  exact  amount  deductible.ioi 

Suits  Against  Former  Residents  Now  Abroad.  Where  a 
former  resident  of  the  United  States  now  residing  in  British 
Columbia  fails  to  file  his  return  for  1918  and  refuses  to  file  a 
return  upon  demand  of  the  American  consul  in  that  country, 
the  Commissioner  should  make  a  return  for  him  from  such 
information  as  he  can  obtain,  and  if  no  property  is  found  in  this 
country  which  will  satisfy  the  tax  due,  but  a  judgment  for  the 
amount  of  tax  due  could  be  satisfied  out  of  property  held  by  the 
taxpayer  in  British  Columbia,  recourse  may  be  had  in  the  courts 
of  that  country  for  the  collection  of  the  tax.102 

Lien  for  Unpaid  Taxes.  If  any  person  liable  to  pay  any  tax 
neglects  or  refuses  to  pay  the  same  after  demand,  the  amount  is 
a  lien  in  favor  of  the  United  States  from  the  time  when  the 
assessment-list  was  received  by  the  collector,  except  when  other- 
wise provided,  until  paid,  with  the  interest,  penalties,  and  costs 
that  may  accrue  in  addition  thereto,  upon  all  property  and  rights 
to  property  belonging  to  such  person. los  in  any  case  where  there 
has  been  failure  to  pay  the  tax  and  it  has  become  necessary  to 
seize  and  sell  real  estate  to  satisfy  it  a  bill  in  equity  may  be  filed 
in  a  district  court  of  the  United  States  to  enforce  the  lien  of  the 
United  States  for  tax  upon  any  real  estate  in  which  the  delin- 
quent has  any  right,  title  or  interest.  This  remedy  does  not 
supersede  distraint,  but  is  cumulative.i^^ 

101  Revenue  Act  of  1921,  §250   (d). 

102  S.  1156,  T.  B.  20-19-516.  It  is  probable  that  the  United  States  would 
at  least  have  to  waive  any  penalties  if  it  attempted  to  collect  this  tax  in 
the  courts  of  British  Columbia,  since  the  courts  of  no  country  execute  the 
penal  laws  of  another — even  penalties  for  any  violation  of  statutes  for 
the  protection  of  its  revenues.  It  seems  somewhat  doubtful  whether  the 
courts  of  British  Columbia  would  entertain  an  action  for  the  tax  itself 
(Wisconsin  v.  Pelican  Ins.  Co.,  127  U.  S.  265;  King  of  Spain  v.  Oliver, 
2  Wash.  429;  Whart.  Confl.  L.  Paragraph  833;  Westlake  Internat.  L. 
1st  Ed.  Paragraph  388;  Piggott,  Foreign  Judg.  209,  210). 

103  R.  S.  §3186. 

104  Reg.  45,  Art.  1010. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  871 

Notice  of  Lien.    The  government's  lien  for  collection  of  taxes 
is  not  valid  as  against  any  mortgagee,  purchaser  or  judgment- 
creditor,  until  notice  of  such  lien  has  been  riled  by  the  collector 
in  the  office  of  the  clerk  of  the  district  court  of  the  district 
within  which  the  property  subject  to  such  lien  is  situated,  and  is 
not  valid  in  a  state  which  by  appropriate  legislation  authorizes 
the  filing  of  such  notice  in  the  office  of  the  registrar  or  recorder 
of  deeds  of  the  counties  of  that  state,  unless  the  notice  is  filed  in 
the  office  of  such  registrar  or  recorder  of  deeds  of  the  county  for 
parish  in  the  state  of  Louisiana)    within   which   the  property 
subject  to  the  lien  is  situated.'"''    Where  a  corporation  made  an 
assignment  for  the  benefit  of  creditors  and  a  trustee  was  ap- 
pointed, the  third  and  fourth  installments  of  its  income  tax  for 
1919  not  having  been  paid,  and  two  years  prior  to  the  date  of 
assignment  a  mortgage  was  executed  on  the  corporate  property, 
consisting  solely  of  stock,  furniture,  and  fixtures,  it  has  been 
held  that  if  the  mortgagee  acquired  his  lien  in  good  faith  prior  to 
the  time  a  lien  in  favor  of  the  government  was  effected,  the  gov- 
ernment's lien  for  the  tax  is  not  superior  to  the  rights  of  the 
mortgagee.    The  collector  should,  however,  file  a  claim  with  the 
trustee  for  the  taxes  due  and  the  interest  thereon,  calling  his 
attention  to  the  statutory  provisions,!"'^  which  make  him  person- 
ally liable  if  he  pays  out  trust  funds  before  he  satisfies  and  pays  a 
debt  due  to  the  United  States.^""    A  lien  for  taxes  is  not  similar 

103  Act  of  March  4,  1913,  amending  R.  S.,  §3186.  This  amendment 
seems  to  have  been  made  in  response  to  suggestions  of  the  American  Bar 
Association  (Part  1,  Proceedings  American  Bar  Ass'n.  106  p.  598)  and 
of  the  court  in  U.  S.  v.  Curry,  201  Fed.  371,  in  which  the  harshness  of 
enforcing  the  lien  against  innocent  purchasers  without  knowledge  or  notice 
of  the  lien  was  emphasized.  (See  also  U.  S.  v.  Pacific  R.  R.,  1  Fed.  97.) 
The  suggestion  was  made  by  Judge  Rose  in  the  Curry  case  in  the  follow- 
ing language:  "It  would  seem  that  by  a  comparatively  slight  change  of 
the  statute  law  the  rights  of  the  United  States  could  be  sufficiently  protected 
without  endangering  the  interests  of  other  persons.  The  collector  of  in- 
ternal revenue  at  the  time  he  makes  a  demand  upon  the  taxpayer  might  be 
required  to  transmit  a  copy  of  the  demand  to  some  office  in  which  judg- 
ments and  other  recognized  liens  upon  real  estate  are  recorded  and  the 
records  of  which  are  consequently  carefully  examined  by  conveyancers." 
The  lien  was  held  to  be  superior  to  that  of  any  one  acquiring  any  interest 
in  the  property  after  the  date  of  demand  and  unaffected  by  the  fact  that 
a  subsequent  purchaser  became  such  without  knowledge  of  the  lien  or 
claim  of  the  government  in  the  following  cases:  U.  S.  v.  Pacific  R.  R., 
1  Fed.  97;  U.  S.  v.  Turner,  28  Fed.  Cas.  No.  16,548;  U.  S.  v.  Snyder,  149 
U.  S.  210-  U.  S.  V.  Blacklock,  208  U.  S.  75. 

100  R.  S.,  §3467. 

107  0.  D.  770,  T.  B.  1-21-1379. 


872  FEDERAL  INCOME  TAX 

to  the  lien  of  an  ordinary  incumbrance.  It  is  not  displaced  by  a 
sale  under  a  pre-existing  judgment  or  decree,  unless  otherwise 
directed  by  statute.  It  attaches  to  the  res  without  regard  to  in- 
dividual ownership,  and  when  it  is  enforced  by  sale  pursuant  to 
the  statute  prescribing  the  mode  of  assessing  and  collecting 
taxes,  the  purchaser  takes  a  valid  and  unimpeachable  title.^"^ 
The  lien  may  be  enforced  against  any  transferee  of  real  or  per- 
sonal property  of  the  taxpayer  (except  a  mortgagee,  purchaser 
or  judgment-creditor)  with  respect  to  property  transferred  after 
the  lien  attaches,  that  is,  after  the  filing  of  the  list  with  the 
collector,  although  the  transferee  had  no  notice  of  the  lien.^o^ 
To  create  a  lien  demand  must  be  made  for  a  specific  amount ;  all 
steps  required  by  law  must  be  pursued  strictly.  The  lien  requires 
an  assessment,  a  notice  of  the  tax  due,  and  a  specific  demand 
upon  the  individual  taxpayer  for  payment.^^o  The  government  is 
not  compelled  to  resort  to  distraint  and  sale  of  chattels  and  per- 
sonal effects  of  a  taxpayer,  before  instituting  proceedings  to 
enforce  a  lien  on  the  taxpayer's  real  estate  and  leaseholds. ^ 

Time  When  Lien  Attaches.  The  statute  expressly  provides 
that  a  lien  for  unpaid  taxes  in  favor  of  the  United  States  shall 
attach  from  the  time  when  the  assessment-list  was  received  by 
the  collector,  except  when  otherwise  provided.^^^  The  Revenue 
Act  of  1921  provides  113  that  "all  administrative  special  or  stamp 
provisions  of  law  including  the  law  relating  to  the  assessment  of 
taxes,  so  far  as  applicable,  are  hereby  extended  to  and  made  a 
part  of  this  Act."  Under  the  method  of  collection  prescribed  by 
the  present  law  and  the  1918  Law  it  is  uncertain  when  the 
assessment-list  is  intended  to  reach  the  collector.^  In  the  case 
of  a  corporation  which  has  distributed  its  assets  prior  to  the 
time  when  a  lien  would  attach  thereto,  the  government  may  pro- 
ceed to  collect  the  tax  as  a  general  creditor.^s 

Priority  of  Federal  Taxes.  The  government  has  no  priority 
in  the  matter  of  collecting  taxes   from   a  bankrupt  over  the 

108  Osterberg  v.  Union  Trust  Co.,  93  U.  S.  424. 

109  U.  S.  V.  Curry,  201  Fed.  371  (and'  cases  cited)  is  modified  by  the 
amendment  of  R.  S.,  §  3186. 

iiou.  S.  V.  Pacific  R.  R.,  1  Fed.  97;  U.  S.  v.  Allen,  14  Fed.  263. 

111  U.  S.  V.  Curry,  201  Fed.  371;  Mansfield  v.  Excelsior  Refining  Co., 
135  U.  S.  326;  U.  S.  v.  Blacklock,  208  U.  S.  75. 

112  R.   S.,  §3186. 

113  Revenue  Act  of  1921,  §  1300.  The  Revenue  Act  of  1918  provided 
likewise    (§1305). 

Ill  Revenue  Act  of  1921,  §250;   Revenue  Act  of  1918,   §250. 
115  See  Chapter  10  in  which  this  subject  is  more  fully  discusr.ed. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  873 

administration  expenses  of  the  bankruptcy  proceedings,  its 
priority  in  this  respect  being  limited  to  creditors  of  the  bank- 
rupts "•' 

Payment  of  Tax  Where  Property  Taken  Over  by  Alien  Prop- 
erty Custodian.  Where  the  property  of  an  ahen  enemy  has  been 
taken  over  by  the  alien  property  custodian  and  the  individual 
has  executed  a  return  and  has  no  funds  out  of  which  to  pay  the 
tax  shown,  the  return  should  be  filed  with  the  collector,  but  ihe 
alien  enemy  in  such  case  can  not  be  held  responsible  for  failure 
to  pay  his  tax,  which  is  a  debt  due  the  government  along  with 
those  of  other  creditors  in  the  final  disposition."" 

Taxes  Collectible  by  Distraint.    If  any  person  liable  to  pay  any 
taxes  neglects  or  refuses  to  pay  the  same  within  ten  days  after 
notice  and  demand,  the  collector  or  his  deputy  collector  may  col- 
lect the  taxes,  with  the  5S'   penalty,  and  interest  at  the  rate  of 
l^r   per  month,  by  distraint  and  sale  of  the  goods,  chattels  or 
effects,  including  stocks,  securities,  and  evidences  of  debt,  of  the 
person  delinquent."'^     Certain  property  is  exempted  from  dis- 
traint in  the  case  of  the  head  of  a  family."''    Extensive  provision 
is  made  in  the  statute  for  the  mode  of  levying  distraint  and  pro- 
ceedings  on   distraint.^-"     Collectors   are   enjoined   against   un- 
necessary delays  in  making  sales  and  postponing  sales  beyond 
statutory  periods;  they  are    also    required    to    make    reports 
promptly. 1-1    Surplus  moneys  must  be  deposited  as  internal  rev- 
enue collections  and  cannot  be  returned  to  the  legal  owner  of  the 
property  sold.^--     The  power  to  distrain  personal  property  for 
payment  of  taxes  is  almost  as  old  as  the  common  law.    It  is  also 
competent  for  Congress  to  apply  to  realty  as  well  as  personalty 
the  power  to  distrain  and  sell  when  necessary  to  enforce  the  pay- 
ment of  the  tax.    It  is  only  the  further  legitimate  exercise  of  the 
same  power  for  the  same  purpose.^-"'     When  goods,  chattels  or 
effects  sufficient  to  satisfy  the  taxes  imposed  upon  any  person 
are  not  found  by  the  collector  or  deputy  collector,  he  is  authorized 
to  collect  such  taxes  by  seizure  and  sale  of  real  estate.    Distraint 

110  Smietanka  v.  Zibell,  263  Fed.  883.  See  also  Guaranty  Title  &  Trust 
Co.  V.  Title  Guaranty  &  Surety  Co.,  224  U.  S.  152. 

117  0.  D.  27,  T.  B.  1-19-78. 

iiRR.  S..  §3187. 

110  Only  heads  of  families  are  entitled  to  this  exemption.  (T.  D.  1499.) 
The  state  exemption  laws  are  inapplicable  to  debts  due  the  United  States— 
U.  S.  V.  Howell,  9  Fed.  674. 

I2i>  R.   S.,  §  3188  et  seq. 

121  T.  D.  623,  January  23,   1903. 

122  T.  D.   1373. 

123  Springer  v.  U.  S.,  102  U.  S.  586. 


874  FEDERAL  INCOME  TAX 

may  also  be  used  against  a  delinquent  collector.i-^  Distraint 
warrants  issued  for  the  seizure  of  property  to  be  sold  to  satisfy 
such  taxes  will  be  deemed  to  have  been  served  when  seizure  is 
made  of  any  of  the  property  of  the  delinquent  taxpayer  subject 
to  distraint  by  the  officer  charged  with  the  execution  of  the 
warrant.i-5 

The  property  of  one  spouse  is  not  subject  to  distraint  to  en- 
force payment  of  an  income  tax  obligation  of  the  other  spouse 
unless  there  has  been  a  transfer  of  property  from  one  spouse 
to  the  other  after  a  tax  has  been  assessed  and  demand  made  for 
payment  thereof.i2« 

Addition  of  $5  as  Part  of  Tax.  The  Revenue  Act  of  1921 
omits  the  provision  of  the  1918  Law  that  in  any  case  in  which,  in 
order  to  enforce  payment  of  a  tax  it  is  necessary  for  a  collector 
to  cause  a  warrant  of  distraint  to  be  served,  there  shall  also  be 
added  as  part  of  the  tax  the  sum  of  $5.i-"  The  addition  of  $5 
to  the  tax  where  it  became  necessary  for  a  collector  to  cause  a 
warrant  of  distraint  to  be  served  was  applicable  only  to  income, 
war-profits  and  excess-profits  taxes.^-'^  The  charge  of  $5  was 
held  applicable  when  a  warrant  of  distraint  was  served  irrespec- 
tive of  the  fact  that  the  delinquent  might  be  the  estate  of  an 
insane,  deceased,  or  insolvent  person.i-^  The  charge  of  $5  was 
held  collectible  not  upon  the  issuance  but  upon  the  serving  of 
such  warrant.  If  the  warrant  is  placed  in  the  hands  of  the 
taxpayer  or  is  read  to  him  personally,  it  is  considered  as  having 
been  served  whether  payment  of  the  tax  is  made  at  once  or  is 
deferred  so  that  it  becomes  necessary  to  seize  property  of  the 
taxpayer.  130 

Procedure  in  Case  of  Taxpayers  Contemplating  Removal  or 
Concealment  of  Property  to  Defeat  Collection  of  Tax.     If  the 

Commissioner  finds  that  a  taxpayer  designs  quickly  to  depart 
from  the  United  States  or  to  remove  his  property  therefrom,  or 
to  conceal  himself  or  his  property  therein,  or  to  do  any  other  act 
tending  to  prejudice  or  to  render  wholly  or  partly  ineffectual 
proceedings  to  collect  the  tax  for  the  taxable  year  then  last  past 
or  the  taxable  year  then  current  unless  such  proceedings  be 

124  Reg.  45,   Art.  1009. 

125  T.  D.  3042,  T.  B.  7-21-1454. 

126  0.  D.  1056,  T.  B.  40-21-1856. 

127  Revenue  Act  of  1918,  §250   (f). 

128  T.  D.  3126,  T.  B.  7-21-1454,  modifying  T.  D.  3042;  O.  D.  304,  T.  B. 
24-19-575;   O.  D.  652,  T.  B.  35-20-1175. 

129  0.  D.  270,  T.  B.  18-19-486. 

130  O.  D.  442,  T.  B.  14-20-837. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  875 

brought  without  delay,  the  Commissioner  may  declare  the  tax- 
able period  for  such  taxpayer  inimediateUj  terminated  and  cause 
notice  of  such  finding  and  declaration  to  be  given  the  taxpayer, 
together  with  a  demand  for  immediate  payment  of  the  tax  for 
the  taxable  period  so  declared  terminated  and  of  the  tax  for  the 
preceding  taxable  year  or  so  much  of  said  tax  as  is  unpaid, 
whether  or  not  the  time  otherwise  allowed  by  law  for  filing 
return  and  paying  the  tax  has  expired;  and  such  taxes  shall 
thereupon  become  immediately  due  and  payable.  In  such  a  case 
the  taxpayer  is  entitled  to  a  full  personal  exemption  and  credit 
for  dependents,  if  otherwise  allowable.  In  any  action  or  suit 
brought  to  enforce  payment  of  taxes  made  due  and  payable  by 
virtue  of  the  provisions  of  this  provision  the  finding  of  the 
Commissioner,  whether  made  after  notice  to  the  taxpayer  or  not, 
shall  be  for  all  purposes  presumptive  evidence  of  the  taxpayer's 
design.  A  person  who  is  not  in  default  in  making  returns  or  in 
paying  other  taxes  may  procure  the  postponement  until  the  usual 
time  of  the  payment  of  taxes  declared  or  declarable  to  be  due  as 
above  indicated  by  depositing  with  the  Commissioner  United 
States  bonds  of  a  principal  amount  double  the  estimated  amount 
of  taxes  due  from  such  person  for  the  taxable  year  or  by  furnish- 
ing such  other  security  as  may  be  approved  by  the  Commissionei. 
The  Commissioner  may  approve  and  accept  in  like  manner 
security  for  return  and  payment  of  taxes  made  due  and  payable 
by  virtue  of  the  above  finding  and  declaration,  provided  the  tax- 
payer has  paid  in  full  all  other  income,  war-profits,  or  excess- 
profits  taxes  due  from  him.  If  security  is  approved  and  accepted 
and  such  further  or  other  security  with  respect  to  the  tax  or 
taxes  covered  thereby  is  given  as  the  Commissioner  shall  from 
time  to  time  find  necessary  and  require,  payment  of  such  taxes 
shall  not  be  enforced  by  any  of  the  above  proceedings  prior  to 
the  expiration  of  the  time  otherwise  allowed  for  paying  such 
respective  taxes. ^•'•^  Under  this  provision  it  seems  to  be  within 
the  power  of  the  Commissioner  to  declare  the  taxable  period  of 
a  corporation  terminated  immediately  upon  its  dissolution  and 
to  demand  immediate  payment  of  the  tax  for  such  taxable  period 
and  the  tax  for  the  preceding  year  or  to  require  security  for  the 
payment  thereof  .'■^- 

131  Revenue  Act  of  1921,  §250  (p:)  ;  Revenue  Act  of  1918,  §250  (g)  ; 
Reg.  45,  Art.  1013,  as  amended  by  T.  D.  3229,  T.  B.  39-21-1847,  amending 
T.  D.  3216;  M.  2195,  T.  B.  13-19-429.  The  difference  between  the  present 
law  and  the  1918  Law  is  that  under  the  present  law  the  taxable  period  may 
be  "immediately"  terminated,  while  under  the  1918  Law  it  could  only  be 
terminated  at  the  end  of  the  calendar  month  then  last  past. 

132  See  Chapter  10. 


876  FEDERAL  INCOME  TAX 

Persons  Leaving  Country.  The  present  law  expressly  pro- 
vides that  in  the  case  of  a  citizen  about  to  depart  from  the 
United  States  the  Commissioner  may  at  his  discretion  waive  any 
or  all  of  the  requirements  indicated  in  the  foregoing  paragraph, 
but  that  no  alien  shall  depart  from  the  United  States  unless  he 
first  secures  from  the  collector  or  agent  in  charge  a  certificate 
that  he  has  complied  with  all  the  obligations  imposed  upon  him 
by  the  income,  war-profits,  and  excess-profits  tax  laws.^-""  It  is 
probable  that  the  requirements  will  be  waived  for  the  present 
in  the  case  of  citizens.  But  in  the  case  of  aliens  the  statute 
requires  the  Commissioner  to  enforce  the  pre-existing  regula- 
tions, which  are  indicated  below. 

Aliens  Leaving  Country.  Aliens  departing  from  the  United 
States  were  required  under  the  1918  Law  to  present  certificates 
of  compliance  with  income  tax  obligations  to  internal  revenue 
officers  at  the  point  of  departure.  Aliens,  whether  resident  or 
nonresident,  who  intended  to  depart  from  this  country,  were 
required  to  appear  before  the  collector  or  deputy  collector  of 
internal  revenue  for  the  district  in  which  they  resided  and 
satisfy  all  income  tax  obligations  with  respect  to  income  received 
up  to  and  including  the  calendar  month  next  preceding  that  of 
their  intended  departure.  Upon  payment  of  such  obligations  or 
upon  satisfactory  evidence  that  no  tax  was  due  and  payable, 
the  collector  or  deputy  collector  issued  a  certificate  of  compliance 
to  the  applicant.  A  certificate  of  compliance  issued  by  a  collector 
or  deputy  collector  was  required  to  be  presented  at  the  office 
of  the  revenue  agent  at  the  point  of  departure,  who  issued  an 
income  tax  clearance  which  was  taken  up  at  the  pier.  Aliens 
presenting  themselves  at  the  point  of  departure  without  such 
certificates  of  compliance  were  examined  by  internal  revenue 
officers  at  that  point  and  such  taxes  as  appeared  to  be  due  and 
owing  were  collected. ^"^^    If  any  tax  had  been  withheld  from  the 

133  Revenue  Act  of  1921,  §250  (g).  This  provision  embodies  the  prac- 
tice of  the  treasury  department  under  the  1918  Law^  (See  Reg.  45,  Art. 
1013,  as  amended  by  T.  D.  3229,  T.  B.  39-21-1847,  amending  T.  D.  3216). 
Under  the  latest  ruling  under  that  law  the  Commissioner  waived  the  re- 
quirements in  the  case  of  citizens.  It  is  to  be  noted,  however,  that  he  may 
restore  the  requirement  at  any  time  in  accordance  with  the  practice  in 
1920  and  earlier  years. 

134  Reg.  45,  Art.  1013,  as  amended  by  T.  D.  3229,  T.  B.  39-21-1847,  amend- 
ing T.  D.  3216.  This  ruling  apparently  required  resident  aliens  leaving 
the  country  temporarily  to  pay  all  income  tax  on  all  income  up  to  the 
month  of  departure;  they  were  formerly  permitted  to  make  provisions  for 
the  payment  of  installments  subsequent  to  departure,  and  the  filing  of  re- 
turns and  payment  of  tax  for  the  succeeding  year   (0.  D.  331,  T.  B.  28-19- 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  877 

wages  or  other  income  of  an  alien,  credit  therefor  was  given  to 
the  alien  in  computing  any  balance  of  tax  due  the  United  States 
government.  An  alien  appearing  before  the  collector  was  ques- 
tioned as  to  his  earnings  for  the  current  taxable  year  and  prior 
years. i'*"'  If  the  name  of  an  alien  leaving  the  countiy  did  not 
appear  on  any  Form  1042  filed  by  his  employer  for  past  years, 
the  collector  might,  for  the  purpose  of  determining  the  alien's 
tax  liability,  require  the  employer  to  furnish  statements  of  the 
alien's  earnings  for  the  years  in  question. '■'•''  An  alien  who  was 
a  resident  during  the  past  year  and  decided  to  return  to  his 
native  country  was  classified  as  a  nonresident  alien  for  the  tax- 
able period  of  the  present  year.^-'-"  For  the  pui^DOse  of  the 
Revenue  Act  of  1918  the  Virgin  Islands  are  foreign  territory  and 
a  trip  to  these  islands  was  a  departure  from  the  United  States. 
Citizens  of  the  Virgin  Islands  residing  in  the  United  States  and 
planning  to  go  to  the  islands  were  treated  in  the  same  manner 
as  citizens  of  the  United  States  in  the  matter  of  satisfying 
income  tax  obligations  before  departing  from  this  country. ^•''' 
The  above  rules  with  respect  to  departing  aliens  did  not  apply 
to  representatives  of  foreign  countries  bearing  diplomatic  pass- 
ports.i'-'*  The  serv'ants  of  a  diplomatic  representative  of  a  for- 
eign country  were  not  examined  for  income  purposes  when 
such  servants  accompanied  the  diplomat  upon  his  departure  from 
the  United  States.^^'' 

Penalty  for  Violation.  If  a  taxpayer  violates,  or  attempts 
to  violate,  the  provision  discussed  in  the  foregoing  paragraphs, 
in  addition  to  all  other  penalties  there  will  be  added  as  part  of 
the  tax  25'('  of  the  total  amount  of  the  tax  or  deficiency  in  the 
tax,  together  with  interest  at  the  rate  of  1  per  centum  per 
month  from  the  time  the  tax  became  due."^ 

617).  See  also  O.  D.  131,  T.  B.  3-19-205;  0.  D.  840,  T.  B.  10-21-1501. 
The  ruling  rendered  inapplicable  former  rulings  regarding  American 
citizens  departing  from  this  country.  (See  M.  2195,  T.  B.  13-19-429;  M. 
2643,  T.  B.  51-20-1357;  O.  D.  500,  T.  B.  19-20-923;  0.  D.  566,  T.  B.  27- 
20-1035.  Under  the  present  law  income  tax  obligations  up  to  the  day  of 
departure  (not  up  to  and  including  the  calendar  month  next  preceding 
departure)  will  have  to  be  satisfied. 

135  M.  2195,  T.  B.  28-19-618. 

136  0.  D.  385,  T.  B.  4-20-709. 

137  M.  2195,  T.  B.  13-19-429. 

138  0.  D.  332,  T.  B.  28-19-618. 

139  0.  D.  271,  T.  B.  18-19-487. 
1-»0  0.  D.  812,  T.  B.  7-21-1455. 

141  Revenue  Act  of  1921,  §250   (g).     This  penalty  provision  is  new. 


878  FEDERAL  INCOME   TAX 

Medium  of  Payment  of  Tax.  Collectors  may  receive,  at  par 
with  an  adjustment  for  accrued  interest,  notes  or  certificates  of 
indebtedness  issued  by  the  United  States  and  uncertified  checks 
in  payment  of  income,  war-profits  and  excess-profits  taxes  and 
any  other  taxes  payable  other  than  by  stamp,  during  such  time 
and  under  such  regulations  as  the  Commissioner,  with  the 
approval  of  the  secretary,  shall  prescribe;  but  if  a  check  so 
received  is  not  paid  by  the  bank  on  which  it  is  drawn  the  person 
by  whom  such  check  has  been  tendered  will  remain  liable  for 
the  payment  of  the  tax  and  for  all  legal  penalties  and  additions 
the  same  as  if  such  check  had  not  been  tendered.i^-  Inasmuch 
as  this  provision  re-enacts  in  all  essentials  the  corresponding 
provisions  of  the  Revenue  Act  of  1918,  the  rulings  issued 
under  that  law  will  undoubtedly  be  followed  under  the  present 
law.  These  rulings  are  indicated  below.  The  date  on  which  the 
collector  receives  an  uncertified  check  in  payment  of  the  tax  is 
considered  the  date  of  payment,  unless  the  check  is  returned 
dishonored.1^3  The  tax  may  not  ordinarily  be  paid  by  a  check 
drawn  on  a  foreign  bank  in  foreign  funds,  but  it  may  be  paid 
by  a  Canadian  postal  money  order  at  par.^^^  If  payment  is  made 
by  check  the  taxpayer  as  a  precaution  should  draw  the  check  for 
such  amount  as  to  cover  any  collection  charges  by  the  bank,  in 
order  that  the  net  amount  received  by  the  government  may  be 
the  full  amount  of  tax  due,  that  is,  checks  must  be  collectible  at 
par,  and  taxpayers  who  are  not  sure  that  their  checks  will  be 
paid  at  par,  should  write  beneath  the  amount  the  words  "with- 
out deduction  for  exchange"  or  the  words  "with  exchange."  A 
collector  is  not  required  to  examine  all  checks  to  see  whether  or 
not  they  are  collectible  at  par,  but  will  stamp  on  the  face  of  each 

142  Revenue  Act  of  1921,  §1325;  Revenue  Act  of  1918,  §1314;  Reg.  45, 
Arts.  1731,  1732;  T.  D.  2851;  Act  of  October  3,  1917  (Public  No.  50), 
§1010;  Act  of  March  2,  1911  (36  Stat.  965).  Prior  to  1917  the  treasury 
department  did  not  specifically  authorize  the  acceptance  of  any  form  of 
exchange  in  payment  of  internal  revenue  taxes,  other  than  currency  and 
certified  checks  (T.  D.  1990).  There  was  no  objection  to  a  collector  ac- 
cepting at  his  own  risk,  or  at  the  risk  of  the  government  depositary,  un- 
certified checks  or  any  other  form  of  exchange,  for  collection  only.  (T.  D. 
2158.)  Where  a  form  of  remittance  not  authorized  by  law  was  accepted 
for  collection,  the  5%  penalty  was  incurred  by  the  taxpayer,  if  there  was 
delay  in  collection  and  the  funds  were  not  actually  received  by  the  collector 
within  the  time  provided  by  law.  Receipt  by  the  government  depositary,  in 
the  course  of  collection,  was  held  not  to  be  receipt  by  the  collector,  as  the 
depositary  is  not  an  agent  of  the  collector  or  of  the  government.  (T.  D. 
1651.) 

143  Reg.  45,  Art.  1733;  T.  D.  2851. 

144  0.  D.  1066,  T.  B.  42-21-1870. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  879 

the  words  "this  check  is  in  payment  of  an  obligation  to  the 
United  States  and  must  be  paid  at  par.  No  protest,"  with  his 
name  and  title.  If  the  bank  on  which  the  check  is  drawn  shouid 
refuse  to  pay  it  at  par,  it  will  be  returned  through  the  depositary 
bank  and  will  be  treated  in  the  same  manner  as  a  bad  check.  If 
any  check  is  returned  unpaid,  it  will  be  held  in  suspense  a  few 
days,  during  which  time  the  collector  will  make  an  effort  to 
recover  the  amount  from  the  taxpayer.  If  the  amount  is  recov- 
ered, the  bad  check  will  be  returned  to  the  drawer;  if  it  is  not 
recovered,  the  collector  will  proceed  to  collect  the  taxes  by  the 
usual  methods,  as  though  no  check  had  been  given.  All  expenses 
incident  to  the  attempt  to  collect  such  a  check  and  the  return 
of  it  through  the  depositary  bank  must  be  paid  by  the  drawer 
of  the  check  to  the  bank  on  which  it  is  drawn,  since  no  deduc- 
tion can  be  made  from  amounts  received  in  payment  of  taxes. 
A  taxpayer  who  tenders  a  check,  whether  certified  or  uncerti- 
fied, in  payment  for  taxes  is  also  not  released  from  his  obliga- 
tion until  the  check  has  been  paid.'^''  Where  such  a  check  is  lost 
in  the  mails,  a  collector  is  not  required,  as  a  condition  precedent 
to  the  issuing  of  a  duplicate  check  by  the  taxpayer,  to  furnish 
bond  indemnifying  him  against  possible  loss  in  connection  with 
the  first  check. ^^*'  If  one  check  is  remitted  to  cover  two  or  more 
persons'  taxes,  the  remittance  must  be  accompanied  by  a  letter 
of  transmittal  stating  (a)  the  name  of  the  drawer  of  the  check; 
(b)  the  amount  of  the  check ;  (c)  the  amount  of  any  cash,  money 
order  or  other  instrument  included  in  the  same  remittance;  (d) 
the  name  of  each  person  whose  tax  is  to  be  paid  by  the  remit- 
tance ;  (e)  the  amount  of  the  payment  on  account  of  each  person ; 
and  (f)  the  kind  of  tax  paid.^^'  In  the  payment  of  the  tax  the 
fractional  part  of  a  cent  is  disregarded  unless  it  amounts  to  a 
half  cent  or  more,  in  which  case  the  fraction  is  increased  to  one 
cent."'5 

Payment  of  Tax  by  Certificates  of  Indebtedness.  The 
terms  of  the  acceptance  of  certificates  of  indebtedness  are  pre- 
scribed from  time  to  time.  The  amount  at  par  of  the  certificates 
of  indebtedness  presented  by  any  taxpayer  in  payment  of  taxes 
must  not  exceed  the  amount  of  the  taxes  to  be  paid  by  him.  Col- 
lectors are  not  authorized,  unless  otherwise  notified  by  the  sec- 

145  Reg.  45,  Art.  1734;  T.  D.  2666;  T.  D.  2851. 

146  0.  D.  626,  T.  B.  32-20-1125. 

147  Reg.  45,  Art.   1733;  T.  D.  2851. 

148  Revenue  Act  of  1921,  §1306;  Revenue  Act  of  1918,  §1313;  Reg.  45, 
Art.  1721;  Reg.  33  Rev.,  Art.  41.  The  fractional  part  of  a  cent  is  not 
disregarded  in  the  computation  of  taxes    (T.  D.  3250,  T.  B.  48-21-1955). 


880  FEDERAL  INCOME  TAX 

retary,  to  receive  as  payment  of  income  or  profits  taxes  interim 
receipts  issued  by  federal  reserve  banks  in  lieu  of  the  definite  cer- 
tificates of  the  series.  For  the  purpose  of  saving  taxpayers  the 
expense  of  transmitting  such  certificates  as  are  held  in  federal 
reserve  cities  to  the  office  of  the  collector  in  whose  district  the 
taxes  are  payable,  taxpayers  desiring  to  pay  income  and  profits 
taxes  by  treasury  certificates  of  indebtedness  acceptable  in  pay- 
ment of  such  taxes,  should  communicate  with  the  collector  of  the 
district  in  which  the  taxes  are  payable  and  request  from  him  au- 
thority to  deposit  such  certificates  with  the  federal  reserve  bank 
in  the  city  in  which  the  certificates  are  held.  Collectors  are 
authorized  to  permit  deposits  of  treasury  certificates  of  indebted- 
ness in  any  federal  reserve  bank  with  the  distinct  understanding 
that  the  federal  reserve  bank  is  to  issue  a  certificate  of  deposit  in 
the  collector's  name  covering  the  amount  of  the  certificates  of 
indebtedness  at  par  and  to  state  on  the  face  of  the  certificate  of 
deposit  that  the  amount  represented  thereby  is  in  payment  of 
income  and  profits  taxes.  The  federal  reserve  bank  should  for- 
ward the  original  certificate  of  deposit  to  the  treasurer,  with  its 
daily  transcript,  and  transmit  to  the  collector  the  duplicate  and 
triplicate,  accompanied  by  a  statement  giving  the  name  of  the 
taxpayer  for  whom  the  payment  is  made  in  order  that  the  col- 
lector may  make  the  necessary  record  and  forward  the  duplicate 
to  the  office  of  the  Commissioner. ^^^ 

Procedure  with  Respect  to  Certificates  of  Indebtedness. 
Such  certificates  of  indebtedness  may  be  accepted  by  the  collector 
prior  to  the  date  the  tax  is  due  and  in  that  case  should  be  for- 
warded by  the  collector  to  the  federal  reserve  bank  to  be  held  for 
his  account  until  the  date  the  tax  is  due  and  for  deposit  on  such 
date.  All  coupons  maturing  on  or  before  the  date  the  tax  is  due 
must  be  detached  by  the  taxpayer  and  collected  in  ordinary 
course,  but  all  other  coupons  must  remain  attached  to  the  certifi- 
cate and  be  forwarded  to  the  federal  reserve  bank.  Any  accrued 
interest  to  the  date  the  tax  is  due,  not  covered  by  coupons  de- 
tached as  above  provided,  will  be  remitted  to  the  taxpayer  by  the 
federal  reserve  bank  by  check,  for  which  purpose  the  collector  will 
furnish  to  the  bank  the  name  and  address  of  the  taxpayer,  the 
amount  and  serial  numbers  of  the  certificates  presented  in  each 
case,  the  date  of  issue  of  the  certificates,  and  the  date  the  tax  is 
due.  Collectors  may  in  no  case  pay  interest  on  such  certificates 
nor  accept  them  for  an  amount  other  or  greater  than  their  face 

149  Reg.  45,  Art.  1731,  as  amended  and  supplemented  by  T.  D.  3115,  T. 
B.  9-21-1490.     See  T.  D.  3143,  T.  B.  13-21-1537. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  881 

• 

value.  Receipts  given  by  collectors  to  taxpayers  should  show  the 
amount  of  certificates  of  each  series  received  in  payment  of  taxes. 
For  the  purpose  of  saving  taxpayers  the  expense  of  transmittmg 
such  certificates  as  are  held  in  federal  reserve  cities  to  the  ottice 
of  the  collector  in  whose  district  the  taxes  are  payable,  taxpayers 
desiring  to  pay  taxes  by  acceptable  certificates  of  indebtedness 
should  communicate  with  the  collector  and  request  from  him 
authoritv  to  deposit  such  certificates  to  his  credit  with  the  federal 
reserve  bank  in  the  city  in  which  the  certificates  are  held.^"' 

To  Whom  Tax  Should  Be  Paid.  The  importance  of  paying 
taxes  by  check,  or  of  securing  a  proper  receipt  for  payment  from 
the  deputy  collector  authorized  to  receive  taxes,  is  forcibly  dem- 
onstrated by  a  recent  case  in  which  it  w^as  held  that  payment  of 
money  to  a  deputy  collector  other  than  the  one  authorized  to  re- 
ceive it  is  not  a  satisfaction  of  the  tax  liability,  and  does  not  bind 
the  collector.^''! 

Receipts  for  Payment  of  Tax.  Every  collector  to  whom  any 
payment  of  any  tax  is  made  is  on  request  required  to  give  to 
the  taxpayer  a  full  written  or  printed  receipt,  stating  the  amount 
paid  and  the   particular  account  for  which  the  payment   was 

FORM  OF  Receipt.  The  only  ofl^cial  receipt  for  taxes  that 
collectors  may  sign  under  the  law  is  the  form  prescribed  by  the 
department.  However,  there  is  no  objection,  on  the  part  of  the 
department,  to  collectors  signing  commercial  receipts  or  voucher 
checks,  but  they  should  in  signing  such  receipts  or  vouchers  write 
or  stamp  across  the  face  thereof  "not  an  official  receipt."  The 
official  receipt  must  also  be  furnished,  and  an  unofficial  receipt  is 
not  in  any  manner  binding  on  the  government  and  will  not  be 
received  by  it  as  evidence  of  payment  of  the  tax.i-'  Deputy  col- 
lectors must  give  taxpayers,  at  the  time  of  the  payment,  a  per- 
sonal receipt  stating  that  the  amount  of  payment  has  been  re- 
ceived to  be  forwarded  to  the  collector.i"^     In  the  case  of  pay- 

ir.OReg   45,  Art.  1732,  as  amended  by  T.  D.  3115,  T.  B.  9-21-1490. 

ir.i  Hurst  v.  Lederer,  T.  D.  3221,  T.  B.  38-21-1835.  In  this  case  the  tax- 
payer claimed  to  have  paid  approximately  $2,000  to  a  deputy  collector  in  the 
collector's  office,  but  this  deputy  was  not  authorized  to  receive  payments,  and 
the  taxpayer  was  obliged  to  pay  the  tax  a  second  time. 

ir.'.' Revenue  Act  of  1921,  §251;  Revenue  Act  of  1918,  §251.  Prior  to 
the  enactment  of  this  section  receipts  were  issued  even  when  they  were 
not  requested.  With  regard  to  the  penalty  for  the  simulation  of  income 
tax  receipts,  see  U.  S.  v.  Pittaro,  I.  T.  S.  1921,  H  2358;  T.  D.  2874. 

i^-iT.  D.  2226. 

154  T.  D.  2341. 


882  FEDERAL  INCOME  TAX 

ments  by  check  or  money  order  the  canceled  check  or  money  order 
receipt  is  usually  a  sufficient  receipt.  In  case  of  payments  by 
cash  the  taxpayer  should  in  every  instance  require  receipt.^^^ 

Taxes  Withheld  at  the  Source.  Whenever  any  debtor  pays 
taxes  withheld  at  the  source  on  account  of  payments  made  or  to 
be  made  by  him  to  separate  creditors,  the  collector  is  required, 
on  request,  to  give  a  separate  receipt  for  the  tax  paid  on  account 
of  each  creditor  so  that  the  debtor  can  conveniently  produce  such 
receipts  severally  to  his  creditors  in  satisfaction  of  their  re- 
spective demands  up  to  the  amounts  stated  in  the  receipts.  Such 
receipts  are  sufficient  evidence  in  favor  of  such  debtor  to  justify 
him  in  withholding  from  his  next  payment  to  his  creditor  the 
amount  stated  in  the  receipt.  The  creditor  may,  upon  giving  the 
debtor  a  full  written  receipt  acknowledging  the  payment  to  him 
of  any  sum  actually  paid  and  accepting  and  specifying  the 
amount  of  tax  paid  as  a  further  satisfaction  of  the  debt  to  that 
amount,  require  the  surrender  to  him  of  the  collector's  receipt-^^*^ 

Deposit  of  United  States  Bonds  or  Notes  in  Lieu  of  Surety. 
The  Revenue  Act  of  1921  provides  that  wherever  by  the  laws  of 
the  United  States  or  regulations  made  pursuant  thereto,  any  per- 
son is  required  to  furnish  any  recognizance,  stipulation,  bond, 
guaranty,  or  undertaking,  hei^einafter  called  "penal  bond,"  with 
surety  or  sureties,  such  person  may,  in  lieu  of  such  surety  or 
sureties,  deposit  as  security  with  the  official  having  authority  to 
approve  such  penal  bond.  United  States  Liberty  bonds  or  other 
bonds  or  notes  of  the  United  States  in  a  sum  equal  at  their  par 
value  to  the  amount  of  such  penal  bond  required  to  be  furnished, 
together  with  an  agreement  authorizing  such  official  to  collect  or 
sell  such  bonds  or  notes  so  deposited  in  case  of  any  default  in  the 
performance  of  any  of  the  conditions  or  stipulations  of  such 
penal  bond.  The  acceptance  of  such  United  States  bonds  or  notes 
in  lieu  of  surety  or  sureties  required  by  law  has  the  same  force 
and  effect  as  individual  or  corporate  sureties  or  certified  checks, 
bank  drafts,  post-office  money  orders,  or  cash,  for  the  penalty  or 
amount  of  such  penal  bond.  The  bonds  or  notes  deposited,  and 
such  other  United  States  bonds  or  notes  as  may  be  substituted 
therefor  from  time  to  time  as  such  security,  may  be  deposited 
with  the  treasurer  of  the  United  States,  a  federal  reserve  bank, 
or  other  depository  duly  designated  for  that  purpose  by  the  sec- 
retary, which  will  issue  receipt  therefor,  describing  such  bonds 

155  Reg.  45,  Art.  1021. 

156  Revenue  Act  of  1921,  §  251;  Revenue  Act  of  1918,  §  251.  See  Chapter 
40. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  883 

or  notes  so  deposited.  As  soon  as  security  for  the  performance 
of  such  penal  bond  is  no  longer  necessary,  the  bonds  or  notes  so 
deposited  will  be  returned  to  the  depositor.  This  provision 
neither  affects  nor  impairs  the  priority  of  the  claim  of  the  United 
States  against  the  bonds  or  notes  deposited  or  any  right  or 
remedy  granted  to  the  United  States  for  default  upon  any  obliga- 
tion of  such  penal  bond;  neither  does  it  affect  the  authority  of 
courts  over  the  security,  where  such  bonds  are  taken  as  security 
in  judicial  proceedings,  or  the  authority  of  any  administrative 
officer  of  the  United  States  to  receive  United  States  bonds  for 
security  in  cases  authorized  by  existing  laws.  The  secretary 
may  prescribe  rules  and  regulations  necessary  and  proper  for 
carrying  this  provision  into  effect.^"'" 

Recovery  of  Taxes  Paid.  Taxes  erroneously  paid  or  illegally 
exacted  may  on  occasion  be  recovered  in  either  of  two  ways: 
(1)  from  the  Commissioner,  and  (2)  by  an  action  at  law  against 
the  government  or  the  collector  who  received  payment  thereof. 
Generally  speaking  and  subject  to  the  exceptions  and  definitions 
noted  in  the  following  paragraphs,  two  elements  are  essential  to 
the  taxpayer's  right  of  recovery:  (1)  he  must  have  protested 
against  the  assessment  ^''^  or  collection  of  the  tax  sought  to  be  re- 
covered, and  (2)  such  tax  must  have  been  paid  under  some  form 
and  degree  of  duress  or  coercion. 

Recovery  of  Taxes  from  Commissioner.  The  universally 
recognized  principle  that  an  action  can  not  be  maintained  for  the 
recovery  of  money  paid  in  discharge  of  a  tax  illegally  assessed, 
unless  payment  was  made  under  protest  has  been  held  by  the 
Commissioner  and  other  officers  of  the  department  to  be  too 
technical  and  too  exacting  for  application  to  the  refund  of  taxes 
under  Section  3220  of  the  Revised  Statutes,'"''^  and  it  would  seem 
that  a  protest  is  not  necessary  to  recover  taxes  from  the  Com- 
missioner. But  such  a  protest  is  essential  if  suit  is  to  be  main- 
tained against  an  advcrf^e  decision  of  the  Commissioner.^'"'" 

Recovery  by  Action  at  Law.  The  two  above  mentioned 
essentials  or  conditions  to  the  right  to  recover  taxes  erroneously 
paid  or  illegally  exacted  are  ordinarily  requisite  when  recovery 

157  Revenue  Act  of  1921,  §  1329.     See  also  Revenue  Act  of  1918,  §  1320. 

ii''8  It  has  been  held  that  a  protest  ag:ainst  the  assessment  is  sufficient 
since  any  protest  against  the  collection  would  be  unavailing:.  The  law 
does  not  require  a  person  to  do  what  can  be  of  no  effect.  (Adams  v.  U.  S., 
1  Ct.  CI.  306.)     But  see  Rock  Island  &  C.  R.  Co.  v.  U.  S.,  254  U.  S.  141. 

!•"•{>  Real  Est.  Savings  Bank  v.  U.  S.,  16  Ct.  Cls.  335,  Int.  Rev.  Rec.  154. 
affirmed  104  U.  S.  728;  Chesebrough  v.  U.  S..  192  U.   S.  253. 

100  Chesebrough  v.  U.  S.,  192  U.  S.  253. 


884  FEDERAL  INCOME  TAX 

is  sought  by  means  of  an  action  at  law,  as  contradistinguished 
from  an  appHcation  to  the  Commissioner  for  a  refund.  There  is 
some  irreconcilable  conflict  between  various  dicta,  if  not  deci- 
sions, of  the  Supreme  Court  and  the  lower  federal  courts  in  con- 
sidering the  nature  of  and  necessity  for  a  protest  and  duress  in 
regard  to  the  recovery  of  internal  revenue  taxes,  and  while  the 
scope  of  this  book  does  not  permit  an  exhaustive  examination  of 
the  authorities,  the  subject  is  considered  in  the  following  para- 
graphs in  the  light  of  some  of  the  leading  cases. 

Payment  Under  Protest.  The  ancient  principle  of  the  common 
law  is  of  general  application  that  taxes  voluntarily  paid  can  not 
be  recovered  back  even  if  they  have  been  illegally  laid  or  the 
law  under  which  they  were  laid  proves  to  be  unconstitutional. 
The  rule  is  founded  upon  the  knowledge  of  law  imputed  to  all 
taxpayers;  it  is  also  said  to  be  one  of  sound  public  policy  and 
quiet  and  good  faith,  operating  to  free  the  courts  from  the  un- 
doing of  the  voluntary  arrangements  of  parties  not  induced  by 
fraud,  accident  or  excusable  negligence. ^''^  When  a  voluntary 
payment  of  taxes  is  spoken  of,  the  word  "voluntary"  is  not  used 
in  its  ordinary  and  popular  sense.^^'-  The  purpose  of  paying  a 
tax  under  protest  is,  briefly,  to  preserve  the  taxpayer's  rights  to 
recover  the  tax  should  the  assessment  thereof  prove  to  be  wrong- 
ful or  excessive,  or  the  law  under  which  it  was  laid  void  and  un- 
constitutional. Since  it  is  usually  held  that  the  making  of  a 
protest  and  the  existence  of  duress  are  concomitant  conditions  to 
any  recovery  of  taxes  which  have  been  paid,  the  necessity  for  a 
protest  will  be  more  fully  discussed  in  a  later  paragraph.  It 
appears  that  a  collector  is  not  personally  liable  for  taxes  if  no 
protest  or  objection  is  made  to  their  collection  by  him.i63 

Protest  at  Time  of  Filing  Return.  It  does  not  seem  essen- 
tial, although  it  may  be  a  wise  precaution,  also  to  protest  at  the 
time  of  filing  the  return  upon  which  the  assessment  is  based. 

Form  of  Protest.  There  is  no  statutory  requirement  that  a 
protest  against  the  assessment  and  collection  of  internal  revenue 
taxes  be  in  writing.^*^^    A  written  protest  is,  of  course,  better  evi- 

■  161  Cooley  on  Taxation  (Third  Edition)  Vol.  II,  Ch.  XXIV,  p.  495. 

162  In  many  of  the  cases  cited  hereafter  in  which  the  payment  involved 
was  held  to  be  voluntary,  the  payment  was  most  unwillingly  and  reluctantly 
made. 

163  Commissioners,  etc.,  v.  Buckner,  48  Fed.  533. 

164  Wright  V.  Blakeslee,  101  U.  S.  174;  Stewart  v.  Barnes,  153  U.  S. 
456;  Swift  v.  U.  S.,  Ill  U.  S.  22;  Shaefer  v.  Ketchum,  21  Fed.  Cas.  No. 
12,693.  In  this  respect  the  rule  in  regard  to  internal  revenue  taxes  differs 
from  that  in  regard  to  customs  in  which  case  a  protest  must  be  in  writing. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  885 

dence.  A  protest  against  paying  the  tax  includes  the  penalties 
without  specific  mention  of  the  latter."'"'  In  one  case  in  which  a 
corporation  had  been  assessed  for  taxes  and  the  same  were  not 
paid,  a  writ  of  distraint  was  issued  by  the  collector,  and,  the  cor- 
poration having  been  notified  that  the  tax  would  be  collected  by 
levy,  the  deputy  collector  counted  out  and  took  from  a  represen- 
tative of  the  company  a  sufficient  amount  to  pay  the  tax  against 
verbal  protest  at  the  time.  A  written  notice  of  protest  was  then 
served  in  which  the  corporation  denied  that  it  was  liable  to  the 
tax.  The  court  held  that  the  protest  was  sufficient.^''''  Under  the 
1909  Law  the  treasuiy  department  ruled  that  no  form  of  pro- 
test was  prescribed,  that  any  form  of  protest  would  be  sufficient 
if  filed  before  payment  of  the  tax,  and  that  the  right  of  protest 
was  not  to  be  denied."'" 

Protest  Alone  Not  Sufficient.  A  protest  is  used  to  give 
effect  to  attending  circumstances;  it  gives  notice  that  the  pay- 
ment is  not  to  be  considered  as  admitting  the  right  of  the  tax- 
ing power  to  make  demand  for  or  to  collect  the  tax  in  question. 
But  as  appears  in  the  next  paragraph,  there  must  usually  be 
duress  or  coercion,  and  if  payment  is  made  under  protest  alone 
without  some  form  or  degree  of  compulsion,  the  payment  may  be 
considered  voluntaiy  notwithstanding  a  protest  was  made."'^  It 
has  been  stated:"'"  "Though  there  is  some  conflict  in  the  dicta 
of  the  Supreme  Court,  the  true  doctrine  seems  to  be  that  when 
taxes  are  paid  under  protest  or  with  notice  that  the  payer  con- 
tends that  they  are  illegal  and  intends  to  institute  suit  to  compel 
their  repayment,  a  sufficient  foundation  for  such  a  suit  to  recover 
has  been  established."  This  statement  is  difficult  to  reconcile 
with  the  authorities  cited  in  the  next  paragraph. 

Duress.  The  general  rule  is  that  where  a  party  pays  an  illegal 
demand,  with  full  knowledge  of  all  the  f^cts  rendering  it  illegal, 
without  an  immediate  and  urgent  necessity  therefor,  to  release 
his  person  or  property  from  detention,  or  to  prevent  an   im- 

105  Wright  V.  Blakeslee,  101  U.  S.  174. 

l<i«  Abrast  Realty  Co.  v.  Maxwell,  206  Fed.  333. 

K57T.  D.  1675. 

!••'><  Lamborn  v.  Comm'rs,  97  U.  S.  181;   Merck  v.  Treat,  202  Fed.  133. 

l(i!t  Herold  v.  Kahn,  159  Fed.  608.  This  remark  of  the  court  seems  to  be 
mere  dictum  since,  in  the  first  place,  the  tax  involved  was  paid  under  a 
mistake  of  fact  and,  in  the  second  place,  there  was  probably  duress  in  the 
notice  sent  by  the  collector  statinp:  that  unless  the  tax  was  paid,  "it  will 
be  my  duty  to  collect  the  same  with  a  penalty  *  *  *"  (See  next  par- 
agraph). The  case  of  Beer  v.  Moffat,  192  Fed.  984,  contains  the  same 
doctrine,  but  recovery  was  denied  because  there  was  no  protest  or  demurrer 
to  the  legality  of  the  tax  or  its  payment. 


886  FEDERAL   INCOME   TAX 

mediate  seizure  of  his  person  or  property,  such  payment  must 
be  deemed  voluntary,  and  can  not  be  recovered  back.i^o  j^  y^m 
be  noted  that  a  voluntary  payment  is  among  other  things  a  pay- 
ment "with  full  knowledge  of  all  the  facts  rendering  it  illegal." 
A  payment  made  without  such  knowledge  may  under  certain  cir- 
cumstances be  recovered,  but  not  on  the  theory  of  duress.  The 
yielding  to  paramount  taxing  authority  involved  in  the  payment 
of  a  tax  under  duress  or  coercion  is  quite  different  from  a  pay- 
ment made  under  a  mistake  of  fact;  that  is,  a  payment  made 
when  such  full  knowledge  is  wanting.  This  distinction  is  illus- 
trated by  a  case^'i  in  which  at  the  time  certain  executors  paid  an 
internal  revenue  inheritance  tax  on  a  life  estate  under  protest, 
they  had  no  knowledge  that  the  life  tenant  had  died  and  that  the 
life  estate  had,  therefore,  terminated  so  that  it  was  improper  to 
use  life  tables  to  determine  the  value  of  such  life  estate.  When 
knowledge  is  thus  spoken  of,  however,  the  reference  is  to  knowl- 
edge of  facts,  and  not  knowledge  of  law,  which  all  taxpayers  are 
presumed  to  have.^"-  If  a  payment  is  made  under  a  mistake  of 
law,  no  relief  exists.  Thus  in  one  case  an  importer  who  formally 
entered  goods  imported  from  Porto  Rico  and  purchased  the  re- 
quired stamps  without  protest  or  objection  or  duress  in  the  belief 
that  the  tax  was  lawfully  due,  although  the  goods  were  not  in 
fact  lawfully  taxable,  was  held  to  have  made  his  own  interpreta- 
tion of  law  and  his  payment  of  tax  was  held  voluntary.i^^  Thus 
a  tax  paid  under  a  statute  later  declared  unconstitutional  can  not 
be  recovered  on  the  theory  of  mistake  if  voluntarily  paid,  since 
the  mistake  is  one  of  law.^''^  It  has  been  stated  that  taxes  illegally 
assessed  and  paid  may  always  be  recovered  back  if  the  collector 
understands  from  the  payer  that  the  taxes  are  regarded  as  illegal 
and  that  suit  will  be  instituted  to  compel  the  refunding  of 
them.i^^    In  the  case  containing  this  doctrine  the  tax  recovered 

170  Little  V.  Bowers,  134  U.  S.  547;  Railroad  Co.  v.  Comm'rs,  98  U.  S. 
541;  Lamborn  v.  Comm'rs,  97  U.  S.  181. 

171  Kahn  v.  Herold,  147  Fed.  575,  affirmed  159  Fed.  608. 

172  Lamborn  v.   Comm'rs,  97  U.  S.  181. 

173  Newhall  v.  Jordan,  149  Fed.  586.  See,  however,  Elliott  v.  Swartout, 
10  Pet.  137;  Bend  v.  Hoyt,  13  Pet.  263. 

174  Lamborn  v.  Comm'rs,  97  U.  S.  181.  In  Chesebrough  v.  U.  S.,  192 
U.  S.  253,  and  U.  S.  v.  N.  Y.  &  Cuba  Mail  S.  S.  Co.,  200  U.  S.  488,  the 
constitutionality  of  the  acts  imposing  the  tax  was  attacked,  but  the  court 
(except  the  lower  court  in  the  Chesebrough  case  which  was  reversed)  did 
not  find  it  necessary  to  consider  such  constitutionality  since  the  payments 
were  held  to  be  voluntary  and  the  mistake  in  making  payments,  if  any, 
was  one  of  law.     (See  also  Union  Pacific  Co.  v.  Dodge,  98  U.  S.  541.) 

175  Erskine  v.  Van  Arsdale,  15  Wall.  75.     This  statement  was  contained 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  887 

was  one  on  thimble-skeins  and  pipe-boxes  of  iron  which  were 
exempt.  The  tax,  therefore,  was  paid  under  a  mistake  of  law  and 
although  the  facts  are  only  briefly  reported,  there  seems  to  have 
been  an  absence  of  such  duress  or  coercion  as  to  make  the  pay- 
ment an  involuntary  one.  The  same  absence  of  duress  or  coercion 
appears  in  other  early  cases.'"''  In  a  suit  to  recover  back  real 
property  taxes  paid  by  the  Union  Pacific  Railroad  Company  to 
Dodge  County,  Nebraska,  it  appeared  that  in  due  time  the  tax 
lists  with  warrants  attached  for  their  collection  were  delivered 
to  the  treasurer  of  the  county.  These  warrants  authorized  the 
treasurer,  in  order  to  enforce  collection,  to  seize  the  personal 
property  of  any  persons  making  default  in  the  payment  of  any 
taxes  charged  upon  the  lists.  No  demand  for  taxes  was  neces- 
sary, it  being  the  duty  of  every  person  subject  to  taxation  to  at- 
tend at  the  treasurer's  office  and  make  payment.  The  company 
so  attended  and  made  payment  filing  at  the  same  time  a  protest 
in  general  terms  containing  no  specification  of  alleged  illegality, 
or  designation  of  particular  property  as  wrongfully  included  in 
the  assessment.  Although  the  company  had  personal  property 
in  the  county  which  might  have  been  seized,  no  special  effort  had 
been  made  or  active  steps  taken  to  enforce  collection,  and  no 
other  notice  given  by  the  taxing  authorities  than  such  as  the  law 
implied.    Three  years  afterward  a  case  was  decided  which  was 

in  a  charge  of  the  lower  court  to  the  jury  which  was  sustained  by  the 
Supreme  Court.      (See  next  note.) 

17G  Elliott  V.  Swartout,  10  Pet.  137;  Bend  v.  Hoyt,  13  Pet.  263;  Phila- 
delphia V.  Collector,  5  Wall.  720;  Collector  v.  Hubbard,  12  Wall.  13.  In 
the  first  two  of  these  cases,  which  were  customs  cases,  the  payments  were 
made  to  release  goods  held  for  duties  on  imports  and  the  protest  became 
necessary  in  order  to  show  that  the  legality  of  the  demand  was  not  admitted 
when  payment  was  made.  The  recovery  rested  upon  the  fact  that  the 
payment  was  made  to  release  property  from  detention  and  the  protest 
saved  rights  which  grew  out  of  that  fact.  The  detention  of  property  under 
such  circumstances  would  seem  to  constitute  duress.  (See,  however, 
Newhall  v.  Jordan,  149  Fed.  586  in  which  it  was  conceded  that  the  im- 
porter could  not  have  obtained  possession  of  the  goods  without  making  the 
payment,  recovery  being  still  denied.  See  also  U.  S.  v.  N.  Y.  &  Cuba 
S.  S.  Co.,  200  U.  S.  488.)  In  the  third  and  fourth  of  these  cases,  which 
were  internal  revenue  cases,  recovery  was  based  upon  the  ground  that  the 
several  provisions  in  the  acts  under  which  the  taxes  were  imposed  warranted 
the  conclusion  as  a  necessary  implication  that  Congress  intended  to  give 
the  taxpayer  the  remedy  to  recover,  it  being  expressly  so  stated  in  the 
fourth  case.  The  case  of  Erskine  v.  Van  Arsdale,  15  Wall.  75,  (see  note 
171)  probably  falls  within  the  same  class  as  the  third  and  fourth  cases.  It 
is  to  be  noted  that  the  Court  in  Herold  v.  Kahn.  159  Fed.  608,  uses  Phil- 
adelphia v.  Collector,  5  Wall.  720,  as  one  of  its  authorities  for  the  state- 
ment which  has  been  criticised  above.     (See  note  169.) 


888  FEDERAL  INCOME  TAX 

supposed  to  hold  that  the  particular  lands  were  exempt  from 
taxation,  whereupon  the  company  brought  suit  to  recover  the 
taxes  involved.  It  was  held  that  no  such  immediate  and  urgent 
necessity  for  the  payment  of  the  taxes  in  controversy  existed  as 
to  imply  that  such  payment  was  made  under  compulsion.i^?  jn 
what  is  perhaps  the  leading  case  i'^^  on  the  subject  of  duress, 
stamps  were  purchased  from  the  collector  for  the  purpose  of 
affixing  them  to  a  deed  to  a  building  company.  The  collector  was 
not  informed  at  the  time  of  the  purchase  of  this  particular  pur- 
pose and  no  intimation,  written  or  oral,  was  given  him  of  any 
claim  by  the  purchaser  of  the  stamps  that  the  law  requiring  the 
affixing  of  the  stamps  was  unconstitutional  and  that  he  was 
making  the  purchase  under  duress.  About  19  months  after  the 
payment,  an  application  was  made  to  the  Commissioner  for  a  re- 
fund which  was  denied.  It  was  held  that  no  duress  existed. 
While  this  case  is  cited  as  an  authority  for  the  general  rule  stated 
at  the  beginning  of  this  paragraph  and  does  not  appear  ever 
to  have  been  questioned,  its  facts  do  not  even  disclose  the  making 
of  a  protest,!"^  and  the  only  duress  claimed  did  not  come  from  the 
government  or  its  agent  but  from  a  third  party.i^o  Beyond  this 
and  in  the  light  of  its  facts  it  is  not,  strictly  speaking,  an  au- 
thority upon  the  question  of  duress  and  the  court  intimates  that 
the  rule  as  to  duress  is  less  rigorous  on  some  occasions  than  on 

177  Union  Pacific  Co.  v.  Dodge,  98  U.  S.  541.  The  provisions  of  the 
state  statute  levying  the  tax  involved  in  this  case  do  not  clearly  appear, 
but  it  may  well  be  that  the  rule  as  to  what  constitutes  duress  in  cases  of 
real  property  taxation  may  vary  from  the  rule  in  cases  arising  under  the 
internal  revenue  laws.  For  instance,  the  owner  of  real  property  always 
has  his  action  of  ejectment.  To  the  same  general  effect  see  Simons  v.  U.  S., 
19  Ct.  Cls.  601,  where  the  taxpayer  paid  the  tax  to  obtain  possession  of  his 
property;  Christie  Street  Co.  v.  U.  S.,  126  Fed.  991  (internal  revenue 
cases). 

178  Chesebrough  v.  U.  S.,  192  U.  S.  253.  The  court  cites  Little  v.  Bowers, 
134  U.  S.  547;  and  Union  Pacific  Co.  v.  Dodge,  98  U,  S.  541  in  support  of 
its  conclusion. 

179  The  court  held  that  an  application  to  the  Commissioner  under  §  3220 
was  not  the  statutory  equivalent  of  a  common  law  protest  or  notice  of  suit. 

ISO  It  appeared  that  the  vendee  was  unwilling  to  accept  an  unstamped 
conveyance  and  that  stamps  were  affixed  in  order  to  complete  the  trans- 
action and  obtain  the  consideration.  But  the  court  said  that  "if  that 
constituted  duress  as  between  Chesebrough  and  his  building  company  it 
was  a  matter  with  which  the  collector  had  nothing  to   do." 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  889 

others, ^"'i  In  another  case,'^-  however,  duress  as  to  the  stamp 
tax  on  manifests  of  cargoes  was  claimed  in  that  clearance  papers 
for  vessels  bound  to  foreign  ports  could  not  be  obtained  without 
stamped  manifests  without  which  in  turn  such  vessels  would  be 
prevented  from  sailing  and  their  masters  liable  to  a  penalty. 
The  court  held  that  such  facts  did  not  constitute  duress.  P'urther 
doubt  has  been  thrown  upon  this  entire  question  by  a  com- 
paratively recent  case,'"^-'  in  which  the  taxing  statute  in  con- 
troversy contained  self-executing  or  automatic  provisions  for  its 
enforcement,  whereby  corporations  failing  to  pay  the  tax  for- 
feited their  rights  to  do  business  within  the  state  and  incurred 
a  penalty.  The  court  said  in  part :  "It  is  reasonable  that  a  man 
who  denies  the  legality  of  a  tax  should  have  a  clear  and  certain 
remedy.  The  rule  being  established  that,  apart  from  special 
circumstances,  he  can  not  interfere  by  injunction  with  the  state's 
collection  of  its  revenues,  an  action  at  law  to  recover  back  what 
he  has  paid  is  the  alternative  left.  Of  course,  we  are  speaking  of 
those  cases  where  the  state  is  not  put  to  an  action  if  the  citizen 
refuses  to  pay.  In  these  latter  he  can  interpose  his  objections  by 
way  of  defense ;  but  when,  as  is  common,  the  state  has  a  more 
summai-y  remedy,  such  as  distress,  and  the  party  indicates  by 
protest  that  he  is  yielding  to  what  he  can  not  prevent,  courts 
some  times,  perhaps,  have  been  a  little  too  slow  to  recognize  the 
implied  duress  under  which  payment  is  made.  But  even  if  the 
state  is  driven  to  an  action,  if,  at  the  same  time,  the  citizen  is  put 

181  Note  the  following  language  of  the  court:  "At  the  same  time,  when 
taxes  are  paid  under  protest  that  they  are  being  illegally  exacted,  or  with 
notice  that  the  payer  contends  that  they  are  illegal,  and  intends  to  institute 
suit  to  compel  their  repayment,  a  recovery  in  such  suit  may,  on  occasion, 
be  had,  althoush  generally  speaking,  even  a  protest  or  notice  will  not 
avail  if  the  payment  be  made  voluntarily.  *  *  *  As  we  have  said, 
the  purchase  of  these  stamps  was  purely  voluntary,  and  if,  notivithstanding, 
recovery  could  be  had,  it  could  only  he  on  protest  or  notice,  and  there  was 
none  such  here,  written  or  verbal,  formal  or  informal." 

152  U.  S.  V.  N.  Y.  &  Cuba  S.  S.  Co.,  200  U.  S.  488.  In  this  case  as  in 
Chesebrough  v.  U.  S.,  192  U.  S.  253,  the  collector  was  not  informed  at 
the  time  of  the  purchase  of  the  particular  purpose  for  which  the  stamps 
were  to  be  used,  and  no  intimation  was  given  him,  written  or  oral,  that 
the  taxpayer  claimed  that  the  law  regarding  such  stamps  was  unconsti- 
tutional and  that  it  was  making  the  purchase  under  duress.  The  court 
said  that  all  determining  conditions  were  the  same  as  in  the  Chesebrough 
case. 

153  Atchison  v.  O'Connor,  223  U.  S.  280.  See  also  Gaar,  Scott.  &  Co. 
V.  Shannon,  223  U.  S.  468,  in  which  the  court  said  in  part:  "Neither  a 
statute  imposing  a  tax,  nor  the  execution  thereunder,  nor  a  mere  demand 
for  payment,  is  treated  as  duress.  It  does  not  necessarily  follow  that 
there  will  be  duress  of  goods." 


890  FEDERAL  INCOME  TAX 

at  a  serious  disadvantage  in  the  assertion  of  his  legal,  in  this 
case  of  his  constitutional,  rights,  by  defense  in  the  suit,  justice 
may  require  that  he  should  be  at  liberty  to  avoid  those  disad- 
vantages by  paying  promptly  and  bringing  suit  on  his  side.  He 
is  entitled  to  assert  his  supposed  right  on  reasonably  equal 
terms."  A  clearer  definition  than  exists  at  present  of  the  nature 
of,  and  necessity  for  a  protest  and  duress  in  regard  to  the  re- 
covery of  internal  revenue  taxes  would  be  of  material  assistance 
both  to  the  taxpayer  and  the  government,  since  the  present  un- 
certainty, instead  of  freeing  the  courts  from  the  undoing  of  the 
voluntary  arrangements  of  parties  not  induced  by  fraud,  acci- 
dent or  excusable  negligence,  is  calculated  to  fill  the  courts  with 
questions  which  do  not  go  to  the  merits  of  taxation  controversies. 
The  more  liberal  rule  of  implied  duress  suggested  by  the  Supreme 
Court  in  the  case,!^^  referred  to  above,  if  properly  extended  and 
applied,  would  relieve  many  taxpayers  objecting  in  good  faith  to 
the  imposition  of  a  tax  from  the  risk  of  incurring  a  penalty  in 
order  to  come  technically  within  the  present  rule  as  to  involun- 
tary payments.^su 

184  Atchison  v.  O'Connor,  223  U.  S.  280.  Almost  all  taxing  statutes 
now  contain  summary  and  other  drastic  remedies  for  failure  to  pay  the 
tax  at  the  appointed  time.  Under  the  presumption  that  officers  of  the 
law  will  fulfill  their  duties  a  considerable  extension  of  the  doctrine  of 
duress  implied  from  a  statute  imposing  a  tax  might  well  be  made  without 
detriment  to  the  government's  interests.  It  is  seldom  that  the  government 
and  the  taxpayer  are  on  equal  terms  or  that  the  latter  has  any  choice  but 
to  do  what  the  government  officials  require.  Indeed,  the  only  alternative 
of  a  taxpayer  may  sometimes  be  as  in  Swift  v.  U.  S.,  Ill  U.  S.  22,  to  sub- 
mit to  an  illegal  exaction  or  discontinue  business.  It  would  seem  that  a 
clear  protest  should  always  be  required. 

185  It  has  been  held  by  a  district  court  in  Greenport  Basin  Co.  v.  U.  S., 
269  Fed.  58,  that  under  §  252  of  the  Revenue  Act  of  1918,  a  taxpayer  is 
entitled  to  a  refund  as  a  matter  of  right  and  that  protest  and  duress  are 
not  necessary  in  order  to  maintain  an  action  for  the  recovery  of  taxes 
illegally  assessed.  The  soundness  of  this  decision  seems  extremely  doubt- 
ful. §  252  relates  solely  to  the  matter  of  obtaining  a  credit  or  a  refund  and 
does  not  in  any  way  bear  upon  the  question  of  suing  to  recover  taxes 
illegally  assessed.  The  section  was  apparently  designed  to  counteract  the 
effect  of  §  3228  of  the  Revised  Statutes,  which  limited  refunds  to  a  period 
of  two  years  after  the  tax  had  been  paid.  There  is  no  clear  evidence  of 
congressional  intent  to  abolish  the  rule  hitherto  in  effect,  that  in  suing 
the  government  in  the  courts  for  the  recovery  of  taxes  erroneously  paid, 
it  was  necessary  to  show  that  the  taxes  were  paid  under  protest  and  duress. 
In  other  words,  it  has  always  been  the  rule  that  protest  was  not  necessary 
in  order  to  take  any  action  within  the  treasury  department  by  way  of 
abatement  or  refund  and  the  only  effect  of  §  252  seems  to  be  to  extend  the 
period  of  limitation  and  to  enable  the  taxpayer  to  obtain  a  credit.  Thb. 
court  in  the  same  case  says  that  even  if  protest  and  duress  is  necessary 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  891 

•   .   •     o  «uit    it  is  sufficient  if  the  defendant  computed  the 
in  order  to  maintain  a  suit,  it  is  sumucnt  abatement 

tax  "under  compulsion  of  the  R«^-1^;;«"^„^;;\J'^:;  /t  ^"IpYy  with  every 
of  the  taxes  assessed  before  payment  •  ^h^^  '^^^^;^;;;^^,;  ^Z  be  doubted 
requisite  of  a  payment  under  protest.     This  ^^atement  may  ^ 

.      .ew  of  Xt^hlTa^claitf  f^lnd'a^  a  claim  in 

tll7-:'::^^::^T,r.r.^^^^^^  to  suit.  ^M.  justice  H^- 

this  case  remarked  Jll^  -^^  ^^ --/r:;::::!^^!::  la^s  that 
with  the   government  .     The  coui  t   in  tne   u         i  ^^^^^ 

it  would  be  "a  useless  requirement"  to  ^f^^  .P^^^^^.^^/ ..^."^ent  in  the 
payment.     It  should  be   ^^'f.^^ZT^^^^.t^^^^^^^^^ 

Rock  [^l-V^'foVrSafter      n  aY  ;\hT  in  abatement  was  un- 

to make  a  claim  foi   ^^^^^  \  ^^^^^  ^„,         i^eiple  underlying  protest  and 

the    taxpayer's    objection    to    ««    P'^'P"^^.^    '\'';_\7nhe  courts  and 

„,ay  constitute  a  sufficient  P™'-  /"^^^^■^l;',;;^::^^"^^^         paid  the 

vet  the  taxpayer  may  be  precluded  trom  recovery 

taxes  in  question  without  the  necessary  degree  of  coercion. 

"o  e  of'l  n,ost  iiheral  cases  upon  the  <,ue^n  o<     -ess  .s  the  case  of 

Underwood  Typewriter  Co.  v.  Chambc,-^a,n    (ConM    10     At,  ^ 

S.  113.     In  this  -- /f.V,\^:^r^,tron      The  sututeunder  which  the 

voluntary  Pay-en    o    *«^\;Vta.  would  become  due  on  or  before  August 

rJaT  t^rdaTthetartd  upon  notice  and  ^— J^^ --a';  S 

of  the  unpaid  tax  would  automatically  be  '"''''V°''\"„th  tax  from  the 

And  if  it  were  unsuccessful,  no  matter  what  ""«""  't%;'^  ^  ,m„ 
the  lien  would  attach.  -^  ^-.f^^^^rt^pTov^e^f/e.  uV^urde^'uron  its 
ir::^rw:n:'  hrr^al  ::Z:Z'^  f -ed  or  -;a-ed  in™,..d  » 
hardship  and  loss  which  no  company  shou       ^—e... efface.  ^^^^ 

zr^:z.  ^^«.rt;:rwirs.L  It  ^oum  -  unf.r  tc,  it^.  comp.  .t 

certain   remedy.     This   is  common   p  ^^^   ^^  ^^^ 

,t  is  not  to  the  advantage  of  *e  ^tate  tha      hose^^^^^^    ^^_.^^^^      ^^^^  ^ 
should  refuse  to  pay  then   taxes    no  inconvenience 

rre'^iSL':'rtrLaru;or:Lt:hZ  payment  of  .s .. 


892  FEDERAL  INCOME  TAX 

Payment  After  Receipt  of  Form  1123.  Form  1123,  which 
under  the  1918  Law  was  sent  out  ten  days  before  the  second, 
third  and  fourth  due  dates,  made  "demand"  for  the  tax,  but  did 
not  contain  any  threats  of  penalties  to  be  exacted  in  the  event  of 
nonpayment.  Under  the  strict  rule  with  regard  to  duress  a  tax- 
payer might  not  safely  pay  each  installment  on  the  15th  day  of 
the  various  months  so  far  as  the  technical  requirements  of  a  suit 
to  recover  taxes  are  concerned.!^*"' 

Payment  After  Receipt  of  First  Notice  and  Demand  for 
Tax.  The  earlier  form  is'^  of  notice  and  demand  for  tax  contained 
the  following  language:     "Demand  is  here  made  for  this  tax. 

*  *  *  If  this  tax  is  not  in  my  hands  for  deposit  before  the 
close  of  business  of  the  day  above  specified  it  will  become  my 
duty,  under  the  law,  to  collect  the  same  together  with  5  per 
centum  additional,  and  interest  at  1  per  centum  per  month  until 
paid."  The  form'"^'^s  j^  use  from  1916  until  recently  contains  the 
following  language:  "If  payment  is  not  made  within  ten  days 
from  the  above  date,  it  will  be  my  duty  to  collect  the  same  with 
costs  by  seizure  and  sale  of  property."  The  form  now  in  use  con- 
tains the  language:  "Demand  is  made  for  the  payment  of  the 
said  tax  on  or  before  the  date  given  below.  Failure  to  do  so 
will  cause  a  5  per  cent,  penalty  to  accrue  with  interest  at  1  per 
cent,  per  month  from  due  date  until  paid."!^^  In  a  case  in  which 
a  notice  very  similar  in  form  to  the  first  of  the  above  notices 
and  containing  a  threat  to  collect  penalties  and  interest  was 
served  upon  the  taxpayer  it  was  held  that  payment  was  clearly 

ernmental  obligations  depended.  The  more  orderly  course  is  a  compliance 
with  the  law  by  a  payment,  reserving  the  right  to  contest  the  validity  of 
the  required  payment.  The  payment  of  the  tax  in  question  was  not  a  vol- 
untary one;  it  was  in  the  contemplation  of  the  law  a  payment  under  duress 
of  the  penalties  of  the  act.  And  this  we  hold  from  a  consideration  of  the 
provisions  of  the  act  and  without  a  consideration  of  any  remedies  by  way 
of  distress  which  the  state  might  have  for  the  enforcement  of  payment 
of  this  tax.  A  payment  of  a  tax  made  to  avoid  the  onerous  penalties  of 
the  act  imposing  the  tax  for  its  nonpayment  is  not  a  voluntary  payment." 
(See  also  Home  Tel.  &  Tel.  Co.  v.  Los  Angeles,  (Cal.),  181  Pac.  815.) 

186  Neither  should  the  tax  be  paid  in  advance,  if  it  is  objected  to  as 
illegal.  For  instance,  payment  of  the  four  installments  at  the  time  of 
filing  a  return  would  probably  preclude  a  taxpayer  from  relief  in  the 
courts.  In  Railway  Co.  v.  Humboldt,  87  Kans.  1,  123  Pac.  727,  the  court 
stated  that  the  payment  of  the  second  half  of  a  tax,  due  in  June,  prior  to 
December  20  of  the  preceding  year,  in  order  to  obtain  a  rebate,  was  a  vol- 
untary payment  and  was  therefore  not  recoverable. 

18T  Form  1-17. 

188  Form  1-17. 

189  See   Form   1-17  in   its  latest  revision. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  893 

involuntary  and  under  duress.^'^'  In  another  case  ^'-'^  arising  un- 
der the  1913  Law  the  Supreme  Court  allowed  recovery-  when 
payment  was  made  after  receipt  by  the  taxpayer  of  the  first  of 
the  above  forms  of  notice.  It  is  a  matter  of  doubt  whether  the 
form  of  notice  and  demand  in  use  under  the  1918  Law  and  not 
containing  an  express  threat  to  collect  the  5'.<  penalty  and  in- 
terest, and  containing  no  reference  to  any  seizure  and  sale  of 
property,  but  containing  a  statement  that  such  penalty  and  in- 
terest would  accrue,  was  sufficient  to  constitute  a  payment  made 
thereafter  involuntary. 

Payment  After  Receipt  of  Second  Notice  and  Demand  for 
Tax.  There  can  be  no  doubt  that  payment  upon  receiving  the 
second  notice  and  demand  in  use  under  the  1918  Law  was  clearly 
payment  under  duress,  since  that  notice  threatened  the  seizure 
and  sale  of  the  taxpayer's  property  to  satisfy  the  tax,  penalty, 
interest  and  costs.^^-  If  the  taxpayer  delayed  payment  until  the 
receipt  of  such  notice,  in  order  that  it  might  be  shown  that  pay- 
ment was  clearly  made  under  duress,  penalty  and  interest  was  re- 
quired to  be  paid.  It  was  a  wise  precaution  to  protest  not  only 
against  payment  of  the  tax  but  also  against  payment  of  such 
penalty  and  interest  as  well. 

Abatement,  Credit  and  Refund.  The  taxpayer  may  file  a  claim 
for  abatement  of  an  assessment  which  he  thinks  is  erroneous 
after  the  assessment  has  been  made  and  before  the  tax  is  paid, 
or  may  file  a  claim  for  refund  or  credit  of  a  tax  which  he  thinks 
has  been  erroneously  assessed  after  the  tax  is  paid.  A  further 
discussion  of  this  subject  is  contained  in  a  later  chapter  on  abate- 
ment and  refund.!"-' 

Committee  on  Appeals  and  Review.  An  advisory  tax  board 
was  created  by  the  Revenue  Act  of  1918  for  the  reasons  and  with 
the  organization  and  power  indicated  elsewhere  in  this  book.^"* 
The  function  of  the  board  was  to  review  upon  appeal  the  ad- 
ministrative decisions  of  the  income  tax  unit  in  important  in- 
come and  excess-profits  tax  cases,  particularly  cases  involving 

moHerold  v.  Kahn,  159  Fed.  608. 

191  Gulf  Oil  Co.  V.  Lewellyn,  248  U.  S.  71,  reversing  245  Fed.  1,  which 
had  reversed  242  Fed.  709.  In  a  case  arising  under  the  1909  Law  it  was 
held  that  payment  after  a  notice  to  the  effect  that  if  the  tax  together  with 
interest  was  not  paid,  the  collector  would  take  steps  to  collect  the  same 
with  penalties  was  involuntary.  (Cambria  Steel  Co.  v.  McCoach,  225 
Fed.  278.) 

192  See  Form  1-21. 

193  See  Chapter  37. 

194  See  Chapter  1.  As  to  submission  of  questions  and  procedure  for 
Advisory  Tax  Board,  See  Reg.  45,  Arts.  1701-1702,  no  longer  in  effect. 


894  FEDERAL  INCOME   TAX 

exceptional  or  unusual  conditions  with  respect  to  invested  capital, 
amortization,  depletion  and  depreciation.  The  committee  on  ap- 
peals and  review  took  over  this  function.^^^ 

Procedure.  When  an  appeal  is  taken  from  a  ruling  of  the 
income  tax  unit  to  the  committee  on  appeals  and  review  or  a 
question  is  certified  to  that  committee  at  the  request  of  the  tax- 
payer, and  an  oral  presentation  is  desired,  the  record  must  im- 
mediately be  examined  to  ascertain  as  to  whether  there  is  a  ques- 
tion of  law  involved.  If  it  is  found  that  a  question  of  law  is  in- 
volved, the  solicitor  must  be  notified  and  he  will  thereupon  desig- 
nate one  member  of  the  solicitor's  office  to  sit  with  the  committee 
and  himself  for  the  purpose  of  hearing  the  appeal,  or  if  the 
solicitor  finds  it  inconvenient  to  sit  with  the  committee  he  may 
designate  two  members  of  his  office  to  do  so.  At  the  hearing  be- 
fore the  committee  the  taxpayer  or  his  attorney  or  representa- 
tive will  be  expected  to  make  his  full  oral  argument  on  the  law  as 
well  as  the  facts,  and  this  presentation  will  be  the  only  oral  pre- 
sentation except  in  unusual  circumstances,  or  unless  a  further 
argument  of  the  facts  or  the  law  is  deemed  desirable  by  either  the 
chairman  of  the  committee  or  the  solicitor.  The  attorney  or  at- 
torneys so  designated  by  the  solicitor  for  the  hearing  will  be  ex- 
pected, in  conjunction  with  the  solicitor  and  the  conference  com- 
mittee in  the  solicitor's  office,  if  the  solicitor  so  desires,  to  con- 
sider the  legal  aspects  of  the  case,  and  the  solicitor's  recommen- 
dation in  the  form  of  an  opinion  or  memorandum  will  then 
be  made  to  the  chairman  of  the  committee,  and  thereupon 
the  committee's  findings  will  be  prepared  and  submitted  to 
the  Commissioner  for  his  approval.  In  any  case  of  appeal 
there  must  be  filed  with  the  committee,  either  at  the  time 
of  filing  the  appeal  or  on  or  before  the  date  set  for  oral 
presentation,  if  oral  argument  is  desired,  a  succinct  written 
statement  of  the  essential  facts  which  the  taxpayer  desires  to 
have  considered  in  connection  with  his  appeal,  duly  sworn  to. 
If  the  taxpayer,  his  attorney,  or  representative  does  not  wish  an 
oral  argument,  his  argument  may  be  made  in  the  form  of  a 
written  statement  or  brief  which  should  be  filed  at  the  time  the 
appeal  is  submitted  to  the  committee.  If  an  oral  presentation  is 
to  be  made,  the  taxpayer,  his  attorney,  or  representative  may  in 
addition  thereto  file  such  brief  or  briefs  as  he  may  desire.  These 
briefs,  not  less  than  three  copies  of  which  should  be  furnished, 

195  I.  T.  S.  1921,  §  2470. 


ASSESSMENT  AND  PAYMENT  OF  THE  TAX  895 

may  be  either  printed  or  typewritten,  and  where  practicable 
should  be  filed  not  less  than  three  days  before  the  appeal  is  to  be 
heard.  Additional  briefs  may  be  filed  at  the  time  of  or  sub- 
sequent to  the  hearing  within  the  time  prescribed  for  the  par- 
ticular case  by  the  committee.'""^ 

« 

me  0.  D.  709,  T.  B.  43-20-1272. 


CHAPTER  36 

PENALTIES  AND  COMPROMISES 

Several  penalties  are  contained  in  the  Revenue  Act  of  1921  for 
failure  to  corpply  with  its  provisions  and  for  making  false  and 
fraudulent  returns.  The  penalties  take  two  general  forms:  (a) 
specific  penalties  of  fines  with  maximum  limits  and  imprison- 
ment, and  (b)  penalties  of  either  5%,  25%  or  50%  based  upon 
the  tax.  In  the  case  of  individuals  specific  penalties  are  held  to 
attach  to  the  person  and  are  unenforceable  after  the  death  of 
such  person.  Ad  valorem  penalties  (those  based  upon  the  tax) 
are  enforceable  regardless  of  the  death  of  the  owner  of  the  in- 
come by  which  the  penalty  is  measured.^  An  ad  valorem  penalty 
is  assessed  and  collected  as  a  part  of  the  tax,  while  a  specific 
penalty  is  recoverable  only  by  suit.-  In  general,  the  penalties 
under  the  1921  Law  are  the  same  as  those  provided  by  the 
Revenue  Act  of  1918.  A  25  7o  penalty  is  provided  in  the  case  of 
taxpayers  violating,  or  attempting  to  violate,  the  provisions  of 
the  statute  as  to  the  collection  of  tax  from  those  designing 
quickly  to  depart  from  the  United  States."*  Certain  other  changes 
and  additions  are  noted  in  the  following  paragraphs. 

Suit  to  Enjoin  Collection  of  Penalties.  While  the  prohibition 
of  suits  to  enjoin  the  collection  of  internal  revenue  taxes  ^  does 
not  specifically  include  "penalties"  as  such,  yet  where  penalties 
are  authorized  by  the  statute  to  be  added  to  the  tax  and  col- 
lected as  a  part  of  the  tax,  the  courts  hold  that  the  penalty  is 
a  part  of  the  tax,  and  that  its  collection  can  not  be  enjoined.^ 

Failure  to  File  Return.  If  an  individual,  corporation,  or  part- 
nership fails  to  file  a  return,  the  specific  penalty,  where  the 
failure  is  not  wilful,  is  not  more  than  $1,000.'^  In  the  case  of 
such  failure  to  file  a  return  within  the  time  prescribed  by  law, 

iReg.  33  Rev.,  Art.  51.  See  U.  S.  v.  Theurer,  213  Fed.  960;  U.  S.  v. 
Pomeroy,  152  Fed.  279,  reversed  on  different  ground,  164  Fed.  324. 

2  Reg.  45,  Art.  1041. 

3  See  Chapter  35. 

4  R.  S.,  §  3224. 

SKohlhamer  v.  Smietanka,  239   Fed.  408. 

6  Revenue  Act  of  1921,  §253;  Revenue  Act  of  1918,  §253.  The  courts 
are  loathe  to  construe  a  statute  so  as  to  impose  a  penalty  unless  there  has 
been  a  substantial  delinquency.  (Savings  Bank  v.  Archbold,  104  U.  S. 
708.)  Technically  this  provision  imposes  a  penalty  in  cases  w^here  there 
has  been  no  substantial  delinquency.  As  a  practical  matter,  such  cases 
are  compromised  by  the  payment  of  nominal  penalties   (see  page  910). 

896 


PENALTIES    AND   COMPROMISES  897 

or  by  the  Commissioner  or  collector,  the  Commissioner  also  adds 
to  the  tax  25 /(  of  its  amount,"  except  as  set  forth  in  the  next 
paragraph.  Two  classes  of  delinquents  are  liable  to  the  penalty : 
(a) those  who  do  not  file  returns  and  for  whom  returns  are  made 
by  the  collector  or  Commissioner;  and  (b)  those  who  file  tardy 
returns  and  are  unable  to  show  reasonable  cause  for  the  delay.'* 
Exceptions.  When  a  return  is  filed  after  the  time  prescribed 
by  law,  and  it  is  shown  that  the  failure  to  file  it  was  due  to  a 
reasonable  cause  and  not  to  wilful  neglect,  the  addition  of  25 'r 
of  the  tax  is  not  made."  Taxpayers  wishing  to  avoid  the  penalty 
must  make  an  aflfirmative  showing  of  the  facts  alleged  as  a  rea- 
sonable cause  for  failure  to  make  a  return  on  time  in  the  form  of 
an  affidavit  under  oath,  which  should  be  attached  to  the  return. 
If  such  an  explanation  is  furnished  with  the  return  or  upon  the 
collector's  demand,  the  collector,  unless  otherwise  directed  by 
the  Commissioner,  will  forward  the  affidavit  with  the  return,  and 
if  the  Commissioner  determines  that  the  delinquency  was  due  to  a 
reasonable  cause,  the  25'  (  penalty  will  not  be  assessed.  "Reason- 
able cause"  is  such  a  condition  of  fact  that  had  the  taxpayer  in 
default  exercised  ordinary  business  care  and  prudence  it  would 
have  been  impracticable  or  impossible  for  him  to  file  a  return  in 
the  prescribed  time.^"  Where  the  attendant  and  surrounding  cir- 
cumstances have  a  tendency  to  cast  doubt  and  suspicion  upon  a 
taxpayer,  a  plea  of  mere  ignorance  is  not  sufl^cient  to  constitute 
a  reasonable  cause  for  failure  to  make  and  file  a  return  on  time.^^ 
Where  the  United  States,  through  the  proper  officer  of  the  Indian 
Service,  files  a  return  of  income  for  a  restricted  Indian,  which  is 
delinquent,  no  penalty  will  be  asserted  for  such  delinquency  since 

7R.  S.,  §3176,  as  amended  by  the  Revenue  Acts  of  1921  and  1918.  As 
this  section  of  the  Revised  Statutes  formerly  read  (as  amended  by  the 
1913  Law)  a  "refusal  or  neglect"  was  a  condition  to  the  addition  of  the 
ad  valor-em  penalty  provided.  These  words  were  held  to  mean  neither  a 
mere  failure  to  file  a  return  within  the  time  required  by  law  nor  a  fail- 
ure to  file  a  return  at  any  time,  but  something  in  between  these  two  ex- 
tremes; that  is,  where  there  had  been  a  refusal  or  inexcusable  neglect. 
(L.  0.  1060,  T.  B.  14-21-1554).  The  50'/(  addition  to  tax,  now  replaced 
by  a  25'^;c  addition,  has  been  held  a  penalty.  (17  Ops.  Atty.  Gen.  433; 
23  Ops.  Atty.  Gen.  398.) 

8  Reg.  45,  Art.  1004.  With  regard  to  supplemental  returns  for  years 
ending  in  1918,  see  T.  B.  R.  31,  T.  B.  7-19-306. 

9R.  S.,  §3176,  as  amended  by  the  Revenue  Acts  of  1918  and  1921;  S. 
1359,  T.  B.  13-20-817. 

10  Reg.  45,  Art.  1004;  Reg.  33  Rev.,  Art.  54. 

no.  818,  T.  B.  3-19-204. 


898  FEDERAL   INCOME   TAX 

it  is  held  that  the  penalty  provisions  of  the  law  are  inoperative 
against  the  government.i- 

Intentional  Neglect  or  Refusal  to  Make  Returns.  Any  indi- 
vidual, corporation  or  partnership  wilfully  refusing  to  make  a 
return  is  guilty  of  a  misdemeanor  and  subject  to  a  fine  not  to 
exceed  $10,000,  or  to  imprisonment  not  to  exceed  one  year,  or 
both,  together  with  the  costs  of  prosecution.i^^  In  case  of  inten- 
tional neglect  or  refusal  to  make  a  return,  the  ad  valorem  pen- 
alty of  25%  of  the  tax  is  also  added.  The  amount  so  added  is 
collected  at  the  same  time  and  in  the  same  manner  and  as  part  of 
the  tax,  unless  the  tax  has  been  paid  before  the  discovery  of  the 
neglect,  in  which  case  the  amount  so  added  is  collected  in  the 
same  manner  as  the  tax.^-^ 

False  Returns.  The  law  provides  that  if  any  deficiency  in  tax 
is  due  to  fraud  with  intent  to  evade  tax,  then,  in  lieu  of  the 
penalty  provided  by  the  Revised  Statutes, i"'  as  amended,  for  false 
or  fraudulent  returns  wilfully  made,  but  in  addition  to  other 
penalties  provided  by  law  for  false  or  fraudulent  returns 
there  shall  be  added  as  part  of  the  tax  50%  of  the  total  amount 
of  the  deficiency, 1"  The  1918  Law  imposed  the  same  penalty 
where  the  "understatement"  was  "false  or  fraudulent  with  in- 
tent to  evade  the  tax."  The  term  "understatement"  had  par- 
ticular reference  to  the  understatement  of  the  amount  of  the 
tax  in  the  return.  This  was  true  whether  such  understatement 
resulted  from  the  false  or  fraudulent  computation  of  the  tax  or 

12  0.  D.  1130,  T.  B.  49-21-1966. 

13  Revenue  Act  of  1921,  §253;  Revenue  Act  of  1918,  §253. 

14  R.  S.,  §3176,  as  amended  by  the  Revenue  Acts  of  1921  and  1918; 
Reg.  45,  Art.  1004.  Under  the  1913  Law  the  ad  valorem  penalty  of  100% 
was  added.  (T.  D.  1950.)  The  inference  of  R.  S.  3176,  as  then  in  force, 
is  clear  that  for  intentional  failure  to  file  a  return  only  the  50%  penalty 
should  be  added,  and  it  is  difficult  to  understand  by  what  authority  the 
100%  penalty  was  added  for  failure  to  make  any  return  at  all,  even 
though  the  failure  was  intentional. 

15  R.  S.,  §  3176,  as  amended  by  Revenue  Acts  of  1918  and  1921. 

10  Revenue  Act  of  1921,  §250;  Revenue  Act  of  1918,  §250;  O.  1008,  T. 
B.  10-20-782.  The  law  also  provides  that  "in  case  a  false  or  fraudulent 
return  is  wilfully  made,  the  Commissioner  shall  add  to  the  tax  50  per 
centum  of  its  amount."  The  amount  so  added  to  any  tax  shall  be  collected 
at  the  same  time  and  in  the  same  manner  and  as  part  of  the  tax  unless  the 
tax  has  been  paid  before  the  discovery  of  the  neglect,  falsity  or  fraud,  in 
which  case  the  amount  so  added  shall  be  collected  in  the  same  manner  as 
the  tax.  (R.  S.,  §3176,  as  amended  by  Revenue  Acts  of  1921  and  1918. 
See  also  Reg.  45,  Art.  1005.)  Under  this  provision  before  the  Revenue 
Act  of  1918,  it  was  held  that  the  corresponding  penalty  should  be  added 
to  the  amount  of  the  tax  shown  by  the  correct  return.  (Reg.  33  Rev., 
Art.  53.) 


PENALTIES    AND    COMPROMISES  899 

from  false  or  fraudulent  misstatements  or  omissions  of  items  of 
income  or  misstatements  of  items  of  deduction  or  from  other 
false  or  fraudulent  entries  or  omissions,''  The  above  provision 
does  not  include  returns  which  are  false  in  the  sense  of  contain- 
ing mistakes  or  unintentional  misstatements.  A  return  may  be 
false  in  the  sense  used  in  those  sections  of  the  law  which  permit 
summary  assessments  in  the  case  of  erroneous,  false  or  fraudu- 
lent returns  without  being  false  in  the  sense  of  the  section  pre- 
scribing the  penalty  of  50  V(  .^^  Under  the  1918  Law,  if  a  return 
made  in  good  faith  was  false  in  the.  sense  of  being  incorrect, 
but  such  falsity  was  due  to  negligence  on  the  part  of  the  tax- 
payer, "without  intent  to  defraud,"  the  50'^  was  not  added,  but 
a  penalty  of  5^/c  of  the  total  amount  of  any  deficiency  plus  in- 
terest at  1' '(  per  month  on  the  amount  of  the  deficiency  of  each 
installment  from  the  time  such  installment  is  due,  was  added. 
"Negligence  on  the  part  of  the  taxpayer,  but  without  intent  to 
defraud,"  was  presumed  to  exist  in  every  case  in  which  a  deduc- 
tion had  been  made  or  income  had  been  omitted  in  direct  conflict 
with  the  specific  provisions  of  the  law  and  regulations,  but  was 
not  presumed  to  exist  if  the  understatement  might  be  ascribed 
to  an  error  of  judgment  as  to  some  matter  not  so  concluded.^'' 
Whether  it  would  be  held  that  negligence,  without  intent  to  de- 
fraud could  exist  where  the  taxpayer  was  known  to  have  knowl- 
edge of  the  law  and  regulations,  is  not  clear.  Under  the  present 
law  the  50' r  penalty  is  not  imposed,  but  the  5'(  penalty  is  im- 
posed and  interest  at  1  %  per  month  is  added  if  any  part  of  the 
deficiency  is  "due  to  negligence  or  intentional  disregard  of  a}(- 
thorized  rules  and  reg illations  with  knowledge  thereof,  but  with- 
out intent  to  defraud."-'*  As  indicated  above,  the  treasury  de- 
partment in  construing  the  1918  Law,  arrived  at  practically  the 
same  result  as  is  reached  by  the  more  specific  provisions  of  the 
present  law,  except  that  the  present  law  now  makes  it  certain 
that  only  the  5'y  penalty  and  interest  attaches  where  the  de- 
ficiency is  due  to  intentional  disregard  of  authorized  rules  and 
regulations  ivith  knowledge  thereof.  Under  the  present  law,  in 
case  of  any  deficiency,  interest  will  be  added  at  the  rate  of  one- 
half  of  1 /(  per  month  from  the  time  the  tax  was  due,  or  if  paid 
on  the  installment  basis, 'on  the  deficiency  of  each  installment 

17  0.  1008,  T.  B.  10-20-782. 

18  Revenue  Act  of  1918,  §250;  R.  S.,  §3176,  as  amended  by  Revenue 
Act  of  1918.  Eliot  Nat.  Bank  v.  Gill,  218  Fed.  600;  Woods  v.  Lewellyn, 
252  Fed.  106.     See,  how^ever,  U.  S.  v.  Nashville  etc.  Ry.  Co.,  249  Fed.  678. 

i!i  Revenue  Act  of  1918,  §250;  A.  R.  M.  23,  T.  B.  7-20-746. 
20  Revenue  Act  of  1921,  §250   (b). 


900  FEDERAL   INCOME   TAX 

from  the  time  the  installment  was  due  except  that  where  the  de- 
ficiency is  due  to  negligence  or  intentional  disregard  of  au- 
thorized rules  and  regulations  with  knowledge  thereof,  but  with- 
out intent  to  defraud,  interest  will  be  added  at  the  rate  of  1% 
per  month.21  Under  the  1918  Law  no  penalty  was  imposed  in 
case  a  return  made  in  good  faith  was  false  in  the  sense  of  being 
incorrect,  in  the  absence  of  fault  on  the  part  of  the  taxpayer, -- 
but  this  provision  is  not  contained  in  the  present  law.  Where 
an  amended  return  showing  additional  tax  liability  has  been  filed, 
no  interest  on  the  additional  tax  will  be  collected  unless  10  days 
after  notice  and  demand  by  the  collector  the  amount  of  the  addi- 
tional tax  assessed  has  not  been  paid,  provided  there  appears  to 
have  been  no  neglect  or  intent  to  defraud  upon  the  part  of  the 
taxpayer.--'  In  cases  where  an  addition  of  25  Vt  or  50%  is  made 
to  the  tax  on  account  of  delinquency  or  fraud,  and  the  taxpayer 
fails  to  pay  the  tax  within  10  days  after  notice  and  demand  from 
the  collector,  the  5 /(  penalty  and  interest  attach  not  only  to  the 
amount  of  tax  shown  to  be  due  by  the  return,  but  also  to  the 
25%  or  50%  addition  to  the  tax.-^  In  general,  negligence  is  at- 
tributable to  the  taxpayer  if  he  computes  the  tax  in  disregard 
of  the  instructions  on  the  return  form  or  otherwise  incorrectly, 
unless  he  can  show  that  his  error  was  due  to  an  honest  misunder- 
standing of  the  facts  or  the  law  of  which  an  average  reasonable 
man  might  be  capable.--^  In  addition  to  the  ad  valorem  penalties 
above  enumerated  for  making  false  and  fraudulent  returns,  the 
making  of  such  returns  may  subject  the  taxpayer  to  a  fine  of 
$10,000  and  imprisonment  for  not  more  than  one  year,  together 
with  the  costs  of  prosecution,  for  wilfully  attempting  "in  any 
manner  to  defeat  or  evade  the  tax."-''  The  penalties  applying  to 
false  or  fraudulent  returns  apply  to  amended  as  well  as  original 
returns.-' 

Red  Cross  Contributions.  The  penalty  for  negligence  was 
not  asserted  against  a  corporation  when  a  deduction  was  taken 
for  contributions  to  the  Red  Cross  or  similar  war  works,  but 
such  item  was  specifically  and  separately  listed  in  the  schedules 
attached  to  the  return.--^ 

21  Revenue  Act  of  1921,  §250    (b). 

22  Revenue  Act  of  1918,  §  250. 

23  O.  D.  366,  T.  B.  2-20-678. 

24  0.  D.  441,  T.  B.   14-20-836. 

25  Reg.  45,  Art.  1005. 

2<;  Revenue  Act  of  1921,  §253;   Revenue  Act  of  1918,  §253. 

27  Levy  v.  U.  S.,  271  Fed.  942. 

28  A.  R.  R.  360,  T.  B.  1-21-1377;  T.  D.  3105,  T.  B.  1-21-1385. 


PENALTIES    AND    COMPROMISES  901 

Appreciation  in  Value  of  Lumber  Properties.  A  number 
of  taxpayers  engaged  in  the  lumber  business  were  advised  by 
counsel  that  they  were  entitled  to  include  the  appreciation  in  the 
value  of  their  properties  in  invested  capital  under  the  1917  Law. 
Being  also  advised  that  they  could  not  safely  make  a  voluntary 
return  along  the  lines  insisted  upon  by  the  treasury  department, 
and  wishing  to  test  the  matter  in  the  courts,  these  taxpayers  in- 
cluded such  appreciation  in  invested  capital,  calling  specific  at- 
tention on  the  returns  to  the  fact  that  they  had  done  so.  Addi- 
tional taxes  were  not  assessed  by  the  department  prior  to  the 
making  of  their  1918  returns,  and  many  of  the  taxpayers  con- 
strued this  failure  to  assess  additional  taxes  as  an  acquiescence 
in  the  soundness  of  their  position  and  made  1918  returns  on  the 
same  basis.  It  was  held  that  since  a  complete  disclosure  was 
made  in  the  return  no  penalty  should  be  asserted. -'• 

Tax  on  Bank  Stock.  Banks  which  deducted  1919  taxes 
assessed  against  their  shareholders  on  account  of  their  ownership 
of  the  shares  of  stock  issued  by  such  banks,  have  been  held  guilty 
of  negligence  and  subject  to  the  o'/<   penalty .'"" 

Gains  from  Sales  of  Capital  Assets.  Taxpayers  omitting 
to  include  in  gross  income  gains  derived  from  the  sale  of  capital 
assets,  in  reliance  upon  decisions  in  the  lower  federal  courts  that 
such  gains  were  not  taxable,  but  making  a  full  disclosure  of  the 
facts,  were  not  subjected  to  the  penalties  for  negligence  or 
fraud."'^ 

Fraudulent  Returns.  Where  a  false  or  fraudulent  return  is 
made,  then,  in  addition  to  the  other  penalties  provided  by  law  for 
false  or  fraudulent  returns,  there  shall  be  added  as  part  of  the 
tax  50%  of  the  amount  of  the  deficiency.  This  increase  is  only 
made  in  case  the  return  is  fraudulently  false.-'--  The  Revenue  Act 
of  1921  provides  that  in  such  case  the  whole  amount  of  the  tax 
unpaid,  including  the  penalty  so  added,  shall  become  due  and 
payable  upon  notice  and  demand  by  the  collector.-^-'  In  a  case 
in  which  a  taxpayer  in  good  faith  and  without  any  fault  on  his 
part  failed  to  report  certain  items  of  income  in  his  return  and 
also  negligently  failed  to  report  other  items  of  income,  and  also 
fraudulently  and  with  intent  to  evade  the  tax  failed  to  report 

20  A.  R.  M.  105,  T.  B.  2-21-1392. 

-0  O.  D.  944,  T.  B.  23-21-1677. 

31  M.  2791,  T.  B.  23-21-1674. 

•'!•-' Revenue  Act  of  1921,  §250;  Revenue  Act  of  1918,  §250.  Nat.  Bank 
of  Commerce  v.  Allen,  223  Fed.  472. 

•"••>  Revenue  Act  of  1921,  §  250.  This  provision  was  not  contained  in  the 
1918  Law. 


902  FEDERAL  INCOME   TAX 

other  items  of  income,  it  has  been  ruled  that  the  return  is  to  be 
dealt  v/ith  as  a  whole;  that  no  part  of  the  deficiency  or  under- 
statement is  free  from  penalty  if  a  part  of  the  return  is  tainted 
with  fraud  or  negligence;  that  the  penalty  of  5%  of  the  whole 
amount  of  the  deficiency  does  not  attach  because  a  greater 
penalty  is  provided,  the  statute  making  no  provision  for  dividing 
up  the  deficiency  and  applying  to  various  parts  of  it  different 
penalties;  that  the  penalty  of  50%  will  be  applied  to  the  entire 
amount  of  deficiency  or  understatement  which  is  tainted  with 
fraud  and  not  to  simply  a  part  thereof."''^  A  taxpayer  who  filed 
a  return  of  income  which  did  not  include  profit  on  the  sale  of 
certain  corporate  stock  and  in  reply  to  an  inquiry  by  an  examin- 
mg  officer  stated  that  he  had  not  made  any  money  on  outside  in- 
vestments during  the  year,  but  in  reply  to  a  direct  inquiry  in  re- 
gard to  the  sale  of  the  stock,  based  on  confidential  information, 
admitted  the  sale,  but  made  no  explanation  of  his  failure  to  in- 
clude the  profit  on  the  sale  in  his  return  for  the  taxable  year,  is 
held  to  have  filed  a  false  and  fraudulent  return  for  the  purpose 
of  evading  taxation  and  the  100  a  additional  tax  should  be 
assessed,'"^^ 

Fine  Against  or  Imprisonment  of  Officer  of  Corporation  or 
Member  of  Partnership  or  Employee  of  Either.  In  case  an 
officer  of  a  corporation  or  member  of  a  partnership  or  an  em- 
ployee of  either,  charged  with  the  duty  and  responsibility  of 
making  a  return,  paying  or  collecting  the  tax,  or  supplying  in- 
formation at  the  source,  wilfully  refuses  to  make  such  return, 
pay  or  collect  such  tax,  or  to  supply  such  information,  or  at- 
tempts in  any  manner  to  defeat  or  evade  the  tax,  he  is  guilty  of  a 
misdemeanor  and  subject  to  a  fine  not  to  exceed  $10,000,  or  to 
imprisonment  not  to  exceed  one  year,  or  both,  together  with  the 
costs  of  prosecution.^''^ 

Returns  of  Information  at  Source.  Any  individual,  corporation 
or  partnership  called  upon  to  supply  information  at  the  source, 
who  fails  to  do  so  at  the  time  or  times  specified  in  each  year, 
when  such  failure  is  not  wilful,  is  liable  to  a  penalty  of  not  more 
than  $1,000.  If  such  failure  to  file  information  at  the  source  is 
wilful,  the  delinquent  is  guilty  of  a  misdemeanor  and  subject  to 
a  fine  not  to  exceed  $10,000,  or  to  imprisonment  not  to  exceed 
one  year,  or  both,  together  with  the  costs  of  prosecution.^''' 

34  0.  1028,  T.  B.  18-20-903. 

35  S.  926,  T.  B.  1-19-105.     This  ruling  was  made  under  the  1913  Law. 
3f:  Revenue  Act  of  1921,  §253;  Revenue  Act  of  1918,  §253. 

37  Revenue  Act  of  1921,  §253;   Revenue  Act  of  1918,  §253. 


PENALTIES    AND    COMPROMISES  903 


Returns  of   Withholding   Agents.     Failure  to   make   and   file 
withholding  returns  on  or  before  iMarch  1st  renders  a  withhold- 
ing agent  liable  to  the  specific  penally  of  not  more  than  $1,000-'^ 
unless  the  tax  is  paid  by  the  recipient  of  the  income.'-"'     If  the 
failure  of  the  withholding  agent  was  fraudulent  and  for  the  pur- 
pose of  evading  the  tax,  however,  he  will  be  guilty  of  a  mis- 
demeanor and  fined  not  more  than  $10,000  or  imprisoned  for 
not  more  than  one  year,  or  both,  together  with   the  costs  of 
prosecution,  irrespective  of  whether  or  not  the  tax  is  paid  by  the 
recipient  of  the  income.^"    The  ad  valorem  penalties  for  frai«Iu- 
h'Ht  returns  should  be  assessed  against  withholding  agents  un- 
der the  income-tax  provisions  of  the  law.    The  ad  ralorcm  penal- 
ties for  delinquent  returns  should  be  assessed  against  withhold- 
ing agents,  except  that  if  the  tax  required  to  be  withheld  is  paid 
by  the  recipient  of  the  income,  no  such  penalty  should  be  col- 
lected from  the  withholding  agent  unless  his  delinquency  was 
fraudulent  and  for  the  purpose  of  evading  payment.^' 

Attempts  to  Evade  the  Tax.  Any  individual,  corporation  or 
partnership  wilfully  attempting  in  any  manner  to  defeat  or  evade 
the  tax  is  guilty  of  a  misdemeanor  and  may  be  fined  not  more 
than  $10,000,  or  imprisoned  for  not  more  than  one  year,  or  both, 
together  with  the  costs  of  prosecution.'-  This  includes  a  tax  yet 
to  be  assessed  as  well  as  a  tax  already  assessed.^-  The  giving  of 
instructions  or  advice  with  the  purpose  and  intent  of  inducing 

3S  Revenue  Act  of  1921,  §253;   Revenue  Act  of  1918,  §253. 

3-..  Revenue  Act  of  1921,  §221    (e)  ;  Revenue  Act  of  1918,  §221    (e). 

40  Revenue  Act  of  1918,  §§253,  221   (e). 

41  S.   1334,  T.  B.   8-20-758,  apparently  overruling  Mimeograph    Letter  to 
Collectors,  No.  1265. 

4:i  Revenue  Act  of  1918,  §253.  The  following  comment  of  Mr.  Justice 
Holmes  in  Bullen  v.  Wisconsin,  240  U.  S.  025,  is  interesting  in  this  con- 
nection- "We  do  not  speak  of  evasion,  because,  when  the  law  draws  a  line, 
a  case  is  on  one  side  of  it  or  the  other,  and  if  on  the  safe  side  is  none  the 
worse  legally  that  a  party  has  availed  himself  to  the  full  of  what  the  law 
permits  When  an  act  is  condemned  as  an  evasion,  what  is  meant  is  that 
it  is  on  the  wrong  side  of  the  line  indicated  by  the  policy  if  not  by  the 
mere  letter  of  the  law."  The  distinction  between  a  legal  avoidance  and  an 
ille^^al  evasion  must  be  kept  in  mind  (see  U.  S.  v.  Isham.  17  Wall.  476,  84 
U  S  496-  S  1385,  T.  B.  19-20-928;  L.  O.  1062,  T.  B.  14-21-1548,  over- 
ruling L  O.  1035,  T.  B.  40-20-1222).  The  fact  that  a  transaction  has 
for  its  purpose  the  reduction  of  taxes  does  not  make  it  illegal  if  the  means 
employed  are  in  themselves  legal.  As  to  taxpayers  violating  or  attempting 
to  violate  the  provisions  of  the  law  respecting  taxpayers  designing  to  depart 
from  the  United  States,  see  Chapter  35. 

4:!  Levy  v.  U.  S.,  271  U.  S.  942. 


904  FEDERAL  INCOME  TAX 

persons  liable  to  make  returns  or  pay  tax  to  refrain  from  making 
returns  or  paying  tax  is  an  attempt  to  defeat  the  tax.^^ 

Failure  to  Pay  Tax.  Any  individual,  corporation  or  partner- 
ship failing  wilfully  or  otherwise  to  pay  the  tax  at  the  time  or 
times  required  is  liable  to  the  same  specific  penalties  which  at- 
tach for  failure  to  make  a  return  accordingly  as  such  failure  is 
or  is  not  wilful.^''  In  addition,  as  set  forth  in  another  chapter  ^^ 
interest  will  be  added,  the  tax  will  become  a  lien,  and  the  goods, 
chattels  or  effects,  including  stocks,  securities  and  evidences  of 
debt,  of  the  taxpayer  will  be  subject  to  distraint  and  sale. 

Delay  in  the  Payment  of  the  Tax.  As  a  general  rule,  if 
any  tax  remains  unpaid  after  the  date  when  it  is  due,  and  for  ten 
days  after  notice  and  demand  by  the  collector,  there  will  be 
added  as  part  of  the  tax  the  sum  of  5%  on  the  amount  due  but 
unpaid,  and  interest  at  the  rate  of  1%  per  month  upon  such 
amount  from  the  time  it  became  due.  This  penalty  and  interest 
do  not  accrue  in  case  of  any  tax  due  from  the  estates  of  insane, 
deceased  or  insolvent  persons.  When  an  assessment  has  been 
made  for  a  tax  or  penalty  and  a  bona  fide  claim  for  its  abate- 
ment is  filed  within  ten  days  after  demand  for  payment,  where 
the  taxpayer  has  not  had  the  benefit  of  the  provision  of  the  1921 
Law  allowing  him  30  days  in  which  to  file  an  appeal,  the  time 
ceases  to  run  against  the  claimant  as  to  the  5%  penalty,  from 
the  time  the  tax  was  due  until  the  claim  is  decided.  Upon  re- 
ceipt of  a  notice  of  rejection  of  the  claim  or  so  much  thereof  as 
is  not  allowed  the  collector  will  notify  the  claimant  and  demand 
payment  of  the  tax.  If  the  tax  is  not  then  paid  within  10  days, 
the  5%  penalty  will  be  assessed  on  the  amount  of  tax  not  abated. 
If  abatement  of  the  entire  tax  assessed  is  not  demanded  in  a 
claim,  and  the  balance  of  the  tax  is  not  paid  within  the  required 
10  days,  the  5%  penalty  will  immediately  accrue  on  such  bal- 
ance.^7  Under  the  1918  Law,  interest  at  the  rate  of  one-half  of 
1  %  per  month,  in  any  event,  ran  from  the  time  the  tax  was  due 
until  the  claim  was  decided,  notwithstanding  that  a  claim  for 
abatement  had  been  filed.^''  Where  a  warrant  of  distraint  was 
served,  $5  was  added.'^^    Under  the  present  law  interest  from  the 

44  S.  931,  T.  B.  1-19-108. 

45  Revenue  Act  of  1921,  §253;  Revenue  Act  of  1918,  §253. 
40  See  Chapter  35. 

47  Revenue  Act  of  1921,  §  250  (e)  ;  Revenue  Act  of  1918,  §  250  (e)  ; 
Reg.  45,  Art.  1006;  Reg.  14,  October  15,  1916;  Reg.  1.,  p.  110.  For  the 
rules  M^hen  property  passed  into  the  hands  of  the  alien  propei'ty  custodian 
prior  to  the  expiration  of  the  10  days,  see  O.  1026,  T.  B.  17-20-876. 

48  Revenue  Act  of  1918,  §250   (e).     See  Chapter  37. 

40  Reg.  45,  Art.  1006.  • 


PENALTIES    AND    COMPROMISES  905 

time  the  amount  was  due  until  the  claim  is  decided  will  be  at  the 
rate  of  one-half  of  1';  per  month  on  that  part  rejected.--"  In 
cases  where  delinquent  returns  are  tiled  and  the  total  tax  is  paid 
at  the  time  of  filing,  the  penalty  of  5';  and  interest  at  the  rate 
of  1'.  per  month  attaches  only  to  the  amount  of  any  installment 
overdue."'^ 

Where  a  taxpayer  filed  an  amended  return  showing  a  lesser 
amount  of  tax  due  than  that  shown  in  his  original  return,  but 
did  not  file  a  claim  for  abatement  of  the  excess  tax  until  after 
10  days  following  notice  and  demand  from  the  collector,  assum- 
ing that  the  amended  return  was  a  substitute  for  the  original  re- 
turn, the  claim  subsequently  being  rejected,  it  has  been   held 
that  the  5';   penalty  and  the  l^'    interest  must  be  asserted  for 
failure  to  pay  the  tax  within  10  days  after  notice  and  demand. 
"Reasonable  cause"  is  associated  only  with  the  25';    penalty  in 
case  of  failure  to  file  return  within  the  time  prescribed,  and  will 
not  relieve  a  taxpayer  from  penalties  incident  to  failure  to  pay 
any  tax  due  within  10  days  after  notice  and  demand.'^-     But  if 
such  claim  were  allowed,  no  penalty  would  be  asserted."-^'    A  tax- 
payer having  filed  his  return  and  paid  the  first  installment  of  tax 
is  aware  of  his  liability  to  pay  the  balance  of  the  tax  on  the  re- 
spective due  dates,  and  failure  to  receive  notice  and  demand  for 
the  payment  of  the  later  installments  by  reason  of  his  absence 
from   this   country   does   not   constitute   a   suflicient   cause   for 
waiving  the  penalty  and  interest  on  any  installment  of  the  tax 
not  paid  when  due.-^'^ 

Penalty  for  Divulging  Information.  The  penalty  m  the  case 
of  any  collector,  deputy  collector,  agent,  clerk  or  other  officer  or 
employee  of  the  United  States  who  divulges  information  in  his 
possession  and  acquired  in  the  performance  of  his  duties,  is 
treated  elsewhere  in  this  book."' 

Statute  of  Limitations.  The  Revenue  Act  of  1921,  amending 
a  prior  statute,  provides-"'  that  no  person  shall  be  prosecuted, 
tried  or  punished  for  any  of  the  various  offenses  arising  under  the 
internal  revenue  laws  of  the  United  States  unless  the  indictment 

no  Revenue   Act  of   1921,   §250    (e). 

.-.1  O.  D.   1111,  T.   B.   47-21-1935,   overruling   O.   D.   313.   T.   B.   2d-19-588. 

r.2  O.  D.  706,  T.  B.  43-20-1208. 

--■•to.  D.  846.  T.  B.   11-21-1511. 

^^  O.  D.  408,  T.  B.  9-20-775. 

•"«>T.  D.  2903;  R.  S.,  §  1367,  as  amended  hy  Revenue  Act  of  1921;  O.  907. 
T    B.  lS-1 9-489.     See  Chapter  34. 

•  •-'■-  Revenue  Act  of  1921.  §  1321,  amending  the  act  entitled  "An  act  to  limit 
the  time  within  which  prosecutions  may  be  instituted  against  persons 
charged  with  violating  internal  revenue  laws",  approved  July  5,  1884. 


906  FEDERAL   INCOME   TAX 

is  found  or  the  information  instituted  within  three  years  next 
after  the  commission  of  the  offense,  except  that  the  time  during 
which  the  person  committing  the  offense  is  absent  from  the  dis- 
trict wherein  the  same  is  committed  shall  not  be  taken  as  any  part 
of  the  time  limited  by  law  for  the  commencement  of  such  pro- 
ceedings. Where  a  complaint  is  instituted  by  a  commissioner  of 
the  United  States  within  the  period  above  limited,  the  time  shall 
be  extended  until  the  discharge  of  the  grand  jury  at  its  next  ses- 
sion within  the  district.  The  above  provisions  do  not  apply  to 
offenses  committed  by  officers  of  the  United  States.-'''^  The  Re- 
vised Statutes  provide  that  no  suit  or  prosecution  for  any  penalty 
or  forfeiture,  pecuniary  or  otherwise,  accruing  under  the  laws  of 
the  United  States,  shall  be  maintained,  except  in  cases  where  it 
is  otherwise  specially  provided,  unless  the  same  is  commenced 
within  five  years  from  the  time  when  the  penalty  or  forfeiture 
accrued.  The  statute  does  not  run,  however,  if  the  person  liable 
for  the  penalty  is  not  to  be  found  within  the  United  States  so  that 
proper  process  may  be  instituted  and  served  against  him.^"^  The 
period  of  limitation  applies  whether  the  action  is  in  personam  or 
in  rem?'^  The  courts  have  no  power  to  engraft  any  exception  on 
this  statute  in  cases  of  concealed  fraud  which  is  not  discovered 
until  after  the  expiration  of  five  years.''"  The  states  can  not  pass 
any  statute  of  limitations  which  will  bind  the  federal  govern- 
ment, or  which  will  furnish  the  rules  for  determining  whether  an 
action  is  brought  in  time,  except  as  Congress  has  clearly  mani- 
fested its  intention  that  the  United  States  shall  be  so  bound.*'i 
It  has  been  held  that  where  an  income  tax  return  under  the 
Revenue  Act  of  1918  has  been  found  to  be  false  and  fraudulent 
and  the  additional  tax  has  been  assessed  and  paid  at  a  time  when 

•'■'"  This  act,  as  amended  by  the  Revenue  Act  of  1921,  also  provides  that 
"the  provisions  of  this  Act  shall  not  apply  to  oflfenses  committed  prior  to 
its  passage"  and  that  "any  prosecution  or  proceeding  under  an  indictment 
found  or  information  instituted  prior  to  the  passage  of  this  Act  shall  not 
be  affected  in  any  manner  by  this  amendment,  but  such  prosecution  or 
proceedings  shall  be  subject  to  the  limitations  imposed  by  law  prior  to  the 
passage  of  this  act". 

•"'■'^  R.  S.,  §  1047.  Unless  tax  liability  is  discovered  within  three  years 
from  the  time  the  returns  were  due  under  the  1909,  the  1913  and  the  1916 
Laws,  the  commissioner  has  no  authority  to  assess  the  100%  ad  valorem 
penalty  for  false  or  fraudulent  returns  in  the  absence  of  a  waiver  of  the 
rights  as  to  the  limitation  of  assessment  of  such  penalties.  (Sol.  Op.  60, 
T.  B.  36-20-1189;  0.  D.  530,  T.  B.  22-20-977.)     See  Chapter  35. 

™  Hatch  V.   Th:  Boston,  3  Fed.  807,  810. 

•1"  U.  S.  V.  Maillard,  26  Fed.  Cas.  No.  15,709. 

eiArnson  v.  Murphy,  109  U.  S.  238;  U.  S.  v.  Nashville  Rd.  Co.,  118  U. 
S.  125. 


PENALTIES    AND    COMPROMISES  907 

the  grounds  for  asserting  the  50'.  fi-aud  penalty  were  fully 
known  to  the  treasury  department,  the  penalty  may  still  be 
thereafter  assessed."- 

There  is  sufficient  valid  consideration  to  support  the  ac- 
ceptance of  an  offer  in  compromise  of  a  specific  penalty  made  by 
the  taxpayer,  even  though  the  action  thereon  is  barred  by  the 
statute  of  limitations.''-'  Oflers  in  compromise  rest  upon  the 
same  legal  principles  as  ordinary  contracts.''^  While  there  are 
cases  holding  that  the  acceptance  of  an  offer  relates  back  to  the 
date  of  the  offer,  the  general  rule  in  ordinary  cases  is  that  the 
date  of  a  contract  is  the  date  of  its  acceptance.'"'"'  Therefore,  if  a 
claim  of  the  government  for  penalties  is  without  any  foundation 
at  all,  either  in  law  or  in  equity,  there  is  not  sufficient  considera- 
tion for  compromise.  If,  on  the  other  hand,  the  government  does 
surrender  its  claim  and  the  claim  has  some  foundation,  either  in 
law  or  in  equity,  there  is  sufficient  consideration.  Since  the 
statute  of  limitations  relating  to  penalties  does  not  extinguish 
the  cause  of  action  but  merely  bars  the  remedy  of  the  government 
and  the  statute  of  limitations  is  not  a  question  of  jurisdiction 
but  of  personal  defense,  an  offer  in  compromise  may  legally  be 
accepted  after  the  expiration  of  the  period  of  limitation.''"  Con- 
sequently, when  an  offer  in  compromise  is  made  before  the  ex- 
piration of  the  period  and  is  not  withdrawn,  it  has  been  ruled 
that  the  failure  to  withdraw  can  be  considered  as  a  renewal  of 
the  offer  to  meet  changed  conditions  and  may  be  properly  and 
legally  accepted.'"'" 

Compromise  of  Taxes  and  Penalties.  The  Commissioner,  with 
the  advice  and  consent  of  the  Secretary,  may  compromise  any 
civil  or  criminal  case  arising  under  the  internal  revenue  laws 
instead  of  commencing  suit  thereon;  and,  with  the  advice  and 

•■••-Sol.  Op.  52,  T.  B.  36-20-1188.  The  rule  under  the  191(5  Law  was 
different.  Under  that  law  and  the  Revenue  Act  of  1917,  if  the  additional 
tax  had  been  assessed  but  not  paid,  or  paid  but  not  assessed,  .the  penalty 
might  be  as.serted;  but  if  it  had  been  both  assessed  and  paid,  the  pen- 
alty could  not  be  asserted.  Under  all  three  of  these  acts,  if  the  additional 
tax  has  been  assessed  or  paid,  or  assessed  and  paid  prior  to  discovery  of 
the  fraud,  the  penalty  may  be  assessed  at  any  time  after  the  discovery 
and  within  the  statutory  period  for  assessment  of  taxes. 

«:5Sol.  Op.  7,  T.  B.  25-20-1019. 

<■'!  Bouffhton  v.  U.  S.,  12  Ct.  CI.  330. 

<■•"'>  Williston  on  Contracts,  Vol.  1,  §§9(5-97. 

«<">See  Taylor  v.  Weeks,  129  Mich.  233,  88  N.  W.  4fi6;  Burriss  v.  Starr, 
165  N.  C.  657,  81  S.  E.  929;  Herrington  v.  Davitt.  220  N.  Y.  162,  115  N. 
E.  476,  1  A.  L.  R.  1700. 

«7Sol.   Op.   7,   T.   B.  25-20-1019. 


908  FEDERAL  INCOME   TAX 

consent  of  the  said  Secretary,  and  the  recommendation  of  the 
Attorney-general,  he  may  compromise  any  case  after  a  suit 
thereon  has  been  commenced.  Whenever  a  compromise  is  made 
in  any  case  the  opinion  of  the  solicitor  of  internal  revenue  or  of 
the  officer  acting  as  such,  with  his  reason  therefor,  with  a  state- 
ment of  the  amount  of  tax  assessed,  the  amount  of  additional 
tax  or  penalty  imposed  by  law  in  consequence  of  the  neglect  or 
delinquency  of  the  person  against  whom  the  tax  is  assessed,  and 
the  amount  actually  paid  in  accordance  with  the  terms  of  the 
compromise,  must  be  placed  on  file  in  the  office  of  the  Com- 
missioner. Accordingly,  the  power  to  compromise  extends  to 
(a)  both  civil  and  criminal  cases;  (b)  cases  whether  before 
or  after  suit;  and  (c)  both  taxes  and  penalties,  except  that 
taxes  legally  due  from  a  solvent  taxpayer  may  not  be  com- 
promised.*''^ Subject  to  the  limitation  that  he  must  act  with 
the  advice  and  consent  of  the  Secretary  (and  the  Attorney-gen- 
eral, if  suit  has  been  commenced) ,  the  Commissioner  has  power 
to  compromise  penalties  and  interest  claims  whenever,  in  his 
judgment,  such  a  compromise  is  for  the  interest  of  the  United 
States.  Congress  has  not  said  that  such  compromises  may  be 
made  only  when  in  the  judgment  of  the  Commissioner  more 
money  can  thereby  be  realized  than  can  be  realized  by  com- 
mencing and  prosecuting  a  suit.  It  cannot  be  said,  therefore, 
as  a  matter  of  law,  that  the  power  to  compromise  is  limited  to 
cases  in  which  either  the  liability  for  the  penalty  or  the  col- 
lectibility of  the  claim  is  doubtful.  The  judgment  of  the  Com- 
missioner as  to  what  is  for  the  interest  of  the  United  States 
is  conclusive,  and  what  considerations  shall  control  depend  upon 
his  discretion  and  sound  judgment  exercised  in  good  faith. 
It  may  be  that  with  respect  to  the  amount  of  tax  to  be  collected 
or  the  amount  of  penalty  resulting  from  wilful  fraud,  the  Com- 
missioner may  never  find  a  case  in  which  he  will  feel  justified 
in  accepting  less  than  can  be  legally  collected,  whereas  in  cases 
of  penalties  resulting  from  accident,  negligence,  or  technical 
omission  he  may  honestly  believe  that  the  interest  of  the  United 
States  will  be  best  served  by  accepting  less  than  the  full  penalty. 
He  has  the  right  to  compromise  upon  any  ground  which  in 
his  judgement  renders  the  compromise  for  the  interest  of  the 
United  States.'-'*  The  Commissioner  has  under  this  section  no 
power   to   compromise   a   suit   against   the    government,""   the 

G8R.    S.   §§3229,   3469;    Reg.   45,   Art.    1011;    S.    1371,    T.   B.   24-20-1006; 
0.  D.  799,  T.  B.  6-21-1438. 

C9  Op.  Atty.  Gen.,  June  3,  1919;  I.  T.  S.  1921,  112149. 
w  23  Op.  Atty.  Gen.  507. 


PENALTIES    AND    COMPROMISES  909 

power  being  limited  to  suits  which  the  government  may  prose- 
cute. A  compromise  operates  for  the  protection  of  the  offender 
against  subsequent  proceedings  as  fully  as  a  formal  conviction 
or  acquittal,  and  is  a  bar  to  further  action."'  Where  an  action 
is  brought  by  the  United  States  against  a  delinquent  taxpayer 
for  having  failed  to  file  a  return,  the  verdict  must  specifically 
state  the  amount  of  the  penalty,  after  which  the  only  remedy  of 
the  defendant  (other  than  an  appeal)  is  to  apply  for  a  compro- 
mise."-' Offers  in  compromise  should  include  payments  of  costs. '•' 
The  amount  of  the  otter  should  be  deposited  with  the  Commis- 
sioner, but  cannot  be  held  or  set  off  against  the  tax  due."^  Re- 
funds cannot  be  made  of  offers  in  compromise  where  it  is  sub- 
sequently ascertained  that  no  violation  of  law  was  involved.""' 

Specific  Penalties.  While  the  sections  of  the  revised  stat- 
utes relating  to  compromise '"'  do  not  in  express  language  refer 
to  the  compromise  of  the  specific  penalty  for  failure  to  file  the 
return,  neither  are  they  restricted  in  terms,  nor  by  any  reason 
of  public  policy,  to  penalties  for  the  nonpayment  of  taxes.  In 
the  opinion  of  the  Attorney-general  the  application  of  the.se 
sections  to  the  compromise  of  penalties  for  failure  to  file  returns 
in  time  is  proper,  and,  further,  in  such  compromises  the  Com- 
missioner is  authorized  to  consider  not  only  the  pecuniary  in- 
terests of  the  treasury,  but  also  ereneral  considerations  of  jus- 
tice, equity  and  public  policy." 

Ad  Valorem  Penalties.  Congress  has  left  it  to  the  judgment 
and  discretion  of  the  Commissioner  to  determine  when  it  is  to 
the  interest  of  the  United  States  to  compromise  the  ad  valorem 
penalties  imposed  for  failure  to  file  returns,  for  false  and  fraud- 
ulent returns,  for  nonpayment  of  taxes  when  due,  and  interest, 
instead  of  commencing  or  prosecuting  suits  therefor.  The  only 
limitation  placed  upon  the  exercise  of  this  judgment  and  dis- 
cretion is  that  the  Commissioner's  action  shall  be  with  the  advice 
and  consent  of  the  Secretary  (and  Attorney-general  if  suit  has 
been  commenced).  Subject  to  this  limitation  the  Commissioner 
has  power  to  compromise  such  penalties  and  interest,  whenever, 
in  his  judgment,  such  a  compromise  is  for  the  interest  of  the 

71  U.  S.  V.  Chouteau,  102  U.  S.  603;   Rau  v.  U.  S.,  260  Fed.  131. 

72  U.  S.  V.  Acorn  Roofing  Co.,  204  Fed.  157. 

73  0.  907,  T.  B.  18-19-489;  T.  D.  642,  March  20,  1903. 

74  Bouphton  V.  U.  S.,  12  Ct.  Cls.  330. 
7r.  Reg.  45,  Art.  1011. 

7<iR.  S.,  §§3229,  3469. 
77  29  Op.  Atty.  Gen.  217. 


910  FEDERAL   INCOME   TAX 

United  States. ^'^  Where  a  liability  to  an  ad  valor'em  fraud 
penalty  exists,  it  may  at  any  stage  be  compromised  by  the  Com- 
missioner and  the  approving  officials,  whether  or  not  it  has 
been  formally  assessed J*^ 

Offers  in  Compromise.  Under  the  1918  Law,  when  returns 
of  income  or  returns  of  information  at  the  source '  were  filed 
after  their  due  dates,  the  specific  penalty  was  asserted  unless 
it  could  be  shown  that  the  delay  was  due  to  a  reasonable  cause, 
and  offers  in  compromise  were  accepted  in  minimum  amounts 
as  follows:  (1)  Delinquent  returns  of  income  and  information 
by  individuals,  $5;  and  (2)  delinquent  returns  of  income  by 
corporations,  $10.  Such  offers  were  received  where  the  neglect 
of  the  taxpayer  was  not  intentional.'^'*  Offers  in  compromise  do 
not  receive  favorable  consideration  in  cases  where  returns  for 
the  year  in  question  have  not  been  filed,  but  such  offers  are 
accepted  "subject  to  the  filing  of  the  return. "■'^^  All  delinquents 
who  do  not  compromise  their  liabilities  to  the  specific  penalty, 
after  ample  opportunity,  are  reported  to  the  United  States  dis- 
trict attorney  for  proceedings.*^-  It  is  the  duty  of  every  district 
attorney  to  prosecute  every  case  for  the  collection  of  a  fine, 
penalty  or  forfeiture  reported  to  him  by  any  collector,  unless, 
upon  inquiry  and  examination,  he  decides  that  such  proceed- 

78  Op.  Atty.  Gen.  dated  June  3,  1919;  I.  T.  S.  1921,  112149.  See  T.  D. 
2871;  0.  D.  539,  T.  B.  23-20-990.  A  penalty  (50%)  corresponding  to  the 
penalty  of  25%  increase  in  tax  for  failure  to  file  returns  is  found  in  prac- 
tically all  revenue  laws  relating  to  special  taxes,  and  one  construction  has 
been  that  no  administrative  officer  is  clothed  with  authority  to  compromise 
such  increase  in  tax.  (T.  D.  1701.)  It  has  been  held  that  the  income  tax 
law  is  explicit  and  mandatory  in  its  provisions  relative  to  the  additional 
assessment  of  25%  of  the  tax  otherwise  due,  in  case  of  failure  to  file  a 
return  of  income  within  the  prescribed  time  except  when  a  return  is  filed 
after  such  time  and  it  is  shown  that  the  failure  was  due  to  reasonable 
cause  and  not  to  wilful  neglect,  does  not  give  discretionary  authority  for 
remission  of  these  additional  taxes  to  any  officer  of  the  government.  Con- 
gress passed  an  act  providing  particularly  for  the  refund  of  such  ad- 
ditional taxes,  assessed  under  the  1909  Law,  for  neglect  to  file  returns, 
but  no  such  statute  has  been  passed  with  respect  to  penalties  incurred 
under  the  1913,  1916,  1918  or  1921   Laws.      (Act  of  March  3,  1913.) 

79  L.  O.  1072,  T.  B.  41-21-1864. 

80  Mimeograph  Letter  to  Collectors,  No.  2077,  dated  March  13,  1919. 
Cards,  Form  7245A,  prepared  in  the  manner  indicated  in  M.  1480,  dated 
February  26,  1917,  should  accompany  every  original  delinquent  return  filed 
after  the  last  dates  for  filing  returns  before  the  specific  penalty  will  be 
asserted.  (See  also  mimeograph  letter  to  collectors,  No.  1480,  dated 
February  26,  1917;  T.  D.  2311;  T.  D.  2349.) 

81  T.  D.  2311. 

82  T.  D.  2311. 


PENALTIES    AND    COMPROMISES  911 

ings  cannot  properly  be  sustained,  or  that  the  needs  of  public 
justice  do  not  require  that  such  proceedings  be  instituted;  in 
which  case  he  reports  the  facts  to  the  Commissioner  for  his 
direction.^'-  Under  the  1864  Law  as  amended  in  1870  only  one 
penalty  was  permitted  to  be  recovered  for  all  failures  to  make 
a  return  prior  to  the  commencement  of  the  action  for  the  col- 
lection of  a  penalty."^'  Where  an  offer  in  compromise  is  ac- 
cepted by  the  government,  but  no  release  is  tendered  by  the  gov- 
ernment before  the  death  of  the  taxpayer,  his  estate  is  not 
bound  by  the  contract  of  compromise.^'' 

Duty  of  Collector  Regarding  Violations  of  the  Law.  It  is  the 
duty  of  every  collector  of  internal  revenue  having  knowledge 
of  any  wilful  violation  of  any  law  of  the  United  States  relating 
to  the  revenue,  within  thirty  days  after  coming  into  possession 
of  such  knowledge,  to  file  with  the  district  attorney  of  the  district 
in  which  any  fine,  penalty  or  forfeiture  may  be  incurred,  a 
statement  of  all  the  facts  and  circumstances  of  the  case  within 
his  knowledge,  together  with  the  names  of  the  witnesses,  set- 
ting forth  the  provisions  of  law  believed  to  be  so  violated  on 
which  reliance  may  be  had  for  condemnation  or  conviction.'''^ 

S-s  R.  S.,  §  838. 

8-*U.  S.  V.  Brooklyn  etc.  Ry.  Co.,  14  Fed.  284;  U.  S.  v.  N.  Y.  Guaranty 
Co.,  8  Ben.  269. 

«•'»  U.  S.  V.  Richardson,  9  Fed.  804. 

•':•■'  R.  S.,  §  3164,  as  amended  by  Revenue  Act  of  1918  and  re-enacted  as 
amended  by  §  1311   of  the  Revenue  Act  of  1921. 


CHAPTER  37 

ABATEMENT,  CREDIT,  REFUND  AND  RECOVERY  OF  TAXES 

The  prompt  collection  of  the  revenue  and  its  faithful  applica- 
tion is  one  of  the  most  vital  duties  of  government.  Depending, 
as  the  government  does,  upon  its  revenue  to  meet  not  only  its 
current  expenses,  but  to  pay  the  interest  on  its  debt,  it  is  of  the 
utmost  importance  that  it  should  be  collected  with  dispatch,  and 
that  the  officers  of  the  treasury  should  be  able  to  make  a  reliable 
estimate  of  means  in  order  to  meet  liabilities.  It  would  be  diffi- 
cult to  do  this,  if  the  receipts  paid  into  the  treasury  were  liable  to 
be  taken  out  of  it,  on  suits  for  alleged  errors  and  mistakes,  con- 
cerning which  the  officers  charged  with  the  collection  and  dis- 
bursement of  the  revenue  had  received  no  information.  To  guard 
against  such  consequences,  Congress  has  from  time  to  time 
passed  laws  on  the  subject  of  the  revenue,  which  not  only  pro- 
vide for  the  manner  of  its  collection,  but  also  point  out  a  way  in 
which  errors  can  be  corrected.  These  laws  constitute  a  system 
which  Congress  has  provided  for  the  benefit  of  those  persons 
who  complain  of  illegal  assessments  of  taxes  and  illegal  exactions 
of  duties.  The  party  aggrieved  can  test  the  question  of  the 
illegality  of  an  assessment  or  collection  of  taxes  by  suit ;  but  he 
can  not  do  this  until  he  has  taken  an  appeal  to  the  Commissioner. 
In  other  words,  the  person  who  believes  he  has  suffered  wrong  at 
the  hands  of  the  collector  can  appeal  to  the  courts ;  but  he  can  not 
do  this  until  he  has  taken  an  intermediate  appeal  to  the  Com- 
missioner, and,  in  any  event,  he  is  barred  from  bringing  a  suit, 
unless  he  does  it  within  the  period  limited  by  law.  The  object 
of  these  different  provisions  is  apparent.  While  the  govern- 
ment is  desirous  of  securing  to  the  citizen  a  mode  of  redress 
against  erroneous  assessments  or  collections,  it  says  to  him: 
"We  want  all  controverted  questions  concerning  the  revenue  set- 
tled speedily,  and  if  you  have  complaint  to  make,  you  must  let 
the  Commissioner  know  the  grounds  of  it;  but  if  he  decides 
against  you,  or  fails  to  decide  at  all,  you  can  test  the  question  in 
the  courts  if  you  bring  your  suit  within  a  limited  period  of 
time."i    The  Commissioner,  subject  to  regulations  prescribed  by 

1  U.  S.  V.  Savings  Bank,  104  U.  S.  728.  See  also  Nichols  v.  U.  S.,  7  Wall. 
122,  modified  in  regard  to  its  holding  that  cases  under  the  revenue  laws 
were  not  within  the  jurisdiction  of  the  court  of  claims  in  U.  S.  v.  Kaufman, 
96  U.  S.  567  and  U.  S.  v.  Savings  Bank,  104  U.  S.  728. 

912 


ABATEMENT.   REFUND   AND   RECOVERY   OK  TAXES  913 

the  secretary,  is  authorized  to  remit,  refund,  and  pay  back  all 
taxes  erroneously  or  illegally  assessed,  or  collected,  all  penalties 
collected  without  authority,  and  all  taxes  that  appear  to  be  un- 
justly assessed  or  excessive  in  amount,  or  in  any  manner  wrong- 
fully collected.-    The  Revenue  Act  of  1918  contained  a  new  pro- 
vision authorizing  the  crediting  against  any  income,  war-profits 
or  excess-profits  taxes  due,  or  any  installment  thereof,  of  any 
amount  of  income,  war-profits  or  excess-profits  taxes   paid   in 
excess  of  that  due  under  the  Act  of  August  5,  1909,  the  Act  of 
October  3,  1913,  the  Revenue  Act  of  1916,  as  amended,  or  the 
Revenue  Act  of  1917.     It  also  authorized  the  immediate  refund- 
ing of  any  balance  of  such  excess  payment.-'     This  provision  is 
amended  by  the  Revenue  Act  of  1921,  as  indicated  below  in  this 
chapter.     The  principal  changes  made  by  the  Revenue  Act  of 
1921  discussed  in  this  chapter  bear  upon  the  statutes  of  limita- 
tion upon  the  recovery  of  taxes  and  penalties  from  the  Commis- 
sioner or  in  the  courts,  and  the  provision  allowing  interest  to  the 
taxpayer  in  certain  cases. 

Who  May  Claim  Recovery  of  Tax.  As  a  general  rule,  the  tax- 
payer against  whom  the  tax  is  assessed  and  by  whom  the  tax  is 
paid  is  the  one  who  is  entitled  to  claim  abatement  or  refund  or 
sue  for  its  recovery.  If  the  person  against  whom  the  tax  is  as- 
sessed is  dead,  the  claim  should  be  made  in  the  name  of  the  ex- 
ecutor or  administrator.^  In  cases  where  the  tax  has  been  with- 
held at  the  source  the  claim  for  abatement  or  refund  may  be 
made  either  by  the  withholding  agent  against  whom  the  assess- 
ment was  made  or  by  the  person  for  whose  account  such  taxes 
were  withheld."'  Where  one  corporation  had  leased  all  of  its  prop- 
erty to  another,  a  tax  being  thereafter  assessed  upon  the  lessor, 
and  its  claim  for  an  abatement  being  rejected,  the  tax  was  paid 

2  R.  S.,  §  3220,  as  amended  by  the  Revenue  Act  of  1918  by  striking  out  the 
words  "on  appeal  made  to  him  (commissioner  of  internal  revenue)." 

3  Revenue  Act  of  1918,  §  252. 

4  Reg  33  Rev.,  Art.  266.  Certified  copies  of  the  letters  of  admmistration. 
letters  testamentary  or  other  similar  evidence  should  be  annexed  to  the  claim 

in  such  cases.  ,,^,r.  •   ^        * 

5  Reg  33  Art.  33.  If  an  individual  who  received  during  101  <  interest  on 
bonds  containing  a  tax-free  covenant  clause  was  not  liable  to  the  payment 
of  normal  income  tax  for  that  year,  the  amount  of  tax  paid  at  the  source 
in  his  behalf  by  the  debtor  corporation  is  refundable  to  the  debtor  corpora- 
tion if  such  tax  was  not  actually  withheld  from  the  individual  bondholder. 
The'amount  of  any  income  or  excess-profits  taxes,  or  any  installment  thereof, 
shown  to  be  due  on  the  debtor  corporation's  income  and  profits  tax  return 
may  be  credited  with  the  amount  of  the  excess  tax  in  question  paid  at  the 
source.     (O.  D.  1103.  T.  B.  46-21-1924.) 


914  FEDERAL  INCOME  TAX 

by  the  lessee  to  avoid  the  penalty  threatened  by  the  collector  and 
to  avoid  distraint  and  sale  of  the  leased  property.  The  court  held 
that  the  payment  by  the  lessee  was  not  voluntary  and  that  it  was 
entitled  to  sue  for  its  recovery  without  regard  to  privity  of  con- 
tract between  it  and  the  collector."  In  view  of  the  fact  that  the 
statutes  of  New  Jersey  under  which  a  merger  or  consolidation 
of  corporations  resulting  in  the  formation  of  another  corpora- 
tion is  accomplished  provide,  in  effect,  that  the  successor  cor- 
poration shall  represent  predecessor  corporations  in  the  enforce- 
ment of  their  rights,  it  is  held  that  the  successor  corporation  is 
entitled  to  file  claim  for  credit  on  account  of  the  overpayment  of 
tax  by  the  predecessor  corporation."  A  taxpayer,  the  sole  pro- 
prietor of  several  enterprises,  who  in  1917  filed  in  error  partner- 
ship returns  and  paid  the  taxes  due  thereon  in  addition  to  taxes 
under  his  individual  return,  may  apply  the  erroneous  payment  of 
taxes  due  on  account  of  the  returns  of  these  nonexistent  partner- 
ships as  a  credit  against  taxes  due  on  his  amended  individual  re- 
turns for  1917  and  subsequent  years."^ 

Abatement.  A  claim  in  abatement  is  applicable  to  taxes  which 
have  been  assessed  but  not  yet  paid.  The  Commissioner  obtains 
jurisdiction  to  pass  upon  a  claim  and  the  merits  of  a  case  come 
before  him  only  when  a  proper  claim  has  been  made.  Under  a 
claim  for  abatement  he  can  only  determine  whether  or  not  the 
assessment  should  be  abated.  Any  further  action  would  be  in 
violation  of  the  regulations  and  beyond  his  jurisdiction."  The 
Commissioner  possesses  no  equity  powers  in  case  of  abatement; 
if  the  tax  is  a  legal  one  he  can  not  abate  it.^"  It  seems  that  the 
Commissioner  has  no  authority  to  revoke  the  abatement  of  a  tax 
once  made  by  him,  but  he  may  re-assess  the  tax."  The  five- 
year  statutory  period  of  limitations  does  not  apply  to  claims  for 
abatement. ^- 

Effect  of  Rejection  of  Claim  for  Abatement.  It  is  now 
settled  by  the  Supreme  Court  that  the  rejection  of  a  claim  in 
abatement  does  not  dispense  with  the  necessity  of  a  claim  for  re- 
fund as  a  prerequisite  to  recovery  in  the  courts,  even  though  it 

6  Cambria  Steel  Co.  v.  McCoach,  225  Fed.  278. 

7  0.  D.  950,  T.  B.  24-21-1690. 
s  O.  D.  962,  T.  B.  26-21-1710. 

9  Rock  Island  etc.,  Rd.  Co.  v.  U.  S.,  254  U.  S.  141;  Hastings  v.  Herold, 
184  Fed.  759. 

10  Decision  No.  180,  36  Int.  Rev.  Rec.  13. 

11  U.  S.  V.  Alexander,  110  U.  S.  325. 

12  O.  833.  T.  B.  4-19-235. 


ABATEMENT.  REFUND  AND  RECOVERY  OF  TAXES     015 

may  seem  a  useless  form  to  appeal  to  the  Commissioner  for  a 
second  time.^-' 

PROCEDURE  FOR  CLAIMING  ABATEMENT.    Claim  for  abatement 
of  taxes  or  penalties  erroneously  or  illegally  assessed,  or  which 
are  abatable  under  remedial  acts,  must  be  made  out  on  the  form 
prescribed  by  the  government"  and  must  be  sustained  by  the 
affidavits  of  the  parties  against  whom  the  taxes  were  assessed, 
or  of  other  parties  cognizant  of  the  facts.i"-    The  practice  is  to 
obtain  the  official  form  from  the  local  collector,  prepare  it  accord- 
ing to  instructions  and  file  it  with  the  local  collector.    The  claim 
for  abatement  can  only  be  made  between  the  time  the  tax  is  as- 
sessed and  the  date  it  is  due.     If  the  claim  has  not  been  acted 
upon  within  ten  days  after  notice  and  demand  for  the  tax.  5'; 
penalty  for  failure  to  pay  the  tax  will  not  accrue  if  the  tax  is 
paid  within  ten  days  after  the  claim  for  abatement  is  rejected, 
and  interest  from  the  time  the  amount  was  due  until  the  claim 
is  decided  will  be  at  the  rate  of  1/2'.   per  month  instead  of  I'i. 
The  rule  waiving  penalty  and  reducing  interest  obtains  only  as 
to  any  amount  of  tax  which  is  the  subject  of  a  houa  fide  claim 
for  abatement.!'-    When  a  tax  has  been  assessed  and  turned  over 
to  the  collector,  the  presumption  is  that  the  assessment  is  cor- 
rect.    The  burden  of  proof  in  rebutting  the  presumption  and 
showing  that  it  was  improperly  or  illegally  assessed,   or  that 
relief  should  be  given  under  a  remedial  statute,  rests  upon  the 
applicant  for  abatement.    The  affidavits  must  therefore  contain 
full  and  explicit  statements  of  all  the  material  facts  relating  to 
the  claim  in  support  of  which  they  are  offered  and  to  the  proper 
consideration  of  which  they  are  essential.    The  filing  of  a  claim 
for  abatement  does  not  necessarily  operate  as  a  suspension  of  the 
collection  of  the  tax  or  make  it  any  less  the  duty  of  the  collector 
to  exercise  due  diligence  to  prevent  the  collection  of  the  tax  being 
jeopardized.     Under  the  Revised   Statutes''   every   collector   is 

13  Rock  Island  etc.,  R.l.  Co.  v.  U.  S.,  254  U.  S.  141,  affirming;  the  doctnne 
of  Hastin^rs  v.  HeruUi,  184  Fed.  759,  and  overruling:  Loomis  v.  Wattles, 
266  Fed  876;  Weaver  v.  Ewers,  195  Fed.  247;  Grier  v.  Tucker,  150  Fed.  b58; 
Schwarzchild  &  Sulzberger  Co.  v.  Rucker.  143  Fed.  656;  De  BY^^""-^^"""^' 
162  Fed  961;  San  Francisco  Society  v.  Cary.  2  Sawy.  393.  and  T.  U.  1-9^. 
T  D  974  In  the  Rock  Island  case  the  court  made  the  interestinp:  remark 
that  '"men  must  turn  square  corners  when  they  deal  with  the  jrovernment". 

14  The  form  prescribed  by  the  government  is  known  as  Form  47. 
l-'Reff.  45,  Art.  1032.     ReR.  No.  14  Rev.  October  15,  1911,  as  modified  by 

'I'iRfvenue  Act  of  1921,  §  250  (e)  ;  Revenue  Act  of  1918.  §  250  (e). 
HR.  S.,  §3218. 


916  FEDERAL   INCOME   TAX 

charged  with  the  whole  amount  of  taxes,  whether  contained  in 
lists  transmitted  to  him  by  the  Commissioner  or  by  other  col- 
lectors, or  delivered  to  him  by  his  predecessor  in  office,  and  he  is 
credited  only  with  all  payments  into  the  treasury  made  as  pro- 
vided by  law,  and  with  the  amount  of  taxes  contained  in  the 
lists  transmitted  by  him  to  other  collectors  and  by  them  re- 
ceipted for,  and  also  with  the  amount  of  taxes  of  such  persons 
as  may  have  absconded  or  become  insolvent  prior  to  the  day 
when  the  tax  ought  to  have  been  collected,  and  with  all  uncol- 
lected taxes  transferred  by  him  to  his  successor  in  office,  and 
this  is  conditioned  upon  proof,  to  the  satisfaction  of  the  Com- 
missioner, that  due  diligence  was  used  by  him  in  his  endeavor  to 
collect  the  tax.  There  is  no  provision  of  law  or  of  the  regulations 
for  crediting  a  collector  with  any  amount  of  tax  which  he  might 
be  unable  to  collect  by  reason  of  a  decrease  in  the  assets  of  a 
taxpayer  subsequent  to  the  transmission  of  the  list  to  him,  and 
in  no  case  is  he  relieved  of  liability  for  the  amount  of  the  tax  in 
the  absence  of  due  diligence  in  endeavoring  to  collect  it.  While 
there  is  no  provision  of  law  expressly  authorizing  the  collector 
to  require  a  bond  as  a  condition  of  suspending  the  collection  of 
the  tax,  he  is  personally  charged  with  the  amount  of  the  assess- 
ments made  against  taxpayers  in  his  district  and  he  is  required 
to  use  due  diligence  in  collecting  such  taxes.  If  he  fails  to  exercise 
due  diligence,  it  is  clear  that  he  becomes  personally  liable  for  any 
tax  which  may  be  lost  through  such  failure.  He  may  require  the 
tax  to  be  paid  and  leave  the  taxpayer  to  his  remedy  by  a  claim 
for  credit  or  refund,  and  if  he  sees  fit  to  suspend  the  collection 
of  the  tax  in  any  case  where  a  final  collection  may  thus  be 
jeopardized,  he  does  it  at  his  own  risk.  It  is  within  his  discre- 
tion to  protect  himself  by  requiring  the  taxpayer  to  execute  a 
bond  in  the  amount  of  the  tax  collection  of  which  is  postponed.i*^ 
Where  property  of  a  corporation  is  in  the  hands  of  a  receiver 
who  files  a  claim  for  abatement  of  an  additional  assessment  of 
income  and  profits  taxes  for  1917,  no  bond  will  be  required  as 
security  for  the  payment  of  such  taxes.^^  A  claim  for  abatement 
of  an  apparently  excessive  tax  assessed  on  the  basis  of  a  tenta- 
tive return  filed  under  the  Revenue  Act  of  1918  would  not  be  con- 
sidered prior  to  the  filing  of  a  completed  return.^" 

18  0.  957,  T.  B.  31-19-652;  Reg.  45,  Art.  1032;  A.  R.  R.  331,  T.  B.  48-20- 
1328. 

19  O.  D.  733,  T.  B.  47-20-1316. 

20  O.  D.  634,  T.  B.  33-20-1139. 


ABATEMENT.   REFUND   AND   RECOVERY    OF  TAXES  017 

PAYMENT  WHERE  CLAIM    FOR  ABATEMENT   DENIED.      Where  a 

bona  fide  claim  for  abatement  or  a  claim  for  credit  is  rejected, 
the  tax  which  is  the  subject  of  the  claim  is  chargeable  with  inter- 
est at  the  rate  of  one-half  of  1 '  -  per  month  from  the  time  the  tax 
was  due  until  the  claim  is  decided  adversely  to  the  taxpayer; 
notice  of  the  adverse  decision  is  sent  to  the  collector  who  must 
send  to  the  claimant  a  notice  and  demiind  for  payment  of  the  as- 
sessment;  if  the  tax  is  paid  within  the  10-day  period  following 
the  sending  of  the  notice,  the  5'.    penalty  is  not  collectible,  and 
the  only  interest  collectible  is  that  at  the  rate  of  one-half  of  1'. 
per  month  from  the  time  the  tax  was  due  until  the  date  of  the 
Commissioner's  decision;  if  the  tax  is  not  paid  within  the  10-day 
period,  the  5'.'  penalty  attaches  in  addition  to  the  above  interest 
and  also  interest  at  the  rate  of  l'<   per  month  from  the  date  of 
the  adverse  decision  by  the  Commissioner  to  the  date  of  pay- 
ment.-^ 

Effect  of  New  Provision  for  Appeal  from  Additional  Assess- 
ments.   Although  retaining  the  provisions  indicated  in  the  fore- 
going paragraphs  that  as  to  any  amount  which  is  the  subject  of  a 
bona  fide  claim  for  abatement  interest  shall  be  limited  to  one- 
half  of  l'<  ,  the  Revenue  Act  of  1921  contains  a  new  provision 
for  notification  of  the  taxpayer  and  an  appeal  with  hearing  in 
regard  to  additional  taxes  proposed  to  be  assessed  by  the  Com- 
missioner --    Where  the  taxpayer  has  had  the  benefit  of  this  pro- 
vision no  abatement  claim  will  be  entertained.--    The  law.  there- 
fore   limits  the  rule  that  interest  upon  a  bona  fide  abatement 
claim   shall  be  at  the   rate  of  one-half    of    1'.     to    cases    in 
which    the    taxpayer    has  not    had    the  benefit    of    an    appeal 
and  hearing.-^    Such  provision  limiting  the  interest  in  the  case  ot 
bona  fide  abatement  claims  will  still  apply,  however   in  cases  m 
which  the  benefit  of  an  appeal  and  hearing  is  withheld  because 
the  collection  of  the  tax  will  be  jeopardized  by  delay,  and  alst)  to 
cases  in  which  the  taxpayer  discovers  that  he  has  returned  an 
excessive  tax  but  has  not  yet  paid  the  whole  thereot.  and  files  a 
claim  for  abatement  against  subsequent   installments  covering 
such  excess.     The  practice  upon  the  appeal  from  an  additional 
assessment  under  the  new  provision  of  the  1921  Law  above  indi- 
cated must  be  determined  by  regulations.  It  does  not  seem  neces- 

21  Sol.  Op.  32,  T.  B.  31-20-1106. 

22  This  provision  is  discussed  in  Chapter  35. 

23  Revenue  Act  of  1921,  §250  (d). 

24  Revenue  Act  of  1921,  §  250  (e). 


918  FEDERAL   INCOME   TAX 

sary  to  require  the  filing  of  abatement  claims,  since  the  assess- 
ment itself  is  withheld  until  the  determination  of  the  hearing  and 
appeal. 

Credit  and  Refund.  Prior  to  the  passage  of  the  Revenue  Act 
of  1918,  the  fact  that  the  taxpayer  has  overpaid  his  taxes  for  a 
previous  year  could  have  no  effect  upon  the  amount  of  tax  for 
which  he  is  liable  for  a  different  year.  Consequently,  when  such 
conditions  existed  the  only  course  which  the  government  could 
pursue  was  to  collect  the  present  amount  in  full  and  permit  the 
taxpayer  to  file  a  claim  for  refund  of  any  amount  overpaid.  Con- 
gress, recognizing  the  injustice  and  hardship  frequently  involved 
in  such  an  awkward  procedure,  provided  for  crediting  the  amount 
of  any  overpayment  against  taxes  presently  due.--^ 

The  Commissioner  is  authorized  to  allow  credits  and  refunds 
by  virtue  of  the  following  provision :-'' 

"That  if  upon  examination  of  any  return  of  income  made  pur- 
suant to  this  Act,  the  Act  of  August  5,  1909,  entitled  'An  Act  to 
provide  revenue,  equalize  duties,  and  encourage  the  industries  of 
the  United  States,  and  for  other  purposes,'  the  Act  of  October  3, 
1913,  entitled  'An  Act  to  reduce  tariff  duties  and  to  provide 
revenue  for  the  government,  and  for  other  purposes,'  the  Revenue 
Act  of  1916,  as  amended,  or  the  Revenue  Act  of  1917,  it  appears 
that  an  amount  of  income,  war-profits,  or  excess-profits  tax  has 
been  paid  in  excess  of  that  properly  due,  then,  notwithstanding 
the  provisions  of  section  3228  of  the  Revised  Statutes,  the 
amount  of  the  excess  shall  be  credited  against  any  income,  war- 
profits,  or  excess-profits  taxes,  or  installment  thereof,  then  due 
from  the  taxpayer  under  any  other  return,  and  any  balance  of 
such  excess  shall  be  immediately  refunded  to  the  taxpayer." 

This  provision  is  supplemental  to  certain  provisions  of  the 
Revised  Statutes^^  indicating  the  policy  of  Congress  regarding 
refunds.  Under  the  provision  just  quoted  the  amount  of  tax 
erroneously   collected   on   an   income   return   under   the   Act   of 

25  A.  R.  M.  46,  T.  B.  19-20-924. 

26  Revenue  Act  of  1921,  §252;  Revenue  Act  of  1918,  §252.  Under  this 
provision  munitions  tax  overpayments  for  one  year  may  not  be  credited 
against  an  additional  assessment  of  munitions  taxes  for  a  subsequent  or 
prior  year,  or  against  additional  assessments  of  income,  excess-profits  and 
war-profits  taxes  for  the  same  or  for  any  subsequent  or  prior  taxable  year 
(A.  R.  M.  123,  T.  B.  18-21-1613).  The  tax  imposed  on  undistriMited  net 
Income  of  corporations  by  the  Revenue  Act  of  September  8,  1916,  as 
amended,  is  held  to  be  an  income  tax,  and  may  be  credited  against  an  ad- 
ditional amount  of  income  due  from  the  taxpayer  (O.  974,  T.  B.  1-20-662). 

27  R.  S.,  §3220,  as  amended  by  §1315  of  the  Revenue  Act  of  1921; 
3221;  3228,  as  amended  by  §  1316  of  the  Revenue  Act  of  1921. 


ABATEMENT.   REFUND   AND   RECOVERY   OF  TAXES  919 

August  5,  1909,  the  Act  of  October  3,  1913,  the  Revenue  Act  of 
1916,  the  Revenue  Act  of  1916,  as  amended  by  the  Revenue  Act 
of  1917,  or  the  Revenue  Act  of  1918  may,  at  any  time  within 
five  years  from  the  time  the  return  was  due,  be  credited  against 
the  tax  due  on  any  other  income  return  under  those  Acts  whether 
or  not  the  taxpayer  makes  a  claim  for  the  credit,  and  the  balance 
of  the  excessive  amount  so  erroneously  collected  over  and  above 
the  amount  so  credited  may  be  refunded,  whether  or  not  a  claim 
for  the  same  is  made.-"^ 

An  assessment  made  upon  an  erroneous  theory  or  by  mistake 
will  not  be  remitted  or  abated  because  so  made,  if,  at  the  time 
its  validity  is  passed  on  the  Commissioner  is  in  the  possession 
of  evidence  which  shows  an  equivalent  amount  of  tax  due  in  con- 
nection with  the  income,  transaction  or  matter  upon  which  the 
assessment  is  predicated.-"' 

Review  of  Commissioner's  Decision.  Where  the  Com- 
missioner, in  a  case  within  the  scope  of  his  authority  and  juris- 
diction, has  ordered  an  abatement,  credit  or  refund,  a  court  can 
not  inquire  as  to  the  sufficiency  of  the  evidence  before  him,'"' 
and  neither  the  comptroller  of  the  treasury  nor  any  accounting 
officer  has  authority  to  review  the  Commissioner's  decision. •'■' 
Decisions  by  the  Commissioner,  in  cases  where  a  refund  is  di- 
rected, are  binding  and,  in  the  absence  of  fraud,  or  mistake  of 
calculation,  not  subject  to  revision.-'-  The  Commissioner's  de- 
cision is  conclusive  as  to  the  questions  of  fact.""  His  decisions 
are  in  the  nature  of  awards  made  by  arbitrators,  and  generally 
speaking  bind  both  the  claimant  and  the  government.  Prior  to 
the  enactment  of  the  provision  of  the  present  law  discussed  be- 
low, refund  might  be  impeached  for  fraud,  want  of  jurisdiction, 
mistake  apparent  in  the  certificate,  or  for  such  irregularities  as 
would  avoid  an  award.-'*  The  Commissioner  might  recon- 
sider and  revoke  an  allowance  for  refund  at  any  time  before  the 
allowance  was  paid,  but  whether  a  Commissioner  might  revoke 
an  allowance  made  by  his  predecessor  was  not  clear.--"'     Where 

->^  Sol.  Op.  79,  T.  B.  49-20-1337. 

2!»T.  D.  3251,  T.  B.  49-21-1967. 

"'>  W^oolner  v.  U.  S.,  13  Ct.  Cls.  355. 

;!1  Bank  of  Greencastle  v.  U.  S.,  15  Ct.  Cls.  225.  In  Sybrantit  v.  U.  S.,  19 
Ct.  Cls.  4(51,  it  was  held  that  even  three  adverse  decisions  of  successive  secre- 
taries would  not  prevent  a  Commissioner  from  taking  up  and  allowing  a 
claim  for  the  refund  of  taxes. 

■■''■^  Dugan  v.  U.  S.,  34  Ct.  Cls.  458. 

:?-i  U.  S.  V.  Wright,  11  Wall.  648. 

34  Dugan  V.  U.  S.,  34  Ct.  Cls.  458;  Gumming  v.  U.  S.,  22  Ct.  Cls.  344. 

»'•  Ridgway  v.  U.  S.,  18  Ct.  Cls.  707. 


920  FEDERAL  INCOME   TAX 

one  Commissioner  recommended  the  allowance  of  the  claim  and 
referred  the  matter  to  the  secretary  for  advisement,  a  succeeding 
Commissioner  to  whom  the  matter  was  referred  back  could  re- 
ject the  claim.3'*  The  Commissioner  was  not  precluded  from 
allowing-  a  claim  for  refund  because  a  former  Commissioner  had 
rejected  a  claim  for  abatement,  and  he  was  authorized  to  recon- 
sider and  allow  a  claim  which  he  had,  through  error  of  law,  pre- 
viously rejected.-'''  No  equity  powers  were  conferred  on  the  Com- 
missioner, and  the  Commissioner  was  authorized,  not  obliged,  to 
refund.''"^  The  uncertainties  and  doubts  bearing  upon  the  finality 
of  decisions  as  to  abatement,  credit  and  refund  have  been  con- 
siderably clarified  by  a  provision  of  the  present  law  that  if  after 
determination  and  assessment  in  any  case  the  taxpayer  has  with- 
out protest  paid  in  whole  any  tax  or  penalty  or  accepted  any 
abatement,  credit  or  refund  based  on  such  determination  and 
assessment,  and  an  agreement  is  made  in  writing  between  the 
taxpayer  and  the  Commissioner  with  the  approval  of  the  secre- 
tary, such  determination  and  assessment  will  be  final  and  con- 
clusive (except  upon  a  showing  of  fraud  or  malfeasance  or  mis- 
representation of  fact  materially  affecting  the  determination  or 
assessment  made.)  Such  a  case  may  not  be  reopened,  or  the  de- 
termination and  assessment  modified,  by  any  officer,  employee  or 
agent  of  the  United  States,  and  no  suit,  action  or  proceeding  to 
annul,  modify  or  set  aside  such  determination  or  assessment 
will  be  entertained  by  any  United  States  court.-'^ 

Procedure  for  Handling  Abatement,  Credit  or  Refund  Claims, 
Effective  December  16,  1921.  For  the  more  expeditious  handling 
of  refund,  credit,  and  abatement  claims,  and  to  provide  for  the 
refund  or  credit  of  overpayments  where  no  claims  have  been  filed, 
the  following  procedure  has  been  established  to  become  effective 
December  16,  1921 : 

1.  Reduction  of  assessments  and  adjustments  of  overpay- 
ments will  be  accomplished  in  one  of  three  ways : 

(a)  On  the  basis  of  an  application  submitted  by  a  tax- 
payer on  Form  46,  47  or  47 A,  together  with  appropriate  sup- 
porting evidence  to  be  filed  in  the  office  of  the  collector  of  the 
district  in  which  the  tax  is  assessed. 

(b)  On  the  basis  of  a  certificate  of  overassessment  pre- 
pared by  the  appropriate  administrative  unit  in  the  bureau 

■'>*'>  Stotesbury  v.  U.  S.,  23  Ct.  Cls.  285. 
•■'•7  14  Op.  Atty.  Gen.  615. 

38  16  Op.  Atty.  Gen.  667;  13  Op.  Atty.  Gen.  439. 

39  Revenue  Act  of  1921,  §  1312.     See  Chapter  35. 


ABATEMENT.   REFUND   AND   RECOVERY   OF  TAXES  921 

in  each  case  in  which  an  overassessment  of  tax  is  disclosed 
through  the  audit  of  a  return. 

(c)  On  the  basis  of  a  blanket  claim  (Form  751)  ;  a  sched- 
ule of  taxes  found  to  be  uncollectible  (Porm  53)  ;  or  a  sched- 
ule of  duplicate  payments  and  overpayments  due  to  obvious 
error  on  all  forms  of  taxable  returns  (blanket  form  47  or 
47B)  submitted  by  a  collector.  Form  751  will  be  used  only 
in  cases  where  credit  balances  exist,  regardless  of  the  class 
of  return  filed. 

2.  Claims  of  taxpayers  and  the  items  of  collectors'  blanket 
claims  (if  and  when  found  by  an  administrative  unit  to  be  allow- 
able), and  certificates  of  overassessment  (upon  final  approval), 
and  items  credited  in  account  9  (e)  will  be  scheduled  on  Form 
7777  and  submitted  to  the  Commissioner  for  approval.  Upon 
approval  by  the  Commissioner,  such  schedules  will  be  forwarded 
to  the  collectors  of  the  several  districts. 

3.  Upon  receipt  of  such  schedules  the  several  collectors  will 
immediately  check  the  items  thereon  against  the  accounts  of  the 
several  taxpayers  concerned  and  determine  whether  the  several 
amounts  of  overassessments  should  be  abated,  refunded,  or 
credited  against  assessments  remaining  unpaid.  Only  overpay- 
ments of  income  and  profits  taxes  may  be  credited  against  un- 
paid assessments  of  such  taxes.  Whenever,  on  such  examination 
of  a  taxpayer's  account  and  of  the  items  in  account  9  (e),  a  col- 
lector finds  an  amount  of  overpayment,  he  will  examine  all  ac- 
counts of  the  taxpayer  for  subsequent  periods  and  determine  and 
certify  the  amount,  if  any,  of  such  overpayment  that  should  be 
credited  against  the  taxpayer's  account  for  any  subsequent  year 
or  years  and  the  amount  of  such  overpayment  for  which  a  dis- 
bursement check  should  be  issued.  He  will  thereupon  make  ap- 
propriate entries  upon  all  copies  of  the  schedules  and  upon  the 
assessment  list,  indicating  the  application  made  by  him  of  the 
several  amounts  of  overassessment  and  overpayment  (whether 
by  abatement  or  by  credit),  and  the  amounts  to  be  refunded; 
summarize  the  amounts  applied  in  abatement,  the  amounts  of 
overpayment  and  of  credit ;  certify  all  copies  of  the  schedule ; 
retain  one  copy;  and  forward  the  others  to  the  Commissioner  at 
Washington. 

4.  The  collector  will  at  the  same  time  prepare  (in  quadrupli- 
cate) on  Form  7777A  a  schedule  of  net  refundable  amounts  for 
which  disbursement  checks  are  to  be  issued ;  retain  one  copy  of 
the  schedule  for  his  record;  certify  the  other  three  copies  and 
forward  them  together  with  the  copies  of  the  schedules  on  Form 
7777  to  the  Commissioner  at  Washington. 


922  FEDERAL   INCOME   TAX 

5.  Upon  application  of  the  several  amounts  of  overassessment 
and  overpayment  as  abatements  or  credits,  and  the  determina- 
tion of  the  amounts  to  be  refunded,  the  collector  will  make  the 
appropriate  entries  upon  the  certificates  of  overassessment  which 
will  be  forwarded  to  him  with  the  schedules;  and  transmit  ap- 
propriate copies  of  such  certificates  to  the  several  taxpayers  as 
notification  of  the  action  taken  by  the  collector  in  the  way  of 
abatement  or  credit;  provided,  however,  that  in  those  cases  in 
which  any  amount  of  overpayment  is  to  be  refunded,  the  col- 
lector shall  not  send  the  certificate  of  overassessment  to  the  tax- 
payer, but  shall  make  the  appropriate  entries  thereon  and  for- 
ward such  certificates  of  overassessment  with  the  schedule  of 
refundable  amounts  to  the  Commissioner  at  Washington. 

6.  Upon  completion  and  certification  of  a  schedule,  the  col- 
lector will  credit  the  accounts  with  the  amounts  abated  and 
credited  and  make  proper  notations  of  the  refunds.  The  proper 
account  6  will  be  credited,  and  account  18  will  be  debited  with 
the  total  amount  abated  and  applied  as  credits  for  the  reduction 
of  tax  liability.  Account  9  (e)  will  be  debited  with  the  total 
amount  applied  as  credits  from  items  in  account  9  (e).  The  pro- 
cedure as  outlined  in  Section  583  of  the  Internal  Revenue  Manual, 
in  cases  of  this  nature,  should  be  carefully  followed. 

7.  Upon  receipt  of  properly  certified  copies  of  Form  7777  and 
7777A  the  Commissioner  will  cause  to  be  made  the  necessary  en- 
tries in  the  control  accounts  of  the  bureau  of  internal  revenue, 
and  the  necessary  allowance  documents  prepared.  Upon  receipt 
of  these  schedules  the  accounts  unit  of  the  bureau  of  internal 
revenue  will  retain  one  copy  of  Form  7777  for  its  records  and 
forward  a  copy  to  the  general  accounting  office  of  the  comp- 
troller-general as  a  voucher  for  the  collection  of  accounts  of  the 
collector.  He  will  retain  one  copy  of  the  schedule  of  refunds 
Form  7777A  for  his  records;  make  the  necessary  entries  upon 
and  forward  two  copies  with  the  allowance  documents  to  the 
Commissioner  for  his  approval. 

8.  Upon  approval  of  schedules  of  refunds  Form  7777A  the 
Commissioner  will  forward  such  schedules  with  the  allowance 
documents  to  the  disbursing  clerk  of  the  treasury  department. 

9.  Upon  receipt  of  properly  approved  schedules  and  allow- 
ance documents,  the  disbursing  clerk  shall  prepare  disbursement 
checks  in  the  amounts  of  the  several  net  refundable  items  in 
favor  of  the  respective  taxpayers  against  whose  accounts  net 
refundable  amounts  shall  have  been  allowed  by  the  Commis- 
sioner; forward  such  checks,  together  with  the  certificates  of 
overassessment  (which  will  be  transmitted  to  him)   to  the  re- 


ABATEMENT.   REFUND   AND   RECOVERY    OF   TAXES  923 

spective  taxpayers;  retain  one  copy  of  this  schedule  for  his 
record;  and  transmit  the  other  copy  to  the  general  accounting 
office  of  the  comptroller-general  as  a  voucher  for  his  disburse- 
ment account.'^" 

Procedure  for  Claiming  Refund.  The  provisions  for  claimmg 
refund  must  be  strictly  complied  with."  Claim  for  the  refunding 
of  assessed  taxes  and  penalties  must  be  made  out  upon  the  form 
prescribed  by  the  government  (Form  46).  The  burden  of  proof 
rests  upon  the  claimant.  All  the  facts  relied  upon  in  support  of 
the  claim  must  be  clearly  set  forth,  under  oath.^-'  The  practice 
is  to  obtain  a  copy  of  the  form  from  the  collector  to  whom  the 
tax  was  paid  or  the  deputy  collector  of  the  division  of  the  dis- 
trict within  which  the  claimant  resides,  prepare  the  form  accord- 
ing to  instructions  thereon,  and  file  it  with  the  local  collector  for 
further  action.^"'  Collectors  and  revenue  officers  are  forbidden  to 
prepare  affidavits  for  persons  claiming  remission  of  taxes  or  pen- 
alties under  the  internal  revenue  law.-*^  An  appeal  for  abatement 
or  refund  is  imperfect  if  it  does  not  have  endorsed  thereon  the 
affidavit  of  the  deputy  collector  and  certificate  of  the  collector 
required  by  the  regulations,^''  but  this  is  a  matter  of  action  with- 
in the  department.  A  claim  should  be  accompanied  by  the  col- 
lector's receipt  or  the  cancelled  check  showing  payment  of  the 
tax.  The  affidavit  may  be  made  by  an  agent  of  the  person  as- 
sessed, but  in  such  a  case  a  power  of  attorney  must  accompany 
the  claim.  Warrants  in  payment  of  claims  allowed  will  be  drawn 
in  the  names  of  the  persons  entitled  to  the  money  and  will,  unless 
otherwise  directed,  be  sent  directly  to  the  proper  persons  or  their 
duly  authorized  attorneys  or  agents.  In  certain  cases  of  over- 
payment by  taxpayers  the  collector  may  repay  the  excess  after 
allowance  by  the  Commissioner  of  a  claim  for  refund,  made  by 
the  collector  on  Form  751.  The  cases  in  which  refund  is  made 
through  collectors  are  covered  by  specific  provisions  and  dis- 
cussed elsewhere.^"    The  Commissioner  has  no  authority  to  re- 

4"  T.  D.  32G0.  As  to  the  necessity  of  filing  a  claim  for  c-rcdit  or  refund 
as  a  prerequisite  to  suit,  see  p.  934. 

41  Public  Service  Ry.  Co.  v.  Herold,  219  Fed.  301;  Public  Service  Gas  Co. 
V.  Herold,  227  Fed.  49(5,  229  Fed.  902. 

■*-Reg.  45,  Art.  1036,  as  amended  by  T.  D.  2871.  The  form  to  be  used  in 
claiming:  refund  is  officially  known  as  Form  4G. 

^^O.  D.  927,  T.  B.  21-21-1654.  See  letter  of  treasury  department  dated 
March  29,  1919;  I.  T.  S.  1921,  TI  2407,  as  to  forwardinfr  claims  directly  to 
the  Commissioner. 

-«4  T.  D.  2443. 

4.-.  Hastings  v.  Herold,  184  Fed.  759. 

46  See  p.  920. 


924  FEDERAL  INCOME   TAX 

fund  on  equitable  grounds  penalties  legally  collected.-*'  Where 
additional  tax  liability  is  discovered  on  the  audit  of  a  taxpayer's 
return  for  one  year  and  a  refund  is  found  to  be  due  him  for  a 
subsequent  year,  the  procedure  to  be  followed  is  to  make  an  office 
adjustment  to  take  care  of  the  additional  tax  and  advise  the  tax- 
payer to  file  a  claim  for  refund  of  the  net  overpayment.  Where 
additional  tax  has  already  been  placed  on  assessment-list,  tax- 
payer will  be  required  to  file  claim  for  credit  in  order  to  apply 
against  additional  tax  a  corresponding  portion  of  the  refund  due 
him.^s 

Powers  of  Attorney.  The  department  will  recognize  a  gen- 
eral power  of  attorney  as  sufficient  authority  for  the  filing  of 
more  than  one  claim  for  refund  on  behalf  of  the  grantor  of  such 
power.  However,  special  powers  are  required  in  certain  cases. 
In  cases  where  a  number  of  claims  are  to  be  filed  under  a  general 
power  of  attorney  the  original  power  should  be  attached  to  the 
first  claim  filed  on  behalf  of  the  claimant  granting  the  power,  and 
a  copy  thereof  should  be  annexed  to  each  succeeding  claim,  spe- 
cial reference  being  made  in  each  copy  to  the  claim  to  which  the 
original  instrument  was  attached.  The  bureau  does  not  require 
that  a  power  of  attorney  to  file  a  claim  for  refund  be  in  any  spe- 
cial form.  It  is  merely  necessary  that  the  instrument  meet  the 
legal  requirements  of  powers  of  attorney  in  general.^^ 

Procedure  by  Collectors  Upon  Receipt  of  Claims  for  Refund  or 
Abatement.  The  treasury  department  has  prescribed  the  fol- 
lowing procedure  to  be  followed  by  collectors  on  the  receipt  of 
claims  for  refund  or  abatement :  Claims  for  refund  or  for  abate- 
ment, pertaining  to  tax  returns  which  have  not  at  the  time  been 
posted  to  an  assessment-list,  will  be  numbered  to  agree  with, 
attached  to,  and  made  a  part  of,  the  original  return  so  that  the 
total  tax  as  posted  on  the  assessment-list  will  be  the  admitted  tax 
liability  to  the  taxpayer.  If  a  taxpayer  submits  an  amended  re- 
turn as  a  claim  either  for  refund  or  for  abatement  before  the 
original  return  has  been  listed,  such  amended  return  will  be  num- 
bered to  agree  with  and  attached  to  the  original  return  in  the 
same  manner.  Similarly,  errors  or  omissions  in  returns  discov- 
ered by  the  collector  prior  to  the  posting  operate  as  an  amend- 
ment to  the  amount  of  tax  liability  shown  by  the  return.     In 

47  Reg.  45,  Art.  1036;  T.  D.  2871.  In  the  case  of  a  taxpayer's  death,  cer- 
tified copies  of  the  letters  of  administration  or  letters  testamentary,  or  other 
similar  evidence,  should  be  annexed  to  the  claim  to  show  the  authority  of  the 
administrator  or  executor. 

48  O.  D.  867,  T.  B.  14-21-1555. 

49  O.  D.  927,  T.  B.  21-21-1654. 


ABATEMENT.   REFUND   AND   RECOVERY   OF  TAXES  925 

other  words,  all  amendments  or  changes  either  increasing  or  de- 
creasing the  amount  of  tax  liability  and  whether  originated  by 
the  taxpayer  or  by  the  collector  will  be  reflected  on  the  face  of 
the  return  itself  and  the  posting  to  the  assessment-list  will  be  of 
the  correct  amount.     Amended  returns  showing  a  reduced  tax 
liability  will  not  be  acted  upon  by  collectors  if  the  original  return 
has  been  previously  entered  on  the  assessment-list.     All  claims 
pertaining  to  returns  which  have  been  listed  for  assessment  must 
be  submitted  on  Form  46,  if  the  tax  has  been  paid,  or  on  Form  47. 
if  the  tax  has  not  been  paid.    The  following  classes  of  claims  may 
be  included  on  Form  751  (if  for  refund),  or  blanket  Form  47  (if 
for  abatement).     Separate  sheets  properly  designated  of  Form 
751  or  blanket  Form  47  must  be  prepared  for  returns  on  file  in 
the  Commissioner's  office  and  those  on  file  in  the  collector's  office : 
(a)    All   claims   for  refund   or  abatement   pertaining   to   Form 
1040A  income  returns  for  the  calendar  year  1918,  or  subsequent 
years,     (b)   Errors  in  computation.     (These  include  only  mis- 
takes in  arithmetic.)      (c)   Errors  in  specific  exemptions  on  in- 
come returns.     (These  include  such  items  as  failure  to  deduct 
exemptions  for  dependents;  the  $2,000  exemption  for  corpora- 
tions, etc.)      (d)  Payments  in  excess  of  the  total  amount  of  tax 
due  as  shown  by  the  return.     (These  include  such  cases  as  a  re- 
mittance of  $1,500  covering  payment  of  a  tax  liability  of  $1,300, 
etc.)     (e)  Amount  previously  paid  on  submission  of  a  tentative 
income  return  in  excess  of  the  total  tax  liability  shown  by  the 
final  return,     (f)  Duplicate  payments  or  assessments,     (g)   All 
claims  for  refund  on  account   of  nonrevenue  remittances  for- 
warded to  the  collector  in  error  and  deposited  by  him.     (These  in- 
clude such  items  as  state  or  municipal  taxes  sent  to  the  collector 
and  deposited  by  him  as  "unidentified,"  etc.    All  claims  for  refund 
or  abatement  other  than  those  enumerated  above  will  be  for- 
warded to  the  Commissioner  for  settlement.   However,  any  claim 
may  be  so  forwarded  whenever  the  collector  does  not  feel  abso- 
lutely certain  of  the  law,  regulations  or  precedent  involved,  or  if 
his  disbursing  bond  is  insufficient  to  enable  him  to  procure  an 
advance  on  accountable  warrant  of  the  requisite  amount  of  funds 
from  which  to  make  payment.    Before  forwarding  claims  to  the 
Commissioner  for  settlement  certification  must  be  made  on  the 
claim  of  the  account  number,  the  amount  of  tax  originally  due, 
the  dates  and  amounts  of  all  payments  or  other  transactions 
aflfecting  such  amount,  and  the  balance  due  as  shown  by  the  ac- 
count on  the  list.    All  claims  of  this  nature  now  on  file  in  the  col- 
lector's office  and  hereafter  as  received  should  be  certified  and 


926  FEDERAL   INCOME   TAX 

forwarded  immediately.  Claims  submitted  by  taxpayers  direct 
to  the  Commissioner  will  in  future  be  referred  to  the  collector  for 
this  certificate  as  to  the  status  of  the  account  on  the  assessment- 
list.  Until  so  certified  by  the  collector  such  claims  will  not  be 
settled.50 

Claims  for  Credit  of  Taxes  Erroneously  Collected.  To  obtain 
the  credit  mentioned  in  the  preceding  paragraph  the  taxpayer 
should  proceed  as  follows : 

(1)  Where  the  credit  demanded  is  equal  to  or  less  than  any  out- 
standing assessment  of  tax,  a  taxpayer  desiring  to  obtain  such 
credit  should  file  with  the  collector  for  the  district  in  which  his 
original  return  was  filed  a  verified  claim  on  Form  47 A,  containing 
the  following  statements:  (a)  business  engaged  in  by  claimant; 
(b)  character  of  assessment ;  (c)  amount  of  tax  paid  and  for  what 
taxable  year;  (d)  portion  of  tax  under  (c)  claimed  as  a  credit; 
(e)  unpaid  assessment  against  which  credit  is  asked  and  for 
what  taxable  year ;  and  (f )  all  facts  regarding  the  overpayment. 

(2)  where  the  amount  claimed  as  a  credit  is  greater  than  the 
outstanding  assessment  of  tax,  a  taxpayer  desiring  to  obtain  such 
credit  and  the  refund  to  which  he  is  entitled  should  file,  in  addi- 
tion to  the  claim  for  credit  required  to  be  made  on  Form  47A  for 
the  amount  of  the  outstanding  assessment,  a  claim  for  refund  of 
the  overpayment  in  excess  of  the  credit.  This  claim  for  refund 
may  be  attached  to  the  claim  for  credit  or  it  may  be  separately 
filed  with  the  Commissioner.  All  the  facts  regarding  the  total 
overpayment  should  be  stated  in  the  claim  for  refund  and  a  ref- 
erence made  to  such  claim  in  the  claim  for  credit. •''i 

Where  a  corporation  filed  a  return  for  1918  with  the  collector 
of  one  district  and  a  return  for  1919  with  the  collector  of  another 
district,  and  subsequently  rendered  an  amended  return  for  1918, 
showing  less  tax  liability,  together  with  a  claim  for  credit  against 
the  outstanding  tax  due  for  1919,  covering  the  overpayment  to 
the  extent  shown  by  the  amended  return,  it  should  file  the 
amended  return  with  the  collector  with  whom  the  original  return 
was  filed  for  the  year  1918.  The  claim  for  credit  should  be  filed 
with  the  collector  with  whom  the  return  for  1919  was  filed,  who 
should  forward  same  to  the  collector  with  whom  the  return  for 
1918  was  filed,  for  a  notation  thereon  of  the  facts  required  by  the 
certificate  on  the  reverse  side  as  to  the  assessment  overpaid  for 
1918.  When  this  has  been  done,  it  will  be  returned  by  him  to  the 
collector  with  whom  the  1919  return  was  filed,  who  will  make  a 

50  T.  D.  2871. 

51  Reg.  45,  Art.  1034. 


ABATEMENT,  REFUND   AND   RECOVERY   OF  TAXES  927 

notation  thereon  as  to  the  1919  assessment  to  be  credited,  and 
forward  same  to  the  Commissioner  for  consideration.  In  filing 
the  amended  return  the  taxpayer  should  call  attention  to  the  fact 
that  a  claim  for  credit  of  the  overpayment  has  been  filed  with 
the  collector  with  whom  the  1919  return  was  filed,  and  the  col- 
lector with  whom  the  claim  for  credit  was  filed  should  be  notified 
that  an  amended  return  has  been  filed.''- 

ACTiON  ON  Claims  for  Credit.  Upon  receipt  by  the  collector 
of  a  claim  for  credit  on  Form  47 A,  he  will  take  no  action  thereon 
until  the  following  requirements  have  been  met: 

(a)  The  collector  must  ascertain  from  the  Commissioner 
whether  a  claim  for  refund  for  the  year  or  years  upon  which  the 
claim  for  credit  is  based,  and  upon  substantially  the  same  ground, 
has  been  filed.  If  no  such  claim  for  refund  has  been  filed  the  col- 
lector may,  on  notice  thereof  from  the  Commissioner,  accept  for 
filing  the  taxpayer's  claim  for  credit. 

(b)  When  it  is  known  to  the  collector  that  a  refund  claim  of 
the  nature  referred  to  above  is  on  file  with  the  Commissioner, 
and  has  not  been  adjusted,  he  will  not  accept  the  taxpayer's  claim 
for  credit  for  the  same  year  or  years  until  the  taxpayer  has  re- 
quested the  Commissioner  to  reject  such  claim  and  has  been  ad- 
vised by  the  Commissioner  that  such  claim  has  been  rejected. 
Claims  for  refund  may  not  be  converted  into  claims  for  credit, 
except  in  the  manner  above  mentioned.  The  substitution  of  a 
claim  for  credit  for  a  refund  claim  will  be  expedited  by  making 
a  direct  request  to  Washington. 

Upon  acceptance  for  filing  of  a  claim  for  credit  on  Form  47 A 
the  collector  will  certify  thereon  the  required  information  con- 
cerning all  outstanding  assessments  and  payments  covered  there- 
by and  will  note  on  his  records  that  a  claim  for  credit  has  been 
filed.    He  will  thereupon  transmit  the  claim  to  the  Commissioner. 
Due  notice  will  be  given  the  collector  and  the  taxpayer  of  the 
action  taken  on  the  claim.    A  schedule  of  credit  claims  on  Form 
7220A  will  be  transmitted  to  the  collector  once  a  month  and 
formal  credit  shall  be  taken  by  the  collector  at  that  time.    If  a 
claim  is  allowed  against  additional  taxes  due  for  other  years,  but 
such  other  taxes  have  not  yet  been  assessed,  only  the  amount  of 
the  excess  of  such  taxes  over  the  overpayment  shall  be  assessed, 
or  the  excess  of  the  overpayment  over  such  taxes  due  shall  be 
refunded,  as  the  case  may  be.    The  effective  date  of  the  filing  of 
a  claim  for  credit  will  be  actual  date  of  presentation  to  the  col- 
lector.   The  filing  of  a  claim  for  credit  against  the  tax  due  under 

5^  O.  D.  740,  T.  B.  48-20-1327. 


928  FEDERAL  INCOME  TAX 

another  return  will  be  subject  to  the  same  rules  with  respect  to 
the  addition  of  interest  and  penalties  as  if  the  taxpayer  had  filed 
a  claim  for  abatement  of  the  tax  against  which  credit  is  desired. 

Under  no  circumstances  will  a  taxpayer  be  permitted  to  take 
credit  for  an  alleged  refund  due  for  a  prior  year  on  any  return 
filed  for  a  subsequent  year  without  filing  a  formal  claim  for  credit 
on  Form  47A,  under  the  requirements  provided  herein.  An  at- 
tempt to  take  a  credit  contrary  to  the  instructions  herein  set 
forth  will  not  be  held  to  be  a  due  filing  of  a  claim.-''^ 

Payment  Where  Claim  for  Credit  Denied.  Where  a  claim 
for  credit  is  rejected,  the  tax  which  is  the  subject  of  the  claim  is 
chargeable  with  interest  at  the  rate  of  one-half  of  1  'r  per  month 
from  the  time  the  tax  was  due  until  the  claim  is  decided  ad- 
versely to  the  taxpayer;  notice  of  the  adverse  decision  is  sent  to 
the  collector  who  must  send  to  the  claimant  a  notice  and  demand 
for  payment  of  the  assessment;  if  the  tax  is  paid  within  the 
10-day  period  following  the  sending  of  the  notice  the  5' i  penalty 
is  not  collectible,  and  the  only  interest  collectible  is  that  at  the 
rate  of  one-half  of  1%  per  month  from  the  time  the  tax  was  due 
until  the  date  of  the  Commissioner's  decision ;  if  the  tax  is  not 
paid  within  the  10-day  period,  5*^6  penalty  attaches  in  addition 
to  the  above  interest  and  also  interest  at  the  rate  of  19c  per 
month  from  the  date  of  the  adverse  decision  by  the  Commissioner 
to  the  date  of  payment."'^ 

Refund  of  Taxes  Collected  on  Second  Assessment.  As  indi- 
cated more  fully  in  the  preceding  paragraphs,  a  taxpayer  has  four 
years  after  the  payment  of  any  tax  within  which  to  claim  a  re- 
fund, even  though  more  than  five  years  have  elapsed  since  the 
return  was  made."'-''  This  ruling  has  special  application  to  taxes 
collected  on  a  second  assessment,  perhaps  several  years  after  the 
return  was  made.  When  a  second  assessment  is  made  in  case  of 
any  list,  a  statement  or  return,  which  in  the  opinion  of  the  col- 
lector or  deputy  collector  was  false  or  fraudulent,  or  contained 
any  understatement  or  undervaluation,  such  assessment  will  not 
be  remitted,  nor  such  taxes  collected  under  such  assessment  re- 
funded or  paid  back  or  recovered  by  any  suit  unless  it  is  proved 
that  such  list,   statement  or  return  was  not  wilfully  false   or 

53  Reg.  45,  Art.  1035,  as  amended  by  T.  D.  3154,  T.  B.  17-21-1601;  letter 
from  treasury  department  dated  November  9,  1921;  I.  T.  S.  1921,  1[  3212. 
The  above  treasury  decision  became  effective  on  April  12,  1921. 

54  Sol.  Op.  32,  T.  B.  31-20-1106.     See,  however,  footnote  83  in  Chapter  35. 

55  See  0.  833,  T.  B.  4-19-235;  M.  2764,  T.  B.  20-21-1642. 


ABATEMENT,   REFUND   AND   RECOVERY   OF  TAXES  929 

fraudulent,  and  did  not  contain  any  wilful  understatement  or  un- 
dervaluation.^'' 

Statute  of  Limitations/'^  Under  the  Revenue  Act  of  1921  there 
are  two  statutes  of  limitation  with  respect  to  the  refund  of  taxes 
by  the  Commissioner.  It  is  provided  in  the  present  law  that  "no 
credit  or  refund  shall  be  allowed  or  made  after  five  years  from 
the  date  when  the  return  was  due,  unless  before  the  expiration 
of  such  five  years  a  claim  therefor  is  filed  by  the  taxpayer"."''' 
The  Revised  Statutes'''-'  provide  as  follows:  "All  claims  for  the 
refunding  of  any  internal  tax  alleged  to  have  been  erroneously 
or  illegally  assessed  or  collected,  or  of  any  penalty  alleged  to  have 
been  collected  without  authority,  or  of  any  sum  alleged  to  have 
been  excessive  or  in  any  manner  wrongfully  collected,  must  be 
presented  to  the  Commissioner  of  Internal  Revenue  within  four 
years  next  after  payment  of  such  tax,  penalty  or  sum   *   *   *" 

It  will  be  noted  that  this  statutory  period  of  limitation  running 
from  the  "payment  of  such  tax,  penalty  or  sum"  is  equivalent, 
except  in  length,  to  the  period  in  effect  under  the  Revised 
Statutes  before  their  amendment  by  the  1921  Law,  running  from 
the  accural  of  the  cause  of  action.*"'  A  cause  of  action  for  a  refund 
accrued  upon  payment."^  But  the  period  is  now  extended  from 
two  to  four  years  and  the  amended  four-year  period  is  made 
retroactive  as  to  claims  for  refund  under  the  Revenue  Act  of 
1916,  the  Revenue  Act  of  1917,  and  the  Revenue  Act  of  1918. 
The  two  limitations  are  expressed  negatively;  their  affirmative 
implication  is  that  if  claims  are  presented  within  five  years  after 
the  making  of  a  return  or  within  four  years  after  the  payment 
of  the  tax,  they  are  not  barred.  The  five-year  period  is  supple- 
mental to  the  four-year  period  and  the  provision  for  the  five- 
year  period  does  not  take  away  any  right  given  the  taxpayer 
under  the  four-year  period.  Thus,  a  taxpayer  will  be  permitted  to 
present  a  claim  with  regard  to  assessments  made  under  the  Rev- 

•"'•>  R.  S.,  §  322,5,  as  amended  by  the  Revenue  Act  of  1918  and  re-enacted 
without  change  by  §  1323  of  the  present  law.  The  1918  amendment  com- 
bined the  former  proviso  clause  of  R.  S.,  §  3220  with  R.  S.,  §  3225  in  its 
previous  form;  and  also  by  the  insertion  of  the  words  "wilful"  and  "wil- 
fully" was  a  statutory  enactment  of  Northwestern  Ins.  Co.  v.  Fink,  248 
Feb.  568.  The  government  withdrew  from  its  position  in  Camp  Bird,  Ltd., 
V.  Howbert,  249  Fed.  27,  and  the  case  has  been  dismissed  in  the  Supreme 
Court. 

•"•"The  statute  of  limitations  upon  claims  for  credit  or  refund  must  not 
be  confused  with  the  statute  upon  suits  to  recover  taxes.     See  p.  919. 

•^'S  Revenue  Act  of  1921,  §  252. 

•"'!>  §  3228,  as  amended  by  the  Revenue  Act  of  1921. 

«OSee  R.  S.,  §2238  before  amendment  by  Revenue  Act  of  1921. 

«i  Kings  Co,  Savings  Inst.  v.  Blair,  116  U.  S.  200. 


930  FEDERAL   INCOME   TAX 

enue  Act  of  1918,  the  1917  Law,  and  the  1916  Law,  at  any  time 
within  four  years  after  the  assessment  is  paid,  even  though  such 
period  extends  beyond  five  years  after  the  return  is  made.'"'-  If 
at  the  expiration  of  five  years  from  the  date  the  return  was  due, 
no  credit  or  refund  has  been  allowed  by  the  Commissioner  and 
no  claim  for  either  a  credit  or  a  refund  has  been  filed  by  the  tax- 
payer, the  taxpayer  will  be  precluded  from  relief,  if  more  than 
four  years  have  elapsed  since  payment  of  the  tax.  A  claim  for 
abatement  does  not  take  the  place  of  a  claim  for  credit  or  refund ; 
the  claims  are  separate  and  distinct,  and  although  the  result  ac- 
complished may  be  the  same  upon  all  these  claims,  the  require- 
ments of  the  statute  are  not  satisfied  by  permitting  the  use  of  the 
claims  interchangeably.  Neither  do  amended  returns  take  the 
place  of  a  claim  for  credit  or  refund,  and  if  filed  unsupported  by 
such  claim  or  claims,  are  not  in  themselves  sufficient  to  warrant 
the  crediting  or  refunding  of  any  taxes  after  the  expiration  of 
the  statutory  periods.  An  application  for  refund,  though  informal 
or  defective,  may,  however,  be  regarded  as  a  claim  so  far  at  least 
as  to  permit  a  formal  amendment  after  the  statute  of  limitations 
has  run.*'-^  In  an  opinion  rendered  under  the  1918  Law,  it  has 
been  held  that  an  overpayment  made  for  a  year  for  which  the 
return  was  due  within  the  five-year  period  may  be  applied  against 
an  additional  tax  due  from  the  taxpayer  for  any  assessable  or 
nonassessable  year;  but  an  overpayment  made  for  a  year  for 
which  the  return  was  due  before  such  five-year  period  begins  may 
not  be  credited  against  an  additional  tax  due  for  any  year,  unless 
a  claim  for  credit  or  refund  has  been  filed  within  five  years  from 
the  date  the  return  was  due.  It  was  held  under  the  1918  Law 
that  claims  for  the  refund  of  taxes  pending  in  the  Commissioner's 
office  on  February  25,  1919  (the  date  when  the  Revenue  Act  of 
1918  was  enacted)  but  not  filed  within  five  years  from  the  date 
the  return  was  due  were  not  allowable.^'-^    This  injustice  has  now 

6^  0.  833,  T.  B.  4-19-235;  M.  2764,  T.  B.  20-21-1642. 

63  M.  2764,  T.  B.  20-21-1642;  Maryland  Casualty  Co.  v.  U.  S.,  251  U.  S. 
342. 

64  Sol.  Op.  79,  T.  B.  49-20-1337.  This  decision  was  necessary  in  view  of 
the  repeal  of  §  14  (a)  of  the  Revenue  Act  of  1916.  Where  jurisdiction  to 
act  upon  cases  has  been  conferred  by  an  act  of  Congress  and  then  that  act 
is  repealed,  all  pending  suits  under  the  repealed  provision  must  stop.  (As- 
sessor V.  Osborne,  9  Wall.  567;  S.  C.  v.  Gaillard,  101  U.  S.  433;  In  re  Hall, 
167  U.  S.  38;  U.  S.  v.  Kelly,  97  Fed.  460.)  As  to  claims  pending  on  Feb- 
ruary 24,  1919,  but  not  filed  within  five  years  from  the  date  the  return  was 
due,  it  has  been  recommended  that  Congress  remove  the  bar  of  the  statute 
of  limitations,  which  has  now  been  done. 


ABATEMENT,   REFUND   AND   RECOVERY   OF  TAXES  931 

been  remedied  by  a  provision  of  the  Revenue  Act  of  1921  that 
the  five-year  statute  shall  not  bar  claims  for  refund  filed  prior  to 
the  passage  of  the  Revenue  Act  of  1918  under  the  Revenue  Act 
of  1916,  or  filed  prior  to  the  passage  of  the  Revenue  Act  of  1921 
under  the  Revenue  Act  of  1918.""'  The  five-year  period  of  limita- 
tions does  not  apply  to  cases  in  which  upon  an  examination  of 
any  return  made  under  the  Revenue  Act  of  1917,  the  Revenue 
Act  of  1918,  or  the  Revenue  Act  of  1921,  the  invested  capital  of 
a  taxpayer  is  decreased  by  the  Commissioner,  and  such  decrease 
is  due  to  the  fact  that  the  taxpayer  failed  to  take  adequate  de- 
ductions in  previous  years  with  the  result  that  an  amount  of  tax 
in  excess  of  that  properly  due  was  paid  in  any  previous  year  or 
years.  In  such  cases  the  amount  of  such  excess  may  be  credited 
or  refunded  at  any  time  without  the  filing  of  any  claim  therefor."" 

When  a  Refund  Is  Allowed.  A  refund  has  been  held  to  be 
"allowed"  when  the  Commissioner  has  signed  the  allowance 
schedule.  The  issuance  of  a  warrant  by  the  division  of  bookkeep- 
ing and  warrants  is  not  essential.*'^ 

When  a  Credit  Is  Made  or  Allowed.  A  statement  contained 
in  a  letter  from  the  department  that  a  taxpayer  is  entitled  to  a 
credit  is  clearly  not  a  credit  actually  made  or  allowed.  Some- 
thing must  be  done  in  a  formal  way  that  will  amount  to  a  direc- 
tion to  the  collector.  Prior  to  such  a  direction  he  has  nothing  to 
do  with  the  taxpayer's  account  since  it  has  not  assumed  the  sta- 

•!•">  Revenue  Act  of  1921,  §  252. 

'"'  Revenue  Act  of  1921,  §  252.  See  letter  from  treasury  department 
dated  October  9,  1919;  L  T.  S.  1921,  ^2428. 

'wM.  2764,  T.  B.  20-21-1642.  See,  however,  T.  B.  3260.  If  a  revenue 
agent's  report,  or  a  va-luation  engineer's  report  determining  an  overpay- 
ment within  the  five-year  period,  is  not  audited  until  after  the  five-year 
period,  the  auditor  is  barred  from  allowing  the  overpayment  as  an  offset, 
even  though  the  taxpayer  is  not  in  possession  of  the  valuation  engineer's 
finding  and  in  some  cases  not  in  possession  of  the  revenue  agent's  report, 
and  therefore  could  not  have  filed  claim  within  the  five-year  limitation. 
When  an  auditor  finds  an  overpayment  for  1913  and  offsets  it  in  an  A-2 
letter  to  the  taxpayer,  dated  F'ebruary  25,  1919,  and  thereafter  on  a  reaudit 
made  October  10,  1919,  a  greater  depletion  is  allowed,  the  additional  overpay- 
ment determined  subsequent  to  the  expiration  of  the  five-year  period  can 
neither  be  refunded  nor  credited.  When  a  revenue  agent's  report,  dated  May 
8,  1919,  discovers  additional  tax  for  1913  which  was  assessed  and  paid  in 
November,  1919,  a  waiver  having  been  secui-ed,  and  upon  a  reaudit  addi- 
tional depletion  is  allowed  making  the  tax  less  than  that  first  assessed, 
the  overpayment  for  1913,  so  paid  in  1919,  can  not  be  refunded  or  offset 
against  additional  tax  for  subsequent  years,  even  though  the  original  1913 
return  reported  no  tax.  But  in  such  case  the  taxpayer  may  claim  a  refund 
at  any  time  within  four  years  after  the  tax  was  paid  under  R.  S.  3228,  as 
amended. 


932  FEDERAL  INCOME   TAX 

tus  of  an  account  stated  to  him.  Such  direction  by  the  Commis- 
sioner is  usually  made  by  formal  assessment-list  signed  by  him. 
When  such  a  formal  statement  or  direction  to  the  collector  is 
signed  by  the  Commissioner  and  forwarded  to  the  collector, 
showing  the  amount  of  the  tax  to  be  collected  over  and  above  the 
credit,  the  Commissioner  has  formally  made  or  allowed  the 
credit.  When  this  is  done  the  credit  has  been  made  or  allowed, 
but  prior  thereto  anything  that  is  done  in  the  way  of  stating  the 
case  by  employees  of  the  bureau  or  in  the  way  of  statements  to 
the  taxpayer  in  letters  from  the  department  can  be  nothing  more 
than  preliminary  to  the  actual  making  or  allowance  of  the  credit 
by  the  Commissioner.  Where  the  collector  makes  the  credit 
without  specific  instructions  from  the  Commissioner,  the  credit 
is  actually  made  or  allowed  when  the  collector  so  records  it,  and 
in  such  a  case  subsequent  action  by  the  Commissioner  in  the  way 
of  a  review  of  the  collector's  action  would  not  operate  to  fix  the 
time  when  the  credit  was  made  or  allowed,  since  in  such  a  case 
the  collector  had  before  him  the  account  of  the  taxpayer  and  is 
charged  by  law  and  the  regulations  to  enter  the  credit.''''^ 

Credit  Equivalent  to  Payment.  The  word  "paid"  as  used 
in  the  provision '^^  regarding  credit  and  refund  has  been  construed 
in  its  broader  sense  as  including  a  credit  duly  made.  Where  there 
has  been  an  overpayment  on  a  return  for  a  certain  year,  and 
within  five  years  from  the  date  the  return  was  due  the  overpay- 
ment is  credited  to  taxes  due  on  a  return  for  a  subsequent  year, 
such  credit  constitutes  payment  or  part  payment  of  taxes  for  the 
year  in  which  it  was  applied.  Where  a  claim  for  refund  is  filed 
for  an  overpayment  on  a  return,  to  which  a  credit  has  been  pre- 
viously applied  because  of  a  supposed  underpayment,  the  return 
should  be  adjusted  for  the  year  in  which  the  credit  was  applied. 
The  fact  that  no  record  of  a  credit  appears  on  the  assessment-list 
for  the  year  in  which  it  was  made  does  not  aff'ect  its  validity  if 
it  was  in  fact  made  within  the  statutory  period."" 

Suits  to  Recover  Taxes.  If  a  claim  is  rejected  by  the  Commis- 
sioner, a  judicial  remedy  is  given  the  taxpayer  by  an  action 
against  the  collector  or  the  United  States.  If  the  claim  is  allowed 
by  the  Commissioner  and  payment  refused  by  the  accounting 
officers,  a  suit  may  be  brought  directly  against  the  government  in 
the  court  of  claims.'^  The  allowance  of  the  claim  by  the  Com- 
es SoL  Op.  106,  T.  B.  23-21-1678.     See,  however,  T.  D.  3260. 

69  Revenue  Act  of  1921,  §  252;  Revenue  Act  of  1918,  §  252. 

70  Sol.  Op.  107,  T.  B.  25-21-1697.     See,  however,  T.  D.  3260. 

71  Edison  Electric  Co.  v.  U.  S.,  38  Ct.  Cls.  208.  The  court  of  claims  has 
jurisdiction  over  "all  claims  except  for  pensions,  founded  upon  the  Consti- 


ABATEMENT,   REFUND   AND   RECOVERY   OP  TAXES  933 

missioner  is  similar  to  an  account  stated  between  private  parties 
and  may  be  used  as  the  basis  of  an  action  against  the  United 
States  in  the  court  of  claims,  when  payment  is  not  made  by 
reason  of  the  refusal  of  any  of  the  officers  of  the  department  to 
pass  or  to  pay  the  claim,  and  it  will  be  prima  facie  evidence  of 
the  amount  that  is  due,  and  puts  on  the  government  the  burden 
of  showing  fraud  or  mistake."-'  The  district  courts  of  the  United 
States  have  original  jurisdiction  of  all  cases  arising  under  any 
law  providing  for  internal  revenue,  or  from  revenue  from  im- 
ports or  tonnage,  except  those  cases  arising  under  any  law  pro- 
viding revenue  from  imports  jurisdiction  of  which  has  been  con- 
ferred upon  the  court  of  customs  appeals.""'  The  district  courts 
also  had  original  jurisdiction  prior  to  the  Revenue  Act  of  1921, 
concurrent  with  the  court  of  claims,  of  all  claims  not  exceeding 
$10,000  founded  upon  the  Constitution,  or  any  law  of  Congress, 
or  any  regulation  of  an  executive  department,  or  upon  any  con- 
tract, express  or  implied,  with  the  government,  or  for  damages, 
liquidated  or  unliquidated,  in  cases  not  sounding  in  tort  in  re- 
spect to  which  claims  the  party  would  be  entitled  to  redress 
against  the  United  States,  either  in  a  court  of  law,  equity  or 
admiralty,  if  the  United  States  were  suable;  and  of  all  set-offs, 
counterclaims,  claims  for  damages,  whether  liquidated  or  un- 
liquidated, or  other  demands  whatsoever  on  the  part  of  the  gov- 
ernment against  any  claimant  against  the  government  in  such 
court. "^  Such  suits  are  tried  by  the  court  without  a  jury.  They 
were  required  to  be  brought  (except  in  the  case  of  certain  mar- 
ried women,  minors  and  incompetents)  within  six  months  after 
the  cause  of  action  accrued,  but  this  limitation  does  not  seem  to 
bear  upon  suits  to  recover  ovei^payments  of  taxes  or  penalties."' 
By  the  Revenue  Act  of  1921  district  courts  are  given  original 
jurisdiction  concurrent  with  the  court  of  claims,  of  any  suit  or 

tution  of  the  United  States,  oi'  any  law  of  Congress  *  *  *  in  respect  of 
which  the  party  would  be  entitled  to  redress  against  the  United  States, 
either  in  a  court  of  law,  equity  or  admiralty  if  the  United  States  were 
suable."     (Judicial  Code,  §  145,  36  St.  at  L.  1087.) 

72  U.  S.  V.  Savings  Bank,  104  U.  S.  728;  Kaufman  v.  U.  S.,  9G  U.  S.  567; 
Christie-Street  Commission  Co.  v.  U.  S.,  136  Fed.  326. 

'J'-'^  Judicial  Code,  §24  (5).  This  jurisdiction  is  irrespective  of  the  citizen- 
ship of  the  parties  (Philadelphia  v.  Collector,  5  Wall.  720;  Schneider  v. 
Barney,  Fed.  Cas.  No.  12,462). 

7^  Judicial  Code,  §24  (20).  There  are  certain  exceptions  to  this  rule, 
such  as  claims  arising  out  of  the  civil  war,  claims  rejected  prior  to  1887, 
pensions,  and  cases  bearing  upon  compensation  of  officers  of  the  United 
States. 

75  See  R.  S.,  §§  3227,  3228,  and  Revenue  Act  of  1921,  §§  1318,  1319. 


934  FEDERAL   INCOME   TAX 

proceeding,  commenced  after  the  passage  of  the  Revenue  Act  of 
1921,  for  the  recovery  of  any  internal  revenue  taxes  alleged  to 
have  been  erroneously  or  illegally  assessed  or  collected,  or  of  any 
penalty  claimed  to  have  been  collected  without  authority  or  any 
sum  alleged  to  have  been  excessive  or  in  any  manner  wrongfully 
collected,  under  the  internal  revenue  laws,  even  if  the  claim  ex- 
ceeds $10,000,  if  the  collector  by  whom  such  tax,  penalty,  or  sum 
was  collected  is  dead  at  the  time  such  suit  or  proceeding  is  com- 
menced."'^^' 

Where  an  illegal  tax  is  paid,  the  fact  that  it  was  not  paid  with- 
in the  time  allowed  by  law  will  not  prevent  the  taxpayer  from  re- 
covering a  penalty  paid  by  him  for  the  nonpayment  of  the  illegal 
tax,  for,  if  the  tax  was  illegal,  it  was  never  due,  and  therefore 
the  penalty  was  as  much  unauthorized  as  the  tax  itself."'^  A  per- 
son can  not  recover  taxes  paid  which  were  in  fact  due,  even 
though  the  manner  of  their  assessment  or  collection  was  unau- 
thorizedjs 

Prerequisites  to  Suit:  Statute  of  Limitations.  No  suit  or 
proceeding  can  be  maintained  in  any  court  for  the  recovery  of 
any  internal  revenue  tax  alleged  to  have  tseen  erroneously  or 
illegally  assessed  or  collected,  or  of  any  penalty  claimed  to  have 
been  collected  without  authority,  or  of  any  sum  alleged  to  have 
been  excessive  or  in  any  manner  wrongfully  collected,  until  a 
claim  for  refund  or  credit  has  been  duly  filed  with  the  Commis- 
sioner. If  the  Commissioner's  decision  on  a  claim  for  credit  or 
refund  is  delayed  more  than  six  months  from  the  date  of  filing, 
suit  may  be  brought  without  first  securing  the  decision  of  the 
Commissioner.  Otherwise,  the  Commissioner's  decision  is  a 
prerequisite  to  suit.'^^ 

76  Revenue  Act  of  1921,  §  1310  (c). 

77  Camp  Bird,  Ltd.,  v.  Howbert,  262  Fed.  114. 

78  Shafer  v.  Craft,  144  Fed.  907. 

79  R.  S.  3226,  as  amended  by  §  1318  of  the  Revenue  Act  of  1921.  In  its 
amended  form  this  section  does  not  affect  any  suit  or  proceeding  instituted 
prior  to  the  passage  of  the  1921  Law  (November  23,  1921)  but  applies  to 
all  suits  and  proceedings  instituted  after  such  passage.  As  the  provision 
stood  before  its  amendment  by  the  1921  Law,  the  prerequisite  to  suit  was 
an  appeal  to  the  Commissioner.  In  view  of  this  provision,  it  does  not  seem 
that  the  taxpayer  would  be  safe  in  relying  upon  the  procedure  now  adopted 
by  T.  D.  3260  (see  p.  920.)  In  order  to  establish  a  basis  for  recovery  in 
the  courts  it  is  necessary  to  file  a  claim  for  credit  or  refund,  although  the 
department  now  pays  and  credits  claims  without  any  formal  filing.  See 
Rock  Island,  etc,  Rd.  Co.  v.  U.  S.,  254  U.  S.  141,  in  which  this  prerequisite 
to  suit  is  strictly  construed  (see  page  915  above). 


ABATEMENT.   REFUND   AND   RECOVERY   OF  TAXES  935 

Statute  of  Limitations  I^pon  Suits  to  Recover  Taxes.  The 
Revenue  Act  of  1921  provides  a  new  statute  of  limitations  with 
respect  to  suits  or  proceedings  for  the  collection  of  taxes  alleged 
to  have  been  erroneously  or  illegally  assessed  or  collected.  Prior 
to  the  re-enactment  of  the  1921  Law  it  had  been  provided  that 
no  such  suit  or  proceeding  could  be  maintained  in  any  court  unless 
brought  "within  two  years  next  after  the  cause  of  action  ac- 
crued".'^" If,  however,  a  claim  for  refund  had  been  filed,  the 
period  of  limitations  would  not  expire  until  two  years  after  the 
Commissioner  had  denied  the  claim.  The  accrual  of  the  cause  of 
action  for  purposes  of  a  suit  against  the  government  or  a  collector 
was  the  date  when  the  Commissioner  decided  adversely  to  the 
taxpayer;  that  is,  the  claimant  may  await  the  decision  of  the 
Commissioner,  and  if  it  is  adverse,  might  bring  suit  within  two 
years  thereafter.  But  he  was  not  required  to  await  such  adverse 
decision;  he  might  at  his  election  bring  suit  at  any  time  after 
the  expiration  of  six  months  from  the  filing  of  his  claim  for 
refund,  if  no  decision  had  been  rendered  by  the  Commissioner.*^! 
For  example,  if  a  tax  was  paid  on  June  28,  1919,  the  claim  for 
refund  was  required  to  be  filed  on  or  before  June  28,  1921."^-  If 
the  claim  is  filed  on  June  28,  1921,  the  taxpayer  might  commence 
his  action  on  December  29,  1921,  if  no  decision  had  been  rendered 
by  the  Commissioner.  If,  however,  an  adverse  decision  was 
rendered  by  the  Commissioner  on  September  21,  1921,  the  tax- 
payer might  at  once  institute  action  but  had  until  September 
21,  1923,  in  which  to  do  so.  The  rejection  of  a  claim  by  the 
Commissioner  must  be  on  the  merits  and  not  for  irregularity 
in  the  form  in  order  to  support  an  action.^  If  an  imperfect 
claim  was  filed  within  two  years,  it  was  apparently  within  the 
statute,  although  the  corrected  application  was  not  made  within 
that  time,  and  if  suit  was  brought  within  two  years  after  rejec- 

SOR.  S.  3227,  now  repealed  by  Revenue  Act  of  1921;  Maryland  Casualty 
Co.  V.  U.  S.,  251  U.  S.  342. 

81  New  York  Mail  and  Transportation  Co.  v.  Anderson,  234  Fed.  590; 
State  Line  &  S.  R.  Co.  v.  Davis,  228  Fed.  246;  Merck  v.  Treat,  174  Fed.  388; 
Farrell  v.  U.  S.,  167  Fed.  639;  Christie-Street  Commission  Co.  v.  U.  S.,  136 
Fed.  326;  Hicks  v.  James'  Administratrix,  48  Fed.  542.  affirmed  110  U.  S. 
272;  Cheatham  v.  U.  S.,  92  U.  S.  85;  Kings  Co.  Inst.  v.  Blair,  116  U.  S.  200. 
It  has  been  held  that  the  cause  of  action  for  purposes  of  an  action  against 
the  collector  accrued  six  months  after  claimant  had  filed  a  claim  for  refund 
and  that  the  claimant  had  two  years  from  that  date  within  which  to  bring 
suit.  (Schwarzchild  &  Sulzberger  v.  Rucker,  143  Fed.  656.)  This  seems  to 
be  the  view  of  the  ti-easury  department.     See  Reg.  45,  Art.  1037. 

8'-  New  York  Mail  and  Ti'ansportation  Co.  v.  Anderson,  234  Fed.  590. 

83  Hicks  v.  James'  Administratrix,  48  Fed.  542,  affirmed  110  U.  S.  272. 


936  FEDERAL  INCOME   TAX 

tion  of  the  corrected  claim,  it  was  within  the  statute,  although 
more  than  two  years  had  expired  since  the  first  rejection.  If 
the  application  for  refund  was  filed  more  than  two  years  after 
paying  the  tax,  suit  could  not  be  maintained,  and  the  fact  that 
the  Commissioner  rendered  an  adverse  decision  on  the  applica- 
tion, when  filed,  did  not  operate  to  extend  the  time.*^^ 

It  was  thought  that  the  above  rule  did  not  provide  a  definite 
time  within  which  suits  or  proceedings  might  be  begun,  since 
the  rule  made  the  limitation  depend  upon  the  filing  of  a  claim 
for  refund  rather  than  on  the  payment  of  tax."*"'  For  this  reason 
the  statute  of  limitations  upon  suits  or  proceedings  for  the  re- 
covery of  any  tax  alleged  to  have  been  erroneously  or  illegally 
assessed  or  collected,  or  of  any  penalty  claimed  to  have  been  col- 
lected without  authority,  or  of  any  sum  alleged  to  have  been 
excessive  or  in  any  manner  wrongfully  collected,  may  not  be 
begun  under  the  Revenue  Act  of  1921  before  the  expiration  of  six 
months  from  the  time  of  filing  of  a  claim  therefor  with  the  Com- 
missioner, unless  the  Commissioner  renders  a  decision  within 
that  time,  nor  after  the  expiration  of  five  years  "from  the  date 
of  the  payment  of  such  tax,  penalty  or  sum."**'"'  This  extension 
of  the  period  of  limitation  from  two  years  next  after  the  cause 
of  action  accrued  to  five  years  from  the  date  of  payment  does  not 
affect  any  suit  or  proceeding  instituted  prior  to  the  passage  of 
the  Revenue  Act  of  1921,  but  applies  to  all  suits  and  proceedings 
instituted  after  such  passage,  whether  or  not  barred  by  prior 
acts  of  congress.'^" 

Protest  and  Duress.  In  order  to  maintain  an  action  for  the 
recovery  of  taxes  it  is  necessary  that  the  tax  shall  have  been 
paid  under  protest  and  duress.'^'^ 

Suit  Against  Collectors.  The  collector  who  exacted  the  tax 
may  be  sued  for  the  recovery  thereof,  but  an  action  thereon  can- 
not be  commenced  against  his  successor  in  office.  The  remedy 
lies  in  an  action  against  the  collector  to  whom  the  tax  was  paid, 

s-t  P.  S.  Ry.  Co.  V.  Herold,  219  Fed.  301. 

85  Report  of  Senate  Finance  Committee  on  Internal  Revenue  Bill  of  1921, 
p.  32. 

86  R.  S.  3226,  as  amended  by  §  1318  of  the  Revenue  Act  of  1921.  §  1319 
of  the  Revenue  Act  of  1921  repeals,  except  as  to  suits  or  proceedings  in- 
stituted prior  to  the  passage  of  the  Revenue  Act  of  1921,  §  3227  of  the  Re- 
vised Statutes  which  provided  for  a  limitation  upon  such  suits  of  tviro  years 
next  after  the  cause  of  action  accrued. 

87  R.  S.  3226,  as  amended  by  §  1318  of  the  Revenue  Act  of  1921. 

88  p.  S.  Ry.  Co.  V.  Herold,  219  Fed.  301. 


ABATEMENT,   REFUND   AND   RECOVERY   OF  TAXES  937 

or  in  an  action  against  the  United  States.""''  It  has  been  held  that 
an  action  of  assumpsit  may  be  maintained  against  the  collector 
who  actually  exacted  the  tax,  and  such  action  can  be  revived 
against  the  personal  representative  of  the  deceased  collector/"' 
When  once  an  action  has  been  lawfully  commenced  against  a 
collector,  it  does  not  abate  by  reason  of  the  expiration  of  his 
term,  but  in  such  event  the  court  may,  under  the  express  provi- 
sions of  a  statute,  allow  the  suit  to  be  mamtained  against  his 
successor.''^  Suits  against  collectors  are  brought  on  the  theory 
of  money  had  and  received  and  in  such  suits  the  plaintiff  may 
recover  only  such  money  as  he  is  in  equity  entitled  to,  and  as  de- 
fendant is  not  entitled  to  retain."-  Sums  due  the  United  States 
are  a  valid  offset  as  against  amounts  found  due  taxpayers  in 
suits  against  collectors,  though  included  therein  are  items 
which  the  Commissioner  did  not  claim  to  be  due  the  United 
States  when  considering  the  return  for  assessment  purposes.-'-^ 

8!)  For  a  discussion  of  this  subject  see  Chapter  35. 

SOSmietanka  v.  U.  S.,  decided  by  U.  S.  Supreme  Court  October  24,  1921; 
Sage  V.  U.  S.,  250  U.  S.  33;  Cinn.  Gas  &  Elec.  Co.  v.  Gilligan,  T.  B.  29-21- 
1738;  Philadelphia  H.  and  P.  R.  Co.  v.  Lederer,  242  Fed.  492;  Roberts  v. 
Lowe,  236  Fed.  604.  In  the  latter  case  the  court  said  the  latter  remedy  was 
apparently  authorized  by  the  case  of  U.  S.  v.  Emery,  237  U.  S.  28.  As  to 
suing  a  collector  personally  under  a  state  law  for  damages  in  wrongfully 
collecting  taxes,  see  P.  S.  Ry.  Co.  v.  Herold,  229  Fed.  902,  910;  Patton  v. 
Brady,  Executrix,  184  U.  S.  608;  Smietanka  v.  Indiana  Steel  Co.,  42  Sup.  Ct. 
Rep.  1;  Sage  v.  U.  S.,  250  U.  S.  33,  T.  B.  29-21-1738. 

91  Act  of  February  8,  1899;  30  Stat.  L.  822,  c.  121;  Smietanka  v.  U.  S., 
decided  by  U.  S.  Supreme  Court  October  24,  1921;  Sage  v.  U.  S.,  250  U.  S. 
33;  Cinn.  Gas  &  Elec.  Co.  v.  Gilligan,  T.  B.  29-21-1738. 

»2  N.  Y.  Life  Ins.  Co.  v.  Anderson,  257  Fed.  576.  This  case  has  been  re- 
versed on  another  point  (see  263  Fed.  527).  For  a  history  of  the  equitable 
action  of  assumpsit  for  money  had  and  received  see  McKyring  v.  Bull,  16 
N.  Y.  297,  and  Gary  v.  Curtis,  3  How.  236  (dissenting  opinion  by  Story,  J.). 
In  the  latter  case  the  dissenting  opinion  of  Story,  J.,  was  confirmed  as  a 
correct  expression  of  the  Congressional  intent  by  the  explanatory  act  of 
Congress  of  February  26,  1845.  (See  Arnson  v.  Murphy,  109  U.  S.  238.) 
The  case  of  International  Paper  Co.  v.  Burrill,  260  Fed.  664,  which  permits 
an  action  for  recovery  of  a  Massachusetts  tax  illegally  collected  against 
the  collector  personally,  contains  a  thorough  discussion  of  the  subject  of 
actions  against  collectors  and  lays  down  the  rule  that  a  void  act  gives  no 
protection  to  the  collector  from  such  recovery,  that  the  collector  is  not  dis- 
charged from  responsibility  by  the  fact  that  he  deposits  the  illegal  tax 
with  the  treasury  of  the  taxing  authority,  that  the  taxing  authority  may 
not  equip  officials  with  apparent  power  under  unconstitutional  statutes  to 
obtain  money  from  taxpayers  and  to  retain  such  money  in  its  treasury 
unless  the  legislature  of  the  taxing  power  should  "mercifully"  otherwise 
decide. 

93  T.  D.  2882,  T.  B.  9-19-347. 


938  FEDERAL  INCOME   TAX 

Suits  Against  the  United  States.  Suit  for  recovery  of 
taxes  alleged  to  have  been  wrongfully  assessed  and  collected  may 
be  maintained  directly  against  the  United  States  under  the  so- 
called  Tucker  Act.^^  In  answer  to  the  question,  "Can  the  plain- 
tiff bring  suit  to  recover  taxes,  alleged  to  have  been  wrong- 
fully assessed  and  collected  under  the  corporation  tax  law, 
directly  against  the  United  States  under  the  Tucker  Act,  other 
requirements  of  law  having  been  complied  with,  or  is  its  remedy 
against  the  collector  of  internal  revenue  by  whom  the  assess- 
ment and  collection  were  made?"  it  was  held  that  the  question 
was  no  longer  open.^^  ^Yiq  Tucker  Act  refers  to  original  suits, 
and  does  not  permit  a  recovery  of  demands  against  the  United 
States  on  counterclaims."*"' 

Claims  for  Refund  of  Sums  Recovered  by  Suit.  Claims  by 
taxpayers  for  the  amount  of  a  judgment  representing  taxes  or 
penalties  erroneously  collected  should  be  made  on  form  46.  The 
claimant  should  state  the  grounds  of  his  claim  under  oath,  giv- 
ing the  names  of  all  the  parties  to  the  suit,  the  cause  of  action, 
the  date  of  its  commencement,  the  date  of  the  judgment,  the  court 
in  which  it  was  recovered,  and  its  amount.  To  this  affidavit  there 
should  be  annexed  a  certified  copy  of  the  final  judgment,  a  cer- 
tificate of  probable  cause,  and  an  itemized  bill  of  the  costs  paid 
receipted  by  the  clerk  or  other  proper  officer  of  the  court,  together 
with  a  certified  copy  of  the  docket  entries  of  the  court  in  the  case, 
or  so  much  thereof  as  may  be  required  by  the  Commissioner. 
When  a  recovery  is  had  in  any  suit  or  proceeding  against  a  col- 
lector or  other  officer  of  the  revenue  for  any  act  done  by  him,  or 
for  the  recovery  of  any  money  exacted  by  or  paid  to  him  and  by 
him  paid  into  the  treasury,  in  the  performance  of  his  official 
duty,  and  the  court  certifies  that  there  was  probable  cause  for 
the  act  done  by  the  collector  or  other  officer,  or  that  he  acted  un- 
der the  directions  of  the  Secretary  of  the  Treasury,  or  other 
proper  officer  of  the  government,  no  execution  will  issue  against 
such  collector  or  other  officer,  but  the  amount  so  recovered  will, 
upon  final  judgment,  be  provided  for  and  paid  out  of  the  proper 
appropriation  from  the  treasury.  If  the  judgment  debtor  shall 
have  already  paid  the  amount  recovered  against  him,  the  claim 

94  Judicial  Code,  §24,  TI20;  Ch.  397,  24  Stat.  635  (U.  S.  Compiled  Stats., 
p.  3635). 

95  Emery,  Bird  Thayer  Realty  Co.  v.  U.  S.,  198  Fed.  242,  citing  Christie- 
Street  Commission  Co.  v.  U.  S.,  136  Fed.  326. 

90  U.  S.  V.  Nipissing  Mines  Co.,  206  Fed.  431. 


ABATEMENT.   REFUND   AND   RECOVERY   OF   TAXES 


939 


should  be  made  in  his  name.  There  should  also  be  a  certificate 
of  the  clerk  of  the  court  in  which  the  judgment  was  recovered  (or 
other  satisfactory  evidence) ,  showing  that  the  judgment  has  been 
satisfied  and  specifying  the  exact  sum  paid  in  its  satisfaction, 
with  a  detail  of  all  items  of  costs  which  were  paid  by  the  judg- 
ment debtor  for  which  he  is  liable.^" 

Recovery  of  Interest.     It  is  a  well-settled  principle  that  the 
United  States  is  not  liable  to  pay  interest  on  claims  against  it, 
in  the  absence  of  express  statutory  provision  to  that  effect.  It  has 
been  established  as  a  general  rule  in  the  practice  of  the  govern- 
ment that  interest  is  not  allowed  on  claims  against  it,  whether 
such  claims  originate  in  contract  or  in  tort;  whether  they  arise  m 
the  ordinary  business  of  administration,  or  the  private  acts  of 
relief  by  congress  on  special  application.     The  only  recogmzed 
exceptions  are  where  the  government  stipulates  to  pay  interest, 
and  where  interest  is  given  expressly  by  an  act  of  Congress, 
either  by  the  name  of  interest,  or  damages.    Not  only  is  this  the 
general  principle  and  settled  rule  of  the  executive  department  of 
the  government,  but  it  has  been  the  rule  of  the  legislative  de- 
partment, because  congress,  though  well  knowing  the  rule  ob- 
served at  the  treasury,  and  frequently  invited  to  change  it,  has 
refused  to  pass  any  general  law  for  the  allowance  and  payment 
of  interest  on  claims  against  the  government.os    where  a  person 
accepts  from  the  government  without  objection  a  refund  of  a  sum 
illegally  exacted  he  gives  up  his  right  to  sue  for  interest.^^    The 
ground  for  refusal  to  allow  interest  is  the  presumption  that  the 
government  is  always  ready  and  willing  to  pay  its  ordinary  debts. 
In  a  case  where  there  had  been  a  delay  of  thirty  years  m  prose- 
cuting a  claim  to  recover  internal  revenue  taxes,  interest  was  not 
allowed  from  the  date  of  payment  of  the  taxes,  but  was  allowed 
from  the  time  of  commencing  the  suit,  ^oo    The  present  law  con- 
tains a  provision  for  the  recovery  of  interest  as  indicated  in  the 
next  paragraph. 

INTEREST  ON   REFUNDS   AND     JUDGMENTS     UNDER     1921     LAW. 

Upon  the  allowance  of  a  claim  for  the  refund  of  or  credit  for 
internal  revenue  taxes  paid,  interest  is  now  allowable  upon  the 
total  amount  of  such  refund  or  credit  at  the  rate  of  one-half  of 
one  per  centum  per  month  to  the  date  of  such  allowance,  as  fol- 
lows: (1)  if  such  amount  was  paid  under  a  specific  protest  set- 

97  Reg.  45,  Arts.  1031,  1038. 

9S  U.  S.  V.  Bayard,  127  U.  S.  251. 

99  Stewart  v.  Barnes,  153  U.  S.  456. 

100  Burrough  v.  Abel,  105  Fed.  366. 


940  FEDERAL   INCOME   TAX 

ting  forth  in  detail  the  basis  of  and  reasons  for  such  protest, 
from  the  time  when  such  tax  was  paid,  or  (2)  if  such  amount  was 
not  paid  under  protest,  but  pursuant  to  an  additional  assessment, 
from  the  time  such  additional  assessment  was  paid,  or  (3)  if  no 
protest  was  made  and  the  tax  was  not  paid  pursuant  to  an  addi- 
tional assessment,  from  six  months  after  the  date  of  filing  of 
such  claim  for  refund  or  credit.  The  term  "additional  assess- 
ment" means  a  further  assessment  for  a  tax  of  the  same  charac- 
ter previously  paid  in  part.  No  interest  will  be  allowed  on  any 
claim  up  to  the  time  of  the  rendition  of  judgment  by  the  court  of 
claims,  unless  upon  a  contract  expressly  stipulating  for  the  pay- 
ment of  interest,  except  that  interest  may  be  allowed  in  any  judg- 
ment of  any  court  rendered  after  the  passage  of  the  Revenue 
Act  of  1921  against  the  United  States  for  any  internal  revenue 
tax  erroneously  or  illegally  assessed  or  collected,  or  for  any  pen- 
alty collected  without  authority  or  any  sum  which  was  exces- 
sive or  in  any  manner  wrongfully  collected,  under  the  internal 
revenue  laws.^"^ 

Recovery  Against  Collectors.  When,  however,  an  illegal 
tax  has  been  collected,  the  citizen  who  has  paid  it,  and  has  been 
obliged  to  bring  suit  against  the  collector,  is  entitled  to  interest 
in  the  event  of  recovery,  from  the  date  of  the  illegal  exaction. ^^^ 
Where  judgment  is  recovered  in  an  action  against  a  collector, 
interest  may  be  recovered  up  to  the  time  final  judgment  is 
entered  and  a  certificate  from  the  trial  court  that  there  was 
probable  cause  for  the  collection  of  the  tax  has  been  given.  Upon 
giving  such  certificate  the  claim  becomes  one  against  the  United 
States,  stopping  the  right  to  further  interest,  unless  a  review  of 
the  judgment  by  an  appellate  court  is  obtained,  in  which  event 
the  judgment  upon  the  mandate  of  the  appellate  court  will  be 
treated  as  a  final  judgment,  to  the  rendition  of  which  interest 
will  be  allowed,  unless  the  plaintiff  unduly  delays  the  presenta- 
tion of  his  claim. '"-^  A  suit  against  a  collector  is  a  private  suit 
and  there  is  no  claim  against  the  government  until  a  certificate 

101  Revenue  Act  of  1921,  §  1324.  This  provision  was  inserted  for  the 
purpose  of  "expediting  the  refund  of  taxes  and  compelling  the  government, 
in  the  event  that  such  refund  is  unnecessarily  delayed,  to  pay  interest  at 
the  ordinary  rate".  (Report  of  Senate  Finance  Committee  on  Internal 
Revenue  Bill  of  1921,  p.  33.) 

i02Erskine  v.  Van  Arsdale,  15  Wall.  75;  Old  Colony  R.  Co.  v.  Gill,  257 
Fed.  220;  Redfield  v.  Bartels,  139  U.  S.  694;  N.  Y.  Life  Ins.  Co.  v.  Anderson, 
263  Fed.  527;  N.  Y.  Mail  Co.  v.  Anderson,  234  Fed.  .590;  Conant  v.  Kinney, 
162  Fed.  581;  Park  v.  Gilligan,  Dist.  Ct.  So.  Dist.  Ohio;  I.  T.  S.  1921,  113067. 

103  Klock  Produce  Co.  v.  Hartson,  212  Fed.  758. 


.    ABATEMENT,   REFUND  AND   RECOVERY   OF  TAXES  941 

of  probable  cause,  under  the  revised  statutes, i"^  has  been  obtained 
from  the  court,  at  which  time  the  government  assumes  a  definite 
liability  of  the  collector,  which  does  not  include  the  payment  of 
interest  thereafter ;  neither  is  there  any  further  personal  liability 
on  the  part  of  the  collector.  The  interest  which  may  be  recovered 
is  that  put  into  the  judgment  before  there  is  any  certificate  of 
probable  cause,  and  if  none  has  been  put  in,  the  government 
assumes  no  part  of  the  liability  of  the  defendant.  The  liability 
assumed  by  the  government  includes  interest  and  costs  forming 
part  of  the  recovery,  but  does  not  include  interest  after  judg- 
ment.^"'' It  has  been  held  that  where  railroads,  seeking  to  re- 
cover internal  revenue  taxes  illegally  assessed,  delayed  in  press- 
ing their  claims  on  account  of  an  understanding  with  the  col- 
lectors that  the  claims  should  await  the  decision  of  other  pend- 
ing cases,  but  it  became  apparent  that  the  question  of  interest 
could  not  be  adjusted,  the  railroad's  conduct  did  not  disentitle 
them  to  interest  for  any  lack  of  diligence  in  prosecution. i'"' 

Costs.  The  revised  statutes  authorize  the  Commissioner 
to  repay  to  any  collector  or  deputy  collector  the  full  amount 
of  such  sums  of  money  as  may  be  recovered  against  him  in  any 
court,  for  any  internal  revenue  taxes  collected  by  him,  with  the 
cost  and  expenses  of  suit;  also  all  damages  and  costs  recovered 
against  any  assessor,  assistant  assessor,  collector,  deputy  col- 
lector, agent  or  inspector  in  any  suit  brought  against  him  by 
reason  of  anything  done  in  the  due  performance  of  his  official 
duty.  Under  this  section  costs  may  be  recovered  against  the 
collector.^""  Judgment  is  usually  given  in  the  district  court  for 
costs  and  interest. 

Claims  for  Abatement  of  Uncollectible  Taxes.  ""When  a  tax 
under  the  1918  Law  was  found  to  be  uncollectible,  the  collector 
or  deputy  collector  who  made  the  demand  for  payment  and  was 
conversant  with  the  facts  prepared  a  claim  for  abatement  on 
form  53.  Although  credits  allowed  on  account  of  insolvency  or 
absconding  released  the  collector  from  the  obligation  created  by 
his  receipt  for  the  amount  credited,  the  obligation  to  pay  still 
remained  upon  the  person  assessed.  It  was  the  duty  of  the  col- 
lector to  use  the  same  diligence  to  collect  a  tax  after  it  had  been 
abated  as  uncollectible  as  before  abatement.     Collectors  kept  a 

104  R.  S.,  §  989. 

los  White  V.  Arthur,  10  Fed.  80. 

106  Boston  &  P.  R.  Corp.  v.  Gill,  257  Fed.  221. 

107  De  Bary  v.  Carter,  102  Fed.  130.  However,  see  Treat  v.  Farmers 
Loan  and  Trust  Co.,  185  Fed.  760,  763,  as  to  costs  in  the  Supreme  Court  and 
Circuit  Court  of  Appeals. 


942  FEDERAL  INCOME   TAX 

record  of  all  taxes  thus  credited  and  of  the  persons  from  whom 
they  were  due,  and  enforced  payment  whenever  it  was  in  their 
power  to  do  so.i*^^ 

Reopening-  of  Cases.  Where  any  case  in  the  bureau  of  internal 
revenue  has  been  finally  closed  after  the  taxpayer,  or  other  party 
thereto,  has  had  a  hearing  or  has  been  afforded  by  written  notice 
an  opportunity  to  present  oral  or  written  arguments  or  state- 
ments of  fact  in  support  of  his  contentions,  the  case  will  not  be 
reopened  except  (1)  where  a  showing  is  made  of  new  and  material 
facts,  accompanied  by  an  explanation,  satisfactory  to  the  Com- 
missioner, of  the  failure  to  produce  such  facts  prior  to  the  clos- 
ing of  the  case,  or  (2)  where  the  case  is  materially  affected  by 
the  change  of  regulations  or  by  the  final  decision  of  another  case 
either  by  the  Commissioner  or  by  a  court  of  competent  jurisdic- 
tion. The  application  for  reopening  a  case  should  be  addressed 
to  the  Commissioner,  should  state  succinctly  the  facts  and  the 
circumstances  upon  which  the  application  is  based,  and  must  be 
supported  by  the  affidavit  of  a  person  having  knowledge  of  the 
facts.  This  rule  is  not  to  be  construed  as  modifying  the  regula- 
tions relating  to  the  filing  of  claims  in  abatement  or  claims  for 
refund,  nor  as  denying  the  right  of  a  taxpayer  to  a  hearing  or 
to  an  appeal  at  any  stage  of  his  case  until  the  case  has  been 
finally  closed.  After  the  taxpayer  has  exhausted  his  remedies 
within  the  bureau,  however,  and  the  case  has  been  finally  closed, 
it  will  be  reopened  only  under  the  conditions  stated  above.^^^' 

108  Reg.  45,  Art.  1033. 

109  R.  s.,  §  3220,  as  amended  by  the  Revenue  Act  of  1918,  re-enacted  by 
§  1315  of  the  Revenue  Act  of  1921,  without  change.  The  1918  amendment 
extended  the  provision  to  assessors,  assistant  assessors  and  agents. 

110  T.  D.  3240,  T.  B.  46-21-1927. 


CHAPTER  38 

EXAMINATION  OF  TAXPAYERS'   BOOKS 

The  Revenue  Act  of  1921  and  the  Revised  Statutes  contain 
certain  provisions  for  the  examination  of  taxpayers'  books  by 
revenue  agents  or  inspectors,  the  attendance  of  witnesses  before 
the  Commissioner  and  the  production  of  books  in  suits  or  pro- 
ceedings arising  under  the  revenue  lav^s  v^hich  are  set  forth  in 
the  following  paragraphs.  The  Revenue  Act  of  1921  adds  a  new 
provision  to  guard  the  taxpayer  against  unnecessary  examina- 
tions or  investigations. 

Examination  of  Books.  For  the  purpose  of  ascertaining  the 
correctness  of  any  return  or  making  a  return  where  none  has 
been  made,  the  Commissioner  may,  by  any  revenue  agent  or  in- 
spector designated  by  him  for  that  purpose,  examine  any  books, 
papers,  records  or  memoranda  bearing  upon  the  matters  required 
to  be  included  in  the  return. ^  A  taxpayer  is  entitled  to  satisfy 
himself  in  a  reasonable  manner  of  the  official  character  and 
authority  of  any  person  making  request  to  examine  books  or 
accounts  of  his  bank  as  an  official  of  the  internal  revenue 
bureau.-  Under  the  present  law,  no  taxpayer  may  be  subjected 
to  unnecessary  examinations  or  investigations,  and  only  one 
inspection  of  a  taxpayer's  books  of  account  may  be  made  for  each 
taxable  year  unless  the  taxpayer  requests  otherwise  or  unless 
the  Commissioner,  after  investigation,  notifies  the  taxpayer  in 
writing  that  an  additional  inspection  is  necessary.-^ 

Requiring-  Attendance  of  Witnesses.  For  the  purpose  stated 
in  the  previous  paragraph  the  Commissioner  may  require  the 
attendance  of  the  person  rendering  a  return  or  of  any  officer  or 
employee  of  such  person  o/'  the  attendance  of  any  other  person 
having  knoivledge  hi  the  premises^  and  may  take  his  testimony 
with  reference  to  the  matters  required  to  be  included  in  such 
return.      The   Commissioner,   every   collector,    deputy   collector, 

1  Revenue  Act  of  1921,  §1308;  Revenue  Act  of  1918,  §1305.  In  relation 
to  the  income  tax  this  provision  seems  to  supplant  R.  S.,  §  3173,  which  as 
amended,  omits  the  second  case  "in  case  of  income  tax  on  or  before  the 
first  day  of  March  in  each  year,  or  on  or  before  the  last  day  of  the  sixty-day 
period  next  following-  the  closing-  date  of  the  fiscal  year  for  which  it  makes 
a  return  of  its  income"  and  also  omits  the  phrase  "amount  of  annual  income 
charged  with  a  duty  or  tax." 

2  O.  D.  609,  T.  B.  30-20-1096. 

3  Revenue  Act  of  1921,  §  1309. 

•^  The  italicized  words  would  seem  to  have  been  inserted  to  avoid  the  effect 

943 


944  FEDERAL   INCOME   TAX 

internal  revenue  agent,  and  internal  revenue  officer  assigned  to 
duty  under  an  internal  revenue  agent  is  clothed  with  power  to 
administer  oaths  to  such  person  or  persons  as  may  be  required 
to  attend  any  hearing  before  him/' 

Requiring  Production  of  Books.  In  all  suits  and  proceedings, 
other  than  criminal,*"^  arising  under  any  of  the  revenue  laws 
of  the  United  States,  the  attorney  representing  the  government 
may,  whenever  in  his  belief  any  business-book,  invoice  or  paper, 
belonging  to  or  under  the  control  of  the  defendant  or  claimant, 
will  tend  to  prove  any  allegation  made  by  the  United  States, 
make  a  written  motion  particularly  describing  such  book,  invoice 
or  paper,  and  setting  forth  the  allegation  which  he  expects  to 
prove;  and  thereupon  the  court  may,  at  its  discretion,  issue  a 
notice  to  the  defendant  or  claimant  to  produce  the  same.  Upon 
failure  to  do  so  the  allegation  stated  in  the  motion  is  taken  as 
confessed,  unless  the  failure  or  refusal  is  explained  to  the  sat- 
isfaction of  the  court."  This  provision  applies  to  proceedings 
under  the  internal  revenue  laws  as  well  as  the  customs  revenue 
laws.s 

Enforcement  of  Provisions  Requiring  Examination,  Attend- 
ance and  Production.  If  any  person  is  summoned  to  appear,  to 
testify,  or  to  produce  books,  papers  or  other  data,  the  United 
States  district  court  for  the  district  in  which  such  person  re- 
sides is  invested  with  jurisdiction  of  appropriate  means  to  compel 
such  attendance,  testimony,  or  production  of  books,  papers  or 
other  data,  and  to  make  and  issue,  both  in  actions  at  law  and 
suits  in  equity,  such  writs,  orders,  judgments,  decrees  and  process 
as  may  be  necessary  or  appropriate  for  the  enforcement  of  any 
provisions  requiring  such  attendance,  testimony  or  production, 
but  only  at  the  instance  of  the  United  States.  Any  remedy  of 
application  to  the  district  court  is  in  addition  to  and  not  ex- 

of  such  decisions  as  In  re  Chadwick,  5  Fed.  Cas.  No.  2,570,  11  Int.  Rev.  Rec. 
126,133,  which  held  under  a  similar  statute  that  the  books  which  the  as- 
sessor has  the  right  to  examine  are  those  of  the  person  whose  assessment  is 
in  question  and  not  those  of  third  persons  who  have  had  dealings  with  him, 
and  consequently  that  a  corporation  was  not  bound  to  produce  its  books 
upon  an  inquiry  into  the  income  of  its  shareholders. 

5  R.  S.  3165,  as  amended  by  §  1311  of  the  Revenue  Act  of  1921  and  by 
§  1317  of  the  Revenue  Act  of  1918. 

6  In  Boyd  v.  U.  S.,  116  U.  S.  616,  it  was  held  that  proceedings  to  forfeit  a 
person's  goods  for  an  offense  against  the  law,  though  civil  in  form,  and 
whether  in  rew  or  in  personam,  was  a  "criminal"  case,  within  the  mean- 
ing of  this  provision  of  law. 

7  Act  of  June  22,  1874,  18  Stat.  187. 

8  U.  S.  v.  Distillery  No.  28,  25  Fed.  Cas.  No.  14,966. 


EXAMINATION  OF  TAXPAYERS'  BOOKS  945 

elusive  of  any  and  all  remedies  of  the  United  States  in  such 
courts  and  otherwise  to  enforce  such  provisions." 

Constitutionality  of  Statute  Providing  for  Examination  and 
Production  of  Books.  It  has  been  held  that  (1)  the  above  men- 
tioned provision  of  law  requiring  the  production  of  books  is  un- 
constitutional and  void  as  to  suits  for  penalties  or  to  establish  a 
forfeiture,  because  repugnant  to  the  fourth  and  fifth  amend- 
ments to  the  Constitution,  which  are  to  be  construed  in  relation 
to  each  other;  (2)  actual  entry  upon  premises  and  search  for 
and  seizure  of  papers  is  not  required  to  bring  a  case  within  the 
meaning  of  the  fourth  amendment  prohibiting  unreasonable 
searches  and  seizures;  (3)  a  compulsory  production  of  a  party's 
private  books  and  papers  to  be  used  against  him  or  his  property 
in  a  criminal  or  penal  proceeding  or  proceeding  for  a  forfeiture 
is  within  the  spirit  of  such  amendment;  (4)  it  is  equivalent  to 
compulsory  production  to  make  nonproduction  a  confession  of 
the  allegations  which  it  is  pretended  such  books  will  prove; 
(5)  a  proceeding  to  forfeit  goods,  though  civil  in  form  and 
whether  in  rem  or  in  personam,  is  a  criminal  case  within  the 
meaning  of  the  fifth  amendment  which  declares  that  no  man 
"shall  be  compelled  in  any  criminal  case  to  be  a  witness  against 
himself;"  and  (6)  the  seizure  or  compulsory  production  of  a 
man's  private  papers  to  be  used  against  him  is  equivalent  to 
compelling  him  to  be  a  witness  against  himself.^*'  It  is  doubtful, 
however,  whether  this  decision  and  others  of  a  similar  purport" 
relate  to  proceedings  to  assess  and  recover  unpaid  taxes,  or  to 
discover  the  extent  of  a  person's  tax  liability,  to  accomplish 
which  ends  the  compulsory  production  of  books  and  papers  may 
be  considered  a  legitimate  and  appropriate  means  within  the 
legislative  discretion.  The  constitutionality  of  a  similar  statute 
for  the  enforcement  of  the  internal  revenue  laws  has  been  up- 
held,^-  and  it  has  been  asserted  that  acts  conferring  the  high 

9  Revenue  Act  of  1921,  §  1310;  Revenue  Act  of  1918,  §  1318. 

10  Boyd  V.  U.  S.,  116  U.  S.  616. 

11  Weeks  v.  U.  S.,  232  U.  S.  383;  In  re  Pacific  Railway  Comm.,  32  Fed.  241. 

12  In  re  Strouse,  23  Fed.  Cas.  No.  13,548;  1  Sawy.  605;  11  Int.  Rev.  Rec. 
182.  In  re  Piatt,  19  Fed.  Cas.  No.  11,212,  a  distinction  is  pointed  out  be- 
tween the  constitutionality  of  an  act  and  the  constitutionality  of  the  manner 
in  which  the  act  is  administered  in  any  particular  case,  as  follows:  "A 
search  and  seizure  may  be  unreasonably  conducted,  in  execution,  under  the 
statute  authorizing  it,  and  thus  the  right  of  security  sought  to  be  protected 
by  the  fourth  amendment  may  be  violated;  and,  under  what  is  due  process 
of  law,  as  authorized  by  the  statute,  a  person  may  be  deprived  of  his  prop- 
erty, when  the  statute  did  not  contemplate  or  authorize  such  deprivation, 
and  thus  the  fifth  amendment  may  be  violated.    But  these  things  are  not  the 


946  FEDERAL  INCOME   TAX 

power  upon  administrative  officers  of  compelling  the  production 
of  books  and  attendance  of  persons  have  been  acquiesced  in  for 
so  long  a  time  without  serious  objection  that  their  constitu- 
tionality is  no  longer  open  to  debate.^'  Upon  a  habeas  corpus 
proceeding  in  the  case  of  a  tobacco  manufacturer  who  was  com- 
mitted for  failure  to  appear  and  produce  books  in  obedience  to 
a  summons,  it  was  held  that  (1)  he  must  bring  the  books  con- 
taining the  entries  relating  to  his  business  before  the  assessor; 
and  (2)  he  might  then  be  asked  to  exhibit  any  entry  relating 
to  a  particular  point  and  if  he  should  say  he  could  not  do  so 
without  incriminating  himself,  he  would  be  protected  from  ex- 
hibiting it.i^  In  a  later  case^^^  in  the  Supreme  Court,  which  sus- 
tained the  validity  of  the  Interstate  Commerce  Act  so  far  as  it 
gave  power  to  the  Commission  to  require  the  attendance  of  wit- 
nesses and  the  production  of  papers,  it  was  held  that  it  was 
open  to  each  witness  to  contend  that  he  was  protected  by  the 
constitution  from  answering  the  questions  propounded  to  him, 
that  he  was  not  legally  bound  to  produce  the  books  or  papers, 
and  that  neither  the  questions  propounded  nor  the  books  called 
for  related  to  the  matter  under  investigation.  This  authority 
by  analogy  would  seem  to  dispose  of  the  argument  that  informa- 
tion brought  out  in  a  proceeding  under  the  internal  revenue  laws 
to  ascertain  the  amount  of  tax  liability  of  any  taxpayer  might 
be  used  against  him  in  a  later  criminal  proceeding  or  proceeding 
for  a  penalty  or  forfeiture.  While  a  witness  being  examined  de 
bene  esse  under  Section  863  of  the  revised  statutes  may  be  com- 
pelled to  produce  books  and  papers  which  would  be  material  evi- 
dence for  the  party  calling  him  upon  the  trial  of  the  case,  he 

fault  of  the  statute  as  it  stands.  They  grow  out  of  the  fact  that  the  statute 
is  administered,  in  the  particular  case,  in  a  manner  not  authorized  by  the 
statute.  They  are  violative  alike  of  the  statute  and  of  the  Constitution,  but 
they  have  no  effect  to  make  the  statute  unconstitutional." 

13  Perry  v.  Newsome,  19  Fed.  Cas.  No.  11,009;  10  Int.  Rev.  Rec.  20. 

14  In  re  Lippman,  3  Ben.  95;  15  Fed.  Cas.  No.  8,382;  9  Int.  Rev.  Rec.  1. 
This  case  arose  under  §  14  of  the  Act  of  June  30,  1864. 

15  Interstate  Commerce  Commission  v.  Brimson,  154  U.  S.  447;  155  U.  S.  3. 
This  argument  is  disposed  of  in  another  manner  In  re  Phillips,  19  Fed.  Cas. 
No.  11097;  10  Int.  Rev.  Rec.  107.  The  court  makes  the  following  quotation 
from  Peo.  v.  Hackley,  24  N.  Y.  83:  "But  neither  the  law  nor  the  Consti- 
tution is  so  sedulous  to  screen  the  guilty  as  the  argument  supposes.  If  a  man 
can  not  give  evidence  upon  the  trial  of  another  person  without  disclosing 
circumstances  which  will  make  his  own  guilt  apparent,  or  at  least  capable 
of  proof,  though  his  account  of  the  transaction  should  never  be  used  as 
evidence,  it  is  the  misfortune  of  his  condition  and  not  any  want  of  humanity 
in  the  law." 


EXAMINATION  OF  TAXPAYP:RS'   BOOKS  947 

may  not  be  compelled  to  produce  his  books  and  papers  merely 
for  the  purpose  of  refreshing  his  memory."'  The  cases  upon  this 
point  are  in  some  confusion  and  the  distinction  between  crimmal 
or  quasi-criminal  proceedings  involving  penalties  and  forfeitures 
and  proceedings  to  ascertain  and  recover  the  amount  of  any  tax 
due,  is  nowhere  clearly  drawn. 

Corporations.    It  will  be  noted  that  in  so  far  as  the  above  men- 
tioned provisions  relating  to  the  examination  of  witnesses  and 
the  production  of  books  and  papers  have  been  or  may  still  be 
declared  void,  their  unconstitutionality  is  based  upon  a  violation 
of  the  fourth  and  fifth  amendments  to  the  Constitution  of  the 
United  States.    It  is  by  no  means  definitely  settled  to  what  extent 
corporations,  which  are  creatures  of  the  state,  are  protected  and 
given  immunity  by  virtue  of  such  amendments.     In  a  compara- 
tively recent  case  in  the  Supreme  Court  i'  it  was  held  that  cor- 
porations were  not  protected  by  the  fifth  amendment  and  that 
while  an  individual  may  lawfully  refuse  to  answer  incriminating 
questions  unless  protected  by  an  immunity  statute,  it  does  not 
follow  that  a  corporation  vested  with  special  privileges  and  fran- 
chises may  refuse  to  produce  its  books  and  papers,  but  the  court 
expressly  stated  that  it  did  not  wish  to  be  understood  as  holding 
that  a  corporation  is  not  entitled  to  immunity  under  the  fourth 
amendment  against  unreasonable  searches  and  seizures. 

National  Banks.    The  law  under  which  national  banks  are  in- 
corporated, which  provides  for  the  occasional  examination  of 

16  U.   S.  V.  Tilden,  28   Fed.   Cas.   No.   16,522;    10   Ben.   566;    25   Int.   Rev. 

^T^nSe  V.  Henkel,  201  U.  S.  43;  Nelson  v.  U.  S.,  201  U.  S.  92.     The  court 
was  considerably  divided  in  this  case.    The  opinion  of  the  "^-J^"^^  J^^^^f^' 
livered  by  Mr.  Justice  Brown.    Mr.  Justice  Harlan  delivered  a  separate  con- 
curring opinion  in  which  he  went  further  than  the  majority  and  stated  his 
opinion   that   a   corporation   could   not    claim    immunity   under    the    fourth 
amendment  for  the  reason  that  it  is  not  a  part  of  the  "people'   or  embraced 
brthe  word  "persons"  as  used  in  that  amendment.     Mr.  Justice  McKenna. 
aL  concurring,  stated  his  opinion  that  corporations  had  no  immunity  under 
the  fourth  amendment,  because  as  stated  m  Boyd  v.  US.,  116  U^  b.  bib,  the 
fourth  and  fifth   amendments  were  complimentary  of  each  other  and  the 
denial  of  the  protection  of  one  carried  a   denial  of  the  protection  of  the 
other      Mr.  Justice  Brewer,  with  whom  the   Chief  Justice  concurred    dis- 
sented, and  stated  their  opinion  that  the  immunities  and  protection  of  the 
fourth  and  fifth  amendments  are  available  to  corporations  so  far  as  m  the 
nature  of  things  they  are  applicable.     In  International  Mining  Co   v.  Penn- 
sylvania Railroad  Co.,  152  Fed.  557,  Judge  Holland,  in  holding'  that  a  cor- 
poration may  not  refuse  to  produce  its  books  in  an  action  against  it  to  re- 
cover damages  or  penalties  for  a  violation  of  the  Interstate  Commerce  Com- 
mission Act,  expresses  the  opinion  that  the  question  had  been  practically  dis- 
posed of  by  the  Henkel  case. 


948  FEDERAL   INCOME  TAX 

their  affairs  and  reports  of  their  condition  to  the  national  gov- 
ernment and  enacts  that  they  shall  not  be  subject  to  any  visitorial 
powers  other  than  are  authorized  by  the  act  or  are  vested  in  the 
courts  of  justice,  does  not  exempt  them  from  liability  to  exam- 
ination.^'^ 

Examination  of  Books  and  Papers  in  the  Cases  of  Special  Taxes 
and  Other  Cases.  In  the  case  of  any  special  tax  and  in  the 
case  of  other !'>>  taxes  it  is  the  duty  of  any  person,  partnership, 
firm,  association  or  corporation  liable  to  make  a  verified  return 
to  the  collector  where  the  articles  or  objects  or  goods,  wares 
or  merchandise  charged  with  the  tax  are  located.  In  case  of 
failure  to  make  such  return,  if  the  person  liable  consents  to 
disclose  the  particulars,  it  is  the  duty  of  the  collector  or  deputy 
collector  to  make  the  list  or  return  which,  when  consented  to,  is 
received  as  the  return  of  such  person.  If  any  person,  on  being 
notified  or  required  to  make  his  return  by  the  leaving  at  his 
place  of  residence  or  business  with  someone  of  suitable  age  or 
discretion  or  the  depositing  in  the  nearest  post-office  a  memoran- 
dum addressed  to  him,  refuses  or  neglects  to  make  the  return 
within  ten  days  from  the  date  of  the  notice,  or  delivers  any 
return,  which  in  the  opinion  of  the  collector  is  erroneous,  false 
or  fraudulent  or  contains  any  under-valuation  or  under-state- 
ment  or  refuses  to  allow  a  regularly  authorized  government  offi- 
cer to  examine  his  or  its  books,  the  collector  may  summon  such 
person,  partnership,  firm,  association  or  corporation  or  any  per- 
son having  possession,  custody  or  care  of  the  books  of  account 
containing  entries  relating  to  the  business  of  such  person,  part- 
nership, firm,  association  or  corporation,  or  any  other  person, 
to  appear  before  him  and  produce  the  books  and  give  testimony 
or  answer  interrogatories  respecting  any  objects  liable  to  tax  or 
the  returns  thereof.  When  the  person  intended  to  be  summoned 
does  not  reside  in  the  state  or  territory  in  which  the  collector's 
district  lies,  the  collector  may  enter  any  collection  district  where 
the  person  may  be  found  arid  there  make  the  above  examina- 
tion.2o 

Inspection  of  Government  Contracts.  The  Revenue  Act  of 
1918  provided  that  every  person  who  on  or  after  April  6,  1917, 
entered  into  any  contract,  undertaking,  or  agreement  with  the 
United  States  or  with  any  department,  bureau,  officer,  commis- 

is  U.  S.  V.  Rhawn,  27  Fed.  Cas.  No.  16,150. 

19  See  note  1. 

20  R.  S.,  §3173,  as  amended  by  Revenue  Act  of  1921,  §1311,  and  by 
Revenue  Act  of  1918,  §  1317.     See  Reg.  33,  Art.  186. 


EXAMINATION  OF  TAXPAYERS'  BOOKS  949 

sion,  board,  or  agency  under  the  United  States  or  acting  in  its 
behalf,  or  with  any  other  person  having  contract  relations  with 
the  United  States,  for  the  performance  of  any  work  or  the  supply- 
ing of  any  materials  or  property  for  the  use  of  or  for  the  account 
of  the  United  States,  is  required,  within  thirty  days  after  a  re- 
quest of  the  Commissioner  therefor,  to  file  with  the  Commis- 
sioner a  true  and  correct  copy  of  every  such  contract,  undertak- 
ing, or  agreement.  Failure  to  comply  with  such  requests  of  the 
Commissioner  is  punishable  as  a  misdemeanor  and  by  a  fine  of 
not  more  than  $1,000,  or  by  imprisonment  for  not  more  than 
one  year,  or  both.  The  Commissioner  (when  not  violative  of  the 
technical  military  or  naval  secrets  of  the  government)  has  access 
to  all  information  and  data  relating  to  any  such  contract,  under- 
taking or  agreement,  in  the  possession,  control  or  custody  of  any 
department,  bureau,  board,  agency,  officer  or  commission  of  the 
United  States  and  may  call  upon  any  such  department,  bureau, 
board,  agency,  officer  or  commission  for  a  full  statement  and  de- 
scription of  any  allowance  for  amortization,  obsolescence,  depre- 
ciation or  loss,  or  of  any  valuation,  appraisal,  adjustment  or  final 
settlement,  made  in  pursuance  of  any  such  contract,  undertaking, 
or  agreement.-^  The  above  provision  is  omitted  from  the  present 
law. 

Instructions  to  Revenue  Agents.  The  following  instructions 
have  been  given  by  the  treasury  department  to  revenue  agents 
and  examiners:  "In  conducting  their  examination  the  agents 
will,  except  in  clear  cases  of  misrepresentation,  proceed  on  the 
assumption  that  all  errors  in  the  returns  rendered  are  uninten- 
tional ;  and  they  will,  so  far  as  possible,  make  their  examination 
in  such  manner  as  not  to  interfere  with  the  company's  business, 
either  as  to  the  use  of  its  books  or  in  the  general  conduct  of  its 
affairs.  Contentions  with  officers,  employees  or  representatives 
of  corporations  are  to  be  carefully  avoided,  and  no  action  that 
may  cause  friction,  that  is  not  necessary  in  the  proper  perform- 
ance of  their  duties,  must  be  indulged  in  by  officers  making  these 
examinations.  Ordinarily  no  very  extended  examination  of  the 
company's  books  will  be  necessary,  as  the  verification  of  the 
particular  items  to  which  attention  has  been  called  will  be  suffi- 
cient. Where,  however,  a  thorough  examination  is  found  to  be 
necessary,  and  the  accounts  are  so  kept  as  to  involve  much  labor 
in  their  examination,  the  agent  may  assign  two  assistants  for 
this  purpose.-  Where  discrepancies  between  the  company's  books 
and  the  return  made  are  discovered,  the  officers  of  the  company 

21  Revenue  Act  of  1918,  §  1408. 


950  FEDERAL  INCOME   TAX 

should  be  given  full  opportunity  to  explain  the  same,  and  to 
furnish,  if  so  desired,  a  sworn  statement  in  reference  thereto. 
In  such  cases  the  agent  will,  if  deemed  necessary,  require  the 
attendance  of  any  officer  or  employee  of  the  company,  and  there 
examme  such  officer  or  employee  respecting  the  matter  under 
investigation.  The  witnesses  in  such  cases  should  be  duly  sworn 
by  the  agent,  and  in  case  of  refusal  of  any  such  officer  or  em- 
ployee to  testify,  or  in  the  case  of  refusal  to  produce  the  books 
or  papers  called  for,  the  agent  will  at  once  report  the  fact  to 
this  office."  22 

22  T.  D.  1617. 


CHAPTER  39 

INFORMATION    AT   THE    SOURCE 

To  assist  in  the  administration  of  the  income  tax  law,  certain 
information  is  required  to  be  furnished  by  brokers  as  to  their 
customers,  by  corporations  as  to  dividend  and  interest  payments, 
by  first  or  last  banks  or  collection  agencies  as  to  foreign  items, 
and  by  individuals,  partnerships  and  corporations  generally  (in- 
cluding lessees  or  mortgagors  of  real  or  personal  property, 
fiduciaries,  and  employers)  as  to  payments  of  income  to  others, 
in  order  that  the  treasury  department  may  have  data  on  which 
to  audit  returns  of  income. ^  The  several  classes  of  payments 
which  are  required  to  be  reported,  and  the  provisions  with  re- 
spect to  each,  are  discussed  in  the  following  paragraphs.  The 
Revenue  Act  of  1921  makes  no  change  in  this  regard. 

Miscellaneous  Income,  Gains  and  Profits.  It  is  provided  that 
payments  of  interest,  rent,  salaries,  wages,  premiums,  annuities, 
compensations,  remunerations,  emoluments  or  other  fixed  or  de- 
terminable gains,  profits  and  income  of  $1,000  or  more  must  be 
reported  by  the  payor  thereof.-  "Fixed  or  determinable  gains, 
profits  and  income,"  as  used  in  the  law,"'  would  seem  to  include 
payments  of  all  the  kinds  expressly  enumerated  and  all  pay- 
ments of  a  similar  nature.  In  the  case  of  collection  at  the  source 
payments  must  be  annual  or  periodical,  while  in  the  case  of  in- 
formation at  the  source  the  law  does  not  contain  such  a  limita- 
tion. Hence  any  payments  of  the  kind  described  in  the  law, 
whether  made  in  isolated  cases,  or  from  time  to  time,  must  be 
reported.-^  If  the  aggregate  of  several  payments  made  to  the 
same  payee  equals  or  exceeds  $1,000  in  any  taxable  year,  the 
gross  amount  should  be  reported.  The  payments  may  be  from 
different  forms  of  income,  as  for  instance,  from  interest  and 
rent,  or  interest  and  salary.  In  such  cases,  it  seems  the  total  is 
required  by  law  to  be  reported,  if  the  aggregate  of  all  payments 
in  the  year  to  the  same  payee  equals  or  exceeds  $1,000. 

1  Revenue  Act  of  1921,  §§254,  255  and  256;  Revenue  Act  of  1918,  §§254, 
255  and  256.  These  administrative  provisions  first  appeared  in  the  1916 
Lav?  by  amendment  in  1917. 

2  Revenue  Act  of  1921,  §  256;  Revenue  Act  of  1918,  §  256.  There  must  be 
payment.  Interest  accrued  on  bank  deposits  before  it  has  passed  to  the 
credit  of  the  depositor  need  not  be  reported.     (T.  D.  2670). 

3  Revenue  Act  of  1921,  §  256;  Revenue  Act  of  1918,  §  256. 

*  Reg.  45,  Art.  1071.  Payments  made  to  corporations,  associations,  and 
insurance  companies  for  the  year  1917  did  not  require  reporting. 

951. 


952  FEDERAL  INCOME   TAX 

Salaries,  Wages  or  Compensation.  The  names  of  all  em- 
ployees to  whom  payments  exceeding  $1,000  a  year  are  made, 
whether  such  total  sum  is  made  up  of  wages,  salaries,  commis- 
sions or  compensation  in  any  other  form,  must  be  reported. 
A  domestic  corporation  employing  American  citizens  in  Canada 
on  a  commission  basis,  and  paying  such  commissions  weekly  in 
Canadian  money,  should  compute  each  commission  separately 
in  accordance  with  the  rate  of  exchange  in  effect  on  the  date  of 
each  payment  and  report  the  aggregate  amount  paid  during  the 
taxable  year."'  Heads  of  branch  offices  and  subcontractors  em- 
ploying labor,  who  keep  the  only  complete  record  of  payments 
therefor,  should  file  returns  of  information  in  regard  to  such 
payments  directly  with  the  Commissioner.  When  both  main 
office  and  branch  office  have  adequate  records,  the  return  should 
be  filed  by  the  main  office.  In  the  case  of  an  employer  having 
a  large  number  of  employees  who  are  moved  from  place  to  place 
as  the  exigencies  of  the  service  require,  and  who  consequently 
has  no  complete  record  of  annual  payments  to  them  at  any  one 
place,  the  salary  of  two  representative  months  may  be  taken  to 
establish  a  fair  monthly  wage,  and  unless  the  yearly  payment 
based  on  this  estimate  in  the  case  of  an  employee  amounts  to 
$1,000  or  more,  no  return  of  payments  to  such  employee  is  re- 
quired.•"'  When  living  quarters  such  as  camps  are  furnished  for 
the  convenience  of  the  employer,  the  ratable  cost  need  not  be 
added  to  the  cash  compensation  of  the  employee  in  determining 
whether  it  equals  $1,000  annually.  But  where  a  person  receives 
as  compensation  for  services  rendered  a  salary'  and  in  addition 
thereto  living  quarters,  the  value  to  such  person  of  the  quarters 
furnished  constitutes  income  subject  to  tax,  and  a  return  of 
information  is  required  in  such  case  where  the  cash  compensa- 
tion received  plus  the  value  of  living  quarters  furnished  equals 
$1,000  for  the  year."  The  value  to  a  domestic  servant  of  the 
board  and  lodging  received  as  part  of  his  compensation  for  serv- 
ices rendered  is  deemed  to  be  the  same  amount  which  he  would  be 
required  to  pay  for  board  and  lodging  elsewhere  than  in  his  em- 
ployer's household."^    Bills  paid  to  employees  for  board  and  lodg- 

5  0.  D.  1066,  T.  B.  42-21-1870. 

6  Reg.  45,  Art.  1072. 

7T.  D.  2670;  Reg.  33  Rev.,  Art.  34;  letter  from  treasury  department  dated 
October  25,  1917;  L  T.  S.  1921,  Ij  1912.     See  Reg.  45,  Art.  33. 

8  O.  D.  874,  T.  B.  15-21-1566.  The  value  of  the  board  and  lodging  should 
be  entered  separately  on  Form  1099,  as  evidence  of  the  fact  that  such  value 
has  been  considered  in  computing  the  total  amount  received  by  the  servant. 


INFORMATION   AT  THE   SOURCE  953 

ing  while  traveling  under  orders  or  when  the  employee  is  em- 
ployed on  a  salary  basis,  are  not  part  of  the  employee's  salary." 
Commissions  paid  to  soliciting  agents  for  personal  services  in 
securing  insurance  contracts  must  be  reported  at  the  source,  but 
if  the  agent  conducts  a  branch  office  or  is  employed  by  the  com- 
pany under  a  contract  that  makes  it  necessary  to  bear  the  ex- 
penses of  the  branch  office  and  all  payments  received  are  intended 
to  cover  such  expenses,  they  need  not  be  reported. i"  Fees  paid 
by  a  corporation  for  professional  services  should  be  included  in 
a  return  of  information  when  the  amount  paid  to  any  individual 
or  partnership  during  the  calendar  year  equals  or  exceeds 
$1,000.11  In  executing  Form  1099  an  employer  who  is  required 
to  withhold  the  tax  from  an  employee  under  a  state  income  tax 
law  should  report  the  amount  of  the  salary  paid  to  the  employee 
plus  the  amount  of  tax  withheld.  The  employee  should  report 
the  same  amount  in  his  return. i- 

Where  a  business  which  had  been  operated  as  a  partnership 
was  incorporated  in  June,  1920,  and  thereafter  operated  as  a  cor- 
poration, there  being  no  interruption  to  the  business,  and  the 
employees  of  the  partnership  being  retained  by  the  corporation, 
it  was  held  that  for  administrative  purposes  it  will  not  be  con- 
sidered that  there  was  a  change  in  employer.  Since  there  was 
no  interruption  to  business,  and  the  employees  of  the  partnership 
continued  to  be  the  employees  of  the  corporation,  only  one  Form 
1099  covering  the  calendar  year  1920  was  required  to  be  filed  in 
each  case  where  the  total  amount  of  payments  made  equalled  or 
exceeded  $l,000.i-^ 

Payments  Which  Need  Not  Be  Reported.  Payments  of  the 
following  character,  although  over  $1,000,  need  not  be  reported 
in  returns  of  information  on  Form  1099  (revised)  :  (a)  Pay- 
ments of  interest  on  obligations  of  the  United  States;  (b)  divi- 
dends paid  by  domestic  or  resident  foreign  corporations  (other 
than  distributions  by  personal  service  corporations)  ;  (c)  pay- 
ments by  a  broker  to  his  customers ;  (d)  payments  made  to  cor- 
porations;  (e)  bills  paid  for  merchandise,  telegrams,  telephone, 
freight,  storage  and  similar  charges ;  (f )  payments  to  employees 
for  board  and  lodging  while  traveling  in  the  course  of  their  em- 

9T.  D.  2670. 

10  Letter  from  treasury  department  dated  March  28,  1918;  I.  T.  S.  1921, 
11 1910.  See  also  T.  D.  2670  and  letter  from  treasury  department  dated 
March  27,  1918;  I.  T.  S.  1919,  ^  1347. 

11  O.  D.  416,  T.  B.  12-20-800. 

12  O.  D.  401,  T.  B.  6-20-733. 

13  O.  D.  788,  T.  B.  5-21-1422. 


954  FEDERAL  INCOME  TAX 

ployment;!^  (g)  annuities  representing  the  return  of  capital; 
(h)  payments  of  rent  made  to  real  estate  agents  (but  the  agent 
must  report  payments  to  the  landlord  if  they  amount  to  $1,000 
or  more  annually)  ;  (i)  payments  made  by  branches  of  business 
houses  located  in  foreign  countries  to  alien  employees  serving 
in  foreign  countries;  (j)  payments  made  by  the  United  States 
government  to  sailors  and  soldiers  and  to  its  civilian  employees  ;i5 
(k)  amounts  received  through  accident  or  health  insurance  or 
under  v^orkmen's  compensation  acts,  as  compensation  for  per- 
sonal injuries  or  sickness,  plus  the  amount  of  any  damages  re- 
ceived, whether  by  suit  or  agreement,  on  account  of  such  injuries 
or  sickness.i^ 

A  building  and  loan  association  which  makes  payments  to  the 
stockholders  equal  to  the  matured  value  of  shares  of  stock  is  not 
required  to  make  a  return  of  information  unless  the  net  proceeds 
or  income  derived  by  the  stockholder  from  the  transaction 
amounts  to  or  exceeds  $1,000  in  any  taxable  year.  The  portion 
of  the  payment  of  the  matured  value  of  the  shares  of  stock, 
which  represents  the  purchase  price  of  such  shares  is  merely  a 
return  of  principal  or  capital  and  is  held  not  to  be  income.^^ 
Where  a  lease  provides  for  a  payment  of  rental  in  crop  shares, 
the  landlord  and  tenant  sharing  the  expenses  proportionately, 
such  payments  are  not  fixed  or  determinable  and  need  not  be 
reported.i*^ 

Gains  and  Losses  of  Customers  of  Brokers.  When  directed  by 
the  Commissioner,  either  specially  or  by  general  regulation,  every 
person  doing  business  as  a  broker  is  required  to  render  a  return 
showing  the  names  and  addresses  of  customers  to  whom  pay- 
ments were  made  or  for  whom  business  was  transacted  during 
the  calendar  year  or  other  specified  period  next  preceding  and 
giving  the  other  information  called  for  by  the  form.i^ 

14  This  is  true  notwithstanding  the  fact  that  part  of  such  payments  may 
be  taxable  income  to  the  employee  (letter  from  treasury  department  dated 
February  5,  1921;  I.  T.  S.  1921,  Tj  2719). 

15  Reg.  45,  Art.  1074. 

16  0.  D.  858,  T.  B.  13-21-1535. 

17  O.  D.  759,  T.  B.  52-20-1364. 

18  0.  D.  115,  T.  B.  2-19-172. 

19  Revenue  Act  of  1921,  §255;  Revenue  Act  of  1918,  §255;  Reg.  45,  Art. 
1061;  Reg.  33  Rev.,  Art.  33.  The  1918  and  present  law  omit  the  clause  of  the 
prior  law  defining  brokers,  "on  any  exchange  or  board  of  trade  or  other 
similar  place  of  business."  It  will  be  noted  that  under  this  provision  the 
Commissioner  is  given  discretion  to  require  or  not  to  require  such  returns. 
Form  No.  1100  is  to  be  used  in  making  such  returns. 


INFORMATION   AT  THE   SOURCE  955 

Dividends  on  Stock  of  Taxable  Corporations.  When  directed 
by  the  Commissioner,  either  specially  or  by  general  regulation, 
every  domestic  or  resident  corporation  and  every  personal  serv- 
ice corporation  is  required  to  render  a  return  of  its  payments  of 
dividends,  and  distributions  to  stockholders  for  such  period  as 
may  be  specified,  stating  the  name  and  address  of  each  stock- 
holder, the  number  and  class  of  shares  owned  by  him,  the  date 
and  amount  of  each  dividend  paid  him,  and  when  the  surplus 
out  of  which  it  was  paid  was  accumulated.-"  It  will  be  noted 
that  foreign  corporations  may  be  subject  to  this  duty  if  they  are 
subject  to  income  tax.-^ 

Interest  on  Obligations  of  Domestic  Corporations.  In  the  case 
of  payments  of  interest  upon  bonds,  mortgages,  deeds  of  trust, 
or  other  similar  obligations  of  domestic  or  resident  corporations, 
the  name  of  the  payee  is  to  be  reported  regardless  of  the  amount 
of  interest  paid.-- 

Interest  on  Obligations  of  the  United  States.  The  law  pro- 
vides -'^  that  the  officers  or  employees  of  the  United  States  having 
information  as  to  payments  of  interest,  etc.,  and  required  by 
regulations  authorized  by  law  to  make  returns  in  regard  thereto, 
shall  render  true  and  accurate  returns,  under  such  regulations 
and  in  such  form  and  manner  and  to  such  extent  as  may  be  pre- 
scribed by  the  Commissioner  with  the  approval  of  the  secretary. 
The  department  ruled  under  the  1918  Law,  however,  that  pay- 
ments of  interest  on  obligations  of  the  United  States  need  not 
be  reported  on  returns  of  information.-^ 

State  and  Municipal  Bonds.  Although  interest  received  from 
state  and  municipal  bonds  is  not  subject  to  tax,  the  law  does  not 
expressly  exempt  such  payments  from  its  requirements  as  to 
information  at  the  source ;  neither  does  it  expressly  include  such 
payments.  No  express  ruling  has  been  made  as  to  the  procedure 
to  be  followed  in  this  respect. 

20  Revenue  Act  of  1921,  §254;  Revenue  Act  of  1918,  §254;  Reg.  45,  Art. 
1051.  This  section  omits  the  catch-all  phrase  in  modification  of  payments 
of  dividends — "Whether  made  in  cash,  or  its  equivalent,  or  in  stock."  See, 
however,  the  definition  of  the  term  "dividend"  in  Revenue  Act  of  1918,  §  200. 
and  in  Revenue  Act  of  1921,  §  201.  It  will  be  noted  that  under  this  pro- 
vision the  Commissioner  is  given  discretion  to  require  or  not  to  require  such 
returns.    Form  No.  1097  is  to  be  used  in  making  such  returns. 

21  See  Chapter  12.  See  also  telegram  from  treasury  department  dated 
October  14,  1918;  I.  T.  S.  1918,  ^3642. 

22  Revenue  Act  of  1921,  §256;  Revenue  Act  of  1918,  §256. 
2»  Revenue  Act  of  1921,  §  256;  Revenue  Act  of  1918,  §  256. 
24  Reg.  45,  Art.  1074. 


956  FEDERAL  INCOME  TAX 

Return  of  Information  as  to  Payments  to  Nonresident  Aliens. 

In  the  case  of  payments  of  annual  or  periodical  income  to  non- 
resident alien  individuals  or  to  foreign  corporations  not  engaged 
in  trade  or  business  within  the  United  States  and  not  having  any 
office  or  place  of  business  therein,  the  returns  by  withholding 
agents  on  Forms  1098  (revised)  and  1042  (revised)  constituted 
and  were  treated  as  returns  of  information  under  the  1918  Law.-^ 

Foreign  Items.  The  following  regulations  have  been  issued 
under  the  1918  Law  in  regard  to  foreign  items.-" 

Source  of  Information  as  to  Foreign  Items.  The  term 
"foreign  item,"  as  here  used,  means  any  dividend  upon  the  stock 
of  a  nonresident  foreign  corporation  or  any  item  of  interest  upon 
the  bonds  of  foreign  countries  or  nonresident  foreign  corpora- 
tions, whether  or  not  such  dividend  or  interest  is  paid  in  the 
United  States  or  by  check  drawn  on  a  domestic  bank.  Wherever 
a  foreign  country  or  nonresident  foreign  corporation  issuing 
bonds  has  appointed  a  paying  agent  in  this  country,  charged 
with  the  duty  of  paying  the  interest  upon  such  bonds,  such  pay- 
ing agent  shall  be  the  source  of  information.  If  such  foreign 
country  or  foreign  corporation  has  no  such  agent,  then  the  last 
bank  or  collecting  agent  in  this  country  shall  be  the  source  of 
information.  In  the  case  of  dividends  on  the  stock  of  a  non- 
resident foreign  corporation,  however,  the  first  bank  or  collecting 
agent  accepting  such  item  for  collection  shall  be  the  source  of 
information.-" 

Ownership  Certificates  for  Foreign  Items.  When  bonds 
of  foreign  countries,  or  bonds  or  stocks  of  nonresident  foreign 
corporations,  are  owned  by  citizens  or  residents  of  the  United 
States,  individual  or  fiduciary,  by  domestic  or  resident  foreign 
corporations,  or  partnerships,  or  by  personal-service  corpora- 
tions, ownership  certificate  Form  1001a  (revised)  should  be  exe- 
cuted by  the  actual  owner  or  by  his  duly  authorized  agent  when 
presenting  the  item  for  collection,  whether  such  item  is  a  divi- 
dend or  an  interest  payment,  except  in  the  case  of  a  foreign 
country  or  a  foreign  corporation  having  a  fiscal  agent  or  a  paying 
agent  in  this  country  and  issuing  bonds  which  contain  a  tax-free 
covenant  clause.  In  such  a  case  the  fiscal  agent  or  paying  agent 
is  required  to  withhold  the  normal  tax  of  2%  from  the  interest 
on  such  bonds  and  ownership  certificate  Form  1000    (revised) 

25  Reg.  45,  Art.  1076. 

20  See  T.  D.  2759,  amending  Reg.  33  Rev.,  Art.  35,  and  T.  D.  2716  for  the 
rule  under  the  1916  Law. 
27  Reg.  45,  Art.  1077. 


INFORMATION   AT  THE   SOURCE  957 

modified  to  show  the  name  and  address  of  the  fiscal  agent  or  the 
paying  agent,  should  be  used,  unless  the  owner  (if  so  entitled) 
desires  to  claim  exemption,  in  which  case  Form  1001a  (revised) 
should  be  filed.  When  such  foreign  bonds  or  stocks  are  owned 
by  nonresident  alien  individuals,  corporations,  or  partnerships, 
ownership  certificate  Form  1001a  (revised)  should  be  used  on 
behalf  of  such  owners  by  any  responsible  bank  or  banker,  either 
foreign  or  domestic,  having  knowledge  of  such  ownership.  In 
such  a  case  the  bank  or  banker  need  not  fill  in  the  names  of  the 
owners.-"^ 

Nonresident  alien  individuals,  partnerships,  and  corporations 
should  file  Form  1001a  properly  modified,  in  connection  with  in- 
terest coupons  on  bonds  of  a  corporation  organized  in  the  United 
States  but  which  transacts  no  business  in  the  United  States  and 
owns  no  property  therein.-" 

In  cases  where  a  foreign  corporation  is  the  registered  owner 
of  stock  of  a  domestic  corporation  and  the  actual  owner  is  a 
nonresident  alien  individual  or  partnership,  disclosure  of  actual 
ownership  should  be  made  on  Form  1087  (revised)  in  order  that 
a  domestic  corporation  required  to  render  a  return  of  informa- 
tion as  to  dividends  may  have  at  its  disposal  information  as  to 
actual  ownership  of  the  stock.  The  foreign  corporation  as  the 
registered  holder  is  not,  however,  required  to  render  any  return 
or  withhold  any  tax  from  income  paid  to  the  actual  owner  of  the 
stock,  nor  is  there  any  provision  under  the  law,  whereby  any 
withholding  of  tax  at  the  source  is  required  by  the  debtor  cor- 
poration with  respect  to  such  income  whether  actually  owned  by 
the  registered  owner  or  by  a  third  party."'" 

Where  an  individual,  a  resident  of  this  country,  is  entitled 
to  the  interest  accruing  on  some  German  war  loan  securities 
which  are  held  for  him  by  a  German  bank  which  institution 
has  requested  a  domestic  bank  to  transmit  the  amount  to  the 
individual,  by  drawing  a  check  or  draft  upon  the  foreign  bank, 
it  is  held  that  an  ownership  certificate  is  not  required  until  the 
foreign  item  is  actually  collected,  either  by  the  cashing  or  the 
depositing  of  the  check  and  no  responsibility  with  respect  to 
requiring  an  ownership  certificate  attaches  to  the  domestic  bank- 
ing institution  in  connection  with  this  transaction  unless  the 
individual  presents  the  foreign  item  to  it  for  collection.     When 

28  Reg.  45,  Art.  1078,  as  amended  by  T.  D.  3031.  For  a  full  discussion  of 
the  subject  of  ownership  certificates  see  Chapter  40. 

29  0.  D.  354,  T.  B.  31-19-653. 

30  O.  D.  162,  T.  B.  5-19-263. 


958  FEDERAL   INCOME   TAX 

the  foreign  item  is  collected  the  amount  should  be  reported  on 
ownership  certificate,  Form  1001a  (revised)  in  the  equivalent  of 
United  States  money  values,  according  to  the  rate  of  exchange 
in  effect  at  the  time  collection  is  made.  The  check  or  draft 
drawn  by  the  domestic  banking  institution  on  the  foreign  bank- 
ing institution  should  bear  a  notation  as  to  what  the  payment 
represents,  in  order  that  the  first  bank  making  payment  of  such 
amount  may  be  enabled  to  identify  the  check  as  a  foreign  item.-^^ 

Foreign  Items  Presented  for  Collection  Unaccompanied 
BY  Ownership  Certificates.  If  the  foreign  item  is  an  interest 
coupon  detached  from  bonds  containing  a  tax  free  covenant 
clause,  issued  by  a  foreign  country  or  corporation  having  a  pay- 
ing agent  in  the  United  States  an  affidavit  and  ownership  certifi- 
cate, Form  1000  (revised),  should  be  furnished.^- 

In  the  case  of  other  foreign  items  which  are  received  unaccom- 
panied by  an  ownership  certificate  and  the  owner  is  unknown,  an 
affidavit  is  required  of  the  payee,  showing  the  name  and  address 
of  the  payee,  the  name  and  address  of  the  debtor  organization, 
the  date  of  the  dividend  check  or  the  maturity  of  the  interest 
coupon,  the  name  and  address  of  the  person  from  whom  the  divi- 
dend check  or  interest  coupon  was  received,  and  a  statement  that 
the  owner  of  the  securities  is  unknown  to  the  payee.  The  first 
bank  receiving  such  foreign  item  should  prepare  a  certificate  of 
ownership,  Form  1001a  (revised),  crossing  out  the  word  "owner" 
and  substituting  therefor  the  word  "payee."  The  first  bank 
should  stamp  or  write  across  the  face  of  the  certificate  "affidavit 
furnished,"  adding  the  name  of  the  bank.  Thereupon  the  affi- 
davit and  certificate  should  be  forwarded  to  the  Commissioner.^^ 

Return  of  Information  as  to  Foreign  Items.  In  the  case 
of  collections  of  foreign  items,  regardless  of  amount,  the  original 
ownership  certificates,  when  duly  filed,  will  constitute  and  be 
treated  as  returns  of  information,  (a)  In  the  case  of  dividends, 
as  to  which  the  first  bank  or  collecting  agent  is  the  source  of 
information,  it  shall  detach  the  ownership  certificate  and  indorse 
on  the  item  the  words,  "Certificate  detached  and  information 
furnished,"  adding  its  name  and  address.  When  foreign  items 
have  been  indorsed  as  above  prescribed,  the  certificates  must  be 
forwarded  to  the  Commissioner  (sorting  division)  on  or  before 
the  20th  day  of  the  month  following  that  during  which  the  items 

31  0.  D.  641,  T.  B.  34-20-1150. 

32  See  Reg.  45,  Art.  368. 

33  Reg.  45,  Art.  1078  (a),  added  by  T.  D.  3030;  O.  D.  377,  T.  B.  3-20-694. 
The  affidavit  and  certificate  are  forwarded  as  provided  in  Article  1079  of 
Regulations  45. 


INFORMATION   AT  THE  SOURCE  959 

were  accepted,  accompanied  by  a  return  on  Form  1096a  showing 
the  number  of  certificates  and  the  aggregate  amount  of  foreign 
items  disclosed  thereon.  An  annual  return  on  Form  1096b  must 
be  forwarded  to  the  Commissioner  not  later  than  March  15  of 
each  year,  on  which  shall  be  given  a  summary  of  the  monthly  re- 
turns, (b)  In  the  case  of  interest  items,  as  to  which  the  paying 
agent  or  the  last  bank  or  collecting  agent  in  this  country  is  the 
source  of  information,  the  ownership  certificate  must  accompany 
the  coupon  to  such  agent  or  source  of  information,  who  must  for- 
ward the  ownership  certificate  to  the  Commissioner  in  the  same 
manner  as  above  provided  with  respect  to  dividend  items.  Where 
ownership  certificate  Form  1000  (revised)  is  used,  a  monthly 
return  must  be  made  on  Form  1012  (revised)  and  an  annual 
return  on  Form  1013  (revised).  Forms  1012  (revised)  and  1013 
(revised),  when  so  used,  should  be  modified  to  show  the  name 
and  address  of  the  paying  agent.  The  use  of  substitute  certifi- 
cates is  not  permitted  in  the  collection  of  foreign  items.^'^  The 
procedure  as  set  forth  above  with  respect  to  the  return  of  in- 
formation regarding  the  collection  of  foreign  interest  items  is 
applicable  as  well  to  the  interest  on  foreign  registered  bonds.^'"' 

License.  The  law  provides  that  all  individuals,  corporations, 
or  partnerships,  "undertaking  as  a  matter  of  business  or  for 
profit  the  collection  of  foreign  payments  of  interest  or  dividends 
by  means  of  coupons,  checks  or  bills  of  exchange  shall  obtain  a 
license  from  the  Commissioner,  and  shall  be  subject  to  such  regu- 
lations enabling  the  government  to  obtain  the  information  re- 
quired (under  this  title),  as  the  Commissioner,  with  the  approval 
of  the  secretary,  shall  prescribe;  and  whoever  knowingly  under- 
takes to  collect  such  payments  without  having  obtained  a  license 
therefor,  or  without  complying  with  such  regulations,  shall  be 
guilty  of  a  misdemeanor  and  shall  be  fined  not  more  than  $5,000, 
or  imprisoned  for  not  more  than  one  year,  or  both."^^^  Foreign 
items  should  not  be  accepted  for  collection  by  any  bank  or  col- 
lecting agent  so  licensed  unless  properly  indorsed  or  accompanied 
by  proper  ownership  certificates  giving  all  the  information  called 
for  by  such  certificate.''"  Application  for  a  license  for  the  collec- 
tion of  foreign  items  should  be  made  to  the  collector  of  the  dis- 
trict in  which  the  business  is  to  be  carried  on.  Upon  the  accept- 
ance of  such  application  the  collector  will  issue  to  the  applicant, 

»4  Rep:.  45,  Art.  1079. 

35  0.  D.  675,  T.  B.  39-20-1216. 

36  Revenue  Act  of  1921,  §  259;  Revenue  Act  of  1918,  §  259. 

37  Reg.  45,  Art.  1111. 


960  FEDERAL   INCOME   TAX 

without  cost,  a  license  which  will  continue  in  force  until  revoked 
or  cancelled.-'"*  Where  the  collector  is  not  sufficiently  informed  as 
to  the  entire  responsibility  of  the  applicant,  or  where  in  any  case 
he  deems  it  advisable,  the  Commissioner  may,  upon  recommenda- 
tion of  the  collector,  require  of  the  applicant  a  bond  in  duplicate 
with  satisfactory  sureties  in  a  penal  sum  at  least  equal  to  the 
estimated  amount  of  tax  to  be  withheld  by  such  applicant  during 
any  one  year;  such  bond,  however,  may  not  be  less  than  $1,000 
nor  more  than  $100,000.^-'  This  bond,  if  required,  must  be  re- 
newed annually  before  January  1  of  each  year.^o  United  States 
bonds  or  notes  may  be  deposited  under  the  law,  in  lieu  of 
a  bond  with  sureties.^i 

Procedure  in  Paying  Income.  In  order  that  the  payor  of  the 
income  required  by  the  law  to  be  reported  may  obtain  the  neces- 
sary information,  the  law  expressly  provides,  except  in  the  case 
of  reports  of  dividend  payments  and  reports  by  brokers,  that  the 
name  and  address  of  the  recipient  of  income  shall  be  furnished 
upon  demand  to  the  individual,  coi'poration,  or  partnership  pay- 
ing the  income. ■'■-  All  payors  of  income  should  obtain  in  some 
form  the  name  and  address  of  the  recipient  of  such  payments. 
When  the  person  receiving  a  payment  falling  within  the  pro- 
visions of  law  for  information  at  the  soux*ce  is  not  the  actual 
owner  of  the  income  received,  the  name  and  address  of  the  ac- 
tual owner  must  be  furnished  upon  demand  of  the  individual, 
corporation,  or  partnership  paying  the  income,  and  in  default 
of  a  compliance  with  such  demand  the  payee  becomes  liable  to 
a  penalty'  of  not  more  than  $1,000,  unless  the  failure  to  comply 
is  wilful,  in  which  event  the  payee  will  be  guilty  of  a  misde- 
meanor and  will  be  fined  not  more  than  $10,000,  or  imprisoned 
for  not  longer  than  one  year,  or  both,  together  with  the  costs  of 
prosecution.^-^  The  law  imposes  no  duty,  however,  upon  the 
payor  of  the  income  to  inquire  upon  his  own  initiative  as  to  the 
ownership  thereof,  and  it  would  seem  that  such  payor  is  fully 

38  T.  D.  2759.  Application  for  such  license  is  made  on  Form  1017.  A 
license  is  issued  on  Form  1010. 

39  Reg.  33,  Art.  56,  January  5,  1914.  No  bond  is  required  in  connection 
with  the  issuance  of  Form  1010,  license  to  collect  foreign  items,  if  the  col- 
lector is  satisfied  as  to  the  responsibility  of  the  applicant  for  the  license. 
(O.  D.  653,  T.  B.  35-20-1176.) 

40  T.  D.  1909. 

41  Revenue  Act  of  1921,  §  1329. 

42  Revenue  Act  of  1921,  §  256;  Revenue  Act  of  1918,  §  256. 

43  Reg.  45,  Art.  1080;  Reg.  33  Rev.,  Art.  36.  See  also  Revenue  Act  of 
1921,  §  253;  Revenue  Act  of  1918,  §  253. 


INFORMATION    AT  THE   SOURCE  961 

protected  by  reporting  in  good  faith  the  name  and  address  of  the 
one  to  whom  the  income  is  paid. 

Returns  of  Information  at  the  Source.  Returns  of  information 
at  the  source  must  be  made  as  indicated  in  the  following  para- 
graphs. 

Miscellaneous  Income,  Gains  and  Profits.  All  persons 
making  payment  to  another  person  of  fixed  or  determinable  in- 
come of  $1,000  or  more  in  a  taxable  year  must  render  a  return 
thereof  to  the  Commissioner  (sorting  division)  for  the  preceding 
calendar  year  on  or  before  March  15  of  each  year.  The  return 
must  be  made  in  each  case  on  Form  1099  (revised),  accompanied 
by  a  letter  of  transmittal  on  Form  1096  (revised)  showing  the 
number  of  returns  filed  and  the  aggregate  amount  represented 
by  the  payments.  The  street  and  number  where  the  recipient  of 
the  payment  lives  and  whether  he  is  single,  married  or  head  of 
a  family  should  be  stated,  if  possible.  Where  no  present  address 
is  available,  the  last  known  post-office  address  must  be  given.^* 

Return  of  Information  by  Partnerships,  Personal  Serv- 
ice Corporations  and  Fiduciaries.  Partnerships  and  personal 
service  corporations  are  required  to  prepare  reports  on  Form 
1099  (revised)  for  each  member  of  the  partnership  or  personal 
service  corporation,  and  fiduciaries  must  prepare  such  reports 
for  each  beneficiary  of  the  estate  or  trust,  showing  in  every  case 
the  distributive  shares  of  the  members  or  beneficiaries,  whether 
or  not  actually  distributed.  If  the  books  of  account  of  a  partner- 
ship, personal  service  corporation,  or  fiduciary  are  kept  on  the 
basis  of  a  fiscal  year,  the  returns  of  information.  Form  1099  (re- 
vised) ,  showing  the  distributive  shares  of  the  members  or  bene- 
ficiaries must  be  rendered  on  a  fiscal-year  basis.  Such  returns, 
accompanied  by  Form  1096  (revised),  must  be  filed  on  or  before 
the  fifteenth  day  of  the  third  month  following  the  close  of  the 
fiscal  year.  All  other  returns  of  information.  Form  1099  (re- 
vised) ,  required  to  be  filed  by  a  partnership,  personal  service  cor- 

44  Revenue  Act  of  1921,  §256;  Revenue  Act  of  1918,  §256;  Reg.  45,  Art. 
1071.  In  the  case  of  payments  to  nonresident  alien  individuals  or  to  foreign 
corporations  not  engaged  in  trade  or  business  within  the  United  States  and 
not  having  any  office  or  place  of  business  therein,  the  returns  by  withholding 
agents  on  Forms  1098  (revised)  and  1042  (revised)  constituted  and  were 
treated  as  returns  of  information  under  the  1918  Law.  (Reg.  45,  Art.  1076.) 
The  law  does  not  require  a  return  of  information  with  respect  to  the  in- 
come of  nonresident  aliens  which  is  not  fixed  or  determinable.  If  a  with- 
holding agent  files  Forms  1098,  revised,  and  1042,  revised,  in  connection 
with  payments  of  annual  or  periodical  income  to  nonresident  alien  indi- 
viduals, it  will  not  be  necessary  to  file  Form  1099.  (0.  D.  673,  T.  B.  39-20- 
1215.) 


962  FEDERAL   INCOME   TAX 

poration,  or  a  fiduciary  must  be  rendered  on  a  calendar-year 
basis,  regardless  of  the  fact  that  its  books  of  account  are  kept  on 
a  fiscal-year  basis.  Such  returns,  accompanied  by  Form  1096  (re- 
vised), must  be  filed  on  or  before  March  15  of  the  year  following 
that  for  which  the  returns  are  made.^-^  The  above  information 
must  be  furnished  on  Forms  1099,  reporting  the  payments  indi- 
vidually, and  a  summary  prepared  on  Form  1096.  These  forms 
should  not  be  attached  to  and  filed  with  Forms  1041  and  1065, 
but  forwarded  direct  to  the  Commissioner  of  Internal  Revenue, 
Sorting  Section,  Washington,  D.  C,  in  time  to  be  received  not 
later  than  March  15.'*'^ 

Gains  and  Losses  of  Customers  of  Brokers.  The  law  pro- 
vides that  the  return  to  be  made  by  brokers,  if  required  by  the 
Commissioner,  shall  state  the  names  of  customers  (and  impliedly 
their  addresses)  for  whom  such  brokers  have  transacted  any 
business,  with  such  details  as  to  profits,  losses,  or  other  informa- 
tion as  the  Commissioner  may  require  as  to  each  of  such  cus- 
tomers.^^ It  is  ruled  that  the  addresses  of  customers  must  be 
stated  in  such  returns.^s 

Dividends  on  Stock  of  Taxable  Corporations.  With  re- 
spect to  dividend  payments  of  corporations,  the  law  provides  that 
the  return  to  be  made  by  the  corporation  if  required  by  the  Com- 
missioner, shall  state  the  names  and  addresses  of  the  stockhold- 
ers, the  number  of  shares  owned  by  each,  and  the  amount  of  divi- 
dends paid  to  each  during  the  period  covered  by  the  report.^^ 

45  Reg.  45,  Art.  1073,  as  amended  by  T.  D.  3210,  T.  B.  34-21-1785;  O.  D. 
885,  T.  B.  16-21-1585. 

46  M.  2708,  T.  B.  8-21-1469. 

47  Revenue  Act  of  1921,  §255;  Revenue  Act  of  1918,  §255;  Reg.  45,  Art. 
1061.  Two  forms  of  return  were  contemplated  for  the  reporting  by  brokers 
of  the  gains  and  losses  of  their  customers.  One  form  (Form  1100,  never 
issued)  shows  the  total  gains  and  losses  of  each  customer.  The  other  (Form 
1096)  is  merely  a  letter  of  transmittal  under  oath,  to  be  used  in  forwarding 
the  several  Forms  1100  to  the  Commissioner. 

48  Reg.  45,  Art.  1061. 

49  Revenue  Act  of  1921,  §  254;  Revenue  Act  of  1918,  §  254.  Two  forms  of 
return  were  contemplated,  under  the  1918  Law,  which  contained  the  same 
provision  for  the  reporting  of  dividends  paid  by  taxable  corporations. 
Form  1097  (revised)  gives  the  required  infoi'mation  separately  with  regard 
to  each  stockholder,  and  must,  if  required,  be  forwarded  to  the  Commissioner 
within  ten  days  from  the  receipt  of  notice  demanding  it.  Form  1096  (re- 
vised) is  merely  a  letter  of  transmittal  under  oath,  to  be  used  in  forwarding 
the  several  Forms  1097  to  the  Commissioner.  Reporting  at  the  source  by 
corporations  may  be  required  specially  or  by  general  regulation  (Reg.  45, 
Art.  1051). 


information  at  the  source  963 

Interest  on  Obligations  of  Domestic  or  Resident  Corpora- 
tions. In  the  case  of  payments  of  interest,  regardless  of  amount, 
upon  bonds  and  similar  obligations  of  domestic  or  resident  for- 
eign corporations,  the  original  ownership  certificates,  when  duly 
filed,  constitute  and  are  treated  as  returns  of  information.  If  a 
bondholder  files  no  ownership  certificate  in  the  case  of  payments 
of  interest  on  registered  bonds,  the  withholding  agent  is  required 
to  make  out  such  a  certificate  in  each  instance  and  file  it.'^^" 

Exempt  Corporations.  Exempt  corporations  are  required  to 
furnish  information  at  the  source  in  the  same  manner  and  ac- 
cording to  the  same  rules  as  taxable  corporations.'-^ 

Affiliated  Corporations.  Affiliated  corporations  will  not  be 
permitted  to  file  a  consolidated  return  of  information  at  the 
source.  Each  corporation  must  file  a  separate  return  of  infor- 
mation.^'■- 

Department  of  Municipal  Government.  A  department  of  a 
municipal  government  is  required  to  file  a  return  of  infonnation, 
excluding,  however,  payments  made  as  salary  or  wages  to  officials 
or  employees  of  the  state  or  political  subdivision  thereof,  and 
payments  of  interest  on  obligations  of  a  state  or  political  sub- 
division thereof.^^ 

50  Reg.  45,  Art.  1075.  Monthly  return  is  made  on  Form  No.  1012  (revised). 
See  also  Reg.  33  Rev.,  Art.  43;  T.  D.  2769. 

51  T.  D.  2693. 

52  0.  D.  469,  T.  B.  16-20-268. 

53  0.  D.  470,  T.  B.  16-20-869. 


CHAPTER  40 

COLLECTION  OF  THE  TAX  AT  THE  SOURCE 

The  Revenue  Act  of  1921  provides  for  withholding  at  the 
source  on  payments  of  fixed  or  determinable  annual  or  periodical 
gains,  profits,  and  income,  to  any  nonresident  alien  individual 
or  partnership  composed  in  whole  or  in  part  of  nonresident 
aliens  except  income  received  as  dividends  of  the  class  allowed 
as  a  credit  against  the  normal  tax  by  the  law,  and  interest  on 
deposits  with  persons  carrying  on  the  banking  business  paid  to 
persons  not  engaged  in  business  in  the  United  States  and  not 
having  an  office  or  place  of  business  therein,  at  the  rate  of  8%, 
except  if  the  income  is  from  bonds  and  mortgages,  deeds  of 
trust,  or  similar  obligations,  of  a  corporation,  containing  a 
covenant  to  pay  any  portion  of  the  tax  for  the  bondholder,  in 
which  case  withholding  shall  be  at  the  rate  of  2%.^  It  is  also 
provided  that  payments  of  fixed  or  determinable  annual  or 
periodical  gains,  profits,  and  income  (with  the  same  exceptions), 
to  any  foreign  corporation  not  engaged  in  trade  or  business 
within  the  United  States  and  not  having  an  oflfice  or  place  of 
business  therein  shall  be  withheld  at  the  rate  of  I2V2  %  (but  dur- 
ing the  calendar  year  1921  at  the  rate  of  only  10%)  except  in 
cases  where  the  income  is  from  bonds,  mortgages,  or  deeds  of 
trust  or  other  similar  obligations  of  a  corporation  containing  a 
covenant  to  pay  any  portion  of  the  tax  for  the  bondholder,  in 
which  case  withholding  shall  be  at  the  rate  of  2%.^  The  provision 

1  Revenue  Act  of  1921,  §  221. 

2  Revenue  Act  of  1921,  §  237.  The  1913  Law  provided  for  vi^ithholding 
at  the  source  of  the  normal  tax  (1%)  on  payments  of  fixed  or  determinable 
annual  or  periodical  income  to  individuals,  w^hether  citizens,  residents  or 
nonresident  aliens.  (Act  of  October  3,  1913,  §  D.)  The  1916  Law  pro- 
vided also  for  withholding  at  the  source  of  the  normal  tax  (2%)  on  pay- 
ments of  similar  income  to  individuals.  (Revenue  Act  of  1916,  §9  (b), 
(c),  (d),  (e).)  But  by  the  amendment  of  October  3,  1917,  the  law  was 
changed  so  as  to  require  withholding  only  (a)  on  payments  of  fixed  or 
determinable  annual  or  periodical  income  (except  dividends)  to  non- 
resident aliens  at  the  rate  of  2%;  (b)  on  payments  of  interest  upon  bonds 
of  domestic  or  other  resident  corporations  to  foreign  corporations  not  en- 
gaged in  trade  or  business  within  the  United  States  and  not  having  an 
oflfice  or  place  of  business  therein,  at  the  rate  of  6%;  (c)  on  payments 
of  dividends  of  domestic  or  other  resident  corporations  to  foreign  cor- 
porations not  engaged  in  trade  or  business  within  the  United  States  and 
not  having  an  oflice  or  place  of  business  therein,  at  the  rate  of  2%;  (d) 
at  the  rate  of  2%   on  payment  of  interest  on  bonds,  mortgages,  deeds  of 

964 


COLLECTION   OF  THE  TAX  AT  THE  SOURCE  965 

of  the  1921  Law  exempting  interest  on  deposits  from  withhold- 
ing- was  not  contained  in  the  1918  Law.  Under  the  Revenue 
Act  of  1918  no  withholding  was  required  on  payment  of  fixed  or 
determinable  income  to  partnerships  whether  resident  or  non- 
resident, or  whether  or  not  having  any  nonresident  alien  mem- 
bers. No  withholding  is  required  under  either  law  on  payments 
to  citizens  or  residents,  except  in  case  of  payments  of  interest 
upon  bonds,  mortgages,  deeds  of  trust,  or  other  similar  obliga- 
tions, of  a  corporation  containing  a  covenant  to  pay  the  tax,  in 
which  case  withholding  is  required  at  the  rate  of  2%.^  In  no  case 
is  any  tax  withheld  at  the  source  on  payments  to  domestic  corpo- 
rations or  to  foreign  corporations  engaged  in  trade  or  business 
within  the  United  States  or  having  an  office  or  place  of  business 
in  the  United  States.  Personal  service  corporations  may,  after 
receiving  notice  from  the  Commissioner  that  they  have  been 
recognized  as  such,  but  not  before,  proceed  as  though  they  were 
partnerships.^ 

Definition.  For  convenience,  certain  terms  used  in  this  chapter 
are  here  defined.  A  nonresident  foreign  corporation  is  one  not 
engaged  in  trade  or  business  within  the  United  States  and  not 
having  any  office  or  place  of  business  therein. •'•  A  foreign  cor- 
poration not  engaged  in  trade  or  business  within  the  United 
States,  which  has  a  fiscal  agent  in  the  United  States, 
is  not  a  resident  corporation.'"'  The  term  "withholding 
agent"  means  any  person  required  to  deduct  and  withhold  any 
tax  required  to  be  deducted  and  withheld  by  the  law.'^    A  with- 

trust  and  similar  obligations,  of  corporations  to  individuals,  citizens,  res- 
idents or  aliens,  if  such  bonds,  mortgages,  deeds  of  trust  and  similar  ob- 
ligations contained  a  covenant  to  pay  any  portion  of  the  income  tax  for 
the  bondholder,  or  to  pay  the  interest  without  deduction  for  any  tax  which 
the  corporation  might  be  required  or  permitted  to  pay  thereon  or  to  retain 
therefrom  under  any  law  of  the  United  States,  and  (e)  at  the  rate  of  6% 
where  the  owner  of  bonds,  mortgages,  deeds  of  trust,  or  similar  obligations, 
was  not  knov^Ti  (Revenue  Act  of  1916,  as  amended,  §§9  (b),  (c),  (g),  13 
(e),  (f).)  The  amendment  was  retroactive  to  January  1,  1917,  and  any 
normal  tax  withheld  from  income  paid  to  citizens  or  residents  in  1917, 
other  than  interest  described  in  (d)  above,  was  required  by  the  law  to  be 
released  and  paid  over  to  the  persons  from  whose  income  such  tax  was  with- 
held.    (Revenue  Act  of  1917,  §§  9  and  1212.) 

3  Revenue  Act  of  1921,  §221;  Revenue  Act  of  1918,  §221;  Reg.  45,  Art. 
361. 

^Letter  from  treasury  department  dated  November  20,  1919;  I.  T.  S. 
1921,  111848;  O.  D.  839,  T.  B.  29-19-628. 

•■>  Revenue  Act  of  1921,  §  237;  Revenue  Act  of  1918,  §  237. 

C'O.  D.  144,  T.  B.  4-19-225. 

7  Revenue  Act  of  1921,  §200;  Revenue  Act  of  1918,  §200. 


966  FEDERAL  INCOME   TAX 

holding  agent  may  be  a  corporation  with  bonds  outstanding, 
a  trustee  under  a  corporate  mortgage,  or  any  corporation,  part- 
nership or  private  individual.'^  The  term  "bond  interest"  does 
not  include  interest  payments  on  ordinary  bankable  commercial 
paper  of  corporations  or  ordinary  promissory  notes  of  corpora- 
tions not  exceeding  one  year  in  time.-'  The  term  ''covenant  to 
pay  the  tax,"  means  a  covenant,  contract  or  provision  in  the 
bonds,  mortgage,  deed  of  trust  or  other  similar  obligations  of  a 
corporation  by  which  the  obligor  agrees  to  pay  any  portion  of  the 
income  tax  imposed  upon  the  obligee,  or  to  reimburse  the  obligee 
for  any  portion  of  the  tax,  or  to  pay  the  interest  without  deduc- 
tion for  any  tax  which  the  obligor  may  be  required  or  permitted 
to  pay  thereon  or  to  retain  therefrom  under  any  law  of  the 
United  States.io 

Appointment  of  Withholding  Agent.  A  debtor  corporation, 
which  has  appointed  a  withholding  agent,  should  file  with  the 
collector  for  the  district  in  which  the  debtor  corporation  is 
located  notice  of  such  appointment,  giving  the  name  and  address 
of  the  withholding  agent.  Only  one  copy  is  required  and  no 
special  form  is  prescribed.^! 

Fixed  or  Determinable  Annual  or  Periodical  Income.  The 
phrase  "fixed  or  determinable  annual  or  periodical"  income  ex- 
pressly includes  interest  (except  interest  on  deposits  as  indicated 
in  a  preceding  paragraph),  rent,  salaries,  wages,  premiums, 
annuities,  compensations,  remunerations,  emoluments,  but  ex- 
pressly excludes  income  received  as  dividends  of  the  class  al- 
lowed as  a  credit  against  the  normal  tax.  It  also  expressly  ex- 
cludes interest  on  bonds,  mortgages  or  similar  obligations  of 
corporations  containing  covenants  to  pay  any  portion  of  the 
tax.i2  Only  (a)  fixed  or  determinable  (b)  annual  or  periodical 
income  is  subject  to  withholding.  Included  in  such  income, 
giving  an  idea  of  the  general  character  of  income  intended,  the 
statute  specifies  interest,  rent,  salaries,  wages,  premiums,  an- 
nuities, compensations,  remunerations  and  emoluments.  But 
other  kinds  of  income  may  be  included.  Income  is  fixed  when 
it  is  to  be  paid  in  amounts  definitely  pre-determined.  On  the 
other  hand,  it  is  determinable  whenever  there  is  a  basis  of  calcu- 
lation by  which  the  amount  to  be  paid  may  be  ascertained.  The 
income  need  not  be  paid  annually  if  it  is  paid  periodically,  that  is 

8  Reg.  45,  Art.  1533. 

9T.  D.  2090;  T.  B.  "B",  p.  31. 

10  Revenue  Act  of  1921,  §221;  Revenue  Act  of  1918,  §221. 

110.  D.  207,  T.  B.  19-19-359;  T.  B.  "B",  p.  31. 

12  Revenue  Act  of  1921,  §221;  Revenue  Act  of  1918,  §221. 


COLLECTION  OF  THE  TAX   AT  THE  SOURCE  967 

to  say,  from  time  to  time,  whether  or  not  at  regular  intervals. 
That  the  length  of  time  during  which  the  payments  are  to  be 
made  may  be  increased  or  diminished  in  accordance  with  some- 
one's will  or  with  the  happening  of  an  event  does  not  make  the 
payments  any  the  less  determinable  or  periodical^-'  In  the  fol- 
lowing paragraph  the  term  is  defined  in  its  various  aspects. 

Salaries.  Per  diem  salaries  paid  on  a  straight  basis  of  com- 
pensation for  services  rendered  are  fixed  or  determinable  annual 
or  periodical  income,  unless  the  employee  is  required  by  the 
terms  of  his  employment  or  contract  to  pay  therefrom  his  own 
traveling  and  other  legitimate  expenses  incident  to  the  business 
of  his  employment.^^  It  is  held  that  salaries,  wages  and  com- 
missions, paid  by  domestic  business  enterprises  to  nonresident 
alien  employees  for  service  rendered  entirely  in  a  foreign  coun- 
try are  not  income  in  the  hands  of  the  recipient  as  from  a  source 
within  the  United  States.  They  are,  therefore,  not  subject  to 
withholding  at  the  source.^' 

Partnership  Salaries.  Salaries  stipulated  by  contract  or 
articles  of  agreement  between  partnership  members  constitute 
fixed  or  determinable  and  annual  or  periodical  income.  But 
where,  by  agreement  or  otherwise,  members  of  a  firm  are  per- 
mitted to  draw  either  stated  or  unstated  sums  in  advance  of  an 
annual  or  periodical  determination  of  partnership  profits,  no 
withholding  is  required,  as  these  sums  do  not  represent  fixed  or 
determinable  income  within  the  meaning  of  the  law.^'*  With- 
holding seems  to  be  required  against  nonresident  alien  partners 
on  payment  of  the  net  distributive  shares  of  the  income  of  a 
partnership  although  the  regulations  do  not  expressly  so  state. 

Commissions.  A  salesman  working  by  the  month  for  a  com- 
mission on  sales,  which  is  paid  or  credited  monthly,  receives  de- 

13  Reg.  45,  Alt.  362;  Revenue  Act  of  1921,  §§221,  256;  Revenue  Act  of 
1918,  §§221,  256.  Income  of  farmers,  merchants,  agents  (unless  the  com- 
pensation is  in  the  form  of  commissions),  lawyers  (except  annual  retainers), 
doctors,  authors,  inventors,  and  other  professional  persons,  whose  income 
is  irregular  or  indefinite,  is  not  fixed  or  determinable  and  annual  or  peri- 
odical and  is  not,  therefore,  subject  to  withholding.  (T.  D.  1890;  T.  D. 
2090.)  Although  payments  of  income  which  is  not  fixed  or  determinable 
and  annual  or  periodical  are  not  subject  to  withholding,  a  resident  in 
this  country  having  the  receipt,  control,  or  custody  of  such  income  may 
be  required,  as  agent  for  the  nonresident  principal  owner,  to  report  the 
amount  of  such  income  and  to  account  for  any  and  all  tax,  normal  and 
additional  thereon.      (Reg.  45,  Art.  404.)      See  Chapter  5. 

14  T.  D.  2135. 

15  Reg.  45,  Art.  92;  Reg.  33  Rev.,  Art.  32. 

IC  Memorandum  from  treasury  department,  I.  T.  S.  1917,  ^  2282.  See 
Reg.  45,  Art.  362. 


968  FEDERAL  INCOME  TAX 

terminable  periodical  income.^"  A  commission  paid  on  account 
of  a  single  transaction  is  not  fixed  or  determinable  annual  or 
periodical  income. ^'^  Where  a  corporation  engaged  in  business 
as  ship-chandlers  in  accordance  with  the  well  recognized  prac- 
tice of  the  trade,  in  order  to  secure  the  trade  of  certain  ships' 
captains  sells  bills  of  goods  and  supplies  to  a  ship's  captain  at  a 
marked  price,  the  invoice  showing  goods  sold  in  this  amount, 
but  accepts  as  payment  in  full  from  the  ship's  captain  a  smaller 
amount,  the  difference  between  the  two  amounts  being  in  the 
nature  of  discount  or  commissions  and  operating  to  reduce  the 
price  of  the  goods  and  supplies  sold,  it  is  held  that  the  corpora- 
tion is  not  the  payor  of  fixed  or  determinable  annual  or  period- 
ical income.^^ 

Profit  Sharings.  Payments  constituting  a  share  of  the 
profits  of  the  employer  are  fixed  or  determinable  and  annual 
or  periodical  income.-^  The  share  of  profits  of  a  foreign  corpora- 
tion under  an  arrangement  with  a  domestic  corporation  whereby 
the  latter  purchased  goods  from  the  former  at  a  minimum  price 
for  resale  in  the  United  States,  the  domestic  corporation  re- 
ceiving a  commission  in  the  event  of  resale  in  excess  of  the 
minimum  price,  and  the  balance  of  the  excess  (after  the  deduc- 
tion of  certain  expenses)  being  divided  between  the  two  cor- 
porations, represents  income  from  sources  within  the  United 
States,  but  is  not  subject  to  withholding  since  it  is  not  fixed 
or  determinable  income.-^ 

Bonus.  A  benus  paid  in  addition  to  salary  is  fixed  or  deter- 
minable income,"  unless  it  is  a  mere  gift  or  gratuity. 

Dividends.  The  withholding  of  the  tax  at  the  source  is  not 
required  in  the  case  of  income  received  as  dividends  of  the  class 
allowed  as  a  credit  against  the  normal  tax  in  the  case  of  indi- 
viduals and  as  a  deduction  to  corporations.  Distributions  by  a 
personal  service  corporation,  are,  however,  subject  to  the  deduc- 
tion of  the  tax  at  the  source.^^ 

Insurance.  If  a  nonresident  alien  beneficiary  of  an  insurance 
policy  is  given  the  option  of  accepting  the  principal  of  the  policy 
or  of  allowing  it  to  remain  with  the  insurance  company,  subject 

17  Reg.  45,  Art.  362. 

18  0.  D.  907,  T.  B.  19-21-1623. 

19  A.  R.  R.  265,  T.  B.  40-20-1225. 

20  T.  D.  2090. 

210.  D.  384,  T.  B.  4-20-708. 

22  T.  D.  2135. 

23  Revenue  Act  of  1921,  §§221  and  237;  Revenue  Act  of  1918,  §§221  and 
237;     Reg.  45,  Arts.  361,  363. 


COLLECTION  OF  THE  TAX  AT  THE  SOURCE  969 

to  quarterly  installment  payments  of  interest,  the  installment 
payments  are  taxable  income  and  are  subject  to  withholding,  but 
if  the  beneficiary  has  no  option  in  the  matter  and  is  required  to 
accept  the  installment  payments,  the  principal  being  payable  to 
another  person  at  his  death,  such  payments  are  held  to  be  a  part 
of  the  proceeds  of  the  policy.  Under  the  latter  circumstances  it 
follows  that  no  withholding  would  be  required,  since  the  pay- 
ments made  to  the  nonresident  alien  beneficiary  would  not  con- 
stitute taxable  income.-^ 

Interest,  Interest,  as  a  general  rule,  is  held  to  be  fixed  or 
detenninable  and  annual  or  periodical  income  and  subject  to 
withholding.-"' 

Interest  on  call  loans  made  by  a  domestic  bank  for  the  account 
of  a  foreign  bank  is  subject  to  withholding.  While  the  actual 
amount  of  interest  may  vary  daily  on  account  of  the  fluctuation 
of  the  principal,  the  rate  of  interest  is  fixed  and  the  amount  of 
interest  therefore  determinable.  The  total  amount  of  interest 
credited  to  the  account  of  the  foreign  bank  during  the  calendar 
year  is  the  amount  subject  to  withholding.-^'  Profits  derived  by 
a  nonresident  foreign  corporation  from  the  purchase  and  sale 
through  an  agent  in  this  country  of  bank  acceptances  at  a  cer- 
tain rate  of  discount  are  based  on  interest  as  accrued  and  such 
interest,  being  fixed  or  determinable  income,  is  subject  to  with- 
holding.-''' A  domestic  corporation  owning  a  majority  of  the 
stock  of  a  foreign  corporation  should  withhold  the  tax  on  interest 
credited  to  the  latter.-*^  Interest  on  bonds  is  treated  in  a  sub- 
sequent paragraph.  The  Revenue  Act  of  1921  provides-^  that 
interest  on  deposits  with  persons  carrying  on  the  banking  busi- 
ness paid  to  persons  not  engaged  in  business  in  the  United  States 
and  not  having  an  office  or  place  of  business  therein  shall  not  be 
subject  to  withholding.  Any  tax  withheld  since  January  1,  1921, 
on  interest  on  such  deposits  should  be  released  and  credited  to 
such  accounts.""'     No  such  exception  appeared  in  the  1918  Law 

24  0.   D.   767,  T.  B.   1-21-1374. 

25  Letter  from  treasury  department  dated  April  22,  1919;  I.  T.  S.  1921, 
^1755;  Telegram  from  treasury  department  dated  May  23,  1919;  I.  T.  S. 
1921,  H  1763;  Reg.  33,  Art.  67. 

Reg.  33,  Art.  67. 

2fiO.  D.  549,  T.  B.  24-20-1007. 

27  0.  D.  221,  T.  B.  11-19-387. 

2R0.  D.  330,  T.  B.  28-19-616. 

2i»  Revenue   Act  of   1921,  §§221    (a)    and   237. 

•*"  Telegram  from  treasury  department  dated  November  30.  1921;  I.  T. 
S.   1921,  113253. 


970  FEDERAL  INCOME  TAX 

and  banks  were  required  to  withhold  the  tax  on  interest  paid  to 
nonresident  alien  individuals  or  nonresident  foreign  corpora- 
tions.^i  In  many  cases  the  accounts  of  foreign  banks  having 
balances  on  deposit  in  domestic  banks  are  at  times  overdrawn 
and  instead  of  crediting  interest  to  their  accounts  the  domestic 
bank  is  obliged  to  debit  interest  for  the  money  temporarily  ad- 
vanced to  the  foreign  bank.  In  some  cases  foreign  banks  have 
two  accounts  with  domestic  banks,  one  a  deposit  account,  and 
the  other  a  borrowing  account.  In  such  cases  domestic  banks 
were  required  to  deduct  and  withhold  the  tax  from  the  entire 
amount  of  interest  credited  to  foreign  banks  upon  their  deposits 
in  the  domestic  banks  regardless  of  the  amount  of  interest 
charged  the  foreign  banks  on  money  advanced  to  them  through 
loans  on  borrowed  accounts  or  on  account  of  overdrafts  or  other- 
wise. However,  if  the  foreign  banks  rendered  returns  of  their 
total  income  from  all  sources  within  the  United  States  they 
might  deduct  in  such  returns  the  interest  charged  upon  the 
money  advanced  to  them  by  the  domestic  banks  to  the  extent 
allowed  by  the  Revenue  Act  of  1918.^-  In  such  cases  the  foreign 
bank  was  required  to  include  in  its  gross  income  the  entire 
amount  of  the  income  from  which  the  tax  was  withheld  and 
paid  at  the  source,  as  well  as  income  from  all  other  sources 
within  the  United  States,  without  deduction  for  the  tax  so  paid, 
but  any  tax  actually  so  withheld  was  to  be  credited  against  the 
total  tax  as  computed  in  this  return.  In  the  event  that  the 
amount  of  tax  so  paid  at  the  source  by  the  withholding  agent 
was  in  excess  of  the  total  tax  liability  of  the  foreign  bank  a 
claim  for  refund  might  be  filed  for  the  amount  overpaid.^^ 

31  Letter  from  treasury  department  dated  April  22,  1919;  I.  T.  S.  1921, 
Tj  1755.  T.  D.  2652;  letter  from  treasury  department  dated  February  4, 
1918;  L  T.  S.  1918,  113077.  Although  these  rulings  expressly  stated  that 
withholding  was  required  only  with  respect  to  interest  paid  to  nonresident 
aliens,  the  reason  for  limiting  the  rulings  to  individuals  did  not  exist 
under  the  1918  Law.  (Telegram  from  treasury  department  dated  May 
23,  1919;  L  T.  S.  1921,  Tj  1763.)  The  long  established  rule  that  banks  were 
not  required  to  withhold  on  interest  paid  or  accruing  on  deposits  (see  letter 
from  treasury  department  dated  June  29,  1917;  I.  T.  S.  1918,  11177)  was 
revoked  by  T.  D.  2652.  It  seems  that  the  word  "paid,"  as  used  therein, 
is  intended  to  include  interest  which  is  actually  paid  and  also  interest  that 
is  credited  to  the  account  of  nonresident  alien  individuals,  that  is,  de- 
duction was  to  take  place  when  the  interest  was  placed  at  the  depositor's 
credit. 

32  See  Revenue  Act  of  1918,  §§214   (a)   2,  234   (a)   2. 

33  Letter  from  treasury  department  dated  July  26,  1919;  L  T.  S.  1921, 
H  1764. 


COLLECTION  OF  THE  TAX  AT  THE  SOURCE  971 

Equipment  Trust  Certificates.  Where  a  trust  company, 
a  domestic  corporation,  entered  into  an  agreement  with  a  for- 
eign railway  company  by  which  the  trust  company  leased  to 
the  railway  company  certain  railroad  equipment  and  rolling 
stock  for  a  term  of  years,  the  privilege  being  resen-ed  to  the 
lessee  at  the  expiration  of  the  lease  and  upon  meeting  all  obliga- 
tions therein  stipulated,  to  purchase  the  property  for  a  nominal 
consideration,  the  trust  company  at  the  same  time  entering  into 
an  agreement  with  another  domestic  trust  company  under  which 
the  first  trust  company  was  constituted  trustee  for  the  sub- 
scribers obtained  by  the  second  trust  company  to  a  fund  to  be 
used  for  the  purchase  of  the  railroad  equipment  and  rolling 
stock  which  was  the  subject  of  the  rental  agreement,  the  agree- 
ment further  providing  that  the  first  trust  company  should  issue 
to  the  subscribers  of  the  fund  equipment  trust  certificates  with 
semi-annual  dividend  warrants  attached  payable  only  out  of 
rentals  paid  to  the  trustee  under  the  lease  agreement,  it  has 
been  held  that  the  obligation  to  pay  the  principal  of  the  certifi- 
cates and  the  semi-annual  dividends  thereon  is  that  of  the  first 
trust  company  and  that  the  income  derived  from  such  certificates 
should,  therefore,  be  treated  as  a  domestic  item.  Although  the 
term  "dividends"  is  used,  such  payments  are  in  reality  interest 
or  compensation  at  a  fixed  rate  payable  at  a  fixed  date  for  money 
loaned  and  are  not  a  dividend  declared  upon  the  net  earnings  of 
the  first  trust  company.  Neither  the  lease,  the  equipment  trust 
nor  the  certificates  contain  a  tax-free  covenant  clause.  The  divi- 
dends should  be  reported  on  ownership  certificates,  Form  1000, 
revised,  or  Form  1001,  revised,  depending  upon  whether  or  not 
the  owners  of  the  certificates  are  nonresident  aliens.-'^ 

Mercantile  Accounts  Current.  Interest  accruing  on  mer- 
cantile accounts  current  for  nonresident  alien  individuals,  part- 
nerships composed  in  whole  or  in  part  of  nonresident  aliens,  or 
nonresident  foreign  corporations,  if  the  principal  amounts  so 
due  as  well  as  the  interest  are  at  all  times  subject  to  call  and 
payable  on  demand,  is  fixed  or  determinable  and  annual  or  peri- 
odical income  and  should  be  deducted  at  the  source.'-'' 

Race  Track  Winnings.  Winnings  of  horses  at  a  race  track 
credited  by  the  racing  association  to  a  nonresident  alien  owner 
and  trainer  of  the  horses  winning  such  amounts  are  not  fixed 

34  0.  D.   689,  T.  B.  42-20-1249. 

35  Letter  from  treasury  department  dated  April  22,  1919;  I.  T.  S.  1921, 
^1755;  see  telegram  from  treasury  department  dated  May  23,  1919;  I.  T 
S.  1921,  111763. 


972  FEDERAL   INCOME  TAX 

or  determinable  annual  or  periodical  income  and  no  withholding 
by  the  racing  association  is  necessary.-"' 

Rent,  Rent  is  fixed  or  determinable  and  annual  or  periodical 
income  subject  to  withholding,  and  this  is  true  whether  payment 
is  made  in  cash  or  in  notes."-"  Where  permanent  improvements 
are  made  by  a  tenant  under  the  terms  of  a  lease  the  value  thereof 
is  considered  income  to  be  accounted  for  by  the  landlord,  but 
the  amount  is  not  fixed  or  determinable  income.''"*  Rent  paid  by 
domestic  business  enterprises  to  nonresident  aliens  for  property 
located  in  a  foreign  country  is  not  subject  to  tax  as  income  from 
sources  within  the  United  States  and  is,  therefore,  not  subject 
to  collection  at  the  source."^ 

Royalties.  Where  royalties  or  rentals  accrue  under  the  terms 
of  a  lease  or  agrement,  as  for  instance,  royalties  for  the  right 
to  mine  or  remove  minerals  or  other  natural  deposits,  the  royal- 
ties or  rentals  are  not  fixed  or  determinable  and  annual  or 
periodical  income  if  they  represent  a  partial  return  of  capital 
originally  invested  in  the  lands  by  the  lessor.^" 

Promissory  Notes.  Wh'en  a  note  is  given  in  payment  of  fixed 
or  determinable  and  annual  or  periodical  income  the  duty  of 
withholding  the  tax  is  imposed  upon  the  maker  of  the  note.^^ 

Exempt  Income.  Although  exempt  income  may  be  fixed  or 
determinable  and  annual  or  periodical,  no  withholding  is  re- 
quired upon  the  payment  thereof.^-  Thus,  an  annuity  paid  by  a 
domestic  corporation  to  a  nonresident  alien  individual  is  not 
subject  to  withholding  except  to  the  extent  that  the  aggregate 
amount  of  the  payments  to  the  annuitant  exceeds  the  amount 
paid  to  purchase  the  annuity .^^ 

Bond  Interest.  The  rate  of  tax  to  be  withheld  and  the  duty  of 
withholding  upon  the  payment  of  bond  interest  to  nonresident 
aliens,  partnerships  composed  in  whole  or  in  part  of  nonresident 
alien  individuals,  and  nonresident  foreign  corporations  depends 
upon  whether  the  bonds  upon  which  the  interest  is  paid  contain 
or  do  not  contain  a  covenant  to  pay  the  tax,  and  upon  whether 

»cs.  975,  T.  B.  2-19-157. 

37  T.  D.  2090. 

38  T.  D.  2442.  See  Chapter  18  as  to  when  such  income  is  to  be  reported 
by  the  landlord. 

39  Reg.  45,  Art.  92;  Reg.  33  Rev.,  Art.  32. 

40  Letter  from  treasury  department  dated  March  10,  1916;  I.  T.  S. 
1919,  11571;   T.  B.   R.  29,  T.  B.  7-19-303. 

«  Reg.  33,  Art.  68. 

42  T.  D.  1890;  O.  D.  628,  T.  B.  33-20-1129. 

43  O.  D.  1086,  T.  B.  44-21-1898. 


COLLECTION   OF  THE  TAX  AT  THE  SOURCE 


973 


the  owner  of  the  bonds  in  question  is  known.  The  rates  of  tax 
and  the  rules  respecting  the  withholding  of  interest  paid  upon 
both  classes  of  bonds  are  given  in  the  following  paragraphs. 

INTEREST  UPON  BONDS  NOT  CONTAINING  TAX-FREE  COVENANT. 

Interest  paid  in  1918  and  thereafter  upon  bonds  not  containing  a 
tax-free  covenant  is  subject  to  withholding  at  the  rate  of  8' ;   in 
the  case  of  nonresident  aliens  or  partnerships    composed    in 
whole  or  in  part  of  nonresident  alien  individuals  and  10^;   in  the 
case  of  nonresident  foreign   corporations  except  that  for  the 
calendar  year  1922  and  subsequent  years  the  rate  is  12147^    m 
the  case  of  such  corporations.    No  tax  was  required  to  be  with- 
held   under  the  1918  Law,  from  such  interest  when  the  bonds 
in  question  were  owned  by  nonresident  foreign  partnerships.^ 
The  tax  should  be  withheld  from  such  interest  payments  at  the 
rates  in  force  for  the  year  in  which  payment  is  actually  made, 
notwithstanding  the  interest  represents  income  for  the  year  in 
which  the  coupons  become  due  and  payable.    This  is  true  even 
though  interest  coupons  which  have  matured  but  which  have  not 
been  cashed  represent  gross  income  for  the  year  of  matunty 
because  the  Revenue  Act  of  1918  provided  that  the  withholding 
agent  must  withhold  at  the  rates  prescribed  by  that  law  m  the 
case  of  every  payment  made  after  February  24,  1919,  and  the 
tax  was  required  to  be  withheld  from  the  whole  payment,  not 
merely  that  part  which  applied  to  the  period  after  February  24, 
1919      In  case  an  amount  of  tax  is  withheld  beyond  the  tax 
liability  of  the  taxpayer  the  excess  will  be  refunded  upon  appli- 
cation ^■'    No  tax  is  required  to  be  withheld  from  payments  of 
interest  upon  bonds  due  prior  to  March  1,  1913,  but  paid  sub- 

44  Letter  from  treasury  department  dated  April  18,  1919;  L  T.  S.  1919, 

45  Letter  from  treasury  department  dated  September  23    1919;   I    T.   S 

LTLLVaepartLt  dited  June^9  1919;  L  T^  ^-^J^^^ ^T '  S  ^^It 
eram  from  treasury  department  dated  September  8,  1919,  IT.  b.  19^1, 
fm?  Owing  to  the  German  occupation  of  Belgium  durmg  the  war  and 
lo  the   genera!  unsettled  conditions  in   different  parts  of   Europe,   it  was 

mpossible  for  foreign  owners  of  American  securities  to  deposit  coupons 
for  collection  when  they  became  due  during  the  years  1915,  191b,  1917  and 
1918      Such  coupons  were  presented  for  collection   in  large   Quantities   in 

he  year  1919.  In  such  cases  the  amount  of  the  coupons  should  have  been 
enter  d  as  income  on  the  returns  of  the  various  recipients  for  the  years  in 
which  coupons  matured,  but  the  withholding  agent  was  required  to  withhold 
the  tax  fr'om  these  coupons  at  the  rate  in  force  at  the  t>me  of  payment. 

(Letter   from    treasury   department   dated    September    23,    1919,    I.    T.    S. 

1921,  111778.) 


974  FEDERAL  INCOME   TAX 

sequently  to  that  date.^"  Bonds  not  containing  a  tax-free  cove- 
nant are  not  permitted  to  be  considered  tax-free  bonds  at  the 
option  of  the  issuing  corporations,  and  the  issuing  corporations 
are  prohibited  from  paying  the  tax  on  interest  derived  from 
such  bonds,  when  they  are  owned  by  citizens  or  residents  of  the 
United  States.-^^ 

In  a  case  in  which  a  company  was  trustee  for  the  debenture 
holders  of  a  banking  corporation  under  an  agreement  whereby 
the  trustee  was  to  hold  the  collateral  deposited  to  secure  pay- 
ment of  the  principal  of  the  bonds  and  interest,  the  bonds  did 
not  contain  a  tax-free  covenant  clause.  Since  the  insolvency  of 
the  banking  corporation  in  1914  the  trustee  was  engaged  in 
liquidating  the  collateral  and  applying  the  proceeds  in  payment 
of  the  debentures.  The  principal  of  the  collateral  having  proved 
insufficient  to  cover  the  principal  of  the  debentures,  a  part  of  the 
interest  collected  on  the  collateral  was  applied  in  payment  of  the 
debenture  principal  and  the  question  was  presented  whether, 
with  respect  to  payments  to  nonresident  alien  bondholders,  the 
tax  should  be  withheld  and  paid  on  the  collateral  interest  ac- 
cepted in  part  satisfaction  of  the  debt,  and  whether  the  trustee 
should  withhold  and  pay  a  tax  of  8  a  on  the  amounts  paid  during 
1920  as  arrears  of  interest.  It  was  held  that  no  tax  was  due  on 
the  interest  from  the  collateral  security  applied  in  satisfaction 
of  the  debenture  principal,  but  the  trustee  was  required  to 
withhold  and  pay  a  tax  of  8%  on  the  amounts  paid  in  1920  to 
nonresident  aliens  on  account  of  arrears  of  interest.^^ 

Interest  Upon  Bonds  Containing  a  Tax-Free  Covenant. 
In  any  case  where  bonds,  mortgages,  deeds  of  trust,  or  other 
similar  obligations  of  a  corporation^-'  contain  a  covenant,  con- 
tract, or  provision  by  which  the  obligor  agrees  to  pay  any  por- 
tion of  the  income  tax  imposed  upon  the  obligee,  or  to  reimburse 
the  obligee  for  any  portion  of  the  tax,  or  to  pay  the  interest 

46  Telegram  from  treasury  department  dated  August  26,  1919;  I.  T.  S. 
1919,  113547. 

47  Telegram  from  treasury  department  dated  June  2,  1919;  I.  T.  S. 
1921,  111779. 

48  O.  D.  624,  T.  B.  32-20-1120. 

49  These  provisions  are  not  applicable  to  bonds  containing  a  tax-free 
covenant  clause  issued  by  a  partnership.  No  tax  is  required  to  be  with- 
held from  the  interest  on  bonds  issued  by  an  obligor  other  than  a  corporation 
unless  the  interest  is  paid  to  nonresident  alien  individuals,  partnerships 
composed  in  whole  or  in  part  of  nonresident  alien  individuals  or  non- 
resident foreign  corporations,  in  which  case  the  normal  tax  of  8%  or  a 
tax  of  10%  or  12J%,  is  required  to  be  withheld.  (O.  D.  713,  T.  B.  44-20- 
1278.) 


COLLECTION  OF  THE  TAX  AT  THE  SOURCE  975 

without  deduction  for  any  tax  which  the  obhgor  may  be  required 
or  permitted  to  pay  thereon  or  to  retain  therefrom  under  any 
law  of  the  United  States,  the  corporation  or  its  withholding 
agent  is  required  to  deduct  and  withhold  a  tax  equal  to  2'r 
of  the  interest  if  paid  to  (a)  an  individual  whether  citizen  or 
resident  or  nonresident  alien,  (b)  a  partnership,  whether  domes- 
tic or  foreign,  resident  or  nonresident,  and  (c)  a  nonresident 
foreign  corporation.^  In  all  such  cases  the  tax  to  be  withheld 
is  at  the  rate  of  2  %  of  the  interest  paid  regardless  of  the  status 
of  the  payee.  Although  the  law  requires  the  deduction  of  the 
tax  at  higher  rates  in  the  case  of  payments  of  other  income  to 
nonresident  aliens,  partnerships  with  nonresident  alien  members 
and  nonresident  foreign  corporations,  only  2%  is  withheld  and 
the  recipient  of  the  interest  is  required  to  account  in  his  personal 
return  for  the  remainder  of  the  tax  that  may  be  due  thereon. 
The  corporation  is  relieved  from  withholding  in  the  case  of 
interest  payments  on  such  bonds  only  when  the  citizen  or  resi- 
dent entitled  to  receive  such  interest  files  with  the  withholding 
agent  on  or  before  February  1,  of  the  year  following  that  in 
which  the  interest  is  received,  a  signed  notice  in  writing  claim- 
ing the  benefit  of  the  personal  exemption  or  credit  for  depend- 
ents specified  in  the  law,  or  both.  In  the  case  of  nonresident 
aliens  withholding,  under  the  1918  Law,  was  required  regard- 
less of  whether  or  not  the  nonresident  alien  might  in  his  personal 
return  be  allowed  to  claim  the  personal  exemption. -^i  The  prac- 
tical effect  of  these  provisions  of  the  law  is  that  where  a  cor- 
poration has  issued  bonds  containing  a  covenant  to  pay  the  tax, 
it  will  be  required  to  go  through  the  motions  of  withholding  2%* 
on  all  payments  to  bondholders  other  than  domestic  corporations 
and  resident  foreign  corporations,  unless  in  the  case  of  citizens 
or  residents  a  certificate  is  filed  claiming  exemption  from  the 
tax  on  such  income.  No  tax  will  actually  be  withheld,  since  the 
interest  will  be  paid  in  full  under  the  terms  of  the  covenant,  and 
the  corporation  will  pay  a  tax  equivalent  to  the  amount  theo- 
retically withheld.  The  recipient  of  the  interest  will  report  in 
his  return  of  income  the  full  amount  of  the  interest  received  but 
he  will  deduct  from  the  amount  of  tax  otherwise  payable  thereon 
a  sum  equal  to  2%  of  the  total  amount  of  such  interest.     The 

50  Revenue  Act  of  1921,  §§221  and  237;  Revenue  Act  of  1918,  §§221 
and  237.  This  provision  is  inserted  in  the  law  for  the  purpose  of  shifting 
the  burden  of  the  tax  from  the  bondholder  to  the  debtor  corporation,  a  bur- 
den the  corporation  would  generally  not  be  required  to  assume  were  it 
not  for  the  withholding  provision. 

51  Revenue  Act  of  1918,  §221;  Reg.  45,  Art.  362. 


976  FEDERAL  INCOME   TAX 

ruling's  under  the  1918  Law  also  required  that  he  add  to  his 
income  the  amount  of  the  tax  so  paid  for  him  on  the  theory  that 
it  is  additional  interest,''-  but  the  Revenue  Act  of  1921  specifical- 
ly provides  that  it  shall  not  be  so  included.''"^  If  a  citizen  or  resi- 
dent is  not  subject  to  the  income  tax  by  reason  of  the  personal 
exemption  to  which  he  is  entitled,  he  should  file  with  the  debtor 
corporation  on  or  before  February  1,  of  the  year  following  that 
in  which  the  interest  was  paid,  a  certificate  claiming  exemption, 
as  otherwise  he  will  subject  the  paying  corporation  to  the  ex- 
pense of  2/c  of  the  amount  of  the  interest  paid  him,  although 
no  tax  is  due  thereon. 

Where  a  domestic  corporation  issues  tax-free  bonds  which 
contain  an  agreement  to  pay  to  the  bearer  at  maturity  of  the 
coupons  the  sum  of  5  pounds  sterling  at  the  London  office  of  a 
domestic  bank,  or  $24,34  in  gold  coin  of  the  United  States  at  a 
bank  in  the  foreign  country  in  which  the  debtor  corporation  is 
engaged  in  business,  and  a  citizen  of  Great  Britain  elects  to 
accept  payment  in  pounds  sterling  and  receives  the  equivalent  of 
$19.75  according  to  the  rate  of  exchange  upon  the  date  he 
receives  payment  in  London,  it  has  been  ruled  that  the  debtor 
corporation  is  required  to  withhold  the  normal  tax  of  2%  on 
the  amount  of  $19.75,  if  that  amount  is  the  equivalent  of  5 
pounds  when  actually  received  by  the  nonresident  alien  indi- 
vidual.^* 

Car-Trust  Certificates.  Car-trust  certificates  are  held  to  be 
obligations  similar  to  corporate  bonds  and  mortgages.  The  trus- 
tees are,  therefore,  required  to  withhold  the  tax  at  the  rate  of 
2%  if  the  certificates  contain  a  covenant,  contract,  or  provision 
by  which  the  obligor  agrees  to  pay  any  portion  of  the  income 
tax  imposed  upon  the  obligee,  or  to  reimburse  the  obligee  for 
any  portion  of  the  tax,  or  to  pay  the  interest  without  deduction 
for  any  tax  which  the  obligor  may  be  required  or  permitted  to 
pay  thereon  or  to  retain  therefrom  under  any  law  of  the  United 
States.55 

Unknown  Owners.  Withholding  in  all  cases  at  the  highest 
applicable  rate  is  required  from  interest  on  bonds  or  other 
securities  where  the  owner  of  such  securities  is  unknown  to  the 
withholding  agent."^^     The  "highest  applicable  rate"  is   (a)   2% 

52  Reg.   45,   Art.   31. 

53  Revenue  Act  of  1921,  §  234  (a)  3. 

54  O.  D.  700,  T.  B.  43-20-1262. 

55  Reg.  33  Rev.,  Art.  188. 
sfiReg.  45,  Art.  361. 


COLLECTION  OF  THE  TAX  AT  THE  SOURCE  977 

in  the  case  of  interest  upon  bonds  or  other  obligations  of  domes- 
tic or  resident  foreign  corporations  containing  a  tax-free  cove- 
nant clause,  (b)  8%  in  the  case  of  fixed  or  determinable  annual 
or  periodical  income  (other  than  dividends  allowed  as  a  credit 
and  interest  on  coi^porate  bonds  containing  a  tax-free  covenant) 
payable  to  an  unknown  owner.'"'" 

Scrip.  Scrip  issued  by  a  corporation  to  bondholders  in  pay- 
ment of  interest  upon  its  bonds  is  equivalent  to  cash  and  is 
subject  to  withholding.  When  a  corporation  which  defaulted 
in  the  payment  of  bond  interest  is  reorganized  and  the  new 
corporation  issues  scrip  in  exchange  for  the  coupons  represent- 
ing the  defaulted  interest,  ownership  certificates  are  required 
to  be  filed  by  the  owners  covering  the  face  value  of  the  coupons 
exchanged,  the  form  of  certificate  depending  upon  whether  or 
not  the  bonds  are  tax-free  and  whether  or  not  the  owner  claims 
exemption  from  having  tax  paid  at  the  source.  The  withholding 
requirements  of  the  law  are  not  applicable  to  the  interest  paid 
by  the  terms  of  the  scrip  on  the  defaulted  bond  interest,  unless 
the  scrip  is  held  by  nonresident  aliens.-"'^  Where  as  a  result  of 
the  reorganization  of  a  domestic  corporation  in  1919,  bonds  and 
stocks  were  issued  to  holders  of  securities  of  that  corporation, 
certain  of  the  holders,  due  to  limited  participation,  receiving 
scrip  certificates,  which,  when  presented  with  others  aggregat- 
ing a  certain  amount  entitled  the  holder  to  a  bond  of  a  stated 
value,  together  with  interest  thereon  from  June,  1919,  bonds 
equal  to  the  aggregate  of  scrip  issued  being  certified  by  the  trus- 
tee under  the  mortgage  and  issued  to  tlie  treasurer  of  the  corpo- 
ration in  trust  for  the  holders  of  the  scrip  and  the  interest  cou- 
pons of  these  bonds,  which  do  not  contain  a  tax-free  covenant 
clause,  being  presented  from  time  to  time  by  the  treasurer  for 
payment,  accompanied  by  ownership  certificates.  Form  1001, 
revised,  he  holding  the  interest  so  collected  in  trust  to  be  paid 
over  to  the  scrip  holders ;  no  interest  being  paid  to  scrip  holders 
except  when  in  accordance  with  the  above  plan  they  present 
scrip  and  receive  in  exchange  a  bond  together  with  accrued 
interest  thereon,  it  has  been  held  that  the  scrip  holders  can  not 

57  Letter  from  treasury  department  dated  June  2,  1919;  I.  T.  S.  1919, 
Ti3383;  letter  from  treasury  department  dated  April  18,  1919;  I.  T.  S. 
1919,  T13318;  O.  D.  517,  T.  B.  21-20-956.  This  ruling  seemed  to  ignore  the 
fact  that  10%  should  have  been  withheld  if  the  owner  is  a  foreign  cor- 
poration, which  rate  might  well  be  taken  to  be  the  "highest  applicable 
rate"  as  to  all  income  subject  to  withholding,  except  interest  on  tax-free 
covenant  bonds. 

58  0.  D.  279,  T.  B.  20-19-512;   O.  D.  562,  T.  B.  26-20-1032. 


978  FEDERAL   INCOME   TAX 

be  considered  owners  of  the  bonds  until  the  bonds  are  actually 
delivered  in  exchange  for  the  scrip.  The  accrued  interest  due 
the  scrip  holders  is,  in  effect,  interest  on  the  scrip  and  not  in- 
terest on  the  bonds;  consequently^  no  ownership  certificates  are 
required  to  be  filed  by  the  scrip  holders  when  receiving  the  ac- 
crued interest  upon  exchanging  their  scrip  for  bonds.  When 
bonds  are  exchanged  for  scrip  held  by  nonresident  alien  individ- 
uals, partnerships  with  nonresident  alien  members  or  nonresi- 
dent alien  corporations,  the  normal  tax  of  8%  or  10%  or  121/2% 
should  be  withheld  from  the  accrued  interest  and  returned  in 
the  manner  prescribed  by  law.^^ 

Against  Whom  the  Tax  Is  Withheld.  Although  the  foregoing 
paragraphs  indicate  the  classes  of  taxpayers  against  whom  a  tax 
is  withheld  the  law  will  be  restated  under  this  heading  for  the 
sake  of  convenient  reference. 

Citizens  and  Residents.  No  tax  is  withheld  on  payments 
to  citizens  and  residents  except  in  cases  where  interest  is  paid 
upon  any  bonds,  mortgages,  deeds  of  trust,  or  similar  obliga- 
tions of  corporations  containing  covenants  to  pay  the  tax,  in 
which  case  the  tax  is  required  to  be  withheld  at  the  rate  of  2%. 

Citizens  of  United  States  Possessions.  The  income  of  a 
citizen  of  a  possession  of  the  United  States,  who  is  not  otherwise 
a  citizen  or  a  resident  of  the  United  States,  from  sources  within 
the  United  States,  is  subject  to  withholding.'^^ 

Nonresident  Aliens.  In  the  case  of  payments  of  interest 
upon  bonds  of  corporations  containing  covenants  to  pay  the  tax, 
the  tax  is  withheld  at  the  rate  of  2%.  In  all  other  cases  where 
payment  is  made  of  fixed  or  determinable  annual  or  periodical 
income  the  tax  is  withheld  at  the  rate  of  8%.  A  withholding 
agent  is  not  relieved  from  obligation  to  pay  to  the  federal  gov- 
ernment the  amount  of  tax  correctly  withheld  from  the  income  of 
a  nonresident  alien  by  reason  of  the  fact  that  the  nonresident 
alien  has  filed  a  return  showing  no  tax  liability .^^  A  domestic 
corporation  is  not  relieved  from  withholding  on  royalties  paid 
to  a  nonresident  alien  by  reason  of  the  fact  that  the  alien  has 
appointed  a  domestic  banker  to  act  as  his  agent  for  the  purpose 
of  paying  his  taxes  in  the  United  States.''^ 

Fiduciaries.  The  tax  is  withheld  on  payments  of  bond  inter- 
est to  fiduciaries  who  are  citizens  or  residents  of  the  United 
States  and  who  have  an  office  or  place  of  business  therein  in  the 

59  O.  D.  680,  T.  B.  41-20-1233. 

60  Reg.  45,  Art.  1121. 

61  O.  D.  985,  T.  B.  31-21-1756. 

62  O.  D.   1087,  T.   B.  44-21-1899. 


COLLECTION  OF  THE  TAX  AT  THE  SOURCE  979 

same  manner  and  to  the  same  extent  as  in  the  case  of  citizens 
and  residents,  whether  the  fiduciary  is  an  individual  or  corpora- 
tion. The  tax  is  withheld  on  payments  to  foreign  fiduciaries  in 
the  same  manner  and  to  the  same  extent  as  in  the  case  of  non- 
resident aliens  whether  the  fiduciary  is  an  individual  or  a  cor- 
poration. Fiduciaries  are  subject  to  all  the  provisions  of  the  law 
which  apply  to  individuals.*'*'  Bond  interest  paid  to  a  nonresident 
alien  fiduciary  is  subject  to  withholding  even  though  the  bene- 
ficiaries of  the  income  are  citizens  or  residents  of  the  United 
States.''-* 

Partnerships.  On  payments  to  partnerships,  whether  do- 
mestic or  foreign,  resident  or  nonresident,  of  interest  upon  bonds 
of  corporations  containing  covenants  to  pay  the  tax,  the  tax  is 
withheld  at  the  rate  of  2'<  .  Under  the  1918  Law,  no  tax  was 
withheld  on  payment  of  any  other  form  of  income,'''^  but  under 
the  present  law  withholding  is  required  against  partnerships 
composed  in  whole  or  in  part  of  nonresident  alien  individuals  to 
the  same  extent  as  against  nonresident  alien  individuals.'"''''  Pend- 
ing the  issuance  of  regulations  on  this  subject  income  subject  to 
withholding  should  be  withheld  when  paid  to  any  partnership.'"'" 

Personal  Service  Corporations.  Personal  service  corpora- 
tions, after  receiving  notice  from  the  Commissioner  that  their 
returns  as  personal  service  corporations  have  been  approved,  but 
not  before,  may  for  purposes  of  withholding  proceed  as  partner- 
ships in  claiming  exemptions  and  in  obtaining  the  benefit  of 
haying  the  tax  paid  for  them  under  tax-free  covenants.'''^ 

Corporations.  No  tax  is  withheld  in  any  case  on  payment  of 
income  to  domestic  corporations  or  to  resident  foreign  corpora- 
tions. In  the  case  of  nonresident  foreign  corporations  the  tax  is 
withheld  at  the  rate  of  2V'  on  all  payments  of  interest  upon 
bonds  of  corporations  containing  covenants  to  pay  the  tax;  and 
at  the  rate  of  10 'r  on  all  other  fixed  or  determinable  annual  or 
periodical  income  regardless  of  the  fact  that  the  corporation  has 
filed  or  intends  to  file  a   return  covering  its  income  from  all 

<«  Revenue  Act  of  1921,  §§225  and  221;  Revenue  Act  of  1918,  §§225  and 
221;  Reg.  45,  Art.  374;  O.  D.  1085,  T.  B.  44-21-1897. 
64  0.  D.  670,  T.  B.  39-20-1212. 
en  Revenue  Act  of  1918,  §221;  Reg.  45,  Art.  361. 
fi«  Revenue  Act  of  1921,  §221. 

67  Telegram  from  treasury  department  dated  December  2,  1921;  I.  T.  S. 
1921,  Tl  3254.  It  would  seem,  however,  that  withholding  against  partner- 
ships is  unnecessary  if  the  payor  satisfies  himself  that  the  partnership 
has  no  nonresident  alien  members. 

68  Letter  from  treasury  department  dated  November  20,  1919;  I.  T.  S. 
1921,  TI1848. 


980  FEDERAL   INCOME   TAX 

sources,  within  the  United  States.*'-*  For  the  calendar  year  1922 
and  subsequent  years  the  rate  is  121/2''-  For  the  purpose  of 
withholding,  a  Porto  Rican  corporation  is  a  foreign  corpora- 
tionJ" 

Agents.  The  fact  that  an  individual,  partnership  or  cor- 
poration may  have  an  agent  within  this  country  to  collect  and 
receive  income,  does  not  operate  to  prevent  withholding  of  the 
tax  on  payments  of  income  to  such  agent  in  cases  where  pay- 
ments direct  to  the  principal  would  be  subject  to  withholding. 
The  appointment  of  an  agent  in  this  country  does  not,  in  itself, 
establish  the  residence  of  the  principal  in  this  country,  for  the 
purpose  of  the  income  tax,  nor  does  such  appointment  exempt 
a  nonresident  foreign  corporation  from  the  withholding  pro- 
visions unless,  in  addition  to  the  appointment  of  the  agent,  the 
corporation  is  engaged  in  business  in  this  country  or  has  an  office 
or  place  of  business  herein.  The  appointment  of  an  agent  in 
this  country  will  exempt  a  nonresident  foreign  corporation  from 
the  withholding  provisions  of  the  statute  provided  the  agent 
furnishes  the  person  otherwise  obliged  to  withhold  with  a  cer- 
tificate stating  that  the  foreign  corporation  has  an  office  or  place 
of  business  in  the  United  States  and  that  he  will  make  all  neces- 
sary returns  and  pay  all  taxes  shown  to  be  due."'  Agents  of 
nonresident  aliens,  foreign  partnerships  or  foreign  corporations 
subject  to  the  withholding  provision  should  proceed,  in  collecting 
income  from  their  principals,  in  the  same  manner  as  the  princi- 
pals would  proceed  in  acting  for  themselves. 

Who  Are  Required  to  Withhold  Tax.  Under  the  1921  Law  and 
the  1918  Law  it  is  required  that  all  individuals,  corporations  and 
partnerships,  in  whatever  capacity  acting,  including  lessees  or 
mortgagors  of  real  or  personal  property,  fiduciaries,  employers, 
and  all  officers  and  employees  of  the  United  States,  having  the 
control,  receipt,  custody,  disposal,  or  payment,  of  interest,  rent, 
salaries,  wages,  premiums,  annuities,  compensations,  remunera- 
tions, emoluments,  or  other  fixed  or  determinable  annual  or 
periodical  gains,  profits,  and  income  shall  withhold  the  tax, 
when  withholding  is  required  by  reason  of  the  status  of  the 
recipient  of  the  income."-     It  has  been  held  that  a  foreign  cor- 

69  Revenue  Act  of  1921,  §§221  and  237;  Revenue  Act  of  1918,  §§221  and 
237;  Reg.  45,  Art.  361;  O.  D.  910,  T.  B.  19-21-1627;  0.  D.  858,  T.  B.  12- 
21-1523. 

70  Revenue  Act  of  1921,  §237;  Reg.  45,  Art.  1133. 
710.   D.  358,  T.  B.  1-20-661. 

72  Revenue  Act  of  1921,  §§221  and  237;  Revenue  Act  of  1918,  §§221 
and  237. 


COLLECTION  OF  THE  TAX  AT  THE  SOURCE  981 

poration  having  a  fiscal  agency  in  this  country  is  required  to 
withhold  a  tax  of  2' '<  upon  the  interest  upon  its  tax-free  cove- 
nant bonds.'-' 

Duty  of  Employer  to  Determine  Status  of  Alien  Em- 
ployees. Employers  are  responsible  for  the  deduction  of  the 
tax  at  the  source  on  payments  of  salary  or  compensation  to  non- 
resident alien  employees.'^  Aliens  employed  in  the  United 
States  are  prima  facie  regarded  as  nonresidents  for  the  purpose 
of  withholding.'"'  If  wages  are  paid  without  withholding  the 
tax,  the  employer  should  be  provided  with  written  proof  of  facts 
which  overcome  the  presumption  that  the  alien  is  a  nonresi- 
dent."*' Such  presumption  may  be  overcome  as  outlined  in  an- 
other chapter."'  The  employer  may  rely  upon  the  evidence  of 
residence  afforded  by  the  fact  that  the  alien  has  filed  Form  1078 
(revised)  or  an  equivalent  certificate  establishing  residence."^ 
A  record  of  such  forms  of  certificates  should  be  kept  by  every 
employer  and  the  certificates  forwarded  to  the  Commissioner 
(Sorting  Division,  Washington,  D.  C.)  not  later  than  the  twen- 
tieth day  of  the  month  succeeding  that  during  which  they  were 

'3  Reg.  45,  Art.  361;  letters  from  treasury  department  dated  July  9, 
1918;  (I.  T.  S.  1918,  113612)  and  July  18,  1918;  (L  T.  S.  1918,  ^3613); 
O.  D.  561,  T.  B.  26-20-1030. 

T4  Letter  from  treasury  department  dated  May  21,  1919;  I.  T.  S.  1919, 
^3394.  This  was  first  required  in  September,  1915.  (See  T.  D.  2242.) 
Withholding  after  February  25,  1919,  should  be  at  the  rate  of  8  per  cent. 
Although  nonresident  aliens  were  subject  to  a  normal  tax  of  12  per  cent 
for  1918,  only  2  per  cent  was  required  to  be  withheld  during  that  year, 
the  balance  due  to  be  accounted  for  in  the  individual  income  tax  returns. 

75  Reg.  45,  Art.  313,  as  amended  by  T.  D.  3155,  T.  B.  17^21-1599. 

7«Reg.  45,  Art.  315,  as  amended  by  T.  D.  3155,  T.  B.  17-21-1599.  See 
Reg.  45,  Art.  316,  however. 

""  See  Chapter  3. 

TS  Reg.  45,  Art.  315,  as  amended  by  T.  D.  3155,  T.  B.  17-21-1599.  If  an 
officer,  qualified  to  administer  oaths,  is  not  reasonably  accessible,  Form  1078 
(Revised),  will  be  accepted  if  signed  in  the  presence  of  an  official  of  the 
employer  company  under  whose  supervision  the  employee's  duties  are 
performed,  and  one  other  credible  witness.  (Letter  from  treasury  depart- 
ment dated  September  20,  1919;  I.  T.  S.  1919,  ^3612.)  Having  secured 
such  evidence  from  the  alien,  the  employer  may  rely  thereon  unless  the 
statement  of  the  alien  was  false  and  the  employer  has  reasonable  cause 
to  believe  it  false,  and  may  continue  to  rely  thereon  until  the  alien  ceases 
to  be  a  resident.  It  is  not  necessary  to  secure  new  certificates  for  each 
taxable  year.  (Letter  from  treasury  department  dated  July  9,  1919;  I.  T. 
S.  1921,  t[  525.  An  alien  who  has  established  a  residence  in  the  United  States 
continues  to  be  a  resident  until  he  or  his  family  evidence  an  intention  to 
change  their  residence  to  another  country  by  starting  to  remove.)  (Reg. 
45,  Art.  314,  as  amended  by  T.  D.  3155,  T.  B.  17-21-1599;  T.  D.  2794.) 


982  FEDERAL   INCOME   TAX 

receivedJ^  An  employer  who  seeks  to  account  for  failure  to 
withhold  the  required  tax  and  who  did  not  at  the  time  secure 
Form  1078  (revised)  or  its  equivalent,  is  permitted  to  prove  the 
former  status  of  the  alien  by  any  material  evidence.^"  The  burden 
of  proof  in  such  cases  is  on  the  employer  and  such  proof  must 
be  in  writing.  Hence  the  name  and  address  of  employees  should 
be  secured,  regardless  of  the  fact  that  for  the  convenience  of  the 
employer  the  individual  is  known  by  number.-^i  In  the  case  of 
alien  seamen,  the  regulations  provide  that  residence  may  be 
established  on  a  vessel  regularly  engaged  in  coastwise  trade.^^ 
This  provision,  however,  merely  places  alien  seamen  employed 
on  a  vessel  regularly  engaged  in  coastwise  trade  on  the  same 
footing  with  an  alien  employed  within  the  United  States  for  pur- 
poses of  proving  residence  within  the  United  States.  The  em- 
ployer should,  therefore,  be  governed  by  the  above  requirements 
with  respect  to  the  necessity  for  filing  Form  1078   (revised)  .^ 

Employees  of  Mining  Contractors — "Back  Hands."  It  is 
customary  in  a  great  many  mining  districts  to  let  out  a  certain 
portion  of  a  mine  to  some  miner  who  is  usually  termed  a  con- 
tractor, who  employs  additional  labor  for  the  production  of  coal 
for  the  section  of  the  mine  assigned  to  him.  These  men,  usually 
termed  "back  hands,"  sometimes  do  not  appear  upon  the  pay-roll 
and  are  very  frequently  not  officially  known  to  an  operator  or 
employer.  The  operator  frequently  does  not  know  the  amount 
of  earnings  of  the  "back  hand"  or  laborer  employed  by  the 
contractor  and  the  latter  usually  keeps  no  books  of  account.  In 
such  cases  the  duty  of  withholding  the  tax  at  the  source  is  that 
of  the  contractor  and  not  of  the  corporation."*^ 

Change  of  Status  of  Employee.  Where  the  status  of  an 
alien  changes  during  the  year  from  that  of  resident  to  that  of 
nonresident,  or  from  that  of  a  nonresident  to  that  of  resident, 
the  status  which  exists  at  the  end  of  the  taxable  year  is  the  one 
which  determines  his  right  to  exemption  as  to  the  whole  year. 
Where  an  employer  has  withheld  wages  from  a  nonresident  alien 

79  Letter  from  treasury  department  dated  May  21,  1919;  I.  T.  S.  1921, 
11527;  Letter  from  treasury  department  dated  July  9,  1919;  I.  T.  S.  1919, 
TI3492;  0.  D.  143,  T.  B.  4-19-224. 

80  Reg.  45,  Art.  1315,  as  amended  by  T.  D.  3155,  T.  B.  17-21-1599. 

81  Reg.  45,  Art.  315;  T.  D.  2794;  Letter  from  treasury  department  dated 
May  26,  1919;  L  T.  S.  1921,  1|1740;  O.  D.  175,  T.  B.  7-19-298. 

82  Reg.  45,  Art.  312. 

83  Letter  from  treasury  department  dated  September  20,  1919 ;  I.  T.  S. 
1921,  U^  520,  1694. 

84  Letter  from  treasury  department  dated  May  26,  1919;  L  T.  S.  1921, 
If  1740;  O.  D.  175,  T.  B.  7-19-298. 


COLLECTION   OF  THE  TAX  AT  THE  SOURCE  983 

during  part  of  the  year  and  thereafter  the  employee  becomes 
a  resident  (before  the  employer  has  paid  over  to  the  United 
States  the  amount  of  tax  withheld),  the  employer  is  authorized 
on  receiving  proof  of  the  change,  to  refund  to  the  employee  the 
amounts  which  had  been  withheld  from  him  during  the  earlier 
part  of  the  taxable  year,  while  his  status  was  that  of  a  non- 
resident. As  a  condition  precedent  to  a  refund  an  employer 
should  require  the  employee  to  return  the  receipts  showing  the 
amount  of  tax  previously  withheld  before  making  the  refund.*^'' 
If  the  status  of  a  resident  employee  changes  to  that  of  a  non- 
resident alien,  the  employer  should  withhold  the  tax  at  the  rate 
of  8%  from  all  wages  or  compensation  paid  to  such  employee  on 
and  after  the  date  on  which  the  employer  has  knowledge  of  the 
change.  Although  an  employee  in  such  case  will  be  taxable  as 
a  nonresident  alien  for  the  entire  taxable  year  during  which  his 
status  is  changed  from  that  of  a  resident  to  that  of  a  non- 
resident alien,  the  employer  will  not  be  held  liable  for  the  de- 
duction of  the  tax  with  respect  to  wages  paid  prior  to  the 
knowledge  of  the  employer  as  to  the  change  in  status.^^' 

Duties  of  Assignees.  Where  in  connection  with  the  sale  of 
its  property,  payment  of  the  bonds  or  other  obligations  of  a 
corporation  is  assumed  by  the  assignee,  such  assignee,  whether 
an  individual,  partnership,  corporation,  or  a  state  or  political 
subdivision  thereof,  must  deduct  and  withhold  such  taxes  as 
would  have  been  required  to  be  withheld  by  the  assignor  had 
no  such  sale  and  transfer  been  made."^" 

Exemption  From  Withholding.  Withholding  from  interest  on 
bonds  or  other  obligations  containing  a  tax-free  covenant  will 
not  be  required  in  the  case  of  a  citizen  or  resident  alien  individ- 
ual if  he  files  with  the  withholding  agent  when  presenting  inter- 
est coupons  for  payment,  or  not  later  than  February  first  fol- 
lowing the  taxable  year,  an  ownership  certificate  on  Form  1001 
(revised)  claiming  a  personal  exemption  or  credit  for  depend- 
ents. To  avoid  inconvenience  a  resident  alien  individual  should 
file  a  certificate  of  residence  on  Form  1078  (revised)  with  with- 
holding agents,  who  should  forward  such  certificates  to  the  Com- 
missioner (Sorting  Division)  with  a  letter  of  transmittal.^^'^  The 

85  0.  D.  302,  T.  B.  24-19-569. 

80  Letter  from  treasury  department  dated  August  6,  1919;  I.  T.  S. 
1921,  111751;  letter  from  treasury  department  dated  June  12,  1919;  I.  T. 
S.  1921,  TI1749;  0.  D.  128,  T.  B.  3-19-196;  O.  D.  302,  T.  B.  24-19-569;  O. 
D.  254,  T.  B.  15-19-447. 

87  Reg.  45,  Art.  364. 

88  Reg.  45,  Art.  363. 


984  FEDERAL   INCOME   TAX 

extent  to  which  nonresident  aliens  may  secure  exemption  from 
withholding  as  against  any  income  from  sources  within  the 
United  States  up  to  the  amount  of  any  personal  exemption  and 
credit  for  dependents  which  may  be  allowed  to  them  under  the 
similar  credit  provision  of  the  statute  is  discussed  elsewhere.'^" 
Tax  erroneously  withheld  from  the  wages  of  a  nonresident 
alien  seaman  who  can  not  now  be  located  for  the  purpose  of 
making  refund  should  be  reported  on  the  annual  list  return, 
Form  1042,  and  paid  to  the  government,  and  when  the  seaman 
is  located  he  should  be  advised  of  his  right  to  file  claim  for 
refund.'"' 

Ownership  Certificates.  The  owners  of  bonds  or  other  obli- 
gations, whether  or  not  containing  a  tax-free  covenant,  issued  by 
domestic  or  resident  foreign  corporations,  when  presenting  in- 
terest coupons  for  payment,  are  required  to  file  a  certificate  of 
ownership  for  each  issue  of  bonds,  showing  the  name  and  ad- 
dress of  the  debtor  corporation,  the  name  and  address  of  the 
owner  of  the  bonds,  the  nature  of  the  obligations,  the  amount 
of  interest  and  its  due  date,  and  the  amount  of  any  tax  withheld. 
No  ownership  certificates  need  be  filed  in  the  case  of  interest 
payments  on  bonds  the  income  from  which  is  not  included  in 
gross  income,  nor  in  the  case  of  any  obligation  of  the  United 
States.'*!  All  the  information  called  for  by  ownership  certifi- 
cates is  necessary  for  the  efficient  administration  of  the  Rev- 
enue Act.  Debtor  corporations  will  be  held  responsible  for  the 
proper  execution  of  certificates,  but  not  as  to  misstatements  by 
bond  owners.  Ownership  certificates  should  not  be  accepted  and 
payments  should  be  refused  unless  all  information  called  for 
thereon  is  shown.^^  Ownership  certificates  executed  by  the  owner 
must  indicate  whether  or  not  he  is  married  or  the  head  of  a 
family.^''  But  interrogatories  as  to  the  marital  status  on  owner- 
ship certificates  need  not  be  answered  when  certificates  are  ex- 
empted by  nonresident  alien  individuals.-'^  But  if  he  states  that  he 

89  See  Chapter  31. 

90  O.  D.  258,  T.  B,  16-19-463. 

91  Reg.  45,  Art.  364.  Bonds  of  the  war  finance  corporation  are  held  not 
to  be  government  bonds.  (O.  D.  284,  T.  B.  21-19-527.)  Debentures  may 
be  the  equivalent  of  bonds  so  that  ownership  certificates  are  necessary  in 
connection  with  payments  thereon   (O.  D.  1060,  T.  B.  41-21-1861). 

92  M.  2725,  T.  B.  11-21-1514.  Telegram  from  treasury  department  dated 
April  7,  1919;  I.  T.  S.  1921,  TI1814;  telegram  from  treasury  department 
dated  February  28,  1918;  I.  T.  S.  1918,  TI3146;  O.  D.  615,  T.  B.  31-20-1104. 

93  Letter  from  treasury  department  dated  March  26,  1918;  L  T.  S. 
1921,  II  1824. 

94  Telegram  from  treasury  department  dated  May  23,  1918;  I.  T.  S. 
1918,  113380. 


COLLECTION  OF  THE  TAX  AT  THE  SOURCE  085 

is  married  it  is  not  also  necessary  that  he  state  that  he  is  head 
of  a  family.'"'  The  address  may  be  omitted  from  ownership 
certificates  in  the  case  of  prominent  corporations  and  in  its  place 
a  description  of  the  bond  issue  may  be  inserted.'*'  Separate 
ownership  certificates  will  be  required  for  each  interest  coupon 
of  ditt'erent  maturity  date  even  though  of  the  same  issue.^^ 
The  official  position  of  the  person  authorized  to  sign  owner- 
ship certificates  in  behalf  of  a  corporation  and  the  identity  of  the 
person  signing  in  behalf  of  a  partnership  is  required  to  be  dis- 
closed on  the  certificates."''  Pending  a  decision  by  the  United 
States  Supreme  Court  on  the  taxability  of  interest  on  joint-stock 
land  bank  bonds,  no  ownership  certificates  are  required  in  col- 
lecting interest  on  such  bonds. i""  In  the  case  of  interest  pay- 
ments on  overdue  bonds,  the  interest  coupons  of  which  have 
been  exhausted,  ownership  certificates  are  required  to  be  filed 
when  collecting  the  interest  in  the  same  manner  as  if  interest 
coupons  were  presented  for  collection.!"^ 

Where  Conditions  Change  Between  Interest  Dates. 
Where  an  interest  coupon  is  presented  for  payment  of  interest 
upon  a  bond  which  has  been  sold  between  interest  dates,  the 
coupon  should  be  accompanied  by  the  ownership  certificate  of 
the  purchaser  only,  and  the  certificate  should  cover  the  full 
amount  of  the  coupon.  The  purchaser  may,  if  he  does  not  claim 
exemption  from  having  the  tax  paid  at  the  source,  take  credit 
in  his  return  for  the  tax  paid  at  the  source  on  the  entire  amount 
of  interest  represented  by  the  coupon.  The  discrepancy  between 
the  amount  of  bond  interest  reported  in  the  purchaser's  return 
in  such  cases,  and  the  amount  of  interest  shown  by  his  owner- 
ship certificates  to  have  been  collected  by  him  should  be  ex- 
plained by  a  statement  attached  to  and  made  a  part  of  the 
return,  showing  the  total  amount  of  interest  collected  and  the 

9«  Letter  from  treasury  department  dated  March  30,  1918;  I.  T.  S.  1919, 
TI671. 

9"  Telegram  from  treasury  department  dated  February  11,  1918;  I.  T. 
S.  1921,  111817. 

S»S  Telegram  from  treasury  department  dated  June  24,  1919;  I.  T.  S. 
1921,  TI1822. 

99  Telegram  from  treasury  department  dated  June  16,  1921;  I.  T.  S. 
1921,  113065. 

100  0.  D.  758,  T.  B.  52-20-1363. 

101  0.  D.  392.  T.  B.  5-20-719. 


986  FEDERAL   INCOME   TAX 

amount  of  interest  accrued  on  the  bond  to  the  date  of  purchase.^02 
Certain  bonds  contain  the  privilege  of  being  converted  into  the 
stock  of  the  corporation  which  issued  the  bonds.  If  the  owner 
of  the  bonds  exercises  his  privilege  of  conversion  between  inter- 
est dates  and  is  allowed  accrued  interest,  he  is  required  to  file 
an  ownership  certificate  covering  such  accrued  interest  when 
it  is  paid.103 

Forms  of  Ownership  Certificates.    The  following  is  a  list 
of  the  latest  revisions  of  ownership  certificates : 

Form  1000 Revised  January,   1921 


1001.. 
lOOlA 
1058.. 
1059.. 
1087.. 


January,  1921 

January,  1921 

January,  1921 

January,  1921 

April,  1919 


Form  1071  is  now  obsolete.  Form  lOOlA  being  used  in  its  place. 

Rules  for  Use  of  Forms.  As  a  general  rule,  Form  1000 
is  used  when  withholding  is  required  and  Form  1001  is  used 
when  no  withholding  is  required.  Forms  1058  and  1059  are 
substitute  certificates  to  be  used  as  indicated  below  in  the  place 
of  the  original  ownership  certificates  which  are  sent  to  Wash- 
ington. Form  1058  is  used  in  lieu  of  original  ownership  cer- 
tificate Form  1001,  and  Form  1059  is  used  in  lieu  of  original 
ownership  certificate  Form  1000.  The  use  of  Form  1087  is 
indicated  in  Chapter  5.  Form  lOOlA  is  used  in  connection  with 
foreign  items,  as  defined  above.  The  following  is  a  table  indicat- 
ing the  particular  form  of  ownership  or  substitute  certificates 
to  be  used  in  particular  cases  as  stated  in  the  text  following 
the  table :  , 

1020.  D.  830,  T.  B.  9-21-1483;  Letter  from  treasury  department  dated 
February  16,  1921;  I.  T.  S.  1921,  If  2724,  revoking  letters  from  treasury  de- 
partment dated  July  21,  1920,  and  August  17,  1920;  I.  T.  S.  1921,  ^^  1880- 
1893. 

i"3  0.  D.  949,  T.  B.  24-21-1689. 


COLLECTION  OF  THE  TAX  AT  THE  SOURCE 


987 


Table  for  Use  of  Ownership  and  Substitute  Certificates.^ 


CLASSIFICATION 

OF 

OWNER 


ritizen  nr  Risident— 

Individual    or    fiduciary    claiming    ex 

einplion    

Individual    or    fiduciary   not   claiming 

exemption    

Partnersliip      and      Personal      Service 

Corporations'     

Corporations   

Nonresident   Alien    

Individual  or  fiduciary   

Partnership     

Corporations '     

Bunl\s  receiving  coupons  not  accompanied 
l)y  Ownersliip  Certificates  —  Owner- 
ship      

Unlsnown   

t'oreimn    Governments    

Foreign  Charitable  or  Exempt  Corporations 


SUBSTITUTE 

OWNERSHIP   CERTIFICATES 

Bonds  of  Domestic   or 

Resident  Foreign 

Corporations 

With 

With 

Witlioiit 

Without 

Tax-Free 

Tax-Free 

Foreign 

Tax-Free 

Tax-Free 

Covenant 

Covenant 

Items  = 

Covenant 

Covenant 

(1000  or 

10018 

1001 

1001  A)3 
(1000  or 

1058 

1058 

1000 

1001  A)3 
(1000  or 

1059 

1058 

1000 

1001 

1001  A)3 

1059 

1058 

1001 

1001 

(1000  or 

1058 

1058 

1001  A)3 

None 

None 

1000 

1000 

1001  A 

Permitted 
None 

Permitted 
None 

1000 

1001 

1001  A 

Permitted 

None 

Permitted 
None 

1000  3 

1000 

1001  A 
(1000  or 

Permitted 

Permitted 

1000 

1000 

1001  A)* 
(1000  or 

1001 

1001 

1001  A)a 

1000 

1000 

1  See  Reg.  45,  Arts.  365-7,  1078;  letter  from  treasury  department  dateci 
May  20,  1919;  I.  T.  S.  1919,  1|3338;  telegram  from  treasury  department 
dated  July  7,  1919;  I.  T.  S.  1919,  113474.  O.  D.  144,  T.  B.  4-19-225;  0.  D. 
520,  T.  B.  21-20-958. 

-  The  term  "foreign  item",  as  here  used,  means  any  dividend  upon  the 
stock  of  a  nonresident  foreign  corporation  or  any  item  of  interest  upon 
the  bonds  of  foreign  countries  or  nonresident  foreign  corporations, 
whether  or  not  such  dividend  or  interest  is  paid  in  the  U.  S.  or  by  check 
drawn  on  a  domestic  bank.     (Reg.  45,  Art.  1077.) 

•5 1000  is  used  in  this  instance  if  the  foreign  country  or  foreign  corporation 
has  a  fiscal  agent  in  this  country  and  if  the  bonds  contain  a  tax-free  cov- 
enant clause,  unless  exemption  is  claimed.  (Reg.  45,  Art.  1078;  letter  from 
treasury  department  dated  May  20,  1919;  I.  T.  S.  1919,  ^3338.) 

*  1001  A  is  used  in  this  instance  if  the  owner  is  known  to  be  a  nonresident 
alien  individual,  corporation,  or  partnership,  and  in  the  case  of  bonds  not 
containing  a  tax-free  covenant  and  stocks  of  foreign  corporations. 

5  A  foreign  corporation  not  engaged  in  trade  or  business  within  the  U. 
S.,  which  has  a  fiscal  agent  in  the  U.  S.,  is  not  a  resident  corporation. 
(Letter  from  treasury  department  dated  May  20,  1919;  I.  T.  S.  1919, 
1[3338.) 

6  In  the  case  of  registered  bonds  having  a  tax-free  covenant  1000  is 
used  by  the  withholding  agent  if  the  oviTier  files  no  certificate.  That  is, 
if  the  owner  files  no  certificate  the  withholding  agent  must  presume  that 
he  does  not  claim  exemption  from  withholding.     (Reg.  45,  Art.  369.) 

7  Before  a  corporation  can  be  regarded  as  a  personal  service  corporation 
it  must  have  received  notice  from  the  Commissioner  that  its  claim  to  be 
regarded  as  a  personal  service  corporation  has  been  approved.  (Letter 
from  treasury  department  dated  November  20,  1919;  I.  T.  S.  1921, 
^  1848.)  Personal  service  corporations  are  to  be  treated,  so  far  as  prac- 
ticable, on  the  same  basis  as  partnerships.  Corporations  which  have  re- 
ceived notice  that  their  returns  as  personal  service  corporations  have  been 
approved  may  thereafter,  and  not  before,  issue  Form  1000  in  collecting 
interest  from  bonds  or  other  obligations  of  a  corporation  containing  a  so- 


988  FEDERAL  INCOME   TAX 

called  tax-free  covenant  clause  in  the  same  manner  and  to  the  same  ex- 
tent that  partnerships  are  authorized  to  use  that  form.  The  form  should 
bear  the  stamped  or  written  notation  "approved  by  the  treasury  department 
as  personal  service  corporation  on   (date)."     (0.  D.  339,  T.  B.  29-19-628.) 

■'^  A  foreign  corporation,  notwithstanding  it  claims  to  be  exempt,  is  re- 
quired to  file  Form  1000  (revised)  in  collecting  interest  on  bonds  issued 
by  domestic  or  resident  corporations,  and  the  debtor  corporation,  or  its 
withholding  agent,  is  required  to  pay  the  tax  due.  Such  foreign  corporation, 
however,  has  the  privilege  of  establishing  its  exemption.  When  a  debtor 
corporation  has  assumed  the  payment  of  the  2%  normal  tax  on  the  inter- 
est derived  from  its  tax-free  bonds,  owned  by  an  exempt  foreign  cor- 
poration, it  may  file  a  claim  for  refund  accompanied  by  the  proof  of 
exemption  submitted  by  the  foreign  corporation.  Otherwise,  the  foreign 
corporation  should  file  a  claim  for  refund  accompanied  by  the  required 
proof.      (O.   D.  616,  T.  B.  31-20-1105.) 

9  Income  payable  to  a  foreign  government  is  not  subject  to  tax,  but 
should  be  reported  on  line  6  of  Form  1001-A,  crossing  out  the  word  "cor-, 
poration"  and  substituting  "foreign  government".  With  respect  to  foreign 
items  presented  for  collection  unaccompanied  by  an  ownership  certificate, 
if  the  item  is  a  coupon  detached  from  a  bond  containing  a  tax-free  cov- 
enant clause  and  the  debtor  organization  has  a  paying  agent  in  the  United 
States,  line  6  of  Form  1000  is  the  proper  place  for  reporting  such  income.  (O 
D.  520,  T.  B.  21-20-958.) 

Form  of  Certificate  Where  Withholding  Required.  Form 
1000  (revised)  should  be  used  (a)  by  citizens  or  residents  of 
the  United  States  when  no  personal  exemption  or  credit  is 
claimed  against  interest  on  bonds  containing  a  tax-free  cove- 
nant; (b)  by  nonresident  alien  individuals  and  nonresident  for- 
eign corporations,  whether  or  not  such  bonds  contain  a  tax-free 
covenant;  (c)  by  partnerships,  and  personal  service  corpora- 
tions, resident  or  nonresident,  in  the  case  of  bonds  containing 
a  tax-free  covenant,  and  (d)  where  the  owner  is  unknown  to 
the  withholding  agent.i"^  When  a  debtor  corporation  fails  to 
withhold  the  2%  tax  where  its  bonds  contain  a  tax-free  clause, 
and  the  owner  has  filed  Form  1000,  there  is  no  obligation  on 
the  bank  first  receiving  the  coupons  to  withhold  the  tax,  as 
assessment  will  be  made  against  the  debtor  or  its  disbursing 
agent  based  on  the  tax  liability  as  disclosed  by  Form  lOOO.i"^ 

Form  of  Certificate  Where  No  Withholding  Required. 
Form  1001  (revised)  should  be  used  (a)  by  citizens  or  resi- 
dents of  the  United  States  when  personal  exemption  is  claimed 
against  interest  on  bonds  containing  a  tax-free  covenant  and 
when  presenting  coupons  from  bonds  not  containing  a  tax-free 
covenant;   (b)   by  domestic  corporations;    (c)   by  partnerships, 

104  Reg.  45,  Art.  365. 

lO'-^  O.  D.  56,  T.  B.  1-19-76. 


COLLECTION   OF  THE  TAX  AT  THE  SOURCE 


989 


resident  or  nonresident,  in  the  case  of  bonds  not  containing  a 
tax-free  covenant;  and    (d)    by   resident  foreign  corporations 
whether  or  not  such  bonds  contain  a  tax-free  covenant;  and  (e) 
for  foreign  governments,  whether  or  not  the  bonds  contain  a 
tax-free  covenant.    In  case  a  citizen  or  resident  alien  individual 
receives   interest  on  bonds  containing  a   tax-free  covenant  in 
excess  of  the  amount  of  personal  exemption  which  the  indmdual 
may  claim,  any  such  excess  must  be  reported  on  Form  1000  (re- 
vised)  1"'^    That  is,  he  cannot  claim  exemption  from  withholding 
with  respect  to  an  amount  greater  than  his  personal  exemption 
even  though  he  may  want  to  relieve  the  paying  corporation  of 
the  contract  duty  to  assume  the  burden  of  the  tax  on  his  behalf^ 
Where  a  corporation  sets  aside  certain  amounts  ^^  ^«^"^;^^ 
fund  under  the  control  of  a  trustee  and  ^uch  fund  is  invested 
by  the  trustee  in  whole  or  in  part  in  bonds,  the  trustee  when 
presenting  coupons  from  the  bonds  for  payment  is  required  to 
file  ownership  certificates.  Form  1001,  revised,  whether  or  not 
the  bonds  contain  a  tax-free  covenant  clause.ioT 

USE  OF  SUBSTITUTE  CERTIFICATES.    Resident  collecting  agents, 
responsible  banks  and  bankers,  receiving  interest  coupons  for 
collection  with  ownership  certificates  attached,  may  present  the 
ou'ons  with  the  original  certificates  to  the  debtor  corporation 
or  L  duly  authorized  withholding  agent  ^^^ ^^'"'f^'^l'' ^^"^ 
detach  and  forward  the  original  certificates  direct    o  the  Com- 
missioner, provided  each  such  collecting  agent  shall  substitute 
for  such  original  certificates  its  own  certificates-Form  1058 
(revised)   or  Form  1059   (revised)-and  shall  keep  a  compete 
record  of  each  transaction,  showing  (a)  serial  number  of  item 
received;   (b)    date  received;   (c)   name  and  address  of  person 
from  whom  received;  (d)  name  of  debtor  con)oration ;  (e)  class 
of  bonds  from  which  coupons  were  cut  (whether  containing  a 
tax-free  covenant  or  not)  ;  and    (f)   face  amount  of  coupon  • 
The  original  certificate  for  which  the  certificate  of  the  col- 
lecting agent  is  substituted  should  be  indorsed,  preferably  with 
a  rubber  stamp,  by  the  collecting  agent  as  follows: 

Owner's  certificate  No 

(Name  of  collecting  agent.) 

xu .  •  .  • 

(Give  date  of  certificate.) 

The  counterpart  of  the  within  certificate  bearing  like  number  ^vas  attached 
to  the  coupons' within  mentioned  for  delivery  to  the  debtor  or  withholding 
agent,  by  whom  the  coupons  are  payable. 

106  Reg.  45,  Art.  366.  or  nn  nao 

107  Re|.  45,  Art.  541  (a)  added  by  T.  D.  3056,  T.  B.  35-20-1173. 


990  FEDERAL   INCOME   TAX 

Where  substitute  certificates  are  used,  the  name  of  the  bank 
or  collecting  agent  may  be  printed  or  stamped  and  the  fac- 
simile of  the  signature  of  the  person  authorized  to  sign  the 
substitute  certificate  for  the  bank  or  collecting  agent  may  also 
be  printed  or  stamped  on  the  certificate.  However,  in  all  cases 
the  bank  must  first  file  with  the  Commissioner  of  Internal 
Revenue,  sorting  division,  a  certificate  of  its  authorization  in 
substantially  the  following  form : 


(City.)  (Date.) 

The  Commissioner  of  Internal  Revenue,  Washington,  D,  C. 

The  undersigned  hereby  authorizes  the  use  of  the  facsimile 
signature  shown  beiow  upon  all  substitute  income-tax  certifi- 
cates issued  in  its  name  until  this  authorization  is  revoked  by 
written  notice  to  you. 

(Name  of  bank  or  collecting  agent.) 

By 

(Signature  of  person  authorized  to  sign.) 


(Official  position.) 

(Facsimile  signature  of  person  authorized  to  sign.) 

As  a  convenience  to  banks  and  trust  companies  having  a 
large  number  of  ownership  certificates  to  execute  in  the  col- 
lection of  interest  on  bonds,  it  has  been  provided  that  the  name 
of  the  bank  or  trust  company  may  be  printed  or  stamped  and 
the  facsimile  of  the  signature  of  the  person  authorized  to  sign 
for  the  bank  or  trust  company  in  executing  the  said  ownership 
certificates  may  be  printed  or  stamped  on  the  certificate;  pro- 
vided that  in  all  cases  the  bank  or  trust  company  shall  first  file 
with  the  Commissioner  (sorting  division)  a  certificate  of 
authorization  in  substantially  the  following  form  i^^^ 


(City.)  (Date.) 

The  Commissioner  of  Internal  Revenue,  Washington,  D.  C. : 

108  T.  B.  "B",  p.  28. 


COLLECTION  OF  THE  TAX  AT  THE  SOURCE  991 

The  undersigned  hereby  authorizes  the  use  of  the  facsimile 
signature  shown  below  upon  all  income  tax  ownership  certifi- 
cates issued  in  its  name  until  authorization  is  revoked  by  writ- 
ten notice  to  you. 

(Name  of  bank  or  trust  company.) 

By 

(Sig.  of  person  authorized  to  sign.) 


(Oflficial  position.) 


(Facsimile  signature  of  person 
authorized  to  sign.) 


For  the  purpose  of  identification  the  substitute  certificates 
should  be  numbered  consecutively  and  corresponding  numbers 
given  the  original  certificates  of  ownership.  The  use  of  sub- 
stitute certificates  by  collecting  agents,  banks  and  bankers  is  not 
permitted,  in  the  case  of  ownership  certificates  presented  with 
coupons  for  collection  by  nonresident  alien  individuals,  partner- 
ships, or  corporations.^^^^  Substitute  certificates  may  be  used 
in  connection  with  payments  of  income  made  to  the  alien  prop- 
erty custodian.il" 

INTEREST  Coupons  Without  Ow^nership  Certificates. 
Where  interest  coupons  are  received  unaccompanied  by  certifi- 
cates of  ownership  the  first  bank  should  require  of  the  payee  an 
aflSdavit  showing  the  name  and  address  of  the  payee,  the  name 
and  address  of  the  debtor  corporation,  the  date  of  the  maturity 
of  the  interest,  the  name  and  address  of  the  person  from  whom 
the  coupons  were  received,  the  amount  of  the  interest,  and  a 
statement  that  the  owner  of  the  bonds  is  unknown  to  the  payee. 
Such  affidavit  should  be  forwarded  to  the  collector  with  the 
monthly  return  on  Form  1012  (revised).  The  first  bank  re- 
ceiving such  coupons  should  also  prepare  a  certificate  on  Form 
1000  (revised),  crossing  out  "owner"  and  inserting  "payee" 
and  entering  the  amount  of  interest  on  line  six  and  should 
stamp  or  write  across  the  face  of  the  certificate  "Affidavit  fur- 
nished," adding  the  name  of  the  bank.^^i 

109  Reg.  45,  Art.  367,  as  amended  by  T.  D.  2967,  T.  B.  6-20-732;  T.  B.  "B," 
p.  28. 

110  Letter  from  treasury  department  dated  June  6,  1918:  I.  T.  S.  1919, 
T[  1522. 

111  Reg.  45,  Art.  368,  as  amended  by  T.  D.  3018,  T.  B.  22-20-973. 


992  FEDERAL   INCOME   TAX 

In  a  case  in  which  a  foreign  bank  placed  in  the  mails  to  be 
transmitted  to  an  American  firm,  a  package  containing  coupons 
clipped  from  bonds  of  a  domestic  corporation,  the  ship  upon 
which  the  package  was  forwarded  was  sunk  by  a  submarine  and 
the  insurance  company  which  had  insured  the  foreign  bank 
against  loss  paid  to  it  the  face  value  of  such  coupons.  The 
insurance  company  filed  an  indemnity  bond,  but  settlement  of 
the  claim  for  an  amount  representing  the  face  value  of  the  cou- 
pons was  deferred  by  the  debtor  corporation,  pending  the  re- 
ceipt by  it  of  an  ownership  certificate  from  the  insurance  com- 
pany, covering  the  amount  of  the  claim.  It  was  held  that  the 
amount  representing  the  face  value  of  the  coupons  did  not  con- 
stitute income  to  the  insurance  company,  but  was  nevertheless 
income  of  the  bondholders.  The  insurance  company  was  re- 
quired to  obtain  ownership  certificates  from  the  owners  of  the 
bonds  and  forward  them  to  the  debtor  corporation  with  the 
claim.  If  the  bondholders  were  unknown,  the  insurance  com- 
pany, as  payee,  was  required  to  furnish  a  certificate  on  Form 
1000  ( revised ).^^-'  Ownership  certificates  are  required  to  be 
filed  with  respect  to  interest  payments  upon  first-mortgage  par- 
ticipation bonds  issued  by  a  trust  company  and  secured  by  a 
real  estate  mortgage  deposited  with  the  trustee.  In  cases  whert 
coupons  of  the  bonds  are  not  accompanied  by  ownership  certifi- 
cates, the  first  bank  is  required  to  furnish  a  certificate.  Where 
no  ownership  certificates  are  filed  in  connection  with  interest 
upon  such  registered  bonds,  the  withholding  agent  will  be  re- 
quired to  prepare  certificates.^i^ 

Interest  on  Registered  Bonds.  Where  a  bondholder  files  no 
ownership  certificate  in  the  case  of  payments  of  interest  on 
registered  bonds  the  withholding  agent  should  make  out  such  a 
certificate  in  each  instance  (a)  on  Form  1000  (revised)  if  the 
bondholder  is  a  citizen  or  resident  of  the  United  States  or  a 
resident  or  nonresident  partnership  or  a  personal  service  cor- 
poration and  the  bonds  contain  a  tax-free  covenant,  or  if  the 
bondholder  is  a  nonresident  alien  individual  or  a  nonresident 
foreign  corporation,  and    (b)    on   Form   1001    (revised)    in  all 

112  0.  D.  633,  T.  B.  33-20-1136.  Since  the  insurance  company  paid  to 
the  foreign  bank  the  face  value  of  the  coupons,  without  deduction  for 
tax  due  the  United  States,  the  recovery  of  the  excess  amount  paid  was  held 
to  be  a  matter  to  be  adjusted  between  the  insurance  company  and  the 
bondholders,  and  between  the  bondholders  and  the  corporation  issuing 
the  bonds. 

113  T.  B.  "B",  p.  31. 


COLLECTION   OF  THE  TAX  AT  THE  SOURCE  993 

other  cases.     When   so  used  Forms   1000    (revised)    and   1001 
(revised)  need  not  be  signed.^^^ 

Return  of  Tax  Withheld.  Every  withholding  agent  is  re- 
quired to  make  an  annual  return  to  the  collector  of  the  tax  with- 
held from  interest  on  coiporate  bonds  or  other  obligations  on  or 
before  March  1  on  P'orm  1013  (revised).  He  is  also  required  to 
make  a  monthly  return  on  Form  1012  (revised)  on  or  before  the 
20th  day  of  the  month  following  that  for  which  the  return  is 
made.  If  there  is  not  sufficient  space  on  Form  1012,  it  should 
be  continued  on  Form  1012-A.  Remittances  frequently  accom- 
pany this  return.  This  is  improper  and  should  be  avoided. 
The  original  ownership  certificates,  or  the  substitute  certifi- 
cates, where  authorized,  must  be  forwarded  to  the  collector 
with  the  monthly  return.  Every  person  required  to  deduct  and 
withhold  any  tax  from  income  other  than  such  bond  interest 
must  make  an  annual  return  thereof  to  the  collector  on  or  before 
March  1  on  Form  1042  (revised),  accompanied  by  a  separate 
report  on  Form  1098  (revised),  for  each  nonresident  alien  in- 
dividual, partnership  composed  in  whole  or  in  part  of  non- 
resident alien  individuals  or  nonresident  foreign  corporation  to 
whom  income  other  than  bond  interest  was  paid  during  the 
previous  taxable  year.  In  every  case  of  both  classes  the  tax 
withheld  must  be  paid  on  or  before  June  15  of  each  year  to  the 
collector."^ 

Release  of  Excess  Tax  Withheld.  Any  sum  withheld  for 
tax  in  excess  of  the  aggregate  amount  required  under  the  law 
will  be  released  by  the  withholding  agent  and  paid  over  to  the 
person  from  whom  it  was  withheld  or  his  proper  representative. 
With  reference  to  how  a  debtor  corporation  may  release  and  pay 
over  the  amount  of  tax  so  withheld  in  a  case  where  a  bank  or 
other  collection  agency  detached  the  ownership  certificate  which 
accompanied  an  interest  coupon  and  substituted  its  own  certifi- 
cate (Form  1059),  which  does  not  disclose  the  name  and  ad- 
dress of  the  bond  owner,  in  such  cases  the  withholding  agent 
should  request  the  bank  or  collection  agency  to  disclose  the  name 
and  address  of  the  owner  of  the  bonds,  as  shown  by  the  original 
certificate,  and  it  shall  be  the  duty  of  the  bank  or  collection 
agency  to  make  such  disclosure  to  the  withholding  agent.  Where 
withholding  agents  have  so  released  any  excess  of  tax,  an  item- 
ized statement  showing  the  names,  addresses  and  amounts  re- 
funded  should  be  attached  to  the  annual   list   returns    (Form 

114  Reg.  45,  Art.  369. 

115  Reg.  45,  Art.  370;  T.  B.  "B",  p.  32. 


994  FEDERAL   INCOME  TAX 

1013),  in  order  to  reconcile  any  discrepancy  between  the  aggre- 
gate amount  of  taxes  returned  as  shown  by  the  monthly  list 
returns  (Form  1012)  and  the  aggregate  amount  as  shown  by  the 
annual  list  return."'' 

Use  of  Information  Return  Where  No  Actual  With- 
holding. Where  a  debtor  corporation  or  its  duly  authorized 
withholding  agent  has  made  payments  of  interest  on  its  bonds, 
but  in  certain  instances  has  been  required  to  withhold  no  tax, 
the  ownership  certificates  on  Form  1001  (revised)  filed  in  con- 
nection with  such  payments  should  be  transmitted  directly  to 
the  Commissioner  (sorting  division),  accompanied  by  a  return 
on  Form  1096-A  showing  the  number  of  ownership  certificates 
thus  transmitted  and  the  total  amount  of  interest  paid.  This 
return  shall  be  made  by  the  20th  day  of  each  month  following 
that  for  which  the  return  is  made  and  need  not  be  sworn  to. 
An  annual  return  shall  be  forwarded  to  the  Commissioner  not 
later  than  March  15  of  each  year  on  Form  1096-B,  on  which 
shall  be  given  a  summary  of  the  monthly  returns.  To  the  extent 
that  there  has  been  actual  withholding  of  the  tax,  returns  should 
be  made."" 

Ownership  Certificates  in  the  Case  of  Fiduciaries  and 
Joint  Owners.  When  fiduciaries  have  the  control  and  custody 
of  more  than  one  estate  or  trust,  and  such  estates  and  trusts 
have  as  assets  bonds  of  corporations  and  other  securities,  a 
certificate  of  ownership  shall  be  executed  for  each  estate  or 
trust,  regardless  of  the  fact  that  the  bonds  are  of  the  same 
issue.  Separate  ownership  certificates  are  not  required  for  each 
beneficiary.""^  When  bonds  are  owned  jointly  by  several  per- 
sons, a  separate  ownership  certificate  must  be  executed  in  be- 
half of  each  of  the  owners."" 

Withholding  in  the  Case  of  Enemies.  Payments  made  after 
October  6,  1917,  to  the  Alien  Property  Custodian  are  in  the 
same  category  as  payments  made  to  or  for  citizens  or  residents 
of  the  United  States.  Withholding  at  the  source  is  accordingly 
unnecessary  except  in  the  case  of  interest  payments  on  corporate 
bonds  or  other  obligations  containing  a  tax-free  covenant  where 

!!•>  Reg.  45,  Art.  372.  The  2%  tax  withheld  on  dividends  of  domestic 
corporations  in  1918  should  be  released  in  this  manner.  (Letter  from  treas- 
ury department  dated  March  24,  1919;  I.  T.  S.  1919,  TI3283.) 

1^7  Reg.  45,  Art.  373.  Return  is  made  in  this  case  in  accordance  with 
Reg.  45,  Art.  370. 

118  Reg.  45,  Art.  374 ;  letter  from  treasury  department  dated  November 
17,  1921;  I.  T.  S.  1921,  113223. 

119  Reg.  45,  Art.  374. 


COLLECTION   OF  THE  TAX  AT  THE  SOURCE  995 

no  exemption  is  claimed.  The  Alien  Property  Custodian  should 
use  FoiTn  1000  (Revised)  in  collecting  interest  on  bonds  con- 
taining a  tax-free  covenant  and  in  all  other  cases  should  use 
Form  1001  (Revised),  except  that  in  cases  in  which  the  Alien 
Property  Custodian  shall,  under  the  Trading-With-the-Enemy 
Act,  demand  payment  to  himself  of  interest  accrued  upon  bonds 
or  other  securities  not  yet  reduced  to  his  custody  (even  though 
they  be  registered  in  the  name  of  an  enemy,  ally  of  an  enemy,  or 
his  agent  or  trustee),  the  corporation  paying  such  income  to  the 
Alien  Property  Custodian  is  authorized  to  accept  from  the  Alien 
Property  Custodian  ownership  certificates,  Forms  1000  (Re- 
vised) and  1001  (Revised),  altered  by  the  substitution  (in  lieu 
of  the  certificate  required  thereon)  of  a  certificate  that  the  Alien 
Property  Custodian  is  entitled  to  the  interest  entered  therein 
with  or  without  deduction  of  tax,  as  the  case  may  be.  No  dis- 
tinction is  to  be  made  between  payments  directly  to  the  Alien 
Property  Custodian  and  to  his  depositaries  and  between  interest 
on  registered  bonds  and  interest  on  coupon  bonds.  In  the  case 
of  enemies  or  allies  of  enemies  holding  a  license  granted  under 
the  provisions  of  the  Trading-With-the-Enemy  Act,  withholding 
is  required  as  in  the  case  of  any  nonresident  alien  not  an  enemy 
or  ally  of  enemy. i-"  Any  tax  erroneously  withheld  after  October 
G,  1917,  will  be  deemed  to  have  been  erroneously  withheld,  up 
to  the  time  of  restoration  of  the  property  to  the  original  owners 
by  the  Alien  Property  Custodian,  but,  after  the  restoration  of 
the  property,  the  tax  so  withheld  if  otherwise  properly  with- 
held in  accordance  with  the  Revenue  Act  of  1916,  as  amended, 
if  not  in  excess  of  the  tax  liability  of  such  alien  will  be  deemed 
to  have  been  properly  withheld  and,  if  returned  and  paid  to  the 
government  as  income  tax,  may  be  taken  as  a  credit  against  the 
tax  shown  to  be  due  by  the  return  required  for  the  respective 
year  to  be  submitted  at  or  after  the  restoration  of  the  property 
by  the  Alien  Property  Custodian. ^-^ 

Return  of  Income  From  Which  Tax  Withheld.  The  entire 
amount  of  the  income  from  which  the  tax  was  withheld  should  be 
included  in  gross  income  without  deduction  for  such  payment 
of  the  tax.  But  any  tax  actually  so  withheld  will  be  credited 
against  the  total  tax  as  computed  in  the  taxpayer's  return.     If 

120  Reg.  45,  Art.  375,  as  amended  by  T.  D.  2969,  T.  B.  7-20-742.  For 
the  rule  with  respect  to  withholding  on  income  paid  to  or  for  alien  enemies 
see  T.  D.  2673.  This  ruling  is  not  revoked  by  the  attorney-general's  opin- 
ion of  June  21,  1920,  published   in  T.   B.  30-20-1092. 

I'-ii  0.   D.   657,   T.   B.   36-20-1185. 


996  FEDERAL  INCOME   TAX 

the  tax  is  paid  by  the  recipient  of  the  income  or  by  the  with- 
holding agent  it  will  not  be  re-collected  from  the  other,  re- 
gardless of  the  original  liability  therefor,  and  in  such  event  no 
penalty  will  be  asserted  against  either  person  where  no  fraud 
or  purpose  to  evade  payment  is  involved. i—  The  amount  of  nor- 
mal income  tax  paid  at  the  source  by  a  debtor  corporation  in  be- 
half of  a  bondholder  may  be  credited  against  the  total  tax  due 
from  the  bondholder  even  though  he  may  be  liable  to  surtax 
Only.123 

122  Reg.  45,  Art.  376. 

123  O.  D.  423,  T.  B.  13-20-812. 


CHAPTER  41 

COVENANTS  TO  PAY  TAXES 

Covenants  to  pay  taxes  are  contained  in  bonds,  mortgages, 
notes,  leases,  and  similar  instruments  whereby  it  is  stipulated, 
in  general,  that  the  debtor,  lessee,  or  other  payor  shall  pay  the 
interest,   rent,   or   other   income   without   deduction   for   taxes. 
Many  such  covenants  became  operative  under  the  1913  Law,  and 
the  1916  Law  prior  to  its  amendment  by  the  act  of  October  3, 
1917,  by  reason  of  the  requirement  in  those  laws  that  the  normal 
tax  should  be  withheld  at  the  source.     They  operate  under  the 
1916  Law  as  amended  and  under  the  present  law  and  the  1918 
Law  only  in  certain  cases  and  to  a  limited  extent.  Such  covenants 
for  the  purpose  of  this  discussion  may  be  divided  into  two  classes : 
(1)  Those  which  are  contained  in  bonds,  mortgages,  or  deeds  of 
trust,  or  other  similar  obligations  of  a  corporation,  and  (2)  those 
contained  in  other  instruments.     Those  contained  in  the  second 
class  operate  only  when  the  payee  is  a  nonresident  alien  or  a 
nonresident  foreign  corporation,  unless  the  covenant  is  so  broad 
that  it  imposes  an  obligation  on  the  payor  notwithstanding  that 
the  interest,  rent,  or  other  payments  thereunder  are  made  in 
full  without  deduction  of  any  tax  at  the  source.    Covenants  of 
the  first  class  stated  above  may  be  of  two  kinds:     (a)  Those 
which  agree  to  assume  the  tax  of  the  payee  only  to  the  extent 
that  the  interest  specified  in  the  obligation  shall  be  paid  in  full, 
and  (b)  covenants  which  may  be  so  broad  in  their  terms  as  to 
obligate  the  debtor  to  reimburse  the  creditor  for  any  tax  which 
may  be  imposed  upon  him  with  respect  to  the  interest  after  it 
has  been   received  in  full  by  the  creditor.     Covenants  broad 
enough  to  fall  within  the  second  class  are  very  unusual  and  are 
not  covered  by  the  discussion  in  this  chapter.    Those  covenants 
to  pay  the  tax  which  are  embraced  within  the  language  of  the 
statute!  and  discussed  in  this  chapter  are  only  those  which  have 
all  the  following  qualifications :     (a)  They  must  be  made  by  cor- 
porations;   (b)    they  must  be  contained   in  bonds,  mortgages, 
deeds  of  trust,  or  other  similar  obligations,  and  (c)  they  must 
be  such  as  to  bind  the  debtor  corporation  to  pay  some  portion 
of  the  tax  imposed  by  the  Revenue  Act  of  1921  on  the  creditor, 
or  to  reimburse  the  creditor  for  any  portion  of  the  tax,  or  to 

1  Revenue  Act  of  1921,  §  221  (b)  ;  Revenue  Act  of  1918,  §  221  (b).  0.  D. 
519,  T.  B.  21-20-957. 

997 


998  FEDERAL   INCOME   TAX 

pay  the  interest  without  deduction  for  any  tax  which  the  debtor 
may  be  required  or  permitted  to  pay  thereon,  or  to  retain  there- 
from, under  any  law  of  the  United  States.  Where  payment  of 
interest  is  made  under  such  covenants  a  tax  equal  to  2%  of  the 
interest  is  required  to  be  withheld  at  the  source  if  the  owner 
of  the  obligations  is  (a)  an  individual,  whether  he  is  a  citizen  or 
alien,  resident  or  nonresident;  (b)  a  partnership,  whether  do- 
mestic or  foreign,  resident  or  nonresident ;  (c)  a  nonresident 
foreign  corporation.-  Withholding  at  the  highest  applicable 
rate  is  required  from  interest  on  bonds  or  other  securities  where 
the  owner  of  such  securities  is  unknown  to  the  withholding 
agent.  The  term  "highest  applicable  rate"  means  27c  in  the 
case  of  tax-free  covenant  bonds  and  8 /{  in  the  case  of  bonds  not 
containing  such  covenants.-^  The  tax  is  not  required  to  be  with- 
held on  payments  to  domestic  corporations  or  to  resident  foreign 
corporations.  It  is  required  to  be  withheld  on  payments  to  a 
fiduciary  although  the  fiduciary  may  be  a  corporation.  The  tax 
cannot  be  withheld  except  against  payees  specified  in  the  statute. 
If  the  bond  contains  a  covenant  to  pay  the  tax  but  the  mortgage 
does  not,  or  vice  versa,  the  tax  must  be  withheld  under  this 
provision.  Where  neither  bonds  nor  the  trust  deeds  given  by 
the  obligor  to  secure  them  contain  a  tax-free  covenant,  supple- 
mental agreements  executed  by  the  obligor  corporation  and  the 
trustee  containing  a  tax-free  covenant  and  which  modify  the 
original  trust  deeds  to  that  extent  are  of  the  same  effect  from 
the  date  of  their  proper  execution  as  if  they  had  been  part  of 
the  original  deeds  of  trust,  provided  proper  authority  exists  for 
the  modification  of  the  trust  deeds  in  this  manner.  The  authority 
must  be  contained  in  the  original  trust  deeds  or  actually  secured 
from  the  bondholders.^ 

Foreign  Corporations — Definition.  The  term  "nonresident  for- 
eign corporation"  is  used  in  this  chapter  to  include  corporations 
not  engaged  in  trade  or  business  within  the  United  States  and 
not  having  any  office  or  place  of  business  therein.  Foreign  cor- 
porations which  are  either  engaged  in  business  within  the  country 

^Revenue  Act  of  1921,  §§221,  237;  Revenue  Act  of  1918,  §§221,  237; 
Reg.  45,  Art.  361. 

3  Reg.  45,  Art.  361 ;  Mimeograph  letter  from  treasury  department.  No. 
2143,  dated  June  2,  1919;  I.  T.  S.  1921,  1|  1775.  This  is  the  ruling  notwith- 
standing that  10%  is  withheld  in  some  cases  against  nonresident  foreign 
corporations  for  the  year  1921  and  12^/^%  for  subsequent  years. 

4  O.  D.  414,  T.  B.  12-20-797. 


COVENANTS  TO  PAY  TAXES  999 

or  have  an  office  or  place  of  business  therein  are  referred  to  as 
"resident  foreign  corporations."' 

Rate  of  Tax  to  Be  Withheld.  If  the  covenant  specifies  that  a 
tax  of  1%  will  be  paid,  2%  must  nevertheless  be  withheld;  1% 
being  assumed  by  the  debtor  corporation  and  the  other  1%  by 
the  bondholder.  In  such  cases  only  99/1  of  the  full  amount  of 
interest  should  be  paid  to  the  bondholder.  If  the  covenant  speci- 
fies that  more  than  2%  will  be  paid  by  the  debtor  corporation, 
only  2%  may  be  withheld,  the  covenant  being  inoperative  under 
the  law  with  respect  to  any  additional  amount  specified  therein. 
In  the  case  of  payments  to  nonresident  aliens  or  nonresident 
foreign  corporations,  only  2S/c  may  be  withheld  on  obligations 
containing  tax-free  covenants,  notwithstanding  that  on  other 
income  8%,  10%  or  121/2%  is  required  to  be  withheld  in  such 
cases.  Obligations  of  individuals  or  partnerships,  whether  or 
not  containing  tax-free  covenants,  do  not  require  withholding  at 
the  2%  rate  or  at  any  rate  against  citizens,  residents,  domestic 
corporations,  or  resident  foreign  corporations.  If  the  bond,  mort- 
gage, deed  of  trust,  or  similar  obligation  does  not  contain  a  con- 
tract or  provision  obligating  the  debtor  (a)  to  pay  some  portion 
of  the  tax  imposed  by  the  Revenue  Act  of  1921  on  the  creditor, 
or  (b)  to  reimburse  the  creditor  for  any  portion  of  the  tax,  or 
(c)  to  pay  the  interest  without  deduction  for  any  tax  which  the 
debtor  may  be  required  or  permitted  to  pay  thereon,  or  to  retain 
therefrom,  under  the  laws  of  the  United  States,  the  debtor  cor- 
poration can  not  voluntarily  undertake  to  withhold  the  tax  under 
this  provision  and  thereby  assume  the  tax  for  its  bondholders. 
Obligations  of  corporations  other  than  bonds,  mortgages,  deeds 
of  trust  or  similar  obligations  do  not  require  withholding  at  the 
2%  rate  or  at  any  rate  against  citizens,  residents,  domestic  cor- 
porations or  resident  foreign  corporations.''  A  domestic  corpo- 
ration owning  no  property  and  doing  no  business  in  the  United 
States  issuing  bonds  containing  a  tax-free  covenant,  is  not  ab- 
solved from  the  withholding  requirements  in  the  case  of  bond- 
holders who  are  citizens  or  residents  of  the  United  States.  The 
situation  is  not  analogous  to  that  of  interest  from  nonresident 
corporations  paid  to  nonresident  alien  individuals.  Such  income 
is  not  taxable  gross  income  and  need  not  be  reported  by  the 
nonresident  alien  individual.  Such  interest,  however,  paid  to 
citizens  and  residents  of  the  United  States  is  taxable  gross  in- 

5  See  Revenue  Act  of  1921,  §237  and  Revenue  Act  of  1918,  §237;  Reg. 
45,  Art.  1509. 

6  Telegram  from  treasury  department  dated  June  2,  1919;  I.  T.  S.  1921, 
11 1779. 


1000  FEDERAL  INCOME   TAX 

come,  must  be  reported  by  the  taxpayer,  and  a  tax  upon  such 
income  is  due  the  United  States.  No  exception  as  to  withholding 
requirements  may  be  made  even  though  the  amount  of  tax  with- 
held and  paid  to  the  United  States  possession  or  foreign  country 
is  claimed  by  the  bondholder  as  a  credit  against  his  income  tax 
liability  to  the  United  States  governments 

Object  of  Withholding  Provision  in  Case  of  Tax-Free  Covenant 
Bonds.  Withholding  the  tax  at  the  source  at  the  rate  of  2%  on 
interest  paid  upon  obligations  containing  tax-free  covenants  is 
not  a  measure  designed  or  intended  to  insure  the  collection  of 
revenue,  as  is  withholding  at  the  source  generally.  It  is  a 
measure  whereby  corporations  may  be  compelled  to  pay  a  part 
of  the  tax  which  would  otherwise  be  imposed  upon  the  bond- 
holder. The  provision  is  inserted  in  the  law  on  the  theory  that 
since  corporations  have  issued  bonds,  mortgages,  deeds  of  trust, 
or  similar  obligations,  agreeing  to  pay  interest  thereon  in  full 
without  deduction  for  any  tax  which  might  be  required  to  be 
withheld  at  the  source  and  that  this  provision  has  presumably 
influenced  either  the  price  at  which  the  bonds  or  obligations 
were  sold  or  their  rate  of  interest,  the  law  should  compel  the 
corporation  to  assume  some  part  of  the  tax  of  the  bondholder. 
Apparently  the  entire  normal  tax  was  deemed  to  be  too  great  a 
burden  and  2%  was  considered  appropriate.  No  reason  is  ad- 
vanced, however,  for  excluding  domestic  corporation  bondholders 
from  the  benefits  accruing  to  individual  or  partnership  bond- 
holders under  "tax-free  covenants."  In  the  case  of  savings 
banks  and  insurance  companies  the  advantage  if  given  would 
inure  ultimately  to  the  benefit  of  depositors  or  policyholders. 

Procedure  of  Corporation  Issuing  Tax-Free  Covenant  Bonds. 
Since  there  is  a  requirement  in  the  law  that  a  2  %  tax  be  assumed 
by  the  corporation  on  interest  paid  to  a  large  proportion  of  its 
bondholders  where  the  bond  contains  a  tax-free  covenant,  it  be- 
comes a  matter  of  importance  to  officers  of  corporations  to  deter- 
mine whether  or  not  the  covenants  in  the  bonds,  mortgages,  deeds 
of  trust,  or  similar  obligations  of  their  respective  corporations 
are  broad  enough  in  general  language,  or  specific  enough,  to 
require  the  assumption  of  the  burden  under  the  Revenue  Acts 
of  1918  or  1921.  Unless  there  is  a  legal  obligation  to  pay  the 
tax,  or  any  part  thereof,  for  the  bondholder,  the  officers  of  the 
corporation  may  incur  personal  liability  in  making  such  pay- 
ments, since  the  payment  of  the  tax  of  a  bondholder  without 
legal  compulsion  would  constitute  a  diversion  of  the  funds  of  the 

7  0.  D.  455,  T.  B.  15-20-852. 


COVENANTS  TO  PAY  TAXES  1001 

corporation  to  which  stockholders  and  creditors  may  object. 
Furthermore,  the  corporation  may  incur  liability  for  not  with- 
holding the  proper  amount  of  tax  on  payments  to  nonresident 
aliens  or  nonresident  foreign  corporations.  The  law  requires^ 
that  if  the  bond  contains  a  covenant  to  pay  the  tax,  only  2% 
shall  be  withheld,  and  that  if  the  bond  or  obligation  does  not 
contain'^  such  a  covenant,  8%  shall  be  withheld  on  payments  to 
nonresident  aliens.  There  is  no  authority  in  the  law  for  with- 
holding 8%  and  assuming  to  pay  all  or  only  2%  for  the  bond- 
holder. Either  the  obligation  is  one  which  requires  withholding 
at  the  rate  of  2%  and  the  assumption  of  the  tax  by  the  corpo- 
ration, or  it  is  one  which  requires  withholding  at  the  rate  of  8% 
on  payments  of  interest  to  nonresident  aliens  and  the  assumption 
of  no  part  of  the  tax  by  the  corporation.  An  examination  of 
the  covenant  in  each  mortgage  or  issue  of  corporate  bonds  or 
similar  obligations  is  therefore  essential. 

Examples  of  Covenants  to  Pay  Taxes.  A  covenant  reading  as 
follows  does  not  require  or  authorize  the  corporation  to  assume 
any  part  of  the  income  tax  of  its  bondholders:  "Both  principal 
and  interest  of  this  bond  are  payable  without  deduction  for  any 
taxes,  assessments  or  other  governmental  charges  which  the 
company  may  be  required  to  pay  thereon  or  authorized  to  retain 
therefrom  under  any  present  or  future  law  or  requirement  of 
the  United  States  of  America  (except  any  federal  income  tax) 
or  any  state,  county,  municipality  or  other  governmental  sub- 
division thereof." 9  Many  covenants  to  pay  taxes  were  entered 
into  prior  to  the  enactment  of  the  1913  Law,  and  without  con- 
.templation  of  an  income  tax  law  requiring  collection  at  the  source. 
In  such  covenants  no  specific  reference  is  made  to  an  income  tax 
and  the  force  of  the  covenant  with  respect  to  the  present  income 
tax  depends  upon  the  general  language  used  therein.  One  typical 
form  reads  as  follows:  "Both  the  principal  and  interest  of  this 
bond  are  payable  without  deduction  for  any  tax  or  taxes,  assess- 
ment or  assessments,  or  other  governmental  charges,  which  the 
company  may  be  required  or  permitted  to  pay  thereon,  or  to  re- 
tain therefrom,  under  any  present  or  future  law  of  the  United 
States,  or  of  any  state,  county,  municipality  or  other  lawful  tax- 
ing authority  thereof."  Whether  this  form  of  covenant  requires 
the  corporation  to  pay  the  income  tax  of  the  bondholder,  or  only 
such  taxes  as  are  imposed  on  the  bond  or  interest,  as  such,  is 
an  unsettled  question.    In  a  recent  case  it  was  held  that  a  clause 

8  Revenue  Act  of  1918,  §221;   Revenue  Act  of  1921,  §221. 

9  Letter  from  treasury  department  dated  November  21,  1917;  I.  T.  S.  1921, 
H  1802. 


1002  FEDERAL  INCOME   TAX 

in  bonds  issued  by  a  corporation  promising  payment  "without 
deduction  from  either  such  principal  or  interest,  for  any  tax  or 
taxes,  which  the  Marion  Hotel  Company  may  be  required  to  pay 
or  retain  therefrom,  under  any  present  or  future  law,  the  Marion 
Hotel  Company  agreeing  to  pay  such  tax  or  taxes,"  did  not  re- 
quire the  corporation  to  pay  the  federal  income  tax  of  the  bond- 
holder which  it  retained  from  the  payment  of  interest  on  the 
bonds,  since  the  tax  is  not  a  tax  on  the  bond,  but  a  personal 
obligation  of  the  bondholder,  arising  out  of  the  possession  of  an 
income  in  excess  of  the  exemptions  and  deductions  allowed  by 
such  law.io  The  Supreme  Court  of  Massachusetts  in  deciding 
whether  the  income  tax  came  within  the  terms  of  a  covenant  by 
a  lessee  to  pay  "all  taxes  and  assessments  *  *  *  upon  or  in 
respect  of  the  rent  *  *  *  howsoever  and  to  whomsoever  as- 
sessed," held  that  the  1913  Law  imposed  the  tax  "in  respect  of 
the  rent"  and  held  that  the  language  quoted  was  effective  to 
compel  the  tenant  to  assume  the  tax  of  the  landlord  to  the  extent 
that  the  law  required  the  amounts  thereof  to  be  withheld  at  the 
source.ii  Other  covenants  provided  that  the  debtor  "will  pay  the 
principal  and  interest  of  these  bonds  without  deduction  for 
taxes."  It  is  questionable  whether  or  not  covenants  of  this  kind 
are  broad  enough  to  include  taxes  upon  the  bondholder  as  well 
as  taxes  assessed  against  the  corporation  upon  the  mortgage  or 
bond  or  interest.  Where  a  lease  provided  that  the  lessee  should 
"pay  all  taxes  and  assessments — upon  the  yearly  payments  herein 

10  Urquhart  v.  Marion  Hotel  Co.,  128  Ark.  283,  194  S.  W.  1.  The  court 
referred  to  the  early  cases  of  Haight  v.  Railroad  Co.,  6  Wall.  15;  Baltimore 
V.  Baltimore  R.  R.,  10  Wall.  543. 

11  Suter  V.  Jordan-Marsh  Company,  225  Mass.  34,  113  N.  E.  580.  The 
court  seemed  to  rest  its  decision  in  this  case  on  the  conclusion  that  the  tax 
was  levied  upon  the  separate  sources  from  which  a  part  of  the  net  income 
was  derived.  This  conclusion  appears  to  be  against  the  weight  of  authority 
that  the  tax  is  on  the  person  and  not  on  his  property.  If  such  conclusion 
had  been  reached  by  the  court  the  decision  might  have  been  different.  See, 
however,  Catawissa  R.  R.  Co.  v.  Phila.  &  Reading  Co.,  255  Pa.  269,  99  Atl. 
807,  where  the  court  held  that  the  income  tax  was  "imposed  upon  rental 
received  by  the  lessor  from  the  lessee."  See  Codman  v.  Amer.  Piano  Co.,  229 
Mass.  285,  118  N.  E.  344.  In  this  case  it  was  held  that  where  a  lessee 
which  covenanted  to  pay  all  taxes  and  assessments  whatsoever  which 
might  be  payable  "for  or  in  respect  of"  the  leased  premises  during  the  term, 
except  assessments  for  benefits,  was  not  liable  to  its  lessors  for  the 
amount  of  federal  income  tax  on  the  amount  of  rent  reserved  in  the  lease, 
since  while  the  taxes  on  real  estate  itself  came  within  the  terms  of  the 
covenant,  taxes  on  the  rentals  as  income  did  not.  Taxes  "for  or  in  re- 
spect of"  the  leased  premises  were  held  to  mean  taxes  relating  directly  to 
the  premises  themselves  and  not  to  the  rent  which,  when  due,  was  a  separate 
and  independent  estate. 


COVENANTS  TO  PAY  TAXES  1003 

agreed  to  be  made  by  the  party  of  the  second  part  to  the  party 
of  the  first  part — for  the  payment  or  collection  of  which  taxes 
or  assessments  the  said  party  of  the  first  part  would  otherwise 
be  liable  or  accountable  under  any  lawful  authority  whatever"; 
and  that  the  lessee  "should  pay  all  taxes,  charges,  levies,  claims, 
liens  and  assessments  of  any  and  every  kind,  which  during  the 
continuance  of  the  term  hereby  demised,  shall,  in  pursuance  of 
any  lawful  authority,  be  assessed  or  imposed  upon  the  demised 
premises,  or  any  part  thereof — all  payments  required  to  be  made 
by  the  party  of  the  first  part  during  the  term  of  this  indenture — 
shall  be  assumed  and  discharged  by  the  party  of  the  second  part 
as  if  the  party  of  the  second  part  were  primarily  liable  for 
same,"  it  was  held  that  the  lessee  was  liable  for  the  income  tax 
of  the  lessor  on  the  ground  that  it  was  the  apparent  intention  of 
the  parties  that  the  lessor  should  receive  the  amounts  stipulated 
as  rent  without  deduction  by  reason  of  any  tax,  charge  or  assess- 
ment of  any  kind  and  that  the  language  was  sufficiently  broad 
to  cover  the  federal  income  tax  although  not  enacted  at  the  time 
the  lease  was  made.^^  in  another  case  where  a  covenant  provided 
that  the  specified  rent  should  be  paid  "without  any  deduction, 
defalcation  or  abatement  for  any  tax,  charges  or  assessments 
whatsoever,  *  *  *  jt  being  the  express  agreement  of  the  said 
parties  that  the  said  covenantor,  his  heirs  and  assigns,  shall  pay 
all  taxes  whatsoever  that  shall  hereafter  be  laid,  levied  or  as- 
sessed by  virtue  of  any  law  whatever,  as  well  on  the  said  hereby 
granted  lot  and  buildings  thereon  erected  or  to  be  erected  as  on 
the  said  yearly  rental  now  charged  thereon,"  it  was  held  that 
the  covenant  did  impose  an  obligation  upon  the  lessee  to  pay  the 
federal  income  tax  since  it  was  manifestly  the  intention  of  the 
parties,  by  this  covenant,  to  secure  to  the  grantor  the  full  pay- 
ment of  the  yearly  rent  without  any  deduction,  defalcation  or 
abatement  for  any  taxes,  charges  or  assessments  whatsoever.^^ 
Again,  where  a  lease  provided  that  the  lessee  should  "pay  all 
taxes,  charges  and  assessments  *  *  *  imposed  under  any  exist- 
ing or  future  law  on  the  demised  premises,  or  any  part  thereof, 
or  on  the  business  there  carried  on,  or  on  the  gross  receipts  or 
net,  derived  therefrom,  or  upon  the  capital  stock  of  'the  lessor' 
or  the  dividends  thereon,  or  upon  the  franchises  of  the  said  com- 
pany, for  the  payment  or  collection  of  any  of  which  said  taxes 

12  Northern  Pennsylvania  R.  R.  Co.  v.  Philadelphia  &  Reading  Ry.  Co. 
43  Pa.  C.  C.  150;  aff'd  249  Pa.  326,  94  Atl.  834.  See  also  Philadelphia 
City  P.  Ry.  Co.  v.  Philadelphia  R.  T.  Co.,  263  Pa.  561,  107  Atl.  329. 

13  Van  Beil  v.  Brogan,  65  Pa.  Super.  384,  reversing  23  D.  R.  1055  (Dau- 
phin County  Court,  Pa.  1914).    Ehrlich  v.  Brogan,  262  Pa.  362. 


1004  FEDERAL   INCOME   TAX 

the  'lessor'  may  otherwise  become  hable,"  it  was  held  that  the 
lessee  was  not  required  to  pay  the  federal  income  tax  on  the 
rental  received  by  the  lessor  on  the  ground  that  such  tax  was 
not  expressly  mentioned  and  the  covenant  was  not  broad  enough 
to  discharge  all  liability  for  taxes  of  every  kind  for  which  the 
lessor  should  become  primarily  liable.^*  The  cases  referred  to 
above  are  cases  which  have  been  decided  under  the  1913  or  1916 
Laws.  Other  cases  arising  under  different  statutes  are  referred 
to  in  the  foot  note.i^  Where  lessees  covenant  to  pay  all  taxes 
which  during  the  term  of  a  lease  may  be  lawfully  levied,  laid  or 
assessed  against  the  rent  payable,  whether  levied  or  assessed  on 
the  same  as  rental  or  as  income  of  any  person  entitled  thereto, 
such  lessees  are  liable  to  reimburse  the  lessor  not  only  for  the 
normal  federal  income  tax,  but  also  for  the  surtax  paid  by  him 
on  rentals  received  although  such  surtax  did  not  come  into  exist- 
ence until  after  the  date  of  the  lease,  the  surtax  being  a  direct 
tax  which  may  be  assessed  on  rentals  when  received  as  income.^^ 
Under  a  clause  which  provided  that  the  lessee  should  pay  "one- 
third  of  all  taxes  or  assessments,  special  or  otherwise,  and  public 
charges  of  every  kind  or  nature  that  shall  or  may  be  taxed  or 
assessed  against  the  Des  Moines  company  or  its  property  during 
the  aforesaid  term  of  years"  it  has  been  held  that  the  lessee  was 
under  no  obligation  to  pay  federal  income  tax  imposed  pursuant 
to  the  1913,  1916  and  1918  Laws  upon  sums  received  by  the 
lessor.  In  making  this  decision  the  court  treated  the  fact  that 
at  the  time  the  covenant  was  made  no  such  taxes  were  levied, 
or  were  apparently  to  be  anticipated,  as  bearing  on  the  intent 
of  the  parties,  and  held  that  an  intent  to  include  all  possible 

14  Little  Schuylkill,  etc.  Co.  v.  Philadelphia  &  Reading  Ry.  Co.,  44  P.  A. 
County  Court,  Rep.  197,  aff'd  69  Pa.  Super.  122.  Allocatur  to  the  Supreme 
Court  has  been  denied.  It  seems  in  this  case  the  intention  of  the  lessor 
was  to  have  the  lessee  pay  any  and  all  taxes  so  that  the  net  amount  of  the 
rental  could  be  distributed  without  diminution  to  the  stockholders,  but  the 
court  held  that  the  language  of  the  covenant  was  not  broad  enough  to  ac- 
complish this  purpose. 

15  Northern  Trust  Co.  v.  Buck,  263  111.  222,  104  N.  E.  1114;  Pettebone  v. 
Smith,  150  Pa.  118,  24  Atl.  693;  Chicago,  etc.,  Ry.  v.  Kansas  City  N.  W.  R. 
R.,  75  Kans.  167,  88  Pac.  1085;  Erie,  etc.,  R.  R.  v.  Pennsylvania  R.  R.,  208 
Pa.  506,  57  Atl.  980;  Clopton  v.  Phila.  &  Reading  R.  R.  Co.,  54  Pa.  356, 
Northern  Central  R.  R.  Co.  v.  Jackson,  7  Wall.  262;  U.  S.  v.  Baltimore  & 
Ohio  R.  R.  Co.,  17  Wall.  322.  See  also  article  in  Illinois  Law  Review, 
January,  1915.  Phila.,  G.  &  N.  R.  Co.,  v.  Phila.  &  R.  Ry.  Co.,  265  Pa.  325, 
108  Atl.  528. 

16  Kimball  v.  Cotting,  234  Mass.  172,  125  N.  E.  551. 


COVENANTS  TO  PAY  TAXES  1005 

forms  of  taxation  is  not  conclusively  established  by  the  use  oi 
sweeping  general  terms,  if  by  a  proper  application  of  the  rule  ot 
ejiisdem  generis,  or  other  recognized  canon,  the  covenant  may 
be  satisfied  by  a  less  burdensome  construction.^^ 

iTDes  Moines  Co.  v.  Chicago  Gt.  West.  Ry.  Co.,  177  N.  W.  90,  188  Iowa 
1019. 


CHAPTER  42 

CONSTITUTIONALITY  OF  THE  LAW 

It  is  not  the  purpose  of  this  chapter  to  discuss  exhaustively 
the  constitutional  questions  which  may  exist  with  respect  to  the 
present  internal  revenue  laws,  but  to  point  out  certain  features 
of  such  laws  v/ith  respect  to  which  questions  of  constitutionality 
have  been  raised,  and  also  to  point  out  briefly  a  few  general  prin- 
ciples which  may  have  a  bearing  upon  the  constitutionality  of 
provisions  of  the  Revenue  Act  of  1921  and  the  Revenue  Act  of 
1918.  It  is  a  long  established  principle  vital  to  our  constitutional 
system  that  a  court  is  not  authorized  to  adjudge  a  statute  uncon- 
stitutional where  the  question  as  to  its  constitutionality  is  at  all 
doubtful,  and  that  unless  the  statute  is  plainly  and  palpably  un- 
constitutional, it  will  be  upheld.  Instead  of  seeking  for  excuses 
for  holding  acts  of  the  legislative  power  void  by  reason  of  their 
conflict  with  the  constitution  the  efl'ort  should  be  made  to  recon- 
cile them,  if  possible,  and  not  to  hold  the  laws  invalid  unless  the 
opposition  between  the  constitution  and  the  laws  be  such  that  the 
court  feels  a  clear  and  strong  conviction  of  their  incompatibility 
with  each  other.i  Unless  it  be  impossible  to  avoid  it,  a  general 
revenue  statute  should  never  be  declared  inoperative  in  all  its 
parts  because  a  particular  part  relating  to  a  distinct  subject,  is 
invalid.  It  is  an  elementary  principle  that  the  same  statute  may 
be  in  part  constitutional  and  in  part  unconstitutional,  and  that 
if  the  parts  are  wholly  independent  of  each  other  that  which  is 
constitutional  may  stand  when  that  which  is  unconstitutional  is 
rejected.  It  is  only  when  different  clauses  of  an  act  are  so  de- 
pendent upon  each  other  that  it  is  evident  the  legislature  would 
not  have  enacted  one  of  them  without  the  other — as  when  the  two 
things  provided  are  necessary  parts  of  one  system — that  the 
whole  act  will  fall  with  the  invalidity  of  one  clause.  When  there 
is  no  such  connection  and  dependency,  the  act  will  stand,  though 
different  parts  of  it  are  rejected.  A  diflFerent  rule  might  be  dis- 
astrous to  the  financial  operation  of  the  government  and  produce 
the  utmost  confusion  in  the  business  of  the  entire  country."-    It 

1  Booth  V.  Illinois,  184  U.  S.  431;  Fletcher  v.  Peck,  6  Cranch  87;  Bro\vn 
V.  Walker,  161  U.  S.  591;  U.  S.  v.  Delaware  &  H.  Co.,  213  U.  S.  366. 

2  Field  V.  Clark,  143  U.  S.  649;  Rainey  v.  U.  S.,  232  U.  S.  310;  Under- 
wood Typewriter  Co.  v.  Chambarlain,  92  Conn.  199,  102  Atl.  600,  254 
U.  S.  113;  State  ex  rel.  Manitowoc  Gas  Co.  v.  Wis.  Tax  Commission,  161  Wis. 
Ill,   152   N.   W.   848;    Robertson   v.   Pratt,    13    Haw.   590;    Alpha   Portland 

1006 


CONSTITUTIONALITY    OF    THE    LAW  1007 

will  be  noted  that  the  Revenue  Act  of  1921  provides  expressly 
that  if  any  provision  or  the  application  thereof  to  any  person  or 
circumstances  is  held  invalid,  the  remainder  of  the  act  and  the 
application  of  such  provision  to  other  persons  or  circumstances 
shall  not  be  affected/' 

Construction  of  Constitutional  Provisions.     Constitutions  are 
designed  by  their  f  ramers  and  accepted  by  the  people  as  enduring 
instruments  so  comprehensive  and  general  in  their  terms  that  a 
free    intelligent  and  moral  body  of  citizens  may  govern  them- 
selves under  their  beneficent  provisions  through  radical  changes 
in  social,  economic  and  industrial  conditions.    They  declare  only 
fundamental  principles  as  to  the  form  of  government  and  the 
mode  in  which  it  shall  be  exercised.     Certain  great  powers  are 
conferred  and  some  limitations  as  to  their  exercise  are  estab- 
lished.    The  amendments  to  a  constitution  together  with  the 
original  constitution  form  one  instrument  which  is  to  be  inter- 
preted in  the  light  of  the  conditions  under  which  its  several  parts 
were  framed,  the  ends  which  it  was  designed  to  accomplish,  the 
benefits  which  it  was  expected  to  confer,  and  the  evils  which  it 
was  hoped  to  remedy.     It  is  a  grant  from  the  sovereign  m  the 
exercise  of  a  delegated  power.     It  is  a  statement  of  general 
principles  and  not  a  specification  of  details.     Amendments  to 
the  constitution  ought  to  be  construed  in  the  same  spirit  and 
according  to  the  same  rules  as  the  original,  and,  in  regard  to 
questions  of  taxation,  in  connection  with  the  taxing  clauses  of 
the  original  constitution,  and  the  effect  attributed  to  them  be- 
fore the  amendment  was  adopted.     The  constitution   is  to  be 
interpreted  as  the  constitution  of  the  sovereign  state  and  not  as 
a  statute  or  an  ordinary  piece  of  legislation.     Its  words  must 
be  given  a  construction  adapted  to  carry  into  effect  its  purposes.^ 
Power  of  Congress  to  Levy   Income   Taxes.     The   Sixteenth 
Amendment  to  the  Federal  Constitution  authorized  Congress  "to 
lay  and  collect  taxes  on  incomes  from  whatever  source  derived, 
without  apportionment."   As  Chief  Justice  White  has  said,'  this 

Cement  Co.  v.  Knapp,  230  N.  Y.  48,  231  N.  Y.  8.  In  income  tax  cases,  148 
Wis  456  134  N.  W.  673,  135  N.  W.  164,  the  court  in  pursuance  of  this 
rule  discussed  only  the  contentions  in  regard  to  the  constitutionality  of  the 
Wisconsin  Income  Tax  Law  which  might  be  considered  as  going  to  the 
validity  of  the  whole  act  and  declined  to  express  any  opinion  as  to  the 
"minor  provisions  which  are  probably  to  be  regarded  as  matters  of  detail. 

3  Revenue  Act  of  1921,  §  1403;  Revenue  Act  of  1918,  §  1402. 

4Trefry  v.  Putnam,  227  Mass.  522,  116  N.  E.  904;  Eisner  v.  Macomber, 

252  U.  S.  189. 

5Brushaber  v.  Union  Pacific  R.  R.  Co.,  240  U.  S.  1. 


1008  FEDERAL  INCOME   TAX 

amendment  does  not  confer  power  to  levy  income  taxes  in  a 
generic  sense  or  to  limit  and  distinguish  between  one  kind  of 
income  tax  and  another,  but  the  whole  purpose  was  to  relieve 
all  income  taxes,  when  imposed,  from  apportionment;  in  short, 
the  purpose  was  to  do  away  with  the  principle  upon  which  the 
case*^  holding  the  1894  Law  unconstitutional  was  decided.  The 
amendment  places  no  limitation  as  to  the  nature  and  character 
of  the  income  taxes  which  it  authorizes.  Congress  derives  from 
the  Constitution'''  its  powers  "to  lay  and  collect  taxes,  duties,  im- 
posts and  excises."  This  power  is  exhaustive  and  embraces  every 
conceivable  power  of  taxation,  limited  only  by  the  constitutional 
provisions  that  "all  duties,  imposts,  and  excises  shall  be  uniform 
throughout  the  United  States," ^  that  "direct  taxes  shall  be  appor- 
tioned among  the  several  states"  ^  and  that  "no  capitation  or  other 
direct  tax,  shall  be  laid,  unless  in  proportion  to  the  census."  ^^ 
The  Sixteenth  Amendment  removed  the  limitation  of  appor- 
tionment, but  did  not  enlarge  the  power  of  Congress. 

Taxing  Gains  and  Profits  From  Sale  of  Property.  The  question 
whether  Congress  has  power  to  tax  gains  and  profits  arising 
from  the  sale  of  capital  assets,  viz.,  whether  the  word  "income," 
as  used  in  the  Sixteenth  Amendment,  embraced  such  gains  and 
profits,  has  now  been  definitely  settled  by  the  Supreme  Court.  In 
a  number  of  cases  recently  decided  ^^  that  court  held  such  gains 
and  profits  to  be  taxable,  and  that  no  distinction  existed  between 
gains  from  capital  realized  by  a  single  isolated  sale  of  property 
and  gains  from  capital  realized  by  sales  by  one  engaged  in  buy- 

6  Pollock  V.  Farmers  Loan  &  Trust  Co.,  157  U.  S.  429,  158  U.  S.  601. 

7  Constitution  of  the  United  States,  Art.  1,  §8. 

8  Id.  Art.  1,  §8,  CL  1. 

9  Id.  Art.  1,  §  2,  CI.  3. 

10  Id.  Art.  1,  §  9,  CI.  4. 

11  Walsh  V.  Brewster,  41  Sup.  Ct.  Rep.  392,  T.  B.  16-21-1573;  Goodrich  v. 
Edwards,  41  Sup.  Ct.  Rep.  390,  T.  B.  16-21-1572;  Eldorado  Coal  Co.  v.  Mager, 
65  L.  Ed.  449,  T.  B.  16-21-1571;  Merchants  Loan  &  Trust  Co.  v.  Smietanka, 
41  Sup.  Ct.  Rep.  386,  T.  B.  16-21-1570.  The  court  brushed  aside  the  case  of 
Lynch  v.  Turrish,  247  U.  S.  221,  on  the  ground  that  there  was  no  increase 
after  March  1,  1913,  and  the  case  of  Gray  v.  Darlington,  15  Wall.  63,  also 
much  relied  on,  by  referring  to  the  difference  in  the  statute  under  which 
the  case  was  decided,  the  expressions  relied  on  not  being  necessary  to  a 
decision.  As  bearing  upon  the  taxation  of  capital  gains,  see  generally: 
Trefry  v.  Putnam,  227  Mass.  522,  116  N.  E.  904;  Hays  v.  Gaufey  Mountain 
Coal  Co.,  247  U.  S.  189;  Doyle  v.  Mitchell  Bros.,  247  U.  S.  179;  Eisner  v. 
Macomber,  252  U.  S.  189;  U.  S.  v.  Cleveland  C.  C.  &  St.  L.  Ry.  Co.,  247 
U.  S.  195;  Stratton's  Independence  v.  Howbert,  231  U.  S.  399;  Scott  v. 
Schwab,  255  Fed.  57. 


CONSTITUTIONALITY    OF    THE    LAW  1009 

ing  and  selling  as  a  business — a  merchant,  real  estate  agent  or 
broker. 

Requiring  Disclosure  of  Interest  on  State  and  Municipal  Obli- 
gations. Although  the  Revenue  Act  of  1918  expressly  exempts 
from  taxation  interest  upon  the  obligations  of  a  state  or  any 
political  subdivision  thereof,  presumably  because  a  tax  on  such 
interest  would  be  unconstitutional,  it  requires  any  person  owning 
such  obligations  to  submit  a  statement  showing  the  number  and 
amount  thereof  and  the  income  received  therefrom,  in  such 
manner  and  form  and  with  such  information  as  the  commission- 
er shall  require.^-  It  has  been  asserted  that  this  provision  is 
unconstitutional  in  that  it  imposes  the  burden  upon  state  and 
municipal  obligations  of  compelling  the  owner  to  make  a  compu- 
tation and  disclosure  of  his  income  therefrom — a  burden  which 
if  admitted  in  principle,  could  be  stretched  to  such  an  extent 
that  the  owner  would  prefer  to  pay  the  tax  in  order  to  escape  the 
greater  burden  of  supplying  the  government  with  a  mass  of  de- 
tail in  regard  to  his  ownership  of  such  securities.  Congress 
seems  to  have  no  general  power  to  make  inquiry  into  the  affairs 
of  a  citizen  or  to  investigate  the  affairs  of  citizens  as  a  mere 
matter  of  private  concern  or  governmental  curiosity,!^  and  an 
individual  may  refuse  to  answer  an  unauthorized  inquiry.i^ 
Regarding  the  question  from  the  standpoint  of  individual  liberty 
and  privacy  or  from  the  standpoint  of  authority  in  a  particular 
case  to  make  inquiry  and  compel  answer,  it  is  difficult  to  see  in 
the  above  inquiry  introduced  by  the  Revenue  Act  of  1918  as  to 
state  and  municipal  obligations  any  legitimate  purpose  connected 
with  the  raising  of  revenue  or  any  other  function  of  the  federal 
government.  It  does  not  seem  that  taxpayers  should  be  obliged 
to  speculate  as  to  a  possible  undisclosed  purpose  on  the  part  of 
Congress  which  might  render  the  provision  authorized  and 
proper.  The  provision  has  been  withdrawn  in  the  Revenue  Act 
of  1921. 

Want  of  Due  Process  of  Law.  The  due  process  clause  of  the 
Fifth  Amendment  to  the  Federal  Constitution  which  provides 
that  "nor  (shall  any  person)  be  deprived  of  life,  liberty,  or  prop- 
erty without  due  process  of  law,"  is  not  a  limitation  upon  the 
taxing  power  conferred  upon  Congress  by  the  Constitution;  in 

12  Revenue  Act  of  1918,  §213   (a)   4. 

13  See  Interstate  Commerce  Commission  v.  Brinson,  154  U  .S.  447,  478; 
In  re  Chapman,  166  U.  S.  661,  668;  Kilbourn  v.  Thompson,  103  U.  S.  168; 
Harriman  v.  Interstate  Commerce  Commission,  211  U.  S.  407;  In  re  Pacific 
Ry.  Commission,  32  Fed.  241. 

14  Boyd  V.  U.  S.,  116  U.  S.  616. 


1010  FEDERAL  INCOME  TAX 

other  words,  the  Constitution  is  not  self-destructive  and  does 
not  conflict  with  itself  by  conferring  on  the  one  hand  a  taxing 
power  and  taking  the  same  away  on  the  other  by  the  limita- 
tions of  the  due  process  clause.  To  make  a  tax  statute  uncon- 
stitutional the  seeming  exercise  of  the  taxing  power  of  the  act 
must  be  so  arbitrary  as  to  constrain  to  the  conclusion  that  it  is 
not  the  exertion  of  taxation,  but  a  confiscation  of  property,  that 
is,  a  taking  of  the  same  in  violation  of  the  Fifth  Amendment, 
or,  what  is  equivalent  thereto,  that  the  statute  is  so  wanting  in 
basis  for  classification  as  to  produce  such  a  gross  and  patent 
inequality  as  to  inevitably  lead  to  the  same  conclusion.  In 
other  words,  the  Constitution  simply  requires  that  a  statute  shall 
operate  on  all  alike  under  the  same  circumstances.^""  The  judicial 
department  cannot  prescribe  to  the  legislative  department  lim- 
itations upon  the  exercise  of  its  acknowledged  powers.  The 
power  to  tax  may  be  exercised  oppressively  upon  persons;  but 
the  responsibility  of  the  legislature  is  not  to  the  courts  but  to 
the  people  by  whom  its  members  are  elected.  A  tax  will,  there- 
fore, not  be  held  void  because  it  is  deemed  to  be  too  high.i''  In 
a  case  arising  under  the  1909  law  it  has  been  held  that  the 
provision  limiting  the  interest  deduction  of  a  corporation  to 
the  amount  of  "paid-up  capital  stock  *  *  outstanding 
at  the  close  of  the  year"  was  not  unconstitutional  because  it 
denied  equal  protection  of  the  law  to  the  corporation  issuing  its 
stock  at  a  premium.  Congress  may  impose  different  specific 
taxes  upon  difl'erent  trades  and  professions  and  vary  the  rates 
of  excises  upon  various  products.  It  may  tax  real  estate  and 
personal  property  in  a  different  manner.  It  may  allow  deduc- 
tions for  indebtedness  or  not  allow  them.  Such  regulations  of 
this  character,  so  long  as  they  proceed  within  reasonable  limits 
and  general  usage,  are  within  the  discretion  of  Congress.  There 
is  no  precise  application  of  the  rule  of  reasonableness  of  classi- 
fication and  the  rule  of  equality  permits  of  many  practical  in- 
equalities. The  rule  of  equality  under  the  Constitution  only 
requires  that  the  law  imposing  it  shall  operate  on  all  alike  under 
the  same  circumstances."  In  a  case  arising  under  the  1913  Law^^ 
the  Supreme  Court  enumerated  a  number  of  features  of  the  1913 
Law  which,  it  had  been  alleged,  constituted  a  violation  of  the 
due  process  clause,  and  dismissed  them  with  the  statement  that 

15  Brushaber  v.  Union  Pacific  R.  R.  Co.,  240  U.  S.  1,  see  next  paragraph 
on  Uniformity. 

i6McCray  v.  U.  S.,  195  U.  S.  27;  Spencer  v.  Merchant,  125  U.  S.  345. 

17  N.  Y.,  N.  H.  &  H.  R.  R.  Co.  v.  U.  S.,  Ct.  D.  3,  T.  B-  3-21-1400- 

18  Brushaber  v.  Union  Pacific  R.  R.  Co.,  240  U.  S.  1. 


CONSTITUTIONALITY   OF  THE   LAW  1011 

none  in  the  remotest  degree  presented  such  questions.  Among 
such  objections  were  the  following:  (1)  that  the  progressive  rate 
and  exemption  features  of  the  law  were  based  on  wealth  alone 
and  were  wanting  in  due  process  of  law,^''  (2)  that  the  duty 
cast  upon  corporations  of  collecting  the  tax  at  the  source  was 
wanting  in  due  process  of  law,  (a)  because  of  the  cost  to  which 
they  were  subjected,  (b)  because  of  the  resulting  discrimina- 
tion between  corporations  indebted  upon  coupon  and  registered 
bonds  and  corporations  not  so  indebted,  (c)  because  of  the 
further  discrimination  in  the  case  of  corporations  so  indebted 
which  had  assumed  the  payment  of  taxes  on  their  bonds,  (d) 
because  of  the  further  discrimination  against  corporate  bond- 
holders in  the  deprivation  of  the  use  of  their  money  between  the 
deduction  and  payment  of  the  tax  withheld,  (e)  because  of  the 
further  discrimination  against  corporate  bondholders  in  the  fact 
that  they  might  be  obliged  to  pay  the  tax  a  second  time  if  the 
corporation  should  fail  after  deduction,  and  (f)  because  of  a 
further  discrimination  against  bondholders  in  that  they  were 
not  relieved  of  the  duty  of  reporting  bond  income  by  payment 
at  the  source,  the  result  being  a  double  payment  of  the  tax, 
labor  and  expense  in  obtaining  a  refund  and  deprivation  of  the 
use  of  their  money  in  the  meantime;  (3)  that  the  limitation  on 
the  amount  of  interest  deductible  by  corporations  was  wanting  in 
due  process;  (4)  that  the  privilege  granted  to  individuals  of  de- 
ducting dividends  for  purposes  of  normal  tax  was  a  discrimina- 
tion against  corporations  ;2f    (5)    that   the   deduction  of  $3,000 

1!^  Speaking  of  the  progi-essive  feature  of  the  Wisconsin  Income  Tax  Law, 
the  Wisconsin  Court  said  in  the  Income  Tax  Cases,  148  Wis.  456,  134  N.  W. 
673,  135  N.  W.  164 :  "With  regard  to  the  progressive  feature,  it  is  aptly 
said  in  Knowlton  v.  Moore,  178  U.  S.  41,  at  p.  109,  20  Sup.  Ct.  747,  by  the 
present  chief  justice,  that  'taxes  imposed  with  reference  to  ability  of  the 
person  upon  whom  the  burden  is  placed  to  bear  the  same  have  been  levied 
from  the  foundation  of  the  government.  So,  also,  some  authoritative  thinkers, 
and  a  number  of  economic  writers,  contend  that  a  progressive  tax  is  more 
just  and  equal  than  a  proportional  one.  In  the  absence  of  constitutional 
limitation,  the  question  whether  it  is  or  is  not  is  legislative  and  not  ju- 
dicial.' " 

20  In  holding  that  the  application  of  a  different  rate  in  the  case  of  cor- 
porations and  individuals  was  permissible,  the  Wisconsin  Court  said  in  the 
Income  Tax  Cases,  148  Wis.  456,  134  N.  W.  673,  135  N.  W.  164:  "The  cor- 
porate privileges,  which  are  exclusively  held  by  corporations,  and  the  real 
differences  between  the  situation  of  a  corporation  and  an  individual,  among 
which  may  be  mentioned  the  fact  that  the  corporation  never  is  obliged  to 
pay  an  inheritance  tax,  plainly  justify  a  difference  of  treatment  in  the  levy- 
ing of  the  income  tax.  Were  the  income  tax  a  tax  upon  property,  there 
could  be  no  difference  in  rate,  for  taxation  of  property  must  still  be  on  a 


1012  FEDERAL  INCOME  TAX 

or  $4,000  to  those  who  pay  the  normal  tax  and  not  to  those  with 
incomes  over  $20,000  was  wanting  in  due  process  ;2i  (6)  that  the 
discrimination  between  married  and  single  people  and  between 
husbands  and  wives  living  together  and  husbands  and  wives  not 
living  together  was  wanting  in  due  process  ;22  (7)  that  the  law 
involved  a  discrimination  and  want  of  due  process  in  favor  of 
house  owners  living  in  their  own  houses  who  were  not  com- 
pelled to  estimate  the  rental  value  against  those  who  paid  rent 
and  were  not  allowed  to  deduct  it  and  in  favor  of  farmers  who 
might  deduct  products  of  the  farm  used  by  them  in  sustaining 
their  families  whereas  family  expenses  might  not,  as  a  rule,  be 
deducted.  In  another  case-^  it  was  held  there  exists  a  substantial 
difference  between  the  carrying  on  of  business  by  corporations 
and  the  same  business  by  a  private  firm  or  individual,  and  the 
1909  Law  was,  therefore,  not  unconstitutional  on  the  ground 
of  arbitrary  discrimination.  In  another  case  the  court  held 
that  the  fact  that  the  tax  was  levied  on  the  income  of  mining 
companies  without  making  adequate  allowance  for  depletion  did 
not  amount  to  the  taking  of  property  without  due  process  of 
law.2^  In  a  case-^  arising  under  the  law  taxing  foreign-built 
yachts  it  was  stated  by  the  court  that  the  distinction  between 

uniform  rule,  but,  as  has  been  heretofore  noted,  it  is  not  a  tax  upon  prop- 
erty within  the  meaning  of  our  Constitution." 

21  In  Campbell  v.  Shaw,  11  Haw.  112,  it  was  held  that  the  Hawaiian  In- 
come Tax  Act  of  1896  was  unconstitutional  by  reason  of  the  fact  that  it 
allowed  an  exemption  of  $2,000  on  incomes  under  $4,000,  whereas  no  such 
exemption  was  allowed  on  incomes  over  $4,000.  In  Robertson  v.  Pratt,  13 
Haw.  590,  it  was  decided  that  an  exemption  of  incomes  to  the  amount  of 
$1,000  was  not  invalid  on  the  ground  that  it  was  excessive.  See  also  Pea- 
cock V.  Pratt,  121  Fed.  772 ;  In  re  Income  Tax  Act,  10  Haw.  317. 

22  With  regard  to  the  provision  of  the  Wisconsin  Income  Tax  Law  that  the 
income  of  a  wife  living  with  her  husband  shall  be  added  to  the  income  of  the 
husband,  the  Wisconsin  court  said  in  the  Income  Tax  Cases,  148  Wis.  456, 
134  N.  W.  673,  135  N.  W.  164:  "This  is  another  case  of  classification,  and 
it  is  only  justifiable  in  case  there  is  some  substantial  difference  of  situation 
which  suggests  the  advisability  of  difference  of  treatment.  We  think  there 
clearly  is  such  a  difference,  in  this,  that  experience  has  demonstrated  that 
otherwise  there  will  be  many  opportunities  for  fraud  and  evasion  of  the  law, 
which  the  close  relationship  of  husband  and  wife  or  parent  and  child  makes 
possible,  if  not  easy.  The  temptation  to  make  colorable  shifts  and  transfers 
of  property  in  order  to  secure  double  or  even  triple  exemptions,  if  there  were 
not  some  provision  of  this  kind  in  the  law,  would  unquestionably  be  very 
great.  There  is  no  such  temptation  or  opportunity  in  the  case  of  the  single 
man,  or  the  man  and  wife  who  are  living  separately." 

23  Flint  V.  Stone-Tracy  Co.,  220  U.  S.  107. 

24  Stanton  v.  Baltic  Mining  Co.,  240  U.  S.  103. 

25  Billings  V.  U.  S.,  232  U.  S.  261. 


CONSTITUTIONALITY   OF  THE   LAW  1013 

things  foreign  and  things  domestic,  and  their  use,  was  apparent 
on  the  face  of  things  and  to  tax  them  separately  was  not  an 
arbitrary  discrimination. 

Uniformity.     The  provision  of  the  Fifth  Amendment  to  the 
Constitution  of  the  United  States  which  prescribes  that  "nor 
(shall  any  person)    be  deprived  of  life,   liberty,   or  property 
without  due  process  of  law"  is  not  an  equal  protection  clause 
and  should  not  be  confused  with  the  Fourteenth  Amendment 
which  prescribes  that  "nor   (shall  any  state)   deny  to  any  per- 
son within  its  jurisdiction  the  equal  protection  of  its  laws." 26 
The  only  uniformity  prescribed  with  reference  to  duties,  imposts 
and  excises  is  a  geographical  or  territorial  uniformity.-'    In  a 
recent  case  the  Supreme  Court  has  held  that  the  provisions  of 
the  1917  Excess-Profits  Tax  Law  defining  invested  capital  ac- 
cording to  original  cost  of  property  instead  of  present  value, 
does  not  render  the  act  "glaringly  unequal"  and  of  "doubtful 
constitutionality." 2s    In  this  case  the  Supreme  Court  said:   "The 
difficulty  of  adjusting  any  system  of  taxation  so  as  to  render  it 
precisely  equal  in  its  bearing  is  proverbial,  and  such  nicety  is 
not  even  required  of  the  states  under  the  equal  protection  clause, 
much  less  of  Congress  under  the  more  general  requirement  of 
due  process  of  law  in  taxation.    Of  course,  it  will  be  understood 
that  Congress  has  very  ample  authority  to  adjust  its  income  taxes 
according  to  its  discretion  within  the  bonds  of  geographical  un- 
iformity." 

Exempting  Certain  Corporations  from  Tax.  The  provision  of 
the  Sixteenth  Amendment  authorizing  a  tax  on  incomes  "from 
whatever  source  derived"  does  not  require  that  the  tax  must  be 
imposed  upon  all  sources  of  income  nor  does  it  exclude  the  power 
to  exempt  certain  classes  of  corporations.^^ 

Retroactive  Features.  The  right  of  Congress  to  impose  a  tax 
by  a  new  statute,  although  the  measure  of  the  tax  is  governed  by 

20  See  Constitution  of  the  United  States,  Art.  14,  §  1. 

27  See  Constitution  of  the  United  States,  Art.  1,  §  8.  See  also  La  Belle 
Iron  Works  v.  United  States,  41  Sup.  Ct.  Rep.  528,  T.  B.  23-21-1680;  Knowl- 
ton  V  Moore,  178  U.  S.  41;  Patton  v.  Brady,  184  U.  S.  608;  Flint  v.  Stone- 
Tracy  Co.,  220  U.  S.  107;  Billings  v.  U.  S.,  232  U.  S.  261;  Brushaber  v. 
Union  Pacific  R.  R.  Co.,  240  U.  S.  1. 

28  LaBelle  Iron  Works  v.  U.  S.,  41  Sup.  Ct.  Rep.  528.  In  Ehret  Co.  v 
Lederer,  273  Fed.  689,  it  was  held  that  the  Commissioner's  construction  of 
§  201  of  the  1917  Law,  particularly  the  phrase  "the  amount  of  the  net  in- 
come in  excess  of  the  deduction,"  was  not  unconstitutional.  (See  Chap- 
ter 43.) 

29  Brushaber  v.  Union  Pacific  R.  R.  Co.,  240  U.  S.  1. 


1014  FEDERAL   INCOME   TAX 

the  income  of  the  past  year  cannot  be  doubted ;  much  less  can  it 
be  doubted  that  Congress  may  impose  a  tax  on  income  of  the  cur- 
rent year,  though  part  of  that  year  has  elapsed  when  the  statute 
is  passed.^o  A  statute  impos,ing  a  tax  upon  all  income  of  a  pre- 
vious year,  although  one  tax  on  that  income  has  already  been 
paid,  is  valid."! 

-•>  Brushaber  v.  Union  Pacific  R.  R.  Co.,  240  U.  S.  1 ;  Billings  v.  U.  S.,  232 
U.  S.  261;  Stockdale  v.  Insurance  Companies,  20  Wall.  323;  Schuylkill  Nav. 
Co.  V.  Elliott,  21  Fed.  Case.  No.  12,  497;  Brady  v.  Anderson,  240  Fed.  665, 
writ  of  certiorari  denied,  244  U.  S.  654,  T.  B.  2494;  U.  S.  v.  McHatton,  266 
Fed.  602;  A.  R.  R.  565,  T.  B.  29-21-1737.  With  regard  to  the  retroactive 
feature  of  the  Wisconsin  Income  Tax  Law  the  Wisconsin  court  in  the  in- 
come tax  cases,  148  Wis.  456,  134  N.  W.  673,  135  N.  W.  164,  overruled  ob- 
jection "without  comment,  for  the  reason  that  it  seems  very  unsubstantial." 

31  Stockdale  v.  Insurance  Companies,  20  Wall.  323. 


CHAPTER  43 

WAR-PROFITS  AND  EXCESS-PROFITS  TAX 

The  Revenue  Act  of  1921  re-enacts  without  change,  the  excess- 
profits  tax  imposed  by  the  1918  Law,  but  provides  for  its  repeal 
as  of  December  31,  1921.^  Certain  provisions  of  the  1918  Law 
referring  only  to  the  war-profits  tax  for  the  year  1918  are 
omitted  from  the  Revenue  Act  of  1921,  and  the  1921  Law  con- 
tains provisions  made  necessary  by  the  limitation  of  the  tax  to 
the  calendar  year  1921.  These  provisions  are  set  forth  in  the 
appropriate  paragraphs  of  this  chapter.  It  is  to  be  noted  that 
the  excess-profits  tax  is  upon  net  income  as  computed  under  the 
1921  Law,  which  because  of  changes  made  in  the  income  tax  may 
be  different  from  net  income  as  computed  under  the  1918  Law. 
This  will,  of  course,  make  a  difference  between  the  excess-profits 
tax  imposed  by  the  1918  Law  and  that  imposed  by  the  1921  Law. 
Other  changes  made  by  the  1921  Law  occur  by  reason  of  changes 
made  in  respect  to  the  income  tax.  Among  such  changes  are  the 
classification  of  certain  domestic  corporations  as  foreign  cor- 
porations and  a  modification  of  the  definition  of  inadmissible 
assets. 

The  repeal  of  the  excess-profits  tax  was  stated  by  the  senate 
finance  committee  to  be  "because  of  its  inequalities  and  difficulty 
of  administration  and  because  of  the  manner  in  which  it  dis- 
criminates against  corporations  with  small  invested  capital." - 
Many  other  criticisms  have  been  leveled  at  this  tax  and  it  was 
also  found  that  it  was  rapidly  losing  its  productivity. 

The  Act  of  March  3,  1917,  was  the  first  excess-profits  tax  law 
enacted  in  this  country."-  It  was  applied  only  to  corporations  and 
partnerships  and  imposed  a  tax  of  8' <  on  all  net  income  in  excess 
of  the  sum  of  $5,000  plus  S7'  of  the  actual  capital  invested.-'  A 
small  amount  of  tax  was  collected  under  this  statute  for  cor- 

1  This  repeal  is  accomplished  by  limiting  the  tax  to  the  calen-lar  year 
1921.  Title  III  of  the  Revenue  Act  of  1921  takes  effect  as  of  January  1, 
1921    (§338). 

2  Report  of  senate  finance  committee  on  the  revenue  bill  of  1921,  p.  23. 

3  39  Stats,  at  Large  1000.. 

■i  The  statute  defined  the  term  "actual  capital  invested"  to  mean  (1) 
actual  cash  paid  in;  (2)  the  actual  cash  value  at  the  time  of  payment 
of  assets  other  than  cash  paid  in,  and  (3)  paid  in  or  earned  surplus  and 
undivided  profits  used  or  employed  in  the  business;  but  to  exclude  money 
or  other  property  borrowed. 

1015 


1016  FEDERAL   INCOME   TAX 

porations  whose  fiscal  years  ended  in  the  succeeding  months  but 
any  amounts  so  collected  were  credited  or  refunded  to  the  tax- 
payers. The  next  law,  enacted  October  3,  1917,  imposed  a  tax  on 
the  net  income  of  individuals,  partnerships  and  corporations,  de- 
rived from  any  business  or  trade.  This  latter  statute  (referred 
to  in  this  Chapter  as  the  1917  Law)  was  retroactive  to  January 
1,  1917,  and  covered  the  period  during  which  the  Act  of  March  3, 
1917,  had  been  in  effect.  The  rates  of  the  1917  Law  as  applied  to 
corporations  having  invested  capital  were  20  S^  of  that  part  of 
the  net  income  which  exceeded  the  excess-profits  deduction  and 
did  not  exceed  15%  of  the  invested  capital;  25%  of  that  part  of 
the  net  income  which  exceeded  15%  of  the  invested  capital  and 
did  not  exceed  20%  of  the  invested  capital;  35%  of  the  net  in- 
come which  exceeded  20%  of  the  invested  capital  and  did  not  ex- 
ceed 25%  of  the  invested  capital;  45%  of  that  part  of  the  net 
income  which  exceeded  25%  of  the  invested  capital  and  did  not 
exceed  33  %  of  the  invested  capital ;  and  60  %  of  that  part  of  the 
net  income  which  exceeded  33%  of  the  invested  capital.^  In  the 
case  of  a  trade  or  business  which  had  no  invested  capital  or  not 
more  than  a  nominal  capital,  the  excess-profits  tax  was  8%  of 
the  entire  net  income  in  excess  of  $3,000  in  the  case  of  a  domes- 
tic corporation,  and  $6,000  in  the  case  of  a  domestic  partner- 
ship, or  a  citizen  or  resident  of  the  United  States.  In  the  case  of 
a  foreign  corporation  or  partnership  or  a  nonresident  alien  this 
rate  was  imposed  upon  the  entire  net  income  without  deduction.^ 
The  Act  of  February  24,  1919,  (referred  to  in  this  chapter  as 
the  Revenue  Act  of  1918  or  the  1918  Law)  imposed  a  tax  on 
income  received  during  the  year  1918  in  lieu  of  the  tax  imposed 
by  the  1917  Law.  In  view  of  the  increased  individual  normal 
and  surtax  rates  upon  the  income  of  individuals  and  partner- 
ships, which  in  most  cases  made  the  income  taxes  paid  by  such 
individuals  as  high  as  the  income  and  excess-profits  or  war- 
profits  taxes  paid  by  corporations  engaged  in  similar  business, 
and  in  view  of  the  difficulty  in  administering  an  excess-profits 
tax  applicable  to  individuals,  it  was  decided  by  Congress  that 
the  war  and  excess-profits  taxes  should  apply  to  corporations 
only.'^  It  was  also  recognized  that  there  exists  a  class  of  corpora- 
tions which  require  very  little  or  no  invested  capital  and  whose 
income  is   derived  mainly  from  the  personal  services  of  the 

5  Revenue  Act  of  1917,  §  201. 

6  Revenue  Act  of  1917,  §209. 

7  Report  of  the  committee  on  ways  and  means  on  the  Revenue  Bill  of  1918, 
September  3,  1918. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1017 

stockholders.  Examples  of  such  corporations  are  corporations 
composed  of  engineers  or  accountants,  who  might  as  readily  have 
formed  partnerships  to  carry  on  their  business.  Such  corpora- 
tions are  called  "personal  service  corporations"  and  were  treated 
as  though  they  were  partnerships.  No  excess-profits  tax  was 
imposed  upon  their  net  income  but  the  stockholders  of  the  per- 
sonal service  corporation  were  taxable  upon  the  entire  net  in- 
come of  the  year,  whether  or  not  such  income  is  distributed  in  the 
form  of  dividends.  The  tax  imposed  by  the  1918  Law  combined 
two  general  principles  of  taxation  :  (a)  that  of  a  war-profits  tax, 
which  is  usually  considered  to  be  a  tax  on  the  excess  of  profits 
made  during  the  years  of  the  war  period  over  the  normal  profits 
of  the  years  prior  to  the  war  and  (b)  an  excess-profits  tax, 
which  is  considered  as  a  tax  upon  the  profits  in  excess  of  a 
specified  percentage  representing  an  approximate  normal  return 
on  the  invested  capital.  The  law,  however,  did  not  adhere  to  a 
clear  distinction  between  war-profits  and  excess-profits  since 
the  war-profits  tax  combined  a  feature  of  the  excess-profits  tax 
in  that  a  minimum  deduction  of  10%  of  the  invested  capital  was 
allowed  regardless  of  the  earnings  of  the  corporation  during  the 
pre-war  period.  Under  the  excess-profits  method  of  computing 
the  tax  the  rate  of  1918  was  30%  of  that  part  of  the  net  income 
which  exceeded  the  excess-profits  deduction  and  did  not  exceed 
20%  of  the  invested  capital  and  65%^^  of  that  part  of  the  income 
which  exceeded  20%)  of  the  invested  capital.  The  war-profits 
tax  rate  was  a  single  rate  of  SO'i  in  excess  of  the  war-profits 
credit.'^  This  combination  of  principles  applied  generally,  how- 
ever, only  to  income  of  the  year  1918.  For  subsequent  years 
the  war-profits  tax  is  discarded  and  the  excess-profits  tax  alone 
imposed,  except  as  to  income  received  from  government  con- 
tracts, as  more  fully  stated  in  a  following  paragraph.  The  rate 
of  the  excess-profits  tax  for  the  taxable  years  1919,  1920  and 
1921  is  20%  on  that  part  of  the  net  income  which  exceeds  the 
excess-profits  credit  and  does  not  exceed  20%  of  the  invested 
capital,  and  40//   on  the  remaining  net  income.*^ 

•'^Revenue  Act  of  1918,  §301  (a).  It  has  been  estimated  that  under 
the  1917  Law,  the  average  amount  of  excess-profits  tax  was  about  30% 
of  the  net  income  of  taxable  corporations  for  the  year  1917.  It  has  been 
conjectured  that  the  war-profits  and  excess-profits  taxes  absorbed  on  an 
average  about  45%  of  the  1918  income.  In  addition  the  income  tax  absorbed 
12%  of  the  remainder  so  that  probably  about  one-half  of  the  net  income 
of  corporations  for  the  year  1918  was  paid  to  the  federal  government  by 
way  of  war-profits,  excess-profits  and  income  taxes. 

9  Revenue  Act  of  1921,  §  301   (a)  ;  Revenue  Act  of  1918,  §  301   (b). 


1018  FEDERAL  INCOME  TAX 

Individuals.  Individuals  are  not  subject  to  the  excess-profits 
tax.  Since  individuals  were  not  allowed  to  file  returns  on  the 
basis  of  their  fiscal  years  under  the  1917  Law,  no  individual 
paid  a  tax  on  1918  income  under  the  1917  Law,  and,  therefore, 
the  1918  Law  contains  no  provision  with  respect  to  individuals 
such  as  the  provision  i"  with  respect  to  partnerships  for  rede- 
termining the  tax  due  on  1917  income. 

Individuals  Under  1917  Law.  Under  the  Revenue  Act  of 
1917,  individuals  were  subject  to  excess-profits  tax  if  they  had 
an  aggregate  net  income  in  excess  of  $6,000  ($3,000  in  the  case 
of  nonresident  aliens)  from  trades,  businesses,  occupations  or 
professions.il 

In  the  case  of  an  individual,  the  terms  "trade,"  "business,"  and 
"trade  or  business"  were  held  to  comprehend  all  his  activities 
for  gain,  profit,  or  livelihood,  entered  into  with  sufficient  fre- 
quency or  occupying  such  portion  of  his  time  or  attention  as  to 
constitute  a  vocation,  including  occupations  and  professions. 
When  such  activities  constituted  a  vocation  they  were  construed 
to  be  a  trade  or  business  whether  continuously  carried  on  during 
the  taxable  year  or  not,  and  all  the  income  arising  therefrom 
was  subject  to  excess-profits  tax. 

In  the  following  cases  the  gain  or  income  was  not  subject  to 
excess-profits  tax,  and  the  capital  from  which  such  gain  or  in- 
come is  derived  could  not  be  included  in  "invested  capital":  (a) 
Gains  or  profits  from  transactions  entered  into  for  profit,  but 
which  are  isolated,  incidental,  or  so  infrequent  as  not  to  con- 
stitute an  occupation,  and  (b)  the  income  from  property  arising 
merely  from  its  ownership,  including  interest,  rent,  and  similar 
income  from  investments  except  in  those  cases  in  which  the 
management  of  such  investments  really  constitutes  a  trade  or 
business.i2 

10  Revenue  Act  of   1918,  §335    (c). 

11  Revenue  Act  of  1917,  §§201,  202  and  203;  Reg.  41,  Art.  12-13.  The 
tei'm  "trade  or  business"  is  also  defined  in  Chapters  25  and  44. 

12  Reg.  41,  Art.  8.  This  ruling  has  received  the  attention  of  the  court 
in  Cadw^alader  v.  Lederer,  273  Fed.  879,  in  a  decision  in  which  it  viras  held 
that  commissions  received  by  a  law^yer  as  executor  and  trustee  of  the 
estate  of  a  friend  were  not  subject  to  the  1917  excess-profits  tax,  where  it 
appeared  that  the  lawyer  did  not  make  a  general  practice  of  so  acting, 
the  court  says  in  this  case  that  it  cannot  "grasp  the  thought  of  a  distinction 
between  such  isolated  things,  growing  out  of  the  importance  of  the  thing 
done  or  the  demands  which  it  makes  upon  the  time  of  the  person  doing 
it".  It  then  explains  article  8  of  regulations  41,  as  follows:  "The  whole 
thought  is  conveyed  in  an  expression  which  is  not  uncommon  when  a  person 
is  asked  to  do  something  which,  as  another  expression  goes,  is  'out  of  line*. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1019 

Several  cases  arose  under  the  Revenue  Act  of  1917  in  defini- 
tion of  the  terms  "trade"  and  "business"  a  few  of  which  are 
given  below: 

(1)  An  expert  oil  man  who  devoted  his  time  and  money  to  the 
purchase  and  sale  of  oil  and  gas  leases  and  to  the  promotion  of 
corporations  developing  such  leases,  and  who  in  1917  disposed  of 
his  entire  holdings  of  the  capital  stock  of  certain  corporations  in 
which  he  owned  all  but  the  qualifying  shares  and  of  which  he 
was  an  active  officer,  was  held  subject  to  the  1917  excess-profits 
tax  on  the  profits  realized  in  1917  from  the  sale  of  his  interests 
in  such  companies.^-' 

(2)  The  sale  of  rights  acquired  through  the  ownership  of 
stock  in  any  corporation  in  which  an  individual  was  not  a  man- 
aging officer  or  agent  was  considered  an  isolated  transaction 
and  any  profit  derived  therefrom  was  not  subject  to  the  1917 
excess-profits  tax,^"^ 

(3)  Likewise  profits  realized  from  the  sale  of  fractional  in- 
terests in  various  vessels  by  an  individual  having  no  control  of 
the  management  of  such  vessels  were  not  subject  to  the  1917  ex- 
cess-profits tax  unless  such  individual  gave  enough  time  and  at- 
tention to  the  buying  and  selling  thereof  as  to  constitute  a 
trade  or  business.^"' 

(4)  A  physician  who  owned  a  farm  and  a  part  interest  in  cer- 
tain oil  interests,  but  who  spent  practically  his  entire  time  in 
1917  in  the  practice  of  his  profession,  the  farm  being  rented  out 
on  a  cash  rental  basis  and  the  management  of  the  interest  in  the 
oil  leases  being  in  the  hands  of  another  individual  was  held  not  en- 
gaged in  the  business  of  farming  or  the  purchase,  promotion  or 
sale  of  oil  properties  in  1917,  and  consequently  not  subject  to  the 

The  expression  first  referred  to  is,  'I  don't  make  a  business  of  doing  this, 
but  I  will  do  it  for  you'.  The  doing  of  it  may  result  in  such  person  de- 
voting practically  his  whole  time  to  it,  without  involving  the  thought  of 
making  it  his  business.  There  is  much  the  same  distinction  made  between 
amateurs  and  professionals  in  athletics,  although  the  test  usually  applied 
there  is  the  commercial  test.  Nevertheless  the  distinction  referred  to 
exists.  The  amateur  does  not  make,  as  the  professional  ex  vi  termini 
does,  the  sport  his  trade,  occupation,  business,  or  profession,  even  although 
he,  as  he  not  infrequently  does,  devotes  more  time  in  developing  and  per- 
fecting skill  in  it  than  the  avowed  professional  does.  The  difference  is 
suggestive  of  a  difference  in  motive,  but  there  is  the  other  thought  also." 

13  A.  R.  M.  41,  T.  B.  16-20-871.  The  decisive  point  in  this  decision 
seems  to  have  been  the  fact  that  the  taxpayer  was  the  managing  officer 
of  the  corporations. 

i-i  A.  R.  M.  41,  T.  B.  16-20-871. 

15  A.  R.  R.  65,  T.  B.  16-20-870. 


1020  FEDERAL  INCOME   TAX 

1917  excess-profits  tax  with  respect  to  a  profit  derived  from  the 
sale  of  the  farm  and  the  interest  in  the  oil  leases.^*"' 

(5)  Amounts  received  for  professional  and  literary  work  have 
been  held  to  be  income  arising  from  a  vocation. i''' 

(6)  Profits  realized  by  an  individual  also  engaged  in  farming 
derived  from  trading  in  grain  futures  have  been  held  to  con- 
stitute income  from  a  trade  or  business.!^ 

(7)  Royalties  received  under  a  license  contract  by  a  taxpayer 
engaged  in  the  automobile  business  who  had  patented  certain 
automobile  improvements  have  been  held  to  be  derived  from  a 
trade  or  business  and  not  the  mere  ownership  of  property,  where 
the  taxpayer  devoted  a  considerable  part  of  his  time  and  atten- 
tion to  the  invention.!'-' 

(8)  Profits  derived  from  a  cattle  feeding  venture  have  been 
held  subject  to  the  excess-profits  tax  imposed  by  the  1917  Law.-'^ 

Partnerships  Under  1918  and  Present  Laws.  Partnerships 
are  not  subject  to  the  excess-profit  tax  under  the  1918  or  the 
present  law. 

Partnerships  Under  1917  Law.  Partnerships  were  subject 
to  the  1917  excess-profits  tax,  if  they  had  a  net  income  of  $6,000 
or  more  ($3,000  or  more  in  the  case  of  a  foreign  partnership ).2i 
A  partnership  which  was  'dissolved  in  July,  1917,  was  held  not 
to  be  relieved  from  such  tax  on  the  ground  that  its  dissolution 
antedated  the  passage  of  the  act.^^ 

The  definition  of  partnerships  has  been  covered  in  full  in  an 
earlier  chapter.-'^  It  has  been  held  in  connection  with  the  1917 
Law  that  several  persons  who  contributed  severally  to  a  fund 
used  to  develop  and  operate  an  oil  field  with  an  agreement  that 
they  were  to  share  pro  rata  in  the  profits  did  not  constitute  a 

ISA.  R.   M.  40,  T.  B.  17-20-879. 

17  A.  R.  R.  247,  T.  B.  34-20-1155.  But  the  estate  of  a  deceased  literary 
man  would  not  be  liable  for  excess-profits  tax  on  royalties  received  (0. 
D.  760,  T.  B.  52-20-1365). 

ISA.  R.  R.  636,  T.  B.  41-21-1865. 

19  A.  R.  R.  425,  T.  B.  42-21-1874.  See  also  Delaski  &  Thropp  Co.  v. 
Iredell,  268  Fed.  377. 

20  A.  R.  R.  629,  T.  B.  40-21-1850.     See  Chapter  8. 

21  Revenue  Act  of  1917,  §§201,  202  and  203;  Reg.  41,  Art.  11.  Partner- 
ships doing  the  same  kind  of  business  as  exempt  corporations  were  exempt 
(Reg.  41,  Art.  13).     See  Chapter  13. 

22  A.  R.  R.  43,  T.  B.  12-20-794;  Reg.  41,  Art.  5.  The  act  was  passed  on 
October  3,  1917,  and  made  retroactive  as  of  January  1,  1917. 

23  This  chapter  does  not  attempt  to  cover  this  subject  in  full  and  Chap- 
ter 8  should  be  consulted. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1021 

partnership.-^  A  taxpayer  and  his  wife  who  both  contributed 
equally  to  a  fund  placed  in  the  hands  of  a  brokerage  firm  for 
dealing  in  grain  futures  have  been  held  to  be  a  partnership, 
where  it  was  understood  by  the  brokerage  firm  that  there  was  to 
be  an  equal  sharing  of  profits  and  losses  between  the  taxpayer 
and  his  wife  on  the  transaction.^^  A  partnership  which  dis- 
solved about  1902  and  whose  quick  assets,  good  will  and  firm  title 
were  sold  to  an  individual  who  carried  on  business  thereafter 
for  its  individual  account  under  the  old  finri  name,  was  held  sub- 
ject to  the  1917  excess-profits  tax  with  respect  to  the  profits  de- 
rived from  certain  transactions  in  1917  involving  the  purchase 
and  sale  of  sugar.^c 

Partnerships  Which  Paid  a  Tax  on  1918  Income.  If  a 
partnership  made  a  return  under  the  1917  Law  for  a  fiscal  year 
beginning  in  1917  and  ending  in  1918,  and  paid  the  tax,  a  cer- 
tain proportion  thereof  was  subject  to  refund.  This  amount  to 
be  refunded  was  to  be  determined  by  taking  the  same  proportion 
of  the  tax  so  paid  which  the  proportion  of  the  fiscal  year  falling 
in  1918  was  to  the  entire  fiscal  year.  Thus,  if  one-fouii:h  of 
the  fiscal  year  fell  in  1917  and  three-fourths  in  1918,  three- 
fourths  of  the  tax  which  had  been  paid  was  subject  to  refund.-" 

Personal  Service  Corporations.  *  Personal  service  corpora- 
tions are  not  subject  to  the  excess-profits  tax,  but  are  taxed  as 
partnerships.2s  Such  corporations  are  described  in  a  preced- 
ing chapter.29 

Personal  Service  Corporations  Under  1917  Law.  The 
1917  Law  imposed  a  tax  of  8%  upon  a  trade  or  business  having 
no  invested  capital  or  not  more  than  a  nominal  capital,  and 
upon  the  salaries,  wages  and  fees  of  individuals.^^     This  pro- 

24  Sol.  Op.  117,  T.  B.  33-21-1772. 

25  A.  R.  R.  636,  T.  B.  41-21-1865.  Checks  for  profits  were  made  to  the 
husband  in  this  case  as  agent  for  the  wife,  but  were  invested  in  liberty  bonds 
which  were  equally  divided  and  registered  in  their  separate  names. 

26  A.  R.  R.  211,  T.  B.  31-20-1108. 

27  Revenue  Act  of  1918,  §335  (c).  See  Chapter  37.  Excess-profits  tax 
paid  by  partnership  with  respect  to  income  received  during  1918  can  not 
be  applied  as  credit  to  tax  due  from  individual  members  for  taxable  year 
1918.  In  such  cases  claim  for  refund  should  be  filed  by  the  partnership. 
(0.  D.  180,  T.  B.  7-19-310.) 

28  Revenue  Act  of  1921,  §§300  and  200;  Revenue  Act  of  1918,  §§300 
and  200. 

29  See  Chapter  11.  Personal  service  corporations  are  abolished  as  of 
December  31,  1921,  but  the  excess-profits  tax  is  repealed  as  of  the  same  date. 

30  Revenue  Act  of  1917,  §  209;  Reg.  41,  Arts.  14,  15. 


]022  FEDERAL  INCOME  TAX 

vision  was  omitted  from  the  1918  Law,  but  in  its  place  were  the 
provisions  respecting  personal  service  corporations.  Under  the 
1917  Law  it  was  held  that  business  concerns  which  rendered 
professional  or  personal  services  would  not  be  taxed  on  the 
basis  of  invested  capital  merely  because  of  the  capital,  if  the 
employment  of  such  capital  was  necessitated  by  delay  and  irregu- 
larity in  the  receipt  of  fees,  etc.,  or  if  such  capital  was  wholly  or 
mainly  used  as  a  fund  from  which  to  advance  salaries,  wages,  etc., 
or  provide  office  furniture,  accommodations  and  equipment,  nor 
because  of  the  form  of  organization,  whether  corporation  or 
partnership,  nor  in  the  case  of  a  partnership  because  of  the 
number  of  partners.  Agents  and  brokers  were  held  to  bfe  tax- 
able at  the  graduated  rates  with  reference  to  invested  capital 
if  they  employed  a  substantial  amount  of  capital  whether  to 
lend  to  principals  or  to  carry  goods  on  their  own  account,  but 
otherwise  were  taxable  only  at  the  flat  rate  of  8%.3i  In  determin- 
ing whether  a  concern  was  taxable  at  the  8%  rate  no  weight 
was  given  to  the  fact  that  it  was  carried  on  by  means  of  per- 
sonal service,  unless  the  principal  owners  were  regularly  en- 
gaged in  the  active  conduct  of  the  trade  or  business.-^-  It  was 
held  that  the  term  nominal  capital  meant,  in  general,  a  small 
or  negligible  capital  the  use  of  which  was  incidental.  The  fol- 
lowing trades  or  businesses  were  held  to  employ  more  than  a 
nominal  capital: 

(a)  A  business  which,  because  of  conditions  arising  from  the 
war  or  exceptional  opportunities  for  profits,  earned  a  dispro- 
portionately high  rate  of  profit  during  the  taxable  year,  if  it 
belonged  to  a  class  necessarily  and  customarily  requiring  capital 
for  its  operation,  stress  to  be  laid  in  doubtful  cases  upon  the 
nominal  relation  of  net  income  to  capital  during  pre-war  years. 

(b)  Corporations  which,  although  their  capitalization  was 
nominal,  in  fact  employed  a  substantial  capital  in  their  business. 

(c)  A  business  having  a  substantial  capital,  which  by  the  ordi- 
nary rules  and  restrictions  governing  the  computation  of  in- 
vested capital  was  reduced  to  a  nominal  amount;  e.  g.,  where 
capital  consisting  originally  of  a  small  amount  of  cash  paid  in 
had  since  appreciated  in  value,  or  where  capital  was  largely 
covered  by  indebtedness  or  consisted  principally  of  tax-free  se- 
curities or  intangible  assets  built  up  or  developed  by  expendi- 
tures regularly  deducted  as  business  expense.^^ 

-iReg.  41,  Arts.  72,  73. 
"'2  Reg.  41,  Art.  71. 
33  Reg.  41,  Art.  74. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1023 

The  following  concerns  and  businesses  have  been  held  taxable 
under  the  1917  Law  in  the  ordinary  way,  because  they  employed 
more  than  a  nominal  capital:'^-' 

(1)  A  company  which  had  never  owned  any  lands,  timber, 
plant,  mill  or  yard,  and  which  had  never  done  any  manufacturing 
or  carried  any  stock  of  manufactured  lumber,  but  whose  principal 
business  consisted  of  buying  lumber  from  manufacturers  and 
reselling  the  same  to  its  own  customers,  such  business  being 
conducted  by  the  partners  personally  with  the  assistance  of  a 
small  clerical  office  force  of  one  bookkeeper  and  two  stenog- 
raphers."'"' 

(2)  A  company  organized  with  a  small  amount  of  capital 
stock,  none  of  which  was  paid  up,  and  which  later  secured  a  lease 
to  wharf  property,  no  bonus  being  paid  for  the  lease,  the  business 
of  the  company  being  subletting  this  leased  property,  its  income 
being  held  derived  chiefly  from  the  possession  of  a  capital  asset 
which  was  not  capital  in  name  only,  but  a  real  tangible  asset.^*^ 

(3)  A  retailing  corporation,  the  stock  of  which  was  owned  by 
two  stockholders  who  were  actively  engaged  in  the  business 
and  were  the  principal  salesmen,  and  which  employed  no  capital 
except  in  paying  for  merchandise  consigned  to  it  by  the  factory 
and  for  the  payment  of  the  freight  charges  thereon,  even  though 
the  capital  used  was  small  in  amount  and  even  though  the  direct 
use  of  capital  by  the  corporation  could  have  been  avoided  by 
having  the  purchasers  make  the  customary  deposits  when  plac- 
ing their  orders,  no  stock  being  carried  by  the  corporation  other 
than  that  passing  through  the  shop  for  test  before  delivery.^" 

(4)  A  corporation  which  had  spent  its  earnings  in  improving 
a  secret  chemical  process  (admitted  to  be  an  intangible  asset) 
the  increased  value  of  which  process  was  due  to  the  improvement 
being  in  eff'ect  "earned  surplus  used  in  the  business,"  where  the 
improvement  was  originally  paid  for  with  borrowed  money  and 

•'i  This  chapter  does  not  attempt  to  cover  this  subject  in  full  and  Chap- 
ter 8  should  be  consulted. 

^5  Cartier-Holland  Lumber  Co.  v.  Doyle,  U.  S.  Dist.  Ct.,  W.  Dist.  Mich. 
So.  Div.;  T.  D.  3080.  In  making  this  decision,  the  court  said:  "They  buy 
and  sell  lumber  and  undertake  and  assume  all  the  risks  and  enjoy  all  the 
benefits  of  a  merchandising  business.  They  employ  a  large  amount  of  cap- 
ital; their  income  is  dependent  upon  .their  personal  services  and  efforts  only 
in  the  same  way  that  the  farmer,  who  works  his  own  farm,  or  the  merchant 
who  conducts  his  own  store  derives  his  income  from  his  individual  en- 
deavors". 

•■■■'■•A.  R.  R.  315,  T.  B.  46-20-1307. 

■'~T.  B.  R.  58,  T.  B.  19-19-492. 


1024  FEDERAL  INCOME  TAX 

subsequent  earnings  were  sufficient  to  repay  the  borrowed  money 
and  to  create  an  "earned  surplus"  before  the  beginning  of  the 
year.3^ 

A  corporation  engaged  in  the  business  of  negotiating  sales  of 
real  estate  for  clients  and  the  collection  of  rents  of  properties 
listed  with  it  for  renting,  its  total  income  being  derived  from 
commissions  on  such  business,  the  corporation  not  owning  any 
real  estate  and  all  its  stockholders  devoting  their  entire  time  and 
attention  to  the  business  with  the  exception  of  one  stockholder 
owning  10  shares  out  of  500  (who  devoted  part  of  his  time  in  the 
business)  and  employing  two  salesmen  on  the  basis  of  commis- 
sions on  the  sales  made  by  them,  but  only  a  small  proportion  of 
the  net  income  being  due  to  the  activities  of  these  salesmen,  has 
been  held  taxable  at  the  8%  rate.^^ 

Personal  Service  Corporations  Which  Paid  a  Tax  on  1918 
Income.  If  any  corporation  which  under  the  1918  Law  was  held 
to  be  a  personal  service  corporation  filed  a  return  and  paid  a  tax 
under  the  1917  Law  for  a  fiscal  year  beginning  in  1917  and  end- 
ing in  1918,  a  portion  of  the  tax  so  paid  was  subject  to  refund. 
The  amount  to  be  refunded  was  determined  by  taking  the  same 
proportion  of  the  tax  so  paid  which  the  proportion  of  the  fiscal 
year  falling  in  1918  was  to  the  entire  fiscal  year.  Thus,  if  five 
months  of  the  fiscal  year  fell  in  the  calendar  year  1918,  five- 
twelfths  of  the  tax  paid  on  the  income  of  the  full  fiscal  year 
was  subject  to  refund.^o 

Corporations  Engaged  Partly  in  Personal  Service  Business. 
Where  a  part  of  the  net  income  of  a  corporation  is  derived  (1) 
from  a  trade  or  business  (or  a  branch  thereof)  in  which  the 
employment  of  capital  is  necessary  and  (2)  a  part  (constitut- 
ing not  less  than  30%  of  its  total  net  income)  is  derived  from 
a  separate  trade  or  business  which,  if  it  constituted  the  sole 
trade  or  business,  would  bring  the  corporation  within  the  class 
of  personal  service  corporations,  the  tax  upon  that  part  of  the 

38  Lincoln  Chemical  Co.  v.  Edwards,  272  Fed.  142;  T.  D.  3183,  T.  B. 
29-21-1740.  In  this  case  Judge  Hand  assumed,  without  deciding,  that 
"nominal  capital"  meant  "nominal  invested  capital".  The  term  "nominal 
capital"  is  a  relative  term.  In  this  case  the  value  of  the  process  in  1917 
was  shown  to  be  only  over  $10,000,  but  this  was,  to  use  the  language  of 
the  court  in  regard  to  an  earned  surplus  of  $2,000,  "in  view  of  the  size 
of  the  business"  more  than  nominal. 

39  A.  R.  R.  210,  T.  B.  31-20-1097.  No  attempt  is  made  in  this  chapter 
to  cover  all  the  rulings  in  this  connection.  Chapter  11  should  be  con- 
sulted. 

40  Revenue  Act  of  1918,  §335   (c).     See  Chapter  37. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1025 

net  income  which  is  derived  from  the  use  of  capital  is  sepa- 
rately computed  (allowing  in  such  computation  only  the  same 
proportionate  part  of  the  war-profits  and  excess-profits  credits) 
and  the  tax  upon  the  second  part  of  the  net  income  is  the  same 
percentage  thereof  as  the  tax  computed  upon  the  first  part  of  the 
net  income  is  of  such  first  part.^i  This  provision  will  apply 
in  the  case  of  partial  personal  service  corporations  until  the 
point  is  reached  where  the  nonpersonal-service  element  becomes 
negligible,  under  which  conditions  such  corporations  would 
make  returns  as  personal  service  corporations.^^  Where  a  cor- 
poration doing  a  commission  and  brokerage  business  satisfies 
the  requirements  of  a  personal  service  corporation,  except  that 
it  in  part  employs  capital,  surplus,  and  borrowed  funds  to  make 
large  advances  to  customers  and  receives  more  interest  than  it 
pays  as  a  result  of  such  transactions,  it  should  be  assessed  un- 
der this  provision.  The  income  from  commissions  and  brok- 
erage should  be  considered  as  arising  from  personal  service, 
and  the  remainder  of  the  income  as  derived  from  the  use  of 
capital.^^ 

Apportionment  of  Invested  Capital  and  Net  Income. 
For  the  purpose  of  determining  whether  or  not  a  corporation 
partly  partaking  of  the  nature  of  a  personal  service  corporation 
is  within  the  scope  of  the  statute  and  also  for  the  purpose  of 
establishing  the  basis  for  the  computation  of  the  tax,  the  cor- 
poration is  required  to  apportion  or  allocate  its  invested  capital 
between  each  trade  or  business  or  branch  thereof  as  nearly  as 
may  be  in  accordance  with  the  actual  facts,  and  to  submit  with 
its  return  an  explanatory  statement  setting  forth  the  manner 
in  which  the  apportionment  of  the  invested  capital  employed  in 
the  production  of  each  part  of  its  net  income  has  been  de- 
termined. There  must  be  assigned  to  any  personal  service  trade 
or  business  or  branch  thereof  an  amount  of  invested  capital 
at  least  as  great  as  that  which  would  ordinarily  be  employed 
by  a  personal  service  corporation  of  similar  size  and  standing 
for  the  payment  of  salaries  and  office  expenses,  maintenance 
of  library  and  equipment,  credit  advances  to  clients,  etc.^^ 

Computation  of  Tax  Upon  Net  Income.  (1)  The  tax 
upon  the  nonpersonal  service  part  of  the  net  income  is  computed 

41  Revenue  Act  of  1921,  §303;  Revenue  Act  of  1918,  §303. 
•12  0.  D.  79,  T.  B.  1-19-114. 

43  T.  B.  M.  50,  T.  B.  12-19-410. 

44  Reg.  45,  Art.  741.  For  the  method  of  determining  the  portion  of  the 
net  income  from  each  trade  or  business  or  branch  thereof  see  p.  1030. 


1026  FEDERAL  INCOME   TAX 

upon  the  basis  of  (a)  such  part  of  the  entire  average  net  income 
for  the  prewar  period  as  was  derived  from  the  same  trade  or 
business  or  branch  thereof;  (b)  such  part  of  the  entire  average 
invested  capital  for  the  prewar  period  as  was  employed  in  the 
production  of  the  part  of  the  net  income  for  that  period  de- 
termined under  (a)  ;  (c)  such  part  of  the  entire  invested  capital 
for  the  taxable  year  as  has  been  employed  in  the  production  of 
the  net  income  upon  which  the  tax  is  being  computed;  and  (d) 
the  same  proportion  of  the  specific  exemption  and  credits  as 
the  proportion  which  the  part  of  the  net  income  upon  which  the 
tax  is  being  computed  is  of  the  entire  net  income.  If  the  cor- 
poration was  in  existence  during  the  prewar  period,  but  did 
not  conduct  this  trade  or  business  or  branch  thereof  during  that 
period,  the  war-profits  credit  is  10%  of  the  invested  capital  for 
the  taxable  year.  (2)  The  tax  upon  the  personal  service  part  of 
the  net  income  is  the  same  percentage  thereof  as  the  tax  com- 
puted under  (1)  is  of  the  nonpersonal  service  part  of  the 
net  income.  The  tax  under  this  paragraph  may  in  no  case  be 
less  than  20%  of  the  personal  service  part  of  the  entire  net  in- 
come, unless  the  tax  upon  the  entire  net  income  if  computed  in 
the  ordinary  way  would  be  less  than  20%  of  such  entire  net 
income.  In  that  event,  and  in  any  case  in  which  the  amount  of 
the  total  tax  as  computed  above  is  the  same  as  or  greater  than 
the  tax  as  computed  in  the  ordinary  way,  the  tax  must  be  com- 
puted as  if  all  the  income  was  derived  from  the  use  of  capital.^^ 

Corporations.  All  corporations  except  those  expressly  exempt 
by  the  statute  are  subject  to  the  excess-profits  tax.  The  term 
"corporations"  includes  associations,  joint-stock  companies 
and  insurance  companies.^''  A  corporation  dissolved  prior  to 
February  25,  1919,  when  the  1918  Law  went  into  effect,  but 
which  was  in  receipt  of  income  after  January  1,  1918,  was  sub- 
ject to  the  tax  imposed  by  the  1918  Law  for  the  reason  that  the 
law  was  retroactive  to  the  first  day  of  January,  1918.'^'^ 

Exempt  Corporations.  Corporations  exempt  from  the  in- 
come tax  are  also  exempt  for  the  purpose  of  excess-profits  tax.^s 

45  Reg.  45,  Art.  742.     See  illustration  No.  5,  appendix  to  the  1920  edition. 

46  See  letter  from  treasury  department  dated  November  17,  1917;  W. 
T.   S.  1919,  11757. 

47  See  Chapter  10.  Every  corporation  was  taxable  under  the  1917  Law 
if  it  had  a  net  income  of  more  than  $3,000,  or  in  the  case  of  a  foreign 
corporation  of  $3,000  or  more  from  sources  within  the  United  States 
(Revenue  Act  of  1917,  §§  201,  202  and  203;  Reg.  41,  Art  10). 

48  Revenue  Act  of  1921,  §304;  Revenue  Act  of  1918,  §304  (a).  See 
Chapter  13  for  a  list  of  exempt  corporations  under  the  income  tax  law. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1027 

In  addition,  any  corporation  whose  net  income  for  the  full  tax- 
able year  of  twelve  months  is  less  than  $3,000  is  exempt  from 
this  tax.  If  the  taxable  period  is  less  than  twelve  months  the 
corporation  is  exempt  from  the  tax,  if  its  net  income  for  the 
period  is  less  than  the  same  proportion  of  $3,000  as  the  num- 
ber of  months  in  the  period  is  of  twelve  months,  any  fractional 
part  of  a  month  being  counted  as  the  number  of  days  in  such 
part  of  a  month  divided  by  30.-*^ 

Corporations  Deriving   Income   from    Government   Con- 
tracts.    Special  provisions  apply  to  corporations  deriving  in- 
come from   government  contracts  as  defined   in  the  following 
paragraph.     For  the  taxable  year  1919  and  thereafter  eveiy 
corporation  which  derives  in  such  year  a  net  income  of  more 
than  $10,000  from  any  government  contract  or  contracts  made 
between  April  6,  1917,  and  November  11,  1918,  both  dates  in- 
clusive, will  be  required  to  pay  the  tax  at  the  1918  rates  on  the 
net  income  attributable  to  such  government  contracts,  such  tax 
to  be  computed  according  to  the  rule  stated  in  a  subsequent 
paragraph.50     Corporations  which  have  no  prewar  period  and 
which  were  in  receipt  of  50  ^f  or  more  of  gross  income  during 
the  taxable  year  from  gains,  profits,  commissions  of  other  in- 
come derived  from  a  government  contract  or  contracts  made 
between  April  6,  1917,  and  November  11,  1918,  both  dates  in- 
clusive, will  be  limited  to  a  war-profits  credit  of  10%  of  the  in- 
vested capital  of  the  taxable  year,3i  although  other  corporations 
(other  than  corporations  a  majority  of  whose  stock  at  any  time 
during  the  taxable  year  is  owned  or  controlled,  directly  or  in- 
directly, by  a  corporation  which  was  in  existence   during  the 
whole  of  at  least  one  calendar  year  during  the  prewar  period) 
which  had  no  prewar  period  may  claim  a  higher  deduction  if 
the  earnings  of  similar  corporations  during  the  prewar  period 
were  more  than  10  7^  •    Corporations  50  7o  or  more  of  whose  gross 
income  for  the  taxable  year  consists  of  gains,  profits,  commis- 
sions or  other  income  derived  on  a  cost-plus  basis  from  a  govern- 
ment contract  or  contracts  made  between  April  6,   1917,  and 
November  11,  1918,  both  dates  inclusive,  will  not  be  allowed  to 
avail  themselves  of  the  remedial  provision  which  will  permit 
other  corpor^itions  to  be  assessed  on  the  basis  of  the  tax  paid  by 

49  Revenue  Act  of  1921,  §  304  (b)  ;  Revenue  Act  of  1918,  §  304   (b)  ;  Reg. 
45,  Art.  751. 

50  Revenue  Act  of  1921,   §301    (b)  ;   Revenue  Act  of    1918,    §301     (c). 
See  p.  1036  and  illustration  No.  4,  appendix  of  1920  edition. 

51  Revenue  Act  of  1918,  §311    (d). 


1028  FEDERAL  INCOME   TAX 

representative  corporations."-  It  is  to  be  noted  that  the  first 
two  provisions  refer  to  government  contracts  generally  while 
the  third  provision  is  limited  to  cost-plus  contracts.  A  corpora- 
tion organized  after  August  1,  1914,  and  not  a  successor  to  a 
then  existing  business,  50%  or  more  of  whose  gross  income  con- 
sists of  gains,  profits,  commissions  or  other  income  derived  from 
government  contracts  made  between  April  6,  1917,  and  Novem- 
ber 11,  1918,  both  dates  inclusive,  can  not  be  considered  as 
affiliated  with  any  other  corporation  for  the  purpose  of  making 
consolidated  returns.''^ 

If  in  1919  a  corporation  derives  a  profit  in  excess  of  $10,- 
000  from  government  contracts,  but  sustains  a  net  loss  on  other 
operations,  it  may  deduct  the  amount  of  such  loss  in  ascertaining 
its  net  income  subject  to  tax.  If  the  amount  of  the  excess- 
profits  credits  exceeds  the  company's  total  net  income  from  all 
sources  for  1919  no  tax  will  be  imposed  upon  the  portion  of  its 
net  income  for  that  year  which  was  derived  from  government 
contracts.^* 

Government  Contracts.  A  government  contract  is  defined 
in  the  law  to  be  (a)  a  contract  made  with  the  United  States, 
or  with  any  department,  bureau,  officer,  commission,  board,  or 
agency,  under  the  United  States  and  acting  in  its  behalf,  or  with 
any  agency  controlled  by  any  of  the  above  if  the  contract  is  for 
the  benefit  of  the  United  States,  or  (b)  a  subcontract  made  with 
a  contractor  performing  such  a  contract  if  the  products  or 
services  to  be  furnished  under  the  subcontract  are  for  the  benefit 
of  the  United  States.  The  term  "government  contract  or  con- 
tracts made  between  April  6,  1917,  and  November  11,  1918,  both 
dates  inclusive,"  when  applied  to  a  contract  of  the  kind  referred 
to  in  clause  (a)  of  this  paragraph,  includes  all  such  contracts 
which,  although  entered  into  during  such  period,  were  originally 
not  enforceable,  but  which  have  been  or  may  become  enforceable 
by  reason  of  subsequent  validation  in  pursuance  of  law.^^  The 
same  applies  to  procurement  orders  issued  after  November  11, 
1918,  in  confirmation  of  informal  orders  entered  into  prior  to 
November  12,  1918.^*^    The  term  "contract"  has  a  definite  com- 

52  Revenue  Act  of  1918,  §327   (d).     See  p.  1116. 

53  Revenue  Act  of  1918,  §240   (a).     See  p.  1132. 

54  O.  D.  532,  T.  B.  22-20-979.  Since  the  company's  net  income  included 
an  item  of  net  profit  from  government  contracts  in  excess  of  $10,000,  it 
w^ill  be  required  to  supply  fully  all  of  the  data  called  for  by  the  supporting 
schedules  of  form  1120-S. 

55  Revenue  Act  of  1918,  §1;  Revenue  Act  of  1921,  §200. 

56  0.   D.   394,   T.  B.   5-20-721. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1029 

mercial  meaning  and  is  broad  enough  to  include  any  reciprocal 
promise  or  engagement  whether  or  not  evidenced  by  a  formally 
executed  document.  It  may  be  either  oral  or  written,  and  a  con- 
tract entered  into  with  an  agent  is  binding  upon  the  principal. 
The  fact  that  a  formal  contract  was  executed  after  November 
11,  1918,  would  not  affect  the  status  of  the  original  contract  un- 
less such  contract  was  thereby  revoked  or  supplanted,  but  would 
be  further  evidence  of  the  contract  and  in  confirmation  of  it. 
The  fact  that  a  formally  executed  contract  bears  a  date  sub- 
sequent to  the  date  of  offer  and  acceptance,  if  that  be  the  case, 
will  not  change  this  conclusion.  It  is  held,  therefore,  that  the 
acceptance  of  an  award  by  an  agent  for  a  principal  constitutes 
a  government  contract  even  though  the  formal  contract  bears  a 
date  subsequent  to  November  11,  1918. •'''^  Contracts  with  the 
American  Red  Cross  are  considered  government  contracts.^^ 
The  term  ''government  contract"  includes  contracts  relating  to 
sales  of  standard  goods  and  services  at  open  market  prices  as 
well  as  those  of  a  special  nature,-''^  and  includes  contracts  made 
with  the  United  States,  even  though  not  connected  with  the 
prosecution  of  the  war.^o 

Amended  Government  Contracts.  A  government  contract 
entered  into  in  1917,  amended  as  to  some  of  its  provisions  in 
1918,  and  further  modified  in  1919,  is  in  effect  the  same  con- 
tract as  entered  into  in  1917  if  the  original  contract  has  not  been 
revoked  or  supplanted  by  a  new  contract.*"'! 

Contracts  Under  the  Naval  Appropriation  Acts.  Con- 
tracts entered  into  pursuant  to  the  Naval  Appropriation  Acts  of 
March  4,  1917,  and  July  1,  1918,  if  entered  into  between  April 
6,  1917,  and  November  11,  1918,  are  "government  contracts," 
even  though  these  acts  by  their  terms  made  obligatory  com- 
pliance with  all  orders  placed  by  the  President,  and  authorized 
the  President  to  take  immediate  possession  of  a  factory  upon 
failure  to  comply,  allowing  such  reasonable  compensation  as  he 
should  determine.  Such  contracts  are  not  to  be  placed  in  a 
category  different  from  other  contracts  merely  because  they 
were  given  under  the  authority  of  a  statute  providing  a  penalty 
for  failure  to  comply  therewith.^^ 

57  0.  D.  540,  T.  B.  24-20-993. 

58  0.  D.  261,  T.  B.  17-19-468. 

59  0.  916,  T.  B.  21-19-519. 

60  0.  D.  677,  T.  B.  41-20-1228. 

61  0.  D.  295,  T.  B.  24-19-557;  O.  D.  1063,  T.  B.  42-21-1867. 

62  O.  D.  477,  T.  B.  17-20-889. 


1030  FEDERAL  INCOME   TAX 

What  Are  Not  Government  Contracts.  Contracts  en- 
tered into  between  a  taxpayer  and  the  Knights  of  Columbus  or 
the  Young  Men's  Christian  Association  are  not  considered  gov- 
ernment contracts.^3  ^  contract  entered  into  on  May  1,  1918, 
with  the  Director-General  of  Railroads  for  certain  cars  for  the 
account,  use  and  benefit  of  various  railroads  under  federal  con- 
trol is  not  "a  government  contract"  for  the  reason  that  the  cars 
are  not  for  the  use  or  for  the  account  of  the  United  States.*^* 
Sales  of  goods  from  existing  stocks  where  delivery  is  immediate 
are  not  government  contracts/''' 

Subcontractors.  A  corporation  which  contracted  with  an- 
other corporation  to  manufacture  and  deliver  machinery  to  be 
used  in  manufacturing  ammunition,  but  did  not  produce  or  fur- 
nish ammunition  or  any  component  part  thereof,  nor  perform 
any  direct  service  in  connection  with  the  production  of  ammuni- 
tion manufactured  by  another  corporation  under  contract  for 
the  United  States  government,  is  not  a  subcontractor.*^*'  A  sub- 
contract entered  into  subsequent  to  November  11,  1918,  based 
on  a  principal  contract  to  furnish  a  product  for  the  benefit  of 
the  United  States  entered  into  between  April  6,  1917,  and 
November  11,  1918,  is  held  to  constitute  a  government  contract.^'^ 

Gold-Mining  Corporations.  In  the  case  of  a  corporation 
engaged  in  the  mining  of  gold,  that  portion  of  its  net  income 
derived  from  the  mining  of  gold  is  exempt  from  excess-profits 
tax.  The  tax  on  the  remaining  portion  of  its  net  income  is  com- 
puted in  the  following  manner:  The  tax  is  first  computed  on 
the  entire  net  income  but  only  such  proportion  thereof  as  the 
proportion  of  net  income  derived  from  sources  other  than  gold 
mining  bears  to  the  entire  net  income,  is  taken  to  be  the  amount 
due.68 

Allocation  of  Net  Income  to  Particular  Source.  In  the  case 
of  corporations  deriving  income  from  government  contracts, 
or  from  mining  or  from  personal  service  trade  or  business,  and 
in  any  other  cases  where  it  is  necessary  to  determine  the  por- 
tion of  the  net  income  derived  from  or  attributable  to  a  par- 
ticular source,  the  corporation  is  required  to  allocate  to  the 
gross  income  derived  from  such  source,  and  to  the  gross  in- 

63  0.  D.  261,  T.  B.  17-19-468. 

64  0.  D.  224,  T.  B.  12-19-394. 

65  0.  916,  T.  B.  21-19-519. 

66  0.  D.  359,  T.  B.  2-20-666. 

67  0.  D.  662,  T.  B.  38-20-1200. 

68  Revenue  Act  of  1921,  §304;  Revenue  Act  of  1918,  §304.  See  illus- 
tration No.  6,  appendix  to  1920  edition. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1031 

come  derived  from  each  other  source,  the  expenses,  losses  and 
other  deductions  properly  appertaining  thereto,  and  to  apply 
any  general  expenses,  losses  and  deductions  (which  can  not 
properly  be  otherwise  apportioned)  ratably  to  the  gross  income 
from  all  sources.  The  gross  income  derived  from  a  particular 
source,  less  the  deductions  properly  appertaining  thereto  and 
less  its  proportion  of  any  general  deductions,  is  the  net  income 
derived  from  such  source.*59  If  exact  determination  of  income 
arising  from  government  contracts  distinctly  from  other 
income  is  impossible,  an  approximation  based  on  the  proportion 
which  sales  to  the  government  bears  to  other  sales  should 
be  used  only  in  case  approximations  based  on  the  respective 
cost  and  selling  price  are  inapplicable.  The  approximation 
should  be  based  upon  the  allocation  of  costs  and  allocation  of 
selling  price,  in  the  most  accurate  manner  possible  from  avail- 
able records.  Amortization  is  not  to  be  charged  exclusively 
against  income  from  government  contracts,  and  selling  and 
administrative  expenses  not  applicable  to  the  government  con- 
tracts should  not  be  so  charged."*^  The  corporation  must  sub- 
mit with  its  return  a  statement  fully  explaining  the  manner  in 
which  such  expenses,  losses  and  deductions  were  allocated  or 
distributed. 

Advertising  Expenses.  Advertising  and  sales  promotion 
are  not  a  part  of  the  necessary  expenses  of  government  con- 
tracts, except  as  relating  to  such  contracts,  and  are  not  proper 
deductions  from  the  gross  income  derived  from  government 
sales.  Such  expenditures,  if  entered  into  on  a  large  scale  at  a 
time  when  the  government  was  doing  practically  no  commer- 
cial business,  may  be  treated  either  as  an  expense  of  the  year 
in  which  incurred  and  deducted  from  the  commercial  income 
only,  or  they  may  be  treated  as  deferred  items  in  the  balance 
sheet  and  set  up  as  good  will  thereon,  being  in  the  nature  of 
expenditures  for  the  building  up  of  future  business  and  not 
for  the  business  secured  during  the  taxable  year  in  which  such 
expenditures  were  incurred.'''^ 

Inventories  of  Government  Contract  Material.  In  so 
far  as  stock  purchased  for  government  contracts  is  used  or 
useful  for  commercial  purposes  no  separate  inventory  thereof 
need  be  made  for  government  contract  accounting,  such  inven- 

69  Reg.  45,  Art.  715. 

70  A.  R.  M.  1,  T.  B.  26-19-597.  See  paragraph  below  on  "Advertising 
Expenses." 

71  0.  D.  394,  T.  B.  5-20-721. 


1032  FEDERAL  INCOME   TAX 

tories  being  treated  as  commercial  inventories  in  the  ordinary 
course  at  the  close  of  the  taxable  year  1919,  If,  however,  a 
portion  of  such  goods  purchased  is  useful  only  for  government 
contracts  and  is  still  on  hand  at  the  close  of  the  taxable  year 
1919,  such  goods  should  be  inventoried  at  the  then  value  if 
lower  than  cost  and  assigned  to  the  government  contract  sec- 
tion of  the  income  statement  for  that  year.'^^ 

Taxable  Year.  The  term  "taxable  year*'  means  the  calendar 
year  or  the  fiscal  year  ending  during  such  calendar  year,  upon 
the  basis  of  which  net  income  is  computed  for  the  purpose  of 
the  income  tax.  The  first  taxable  year  under  the  Revenue  Act 
of  1918  was  the  calendar  year  1918,  or  any  fiscal  year  ending 
during  the  calendar  year  1918.  The  first  taxable  year  under 
the  Revenue  Act  of  1921  is  the  calendar  year  1921,  or  any  fiscal 
year  ending  during  the  calendar  year  1921. ''^ 

Fiscal  Year.  The  term  "fiscal  year"-  means  an  accounting 
period  of  twelve  months  ending  on  the  last  day  of  any  month 
other  than  December.'*'^  If  a  corporation  keeps  its  accounts  on 
the  basis  of  a  fiscal  year,  the  law  requires  that  it  report  its 
income  on  that  basis,  and  not  at  its  option  either  on  that  basis 
or  on  the  basis  of  the  calendar  year  as  was  the  rule  formerly."^ 

Prewar  Period.  The  term  "prewar  period"  means  the  calen- 
dar years  1911,  1912  and  1913,  or,  if  a  corporation  was  not  in 
existence  during  the  whole  of  such  period,  then  as  many  of 
such  years  during  the  whole  of  which  the  corporation  was  in 
existence.  Thus,  if  a  corporation  was  in  existence  during  the 
entire  year  1913,  that  year  becomes  its  prewar  period,  but  if 
in  existence  only  a  part  of  the  year  1913,  it  is  deemed  to  have 
no  prewar  period  and  becomes  taxable  under  the  provisions 
applying  to  corporations  formed  after  the  prewar  period."^' 

Statement  of  the  Tax.  The  tax  imposed  by  Title  III  of  the 
Revenue  Act  of  1921  is  in  lieu  of  the  tax  imposed  by  Title  III  of 
the  Revenue  Act  of  1918,  which  was  in  lieu  of  the  tax  imposed 

72  o.  D.  394,  T.  B.  5-20-721. 

73  Revenue  Act  of  1918,  §§300,  200;  Revenue  Act  of  1921,  §§300,  200. 

74  Revenue  Acts  of  1918  and  1921,  §§  300,  200. 

75  Revenue  Acts  of  1918  and  1921,  §§232,  212   (b)   and  200. 

76  Revenue  Act  of  1918,  §310;  Reg.  41,  Art  6.  Under  the  1917  Lav^^ 
the  earnings  of  the  pre-war  period  determined  the  amount  of  the  excess- 
profits  deduction,  between  the  limits  of  7%  and  9%  of  the  invested  cap- 
ital. Under  the  1918  Law  no  reference  was  made  to  the  pre-war  period 
in  ascertaining  the  excess-profits  credit,  since  that  credit  is  8%  of  the 
invested  capital  regardless  of  the  pre-war  earnings.  But  the  pre-war 
earnings  and  pre-war  invested  capital  were  used  in  computing  the  war- 
profits  credit  under  the  Revenue  Act  of  1918. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1033 

by  Title  II  of  the  Revenue  Act  of  1917,  but  in  addition  to  the 
other  taxes  imposed  by  the  Revenue  Act  of  1918.  The  excess- 
profits  tax  imposed  by  the  present  law  is  likewise  m  addition 
to  the  other  taxes  imposed  by  the  Revenue  Act  of  1921."  The 
war-profits  and  excess-profits  tax  is  imposed  upon  the  net  income 
of  every  corporation,  whether  or  not  derived  from  a  business 
or  trade  or  from  investment  or  otherwise.^s  Briefly  stated, 
the  excess-profits  tax  is  computed  on  the  entire  net  income  of 
the  taxable  year  after  deducting  the  excess-profits  credit  at  the 
rates  specified  in  the  statute.  For  the  taxable  year  1918  the 
war-profits  tax  was  computed  on  the  entire  net  income  m  excess 
of  the  war-profits  credit  at  the  rate  specified  m  the  act,  and 
whichever  of  the  two  taxes  (the  excess-profits  or  war-profits) 
was  the  greater  was  assessed.  The  rates  of  tax,  net  income,  in- 
vested capital,  excess-profits  credit  and  war-profits  credit  are 
more  fully  discussed  in  the  following  paragraphs.  ^^    ,^,^ 

Rates  of  Tax  for  1917.  The  rates  of  tax  imposed  by  the  1917 
Law  are  given  in  the  introductory  paragraph  of  this  chapter.' 
The  statute  provided  for  the  taxation  of  ^he  amount  of  the  net 
income  in  excess  of  the  deduction"  at  twenty  per  centum.^- 
This  phrase  was  held  by  the  Commissioner  to  .^lean  that  the 
first  of  the  graduated  percentages  of  invested  capital  (fifteen  per 
centum)  was  first  to  be  ascertained  and  that  the  deduction  was 
to  be  made  from  the  amount  thereof;  and  if  the  deduction 
was  not  in  excess  of  fifteen  per  centum  of  the  invested  capital  the 
difference  between  the  amount  of  the  deduction  and  the  fifteen 
per  centum  of  invested  capital  was  to  be  taxed  at  twenty  per  cen- 
tum This  construction  has  been  sustained  by  the  court  m  pref- 
erence to  the  construction  that  the  deduction  was  to  be  made 
from  the  whole  of  the  net  income,  and  that  out  of  the  balance  of 

77  Revenue  Act  of  1921,  §  301  (a)  ;  Revenue  Act  of  1918>  §  301  (a)- 

78  See  Revenue  Act  of  1918,  §§213  (a),  233  (a).  Under  the  ISIJ  Law 
in  the  case  of  a  partnership  or  corporation,  all  income  was  deemed  to  be 
received  from  its  trade  or  business,  and  the  terms  'trade,  busmess 
and  "trade  or  business"  included  all  sources  of  income  (Reg  41,  Art.  i  ■ 
All  trades  or  businesses  engaged  in  by  a  corporation  or  P^^'^nership  weie 
treated  as  a  single  trade  or  business,  and  its  entire  mcome  was  demed 
to  be  of  the  class  of  its  principal  trade  or  business  (Reg   41,  Ait.  14). 

79  Some  concerns  were  taxable  at  a  flat  rate  of  8%.  (See  p.  1016.)  As 
to  the  rates  prescribed  for  the  individual  or  concern  not  so  taxable  see 
Reg  41  Arts  14,  16,  17.  As  to  the  computation  of  the  tax  m  the  case  of 
a  partnership  oi'  corporation  or  partnership  with  a  fi^c-l  je-  -dmg 
fn  1917,  see  Reg.  41,  Art  19;  and  as  to  the  computation  of  the  tax  for  a 
period  of  less  than  12  months,  see  Reg.  41,  Art.  20. 

80  See  Revenue  Act  of  1917,  §  201. 


1034  FEDERAL  INCOME  TAX 

net  income  remaining  an  amount  not  in  excess  of  fifteen  per 
centum  of  the  invested  capital  was  to  be  taxed  at  twenty  per 
centum.81 

Rates  of  Tax  for  1918.  The  rates  of  tax  are  stated  in  the 
form  of  three  brackets  as  follows :  ^-  First  bracket,  30  %  of  the 
amount  of  net  income  in  excess  of  the  excess-profits  credit  and 
not  in  excess  of  20%  of  the  invested  capital.  If  the  excess- 
profits  credit  equalled  or  exceeded  20%  of  the  invested  capital, 
no  tax  was  imposed  under  this  bracket.  The  second  bracket 
provided  a  rate  of  65%  of  the  amount  of  net  income  in  excess 
of  20%  of  the  invested  capital.  If,  however,  the  excess-profits 
credit  exceeded  20%  of  the  invested  capital,  this  rate  was  ap- 
plied only  to  the  amount  of  net  income  in  excess  of  such 
excess-profits  credit.s^  The  third  bracket  provided  that  there 
should  be  added  to  the  tax  computed  under  the  first  and  second 
brackets  the  sum,  if  any,  by  which  80%  of  the  amount  of  net 
income  in  excess  of  the  tvar-profits  credit  exceeded  the  amount 
of  tax  computed  under  the  first  and  second  brackets.  As  a 
practical  matter,  if  80%.  of  the  amount  of  net  income  in  excess 
of  the  war-profits  credit  was  greater  than  the  tax  computed 
under  the  first  and  second  brackets,  the  80%  tax  became  the 
tax  due  from  the  corporation  and  the  computation  under  the 
first  and  second  brackets  might  be  disregarded.^^ 

Rates  of  Tax  for  1919,  1920  and  1921.  In  the  case  of  all 
corporations  other  than  those  referred  to  in  the  following  para- 
graphs, the  rates  for  1919  and  subsequent  years  computed  under 
the  first  bracket  as  above  indicated  are  20%  instead  of  30% 
and  under  the  second  bracket  are  40%  instead  of  65%.  No  tax 
is  imposed  under  the  third  bracket.^^ 

SlEhret  Magnesia  Co.  v.  Lederer,  273  Fed.  689;  T.  D.  3200,  T.  B.  32- 
21-1764;  Greenport  Basin  Co.  v.  U.  S.,  269  Fed.  58;  T.  D.  3137,  T.  B.  14- 
21-1556. 

82  Revenue  Act  of  1918,  §301    (a), 

83  Revenue  Act  of  1918,  §301  (d).  See  illustration  No.  2,  appendix  to 
1920  edition. 

84  This  device  of  adding  the  excess  amount  of  the  war-profits  tax  over 
the  excess-profits  tax  to  such  excess-profits  tax  was  invented  by  the  senate 
to  overcome  the  objection  to  the  provision  in  the  bill  as  originally  drafted, 
which  expressly  provided  for  an  alternative  excess-profits  or  war-profits 
tax,  the  larger  of  the  two  being  the  amount  assessed.  The  change  made  by 
the  Senate  did  not  in  substance  change  the  tax  and  it  was  still  a  tax  com- 
puted by  two  alternative  methods,  the  one  productive  of  the  greater  amount 
of  revenue  being  applied  to  the  taxpayer. 

85  Revenue  Act  of  1918,  §  301  (b)  ;  Revenue  Act  of  1921,  §  301.  See 
illustration  No.  1,  appendix  to  1920  edition. 


WAR-PROFITS  AND  EXCESS-PROFITS   TAX  1035 

Fiscal  Year  Ending  in  1919.  If  a  corporation  makes  a  return 
for  a  fiscal  year  beginning  in  1918  and  ending  in  1919  the  tax 
for  such  fiscal  year  is  determined  as  follows:  The  amount  of 
tax  for  the  entire  fiscal  year  computed  at  the  1918  rates  is  first 
determined  and  such  proportion  thereof  as  the  part  of  the 
fiscal  year  falling  in  1918  bears  to  the  entire  fiscal  year  is 
assessed  as  a  portion  of  the  tax.  Similarly  the  1919  rates  are 
applied  to  the  entire  net  income  for  the  fiscal  year  and  such 
portion  assessed  as  the  proportion  of  the  fiscal  year  in  1919  bears 
to  the  full  fiscal  year.^"  The  sum  of  the  two  portions  thus 
ascertained  is  the  tax  for  the  fiscal  year. 

Fiscal  Year  Ending  in  1921.  Since  the  excess-profits  tax  is 
imposed  upon  the  net  income  as  computed  for  the  purpose  of  the 
income  tax  and  the  Revenue  Acts  of  1918  and  1921  contain  dif- 
ferent provisions  regarding  what  constitutes  gross  income  and 
allowable  deductions,  it  is  necessary  to  provide  a  special  rule 
for  the  computation  of  the  excess-profits  tax  of  a  corporation 
(other  than  a  personal  service  corporation)  making  a  return  for 
the  fiscal  year  beginning  in  1920  and  ending  in  1921.  The  tax 
of  such  a  corporation  for  the  taxable  year  1920  consists  of  the 
sum  of  (1)  the  same  proportion  of  the  tax  for  the  entire  period 
computed  under  the  Revenue  Act  of  1918  which  the  portion  of 
such  period  falling  within  the  calendar  year  1920  is  of  the  entire 
period,  and  (2)  the  same  proportion  of  the  tax  for  the  entire 
period  computed  under  the  Revenue  Act  of  1921  which  the  por- 
tion of  such  period  falling  within  the  calendar  year  1921  is  of 
the  entire  period.  Any  amount  paid  on  account  of  the  tax  im- 
posed for  such  taxable  year  by  the  Revenue  Act  of  1918  will 
be  credited  towards  the  payment  of  the  tax  as  above  computed, 

86  Revenue  Act  of  1918,  §  335  (b)  ;  illustration  No.  8,  appendix  to  1920 
edition.  The  same  principles  governed  the  computation  of  the  tax  for  a 
corporation  with  a  fiscal  year  beginning  in  1917  and  ending  in  1918. 
(Revenue  Act  of  1918,  §335.)  Any  amount  paid  on  account  of  the  tax 
imposed  for  such  fiscal  year  by  the  Revenue  Act  of  1917,  was  to  be  credited 
toward  the  payment  of  the  tax  so  computed,  and  if  the  amount  so  paid 
exceeded  the  amount  of  tax  so  computed,  the  excess  was  to  be  expedited  or 
refunded  to  the  corporation.  In  cases  in  which  corporations  whose  fiscal 
years  ended  in  1918,  filed  a  return  and  paid  the  tax  for  the  full  fiscal  year 
under  the  provisions  of  the  Revenue  Act  of  1917,  the  tax  was  to  be  re- 
computed in  the  manner  indicated  and  from  the  amount  so  found  to  be 
due  there  was  deducted  the  amount  of  excess-profits  tax  paid  on  the  basis 
of  the  full  fiscal  year.  It  followed  that  the  income  tax  for  the  same  period 
must  also  be  computed  according  to  the  rule  in  §  205  (a)  of  the  1918  Law. 
after  having  deducted  the  excess-profits  taxes  as  recomputed. 


1036  FEDERAL  INCOME   TAX 

and  if  in  excess  of  such  tax  as  above  computed,  such  excess  will 
be  credited  or  refunded  to  the  taxpayer.'^'' 

Fiscal  Year  Ending  in  1922.  Except  in  the  case  of  a  personal 
service  corporation  the  Revenue  Act  of  1921  makes  provision 
for  the  case  of  a  corporation  making  a  return  for  a  fiscal  year 
ending  in  1922  for  the  reason  that  the  excess-profits  tax  is 
repealed  as  of  December  31,  1921.  The  war-profits  and  excess- 
profits  taxes  for  the  portion  of  such  fiscal  year  falling  within 
the  calendar  year  1921  consists  of  an  amount  equivalent  to  the 
same  proportion  of  the  tax  for  the  entire  period  computed  under 
Title  III  of  the  Revenue  Act  of  1921  which  the  portion  of  such 
period  falling  within  the  calendar  year  1921  is  of  the  entire 
period.s^ 

Corporations  Deriving  Income  From  Government  Contracts. 
For  the  taxable  year  1919,  and  each  taxable  year  thereafter, 
the  rates  to  be  applied  to  corporations  which  derive  in  such 
year  a  net  income  of  more  than  $10,000  from  any  government 
contract  or  contracts  made  between  April  6,  1917,  and  November 
11,  1918,  both  dates  inclusive,  are  determined  as  follows:  (1)  the 
tax  will  be  computed  at  the  1918  rates  on  the  entire  net  income 
of  the  corporation,  in  the  computation  of  which  the  excess-profits 
credit  and  war-profits  credit  applicable  to  the  taxable  year  S9  will 
be  used,  and  (2)  the  tax  will  also  be  computed  on  the  entire  net 
income  of  the  taxable  year  at  the  1919  rates.  The  sum  of  (a) 
such  portion  of  the  tax  computed  under  (1)  as  the  net  income 
attributable  to  such  government  contract  or  contracts  bears  to 
the  entire  net  income  and  (b)  such  portion  of  the  tax  com- 
puted under  (2)  as  the  part  of  net  income  not  attributable  to 
such  government  contract  or  contracts  bears  to  the  entire  in- 
come will  be  the  amount  to  be  paid  by  the  corporation.^"  The 
method  of  computing  the  tax  is  illustrated  below.^^  In  the  case 
of  a  fiscal  year  corporation  this  computation  should  be  based 

87  Revenue  Act  of  1921,  §335  (a).  This  provision  is  in  accordance 
with  the  principles  governing  computation  of  taxes  in  the  case  of  a  cor- 
poration with  a  fiscal  year  ending  in  1918  and  in  1919  (See  Revenue  Act 
of  1918,  §335). 

88  Revenue  Act  of  1921,  §335  (b).  Since  personal  service  corporations 
are  exempt  from  excess-profits  tax  of  the  year  1921,  and  are  abolished  as 
of  the  end  of  that  year,  no  provision  is  necessary  for  the  computation  of 
the  tax  of  personal  service  corporations  with  fiscal  years  ending  in  1922. 

89  0.  D.  378,  T.  B.  3-20-695. 

90  Revenue  Act  of  1918,  §301  (c)  ;  Revenue  Act  of  1921,  §301  (b). 
See  p.  1030  for  rule  as  to  allocation  of  income. 

91  See  illustration  No.  4,  appendix  to  1920  edition. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1037 

on  the  entire  net  income  for  the  fiscal  year  even  though  no  part 
of  the  income  from  government  contracts  was  derived  after  Jan- 
uary 1,  1919.  It  is  a  fundamental  principle  that  no  adjustment 
will  be  made  even  though  it  can  be  definitely  shown  what  pro- 
portion of  the  income  was  derived  during  each  portion  of  the 
fiscal  year.*^-  If  a  corporation  has  a  net  income  from  a  govern- 
ment contract  and  sustains  a  net  loss  from  other  operations, 
in  the  submission  of  a  fiscal  year  return  for  a  period  ending 
in  1919  the  loss  may  be  deducted  from  the  income  from  the 
government  contract.^^ 

Maximum  Limit  of* Tax.  The  Revenue  Act  of  1918  for  the 
first  time  fixes  a  maximum  limit  of  tax.  In  no  case  will  the  tax 
imposed  on  the  net  income  for  the  taxaWe  year  1919  or  subse- 
quent years,  be  more  than  20%  of  the  amount  of  net  income 
in  excess  of  $3,000  and  not  in  excess  of  $20,000,  plus  40  ^c  of 
the  amount  of  net  income  in  excess  of  $20,000.  On  income  of 
the  year  1918  the  maximum  was  80%  of  the  amount  of  net 
income  in  excess  of  $3,000  and  not  in  excess  of  $20,000,  plus 
80%  of  the  amount  of  net  income  in  excess  of  $20,000.  In  the 
case  of  corporations  deriving  more  than  $10,000  of  net  income 
from  government  contracts  in  1919  or  subsequent  years,  these 
limits  will  apply  to  the  respective  amounts  of  tax  computed 
under  the  1918  and  1919  rates,  by  reason  of  the  provision  tax- 
ing 1919  income  from  government  contracts  at  1918  rates. 
Thus,  on  that  part  of  the  net  income  derived  from  government 
contracts  the  maximum  limit  of  30%  and  80%  will  apply  while 
to  that  not  derived  from  government  contracts  the  maximum 
limit  of  20%  and  40%  will  apply.  This  limit  is  not  intended 
to  increase  the  tax  but  to  reduce  it  in  cases  where  the  tax 
calculated  in  the  ordinary  manner  is  greater  than  the  maxi- 
mum computed  according  to  the  rule  stated  in  this  paragraph.'-^^ 
The  limitation  will  generally  operate  only  in  the  case  of  corpo- 
rations with  very  small  invested  capitaL^"^     It  is  applied  to  the 

92  T.  B.  M.  4,  T.  B.  1-19-113. 

93  A.  R.  M.   5,   T.   B.  26-19-620. 

94  Revenue  Act  of  1918,  §302;  Revenue  Act  of  1921,  §302.  See  illus- 
tration in  Art.  733  of  Reg.  45,  as  amended  by  T.  D.  3245,  T.  B.  48-21-1953. 
In  calculating  this  maximum  limit  it  is  to  be  noted  that  foreign  corporations 
receive  the  benefit  of  a  specific  exemption  of  $3,000,  even  though  they  are 
not  accorded  such  exemption  ordinarily  (Revenue  Act  of  1918,  §312;  O. 
D.  402,  T.  B.  6-20-735).  This  conclusion  is  rendered  inescapable  by  the 
use  of  the  words  "in  no  case"  in  §  302. 

93  An  invested  capital  of  less  than  $71,428.58. 


1038  FEDERAL  INCOME   TAX 

consolidated  net  income  of  affiliated  corporations  and  may  not 
be  construed  to  apply  separately  to  the  net  income  of  each  unit 
included  in  the  return.''*^ 

Limitation  When  Return  for  Fractional  Part  of  Year. 
When  a  return  is  rendered  for  a  fractional  part  of  a  year,  the 
limitation  is  to  be  computed  in  the  same  manner  as  if  the  period 
covered  by  the  return  were  a  full  taxable  year.^*" 

Sale  of  Mines,  Oil  or  Gas  Wells.  In  the  case  of  a  bona  fide 
sale  of  mines,  oil  or  gas  wells,  or  any  interest  therein,  where 
the  principal  value  of  the  property  has  been  demonstrated  by 
prospecting  or  exploration  and  discovery  work  done  by  the  tax- 
payer, the  portion  of  the  war-profits  and  excess-profits  tax  at- 
tributable to  such  sale  cannot  exceed  20%  of  the  selling  price  of 
such  property  or  interest.^^  To  apply  this  provision  to  a  par- 
ticular case  the  corporation  should  compute  the  war-profits 
and  excess-profits  taxes  in  the  ordinary  way  upon  its  net  in- 
come, including  its  net  income  from  any  such  sale.  The  pro- 
portion of  the  total  tax  indicated  by  the  ratio  which  the  tax- 
payer's net  income  from  the  sale  of  the  property,  allocated  to 
such  source  by  the  proper  method,-'^  bears  to  its  total  net 
income  is  the  portion  of  the  tax  attributable  to  such  sale,  and 
if  it  exceeds  20%  of  the  selling  price  of  the  property,  such 
portion  of  the  tax  will  be  reduced  to  20%  of  such  selling  price.^^*' 
The  fact  that  a  company  is  entitled  to  the  benefit  of  this 
limitation  will  not  disqualify  it  for  special  assessment  by  refer- 
ence to  representative  corporations,^*^!  neither  can  the  fact  that 
it  is  entitled  to  the  benefit  of  the  limitation  be  used  as  a  basis 
for  claiming  special  assessment.  If  a  corporation  falls  within 
the  class  specified  in  the  statute  as  being  entitled  to  special 
assessment,  the  tax  will  be  determined  by  this  method.     The 

96  0.  D.  80,  T.  B.  1-19-115. 

97  Reg.  45,  Arts.  732,  733,  as  amended  by  T.  D.  3245,  T.  B.  48-21-1953. 
The  latter  article  gives  an  illustration  of  this  computation. 

98  Revenue  Act  of  1921,  §337;  Revenue  Act  of  1918,  §337.  This  limi- 
tation cannot  be  applied  to  the  assessment  of  1917  taxes  (T.  B.  M.  60, 
T.   B.  15-19-454). 

99  See  Reg.  45,  Art.  715.    See  p.  1030. 

100  Reg.  45,  Art.  971.  See  illustration  No.  7,  appendix  to  1920  edition. 
It  virill  be  noted  that  the  government  ruling  requires  the  total  tax  to  be 
apportioned  for  the  purpose  of  applying  the  limitation.  The  statute  pro- 
vides that  the  "portion"  of  the  tax  attributable  to  such  sale  shall  not 
exceed  20%  of  the  selling  price,  and  the  difference  between  the  amount  of 
tax  computed  on  the  total  income  and  the  amount  computed  on  the  income 
excluding  the  profit  on  the  sale  seems  intended  by  the  lavi^  to  be  the  amount 
which  shall  not  exceed  20%  of  the  selling  price. 

101  See  Revenue  Acts  of  1918   and   1921,  §§  327-8. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1039 

effect  of  the  limitation  is  to  limit  the  amount  of  tax  attributable 
to  the  profit  made  on  the  sale  of  mines,  oil  and  gas  wells  dis- 
covered by  the  taxpayer  and  can  only  be  applied  after  the  tax 
computed  on  such  profit  has  been  computed  without  the  bene- 
fit of  this  provision.102 

Invested  Capital  for  1917.  The  invested  capital  of  a  tax- 
payer for  1917  was  determined  in  large  part  in  the  same  man- 
ner as  invested  capital  for  1918,  as  outlined  in  the  paragraphs 
following.  Where  differences  as  to  the  method  of  computing 
invested  capital  existed,  they  are  pointed  out  in  connection  with 
the  statement  of  the  1918  rule.i^s  The  chief  difference  between 
the  two  statutes  was  occasioned  by  the  fact  that  the  1917  Law 
taxed  individuals  and  partnerships  while  the  1918  Law  and  the 
present  law  does  not.  The  invested  capital  of  partnerships  was 
computed,  however,  under  the  1917  Law  under  the  same  regula- 
tions which  governed  the  computation  of  the  invested  capital 
of  corporations. 10^  Rulings  particularly  applicable  to  the  com- 
putation of  invested  capital  of  individuals  under  the  1917  Law 
are  indicated  below. 

The  invested  capital  of  individuals  consisted  of  the  total  of: 
(1)  actual  cash  paid  into  the  trade  or  business;  (2)  tangible 
property  paid  into  the  trade  or  business,  and  (3)  intangible 
property  paid  into  the  trade  or  business.i^s  Subject  to  the  mak- 
ing of  an  adequate  allowance  for  depreciation,  obsolescence  and 
depletion,  tangible  property  was  valued  according  to  the  follow- 
ing rules: 

In  the  case  of  tangible  property  purchased  with  cash,  the 
valuation  will  be  based  upon  the  cost  (estimated  if  not  known) 
in  cash  at  the  time  purchased. 

In  the  case  of  tangible  property  paid  in  as  such  prior  to  Janu- 
ary 1,  1914,  the  valuation  will  be  based  upon  its  actual  cash 
value  as  of  that  date.  Adequate  evidence  of  such  value  must 
be  furnished  by  the  taxpayer. 

102  0.  D.  395,  T.  B.  5-20-723;  T.  B.  M.  60,  T.  B.  15-19-454. 

103  Cf.  Revenue  Act  of  1918,  §326;  Revenue  Act  of  1917,  §207. 

104  Reg.  41,  Arts.  53,  65.  See  Revenue  Act  of  1917,  §  207.  It  has  been 
held  under  the  Revenue  Act  of  1917  that  stocks  owned  by  individual  part- 
ners could  not  be  recognized  as  invested  capital  of  the  partnership  even 
though  purchased  from  profits  distributed  by  the  partnership  and  pur- 
chased for  the  purpose  of  advancing  the  interests  of  the  partnership. 
(A.  R.  R.  17,  T.  B.  3-20-696;  A.  R.  R.  619,  T.  B.  39-21-1848.) 

105  Reg.  41,  Art.  66. 


1040  FEDERAL   INCOME  TAX 

In  the  case  of  tangible  property  paid  in  on  or  after  January 
1,  1914,  the  valuation  will  be  based  upon  its  actual  cash  value 
at  the  time  of  payment.io^ 

The  20%  limitation  based  upon  capital  was,  of  course,  not 
applied  to  individuals  in  the  case  of  intangible  property.  Such 
property  might  be  included  in  invested  capital  at  a  value  not 
exceeding  the  cash  paid  therefor,  or  the  cash  value  at  the  time 
of  payment  of  tangible  property  paid  therefor,  but  only  if 
bona  fide  payment  was  specifically  made  therefor.^^i 

Profits  earned  during  the  taxable  year  might  be  included  in 
the  invested  capital  of  individuals,  and  were  deemed  to  have 
arisen  ratably  throughout  the  year.  The  capital  at  the  begin- 
ning of  the  year  was  increased  by  the  total  amount  of  such 
profits  remaining  in  the  trade  or  business  averaged  monthly 
over  the  year.^^s 

Where  an  individual  kept  books  of  account,  his  invested  capital 
was  found  in  his  capital  account  (under  whatever  name  it  might 
be  called)  after  making  therein  any  required  adjustments  or 
corrections,  provided  the  assets  other  than  those  not  allowed 
to  be  included  equaled  or  exceeded  the  amount  of  such  capital 
account.  Otherwise  the  invested  capital  was  the  amount  of 
such  assets. 

Where  an  individual  did  not  keep  books  of  account  he  was 
required  to  prepare  and  preserve  a  statement  as  at  the  begin- 
ning of  the  taxable  year  and  as  at  the  end  of  the  taxable  year, 
showing  in  full  all  his  assets  valued  in  accordance  with  the  rules 
stated  above,  and  all  his  liabilities.  The  excess  of  such  assets 
over  such  liabilities  at  the  beginning  of  the  year  and  again  at 
the  end  of  the  year  constituted  the  invested  capital  of  the  indi- 
vidual on  those  dates,  respectively,  provided  that  in  each  case  the 
assets  other  than  those  not  allowed  to  be  included  equaled  or  ex- 
ceeded the  amount  of  such  excess.  Otherwise,  the  invested  capi- 
tal was  the  amount  of  such  assets.  The  amount  of  the  difference 
between  the  capital  thus  shown  as  at  the  beginning  of  the  year 
and  at  the  end  of  the  year,  in  the  absence  of  evidence  to  the 
contrary,  was  deemed  to  have  arisen  ratably  throughout  the 
year,  and  the  capital  at  the  beginning  of  the  year  was  increased 

106  Reg.  41,  Art.  67.  The  presumption  was  that  tangible  assets  employed 
in  the  trade  or  business  were  acquired  with  cash  derived  from  earnings, 
but  the  taxpayer  was  entitled  to  show  that  such  assets  were  paid  in  as 
tangible  property. 

107  Reg.  41,  Art.  68. 

108  Reg.  41,  Art.  69. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1041 

or  decreased,  as  the  case  might  be,  by  such  amount  averaged 
monthly  over  the  year. 

If  an  individual  was  engaged  in  more  than  one  trade  or  busi- 
ness having  invested  capital,  then  his  invested  capital  for  the 
purposes  of  computing  the  deduction  and  applying  the  rates 
of  taxation  was  determined  by  taking  the  total  invested  capital 
of  all  such  trades  or  businesses.ios 

Value  of  Property  as  of  January  1,  1914.  Under  the  1917 
Law  the  value  of  tangible  property  as  of  January  1,  1914,  could 
be  taken  in  the  case  where  such  property  had  been  paid  in  for 
stock  or  shares  prior  to  that  date,  but  not  in  excess  of  the  par 
value  of  the  stock  or  shares.  No  such  provision  appears  in  the 
1918  Law  and  the  value  must  in  all  cases  be  determined  as  of  the 
time  of  acquisition. 110 

Invested  Capital  for  1918,  1919,  1920  and  1921.iii  'Invested 
capital"  is  the  value  of  the  capital  and  surplus  of  the  taxpayer 
determined  in  accordance  with  rules  laid  down  in  the  statute. 
It  does  not  mean  the  par  value  of  the  issued  and  outstanding 
stock  or  the  value  of  the  capital  stock  as  fixed  by  the  treasury 
department  for  the  purpose  of  the  capital  stock  tax.  It  does 
not  mean  the  book  value  of  the  assets,  or  the  present  net  worth 
of  the  assets  as  shown  by  an  appraisal  or  in  any  other  manner.i^^ 
Generally  speaking,  it  means  the  amount  of  cash  or  the  cash 
value  of  the  property  contributed  to  the  corporation  by  the  stock- 
holders and  the  amount  of  earnings  of  the  corporation  which 
have  been  left  in  the  business.  Money  or  other  property  bor- 
rowed is  not  invested  capital.ii^  The  cash  value  of  the  prop- 
erty contributed  by  the  stockholders  to  the  corporation  may  in 
some  cases  exceed  the  value  allowed  by  the  law  for  purposes  of 
invested  capital,  since  the  restrictive  rules  of  the  statute  limit 
the  inclusion  in  invested  capital  of  capital  stock  representing 
intangible  property.  Further,  capital  may  be  contributed  to  the 
business  of  a  corporation  in  a  form  originally  permitting  its  in- 
clusion in  invested  capital  at  its  full  value  (cash,  for  instance) 

109  Reg.  41,  Art.  70.  The  terms  "assets"  and  "liabilities",  as  vised  above, 
related  only  to  assets  or  liabilities  of  the  ti'ade  or  business. 

no  Cf.  Revenue  Act  of  1917,  §  207  and  Revenue  Act  of  1918,  §  326.  See 
Reg.  41,  Art.  55;  O.  D.  89,  T.  B.  1-19-128;  A.  R.  R.  376,  T.  B.  5-21-1423; 
A.  R.  R.  337,  T.  B.  50-20-1347;  O.  D.  1097,  T.  B.  45-21-1916. 

111  As  to  affiliated  corporations  see  p.  1132. 

112  Reg.  45,  Art.  831.  See  La  Belle  Iron  Works  v.  U.  S.,  41  Sup.  Ct. 
Rep.  528,  65  L.  Ed.  604;  T.  B.  23-21-1680.  This  case  is  fully  reviev(red  on 
p.  1087.    See  also  Reg.  41,  Art,  42. 

113  Reg.  45,  Art.  831. 


1042  FEDERAL  INCOME  TAX 

but  may  lose  some  of  its  value  for  purposes  of  invested  capital 
by  being  invested  in  stocks  of  other  corporations  (the  dividends 
of  which  are  not  included  in  net  income)  ^^^  or  by  being  invested 
in  state,  municipal  or  other  bonds,  the  interest  on  which  is 
exempt  from  income  tax.  In  this  respect  the  law  makes  an 
exception  of  bonds  or  other  obligations  of  the  United  States, 
which  may  be  included  in  invested  capital  although  the  inter- 
est therefrom  may  in  some  cases  be  excluded  from  gross 
income.113  Surplus  and  undivided  profits  are  recognized  as  part 
of  invested  capital,  if  they  represent  assets  actually  existing 
and  owned  by  the  corporation.^^  Rentals  on  the  property  of  a 
corporation  charged  while  the  property  is  used  for  construction 
work  of  the  corporation  are  mere  bookkeeping  entries  and  may 
not  be  included  in  invested  capital.i^'^ 

The  amount  of  taxes  withheld  at  the  source  to  be  later  paid 
over  to  the  government  is  not  an  asset  of  the  withholding 
agent  and  cannot  be  included  in  invested  capital.^is  The  surplus 
and  undivided  profits  accounts  may  be  reduced  below  the 
amounts  at  which  they  are  carried  on  the  books,  if  full  recogni- 
tion has  not  been  given  by  the  corporation  to  expenses  incurred 
and  losses  sustained  from  the  original  organization  down  to 
the  taxable  year,  including  among  such  expenses  and  losses 
a  reasonable  allowance  for  depletion,  depreciation  or  obsolescence 
of  property  originally  acquired  for  cash  or  stock,  or  in  any  other 
manner.  The  value  of  the  assets  of  the  company  are  required 
in  all  instances  to  be  taken  as  of  the  time  of  acquisition,  although 
they  may  have  increased  in  value  since  that  date. 

In  a  case  in  which  the  charter  of  a  Georgia  corporation  ex- 
pired by  limitation  and  some  time  after  its  expiration,  the  fact 
being  called  to  the  stockholders'  attention,  a  new  corporation 
was  organized,  which  new  corporation  issued  new  shares  of 
capital  stock  in  exchange  for  all  the  property  and  assets  and  all 
the  interest  of  the  stockholders  in  the  old  company,  it  has 
been  held  under  the  Georgia  statutes  that  for  purposes  of  in- 

114  Reg.  45,  Art.  815. 

115  The  purpose  of  permitting  bonds  of  the  United  States  to  be  included 
in  invested  capital,  although  the  interest  may  be  excluded  in  whole  or  in 
part  from  gross  income,  is  to  provide  an  incentive  to  invest  in  and  hold 
such  bonds. 

116  Reg.  41,  Art.  42.  A  corporation  may  not  report  its  income  on  a  cash 
receipts  and  disbursements  basis  and  compute  its  invested  capital  on  an 
accrual  basis   (0.  D.  1007,  T.  B.  34-21-1787). 

117  0.  D.  811,  T.  B.  7-21-1453;  O.  D.  1061,  T.  B.  41-21-1862. 

118  O.  D.  202,  T.  B.  9-19-350. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1043 

vested  capital  a  new  and  distinct  corporation  was  created,  the 
invested  capital  of  which  should  be  computed  accordingly. 'i'' 

The  fair  market  value  of  the  assets  as  of  March  1,  1913,  has 
no  bearing  on  invested  capital.^-'^  If  values  have  been  marked 
up  on  the  books  of  the  corporation  a  deduction  must  be  made 
in  respect  of  such  book  appreciation.  Full  effect  must  also  be 
given  to  any  liquidation  of  original  capital  at  any  time  prior 
to  or  during  the  taxable  year.i^i  j^  the  case  of  a  reorganization, 
consolidation  or  change  of  ownership  of  a  trade  or  business 
after  January  1,  1911,  the  invested  capital  of  the  predecessor 
for  the  prewar  period  is  deemed  to  be  the  invested  capital  for 
such  period  of  the  new  organization  now  engaged  in  the  busi- 
ness. In  the  case  of  a  reorganization,  consolidation  or  change 
of  ownership  of  a  trade  or  business,  or  change  of  ownership  of 
property  after  March  3,  1917  (if  50%  or  more  of  the  interest  or 
control  remains  in  the  same  persons),  the  assets  so  transferred 
will  not  be  allowed  a  higher  valuation  in  determining  invested 
capital  than  under  the  previous  ownership.  If  tlie  previous 
owner  was  not  a  corporation,  the  value  of  the  assets  in  the 
hands  of  the  present  owner  will  be  taken  at  the  cost  to  the 
previous  owner  when  acquired  by  him.  The  law  contemplates 
that  the  invested  capital  shall  be  the  average  amount  employed 
for  a  full  year  and  if  a  corporation  makes  a  return  for  a  period 
less  than  twelve  months  the  invested  capital  must  be  prorated 
accordingly.  Thus  although  a  corporation  actually  had  an  in- 
vested capital  of  $100,000  and  was  in  existence  for  six  months 
of  the  year  1918,  for  the  purpose  of  this  tax  its  invested  capital 
would  be  considered  as  being  only  $50,000.1-  \Yith  respect  to 
the  value  to  be  placed  upon  the  several  classes  of  assets  of  a 
corporation,  such  assets  are  divided  into  three  clasess:   (1)  cash 

119  A.  R.  R.  268,  T.  B.  41-20-1238.  See  Terry  v.  Merchants  &  P.  Bk., 
66  Ga.  177;  Logan  v.  W.  A.  R.  Co.,  87  Ga.  533,  13  S.  E.  516;  Bertram  v. 
Collins  Mfg.  Co.,  69  Ga.  751 ;  Rau  v.  Union  Paper  Mill  Co.,  95  Ga.  208,  22 
S.  E.  146;  Venable  v.  Southern  Granite  Co.,  135  Ga.  508,  69  S.  E.  822; 
Stearns  Coal  Co.  v.  Van  Winkle,  221  Fed.  590;  Pewabic  Min.  Co.  v.  Mason, 
145  U.  S.  349,  12  Sup.  Ct.  887. 

120  Reg.  45,  Art.  831. 

121  See  Reg.  41,  Art.  42. 

122  See  letter  from  treasury  department  dated  March  20,  1918;  W.  T. 
S.  1919,  Tf  764.  This  amounts  to  an  assumption  that  if  the  corporation 
had  been  in  business  for  the  full  year  it  would  have  earned  twice  the  amount 
it  did  during  the  six  months  period.  If  it  can  be  shown  that  by  the  very 
nature  of  its  business  no  more  income  would  have  been  earned  had  the  cor- 
poration been  in  existence  for  the  full  year,  it  would  seem  that  the  case 
is  one  for  remedial  action  under  §  327.     See  p.  1116. 


1044  FEDERAL  INCOME   TAX' 

paid  in;  (2)  tangible  property  paid  in,  and  (3)  intangible  prop- 
erty paid  in.  Regardless  of  the  character  of  the  asset  when  paid 
in  a  further  distinction  is  made  with  respect  to  the  character  of 
the  asset  during  the  taxable  year.  For  this  purpose  the  assets 
are  divided  into  two  classes:  (1)  admissible  assets,  and  (2)  inad- 
missible assets.  The  several  classes  and  the  adjustments  re- 
quired to  be  made  with  respect  to  each  and  to  all  as  a  whole 
are  discussed  in  the  following  paragraphs. 

No  Par  Value  Stock.  The  par  value  of  stock  or  shares 
in  the  case  of  stock  or  shares  issued  at  a  nominal  value  or 
having  no  par  value  is  deemed  to  be  the  fair  market  value  as 
of  the  date  said  stock  or  shares  are  issued.^-^ 

Cash  Paid  In.  The  amount  of  cash  paid  to  a  corporation  in 
exchange  for  its  stock  is  invested  capital  and  remains  such 
whether  used  for  the  purpose  of  acquiring  tangible  or  intangible 
property.i-^  Amounts  paid  in  for  stock  become  invested  capital 
when  the  cash  is  actually  received  and  not  when  stock,  which 
is  paid  for  in  installments,  is  issued.^-^  Thus,  if  the  stock- 
holders of  a  corporation  have  actually  and  in  good  faith  paid  in 
cash  for  its  stock,  such  cash  may  be  used  to  purchase  good  will, 
patents,  copyrights,  trade-marks  or  trade  brands,  and  the  intan- 
gible assets  so  acquired  may  be  included  in  invested  capital  to 
the  extent  of  their  cost.  It  is  only  when  such  intangible  assets 
are  acquired  in  exchange  for  stock  that  the  restrictive  provi- 
sions of  the  statute  limiting  the  amount  of  intangible  assets 
which  may  be  included  in  invested  capital  apply.  If,  however, 
the  cash  is  used  to  acquire  inadmissible  assets,  the  invested 
capital  will  be  reduced  accordingly.  But  if  the  vendors  of  the 
property  retain  an  interest  or  control  of  50%  or  more  in  the 
property  and  it  was  transferred  after  March  3,  1917,  the  value 
for  invested  capital  is  limited  as  indicated  below,  whether  the 
property  is  tangible  or  intangible.i^s 

Stock  Sold  at  a  Discount — Brokers'  Commissions. 
Reasonable  commissions  or  other  forms  of  compensation  law- 
fully paid  by  the  corporation  for  the  sale  of  its  capital  stock 
are  not  to  be  deducted  in  computing  invested  capital.^^? 

123  Revenue  Acts  of  1918  and  1921,  §  325.  The  same  principle  has  been 
followed  under  the  1917  Law  (T.  B.  R.  38,  T.  B.  11-19-390;  A.  R.  R.  520, 
T.  B.  44-21-1893).     See  O.  D.  348,  T.  B.  30-19-644. 

124  Revenue  Acts  of  1918  and  1921,  §326   (a). 

125  O.  D.  991,  T.  B.  32-21-1765. 

126  See  Revenue  Acts  of  1918  and  1921,  §  331.    See  p.  1053. 

127  T.  B.  R.  4,  T.  B.  11-19-391  overruling  a  letter  from  the  Treasury 
Department  dated  April  14,  1919;  W.  T.  S.  1919,  111041.     This  rule  is  a 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1045 

Bonus  Stock.  Capital  stock  issued  as  a  bonus  in  con- 
nection with  the  sale  of  a  corporation's  bonds  may  not  be 
included  in  invested  capital,  unless  the  corporation  proves  to  the 
satisfaction  of  the  Commissioner  that  such  stock  bonus  enabled 
the  corporation  to  secure  a  higher  price  for  the  bonds  than  it 
could  otherwise  have  secured.  Whenever  this  fact  is  estab- 
lished, bonus  stock  may  be  included  in  invested  capital  to  the 
extent  of  the  difference  between  the  selling  price  of  the  bonds 
and  the  price  at  which  they  could  have  been  sold  if  issued  with- 
out such  stock  bonus.  The  excess  of  the  face  value  of  such  bonds 
over  the  price  at  which  they  could  have  been  sold  if  issued  with- 
out the  stock  bonus  is  deemed  discount  and  is  subject  to 
amortization.^-^ 

Stock  Issued  for  Services.  Shares  of  stock  distributed 
by  a  corporation  to  its  employees  in  payment  of  services  ren- 
dered, where  the  amount  is  not  excessive,  may  be  included  in 
invested  capital  to  the  extent  of  the  actual  cash  value  of  the 
services  rendered.^^a 

Tangible  Property  Paid  In.  When  stock  or  shares  have  been 
issued  for  tangible  property,  the  actual  cash  value  of  the  tangi- 
ble property  at  the  time  it  is  paid  in  becomes  invested  capital.i^o 
If  the  actual  cash  value  of  such  tangible  property  exceeds  the 
par  value  of  the  stock  issued  therefor,i3i  the  excess  over  the  par 
value  may  be  treated  as  paid-in  surplus,  provided  it  is  shown 
to  the  satisfaction  of  the  Commissioner  that  the  value  of  the 
property  was  clearly  and  substantially  in  excess  of  the  par 
value  of  the  stock.  Evidence  offered  to  support  a  claim  for  a 
paid-in  surplus  must  be  as  of  the  date  of  the  payment,  and 
may  consist  among  other  things  of  (a)  an  appraisal  of  the 
property   by   disinterested  authorities   made   on   or   about   the 

corollary  of  the  rule  that  such  commissions  may  not  be  deducted  in  com- 
puting net  income.     See  Chapter  22. 

128  Reg.  45,  Art.  832. 

129  o.  D.  248,  T.  B.  13-19-431. 

i.w  While  the  fact  that  a  company  may  have  defective  accounting  records, 
and  can  not  accurately  compute  its  invested  capital,  may  under  certain 
circumstances  justify  an  assessment  under  §210  of  the  Revenue  Act  of 
1917,  or  §328  of  the  Revenue  Acts  of  1918  and  1921,  it  does  not  permit 
valuation  of  assets  as  at  a  time  subsequent  to  the  date  on  which  they  were 
paid  in  for  stock  for  computing  invested  capital.  The  assets  of  a  cor- 
poration can  not  be  valued  as  of  March  1,  1913,  for  the  purpose  of  com- 
puting invested  capital.      (T.  B.  M.  57,  T.  B.   14-19-440.) 

131  The  par  value  of  stock  or  shares,  in  the  case  of  stock  or  shares  issued 
at  a  nominal  value  or  having  no  par  value,  is  deemed  to  be  the  fair  market 
value  as  of  the  date  such  stock  or  shares  are  issued  (Revenue  Acts  of 
1918  and  1921,  §325). 


1046  FEDERAL  INCOME  TAX 

date  of  the  transaction;  (b)  certification  of  the  assessed  value 
in  the  case  of  real  estate;  and  (c)  proof  of  a  market  price  in 
excess  of  the  par  value  of  the  stock  or  shares.  The  additional 
value  allowed  in  any  case  is  confined  to  the  value  definitely- 
known  or  accurately  ascertainable  at  the  time  of  the  payment. 
No  claim  will  be  allowed  for  a  paid-in  surplus  in  a  case  in 
which  the  additional  value  has  been  developed  or  ascertained 
subsequently  to  the  date  on  which  the  property  was  paid  in  to 
the  corporation,  or  in  respect  of  property  which  the  stock- 
holders or  their  agents  on  or  shortly  before  the  date  of  such 
payment  acquired  at  a  bargain  price,  as  for  instance,  at  a  re- 
ceiver's sale.  Generally,  allowable  claims  of  this  character 
will  arise  out  of  transactions  in  which  there  has  been  no  sub- 
stantial change  of  beneficial  interest  in  the  property  paid  in  to 
the  corporation,  and  in  all  cases  the  proof  of  value  must  be 
clear  and  explicit,^''-  It  need  not  consist  of  an  appraisal  made  on 
the  date  of  acquisition,  but  the  evidence  must  be  "as  of"  that 
date,  that  is,  in  the  light  only  of  knowledge  or  facts  ascertainable 
on  that  date  and  not  in  the  light  of  subsequent  happenings.^^^ 
The  following  rulings  have  also  been  made  as  to  the  extent  to 
which  a  paid-in  surplus  may  be  claimed: 

(1)  Where  a  corporation  is  one  of  the  parties  to  a  contract, 
it  cannot  be  held  to  be  paid-in  surplus.  Contracts  which  may 
be  regarded  as  tangible  assets  can  only  constitute  paid-in  sur- 

132  Reg.  45,  Art.  836;  A.  R.  R.  390,  T.  B.  9-21-1487.  In  1917  the  rule 
was :  Where  it  can  be  shown  by  evidence  satisfactory  to  the  Commissioner 
that  tangible  property  has  been  conveyed  to  a  corporation  or  partnership 
by  gift  or  at  a  value,  accurately  ascertainable  or  definitely  known  as  at 
the  date  of  conveyance,  clearly  and  substantially  in  excess  of  the  cash  or 
the  par  value  of  the  stock  or  shares  paid  therefor,  then  the  amount  of  the 
excess  shall  be  deemed  to  be  paid-in  surplus.  The  adopted  value  shall 
not  cover  mineral  deposits  or  other  properties  discovered  or  developed 
after  the  date  of  conveyance,  but  shall  be  confined  to  the  value  accurately 
ascertainable  or  definitely  known  at  that  time.  Evidence  tending  to  sup- 
port a  claim  for  a  paid-in  surplus  under  these  circumstances  must  be  as 
of  the  date  of  conveyance,  and  may  consist,  among  other  things,  of  (1) 
an  appraisal  of  the  property  by  disinterested  authorities,  (2)  the  assessed 
value  in  the  case  of  real  estate,  and  (3)  the  market  price  in  excess  of  the 
par  value  of  the  stock  or  shares.  (Reg.  41,  Art.  63.  See  A.  R.  R.  161, 
T.  B.  28-20-1064.)  This  ruling  was  supported  by  the  language  of  the 
1917  Law  (§207  (a))  which  permitted  the  inclusion  of  "the  actual  cash 
value  of  tangible  property  paid  in     *     *     *     at  the  time  of  such  payment." 

133  A.  R.  R.  161,  T.  B.  28-20-1064.  It  may  not  be  reached  by  the  empirical 
process  of  adjusting  values  reached  several  years  later  (A.  R.  R.  358,  T. 
B.  2-21-1393).  See  Chapter  17  for  a  full  discussion  of  the  valuation  of 
property. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1047 

plus,  if  they  were  made  between  outside  parties  and  the  rights 
of  either  of  the  parties  is  then  transferred  to  a  corporation 
without  adequate  consideration. i^* 

(2)  Where  bondholders  purchased  at  a  foreclosure  sale  the 
property  covered  by  the  mortgage  securing  the  bonds,  and  then 
transferred  the  property  to  a  new  corporation  in  exchange  for 
its  total  authorized  stock  issue,  the  invested  capital  of  the  new 
corporation  will  be  the  value  of  the  property  as  of  the  date  of 
transfer  to  the  corporation.i^y 

(3)  Where  a  corporation  exchanges  its  stock  for  the  assets 
of  a  partnership,  which  are  greatly  in  excess  of  the  par  value  of 
the  stock,  and  there  is  no  written  obligation  to  the  partners  as 
to  the  payment  of  the  excess,  the  taxpayer  is  entitled  to  submit 
evidence  in  support  of  a  claim  for  paid-in  surplus;  however,  if 
the  corporation  is  obligated  to  the  partners  for  any  portion  of 
the  excess,  a  claim  can  not  be  sustained.^-^^' 

(4)  Where  a  corporation  purchases  for  its  own  stock  the 
property  of  another  corporation  (through  a  purchase  of  capital 
stock  furthered  by  a  merger)  at  a  bargain  as  shown  by  an 
appraisal,  it  may  not  include  the  excess  of  the  value  over 
the  purchase  price  in  invested  capital  as  paid-in  surplus.  Paid-in 
surplus  does  not  contemplate  an  excess  value  of  property  pur- 
chased in  a  bona  fide  sale  over  the  purchase  price  thereof.i^" 

(5)  A  paid-in  surplus  may  consist  of  claims  against  a  corpora- 
tion owed  to  and  cancelled  by  creditor  stockholders.^^s 

Record  to  Be  Kept.  The  Commissioner  is  required  to  keep 
a  record  of  all  cases  in  which  tangible  property  is  included  in 
invested  capital  at  a  value  in  excess  of  the  par  value  of  the 
stock  issued  therefor,  containing  (a)  the  name  and  address  of 
the  taxpayer;  (b)  the  business  in  which  it  is  engaged;  (c)  the 
amount  of  invested  capital  and  net  income  shown  by  the  re- 
turn; (d)  the  value  of  the  tangible  property  at  the  time  it  was 
paid  in ;  (e)  the  par  value  of  the  stock  specifically  issued  there- 
for, and  (f)  the  amount  included  as  paid-in  suiT)lus.  He  is 
also  required  to  furnish  a  cop;^  of  such  record  and  other  detailed 
information  with  respect  to  such  cases  when  required  by  resolu- 
tion of  either  House  of  Congress  v^ithout  regard  to  the  restric- 

134  A.  R.  R.  233,  T.  B.  40-20-1227. 

135  T.  B.  R.  32,  T.  B.  8-19-334. 

136  O.  D.  249,  T.  B.  13-19-432. 

137  0.  D.  813,  T.  B.  7-21-1457. 

138  A.  R.  R.  678,  T.  B.  47-21-1936. 


1048  FEDERAL  INCOME   TAX 

tions  ordinarily  imposed  on  him  with  respect  to  making  public 
the  contents  of  tax  returns.i^o 

Definition  of  Tangible  Property.  The  term  "tangible  prop- 
erty" means  stocks,  bonds,  notes  and  other  evidences  of  indebted- 
ness, bills  and  accounts  receivable,  leaseholds,  and  other  prop- 
erty other  than  intangible  property.^^^'  A  contract  may  be 
treated  as  tangible  property  only  after  the  submission  of  a 
full  statement  as  to  its  exact  nature  showing  to  the  satis- 
faction of  the  Commissioner  that  it  relates  to  rights  in  tangible 
property  to  such  an  extent  that  its  value  arises  chiefly  there- 
from.141 

Evidences  of  Indebtedness.  Enforceable  notes  or  other 
evidences  of  indebtedness,  either  interest  bearing  or  non-inter- 
est bearing,  of  the  subscriber  received  by  a  corporation  upon  a 
subscription  for  stock  may  be  considered  as  tangible  property 
in  computing  its  invested  capital  to  the  extent  of  the  actual 
cash  value  of  such  notes  or  other  evidences  of  indebtedness  at 
the  time  when  paid  in,  but  only  (a)  if  such  notes  or  evidences 
of  indebtedness  could  under  the  laws  of  the  jurisdiction  in 
which  the  corporation  was  organized  legally  be  received  in  pay- 
ment for  stock,  and  (b)  if  they  were  actually  received  by  the 
corporation  as  absolute,  and  not  as  conditional,  payment  in 
whole  or  in  part  of  the  stock  subscription.i'*^  Notes  received 
from  employees  in  payment  of  stock,  title  to  which  will  re- 
vert to  the  corporation  if  the  employee  severs  his  connection 
with  the  corporation  and  to  be  paid  out  of  earnings  accruing 
on  stock  for  which  they  are  ostensibly  given,  while  tangible 
property  in  a  strict  sense,  add  nothing  to  the  resources  of 
the  corporation  and  are  not  "bona  fide  paid  in"  within  the 
meaning  of  the  statute.  Even  if  an  increase  in  working  capi- 
tal were  achieved  by  the  discounting  of  or  borrowing  on  such 
notes,  such  increased  capital  would  constitute  borrowed  capital 
which  may  not  be  included  in  invested  capital.!*^  Stock  sub- 
scribed for  by  employees  under  an  agreement  permitting  pay- 
ments in  cash,  part  cash  and  part  deferred  payments,  or  all 
deferred  payments,  subject  to  conditions  that  payment  of  sub- 

,  139  Revenue  Acts  of  1918  and  1921,  §  326  (a). 

140  Revenue  Acts  of  1918  and  1921,  §325  (a).  The  1917  Law  contained 
no  definition  of  tangible  property,  but  the  treasury  department  held  that 
the  term  included  stocks,  bonds,  bills  and  accounts  receivable,  notes  and 
other  evidence  of  indebtedness  and  leaseholds.     (Reg.  41,  Art.  47.) 

141  Reg.  45,  Art.  811. 

142  Reg.  45,  Art.  833. 

143  S.  1391,  T.  B.  22-20-980. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1049 

scriptions  should  be  in  weekly  installments;  that  deferred 
payment  should  bear  interest;  and  that  the  agreement  might 
be  canceled  either  upon  request  of  the  employee,  failure  to 
make  payments,  any  attempt  of  the  purchaser  to  sell  his  stock 
or  agreement,  or  resignation  or  dismissal  of  the  employee  prior 
to  the  expiration  of  five  years ;  in  the  event  of  any  cancellation 
the  employee  to  receive  the  full  amount  of  all  payments  with 
interest,  and,  dependent  upon  the  time  held  more  than  one 
year,  certain  percentages  of  the  difference  between  the  sub- 
scription and  market  price  of  the  stock ;  dividends  to  be 
credited  to  the  subscriber's  account  as  additional  payments, 
except  in  case  of  cancellation,  in  which  case  the  subscriber 
incurs  no  charge  for  interest  upon  deferred  payments  may  be 
recognized  as  invested  capital  only  in  so  far  as  the  subscription 
payments  have  been  actually  received  by  the  company.^** 

Intangible  Property.  Intangible  property  may  be  included  in 
invested  capital,  when  it  has  been  acquired  by  direct  purchase, 
at  a  value  not  in  excess  of  the  cash  or  the  value  of  the  tangible 
property  specifically  paid  therefor.i^s  n  ^ay  be  included  in  in- 
vested capital  only  to  the  extent  permitted  by  the  rules  set  forth 
in  the  following  paragraphs,  if  paid  for  with  stock  or  shares. 
Good  will  cannot  be  allowed  as  invested  capital  under  a  claim 
that  a  price  paid  to  stockholders  was  in  excess  of  the  corporate 
book  value  of  the  stock,  because  such  price  was  incident  to  a 
collateral  transaction.!'^*^  Earned  surplus  once  acquired  may  be 
expended  for  intangible  property  without  being  subject  to  any 
limitation  upon  its  inclusion  in  invested  capital,  provided  the 
expenditure  is  properly  capitalized.  Thus,  it  has  been  held  in 
the  case  of  taxpayers  engaged  in  the  publication  of  news- 
papers, that  moneys  expended  out  of  earned  surplus  or  current 
earnings  for  the  sole  purpose  of  building  up  the  circulation 
structure  may  be  added  to  capital  invested  when  proper  proof 
of  such  expenditures  is  made  and  amended  returns  for  prior 
years  have  been  filed,  and  that  the  circulation  structure  so 
built  up  is  intangible  property."" 

Definition.  The  term  "intangible  property  means  patents, 
copyrights,    secret   processes    and    formulae,    good    will,   trade- 

144  A.  R.  R.  10,  T.  B.  1-20-664. 

145  See  Reg.  41,  Art.  60. 

146  A.  R.  R.  413,  T.  B.  10-21-1502. 

147  A.  R.  M.  141,  T.  B.  47-21-1937.  See  also  A.  R.  R.  611,  T.  B.  32-21- 
1766. 


1050  FEDERAL  INCOME  TAX 

marks,  trade  brands,  franchises  and  other  like  property.^^^ 
Most  contracts  are  intangible  property  and  in  the  absence  of 
a  specific  ruling  by  the  Commissioner  to  the  contrary  should  be 
so  regarded.  Contracts  relating  to  or  representing  rights  in 
tangible  property  are  regarded  as  tangible  property  i*^  but  only  if 
bona  fide  paid  in  for  stock  or  shares.i^o  An  unperformed  con- 
tract to  furnish  manufactured  products  represents  no  rights  in 
tangible  property  which  would  entitle  it  to  be  regarded  as  de- 
riving its  value  chiefly  therefrom.  On  the  contrary,  the  value 
of  the  contract  is  of  an  intangible  nature,  contingent  upon  the 
performance  of  its  terms  and  the  realization  of  the  anticipated 
profit.131  Associated  Press,  and  similar  franchises,  and  sub- 
scription lists  and  mailing  lists  are  intangible  property.^^s  The 
actual  cash  value  of  intangible  property  paid  in  for  stock  or 
shares  must  be  determined  in  the  light  of  the  facts  in  each 
case-i^'*^  Among  the  factors  to  be  considered  are  (a)  the  earn- 
ings attributable  to  such  intangible  assets  while  in  the  hands 
of  the  predecessor  owner;  (b)  the  earnings  of  the  corpora- 
tion attributable  to  the  intangible  assets  after  the  date  of  their 
acquisition;  (c)  representative  sales  of  the  stock  of  the  cor- 
poration at  or  about  the  date  of  the  acquisition  of  the  intangible 
assets ;  and  (d)  any  cash  offers  for  the  purchase  of  the  busi- 
ness, including  the  intangible  property,  at  or  about  the  time  of 

148  Revenue  Acts  of  1918  and  1921,  §  325  (a)  ;  A.  R.  R.  29,  T.  B.  9-20- 
776.  In  the  1917  Law  patents  were  not  defined  as  intangible  property. 
(Revenue  Act  of  1917,  §207.)  Under  the  1917  Law  the  term  "other  in- 
tangible property"  as  used  in  §  207  was  construed  to  mean  propex'ty  of 
a  character  similar  to  good  will,  trade-marks  and  the  other  specific  kinds 
of  property  enumerated  in  the  same  clause.  Property  not  clearly  of  such 
character  might  be  held  to  be  tangible  within  the  meaning  of  the  law. 
(Reg.  41,  Art.  47.)  Patents  had  a  status  intermediate  between  tangible 
and  intangible  property.  (Reg.  41,  Art.  56;  T.  B.  M.  17,  T.  B.  3-19-208.) 
When  acquired  for  stock  their  values  must  be  determined  in  the  light  of 
their  cost  to  incorporators  just  prior  to  incorporation  (A.  R.  R.  396,  T. 
B.  8-21-1471).  It  was  held  that  patentable  ideas  and  formulas — embryo 
patents — should  be  treated  as  patents  already  secured  in  A.  R.  R.  328, 
T.  B.  48-20-1329. 

149  Reg.  45,  Art.  811. 

150  0.  D.  306,  T.  B.  24-19-578. 

151 0.  D.  635,  T.  B.  33-20-1140.  In  the  case  stated  in  this  decision 
there  would  seem  to  have  been  a  mixed  aggregate  of  tangible  and  intangi- 
ble property  within  the  meaning  of  §  327. 

152  Reg.  45,  Art.  811. 

153  See  Chapter  17  for  a  full  discussion  of  the  valuation  of  intangible 
property. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1051 

its  acquisition.  A  corporation  claiming  a  value  for  intangible 
property  paid  in  for  stock  or  shares  should  file  with  its  return 
a  full  statement  of  the  facts  relating  to  such  valuation.!''^. 

It  has  been  held  that  where  a  corporation  controlled  by  a 
few  individuals  uses  part  of  its  profits  to  pay  notes  of  its  prin- 
cipal stockholders  previously  given  as  part  of  the  purchase 
price  of  the  stock  of  retiring  stockholders,  the  amount  of  which 
notes  being  equal  to  the  excess  of  the  agreed  price  of  such 
stock  over  its  par  or  book  value,  such  is  not  payment  made 
bona  fide  specifically  as  such  in  cash  or  tangible  property  for 
good  will  or  other  intangible  property,  even  though  the  retiring 
stockholders  had  in  the  contract  of  sale  of  stock  agreed  to  re- 
frain from  entering  into  the  business  conducted  by  the  corpora- 
tion for  a  specified  number  of  years.i^s  In  cases  where  stock  has 
been  issued  for  intangible  property  the  following  rules  apply: 

Intangible  Property  Paid  in  Prior  to  March  3,  1917. 
Where  intangible  property  was  paid  in  prior  to  March  3,  1917, 
such  intangible  property  becomes  invested  capital  in  an  amount 
not  exceeding  (a)  the  actual  cash  value  of  the  property  at  the 
time  paid  in,  (b)  the  par  value  of  the  stock  or  shares  issued 
therefor  156  or  (c)  in  the  aggregate  25%  of  the  par  value  of  the 
total  stock  or  shares  of  the  corporation  outstanding  on  March 
3,  1917,15'^  whichever  is  the  lowest.^^^ 

1-^4  See  Reg.  45,  Art.  851.     See  Chapter  17. 

155  In  its  recommendation  the  committee  referred  to  the  definitions  of 
the  term  good  will  contained  in  the  following  cases:  Boon  v.  Moss,  70  N.  Y. 
465;  Lane  v.  Smythe,  46  N.  J.  Eq.  443,  19  Atl.  199;  Crutwell  v.  Lye,  17 
Ves.  Jr.  335;  Dodge  Stationery  Co.  v.  Dodge,  145  Cal.  380,  78  Pac.  879. 

I'"'*''  The  par  value  of  stock  or  shares  in  the  case  of  stock  or  shares  issued 
at  a  nominal  value  or  having  no  par  value,  is  deemed  to  be  the  fair  market 
value  as  of  the  date  such  stock  or  shares  are  issued.  (Revenue  Acts  of 
1918  and  1921,  §325.) 

i'"'"  Under  the  1917  Law  it  was  held  that  tangible  propei-ty  bona  fide 
purchased  prior  to  March  3,  1917,  with  stock  having  no  par  value  could  be 
included  in  invested  capital  at  a  value  not  exceeding  the  actual  cash  value 
of  such  intangible  property  at  the  time  of  the  purchase  or  in  an  amount 
not  exceeding  20%  of  the  total  shares  of  stock  outstanding  on  March  3, 
1917,  measured  by  their  value  as  at  the  date  or  dates  of  issue.  (Reg.  41, 
Arts.  57,  58.) 

15S  Revenue  Acts  of  1918  and  1921,  §326  (a)  4,  5.  In  the  case  of  a 
reorganization  in  which  the  capital  stock  is  increased  but  the  control  of 
the  business  remains  in  the  same  hands  the  value  of  the  stock  issued  for 
intangible  property  must  be  determined  with  reference  to  the  capitaliza- 
tion of  the  old  company  and  not  the  capitalization  of  the  new  company. 
(Letter  from  treasury  department  dated  March  14,  1918.) 


1052  FEDERAL  INCOME  TAX 

Illustration:  assume  the  par  value  of  the  capital  stock  of  a 
corporation  issued  and  outstanding  on  February  1,  1917,  was 
$100,000.  On  February  2,  1917,  it  issued  an  additional  $100,000 
par  value  of  stock  for  intangible  property  having  a  cash  value 
of  $100,000.  Applying  the  foregoing  rule,  (a)  equals  $100,000 ; 
(b)  equals  $100,000  and  (c)  equals  25%  of  $200,000  (the  par 
value  of  the  stock  outstanding  on  March  3,  1917).  Therefore 
(c),  or  $50,000,  is  all  that  may  be  considered  as  invested  capital 
representing  such  intangible  property.  A  further  limitation 
on  the  inclusion  in  invested  capital  of  capital  stock  represent- 
ing intangible  property  paid  in  both  before  and  after  March  3, 
1917,  is  discussed  in  a  later  paragraph.!"*^ 

Intangible  Property  Paid  in  On  or  After  March  3,  1917, 
Where  the  intangible  property  was  paid  in  after  March 
3,  1917,  such  intangible  property  becomes  invested  capital  in  an 
amount  not  exceeding  (a)  the  actual  cash  value  of  the  property 
at  the  time  paid  in,  (b)  the  par  value  of  the  stock  or  shares 
issued  therefor,  or  (c)  25%  of  the  par  value  of  the  total  stock 
or  shares  of  the  corporation  outstanding  at  the  beginning  of 
the  taxable  year,  whichever  is  lowest. 

Illustration :  assume  a  corporation  has  $200,000  par  value  of 
capital  stock  outstanding  on  December  30,  1917.  On  December 
31,  1917,  it  issues  an  additional  $1CO,000  of  capital  stock  for 
intangible  property  having  a  cash  value  of  $100,000.  Apply- 
ing the  foregoing  rule:  (a)  equals  $100,000;  (b)  equals  $100,000, 
and  for  the  taxable  year  1918  (c)  equals  25  %o  of  $300,000. 
Therefore,  the  invested  capital  representing  such  intangible  prop- 
erty is  $75,000.  But  if  the  same  intangible  property  had  been 
acquired  on  January  2,  1918,  instead  of  December  31,  1917,  the 
invested  capital  for  1918  representing  the  same  value  of  intan- 
gible property  would  be  only  $50,000  instead  of  $75,000,  since 
in  that  case  the  par  value  of  the  capital  stock  outstanding  at  the 
beginning  of  the  taxable  year  would  have  been  only  $200,000.1^0 

A  further  limitation  on  the  inclusion  in  invested  capital  of 
capital  stock  representing  intangible  property  paid  in  both  be- 
fore and  after  March  3,  1917,  is  discussed  in  the  following 
paragraph. 

Where  Intangible  Property  Has  Been  Paid  in  Both 
Before  and  After  March  3,  1917.  Where  intangible  prop- 
erty has  been  paid  into  a  corporation  before  and  also  after 
March  3,  1917,  a  further  limitation  is  imposed  upon  the  value 

159  See  p.  1053. 

160  Revenue  Acts  of  1918  and  1921,  §  326  (a)   4,  5. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1053 

of  the  invested  capital  to  represent  in  the  aggregate  all  such 
intangible  property.  The  law  provides  that  in  no  case  shall 
the  total  amount  of  invested  capital  representing  intangible 
property  paid  in  both  before  and  after  that  date  exceed  in 
the  aggregate  25%  of  the  par  value  of  the  total  stock  or  shares 
of  the  corporation  outstanding  at  the  beginning  of  the  taxable 
year.i<5i 

Illustration:  assume  the  par  value  of  the  capital  stock  out- 
standing February  1,  1917,  was  $100,000  and  that  $100,000 
additional  was  issued  for  intangible  property  of  the  same  cash 
value  on  February  2,  1917,  and  a  further  issue  of  $100,000  par 
value  on  December  31,  1917,  for  intangible  property  also  hav- 
ing an  equal  cash  value.  Applying  the  first  and  second  rules 
stated  in  the  preceding  paragraphs  it  is  found  that  the  invested 
capital  with  respect  to  the  first  intangible  property  is  $50,000 
and  with  respect  to  the  second  intangible  property  is  $75,000, 
making  the  total  for  both  $125,000.  But  applying  the  third 
rule  the  total  invested  capital  representing  both  the  property 
acquired  on  February  2,  1917,  and  that  acquired  on  December 
31,  1917,  is  reduced  in  the  aggregate  to  $75,000.  If  the  second 
property  had  been  acquired  on  January  2,  1918,  instead  of 
December  31,  1917,  the  invested  capital  representing  both  prop- 
erties would  be  reduced  even  lower,  namely  to  $50,000,  which 
amount  would  then  represent  25%  of  the  par  value  of  the  capital 
stock  of  the  corporation  outstanding  January  1,  lOlS.i'^^ 

Stock  or  Shares  Outstanding  on  March  3,  1917.  Where 
since  the  organization  of  a  corporation  its  capital  stock  has  been 
increased  or  reduced  and  such  change  represents  an  actual  ac- 
quisition of  new  property  for  stock  or  an  actual  impairment  of 
original  properties,  the  25%  limitation  will  be  based  on  the  par 
value  of  the  total  stock  outstanding  on  March  3,  1911. ^^''^ 

No  Paid-in  Surplus  as  to  Intangible  Property.  No  paid- 
in  surplus  may  be  included  in  invested  capital  by  reason  of  any 
excess  in  the  actual  value  of  intangible  property  at  the  date  of  ac- 
quisition over  the  par  value  of  the  stock  or  shares  issued  there- 
for. On  the  contrary,  such  intangible  property  is  subject  to  the 
25  %j  limitation  stated  in  the  preceding  paragraphs,  whatever  its 
actual  value  may  be.^''* 

161  Revenue  Acts  of  1918  and  1921,  §  326   (a)   5. 

162  As  to  affiliated  corporations  see  p.  1132. 

163  T.  B.  M.  5,  T.  B.  1-19-120. 

164  A.  R.  M.  80,  T.  B.  37-20-1196;  A.  R.  R.  307,  T.  B.  44-20-1282. 


1054  FEDERAL  INCOME  TAX 

Intangible  Property  Acquired  for  Tangible  Property.  In- 
tangible property  when  acquired  for  tangible  property  other 
than  stock  must  be  taken  into  account  at  the  value  of  such  in- 
tangible property  at  the  date  of  acquisition.  Such  value  is 
measured  by  the  fair  market  value  of  the  tangible  property  ex- 
changed therefor  at  the  date  of  the  transaction  and  not  by  the 
original  cost  of  such  tangible  property.i*^^ 

Mixed  Aggregates  of  Tangible  and  Intangible  Property.  The 
statute  I*'"  provides  that  where  a  mixed  aggregate  of  tangible 
property  and  intangible  property  has  been  paid  in  for  stock  or 
for  stock  and  bonds  and  the  Commissioner  is  unable  satisfacto- 
rily to  determine  the  respective  values  of  the  several  classes  of 
property  at  the  time  of  payment,  or  to  distinguish  the  classes  of 
property  paid  in  for  stock  and  for  bonds,  respectively,  the  cor- 
poration shall  be  assessed  by  reference  to  representative  cor- 
porations engaged  in  a  like  or  similar  trade  or  business.i^'^ 
Where  stock  or  shares  and  bonds  or  other  obligations  have  been 
issued  for  a  mixed  aggregate  of  tangible  and  intangible  prop- 
erty, it  will  be  presumed  in  the  absence  of  satisfactory  evidence 
to  the  contrary  that  the  bonds  were  issued  for  tangible  property 
and  that  the  stock  was  issued  for  the  balance  of  the  tangible 
property,  if  any,  and  for  the  intangible  property.  Where  stock 
or  shares  have  been  issued  for  a  mixed  aggregate  of  tangible 
and  intangible  property  and  certain  liabilities  have  been  assumed 
in  connection  with  the  transaction,  it  will  be  presumed  that 
such  liabilities  are  to  be  charged  against  the  tangible  property 
and  the  intangible  property  in  the  order  named  unless  it  is 
shown  by  evidence  satisfactory  to  the  Commissioner  that  this 
presumption  is  not  in  accordance  with  the  facts.^*'^     Where  a 

165  A.  R.  M.  131,  T.  B.  25-21-1698.  This  ruling  did  not  involve  the 
question  of  appreciation  because  it  v^^as  not  the  value  of  the  tangible  prop- 
erty itself  which  was  written  upon  the  books  of  the  corporation.  An  ex- 
change of  the  tangible  property  for  a  cash  equivalent  would  have  determined 
a  profit  over  original  cost.  This  profit  would  have  been  reflected  in  sur- 
plus. In  a  similar  manner  the  excess  of  the  value  of  the  intangible  prop- 
erty acquired  over  the  cost  of  the  tangible  property  given  in  exchange 
therefor  was  a  proper  credit  to  the  surplus  of  the  corporation.  The 
determination  of  a  current  value  had  no  relation  to  original  cost  because 
tangible  property  before  and  after  transfer  had  an  immediate  realizable 
value.  (See  also  Reg.  41,  Art.  60.)  See  Chapter  17  for  a  discussion  of 
the   valuation   of   property. 

166  Revenue  Acts  of  1918  and  1921,  §327   (c). 

167  See  Revenue  Acts  of  1918  and  1921,  §328. 

168  Reg.  45,  Art.  835.  Under  the  1917  Law  it  was  held  that  where  stock 
or  shares  (or  stock  or  shares  and  bonds  or  other  obligations)  have  been 
issued  for  a  mixed  aggregate  of:    (a)   tangible  property,    (b)    patents  and 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1055 

mixed  aggregate  of  tangible  and  intangible  property  is  acquired 
for  stock  and  no  provision  is  made  that  the  intangibles  shall 
be  specifically  paid  for  as  such,  in  order  that  such  intangibles 
may  be  included  in  invested  capital  it  is  only  necessary  to  show 
the  relative  values  of  the  tangibles  and  intangibles  for  which 
stock  was  issued,  subject  to  the  20%  or  25%  limitation. ^"^ 

Surplus  and  Undivided  Profits  of  Foreign  Branch  Office. 
In  order  to  determine  the  amount  of  surplus  attributable  to  a 
foreign  branch  office  the  amounts  remitted  by  it  to  the  home 
office  should  be  taken  into  earned  surplus  at  their  value  in 
American  currency  at  the  time  of  the  remittances,  and  the  bal- 
ance of  the  net  profits  of  the  branch  office  not  remitted  to  the 
home  office  should  be  converted  into  American  currency  at  the 
rate  of  exchange  as  at  the  end  of  the  taxable  year.i"*^ 

Surplus  and  Undivided  Profits.  Paid-in  or  earned  surplus 
and  undivided  profits  at  the  beginning  of  the  taxable  year  may 
be  included  as  invested  capital.  Surplus  and  undivided  profits 
earned  during  the  year  may  not  be  included.!"^    Appreciation  in 

copyrights,  and  (c)  good  will  or  other  intangible  property,  the  following 
rules  would  govern:  (1)  in  the  absence  of  satisfactory  evidence  to  the  con- 
trary, it  was  presumed  in  the  case  of  a  corporation,  that  its  stock  was 
issued  for  the  following  purposes  in  the  order  named:  (a)  good  will  or 
other  intangible  property,  (b)  patents  and  copyrights,  and  (c)  tangible 
property.  (2)  Upon  the  production  by  the  taxpayer  of  evidence  satisfactory 
to  the  Commissioner  as  to  the  actual  values  at  the  date  of  acquisition  of 
(a)  the  tangible  property  and  (b)  the  patents  and  copyrights,  the  sum 
of  these  two  items  could  be  applied  against  the  total  par  value  of  the  se- 
curities issued  and  the  remainder  was  then  deemed  to  represent  the  par 
value  of  the  securities  issued  for  the  good  will  or  other  intangible  property. 
(3)  Cases  where  mixed  aggregates  of  tangible  and  intangible  property 
have  been  paid  in  for  stock  and  bonds  were,  if  the  Commissioner  was  unable 
to  determine  satisfactorily  the  respective  values  of  the  several  classes  of 
property  at  the  time  of  payment,  treated  as  coming  under  the  head  of 
cases  where  the  invested  capital  could  not  be  satisfactorily  ascertained  and 
the  tax  was  assessed  accordingly.  (Reg.  41,  Art.  59;  T.  B.  R.  49,  T.  B. 
16-19-467;  A.  R.  R.  459,  T.  B.  15-21-1568.) 

1*J9  A.  R.  M.  80,  T.  B.  37-20-1196.     See  A.  R.  R.  307,  T.  B.  44-20-1282. 

170  O.  D.  618,  T.  B.  31-20-1109;  O.  D.  550,  T.  B.  25-20-1009. 

171  Revenue  Acts  of  1918  and  1921,  §  326  (a).  Under  the  1917  Law  some 
doubt  existed  as  to  whether  or  not  surplus  earned  during  the  taxable  year 
and  actually  epiployed  in  the  business  during  a  part  of  that  year  could 
not  be  included  in  invested  capital.  The  treasury  department  ruled  that 
it  could  not  in  the  case  of  corporations  and  partnerships  (Reg.  41,  Art. 
61)  even  though  invested  in  bonds  of  the  United  States  (T.  D.  2541)  or 
set  up  as  "surplus"  on  the  books  or  distributed  in  the  form  of  stock  div- 
idends (Reg.  41,  Art.  61)  but  that  profits  earned  during  the  year  could  be 
included  as  invested  capital  of  individuals  (Id.  Art.  69).  The  1917  Law 
also  provided  that  surplus  or  undivided  profits  in  order  to  be  included  in 


1056  FEDERAL  INCOME   TAX 

values  due  to  reappraisement  can  not  be  regarded  as  paid-in  or 
earned  surplus,^"-  even  though  income  tax  has  been  erroneously 
paid  thereon. I'^s 

Replacement  Fund.  It  was  held  under  the  1918  Law  that 
so  much  of  a  replacement  fund  for  steamers  lost  as  represents 
excess  of  the  amount  of  insurance  received  over  the  book  value 
of  the  steamers  at  the  time  of  their  destruction  may  not  be  in- 
cluded in  invested  capital  for  the  purpose  of  war  and  excess- 
profits  taxes,  even  though  the  interest  received  from  the  in- 
vestment of  such  excess  is  reported  as  taxable  income,  because 
such  excess  is  not  "paid-in  or  earned  surplus."  ^'''^ 

Paid-in  Surplus.  Where  it  is  shown  by  evidence  satisfactory 
to  the  Commissioner  that  tangible  property  has  been  paid  in  by 
a  stockholder  i^^  to  a  corporation  as  a  gift  or  at  a  value  definitely 
known  or  accurately  ascertainable  as  of  the  date  of  such  pay- 
invested  capital  should  be  "used  or  employed  in  the  business,"  but  the  dis- 
tinction, if  any  exists,  between  assets  used  and  assets  not  used  in  the  bus- 
iness of  a  corporation  was  too  fine  for  practical  purposes,  and  since  the 
law  elsewhere  provided  that  all  the  income  of  a  corporation  should  be 
deemed  to  be  received  from  its  trade  or  business,  the  Treasury  Department 
ruled  that  all  surplus  or  undivided  profits  would  be  deemed  to  be  employed 
in  the  business,  unless  invested  in  inadmissible  assets    (Id.  Art.  62). 

172  A.  R.  R.  29,  T.  B.  9-20-776;  A.  R.  R.  71,  T.  B.  18-20-906;  letter  from 
treasury  department  dated  March  5,  1918. 

173  T.  B.  M.  41,  T.  B.  7-19-308.  . 

174  0.  D.  417,  T.  B.  12-20-801.  See  also  Reg.  45,  Art.  50,  and  a  dis- 
cussion of  replacement  funds  in  Chapter  20,  particularly  the  new  pro- 
vision in  regard  thereto  in  the  Revenue  Act  of  1921,  which  differs  from  the 
previous  practice  of  the  department. 

175  The  property  must  be  paid  in  by  a  stockholder.  A  claim  for  paid- 
in  surplus  will  not  be  allowed  in  the  case  of  the  appreciated  value  of  a  lease- 
hold acquired  by  a  company  as  original  lessee  without  cost  and  which  was 
not  paid  in  at  a  fixed  value  for  stock  or  shares  (A.  R.  R.  86,  T.  B.  19-20- 
925).  In  a  case  arising  under  the  1917  Law  two  stockholders  owning  most 
of  the  stock  of  a  company  invented  certain  machinery  for  which  patents 
were  issued  to  them.  The  company  paid  the  cost  of  the  patents  and 
used  them  as  though  it  owned  them  without  compensation  to  the  inventors. 
In  1916  the  patents  were  put  upon  the  books  of  the  company  at  a  certain 
value  and  a  stock  dividend  was  declared.  The  committee  held  that,  even 
assuming  the  patents  not  to  have  been  formally  assigned  to  the  com- 
pany until  1916,  they  were  not  paid  for  by  the  issuance  of  stock  or  by  any 
payment  of  cash,  for  which  reason  the  amount  placed  upon  the  corporate 
books  as  the  value  of  the  patents  could  not  be  included  in  invested  capital 
(A.  R.  R.  9,  T.  B.  1-20-665).  It  is  difficult  to  see  why  such  patents  should 
not  be  included  in  invested  capital  as  paid-in  surplus  on  the  theory  that 
they  constituted  tangible  property  (under  the  1917  Law)  paid  in  by  stock- 
holders as  a  gift.  The  stock  dividend,  in  such  event,  merely  capitalize  the 
paid-in  surplus. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1057 

ment  clearly  and  substantially  in  excess  of  the  cash  or  other  con- 
sideration paid  by  the  corporation  therefor,  then  the  amount  of 
the  excess  will  be  deemed  to  be  paid-in  surplus.  Substantially 
the  same  kind  of  evidence  will  be  required  to  show  the  value  in 
this  case  as  is  required  in  the  case  of  tangible  property  paid  in 
at  a  value  greater  than  the  par  value  of  the  shares  issued  there- 
for, i^*^ 

Oil  Leases  Informally  Transferred  to  Corporation.  It  is 
held  that  where  certain  commercial  leases  of  oil  lands  are  in- 
formally transferred  to  a  corporation  formed  by  the  lessees  for 
the  purpose  of  taking  over  such  leases,  no  consideration  being 
paid  for  such  transfer,  it  will  be  deemed  that  the  transfer  was 
made  at  the  time  of  taking  possession,  and  the  addition  to  in- 
vested capital  of  the  corporation  upon  such  transfer  is  the  fair 
market  price  or  value  of  the  leases  at  the  time  possession  is  so 
taken  by  the  corporation. i~ 

Earned  Surplus. ^^"^  Only  true  earned  surplus  and  undivided 
profits  can  be  included  in  the  computation  of  invested  capital, 
and  if  for  any  reason  the  books  do  not  properly  reflect  the  true 
surplus  such  adjustments  must  be  made  as  are  necessary  in 
order  to  arrive  at  the  correct  amount.  Any  portion  of  surplus 
or  undivided  profits  representing  unearned  interest  or  discount 
which  has  not  been  reported  as  taxable  income  must  be  excluded 
in  the  computation  of  invested  capital  for  war  profits  and  ex- 
cess-profits purposes.i^'^  In  the  computation  of  earned  surplus 
and  undivided  profits  full  recognition  must  first  be  given  to  all 
expenses  incurred  and  losses  sustained  from  the  original  or- 
ganization of  the  corporation  down  to  the  taxable  year,  including 
among  such  expenses  and  losses  reasonable  allowances  for  de- 
preciation, obsolescence,  or  depletion  of  property  (irrespective 
of  the  manner  in  which  such  property  was  originally  acquired) , 
and  for  the  amortization  of  any  discount  on  its  bonds.  There 
can  of  course  be  no  earned  surplus  or  undivided  profits  until 
any  deficit  or  impairment  of  paid-in  capital  due  to  depletion, 
depreciation,  expense,  losses,  or  any  other  cause  has  been  made 
good.  Where  adequate  evidence  is  presented  that  the  amounts 
written  off  or  deducted  in  previous  returns  of  net  income  are  in 
the  aggregate  incorrect  or  unreasonable,  adjustments  must  be 
made,  and  the  taxpayer  will  be  allowed  a  refund  in  respect  of 

iTtJReg.  45,   Art.   837. 
1T7S.  1387,  T.  B.  21-20-965. 

178  This  subject  is  more  fully  discussed  on  p.  1080. 

179  0.  D.  91,  T.  B.  1-19-130. 


1058  FEDERAL   INCOME  TAX 

any  taxes  overpaid  in  prior  years,  or  in  the  case  of  an  underpay- 
ment of  taxes  will  be  additionally  assessed.^^o  Unrealized  ap- 
preciation in  the  value  of  assets  can  not  be  taken  into  considera- 
tion for  the  purpose  of  offsetting  a  decrease  by  reason  of  de- 
preciation, obsolescence  or  depletion.isi 

Installment  Sales.  If  a  taxpayer  reports  profits  on  install- 
ment sales  on  the  basis  of  the  proportionate  part  of  each  in- 
stallment received  representing  profit,  his  surplus  account  as 
at  the  beginning  of  the  taxable  year  must  be  reduced  in  com- 
puting invested  capital  to  the  extent  that  the  surplus  account  in- 
cludes profit  on  such  sales  which  has  not  been  reported  as  tax- 
able income.18-  Where  a  corporation  changes  its  method  of  re- 
porting the  profit  from  installment  sales  from  the  basis  of  re- 
porting the  entire  profit  at  the  date  of  the  sale  to  the  basis  of 
reporting  the  profit  as  being  realized  as  at  the  date-  of  the  col- 
lection of  the  outstanding  accounts,  any  part  of  the  unliquidated 
installment  sales  contracts  at  the  date  the  new  basis  is  adopted 
is  to  be  carried  to  accounts  receivable  on  the  balance  sheet  at 
the  beginning  of  the  taxable  year  in  which  the  change  is  made. 
But  this  does  not  require  the  corporation  to  exclude  from  sur- 
plus any  amount  represented  by  such  contracts  which  has  al- 
ready been  returned  as  income  for  the  prior  years.!"^-"^ 

Purchase  of  Stock  with  Cash  and  Patents.  Where  a  do- 
mestic corporation  exchanges  patent  rights  and  cash  for  stock 
in  a  foreign  corporation  which  derives  no  income  from  sources 
within  the  United  States,  the  shares  of  stock  so  received  con- 
stituted admissible  assets  under  the  1918  Law.^^^^  Such  stock 
was  to  be  valued  in  determining  the  invested  capital  of  the  do- 
mestic corporation  under  the  1918  Law  at  the  amount  of  cash 
paid  therefor,  plus  the  value  of  the  patent  rights  at  the  time 
of  the  purchase,  such  value  not  to  be  taken  as  exceeding  the 
value  of  the  shares  of  stock  received  in  exchange  for  the  patent 
rights.  The  effect  of  the  transaction  might  be  to  increase  or  de- 
crease the  surplus  and  undivided  profits  of  the  domestic  corpora- 
tion though  the  cash  and  patent  rights  remain  the  same.  Such 
increase  or  decrease  was  due  to  such  a  change  in  the  situation 
as  amounted  to  a  realization  of  gain  or  loss.  Any  gain  so 
realized  was  earned  surplus;  as  any  loss  so  realized  effected  a 

ISO  Reg.  45,  Art.  838. 

181  A.  R.  R.  71,  T.  B.  18-20-906. 

182  O.  D.  92,  T.  B.  1-19-131. 

183  O.  D.  793,  T.  B.  6-21-1428. 

184  For  the  rule  under  the  present  law  see  p.  1076. 


WAR-PROFITS  AND  EXCESS-PROFITS  TAX  1059 

decrease  in  earned  surplus.  In  determining  invested  capital, 
earned  surplus  was  considered  regardless  of  the  time  when 
earned,  and  it  is  therefore  immaterial  that  the  gain  or  loss 
realized  from  the  transaction  was  due  to  appreciation  or  de- 
preciation which  in  part  occurred  prior  to  March  1,  1913.i'^'' 

Reserves.  The  amounts  shown  on  the  balance  sheet  as  re- 
serves may  or  may  not  be  included  as  invested  capital  according 
to  the  character  of  the  reserve.^^^'^  Some  reserves  are  merely 
subdivisions  of  the  suiplus  account  and  are  true  surplus  or  un- 
divided profits.  Such  reserves  are,  for  instance,  reserves  for 
bad  debts,  reserves  for  contingencies,  reserves  for  self-in- 
surance, and  reserves  for  federal  income  and  excess-profits  tax. 
Any  reserve  the  additions  to  which  can  not  be  deducted  as  an 
expense  in  the  return  of  income,  may  be  considered  as  a  part 
of  the  surplus  and  undivided  profits  for  the  purpose  of  invested 
capital.  On  the  other  hand,  with  perhaps  only  two  exceptions, 
reserves,  the  additions  to  which  may  be  deducted  in  ascertain- 
ing net  income,  can  not  be  included  as  invested  capital.  Among 
such  reserves  are  resei*ves  for  depreciation  (which  are  presumed 
to  offset  the  loss  in  the  assets)  and  reserves  for  state  or  local 
taxes  in  cases  where  the  corporation  reports  on  an  accrual  basis 
and  the  amounts  carried  to  such  reser\^es  have  been  deducted.  An 
exception  to  this  general  rule  would  appear  to  exist  in  the  case  of 
reserves  for  depreciation  or  depletion  based  upon  the  value  of 
the  property  as  of  March  1,  1913,  or  in  the  case  of  depletion 

185  T.  B.  R.  67,  T.  B.  22-19-538.  In  this  respect  the  principles  applicable 
to  the  determination  of  invested  capital  differ  from  those  applicable  to  the 
computation  of  taxable  income,  for  while  such  part  of  the  realized  ap- 
preciation, if  any,  as  is  attributable  to  the  period  after  March  1,  1913, 
constitutes  taxable  income  such  part  as  is  attributable  to  the  period  before 
March  1,  1913,  though  considered  in  the  computation  of  invested  capital, 
escapes  taxation. 

186  "Reserves"  have  been  variously  classified  by  accountants.  They  are 
classified  by  Mr.  Esquerre  in  "Applied  Theory  of  Accounts"  as  folio vi^s: 
"1.  Reserves  for"  depreciation;  2.  operating  reserves;  3.  reserves  for 
surplus  contingencies;  4.  reserves  for  redemption  of  debt;  5.  secret  re- 
serves; and  6.  reserves  for  exhaustion  of  physical  assets."  Reserves  are 
classified  by  Mr.  Hatfield  in  "Modern  Accounting"  as  follows:  "1.  reserves 
created  to  provide  a  permanent  increase  of  capital,  (a)  as  an  additional 
guaranty  to  creditors,  (b)  to  provide  for  extension  of  its  fixed  or  other 
assets;  2.  reserves  created  to  provide  an  additional  capital  which  can  be 
used  to  cover  unusual  losses  or  to  provide  for  other  emergencies  without 
encroaching  on  the  nominal  capital;  3.  reserves  created  to  provide  for 
equalizing  dividends  by  retaining  part  of  one  year's  profit  to  be  used  to 
make  up  scanty  profits  for  other  years." 


1060  FEDERAL  INCOME  TAX 

based  on  the  value  of  a  mine  or  oil  or  gas  property  thirty  days 
after  discovery.  These  exceptional  cases  are  referred  to  in  the 
following  paragraphs. 

Reserves  for  Taxes.  Reserves  set  aside  out  of  surplus  or 
undivided  profits  of  preceding  years  for  payment  of  federal 
taxes  or  state  taxes  not  yet  due  can  be  included  in  invested  cap- 
ital for  the  taxable  year  if,  and  to  the  extent  that,  such  taxes 
were  not  allowable  deductions  in  computing  net  income  for  the 
preceding  taxable  years.  Inasmuch  as  federal  income  and  excess- 
profits  taxes  are  not  deductible  in  computing  net  income  subject 
to  such  taxes,  reserves  set  aside  for  the  payment  of  such  taxes 
may  be  included  in  invested  capital. ^'^'^  But  amounts  payable  on 
account  of  income  and  excess-profits  taxes  for  any  year  may  be 
included  in  computing  the  surplus  and  undivided  profits  for  the 
succeeding  year  only  for  the  proportionate  part  of  the  year  rep- 
resented by  the  period  of  time  between  the  close  of  the  taxable 
year  and  the  date  or  dates  on  which  such  taxes  become  due  and 
payable.iss  A  deduction  from  the  invested  capital  as  of  the  begin- 
ning of  the  taxable  year  must  therefore  be  made  for  such  taxes 
or  any  installment  thereof,  averaged  for  the  proportionate  part 
of  the  taxable  year  after  the  date  when  the  tax  or  the  installment 
is  due  and  payable.  Where  as  a  result  of  an  audit  by  the  Com- 
missioner, or  the  acceptance  of  an  amended  return,  or  for  any 
other  reason,  the  amount  of  any  such  tax  for  the  preceding  year 
is  subsequently  changed,  a  corresponding  adjustment  will  be 
made  in  the  invested  capital  for  the  taxable  year  upon  the  same 
basis  as  if  the  corrected  amount  of  the  tax  for  the  preceding 
year  had  been  used  in  the  original  computation  of  the  invested 
capital  for  the  taxable  year.^'^'^ 

Reserve  for  Depreciation  or  Depletion.  If  any  reserves 
for  depreciation  or  for  depletion  are  included  in  the  surplus  ac- 
count it  should  be  analyzed  so  as  to  separate  such  reserves  and 
leave  only  real  surplus.    Reserves  for  depreciation  or  depletion 

1S7  Letter  from  treasury  department  dated  March  20,  1918;  W.  T.  S. 
1918,11911. 

188  Reg.  45,  Art.  845;  T.  D.  2791.  Prior  to  this  treasury  decision  it  was 
uncertain  whether  or  not  a  corporation  which  indicated  on  its  books  of 
account  that  the  excess-profits  tax  imposed  on  the  income  for  1917  was 
paid  out  of  the  earnings  of  1918  need  reduce  its  invested  capital  by  reason 
of  such  payments.  It  was  argued  that  the  corporation  had  the  option  of 
paying  the  tax  from  either  the  income  of  1917  or  the  income  of  1918.  This 
ruling  is  intended  to  apply  a  uniform  rule  in  all  cases  regardless  of 
whether  or  not  the  corporation  set  up  a  part  of  its  surplus  as  reserves 
for  federal  taxes. 

189  Reg.  45,  Art.  845. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1061 

can  not  be  included  in  the  computation  of  invested  capital,  except 
to  the  following  extent:  (1)  Excessive  depletion  or  depreciation 
included  therein  and  which  if  charged  off  could  be  restored  may- 
be included  in  the  computation  of  invested  capitaP'"'  and  (2) 
where  depreciation  or  depletion  is  computed  on  the  value  as  of 
March  1,  1913,  or  as  of  any  subsequent  date,  the  proportion  of 
depreciation  or  depletion  representing  the  realization  of  appre- 
ciation of  value  at  March  1,  1913,  or  such  subsequent  date,  may 
if  undistributed  and  used  or  employed  in  the  business  be  treated 
as  surplus  and  included  in  the  computation  of  invested  capital. 
For  the  purpose  of  computing  invested  capital,  depreciation  or 
depletion  computed  on  the  value  as  of  March  1,  1913,  or  as  of  any 
subsequent  date  must,  if  such  value  exceeded  cost,  be  deemed  a 
pro  rata  realization  of  cost  and  appreciation  and  be  apportioned 
accordingly.  Except  as  above  provided,  value  appreciation 
(even  though  evidenced  by  an  appraisal)  which  has  not  been  ac- 
tually realized  and,  in  respect  of  amounts  accrued  since  March 
1,  1913,  reported  as  income  for  the  purpose  of  the  income  tax 
can  not  be  included  in  the  computation  of  invested  capital,  and 
if  already  reflected  in  the  surplus  account  it  must  be  deducted 
therefrom. 1^1 

Patents.  From  the  standpoint  of  assets  a  patent,  or  more 
particularly  a  group  of  patents,  is  closely  analogous  to  good  will. 
Their  value  is  contingent  upon  and  measured  by  their  earning 
power.  While  patents  have  a  definite  life  there  is  a  common 
tendency  to  extend  that  life  by  improvements  upon  the  original, 
and  in  a  successful  business  the  patent  value  merges  more  or 
less  completely  into  a  trade  name  or  other  form  of  good  will. 
Therefore,  while  deductions  in  respect  to  the  depreciation  of 
patents  based  upon  a  normal  life  period  of  seventeen  years  are 
allowable  in  computing  net  income  for  the  purpose  of  the  income 
tax,  such  deductions  are  not  obligatory,  but  are  optional  with 
each  taxpayer.  Where  since  January  1,  1909,  a  corporation  has 
exercised  that  option  to  its  own  benefit  in  computing  its  taxable 
net  income  the  amount  so  deducted  can  not  now  be  restored  in 
computing  invested  capital.^^-  Thus,  a  corporation  owning  pat- 
ents covering  certain  inventions  made  by  its  employees,  the  cost 
of  securing  and  the  salaries  of  such  employees  being  paid  by  the 
corporation  and  charged  to  expense  account,  may  not  include 
in  its  invested  capital  any  amount  representing  either  the  cost 

190  See  Reg.  45,  Art.  840. 

191  Reg.  45,  Art.  844. 

192  Reg.  45,  Art.  843. 


1062  FEDERAL  INCOME  TAX 

of  the  patents  or  appreciation  in  their  value. ^"^  Where,  however, 
the  cost  of  patents  has  been  charged  against  surplus  or  other- 
wise disposed  of  in  such  a  manner  as  not  to  benefit  the  corpora- 
tion in  computing  its  taxable  net  income  since  January  1,  1909, 
any  amount  so  written  off  may  be  restored  in  computing  in- 
vested capital,  if  it  be  shown  to  the  satisfaction  of  the  Com- 
missioner that  the  amount  so  written  off"  represented  a  mere 
book  entry  ascribable  to  a  conservative  policy  of  management 
or  accounting  and  did  not  represent  a  realized  shrinkage  in  the 
value  of  such  assets.  Any  amount  so  restored  may  not  be 
written  ofl^  by  way  of  deductions  from  taxable  net  income  in 
any  subsequent  year  or  years.  Where  a  corporation  has  charged 
to  current  expenses  the  cost  of  developing  or  protecting  patents, 
no  amount  in  respect  thereof  expended  since  January  1,  1909, 
can  be  restored  in  computing  invested  capital.  In  respect  of  ex- 
penditures made  before  January  1,  1909,  a  corporation  now 
seeking  to  restore  them  must  be  prepared  to  show  to  the  satis- 
faction of  the  Commissioner  that  all  such  items  are  proper  cap- 
ital expenditures.  It  can  not  be  said  that  the  correct  computa- 
tidn  of  surplus  and  undivided  profits  necessarily  requires  a  de- 
duction in  respect  of  the  expiration  of  patents.  It  follows, 
therefore,  that  where  a  corporation  in  the  exercise  of  its  option 
has  not  written  down  the  cost  of  patents,  it  is  not  ordinarily 
necessary  to  reduce  the  surplus  and  undivided  profits  in  com- 
puting invested  capital,  whether  the  patents  have  been  acquired 
for  stock  or  shares  or  for  cash  or  other  tangible  property.  Due 
consideration  will  be  given  to  the  facts  in  any  case  in  which  this 
rule  seems  obviously  unreasonable.!^^ 

Property  Taken  for  Debt.  Real  or  personal  property  taken 
by  a  corporation  in  payment  or  satisfaction  of  a  debt,  or  prop- 
erty received  in  exchange  for  other  property,  will  be  an  admis- 
sible asset  at  its  fair  market  value  upon  receipt.  The  profit  or 
loss,  if  any,  resulting  from  the  transaction  will  not  be  reflected 
in  invested  capital  until  the  succeeding  taxable  year.i^^ 

Discount  on  Sale  of  Bonds.  Discount  allowed  on  the  sale  of 
bonds  is  in  effect  an  advance  on  account  of  interest,  so  that  the 
effective  rate  of  interest  in  such  a  case  is  equal  to  the  sum  of 
the  nominal  rate  plus  the  rate  necessary  to  amortize  the  dis- 
count over  the  life  of  the  bonds.  Where,  under  incorrect  ac- 
counting practices,  the  discount  on  bonds  has  been  charged  to  a 

193  A.  R.  R.  71,  T.  B.  18-20-906. 

194  Reg.  45,  Art.  843;  A.  R.  R.  436,  T.  B.  13-21-1536. 
193  Reg.  45,  Art.  847. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1063 

property  account  or  otherwise  carried  as  an  asset,  and  is  so  re- 
flected in  the  surplus  account,  it  is  necessary  in  computing  in- 
vested capital  to  make  an  adjustment  in  respect  of  such  dis- 
count.i-'^' 

Bank  Discount.  Only  the  amount  of  discount  which  has  ac- 
tually been  reported  by  a  bank  in  a  prior  year  as  taxable  in- 
come and  credited  to  surplus  account  may  be  included  in  surplus 
as  of  the  beginning  of  the  taxable  year.i^^ 

Current  Profits.  Profits  earned  during  any  year  can  not  be 
included  in  the  computation  of  invested  capital  for  that  year, 
even  though  during  the  year  such  profits  are  set  up  as  surplus  on 
the  books  or  assumed  to  be  distributed  in  the  form  of  stock  div- 
idends. If  a  dividend  is  declared  and  paid  during  any  year  out 
of  the  profits  of  that  year  and  the  stockholders  pay  back  into 
the  corporation  all  or  a  substantial  part  of  the  amount  of  such 
dividends,  the  amount  so  paid  back  can  not  be  included  in  the 
computation  of  invested  capital  unless  the  corporation  shows  by 
evidence  satisfactory  to  the  Commissioner  that  the  dividends 
were  paid  in  good  faith  and  without  any  understanding,  ex- 
press or  implied,  that  they  were  to  be  paid  back.^'*'^ 

Surrender  Value  of  Insurance  Policies.  Premiums  paid  by  a 
corporation  for  insurance  on  the  lives  of  its  ofl^icers  and  em- 
ployees payable  to  it  can  not  be  deducted  as  expenses  in  comput- 
ing taxable  income.  Such  insurance  policies  are  considered 
tangible  property  and  may  be  included  as  invested  capital  of 
the  corporation  at  their  cash  surrender  value  at  the  beginning 
of  the  taxable  year.  The  whole  amount  of  premiums  paid  on 
such  insurance  can  not  be  included  in  surplus,  but  the  surplus 
will  be  considered  as  increased  as  of  the  beginning  of  each  tax- 
able year  by  the  amount  added  to  the  cash  surrender  value  of  the 
policy.i^^  If  the  policy  has  no  cash  surrender  value,  its  loan 
value  as  of  the  beginning  of  the  year  is  an  admissible  asset  and 
may  be  included  in  invested  capital.-'^o  ^he  cash  surrender  value 
of  a  life  insurance  policy  which  constitutes  surplus  as  at  the 
beginning  of  the  taxable  year  for  invested  capital  purposes  re- 
tains its  character  as  surplus,  even  though  the  policy  constitut- 
ing the  admissible  asset  upon  the  basis  of  which  the  surplus  was 
determined  is  terminated  and  paid.^oi    But  where  the  insurance 

196  Reg.  45,  Art.  848. 

197  Reg.  45,  Art.  849. 

198  Reg.  45,  Art.  850. 

199  Reg.  45,  Art.  846;  A.  R.  R.  229,  T.  B.  41-20-1239. 

200  o.  D.  745,  T.  B.  49-20-1338. 

201  O.  D.  179,  T.  B.  7-19-309. 


1064  FEDERAL  INCOME  TAX 

policy  is  on  the  life  of  a  guarantor  of  accounts  of  the  corpora- 
tion, the  surrender  value  of  the  policy  may  not  be  included  in  in- 
vested capital,  since  the  premiums  thereon  are  deductible  from 
gross  income  as  business  expenses.-"- 

Additions  to  Surplus  Account.  A  corporation's  books  of  ac- 
count will  be  presumed  to  show  the  facts. -*^-'^  If  it  claims  that 
its  capital  or  surplus  account  is  understated  the  burden  of  proof 
will  rest  upon  it.  Additions  to  such  accounts  will  be  accepted 
to  the  following  extent:  (1)  Excessive  depreciation  heretofore 
charged  off  on  property  still  owned  and  in  use,  if  it  is  now 
shown  by  satisfactory  proof  to  have  been  excessive  and  such  ex- 
cess is  substantial  in  amount,  whether  or  not  disallowed  by  the 
Commissioner  as  a  deduction  from  gross  income,  may  be  re- 
stored to  the  surplus  account.  No  such  amount  may  be  restored, 
however,  unless  it  is  shown  that  adequate  depreciation  has  been 
deducted  upon  all  other  property  of  the  corporation  still  in  use, 
nor  in  any  case  in  which  such  amount  has  been  allowed  as  a  de- 
duction for  amortization  or  in  which  the  cost  of  the  property  has 
been  recovered  through  being  included  in  the  price  of  goods  or 
services,  as  for  example,  in  the  case  of  patterns,  dies,  plates, 
special  tools,  etc.,  or  under  a  munition  contract  with  a  foreign 
government;  (2)  Amounts  which  have  been  expended  before 
January  1,  1917,  for  the  acquisition  of  plant,  equipment,  tools, 
patterns,  furniture,  fixtures  or  like  tangible  property,  having 
a  useful  life  extending  substantially  beyond  the  year  in  which 
the  expenditure  was  made,  and  which  have  been  charged  as 
current  expense,  may  (less  proper  deductions  for  depreciation 
or  obsolescence)  be  added  to  the  surplus  account  when  such 
assets  are  still  owned  and  in  active  use  by  the  corporation  during 
the  taxable  year.  Special  tools,  patterns  and  similar  assets  will 
not  be  assigned  any  value  if  their  cost  has  been  recovered 
through  having  been  included  in  the  price  of  goods.  If  their 
cost  has  not  been  so  recovered  and  they  are  held  for  only  oc- 
casional use,  they  will  not  be  assigned  a  value  in  excess  of  the 
fair  value  based  upon  the  earnings  actually  arising  from  their 
current  use,  and  in  no  case  will  such  value  be  more  than  the  cost 
less  depreciation.  Assets  of  this  kind  not  in  current  use  will 
not  be  valued  at  more  than  their  nominal  or  scrap  value.-^^ 
(3)  Amounts  which  have  been  expended  in  the  past  for  intangible 
property  of  any  kind  can  be  restored  to  capital  or  surplus  ac- 

202  o.  D.  1109,  T.   B.  47-21-1938. 

203  o.  D.  1104,  T.  B.  46-21-1926. 

204  Reg.  45,  Art.  840;  O.  D.  901,  T.  B.  18-21-1615. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1065 

count  only  to  the  extent  that  the  corporation  specifically  paid 
such  amounts  for  the  intangible  property  as  such.-*'"'  (4)  Ad- 
justments necessary  to  correct  other  errors  found  in  the  books 
of  account  may  be  made.-*"' 

Limitation  of  Additions  to  Surplus.  Additions  to  surplus 
which  a  corporation  may  desire  to  make  under  the  preceding 
paragraph  fall  broadly  into  two  classes:  (1)  To  correct  returns 
of  income  for  prior  years  in  which  actual  errors  have  been  made, 
as  for  example  where  excessive  depreciation  has  been  deducted, 
additions  to  plant  and  equipment  or  other  capital  charges  have 
been  charged  off  as  an  expense,  inventories  have  been  taken  upon 
a  wrong  basis  of  valuation,  etc.;  (2)  To  reinstate  in  surplus 
deductions  from  income  which  are  as  a  matter  of  good  account- 
ing to  some  extent  optional,  such  as  experimental  expenses, 
patent  litigation,  development  of  good  will  through  advertising 
or  otherwise,  etc.  Adjustments  falling  in  class  (1)  will  be  per- 
mitted for  all  years,  whether  before  or  after  March  1,  1913,  pro- 
vided amended  returns  of  income  are  filed  for  each  year  in 
which  an  erroneous  return  has  been  made.  Due  consideration 
will  be  given  to  the  assessment  of  penalties  in  any  case  in  which 
a  fraudulent  return  has  been  made.  Adjustments  falling  in 
class  (2)  can  not  be  permitted,  as  in  such  cases  it  is  considered 
that  the  corporation  has  exercised  a  binding  option  in  deduct- 
ing such  expenses  from  income.  An  election  of  this  sort  which 
was  made  concurrently  with  the  transaction  can  not  now  be  re- 
vised, and  amended  returns  in  respect  thereof  can  not  be  ac- 
cepted.-"" The  purpose  of  this  rule  is  to  prevent  the  inclusion 
in  surplus  or  invested  capital  of  amounts  theretofore  charged 
to  expenses  when  an  intent  to  evade  taxation  may  be  inferred. 
The  doctrine  of  election  will  not  be  applied  to  transactions  ac- 
complished and  consummated  before  the  incidence  of  the  1909 
Law,  as  in  such  cases  the  capitalization  of  items  formerly 
charged  to  expense  can  not  be  impeached  as  an  attempt  to  evade 
taxation.-os     The  mere  fact  that  a  corporation  did  not  follow 

205  A.  R.  M.  141,  T.  B.  47-21-1937;  A.  R.  R.  32-21-1766;  A.  R.  R.  409, 
T.  B.  11-21-1512.  It  was  also  held  under  the  1917  Law  that  although 
large  sums  may  have  been  spent  in  advertising  and  thereby  an  extensive 
good  will  may  have  been  created,  the  sums  so  spent  could  not  be  considered 
as  amounts  paid  for  good  will  if  the  amounts  were  charged  to  general  ex- 
pense from  time  to  time.  Good  will  could  be  included  only  when  bought 
and  paid  for  specifically  as  such.  (Letter  from  treasury  department 
dated  March  5,  1918.) 

206  Reg.  45,  Art.  840;  Reg.  41,  Art.  64.     See  T.  B.  R.  6,  T.  B.  2-19-151. 
20TReg.  45,  Art.  841;  Reg.  41,  Art.  64;  O.  D.  901,  T.  B.  18-21-1615. 
208  A.  R.  M.  134,  T.  B.  27-21-1719. 


1066  FEDERAL  INCOME   TAX 

the  more  generally  approved  accounting  method  in  charging 
items  to  expense  will  not  entitle  it  to  capitalize  items  and  file 
amended  returns.  Thus,  a  corporation  which  issued  bonds  at  a 
discount  in  January,  1900,  and  elected  then  to  charge  such  dis- 
count to  profit  and  loss  for  the  year  of  issue  and  the  next  two 
succeeding  years,  may  not  now  revise  its  accounts  and  file 
amended  returns  for  the  purpose  of  reinstating  to  invested 
capital  the  unexpired  portion  of  such  discount  and  claiming  as 
a  deduction  from  income  that  portion  applicable  to  each  year.^o^ 
A  corporation  is  required  to  submit  with  its  return  a  statement 
of  the  additions  proposed,  specifying  the  kinds  and  amounts  of 
property  involved,  the  years  in  which  the  expenditures  were 
made,  and  the  method  followed  in  distinguishing  between  capital 
outlays  and  current  expenses,  and  showing  that  adequate  pro- 
vision has  been  made  for  depreciation,  obsolescence  and  deple- 
tion of  such  of  the  assets  afi'ected  by  the  additions  as  are  subject 
to  recognized  depreciation,  obsolescence  or  depletion.  In  any 
case  in  which  there  is  an  operating  deficit,  amounts  restored 
must  first  be  set  off  against  the  deficit  and  only  the  excess  can 
be  actually  included  in  the  computation  of  invested  capital.^io 

Property  Paid  in  and  Subsequently  Written  Off.  Where 
tangible  or  intangible  property  has  been  paid  in  to  a  corpora- 
tion for  stock  or  shares  or  as  paid-in  surplus,  and  has  subse- 
quently been  in  whole  or  in  part  written  off  the  books,  the 
amount  so  written  off  may  upon  evidence  satisfactory  to  the 
Commissioner  be  restored  to  the  capital  or  surplus  account  sub- 
ject to  the  following  limitations:  (1)  The  amount  restored  must 
be  reduced  by  a  proper  deduction  for  any  depreciation,  obsoles- 
cence or  depletion;  and  (2)  the  aggregate  amount  included  in 
computing  invested  capital  on  account  of  such  property  must 
not  exceed  the  amount  which  might  have  been  included  if  such 
property  had  not  been  written  off  .^n 

Borrowed  Capital.  The  term  "borrowed  capital"  means 
money  and  other  property  borrowed,  whether  represented  by 
bonds,  notes,  open  accounts,  or  otherwise.212     Invested  capital 

209  A.  R.  R.  394,  T.  B.  8-21-1472. 

210  Reg.  45,  Art.  841. 

211  Reg.  45,  Art.  842. 

212  Revenue  Acts  of  1918  and  1921,  §325  (a).  Under  the  1917  Law  it 
was  held  that  the  term  "money  or  other  property  borrowed"  included  not 
only  cash  or  other  borrowed  property  which  could  be  identified  as  such,  but 
current  liabilities  and  temporary  indebtedness  oft  all  kinds,  and  any  per- 
manent indebtedness  upon  which  the  taxpayer  was  entitled  to  an  interest 
deduction  in  computing  net  income.     A  corporation  which  was  allowed  to 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1067 

does  not  include  borrowed  capital.-^^  Where  the  amount  of  bor- 
rowed capital  is  abnormal,  however,  the  taxpayer  may  apply  for 
assessment  by  reference  to  representative  corporations.-^-* 
Stockholders  have  no  vested  right  in  the  surplus  of  a  corpora- 
tion, A  corporation  can  not,  without  consideration,  issue  notes 
to  its  stockholders  for  the  amount  of  its  surplus,  except  by  dec- 
laration of  dividends  jn-o  rata  according  to  stockholdings.  Treas- 
ury demand  notes  (never  delivered)  drawn  by  order  of  the 
president  of  a  corporation  payable  to  its  stockholders,  but  not  in 
proportion  to  stockholdings,  do  not  constitute  a  liability  of  the 
corporation,  even  though  such  notes  are  charged  against  surplus 
on  the  company's  books.^i^  items  such  as  deposits  or  amounts 
due  to  other  banks  shown  in  the  balance  sheet  of  a  bank,  unex- 
pired subscriptions  shown  in  the  balance  sheet  of  a  publishing 
concern,  etc.,  are  deemed  liabilities  and  can  not  be  included  in 
computing  invested  capital.^i^  Any  interest  in  a  corporation  rep- 
resented by  bonds,  debentures  or  other  securities,  by  whatever 
name  called,  including  so-called  preferred  stock,  if  with  respect 
to  the  payment  of  either  interest  or  principal  it  ranks  with  or 
prior  to  the  interest  of  the  general  creditors,  is  borrowed  cap- 
ital and  can  not  be  included  in  computing  invested  capital. 
Any  such  preferred  stock,  may,  however,  be  so  included  if  it  is 
deferred  with  respect  to  the  payment  of  both  interest  and  prin- 
cipal to  the  interest  of  the  general  creditors.^i'  Preferred  stock 
if  in  the  records  of  the  corporation  it  is  declared  to  be  part  of  its 
capital  stock  though  convertible  into  first-mortgage  bonds  of 
even  date  therewith,  is  inferior,  on  a  distribution  of  assets  to 
pay  debts,  to  the  rights  of  general  creditors,  and  is  to  be  treated 

deduct  only  a  part  of  the  interest  paid  on  its  indebtedness  might  include 
in  invested  capital  such  proportion  of  its  permanent  indebtedness  as  the 
amount  of  interest  upon  such  indebtedness  which  the  corporation  was  not 
allowed  to  deduct  bore  to  the  total  amount  of  interest  paid  upon  such  in- 
debtedness during  the  taxable  year.     (Reg.  41,  Art.  44.) 

213  Revenue  Acts  of  1918  and  1921,  §326    (b). 

214  See  p.  1116. 

215  A.  R.  R.  473,  T.  B.  17-21-1602. 
210  Reg.  45,  Art.  814. 

217  Reg.  45,  Art.  812.  Where  the  principal  stockholder  of  a  corporation 
loans  money  to  the  corporation  and,  in  order  to  protect  the  credit  of  the 
corporation,  an  agreement  is  signed  to  the  effect  that  the  lender  shall  be 
deferred  to  all  other  creditors  and  shall  receive  one  per  cent,  additional 
interest  in  consideration  thereof,  which  interest  is  not  deducted  by  the 
corporation  as  expense,  the  amount  of  the  loan  cannot  be  included  in  in- 
vested capital  as  preferred  stock.  (Telegram  from  Treasury  Department 
dated  April  4,  1919;  W.  T.  S.  1919,  111021.) 


1068  FEDERAL  INCOME  TAX 

as  invested  capital  so  long  as  it  is  not  converted.^i^  The  ques- 
tion is  not  what  the  parties  call  an  instrument  but  what  the 
facts  and  circumstances  require  it  to  be  called.  The  courts  are 
not  influenced  by  mere  names  but  look  beyond  names  and  give 
to  the  subject  dealt  with  the  character  and  status  which  its 
properties  denote  it  possesses.-i'^  The  term  "debenture"  is  well 
known  in  England  to  describe  any  instrument  issued  by  a  cor- 
poration which  creates  or  acknowledges  a  debt.  As  stated  by 
Lindley,  debenture  stock  is  of  the  same  nature  as  ordinary 
debentures,  except  that  instead  of  each  bond  securing  a  definite 
amount,  the  whole  sum  secured  is  treated  as  a  single  stock,  the 
bonds  are  issued  declaring  the  holder  to  be  entitled  to  a  definite 
sum,  part  of  this  stock.  This  sum  is  not  necessarily  a  round 
sum,  but  may  be  for  any  number  of  pounds,  it  may  include  frac- 
tions of  a  pound  unless  limitation  is  made  in  that  respect.  A 
debenture  stock  may  be  repayable  at  a  fixed  date,  or  may  be  ir- 
redeemable, according  to  the  deed  creating  it,  and  may  be  se- 
cured in  any  manner  in  which  a  debenture  may  be  secured.—o 
Irredeemable  notes  or  bonds  are  not  so  well  known  in  this  coun- 
try. There  are  instances,  however,  of  such  perpetual  debts  and 
it  has  been  held  that  the  character  of  such  obligations  is  not 
affected  by  the  fact  that  they  are  not  redeemable  at  a  fixed 
time.--^  Certificates  stating  that  a  corporation  is  indebted  in  a 
specified  amount  to  the  holders  thereof  payable  at  the  expiration 
of  corporate  existence,  the  payment  of  the  principal  being  sub- 
ordinated to  other  indebtedness,  may  still  be  regarded  as  a  debt 
and  consequently  as  borrowed  capital.  Such  certificates  do  not 
constitute  preferred  stock.  The  term  "stock"  does  not  mean  a 
debt  but    refers  to    an    interest    in    a    corporate    enterprise.222 

218  S.  1200,  T.  B.  27-19-609. 

219  Spencer  v.  Smith,  201  Fed.  647;  Heller  v.  National  Marine  Bank,  89 
Md.  601,  43  Atl.  800. 

220Lindley's  Company  Law,  195. 

221  Philadelphia  &  Reading  R.  Co.  v.  Stichter,  11  Weekly  Notes  of  Cases, 
Pennsylvania,  325. 

222  It  should  be  noted  that  the  instruments  under  consideration  in  this 
ruling  afforded  some  security  to  the  holders  thereof  by  a  provision  pre- 
venting the  corporation  from  mortgaging  its  property  or  franchises  with- 
out the  written  consent  of  at  least  two-thirds  of  the  holders.  There  were 
no  indications  that  the  parties  intended  the  holders  to  be  stockholders,  the 
certificates  having  been  issued  under  a  clause  in  the  charter  granting 
power  to  borrow  money  and  not  to  issue  stock.  The  certificates  provided 
specifically  for  the  payment  of  interest  at  a  specified  rate  per  annum. 
There  was  no  qualification  in  the  charter  or  by-laws  of  the  company  limit- 
ing this  obligation  and  no  reason  appeared  why  the  holders  of  such  cer- 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1069 

Whether  or  not  amounts  received  by  a  corporation  upon  the  sale 
of  so-called  debenture  stock  constitute  invested  capital  or  bor- 
rowed capital  depends  upon  the  rights  and  powers  enjoyed  by 
the  holders  of  such  stock  and  the  obligations  with  respect  there- 
to undertaken  by  the  corporation;  where  so-called  debenture 
stock  is  issued  by  a  corporation  for  cash  or  property  under  a 
power  granted  by  the  charter  to  borrow  money,  and  the  cer- 
tificates of  such  stock  contain  an  agreement  on  the  part  of  the 
corporation  to  repay  the  face  amount  thereof  upon  dissolution, 
and  to  pay  interest  thereon  from  time  to  time,  at  a  certain  rate 
per  cent,  per  annum ;  and  where  it  appears  that  the  claim  of  such 
debenture  stockholders  will,  upon  dissolution  of  the  coiT)oration, 
be  subordinate  to  the  claims  of  general  creditors  but  superior  to 
the  claims  of  the  ordinary  stockholders;  and  where  it  further 
appears  that  the  holders  of  such  certificates  exercise  no  voice  in 
the  control  or  management  of  the  corporation,  the  amounts  re- 
ceived for  the  sale  of  such  stock  constitute  borrowed  capital, 
and  the  interest  paid  thereon,  from  time  to  time,  by  the  cor- 
poration is  properly  deductible  as  a  business  expense. --■•  Where 
upon  the  organization  of  a  corporation  bonds  were  issued  for 
the  tangible  property  received  and  interest  was  paid  to  the  own- 
ers of  such  bonds  up  to  the  year  1917  (paid  and  deducted  by  the 
corporation  to  the  year  1917)  it  has  been  held  under  the  Rev- 
enue Act  of  1917  that  the  amount  of  such  bonds  is  borrowed 
capital  and  can  not  be  included  in  invested  capital  even  though 
the  minutes  of  the  organization  meeting  of  the  corporation  con- 
tained a  resolution  providing  that  the  bonds  should  be  "subject 
to  all  rights  of  creditors  of  said  corporation  now  existing  and 
at  all  times  existing  during  the  terms  of  said  bonds"  and  even 
though  in  1918  the  bondholders  turned  in  their  bonds  in  ex- 
change for  preferred  stock.  It  was  held  that  the  fact  that  the 
corporation  did  not  deduct  interest  on  the  bonds  in  filing  its  1917 
returns  was  not  suflftcient  to  change  or  fix  the  status  for  pur- 

tificates  could  not  sue  for  the  interest  if  default  in  payment  was  made. 
These  considerations  were  foreign  to  the  idea  of  preferred  stock  since  a 
preferred  stockholder  is  not  a  creditor  of  the  corporation  (Warren  v. 
King,  108  U.  S.  389,  2  Sup.  Ct.  789)  and  cannot  sue  for  dividends  unless 
they  are  declared.  Moreover,  there  was  no  indication  in  the  charter  or  by- 
laws of  an  intent  that  the  holders  of  the  certificates  should  share  in  the 
corporate  assets  over  and  above  the  first  amount  of  their  interest. 

223  A.  R.  R.  237,  T.  B.  33-20-1142.  Upon  the  question  of  including  deben- 
ture stock  in  invested  capital  see  also  Doershuck  v.  U.  S.,  U.  S.  Dist.  Ct. 
E.  D.  N.  Y.;  T.  D.  3170,  T.  B.  24-21-1681. 


1070  FEDERAL  INCOME   TAX 

poses  of  invested  capital  nor  was  the  subordination  of  the  liens 
of  the  bonds  to  the  claims  of  general  creditors.--^ 

Amounts  Paid  into  or  Left  in  Business.  Whether  a  given 
amount  paid  into  or  left  in  the  business  of  a  corporation  con- 
stitutes borrowed  capital  or  paid-in  surplus  is  largely  a  question 
of  fact.  Thus,  indebtedness  to  stockholders  actually  canceled 
and  left  in  the  business  would  ordinarily  constitute  paid-in  sur- 
plus, while  amounts  left  in  the  business  representing  salaries  of 
officers  in  excess  of  their  actual  withdrawals  or  deposit  accounts 
in  favor  of  partners  in  a  partnership  succeeded  by  the  corpora- 
tion, will  be  considered  paid-in  surplus  or  borrowed  capital  accord- 
ing to  the  facts  of  the  particular  case.  Where  a  valid  obliga- 
tion on  the  part  of  a  corporation  to  pay  salaries  to  officers  exists, 
and  the  officers  waive  their  rights  to  a  part  of  such  salaries, 
the  amount  waived  constituted  paid-in  surplus.—s  The  general 
principle  is  that  if  interest  is  paid  or  is  to  be  paid  on  any  such 
amount,  or  if  the  stockholdes'  or  officers'  right  to  repayment 
of  such  amount  ranks  with  or  before  that  of  the  general 
creditors,  the  amount  so  left  with  the  corporation  must  be  con- 
sidered as  borrowed  capital.—e  Special  accounts  of  stockholders 
created  because  of  amounts  left  in  the  business  by  certain  of  the 
stockholders  only  and  represented  by  interest-bearing  notes  in 
favor  of  such  stockholders,  cannot  be  considered  invested  capital, 
even  though  such  notes  carry  a  condition  that  demand  for  pay- 
ment will  not  be  made  until  all  general  creditors  are  satisfied."7 
In  1915  the  principal  stockholders  paid  into  a  company  a  sum 
of  money,  no  stock  being  issued  therefor,  no  interest  charged, 
and  no  action  was  taken  by  the  corporation  to  indicate  the  nature 
of  the  payment  except  that  it  was  entered  as  a  contribution  to 
capital  and  was  never  treated  as  an  account  payable.  The  sum 
was  repaid  in  1917,  there  being  no  evidence  as  to  the  nature  of 
the  payment  nor  how  it  was  treated  by  the  corporation.  It 
was  held  that  the  payment  was  in  the  nature  of  a  voluntary 
assessment;  that  the  repayment  must  be  deemed  to  be  out  of 
undivided  profits  or  earned  surplus  so  far  as  possible ;  that  such 
repayment  could  not  be  treated  as  a  return  of  capital  unless 
the  undivided  profits  and  earned  surplus  accumulated  since 
March  1,  1913,  were  first  distributed  as  dividends ;  that  the 
corporation  should  be  permitted  to  include  the  amount  in  its 

224  A.  R.  R.  116,  T.  B.  21-20-962. 

225  0.  D.  1034,  T.  B.  37-21-1821. 
22GReg.  45,  Art.  813. 

227  A.  R.  R.  356,  T.  B.  52-20-1366;  A.  R.  R.  102,  T.  B.  21-20-963. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1071 

invested  capital  for  1917  as  paid-in  surplus,  proper  adjustment 
being  made  for  any  distributions  of  dividends  in  excess  of 
available  net  earnings.—s 

In  a  case  arising  under  the  1917  Law,  an  amount  was  paid  in 
to  a  corporation  regularly  by  its  stockholders  under  a  resolution 
making  an  assessment  upon  such  stockholders.  This  amount 
was  entered  on  the  corporatioru's  books  as  a  capital  reserve  fund 
and  in  1917  was  carried  as  "advances  by  stockholders."  No 
stock  was  issued  for  the  amount  and  no  notes  were  given  by 
the  corporation  acknowledging  its  indebtedness  to  the  stock- 
holders therefor.  Interest  was  paid  upon  the  advance  and  was 
deducted  by  the  corporation  regularly  each  year  in  computing 
net  income.  The  treasury  department  held  this  advance  by 
the  stockholders  not  to  constitute  borrowed  capital  and  per- 
mitted its  inclusion  in  invested  capital  on  the  theory  that  the 
stockholders  would  not  be  entitled  to  repayment  before  the 
general  creditors  had  been  satisfied.  The  interest  paid  by  the 
corporation  was  regarded  as  in  the  nature  of  a  dividend  upon 
preferred  stock.229 

Dividends  Credited  to  Stockholders.  Where  a  corporation 
by  the  consent  of  all  the  stockholders,  declares  dividends,  but 
through  lack  of  cash  with  which  to  make  actual  payment  credits 
the  amount  of  the  dividends  to  the  accounts  of  the  shareholders, 
such  dividends  being  treated  as  liabilities  of  the  corporation  and 
no  interest  being  paid  or  accrued  thereon,  it  has  been  held  that 
the  effect  on  the  corporation's  surplus  and  the  rights  of  the 
stockholders  are  the  same  as  if  the  dividend  had  been  formally 
declared  and  paid.  The  corporation,  while  having  the  use  of  the 
amounts  so  credited,  is  at  all  times  liable  for  them  to  the  stock- 
holders and  must  treat  such  amounts  as  borrowed  capital.-^o 

Informal  Dividends;  Credit  Balances  to  Stockholders' 
Accounts.  Where  a  corporation  notes  and  credits  to  its  stock- 
holders their  proportionate  shares  of  each  year's  earnings  to 
which  they  would  be  entitled  under  a  dividend  declaration,  and 
such  stockholders  return  such  credited  earnings  and  pay  income 
tax  thereon,  but  no  interest  is  paid  upon  the  amounts  stand- 
ing to  the  credit  of  the  stockholders  and  no  formal  dividend 
declaration  is  made  by  the  board  of  directors,  the  amounts 
so  credited  may  be  regarded  as  a  part  of  earned  surplus,  pro- 
vided that  under  the  state  law  the  stockholders  do   not  rank 

228  T.  B.  M.  82,  T.  B.  23-19-552. 

229  A.  R.  M.  44,  T.  B.  18-20-905.     See  also  A.  R.  R.  78,  T.  B.  18-20-904. 

230  O.  D.  1006,  T.  B.  34-21-1786.    See  p.  1066. 


1072  FEDERAL   INCOME   TAX  , 

with  general  creditors  in  respect  of  such  credits.^^i  But  in  a 
case  arising  under  the  1917  Law  -^-  very  similar  in  its  facts  ex- 
cept that  the  balances  standing  to  the  credit  of  the  stockholders 
were  not  in  proportion  to  their  stockholdings  a  different  con- 
clusion was  reached.  The  corporation  involved  had  three  stock- 
holders. During  the  lifetime  of  these  stockholders  no  distri- 
bution of  profits  was  made  and,  the  earnings  were  allowed  to 
accumulate  from  year  to  year.  At  the  death  of  one  stock- 
holder, in  1907,  the  board  of  directors  passed  a  resolution  order- 
ing the  reserve  fund  to  be  prorated  and  credited  to  the  deposit 
accounts  of  the  three  principal  stockholders,  which  was  done. 
None  of  these  profits  was  withdrawn;  the  business  pro- 
ceeded as  before  and  the  profits  were  allowed  again  to  accumu- 
late until  1909,  when  a  second  stockholder  died,  and  the  same 
procedure  was  taken  as  in  1907.  From  the  inception  of  the 
business  no  dividend  was  ever  declared  nor  were  any  of  the 
profits  withdrawn  from  the  business  or  segregated  from  sur- 
plus except  as  above  stated ;  but  against  the  accounts  credited 
comparatively  small  charges  were  made  from  time  to  time  to 
cover  living  expenses  of  two  of  the  stockholders.  Substantially 
all  of  the  profits  thus  credited,  by  verbal  agreement  were  left 
in  the  corporation  funds  for  the  conduct  of  its  business ;  on  the 
amounts  so  credited  no  interest  was  ever  paid  by  the  corpora- 
tion nor  were  notes  issued  therefor,  for  the  reason  that  they 
were  never  considered  as  obligations  of  the  corporation ;  but,  on 
the  contrary,  as  funds  left  in  the  business  to  be  used  as  capi- 
tal; and  banks  and  other  large  creditors  of  the  corporation 
were  cognizant  of  this  verbal  agreement,  and  by  reason  of  it 
extended  credit  to  the  corporation  on  these  funds  considered 
as  capital.  It  was  admitted  that  the  credits  were  not  "surplus" 
in  the  sense  that  all  the  stockholders  had  a  right  to  share  in 
them  ratably.  The  committee  on  appeals  and  review  ruled 
that  the  credits  ranked,  in  law,  with  the  claims  of  other  gen- 
eral creditors;  even  though  by  the  good  faith  and  honor  of  the 
three  stockholders,  they  would  be  voluntarily  deferred  until 
the  claims  of  the  other  general  creditors  had  been  liquidated  in 
full  and  that  the  corporation  was  not  being  penalized  merely 
because  of  its  failure  to  have  made  a  "book  entry"  converting 
these  credits  into  capital  stock  because  the  credits,  being  a 
direct  and  fixed  obligation  of  the  corporation,  had  not  the  same 

231  A.  R.  M.  71,  T.  B.  29-20-1081. 

232  The  1917,  1918  and  1921  Laws  are  not  distinguishable  in  their  pro- 
visions governing  the  point. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1073 

status  among  the  corporation's  liabilities  as  would  have  been 
the  case  had  they,  by  formal  action  of  the  board,  been  con- 
verted into  capital  stock  and  certificates  issued  therefor,  or  had 
the  interested  stockholders  waived  all  proprietary  rights  to 
them  and  thus  actually  contributed  them  to  surplus.-"^-' 

Conversion  of  Bonds  into  Stock.  Where  bonds  are  ex- 
changed for  stock  in  the  same  corporation  under  the  terms  of 
a  convertible  trust  deed,  it  will  be  presumed,  for  the  purpose 
of  computing  invested  capital,  that  the  value  of  the  bonds  is 
equivalent  to  the  value  of  the  stock.  The  addition  to  invested 
capital  vv^ould  accordingly  be  the  amount  for  which  the  bonds 
were  originally  sold.-^^ 

Computing  Invested  Capital.  In  computing  invested  capital 
the  first  step  is  to  add  together  the  paid-in  capital  and  paid-in 
or  earned  surplus  and  undivided  profits  (under  whatever  name 
the  same  may  be  called)  as  shown  by  the  books  at  the  begin- 
ning of  the  taxable  year.  The  total  thus  obtained  is  to  be  ad- 
justed for  any  asset  or  item  which  it  covers  that  is  not  car- 
ried on  the  books  at  the  valuation  prescribed  by  law.-^'^  After 
the  various  adjustments  are  made  the  adjusted  total  of  the 
capital  and  surplus  account  will  represent  the  invested  capital 
at  the  beginning  of  the  taxable  year.  If  there  has  been  any 
change  made  during  the  taxable  year  in  the  amount  of  in- 
vested capital,  the  reduction  or  increase  must  be  noted  in  order 
to  average  the  invested  capital  for  the  year.  Whenever  any 
corrections  are  made  in  respect  of  the  capital  stock  or  surplus, 
corresponding  corrections  must  be  made  in  the  respective  asset 
items  in  the  balance  sheet  of  the  taxpayer  accompanying  the 
return.236  But  it  is  not  necessary  that  the  books  also  be  changed, 
provided  some  permanent  record  of  the  adjustments  is  kept.-'^^ 

Admissible  Assets.  The  term  "admissible  assets"  means  all 
assets  other  than  inadmissible  assets.  Organization  expenses 
and  deferred  charges  against  future  income  are  admissible  assets. 
Admissible  assets  must  be  valued  in  accordance  with  the  pro- 
visions of  the  law  regarding  invested  capital. -^^  Thus,  for 
example,  intangible  property  paid  in  for  stock  or  shares  is  an 
admissible  asset,  but  it  cannot  be  valued  at  an  amount  in  excess 
of  that  at  which  it   may   be   included   in   computing   invested 

233  A.  R.  R.  102,  T.  B.  21-20-963. 

234  0.  D.  306,  T.  B.  24-19-577. 

235  This  was  the  rule  under  the  1917  Law.     See  Reg.  41,  Art.  53. 
23fiReg.  41,  Art.  53. 

237  Letter  from  treasury  department  dated  March  19,  1918. 
23S  Revenue  Acts  of  1918  and  1921,  §  325. 


1074  FEDERAL  INCOME  TAX 

capital  under  the  provision  of  law  limiting  such  amount  to  25% 
of  the  par  value  of  the  total  stock  or  shares  of  the  corporation 
outstanding  on  March  3,  1917,  or  at  the  beginning  of  the  tax- 
able year  accordingly  as  such  property  was  paid  in  prior  to  or 
on  or  after  March  3,  1917.239 

School  District  Warrants.  Warrants  drawn  by  a  school 
district  on  the  superintendent  of  schools  for  a  county  in  favor 
of  the  teachers  of  public  schools  of  a  district  and  cashed  by  a 
bank,  but  returned  by  the  superintendent  with  a  notation  of 
"no  funds"  and  carried  by  the  bank  without  any  remuneration 
in  the  form  of  interest  or  discount  are  admissible  assets,  since 
obligations  to  be  inadmissible  must  be  potentially  interest-bear- 
ing or  dividend-producing  securities.-^^ 

Insurance  Policies.  Insurance  policies  on  the  lives  of 
officers  are  admissible  assets,  as  indicated  elsewhere  in  this 
chapter.241 

Inadmissible  Assets.  The  term  "inadmissible  assets"  means 
stocks,  bonds,  and  other  obligations  (other  than  obligations  of 
the  United  States)  the  dividends  or  interest  from  which  are 
not  required  to  be  included  in  computing  net  income.^^^  Where, 
however,  the  income  derived  from  such  assets  consists  in  part 
of  gain  or  profit  derived  from  the  sale  or  other  disposition 
thereof,  or  where  all  or  part  of  the  interest  derived  from  such 
assets  is  in  effect  included  in  the  net  income  because  of  the 
limitation  upon  the  deduction  of  interest,-^^  the  corresponding 
part  of  such  assets  is  not  deemed  to  be  inadmissible.^^*  A  cor- 
poration cannot  by  including  the  income  from  inadmissible  assets 
as  taxable  income  create  the  right  to  have  such  assets  con- 
sidered admissible  assets.^*^     Inadmissible  assets  will  for  the 

239  Reg.  45,  Art.  818.  Revenue  Acts  of  1918  and  1921,  §326  (a)  4,  5. 
Good  will  so  far  as  it  is  built  up  and  developed  by  advertising  not  charged 
to  expense  may  be  included  in  invested  capital.  A  corporation  may  in  the 
future  exercise  an  option  and,  if  it  so  desires,  treat  advertising  as  a  capital 
item,  not  deducting  it  as  an  expense,  in  which  case  it  may  become  entitled 
to  include  a  pro  tanto  amount  of  good  will  in  its  invested  capital  and  make 
an  addition  to   surplus  accordingly. 

240  o.  D.  1096,  T.  B.  45-21-1915. 

241  See  p.  1063. 

242  Under  the  1917  Law  inadmissible  assets  were  such  stock,  bonds  or 
other  assets  the  income  of  which  was  not  subject  to  the  excess-profits  tax. 
(Reg.  41,  Art.  44.) 

243  See  Revenue  Acts  of  1918  and  1921,  §  234  (a)  2. 

244  Revenue  Acts  of  1918  and  1921,  §325. 

245  Reg.  45,  Art.  815. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1075 

purpose  of  discussion  in  the  following  paragraphs  be  divided 
into  three  classes,  (1)  stocks  of  domestic  corporations;  (2) 
stocks  of  foreign  corporations,  and  (3)  bonds  and  other 
obligations. 

Stock  in  Federal  Reserve  Bank.  Federal  Reserve  Bank 
stock,  held  by  a  member  bank,  is  an  inadmissible  asset  in  de- 
termining invested  capital.-^*' 

Stock  of  Domestic  Corporations.  The  statute  apparently 
intends  that  stocks  of  domestic  corporations  are  ipso  facto  in- 
admissible assets  in  computing  the  invested  capital  of  the  stock- 
holder. The  law  provides  that  the  term  "inadmissible  assets" 
means  ''stock  *  *  *  the  dividends  *  *  *  from  which 
is  [are]  not  included  in  computing  net  income."  -^^  Hence  it 
follows  that  it  is  immaterial  whether  the  corporation  whose 
stock  is  held  actually  pays  dividends  thereon  or  not,  or 
whether  its  operations  are  carried  on  within  or  without  the 
jurisdiction  of  the  United  States.  Although  many  corpora- 
tions find  it  necessary  for  business  reasons  to  hold  stock  in 
other  corporations  which  do  not  pay  dividends  and  such  invest- 
ment is  in  fact  a  necessary  and  proper  investment,  as  for  in- 
stance where  several  corporations  may  own  the  stock  of  storage, 
warehouse  or  terminal  companies  for  their  joint  benefit  (such 
jointly  held  corporations  not  being  intended  to  pay  dividends) 
the  stock  is  nevertheless  inadmissible  under  a  literal  interpreta- 
tion of  the  law.  To  hold  that  stock  of  a  domestic  corporation 
is  admissible  if  the  corporation  paid  no  dividends,  during  the 
taxable  year,  but  inadmissible  if  the  corporation  paid  dividends 
and  the  same  were  not  included  in  the  net  income  of  the  stock- 
holder, would  be  to  establish  an  impracticable  rule,  and  one 
plainly  not  intended  by  the  language  of  the  law.  Hence  it  has 
been  ruled  that  the  failure  to  pay  or  to  receive  dividends  does 
not  change  the  status  of  stock  as  an  inadmissible  asset.-"*^ 
Apparently  the  only  way  that  stock  of  a  domestic  corpora- 
tion can  become  an  admissible  asset  is  by  selling  the  stock, 
in  which  case  the  profit  is  included  in  net  income  and  all  or  a 
portion  of  the  value  of  the  stock  becomes  an  admissible  asset, 
as  is  more  fully  stated  in  a  subsequent  paragraph. 

Stock  of  Domestic  Corporations  Deriving  Substantial 
Income  from  Possessions  of  the  United  States.  The  Rev- 
enue Act  of  1921  provides  for  the  taxation  of  domestic  corpora- 

246  Letter    from    treasury   department   dated    March    13,    1919;    W.    T.    S. 
1921,  ^744;   O.  D.  81,  T.  B.  1-19-118. 

247  Revenue  Acts  of  1918  and  1921,  §325   (a). 

248  Reg.  45,  Art.  815. 


1076  FEDERAL  INCOME   TAX 

tions  only  with  respect  to  income  from  sources  within  the  United 
States,  if  such  domestic  corporations  derive  80%  of  their  gross 
income  for  a  three-year  period  preceding  the  close  of  the 
taxable  year  from  sources  within  a  possession  of  the  United 
States  (excluding  the  Virgin  Islands),  and  50%  of  their  gross 
income  for  such  period  from  the  active  conduct  of  a  trade  or 
business  within  a  possession  of  the  United  States.^^o  Dividends 
on  the  stock  of  such  corporations  are  not  deductible  from  the 
gross  income  of  corporations,  and  such  stock  is,  therefore,  an 
admissible  asset.-^o 

Stock  of  Foreign  Corporations.  If  a  foreign  corporation 
paid  an  income  tax  to  the  United  States  on  any  part  of  its 
income,  its  dividends  were  not  taxed  under  the  1918  Law  when 
received  by  a  domestic  corporation ;  ^oi  and  it  followed  that  the 
stock  of  such  foreign  corporation  was  an  inadmissible  asset.-^^ 
On  the  other  hand,  if  such  foreign  corporation  paid  no  income 
tax  to  the  United  States  its  stock  was  an  admissible  asset.^^'*^ 
This  rule  is  changed  by  the  Revenue  Act  of  1921.  Dividends 
from  a  foreign  corporation  are  free  from  tax  under  the  present 
law,  when  received  by  a  corporation  only  if  it  is  shown  that  more 
than  50%  of  the  gross  income  of  such  foreign  corporation,  for 
the  three-year  period  ending  with  the  close  of  the  taxable  year 
preceding  the  declaration  of  dividends,  was  derived  from  sources 
within  the  United  States.^^^  The  stock  of  foreign  corpora- 
tions with  respect  to  which  this  can  be  shown  will  be  inadmis- 
sible assets  under  the  present  law;  the  stock  of  other  foreign 
corporations  will  be  admissible  assets.^s^ 

Bonds  or  Other  Obligations.  The  bonds  or  other  obliga- 
tions which  are  inadmissible  assets  are  only  those  "the  interest 

249  Revenue  Act  of  1921,  §  262. 

250  Revenue  Act  of  1921,  §§234   (a)   6,  325   (a). 

251  Letter  from  treasury  department  dated  June  9,  1919;  I.  T.  S.  1919, 
II  3427.     See  Chapter  19. 

252  0.  D.  305,  T.  B.  24-19-576. 

253  The  rule  was  different  under  the  1917  Law.  See'  Reg.  41,  Arts.  27 
and  46.  But  it  seems  that  the  rule  stated  in  the  text  is  applicable  to  assess- 
ments under  that  law  as  well  as  the  present  law.  Formerly  in  the  case 
of  a  domestic  corporation  or  partnership  and  of  citizens  or  residents  hold- 
ing stock  in  a  foreign  corporation  part  of  whose  net  income  was  subject 
to  tax,  there  might  be  included  in  invested  capital  such  proportion  of  the 
value  of  the  stock  as  the  net  income  of  such  foreign  corporation  from 
sources  outside  the  United  States  was  of  its  entire  net  income.  (Reg.  41, 
Art.  46.) 

254  Revenue  Act  of  1921,  §  234   (a)   6. 

255  Revenue  Act  of  1921,  §325   (a). 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1077 

from  which  is  not  included  in  computing  net  income."  -•"'"  Bonds 
and  securities  of  industrial  or  railroad  corporations — domestic 
or  foreign — are  admissible,  even  though  the  bond  may  have  a 
so-called  "tax-free  covenant."  Bonds  issued  by  exempt  cor- 
porations are  admissible  assets.  Bonds  and  obligations  of  the 
United  States  are  admissible,  even  if  the  interest  is  exempt. 
Such  bonds,  however,  are  only  bonds  of  the  federal  government 
and  not  of  its  possessions.  Bonds  and  obligations  which  are 
inadmissible  assets  are  those  issued  by  a  state  or  territory  (or 
a  political  subdivision  of  either,  i.  e.,  county,  city,  township, 
etc.),  the  District  of  Columbia  and  the  possessions  of  the  United 
States,  and  also  securities  issued  under  the  provisions  of  the 
Federal  Farm  Loan  Act  of  July  17,  1916.-"^"  Bonds  of  the 
War  Finance  Corporation  are  admissible  if  the  income  there- 
from is  subject  to  the  tax,  but  that  part  of  the  principal  amount 
of  such  bonds  with  respect  to  which  interest  may  be  exempt 
from  excess-profits  tax  is  inadmissible.  Thus,  bonds  of  the 
War  Finance  Corporation  the  principal  of  which  does  not  exceed 
$5,000  are  inadmissible  assets,  and  bonds  of  the  War  Finance 
Corporation  the  principal  of  which  exceeds  $5,000  are  admis- 
sible assets.-^''''^  Since  the  income  derived  from  Porto  Rico  and 
Hawaii  bonds  is  not  subject  to  tax,  the  bonds  are  inadmissible 
assets  and  can  not  therefore  be  included  in  invested  capital.-^'' 
Four  per  cent,  bonds  of  the  government  of  the  Philippine  Islands 
are  also  inadmissible  assets.-""  The  conversion  of  certificates  of 
indebtedness  purchased  by  a  corporation  in  1918  into  Victory 
Liberty  Loan  notes  of  the  same  value  does  not  affect  invested 
capital.-*'!  In  computing  the  amount  of  admissible  assets,  the 
total  cost  of  bonds  subscribed  for,  whether  fully  paid  or  not, 
may  be  included  in  admissible  assets.-*"'-  Federal  land  bank 
bonds  -"^  and  school  warrants  issued  by  a  county  of  a  state  -'"'^ 
have  also  been  held  to  be  inadmissible  assets.  Where 
a  corporation  engaged  in  paving  work  for  municipalities  in  a 
state,  the  statutes  of  which  provide  that  municipal  improve- 
ments shall  be  paid  for  by  assessments  issued  to  the  contractor, 

256  Revenue  Acts  of  1918  and  1921,  §325   (a). 

257  Reg.  45,  Arts.  815-816. 

258  Official  announcement  by  the  bureau  of  internal  revenue  dated  April 
5,  1919;  O.  781,  T.  B.  1-19-116. 

259  0.  D.  86,  T.  B.  1-19-125;  0.  D.  1044,  T.  B.  38-21-1836. 

260  0.  D.  1057,  T.  B.  40-21-1857. 
2610.  D.  93,  T.  B.  1-19-132. 

262  o.  D.  28,  T.  B.  1-19-40. 

263  0.  D.  1069,  T.  B.  42-21-1875. 

264  o.  D.  929,  T.  B.  21-21-1656. 


1078  FEDERAL  INCOME  TAX 

such  assessments  bearing  interest  from  the  date  of  acceptance 
of  the  work  by  the  city  engineer  and  the  contractor  receiving 
interest  from  this  source  from  the  date  of  acceptance  to  the  date 
of  delivery  of  the  certificates  of  indebtedness  (which  were 
assigned  to  a  bank  under  an  agreement  for  the  advance  of  operat- 
ing expenses,  a  discount  being  paid  the  bank  in  addition  to  ac- 
crued interest  on  the  funds  advanced  for  the  prosecution  of 
the  work)  it  has  been  held  that  the  interest  received  by  the 
contractor  is  exempt  and  therefore  the  principal  upon  which 
such  interest  accrued  is  an  inadmissible  asset.-^^ 

Inadmissible  Assets  May  Become  Admissible.  Under  two 
conditions  assets  which  are  otherwise  inadmissible  become  in 
whole  or  in  part  admissible:  (1)  Where  the  inadmissible  asset 
has  been  sold  during  the  year  and  the  profit  thereon  is  in- 
cluded in  net  income,  and  (2)  where  inadmissible  assets  have 
been  purchased  or  carried  during  the  year  with  borrowed  money 
and  the  interest  paid  on  such  borrowed  money  is  not  allowed 
to  be  deducted  in  ascertaining  the  net  income.-^*^  Where  inad- 
missible assets  have  been  sold  or  otherwise  disposed  of,  the 
total  income  from  such  assets  including  the  profit  on  the  sale 
and  the  interest  or  dividends  received  during  the  year  is  first 
ascertained.  Secondly,  the  percentage  of  the  entire  net  income 
attributable  to  the  profit  on  the  sale  of  the  asset  is  ascertained 
and  the  same  percentage  of  the  intangible  asset  becomes  in- 
vested capital  for  the  length  of  time  such  asset  was  owned 
by  the  corporation-^s"!"  In  the  second  class  of  cases  it  seems 
that  the  interest  received  from  the  inadmissible  asset  should 
be  compared  with  the  interest  paid  upon  the  money  borrowed 
to  purchase  or  carry  such  asset.  Thus,  if  the  interest  received 
is  $100  and  the  interest  paid  on  the  borrowed  money  is  $75, 
three-fourths  of  the  inadmissible  asset  becomes  admissible 
(since  three-fourths  of  the  interest  is  in  effect  included  in  tax- 
able income).  This  applies  separately  to  each  issue  or  class  of 
inadmissible  securities  held  by  a  corporation.  For  example, 
it  may  hold   A  company   stock   costing   $100,000   and   B   com- 

265  o.  D.  999,  T.  B.  34-21-1778. 

266  See  Revenue  Acts  of  1918  and  1921,  §  234  (a)  2,  also  Chapter  23. 

267  Under  the  1917  Law  it  was  held  that  wherever  income  consisted  partly 
of  gains  or  profits  subject  to  the  excess-profits  tax  arising  from  trading 
in  stocks,  bonds,  etc.,  the  dividends  or  interest  on  which  were  not  subject 
to  such  tax,  and  partly  from  such  dividends  or  interest,  there  could  be 
included  in  the  invested  capital  an  amount  which  bore  the  same  ratio  to 
the  total  amount  invested  in  such  stock  or  bonds  as  the  amount  of  such 
trading  profits  bore  to  the  total  amount  of  trading  profits  and  dividends  or 
interest.     (Reg.  41,  Art.  45.) 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1079 

pany  stock  costing  $200,000.  During  the  year  it  receives  $8,000 
in  dividends  from  A  company  and  $5,000  from  B  company, 
and  on  September  30  sells  part  of  its  B  company  stock  at  a 
profit  of  $3,000.  For  the  period  from  January  1  to  September 
30,  $75,000  of  its  holdings  of  B  company  stock  becomes  admis- 
sible. After  September  30  its  remaining  holdings  of  B  company 
stock  are  inadmissible,  but  the  proceeds  of  the  sale  are  ad- 
missible unless  invested  in  inadmissibles.-'^'S 

Reduction  of  Invested  Capital  by  Inadmissible  Assets. 
From  invested  capital  must  be  deducted  a  percentage  thereof 
equal  to  the  percentage  which  the  amount  of  inadmissible  assets 
is  of  the  amount  of  admissible  and  inadmissible  assets  held 
during  the  year.-'^'^  In  other  words,  after  the  invested  capital 
has  been  determined  without  reference  to  inadmissible  assets 
but  eliminating  borrowed  capital,  the  invested  capital  so  deter- 
mined is  reduced  by  taking  a  percentage  equal  to  the  percent- 
age of  inadmissible  assets  to  all  the  assets  held  during  the 
taxable  year.^^o  por  the  purpose  of  ascertaining  the  deductible 
percentage  the  amount  of  inadmissible  assets  held  during  the 
year  may  ordinarily  be  determined  by  dividing  by  two  the  sum 
of  the  amount  of  such  assets  held  at  the  beginning  of  the  year 
and  the  amount  held  at  the  end  of  the  year.  The  total  amount 
of  admissible  and  inadmissible  assets  held  during  the  year  may 
ordinarily  be  determined  by  dividing  by  two  the  sum  of  the 
amount  of  such  assets  held  at  the  beginning  of  the  year  and 
the  amount  at  the  end  of  the  year.  If  at  any  time  a  substan- 
tial change  has  taken  place  either  in  the  amount  of  inadmis- 
sible assets  or  in  the  total  amount  of  admissible  and  inadmissible 
assets,  the  effect  of  such  change  should  be  averaged  exactly 
from  the  date  on  which  it  occurred.  In  any  case  where  the 
Commissioner  finds  that  either  amount  determined  as  above 
provided  does   not   substantially  reflect   the   average   situation 

268  Reg.  45,  Art.  817. 

2<'>9  Revenue  Acts  of  1918  and  1921,  §326  (b).  When  invested  capital 
was  determined  under  the  1917  Law  irrespective  of  admissibles  and  in- 
admissibles  the  adjusted  total  of  capital  and  surplus  represented  invested 
capital  at  the  beginning  of  the  taxable  year,  except  that  where  admissible 
assets  were  less  than  the  amount  of  such  adjusted  total,  a  further  reduction 
was  necessary  to  an  aniount  equal  to  the  sum  of  the  admissible  assets. 
If  there  had  been  any  change  during  the  year  in  the  amount  of  invested 
capital,  the  monthly  average  was  taken  (Reg.  41,  Art.  53). 

270  Under  the  1917  Law  it  was  ruled  that  only  so  much  of  the  admis- 
sible assets  as  exceeded  the  borrowed  money  need  be  deducted  from  invested 
capital.  See  letter  from  Treasury  Department  dated  April  2,  1918;  W.  T. 
S.   1918,  11923  and   letter  dated   May  17,   1918,   Id.   ^955. 


1080  FEDERAL   INCOME   TAX 

(lu-()iiKh()iit  Ihc  year,  and  thai  (ho  ainoiint  of  oach  kind  of  assets 
hold  on  a  jrivon  day  of  each  month  throuKhout  the  year  or 
at  nioro  Iroquont  lobular  intervals  can  be  determined,  the 
amount  of  inadmissible  assets  and  the  amount  ot  both  kinds 
of  assets  held  during  the  year  will  be  determined  by  averaging 
the  amounts  held  at  such  several  times.  In  making  these  com- 
pulations the  valuation  at  which  each  asset  is  carried  must  be 
adjusted  in  accordance  with  the  provisions  of  the  statute  and 
of  the  regulations  relating  to  the  valuation  of  assets  for  the 
pui'poso  of  computing  invested  capital  including  in  such  adjust- 
ment the  amount  of  reserves  for  depreciation,  depletion, 
amort i'/-a lion  and  other  reserves  which  represent  the  valuation 
of  assies.  It  is  immaterial  whether  any  asset  was  acquired 
out  of  invested  cajiilal.  oi-  out  of  profits  earned  during  the  year, 
or  l)on'o\ve(i  capital."'' 

Adjustments  Which  Increase  IJook  Values  of  Assets.  The 
adjustments  which  may  increase  the  book  value  of  the  assets 
repivsenting  capital  and  surplus  at  the  beginning  of  the  year 
(and  thus  inci'ease  the  surplus  for  purposes  of  invested  capi- 
tal) are  staled  in  the  preceding  paragraphs.-"-  Briefly  sum- 
marized they  are  (a)  the  value  of  tangible  property  paid  in  in 
excess  of  the  par  value  of  the  stock  issued  therefor;  (b)  addi- 
tions to  the  capital  account  due  to  restoring  to  the  capital 
account  the  value  of  assets  the  cost  of  which  has  been  charged 
to  expense;  (c)  reinstating  the  value  of  assets  which  has  been 
unduly  reduced  on  the  books  of  the  company,  and  (d)  the  in- 
clusion of  n^serxes  or  such  parts  of  reserves  as  are  in  fact 
surplus  or  undiviiled  profits.  In  support  of  the  claim  for  addi- 
tional invested  capital  with  respect  to  any  of  these  items  it  is 
necessary  t()  file  statements  showing  the  information  indicated 
in  {he  resptH'tix'c  [laragrajihs  above. 

Adjustments  Which  Reduce  the  l?ook  Value  of  Assets.  Assets 
may  be  caniod  on  the  books  at  a  valuation  greater  than 
that  which  the  law  expressly  allows  en*  contemplates.  In  such 
cases  the  value  of  such  assets  must  be  reduced   to  within  the 

-71  Ron",  -in,  Art.  852.  As  to  nllilialoil  (.•oi'poralions  soo  p.  llo'J.  Under 
\\w  1017  liiiw,  il"  !uinussil)lo  nssots  wore  in  o.xeess  of  luljustod  eapital  nml 
surplus,  no  further  deduetion  was  required  because  of  inadmissible  assets; 
in  other  words,  only  the  excess  of  inadmissible  assets  over  total  indebtedness 
was  required  to  be  deducted  from  adjusted  capital  and  surplus  (A.  R.  R. 
Ill,  T.  B.  21-20-9(i4).  This  ruling'  is  inapplicable  under  the  present  statute, 
which  provides  for  the  deduction  of  a  pcmiitaiff  of  inadmissibles. 

-T--'  See  p.  10G4. 


\VAR-rU(^FITS    AND    EXrKSS-PlKM'MTS   TAX  lOSl 

limit  allowocl  by  law  and  (ho  capital,  surplus  or  undivided  protUs 
of  a  company  roduccil  acconlinjjly.  Cases  in  which  adjustment 
must  be  made  to  reduce  the  bt)ok  value  are  stated  in  the  follow- 
ing paragraphs. 

As  TO  Vaia'K  ok  INTANGIKLK  AssKTS.  As  stated  above  in 
the  paragraphs  relating  to  intangible  property  paid  in  -••'  the 
value  thereof  must  be  reduced  to  the  lowest  of  three  values: 
(a)  the  actual  cash  value  at  the  lime  of  acquisition;  (b)  the 
par  value  of  the  stock  issued  therefor,  or  (c)  25'.  of  the  par 
value  of  the  stock  outstanding  on  March  o,  1917.  or  at  the  be- 
ginning of  the  taxable  year  as  the  case  may  be.  The  dilVerence 
between  such  minimum  value  and  the  value  al  which  the  assets 
are  carried  on  the  books  of  the  company  is  the  amount  to  be 
deducted  in  this  adjustment. 

As  TO  Trkasi'UY  Stock.  When  any  treasury  stt>ck  is  re- 
turned to  the  corporation  as  a  gift  or  for  a  consideration  sub- 
stantially less  than  its  par  value.  Ihe  stock  so  returned  may 
not  be  treated  as  a  part  of  the  sti)ck  issued  or  exchanged  for 
property.  The  proceeds  derived  in  cash  or  its  equivalent  from 
the  resale  of  such  treasury  stock  should  howi>ver  be  included 
in  the  invested  capital,  if  retained  and  employeti  in  the  busi- 
ness.-"^ The  dilVerence  between  the  par  value  oi'  the  treasury 
stock  so  returned  as  a  gift  and  the  amount  o(  cash  or  its 
equivalent  which  was  derived  from  the  resale  of  such  stock  is 
required  to  be  deducted  from  invested  capital.'-''  Where  a  cor- 
poration either  directly  or  indirectly,  as  for  exanqile  through 
a  trustee,  has  prior  to  the  taxable  year  bought  its  own  stock, 
either  for  the  purpose  of  retirement  or  of  holding  it  in  the 
treasury  or  for  other  purposes,  the  entire  cost  of  such  stock 
must  be  deducted  from  the  aggregate  invested  capital  as  of 
the  beginning  of  the  taxable  year,  if  such  deduction  has  not 
already  been  made.  \\'here  such  stock  is  purchased  during 
the  taxable  year  a  deduction  from  the  invested  capital  as  of 
the  beginning  of  the  taxable  year  and  etfective  from  the  date 

•-<••' Soo  p.  lOJS). 

-">RoK.    l."^.  Art.  S()l;  Roji".    11,  Art.  .^.l. 

liT.'i  See  Koini  1120  for  1918.  SchoduU-  (;;?.  Tlion-  may  bo  rasos.  how- 
ovor.  wluMo  llu>  subso(iuiM\t  lotuvn  of  stock  lo  tlu<  corporation  i.s  in  fact 
equivalent  to  an  additional  contribution  of  capital  equal  to  the  amount 
rocoivcd  by  tlic  corporation  on  tbo  resale  of  such  stock.  Wliei-e  stock 
has  been  issued  t\)r  property  and  a  part  of  the  stock  is  n-turned  to  the 
treasury  of  the  corporatio!i,  the  presum]>tion  is  that  tlu'  prt)i)erty  was 
consciously  overvalued,  but  this  presumption  cannot  stand  if  contrary  to 
fact. 


1082  FEDERAL  INCOME   TAX 

of  such  purchase  is  required  only  to  the  extent  that  such  stock 
has  not  been  purchased  out  of  the  undivided  profits  of  the 
taxable  year.  The  full  amount  derived  in  cash  or  its  equivalent 
from  the  resale  of  such  stock  may  be  included  in  invested  capi- 
tal from  the  date  of  such  resale,  unless  such  stock  had  been 
purchased  out  of  earnings  of  the  taxable  year.-'^*' 

As  TO  Value  of  Assets  Acquired  in  Reorganization.  In  the 
case  of  a  reorganization,  consolidation  or  change  of  owner- 
ship of  a  trade  or  business,  or  change  of  ownership  of  prop- 
erty, after  March  3,  1917,277  certain  reductions  may  be  necessary 
in  the  book  values  of  the  new  owner,  if  such  book  values  re- 
flect the  value  of  the  property  at  the  time  it  was  acquired  by 
such  new  owner.  Such  reduction  is  necessary  only  in  cases 
where  50%  or  more  of  the  interest  or  control  in  such  trade 
or  business  or  property  remains  in  the  same  persons,  or  any 
of  them.  In  such  cases  no  asset  so  acquired  will,  for  the  pur- 
pose of  determining  invested  capital,  be  allowed  a  greater 
value  than  would  have  been  allowed  in  computing  the  invested 
capital  of  the  previous  owner  if  such  asset  had  not  been  so 
transfei-red  to  the  new  owner.  In  other  words,  if  the  previous 
owner  was  a  corporation  and  50%  or  more  of  the  interest  or 
control  of  the  new  corporation  remains  in  the  hands  of  any  of 
those  who  controlled  the  old  corporation,  the  intent  of  the  stat- 
ute seems  to  be  that  the  invested  capital  of  the  new  corpora- 
tion cannot  be  increased  as  to  such  property,  beyond  the  amount 
which  would  have  been  allowed  to  the  old  corporation  had  it 
retained  the  assets.  This  is  true  whether  or  not  the  assets 
were  paid  for  by  the  new  corporation  in  stock  or  in  cash.-^s  If 
the  previous  owner  was  not  a  corporation,  then  the  value  of 
any  asset  so  transferred  must  be  taken  at  its  cost  of  acquisi- 
tion (at  the  date  when  acquired  by  such  previous  owner)  with 
proper  allowance  for  depreciation,  impairment,  betterment  or 
development,  but  no  addition  to  the  original  cost  may  be  made 

276  Reg.  45,  Art.  862. 

277  This  restriction  only  applies  in  the  case  of  a  reorganization  or  change 
of  ownership  after  March  3,  1917  (O.  D.  1097,  T.  B.  45-21-1916).  It  applies 
whether  property  transferred  is  tangible  or  intangible  (A.  R.  R.  383,  T.  B. 
8-21-1470). 

278  Under  the  1917  Law  this  restriction  on  the  value  of  assets  acquired 
on  a  reorganization  after  March  3,  1917,  applied  only  to  cases  where  the 
asset  was  not  paid  for  specifically  as  such  in  cash  or  tangible  property, 
(Revenue  Act  of  1917,  §208;  Reg.  41,  Art.  50)  but  under  the  present  law 
it  applies  also  to  cases  where  payment  may  have  been  made  in  cash  or  by 
tangible  property.     (Revenue  Acts  of  1918  and  1921,  §  331.) 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1083 

for  any  charge  or  expenditure  deducted  as  expense,  or  other- 
wise, on  or  after  March  1,  1913,  in  computing  the  net  income 
of  such  previous  owner  for  purposes  of  taxation.^™  In  all  such 
cases  the  reduction  to  be  made  is  the  difference  between  (a)  the 
book  value  of  such  assets,  and  (b)  in  case  the  previous  owner 
was  a  corporation,  the  value  at  which  the  asset  would  have 
been  considered  invested  capital  to  it,  or  (c)  in  case  the  pre- 
vious owner  was  an  individual  the  cost  of  such  asset  to  such 
owner,  as  indicated  above. 

It  will  be  noted  that  the  Revenue  Act  of  1918  in  its  provi- 
sion regarding  reorganizations  extends  the  corresponding  pro- 
vision of  the  Revenue  Act  of  1917  to  include  a  "change  of 
ownership  of  property  after  March  3,  1917."  -^^ 

A  new  corporation  which  raises  a  certain  sum  from  the  sale 
of  its  capital  stock  as  a  condition  precedent  to  taking  over 
from  the  creditors  of  a  defunct  corporation  the  old  corpora- 
tion's assets  and  assuming  its  liabilities  will  not  be  allowed  as 
invested  capital  the  amount  which  the  old  corporation  could 
have  claimed.  It  is  limited  to  the  amount  received  from  the 
sale  of  its  capital  stock.  The  value  of  the  property  received 
on  condition  of  the  assumption  of  the  unpaid  liabilities  of  the 
old  corporation  is  borrowed  capitaL-^i  In  this  case  the  old  cor- 
poration had  gone  into  the  hands  of  a  receiver  and  its  property 
sold  to  its  creditors  who  were  not  stockholders.  The  transac- 
tion was  closed  and  completed  so  far  as  the  old  corporation  and 
its  stockholders  were  concerned.  The  fact  that  the  stockholders 
of  the  old  and  new  corporations  were  identical  does  not  affect 
the  question. 

Definition.  Where  under  the  laws  of  a  state  a  charter 
granted  to  a  corporation  is  limited  to  a  period  of  years,  the 
renewal  of  such  charter  merely  prolongs  the  existence  of  the 
original  corporation  and  does  not  of  itself  constitute  a  reorgani- 
zation within  the  meaning  of  the  excess-profits  tax  laws.-*^'- 

The  expression  "remains  in  control"  has  been  construed  to 
cover  a  case  in  which  the  assets  of  a  partnership  were  taken 
over  by  a  corporation,  the  former  partners  receiving  approxi- 
mately 49%   of  the  capital  stock  of  the  new  corporation,  but 

270  Revenue  Acts  of  1918  and  1921,  §331;  A.  R.  R.  393,  T.  B.  8-21-1470; 
A.  R.  R.  618,  T.  B.  39-21-1849;  0.  D.  789,  T.  B.  5-21-1424.  Cost  may  in- 
clude expenditures  for  good  will  not  charged  to  expense,  even  though 
written  oflP  the  books  prior  to  the  change  of  ownership. 

280  A.  R.  R.  285,  T.  B.  42-20-1252. 

281  T.  B.  M.  49,  T.  B.  11-19-389. 

282  o.  D.  930,  T.  B.  21-21-1657. 


1084  FEDERAL  INCOME  TAX 

becoming  the  principal  officers  thereof.  The  decision  was  founded 
upon  the  consideration  that  upon  the  reorganization  the  partners 
received  all  the  stock  of  the  new  corporation,  51%  of  which 
they  then  disposed  of  to  the  public.--^  It  has  been  held  that 
where  the  owner  of  a  business  turned  the  business  over  to  a 
corporation  practically  all  the  stock  of  which  was  issued  to  his 
children  and  close  connections,  an  interest  or  control  of  50% 
or  more  did  not  remain  in  the  same  persons ;  the  offer  to  sell 
the  assets  of  the  business  was  construed  as  an  enforceable  agree- 
ment based  upon  a  valid  consideration  for  the  benefit  of  third 
persons.284 

Reorganizations  Entitling  Corporations  to  Revaluation. 
The  provision  referred  to  in  the  preceding  paragraph  pro- 
vides negatively  that  in  the  case  of  a  reorganization,  consolida- 
tion or  change  of  ownership  of  a  trade  or  business  or  change 
of  ownership  of  property  after  March  3,  1917,  if  an  interest  or 
control  in  such  trade  or  business  or  property  of  50%  or  more 

283  A.  R.  R.  409,  T.  B.  11-21-1512.  The  validity  of  this  ruling  seems  ex- 
tremely doubtful.  It  is  founded  upon  the  technical  argument  that  the 
"proceeds  from  the  sale  of  any  or  all  of  the  stock  passed  to  the  partner- 
ship. Out  of  these  proceeds  the  partners  paid  to  the  corporation  such 
amount  or  amounts  as  the  partners  had  agreed  to  pay  in  part  consideration 
for  the  stock  received  by  them.  In  other  words,  the  transaction  was  between 
the  corporation  and  the  partners  and  the  latter  named  the  proportion  in 
which  they  desired  the  stock  distributed  to  them  and  to  their  nominees. 
Hence,  the  partners  did  remain  in  control.  They  exercised  this  control 
in  naming  their  nominees.  It  is  immaterial  that  this  stock  control  was 
not  continuing — that  it  immediately  passed  by  a  small  fraction  into  other 
hands".  It  would  seem  material  under  the  statute  whether  the  control 
is  continuing.  The  word  "remains"  might  well  be  given  a  broader  construc- 
tion than  that  above  indicated  in  which  it  is  limited  to  conditions  imme- 
diately before  and  after  the  change  of  ownership.  Moreover,  to  say  that 
the  partners  exercised  their  control  by  naming  nominees  is  utterly  to  de- 
feat the  statute.  In  all  cases  of  a  reorganization  or  change  of  ownership 
the  old  stockholders  or  owners  do  this,  and  if  it  is  to  preclude  an  increase 
of  invested  capital,  the  statutory  provision  might  as  well  include  all  re- 
organizations and  changes  of  ownership,  rather  than  those  only  in  which 
a  50%  interest  or  control  remains  in  the  same  persons. 

284  A.  R.  R.  645,  T.  B.  42-21-1890.  This  was  an  absolutely  bona  fide 
transaction,  and  there  was  no  doubt  that  the  issuance  of  the  stock  to  the 
children  was  unconditional.  The  father  was  actuated  by  a  desire  to  pro- 
vide for  his  children  during  life  and  then  retire  from  active  business. 
On  the  point  that  where  two  parties  enter  into  an  agreement  under  which 
third  persons  are  to  receive  a  benefit,  the  contract  is  enforceable,  see 
Cobb  V.  Heron,  180  111.  49,  54  N.  E.  189,  aff'd  78  111.  App.  654;  Deen  v. 
Walker,  107  111.  540;  Bay  v.  Williams,  112  111.  91;  Hartman  v.  Pistorious, 
248  111.  568,  94  N.  E.  131;  Searls  v.  Flora,  225  111.  167,  80  N.  E.  98;  Harms 
V.  McCormick,  132  111.  104,  22  N.  E.  511. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1085 

remains  in  the  same  persons,  or  any  of  them,  then  no  asset 
transferred  or  received  shall  be  allowed  a  greater  value  in 
determining  invested  capital  than  would  have  been  allowed  to 
the  previous  owner.  Two  inferences  are  to  be  fairly  drawn 
from  this  provision:  (1)  assets  in  the  case  of  reorganization 
prio7^  to  March  3,  1917,  should  be  valued  as  of  the  date  of 
transfer  to  the  new  corporation  for  the  purpose  of  determining 
the  invested  capital  of  such  corporation  for  the  taxable  year ;  -^-^ 
(2)  assets  in  the  case  of  a  reorganization  after  March  3,  1917, 
should  be  valued  as  of  the  date  of  the  transfer  to  the  new  cor- 
poration for  the  purpose  of  determining  the  invested  capital 
of  such  corporation  for  the  taxable  year,  //  an  interest  or 
control  in  the  trade,  business  or  property  transferred  upon  the 
reorganization  does  not  remain  to  the  extend  of  50'/(  or  more 
in  the  same  persons.  In  cases  arising  upon  this  side  of  the 
question  a  revaluation  of  assets  has  been  permitted  for  pur- 
poses of  determining  invested  capital.  It  has  been  expressly 
ruled  that  in  a  case  falling  under  (1)  above  a  revaluation  of 
assets  is  to  be  permitted  for  purposes  of  invested  capital  where 
there  was  a  change  of  corporate  entity  prior  to  March  3,  1917, 
even  though  there  was  no  change  of  officers,  or  directors,  or 
proportions  of  stockholders.  Inasmuch  as  the  treasury  depart- 
ment treats  the  stockholders  of  a  reorganized  corporation,  who 
surrender  their  stock,  as  liable  to  income  tax  if  the  value  of 
the  stock  received  is  in  excess  of  the  cost  of  the  stock  surren- 
dered, or  its  value  on  March  1,  1913,  it  feels  bound  to  permit 
the  new  corporation  to  obtain  the  benefit  of  a  revaluation  of 
corporation  assets  for  purposes  of  invested  capital.-^'' 

Where  two  corporations  are  engaged  in  different  branches 
of  the  same  business  and  the  certificate  of  incorporation  of  one 
is  amended  so  as  to  change  its  name  and  increase  its  capital 
stock,  which  new  stock  is  issued  prior  to  March  3,  1917,  in 
exchange  for  the  stock  of  the  two  original  companies,  the 
invested  capital  of  the  corporation  whose  certificate  has  been 
so  amended  will  be  determined  by  adding  to  such  corporation's 
original  invested  capital  prior  to  the  transaction  the  appre- 
ciated value  (as  of  the  date  of  the  exchange  of  stock)  of  the 
assets  of  the  other  corporation  the  control  of  which  had  been 
transferred.  No  appreciation  of  value  for  purposes  of  in- 
vested  capital    is    allowable    with    respect    to    the    corporation 

2S5A.  R.  R.  268,  T.  B.  41-20-1238;  A.  R.  M.  60,  T.  B.  25-20-1022. 
280  A.  R.  M.  60,  T.  B.  25-20-1022. 


1086  FEDERAL  INCOME   TAX 

which  amended  its  certificate  since  there  was  no  change  of 
identity  on  the  part  of  this  corporation.^s^  Where  a  corpora- 
tion transfers  its  property  to  an  association  composed  of  its 
stockholders  and  the  association  after  January  1,  1914,  but 
prior  to  March  3,  1917,  transfers  substantially  the  same  assets 
to  a  new  corporation,  the  fair  market  value  of  such  assets 
when  transferred  to  the  new  corporation  should  be  included 
in  determining  the  invested  capital  of  the  latter.^ss  The  re- 
valuation of  assets  upon  a  reorganization  may  not  always  re- 
sult in  an  appreciated  value.  The  invested  capital  of  a  corpo- 
ration is  measured  by  the  original  capital  contribution  of  the 
stockholders  and  need  not  be  reduced  by  any  subsequent 
deficit  in  the  nature  of  an  operating  loss.  Likewise,  deprecia- 
tion and  depletion  of  capital  assets  need  only  be  applied  against 
earned  surplus  and  need  not  be  applied  against  capital  on  paid- 
in  sitrplus."^^  In  the  case  of  a  corporation  the  capital  of  which 
has  been  impaired  by  losses  or  by  depletion  or  depreciation  not 
properly  allowed  for,  a  reorganization  may  result  in  a  capital 
contribution  to  the  new  corporation  smaller  than  the  original 
capital  contribution  of  the  stockholders  of  the  old  corporation. 
In  the  case  of  such  a  reorganization  prior  to  March  3,  1917,  or 
after  that  date,  provided  the  interest  or  control  of  the  assets 
is  changed,  the  reorganized  corporation  may  by  virtue  of  the 
reorganization  be  obliged  in  effect  to  reduce  what  would  have 
been  the  invested  capital  of  the  old  corporation  by  the  amount 
of  any  such  loss,  depletion  or  depreciation.  The  mere  change 
of  domicile  of  a  corporation  without  change  as  to  capital  and 
surplus  does  not  affect  invested  capital  even  though  the  new 
corporation  is  an  entity  distinct  from  the  old.  In  such  case  the 
charter  issued  in  one  state  has  merely  been  surrendered  in  ex- 
change for  a  new  charter  in  another  state  without  change  in 
the  business  or  amount  of  capital  and  surplus  and  the  new  cor- 
poration is  entitled  to  the  same  invested  capital  as  the  old.^^*^ 

As  TO  Values  Marked  Up  on  the  Books  of  Account.  In- 
vested capital  cannot  be  based  upon  an  appraisement  showing 

287  0.  872,  T.  B.  10-19-365;  see  A.  R.  R.  285,  T.  B.  42-20-1252;  Sol.  Op. 
41,  T.  B.  34-20-1159.  This  decision  is  silent  as  to  whether  the  corporation 
whose  assets  were  appreciated  for  purposes  of  invested  capital  was  sub- 
jected to  income  tax  to  the  extent  of  such  appreciation. 

2SS  Sol.  Op.  41,  T.  B.  34-20-1159. 

289  Reg.  45,  Art.  860;  A.  R.  R.  436,  T.  B.  13-21-1536;  letter  from  Treas- 
ury Department  dated  March  19,  1918;  letter  from  Treasury  Department 
dated  April  14,  1916;  W.  T.  S.  1919,  ^1042. 

290  A.  R.  R.  16,  T.  B.  3-20-697. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1087 

the  value  as  of  any  date  subsequent  to  the  date  of  acquisition.^^! 
Therefore,  if  a  corporation  has  marked  up  the  value  of  any  of 
its  assets  the  amount  by  which  the  original  book  values  have 
been  so  increased  must  be  deducted.  This  doctrine  has  now 
been  established  by  a  leading  case  in  the  Supreme  Court,-'-^-  de- 
cided under  the  1917  Law.  In  this  case  a  corporation  acquired 
ore  lands  in  1904  for  $190,000.  Extensive  explorations  and 
developments  between  that  year  and  1912  gave  the  lands  an 
actual  cash  value  of  upwards  of  $10,000,000  in  1912,  which 
value  extended  through  1917.  This  appreciation  in  value  was 
capitalized  by  the  issue  of  a  stock  dividend  in  1912.  In  its 
1917  invested  capital  the  corporation  included  the  ore  lands 
at  their  appreciated  value  so  capitalized.  Invested  capital  was, 
of  course,  reduced  to  this  extent  by  the  Commissioner,  and  re- 
covery of  the  additional  tax  paid  as  a  result  of  the  decrease  of 
invested  capital  was  sought  in  court.  The  contention  of  the 
corporation  was  that  the  increased  value  of  the  ore  lands  was 
"paid-in  or  earned  surplus  and  undivided  profits;  that  under 
the  phrase  "the  actual  cash  value  of  tangible  property  paid  in 
other  than  cash,  for  stock  or  shares  in  such  corporation"  the 
stock  issued  as  a  dividend  was  fully  paid  for  either  (a)  by 
the  tangible  assets  including  the  ore  properties,  at  their  in- 
creased value,  or  (b)  by  the  surrender  of  certificates  represent- 
ing the  old  stock  of  the  corporation  in  exchange  for  new  stock 
including  the  stock  dividend.  These  contentions  were  overruled 
by  the  Supreme  Court.^^s 

291  Reg.  45,  Art.  831 ;  Reg.  41,  Art.  42.  Letter  from  Treasury  Department 
dated  March  5,  1918. 

292  La  Belle  Iron  Works  v.  U.  S.,  41  Sup.  Ct.  Rep.  528,  65  L.  Ed.  604; 
T.  B.  23-21-1680.  See  also  A.  R.  R.  337,  T.  B.  50-20-1347;  A.  R.  M.  413, 
T.  B.  10-21-1502. 

29:5  The  court  made  the  following  comments  on  the  1917  Law  in  this  case: 
"Reading  the  entire  language  of  §  207  in  the  light  of  the  circumstances 
that  surrounded  the  passage  of  the  act,  we  think  its  meaning  as  to  'in- 
vested capital'  is  entirely  clear.  The  great  war  in  Europe  had  been  in  prog- 
ress since  the  year  1914,  and  the  manufacture  and  export  of  war  supplies 
and  other  material  for  the  belligerent  powers  had  stimulated  many  lines 
of  trade  and  business  in  this  country,  resulting  in  large  profits  as  com- 
pared with  the  period  before  the  war,  and  as  compared  with  ordinary  re- 
turns upon  the  capital  embarked.  The  United  States  had  become  directly 
involved  in  the  conflict  in  the  spring  of  1917,  necessitating  heavy  increases 
in  taxation;  at  the  same  time  manufactures  and  trade  of  every  description 
were  rendered  even  more  active,  and  in  certain  lines  more  profitable,  than 
before,  so  that  the  unusual  gains  derived  therefrom  formed  a  natural 
subject  for  special  taxation.  *  *  *  A  scrutiny  of  the  particular  pro- 
visions of  §  207  shows  that  it  was  the  dominant  purpose  of  Congress  to 


11088  FEDERAL   INCOME   TAX 

All  taxpayers  who,  in  the  preparation  of  their  tax  returns 
for  1917  and  subsequent  years,  have  used  appreciated  or  in- 
flated values  in  determining  the  amount  of  their  invested  capi- 
tal are  required  to  file  with  the  collector  amended  returns  for 
each  of  such  years,  in  which  the  invested  capital  should  be  com- 
puted without  the  use  of  appreciated  or  inflated  values.  It 
is  not  required  that  such  amended  returns  shall  include  the 
figures  shown  in  the  original  returns  which  are  unaffected  by 
this  decision.     Only  such  figures  as  are  necessary  to  show  the 

place  the  peculiar  burden  of  this  tax  upon  the  income  of  trades  and  busi- 
nesses exceeding  what  was  deemed  a  normally  reasonable  return  upon  the 
capital  actually  embarked.  But  if  such  capital  were  to  be  computed  accord- 
ing to  appreciated  market  values  based  upon  the  estimates  of  interested 
parties  (on  whose  returns  perforce  the  government  must  in  great  part  rely), 
exaggerations  would  be  at  a  premium,  corrections  difficult,  and  the  tax 
easily  evaded.  §  207  shows  that  Congress  was  fully  alive  to  this  and  de- 
signedly adopted  a  term — 'invested  capital' — and  a  definition  of  it,  that 
would  measurably  guard  against  inflated  valuations.  The  word  'invested' 
in  itself  imports  a  restrictive  qualification.  When  speaking  of  the  capital 
of  a  business  corporation  or  partnership,  such  as  the  act  deals  with,  'to 
invest'  imports  a  laying  out  of  money,  or  money's  worth,  either  by  an  in- 
dividual in  acquiring  an  interest  in  the  concern  with  a  view  to  obtaining 
income  or  profit  from  the  conduct  of  its  business,  or  by  the  concern  itself 
in  acquiring  something  of  permanent  use  in  the  business;  in  either  case 
involving  a  conversion  of  wealth  from  one  form  into  another  suitable  for 
employment  in  the  making  of  the  hoped-for  gains.  See  Webster's  New 
Internat.  Diet.,  'invest,'  8;  Century  Diet.,  'invest,'  7;  Standard  Diet.,  'in- 
vest,' 1. 

"In  order  to  adhere  to  this  restricted  meaning  and  avoid  exaggerated 
valuations,  the  draftsman  of  the  act  resorted  to  the  test  of  including  noth- 
ing but  money,  or  money's  worth,  actually  contributed  or  converted  in 
exchange  for  shares  of  the  capital  stock,  or  actually  acquired  through  the 
business  activities  of  the  corporation  or  partnership  (involving  again  a 
conversion)  and  coming  in  ab  extra,  by  way  of  increase  over  the  original 
capital  stock.  How  consistently  this  was  carried  out  becomes  evident  as 
the  section  is  examined  in  detail.  Cash  paid  in,  and  tangible  property  paid 
in  other  than  cash,  are  confined  to  such  as  were  contributed  for  stock  or 
shares  in  the  corporation  or  partnership ;  and  the  property  is  to  be  taken 
at  its  actual  cash  value  'at  the  time  of  such  payment' — distinctly  negativing 
any  allowance  for  appreciation  in  value.  *  *  *  -pj^g  pi-ovision  of  clause 
(3)  that  includes  'paid  in  or  earned  surplus  and  undivided  profits  used  or 
employed  in  the  business'  recognizes  that  in  some  cases  contributions  are 
received  from  stockholders  in  money  or  its  equivalent  for  the  specific  pur- 
pose of  creating  an  actual  excess  capital  over  and  above  the  par  value 
of  the  stock;  and,  in  view  of  the  context,  surplus  'earned'  as  well  as  that 
'paid  in'  excludes  the  idea  of  capitalizing  (for  the  purposes  of  this  tax)  a 
mere  appreciation  of  values  over  cost. 

"The  same  controlling  thought  is  carried  into  the  proviso,  which  relates 
to  the  valuation  of  patents,  copyrights,  trade-marks,  good  will,  franchises, 
and   similar  intangible   property.     Every  line   shows   evidence   of   a   legis- 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1089 

correct  values  used  in  the  computation  of  invested  capital  and 
such  totals  as  are  necessary  to  a  redetermination  of  the  tax 
need  be  shown.  Payment  of  the  additional  tax  shown  to  be 
due  on  such  amended  returns  must  also  be  made  at  the  time 
the  returns  are  filed.^^^ 

Inventories  must  be  valued  at  cost,  or  cost  or  market,  which- 
ever is  lower.-"-''^ 

As  TO  Inadequate  Allowance  for  Depreciation  or  De- 
pletion. Where  the  corporation  has  not  duly  marked  down 
the  value  of  its  property  subject  to  depreciation,  or  set  up  a 
depreciation  reserve  to  provide  for  replacement  of  values  lost 
by  depreciation,  from  the  time  the  property  was  acquired 
down  to  the  beginning  of  the  taxable  year,  the  proper  amount 
of  depreciation  suffered  during  that  period  must  be  computed 
and  deducted  from  the  value  of  the  assets  in  order  to  reach 
their   present  value   at   the  beginning   of   the   taxable   year.-^*^ 

lative  purpose  to  confine  the  account  to  such  items  as  were  paid  in  for  stock 
or  shares,  and  to  their  values  'at  the  time  of  such  payment';     *     *     * 

"It  is  clear  that  clauses  (1)  and  (2)  refer  to  actual  contributions  of 
cash  or  of  tangible  property  at  its  cash  value  contributed  in  exchange  for 
stock  or  shares  specifically  issued  for  it;  and  that  neither  these  clauses,  nor 
clause  (3)  which  relates  to  surplus,  can  be  construed  as  including  within 
the  definition  of  invested  capital  any  marking  up  of  the  valuation  of  assets 
upon  the  books  to  correspond  with  increase  in  market  value,  or  any  paper 
transaction  by  which  new  shares  are  issued  in  exchange  for  old  ones  in 
the  same  corporation,  but  which  is  not  in  substance  and  effect  a  new  ac- 
quisition of  capital  property  by  the  company. 

"It  is  clear  enough  that  Congress  adopted  the  basis  of  'invested  capital' 
measured  according  to  actual  contributions  made  for  stock  or  shares  and 
actual  accessions  in  the  way  of  surplus,  valuing  them  according  to  actual 
and  bona  fide  transactions  and  by  valuations  obtaining  at  the  time  of  ac- 
quisition, not  only  in  order  to  confine  the  capital,  the  income  from  which  was 
to  be  in  part  exempted  from  the  burden  of  this  special  tax,  to  something 
approximately  representative  of  the  risks  accepted  by  the  investors  in 
embarking  their  means  in  the  enterprise,  but  also  in  order  to  adopt  tests 
that  would  enable  returns  to  be  more  easily  checked  by  examination  of 
records,  and  make  them  less  liable  to  inflation  than  if  a  more  liberal  mean- 
ing of  'capital  and  surplus'  had  been  adopted;  thus  avoiding  the  necessity 
of  employing  a  special  corps  of  valuation  experts  to  grapple  with  the  many 
difficult  problems  that  would  have  ensued  had  general  market  values  been 
adopted  as  the  criteria". 

2!i4  T.  D.  3220,  T.  B.  37-21-1822.  Such  amended  returns  were  required 
by  November  24,  1921.  This  date  has  now  been  extended  to  January 
15,  1922.  (See  T.  D.  3243.)  As  to  penalties  for  failure  to  file  amended 
returns  on  or  before  such  date,  see  R.  S.  3176.  (See  M.  2848;  W.  T.  S. 
1921,  11985.)  Collectors  are  not  allowed  to  extend  this  period. 

205  A.  R.  R.  517,  T.  B.  22-21-1667. 

2n«See  Reg.  41,  Art.  42;  A.  R.  R.  384,  T.  B.  7-21-1456. 


1090  FEDERAL  INCOME  TAX 

Such  depreciation  cannot  be  offset  by  any  unrealized  appre- 
ciation.-o^  Since  the  law  contemplates  that  the  invested  capital 
shall  be  measured  by  the  value  of  the  original  contribution  of 
the  stockholders  to  the  corporation,  paid-in  surplus  represent- 
ing tangible  property  need  not  be  reduced  by  reason  of  depre- 
ciation. All  adjustments  necessary  on  account  of  inadequate 
or  excessive  depreciation  should  be  made  in  connection  with 
earned  surplus  or  undivided  profits.  Therefore,  if  a  corpora- 
tion is  properly  entitled  to  add  to  its  invested  capital  in  the 
form  of  paid-in  surplus  an  amount  representing  excess  in  value 
of  property,  over  the  consideration  paid  therefor,  such  paid-in 
surplus  need  not  be  reduced  on  account  of  depreciation  of  the 
property  on  which  the  excess  value  is  claimed.  It  should  be 
borne  in  mind,  however,  that  while  paid-in  surplus,  as  indi- 
cated above,  need  not  be  reduced  on  account  of  depreciation, 
such  adjustment  must  be  made  in  earned  surplus  or  undivided 
profits,  and  the  computation  must  be  based  not  on  the  cash  paid 
or  stock  issued  for  the  property  but  on  its  actual  value  at  the 
time  acquired  for  the  purpose  of  computing  the  allowable  addi- 
tion to  paid-in  surplus. -^^  Similar  reduction  must  also  be  made 
in  case  of  inadequate  allowance  for  depletion.^^^^  Amounts 
charged  off  for  depletion  during  prior  years  and  disallowed  may 
not,  merely  because  of  the  disallowance,  be  restored  to  in- 
vested capital.""" 

Depletion,  like  depreciation,  must  be  recognized  in  all  cases  in 
which  it  occurs.  Depletion  attaches  to  each  unit  of  mineral  or 
other  property  removed,  and  the  denial  of  a  deduction  in  com- 
puting net  income  under  the  Act  of  August  5,  1909,  or  the  limi- 
tation upon  the  amount  of  the  deduction  allowed  under  the  Act 
of  October  3,  1913,  does  not  relieve  the  corporation  of  its  ob- 
ligation to  make  proper  provision  for  depletion  of  its  property 
in  computing  its  surplus  and  undivided  profits.  Adjustments 
in  respect  of  depreciation  or  depletion  in  prior  years  will  be 
made  or  permitted  only  upon  the  basis  of  affirmative  evidence 
that  as  at  the  beginning  of  the  taxable  year  the  amount  of  de- 
preciation or  depletion  written  off  in  prior  years  was  insuffi- 
cient or  excessive,  as  the  case  may  be.  Where  deductions  for 
depreciation  or  depletion  have  either  on  the  books  of  the  cor- 

297  A.  R.  R.  71,  T.  B.  18-20-906. 

298  A.  R.  R.  436,  T.  B.  13-21-1536.  Letter  from  Treasury  Department 
dated  April  14,  1919;  W.  T.  S.  1919,  111042;  O.  D.  90,  T.  B.  1-19-129. 

299  A.  R.  R.  517,  T.  B.  22-21-1667. 

300  o.  D.  833,  T.  B.  9-21-1489. 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1091 

poration  or  in  its  returns  of  net  income  been  included  in  the 
past  in  expense  or  other  accounts,  rather  than  specifically  as 
depreciation  or  depletion,  or  where  capital  expenditures  have 
been  charged  to  expense  in  lieu  of  depreciation  or  depletion,  a 
statement  indicating  the  extent  to  which  this  practice  has  been 
carried  should  accompany  the  return/'*'^ 

The  Commissioner  has   issued  a  statement  interpreting  the 
above  regulation.     He  states  that  it  was  the  intention  of  the 
department  that  a  corporate  surplus  account  is  not  to  be  dis- 
turbed lightly  and  that  no  change  should  be  made  in  it  either 
by  the  government  or  by  the  taxpayer  except   upon  adequate 
evidence  that  the  surplus  account  was  incorrect.     Unless  the 
taxpayer  can  show  a  state  of  error  the  government  should  deny 
a  claim  for  an  increase  in  the  surplus  shown  by  the  taxpayer's 
books ;  conversely,  before  a  deduction  can  be  made  from  the  tax- 
payer's surplus  account,  the  government  must  show  that  such 
an  adjustment  is  necessary  to  correct  the  account.     Such  proof 
must  be  in  the  form  of  affirmative  evidence ;  it  can  not  rest  upon 
mere  assertion  or  the  working  out  of  the  theoretical  formula. 
A  taxpayer's  corporate  surplus  should  not  be  reduced  by  the 
arbitrary   adjustment   of   depreciation   and   depletion   for   past 
years.     Surplus  accounts  should,  however,  always  be  carefully 
scrutinized  and  checked  up  for  the  purpose  of  preventing  the 
inclusion  therein  of  appreciated  values  of  property.     In  case  of 
doubt  in  such  case  the  burden  should  be  cast  upon  the  taxpayer 
to  prove  that  no  appreciated  values  were  included  in  the  surplus. 
A  presumption  should  always  exist  that  a  taxpayer's  books  of 
account  reflect  actual  facts.     The  burden  of  proof  is  upon  any 
one  who  attempts  to  impugn  the  correctness  of  the  books  of 
account — upon  the  government  if  it  seeks  to  reduce  its  surplus 
account  by  charging  off  depreciation  and  depletion  which  have 
not  been  claimed  by  the  taxpayer  and  upon  the  taxpayer  where 
he  claims  that  too  much  depreciation  and  depletion  have  been 
charged  ofY  in  prior  years.=^«-    There  is  no  warrant  for  reducing 
earned  surplus  because  of  alleged  failure  to  charge  off  sufficient 
depreciation  in  the  past,  unless  the  depreciable  assets  of  the 
corporation  are  valued  on  its  books  at  the  beginning  of  the  tax- 
able year  at  an  amount  in  excess  of  their  actual  value  at  that 
time.-'"-'     The  words  "actual  value"  mean  "sound  value,"  which 

301  Reg.  45,  Art.  839. 

302  0.  D.  1104,  T.  B.  46-21-1926;  A.  R.  M.  106,  T.  B.  18-21-1614. 

303  A.  R.  M.  106,  T.  B.  18-21-1614.    See  also  A.  R.  R.  390,  T.  B.  9-21-1487. 


1092  FEDERAL  INCOME  TAX 

is  "original  cost"  (or  value  as  of  March  1,  1913,  if  applicable, 
including  additions  and  betterments  charged  to  capital  account 
less  depreciation  sustained).  Any  action  on  the  part  of  a  par- 
ticular taxpayer  which  extends  the  useful  life  of  a  depreciable 
asset  beyond  the  normal  or  usual  term,  and  any  circumstance 
which  serves  to  increase  the  salvage  value  of  a  depreciable  asset, 
operates  to  justify  a  reduction  in  the  normal  rate  of  deprecia- 
tion. The  depreciation  of  an  asset  is  arrested  where  it  is  main- 
tained at  a  high  standard  of  efficiency  either  by  the  exercise  of 
unusual  care  in  its  use  or  by  unusual  maintenance  expenditures. 
The  exhaustion  of  capital  through  use,  wear  and  tear  has,  for 
the  purpose  of  computing  invested  capital,  the  same  effect  as  an 
operating  loss,  and  unless  this  loss  is  properly  taken  care  of  out 
of  earnings  in  one  way  or  another  earned  surplus  must  be  ad- 
justed in  accordance  with  the  regulations.  There  are  two  ways 
of  taking  care  of  this  loss  out  of  income.  One  is  by  charging 
ordinary  repairs  directly  to  expense  and  setting  up  a  deprecia- 
tion reserve  against  which  are  properly  chargeable  all  renewals 
and  replacements;  the  other  is  where  renewals  and  replace- 
ments, as  vv^ell  as  repairs,  have  been  charged  directly  against 
gross  income.  Either  way  has  the  effect  of  reducing  the  amount 
added  during  the  year  to  earned  surplus.  Consequently,  the 
mere  fact  that  no  depreciation,  or  a  minimum  depreciation,  has 
been  charged  as  such  is  not  sufficient  reason  for  reducing  the 
earned  surplus  where  renewals  and  replacements  sufficient  to 
care  for  the  decrease  in  value  of  capital  assets  have  been  charged 
directly  to  expense,  or  where  for  any  other  reason  less  than 
the  normal  rate  of  depreciation  is  properly  chargeable.  When 
a  taxpayer  makes  this  claim  there  are  two  methods  of  verifying 
it.  One  is  by  determining  the  plant  efficiency  and  the  other  is 
by  determining  the  value  of  the  capital  assets  remaining.  From 
an  administrative  standpoint  the  latter  is  probably  more  prac- 
tical even  though  it  may  be  said  that  the  former  is  more  ac- 
curate. 

Many  cases  arise  where  corporations  have  been  in  existence 
for  a  long  period  of  years,  sometimes  several  times  the  ordinary 
estimated  life  of  the  depreciable  assets,  and  yet  those  assets  are 
today  in  first-class  condition  and  worth  the  figure  at  which  they 
are  carried  on  the  books,  although  no  depreciation  has  been 
charged  as  such  and  no  additions  to  capital  account  have  been 
made.  In  such  cases  it  is  obvious  that  depreciation  has  been 
adequately  cared  for  by  charges  to  expense,  although  it  fre- 
quently happens  that  it  is  impossible  at  this  late  date  to  segre- 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1093 

gate  and  specify  such  charges  and  there  is  no  warrant  in  the 
law  or  the  regulations  for  requiring  the  depreciable  assets  in 
such  cases  to  be  written  down  below  the  figure  at  which  they 
are  carried  on  the  books,  since  to  do  so  is  to  reduce  earned  sur- 
plus twice,  once  through  the  original  charge  to  expense  (whether 
proper  or  improper)  and  again  through  an  arbitrary  deprecia- 
tion charge  set  up  against  earned  surplus  for  the  purpose  of 
computing  invested  capital.  The  controlling  rule  in  this  matter 
is  stated  above  to  the  effect  that  adjustments  in  respect  of  de- 
preciation or  depletion  in  prior  years  will  be  made  or  permitted 
only  upon  the  basis  of  affirmative  evidence  that  as  at  the  begin- 
ning of  the  taxable  year  the  amount  of  depreciation  or  depletion 
written  off  in  prior  years  was  insufficient  or  excessive,  as  the 
case  may  be.  Mere  failure  in  prior  years  to  have  written  off  on 
the  books  the  maximum  or  ordinary  rate  of  depreciation  is  not 
in  itself  "affirmative  evidence." ^^^"^ 

As  TO  Losses.  Where  a  loss  has  taken  place,  and  the  value 
of  the  asset  has  not  been  marked  down  accordingly,  the  amount 
of  such  loss  must  be  deducted  in  this  adjustment.  But  wherp 
a  loss  has  taken  place  it  will  be  taken  into  account  only  to  th^ 
extent  that  it  has  wiped  out  earned  surplus.  The  amount  of 
the  original  capital  contributed  by  the  stockholders  is  not  re- 
duced by  reason  of  the  loss,  but  no  new  surplus  can  be  included 
as  invested  capital  until  the  full  loss  chargeable  against  the 
capital  account  has  been  made  good.^"'-  Capital  or  surplus  ac- 
tually paid  in  is  not  required  to  be  reduced  because  of  an  impair- 
ment of  capital  in  the  nature  of  an  operating  deficit,  except 
where  there  has  been  directly  or  indirectly  a  liquidation  or  re- 
turn of  their  investment  to  the  stockholders,  in  which  case  full 
effect  must  be  given  to  any  liquidation  of  the  original  capital.-^"" 
Good  will  created  to  offset  impaired  capital  has  no  effect  on  in- 
vested capital.  Subsequent  earnings  must  be  used  first  to  restore 
impaired  capital,  excess  may  be  added  to  original  investment  as 
invested  capital.'^""  A  corporation  to  which  a  certain  amount  of 
capital  was  once  contributed,  and  which  has  not  paid  back  any 
part  thereof  to  its  stockholders,  either  directly  or  indirectly,  is 
allowed  to  claim  the  entire  amount  originally  contributed  as 
invested  capital,  regardless  of  losses  which  may  have  impaired 

304  A.  R.  M.  106  explained,  T.  B.  30-21-1748. 

3or.  A.  R.  R.  436,  T.  B.  13-21-1536.  Letter  from  treasury  departmenc 
dated  March  19,  1918;  Reg.  45,  Art.  860. 

:5or,  Reg.  45,  Art.  860;  A.  R.  R.  436,  T.  B.  13-21-1536. 
■W7  0.   D.  82,  T.  B.   1-19-121. 


1094  FEDERAL  INCOME  TAX 

such  capital,  provided  the  corporation  has  no  surplus  against 
which  the  loss  can  be  charged.  In  other  words,  a  corporation 
which  has  a  deficit  instead  of  a  surplus  may  disregard  the 
deficit  in  the  computation  of  its  invested  capital.  Losses  which 
must  be  taken  into  consideration  under  this  adjustment  are 
those  which  have  been  actually  sustained.  The  mere  deprecia- 
tion in  market  value  of  assets  is  not  considered  to  be  a  loss  im- 
pairing invested  capital.  Thus,  stock  of  other  corporations  may 
have  been  purchased  at  par  and  at  the  beginning  of  the  taxable 
year  may  have  a  market  value  of  only  75.  Nevertheless,  until 
the  stock  is  sold,  it  may  for  purposes  of  invested  capital  be  car- 
ried at  its  original  cost,  and  if  the  corporation  has  marked  the 
value  down  to  market,  it  may  restore  the  value  to  original  cost. 
On  the  other  hand,  such  marking  down  of  assets  to  market  (ex- 
cept in  the  case  of  dealers  who  inventory  their  stock)  does  not 
create  a  loss  which  may  be  deducted  in  computing  the  net  income. 
In  the  case  of  dealers  who  inventory  their  stock,  the  inven- 
tory value  would  govern  and  the  cost  value  cannot  be  restored. 
Allowance  for  Amortization  Under  Munition  Manufac- 
turer's Tax.  The  munition  manufacturer's  tax  was  laid  upon 
the  entire  net  profits  actually  received  or  accrued,  from  the  sale 
or  disposition  of  specific  munitions,  and  it  was  provided  in  Sec- 
tion 302  ''That  in  computing  net  profits  under  the  provisions  of 
this  title,  for  the  purpose  of  the  tax  there  shall  be  allowed  as 
deductions  from  the  gross  amount  received  or  accrued  for  the 
taxable  year  from  the  sale  or  disposition  of  such  articles  manu- 
factured within  the  United  States,  the  following  items ;  *  *  * 
(f )  A  reasonable  allowance  according  to  the  conditions  peculiar 
to  each  concern,  for  amortization  of  the  values  of  buildings  and 
machinery,  account  being  taken  of  the  exceptional  depreciation 
of  special  plants."  It  is  apparent  from  this  language  that  the 
amortization  allowance  in  question  was  authorized  for  the  pur- 
pose of  computing  "net  profits,"  not  "net  income."  The  right 
to  make  a  deduction  for  amortization  in  computing  net  income 
for  the  income  tax  did  not  exist  and  was  repeatedly  denied  by 
the  treasury  department  prior  to  the  passage  of  the  Revenue 
Act  of  1918.  It  is  to  be  noted  further  that  the  taxes  imposed 
by  Title  II  of  the  Revenue  Act  of  1917  and  Title  III  of  the 
Revenue  Act  of  1918  were  explicitly  laid  upon  "net  income,"  and 
were  in  a  variety  of  ways  impressed  with  the  stamp  and  char- 
acter of  an  income  rather  than  a  munition  manufacturer's  tax. 
They  are  in  no  sense  mere  continuations  or  expansions  of  the  tax 
imposed  by  Title  III  of  the  Revenue  Act  of  1916.     It  follows, 


WAR-PROFITS   AND   EXCESS-PROFITS   TAX  1095 

therefore,  that  the  deduction  for  amortization  under  the  muni- 
tion manufacturer's  tax  law  was  not  allowed  for  income  tax  pur- 
poses and  should  not  now  be  permitted  to  affect  the  surplus  or 
any  other  element  entering  into  the  "invested  capital"  em- 
ployed for  purposes  of  the  war-profits  and  excess-profits  taxes. 
In  ruling  upon  a  particular  case  the  treasury  department 
stated:  "This  conclusion  is  supported  by  the  character  of  the 
amortization  allowance  in  question.  It  was  in  many  respects 
quite  dissimilar  from  the  depreciation  and  depletion  allowances. 
It  was  not  based  upon  the  fact  that  plant  and  equipment  ac- 
quired in  the  year  1916  or  earlier  for  the  manufacture  of  muni- 
tions, actually  depreciated  in  use  or  market  value  during  the  tax- 
able year  1916.  There  was  in  general  no  such  depreciation  in 
value  or  impairment  of  useful  life.  Account  was  taken  'of  the 
exceptional  depreciation  of  special  plants'  but  the  principal  al- 
lowance was  'for  the  amortization  of  the  values  of  buildings  and 
machinery,'  whether  those  values  increased  or  decreased  in  the 
immediate  future.  The  principal  amortization  allowance  looked 
to  the  establishment  of  a  special  fund  to  recoup  exceptional  war 
costs  when  war  uses  had  ceased ;  it  did  not  imply  that  there  had 
been  or  would  be  any  immediate  impainnent  of  physical  assets, 
such  as  is  covered  by  the  depletion  allowance,  or  any  immediate 
exhaustion,  wear,  tear  or  obsolescence  in  excess  of  the  amount 
covered  by  the  depreciation  allowance.  It  was,  as  stated,  a 
special  allowance  peculiar  to  this  tax,  designed  possibly  to  mod- 
erate the  (then)  exceptionally  high  rates  of  the  munition  man- 
ufacturer's tax."3"8 

As  TO  Inadmissible  Assets.  The  adjustment  by  way  of  re- 
duction of  invested  capital  which  must  be  made  with  respect  to 
inadmissible  assets  is  indicated  in  an  earlier  paragraph  on  that 
subject.^^"'-'  In  the  case  of  a  corporation  which  has  no  borrowed 
money  the  reduction  will  equal  the  value  of  the  inadmissible 
assets.  In  case  the  corporation  has  borrowed  money  the  amount 
to  be  deducted  is  arrived  at  by  deducting  such  proportion  of  the 
invested  capital  (excluding  borrowed  capital)  as  the  proportion 
of  inadmissible  assets  is  to  the  total  of  inadmissible  and  ad- 
missible assets.'*^^"  Under  the  1917  Law  adjustments  for  inad- 
missible assets  were  made  on  the  theory  that  the  borrowed 
money  was  used  to  purchase  or  carry  the  inadmissible  assets  and 

308  Letter  from   treasury   department  dated    August   13,   1919;    W.   T.    S. 
1921,  11763;  T.  B.  M.  56,  T.  B.  15-19-452. 
309  See  p.  1079. 
310  Revenue  Acts  of  1918  and  1921,  §  326  (c). 


1096  FEDERAL  INCOME  TAX 

only  the  excess  of  such  assets  over  the  borrowed  money  was  de- 
ducted from  invested  capital.  Under  the  present  law,  the  ad- 
justment seems  to  be  on  the  theory  that  capital,  surplus  and 
borrowed  money  are  represented  by  the  inadmissible  assets  in 
proportion  to  the  amount  that  each  bears  to  the  aggregate  cap- 
ital, surplus  and  borrowed  money. 

Adjustments  Due  to  Changes  in  the  Taxable  Year.  After  the 
invested  capital  has  been  ascertained  as  at  the  beginning  of  the 
year  certain  adjustments  may  be  necessary  to  ascertain  the 
average  invested  capital  during  the  year,  which  is  the  amount 
contemplated  by  the  law.^^^  The  invested  capital  as  of  the  be- 
ginning of  any  period  of  one  year  or  less  should  be  adjusted  by 
an  appropriate  addition  or  deduction  for  each  change  in  invested 
capital  during  the  period.  The  amount  so  added  or  deducted  in 
each  case  is  the  amount  of  the  change  averaged  for  the  time  re- 
maining in  the  period  during  which  it  is  in  effect.-"^!-  The  frac- 
tion used  in  finding  such  average  is  the  number  of  days  re- 
maining in  the  period  (including  the  day  on  which  the  change 
occurs)  over  the  number  of  days  in  the  period.  Thus,  if  a  re- 
turn is  made  for  the  calendar  year  ending  December  31,  1918. 
and  if  $100,000  of  additional  capital  was  paid  in  on  February  17. 
1918,  this  addition  to  the  invested  capital  is  in  effect  for  318 
days,  and  the  amount  to  be  added  to  the  invested  capital  as  of 
the  beginning  of  the  year  would  be  318/365  of  $100,000  or  $87,- 
123.29.  If  $50,000  of  this  amount  was  withdrawn  on  October  31, 
]918,  the  amount  to  be  deducted  would  be  62/365  of  $50,000,  or 
$8,493.15.313 

311  Revenue  Acts  of  1918  and  1921  §326   (d). 

312  The  1917  Law  provided  that  the  invested  capital  should  be  "averaged 
monthly"  but  the  treasury  department  instead  of  adopting  a  monthly 
average  required  the  invested  capital  to  be  averaged  from  the  day  on 
which  the  change  took  place.  (See  form  1103  for  1917,  Schedule  D.) 
Under  that  law  the  following  rules  were  made  for  ascertaining  the 
average  invested  capital:  (a)  Add  the  capital  for  each  of  the  several 
months  during  which  no  change  occurs,  and  the  average  capital  (ascer- 
tained as  provided  in  subdivision  (b)  above)  for  each  month  in  which 
a  change  occurs  and  divide  the  total  by  the  number  of  months  in  the 
year  or  period.  (b)  To  ascertain  the  capital  for  any  month  in  which 
a  change  occurs  multiply  the  capital  as  of  the  first  day  of  the  month 
by  the  number  of  days  it  remains  constant  and  the  capital  after  each 
change  by  the  number  of  days  (including  the  day  on  which  the  change 
occurs)  during  which  it  remains  constant,  add  the  products  and  divide 
the  sum  by  the  number  of  days  in  the  month.      (Reg.  41,  Art.  43.) 

313  Reg.  45,  Art.  853.  Adjustments  for  1920 — a  leap  year — should  be 
made  on  the  basis  of  366  days.      (O.   D.  822,  T.  B.  8-21-1473.) 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1097 

Dividends  Paid  from  Surplus.  The  law  expressly  provides 
that  any  distribution  of  dividends  made  during  the  first  60  days 
of  the  year  shall  be  deemed  to  have  been  made  from  the  earnings 
or  profits  accumulated  during  the  preceding  taxable  years."^^  A 
dividend  other  than  a  stock  dividend  affects  the  computation  of 
invested  capital  from  the  date  when  the  dividend  is  payable  and 
not  from  the  date  when  it  is  declared,  except  that  where  no  date 
is  set  for  its  payment  the  date  when  declared  will  be  considered 
also  the  date  when  payable.  For  the  purpose  of  computing  in- 
vested capital  a  dividend  paid  after  the  expiration  of  the  first  60 
days  of  the  taxable  year  will  be  deemed  to  be  paid  out  of  the 
net  income  of  the  taxable  year  to  the  extent  of  the  net  income 
available  for  such  purpose  on  the  date  when  it  is  payable.  The 
method  of  determining  available  net  income  is  stated  in  the  next 
paragraph.  The  surplus  and  undivided  profits  as  of  the  begin- 
ning of  the  taxable  year  will  be  reduced  as  of  the  date  when  the 
dividend  is  payable  by  the  entire  amount  of  any  dividend  pn.id 
during  the  first  60  days  of  the  taxable  year  and  by  the  amaunt 
of  any  other  dividend  in  excess  of  the  current  net  income  avail- 
able for  its  payment.  In  the  case  of  a  dividend  paid  during  the 
first  60  days  of  a  taxable  year  which  exceeds  in  amount  the  sur- 
plus and  undivided  profits  as  of  the  beginning  of  the  taxable  year 
the  excess  will  be  deemed  to  be  paid  out  of  earnings  of  the  tax- 
able year  available  at  the  date  when  the  dividend  is  payable,  and 
to  the  extent  that  such  earnings  are  insufficient  it  will  be  deemed 
to  be  a  liquidation  of  paid  in  capital  or  surplus.  From  the  date 
when  a  dividend  is  payable  the  amount  which  the  several  stock- 
holders are  entitled  to  receive  will  be  treated  as  if  actually  paid 
to  them,  whether  or  not  it  is  so  paid  in  fact,  and  the  surplus  and 
undivided  profits,  either  of  the  taxable  year  or  of  the  preceding 
years,  will  in  accordance  with  the  foregoing  provisions  be 
deemed  to  be  reduced  as  of  that  date  by  the  full  amount  of  the 
dividend.  Amounts  paid  to  stockholders  in  anticipation  of  divi- 
dends, or  amounts  withdrawn  by  stockholders  in  excess  of  divi- 
dends declared,  will  in  computing  invested  capital  have  the  same 
effect  as  if  actually  paid  as  dividends.'^'"'  Where  a  corporation 
issues  interest-bearing  notes  to  its  stockholders  in  lieu  of  a  cash 
dividend,  invested  capital  should  be  reduced  as  of  the  date  of  the 

314  Revenue  Act  of  1918,  §201  (e).  This  provision  will  not  be  in  effect 
after  December  31,  1921,  because  of  the  repeal  of  the  excess-profits 
tax  (Revenue  Act  of  1921,  §201  (f)). 

315  Reg.  45,  Art.  858.  See  paragraphs  above  "amounts  paid  into  or  left  in 
business,"  and  "dividends  credited  to  stockholders,"  p.  1070. 


1098  FEDERAL  INCOME   TAX      ' 

notes,  provided  the  dividend  was  not  declared  from  current 
earnings.21*^  It  is  contemplated  that  a  dividend  must  not  affect 
the  computation  of  invested  capital,  except  from  the  date  when 
the  dividend  is  payable.  The  expression  "except  where  no  date 
is  set  for  its  payment  the  date  when  declared  will  be  considered 
also  the  date  when  payable"  assumes  that  the  corporation  has  re- 
sources to  pay  and  does  immediately  intend  to  pay.  When  the 
corporation  can  conveniently  pay  the  dividend  so  declared  is  a 
matter  of  administrative  decision  by  the  oflEicers  of  the  company 
and  until  such  decision,  as  a  condition  precedent,  is  reached  there 
is,  in  effect,  no  dividend  to  be  paid  and  no  reciprocal  right  on 
the  part  of  stockholders  to  immediately  exact  payment.^^^ 

Method  of  Determining  Available  Net  Income.  Whether 
at  the  time  of  any  payment  made  during  the  taxable  year  there 
is  sufficient  income  of  the  taxable  year  available  for  such  pay- 
ment, or  whether  the  surplus  or  undivided  profits  as  of  the  be- 
ginning of  the  taxable  year  must  be  reduced  by  the  amount  of 
such  payment,  will  be  determined  according  to  the  following 
principles : 

(1)  The  aggregate  amount  of  earnings  of  the  taxable  year 
available  for  all  purposes  up  to  any  given  date  will  be  determined 
upon  the  basis  of  the  same  proportion  of  the  net  income  for  the 
taxable  year  (as  finally  determined  for  the  purpose  of  income 
and  excess-profits  taxes)  as  the  part  of  the  year  already  elapsed 
is  of  the  entire  year,  unless  the  corporation  shows  from  its 
books  or  other  records  that  a  greater  proportion  of  its  earnings 
for  the  year  was  available  on  such  date.  A  fairly  accurate  in- 
formal approximation  of  monthly  earnings,  made  for  the  use  of 
the  officers  of  a  corporation  which  did  not  close  its  books  each 
month  is  insufficient  to  overthrow  the  general  presumption  in 
favor  of  the  average  or  prorating  method  of  ascertaining 
whether  at  the  time  of  any  payment  made  during  the  taxable 
year  there  is  suflficient  income  of  the  taxable  year  available  for 
such  payment.^i^ 

(2)  The  aggregate  amount  available  will  be  deemed  to  be  ap- 
plied for  the  following  purposes  in  the  order  in  which  they  are 
stated:     (a)  accrued  federal  income  and  war-profits  and  excess- 

316  0.  D.  1070,  T.  B.  42-21-1876;  A.  R.  R.  356,  T.  B.  52-20-1366;  A.  R.  R. 
102,   T.   B.  21-20-963. 

31TA.  R.  R.  408,  T.  B.  9-21-1488.  But  if  a  dividend  is  credited  to 
stockholders'  accounts  with  an  agreement  that  it  will  not  be  drawn  against, 
it  effects  a  reduction  of  invested  capital  from  the  date  so  credited.  (O. 
D.  1006,  T.  B.  34-21-1786.) 

318  T.  B.  R.  54,  T.  B.  18-19-491. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1099 

profits  taxes  for  the  taxable  year,  and  (b)  dividends  paid  after 
the  expiration  of  the  first  60  days  of  the  taxable  year  and  other 
corporate  purposes,  including  the  purchase  of  outstanding  stock 
of  the  corporation  previously  issued.-'^''  In  some  cases  the  above 
computation  would  be  indeterminate;  for  instance,  in  any  case  in 
which  the  amount  distributed  as  a  dividend  exceeds  the  earn- 
ings of  the  taxable  year  to  the  date  of  the  dividend  payment  plus 
the  accrued  federal  income  and  profits  taxes  on  such  earnings. 
In  such  cases  the  amount  of  invested  capital  for  the  purpose  of 
this  computation  may  be  deemed  to  be  the  invested  capital  as  of 
the  beginning  of  the  taxable  year,  plus  any  additional  capital 
paid  in  during  such  year  and  minus  any  specific  withdrawal  or 
liquidation  of  capital  during  such  year."^-" 

The  entire  amount  of  federal  income,  war-profits,  and  excess- 
profits  taxes  accrued  for  the  taxable  year  remains  a  part  of  in- 
vested capital  for  the  succeeding  year  (since  it  is  not  deductible 
from  gross  income  in  returns)  until  the  taxes  become  due  in  the 
succeeding  year.  Accrual  of  taxes  for  the  taxable  year  does 
not  aftect  invested  capital  for  the  taxable  year,  except  to  the 
extent  that  the  accrual  of  such  taxes  will  cause  dividend  pay- 
ments to  draw  on  surplus  as  at  the  beginning  of  the  year.-^-i 

Effect  of  Stock  Dividend.  The  payment  of  a  stock  dividend 
has  no  effect  upon  invested  capital.  The  distribution  of  a  stock 
dividend  is  in  effect  a  capitalization  of  current  earnings  or  of 
earned  surplus  on  hand  at  the  beginning  of  the  year.  The  cap- 
italization of  current  earnings  does  not  increase  the  invested  cap- 
ital, and  the  capitalization  of  surplus  on  hand  at  the  beginning 
of  the  year  does  not  decrease  the  invested  capital.-"-  Such  items 
as  appraised  value  of  good  will,  appreciation  in  value  of  real  es- 
tate or  other  tangible  property,  etc.,  although  carried  to  surplus 
and  distributed  as  stock  dividends,  can  not  in  this  manner  be 
capitalized  and  included  in  computing  invested  capital.  If  a 
corporation  has  paid  a  stock  dividend  in  excess  of  its  true  sur- 
plus, it  can  not  be  deemed  to  have  any  greater  invested  capital 
than  could  have  been  computed  had  no  such  stock  dividend  been 
paid.-'-'^ 

310  Reg.  45,  Art.  857. 

320  Reg.  45,  Art.  857;  0.  D.  619,  T.  B.  31-20-1110. 

3210.  D.  85,  T.  B.  1-19-124;  0.  D.  982,  T.  B.  30-21-1749. 

322  T.  B.  R.  3,  T.  B.   1-19-7. 

323  Reg.  45,  Art.  859;  T.  B.  R.  3,  T.  B.  1-19-7.     See  paragraph  above  "as 
to  values  marked  up  on  books  of  account,"  p.  1086. 


1100  FEDERAL   INCOME   TAX 

Effect  of  Liquidating  Dividend.  An  amount  taken  from 
capital  or  paid-in  surplus  to  meet  dividend  requirements  is 
deemed  a  liquidation  of  capital  to  that  extent  and  necessitates 
a  reduction  in  the  invested  capital.^-^  Thus,  if  a  company  pays  a 
dividend  declaring  it  to  be  out  of  earnings  accumulated  prior  to 
March  1,  1913,  and  the  excess  of  depletion  allowable  for  1917 
upon  the  basis  of  the  value  of  the  company's  property  as  of 
March  1,  1913,  over  the  depletion  actually  estimated  on  the  basis 
of  cost,  exceeds  the  dividend  payment,  the  dividend  payment  will 
nevertheless  be  held  to  constitute  an  impairment  of  invested  cap- 
ital, even  though  the  appreciation  in  value  as  of  March  1,  1913, 
was  converted  into  cash  and  reflected  on  the  company's  books 
during  the  current  year.  This  appreciation,  although  it  may 
have  taken  place  prior  to  March  1,  1913,  was  not  income  until 
realized  in  the  taxable  year.^^s  Under  the  excess-profits  tax  the 
earnings  of  the  taxable  year  are  not  to  be  included  in  earned 
surplus  and  undivided  profits,  and  the  appreciation,  therefore, 
can  not  be  taken  into  consideration  to  reduce  or  affect  the  im- 
pairment of  invested  capital  occasioned  by  the  dividend  pay- 
ment.2-*^ 

Increase  of  Capital  Stock.  If  the  capital  stock  is  in- 
creased during  the  taxable  year,  the  invested  capital  will  be 
considered  to  have  been  increased  from  and  after  the  dates  on 
which  the  cash  or  property  for  which  such  stock  is  issued  are 
paid  in.327 

Reduction  of  Capital  Stock.  If  the  capital  stock  is  re- 
duced during  the  year,  the  invested  capital  will  be  considered  to 
be  reduced  accordingly  from  and  after  the  dates  on  which  the 
assets  representing  such  reduction  of  capital  stock  are  paid  to 
the  stockholders.-'''-^  The  mere  reduction  of  the  authorized  cap- 
ital without  a  distribution  of  the  assets  will  not  affect  the  in- 
vested capital. 

Payment  of  Preceding  Year's  Excess-Profits  Tax.  The 
amounts  payable  on  account  of  income  and  excess-profits  taxes 
for  any  year  may  be  included  in  computing  surplus  and  un- 
divided profits  for  the  succeeding  year  only  for  the  proportion- 
ate part  of  the  year  represented  by  the  period  of  time  between 

324  o.  942,  T.  B.  26-19-598. 

325  Baldwin  Locomotive  Works  v.  McCoach,  221  Fed.  59.  See  chapters 
19  and  33. 

326  A.  R.  M.  51,  T.  B.  20-29-43. 

327  See  p.  1096. 

328  See  p.  1096. 


WAR-PROFITS   AND  EXCESS- PROFITS   TAX  1101 

the  close  of  the  taxable  year  and  the  date  or  dates  upon  which 
such  taxes  become  due  and  payable.''--'  The  date  when  the  1918 
taxes  were  actKalhj  paid  has  no  bearing  on  the  computation  of 
the  invested  capital  of  a  corporation  for  the  year  1919,  inas- 
much as  the  controlling  factor  is  the  date  when  such  taxes  were 
due  and  payable,  and  not  the  date  when  they  were  actually  paid. 
In  other  words,  the  amount  of  each  installment  of  the  tax  for 
1918  will  remain  a  part  of  the  invested  capital  for  1919  until 
such  installment  is  due  and  payable,  and  when  such  installment 
is  due,  an  adjustment  should  be  made  in  the  nature  of  a  reduc- 
tion of  the  book  value  of  assets."''"  Income  and  excess-profits 
taxes  are  deemed  to  have  been  paid  out  of  the  net  income  for  the 
taxable  year  for  which  such  taxes  are  levied  and  it  is  immaterial 
whether  or  not  a  reserve  was  set  up  for  such  taxes  and  if  set  up, 
whether  such  taxes  when  paid  have  actually  been  charged 
against  such  reserves.'^^^  It  seems  immaterial  whether  or  not 
sufficient  earnings  of  the  current  year  were  on  hand  when  such 
taxes  were  actually  paid.  In  the  case  of  corporations  having  a 
fiscal  year,  the  federal  income  and  excess-profits  taxes  for  the 
taxable  year  1918  will,  for  the  purpose  of  computing  inve?.ted 
capital  for  the  taxable  year  1919,  be  deemed  to  become  due  and 
payable  as  follows:  (a)  As  to  such  amounts  as  became  due  and 
payable  prior  to  February  25,  1919,  under  the  Revenue  Act  of 
1916,  such  law  shall  govern;  (b)  In  all  other  respects  the  Rev- 
enue Act  of  1918  shall  govern  except  that  the  installments  which 
would  become  due  prior  to  February  25,  1919,  shall  be  deemed 
to  become  due  and  payable  on  that  date;  (c)  Any  amounts 
which  became  due  and  payable  under  the  Revenue  Act  of  1916 
prior  to  February  25,  1919,  shall,  so  far  as  possible,  be  deemed 
to  cancel  the  earlier  installments  payable  under  the  Revenue 
Act  of  1918.3''52 

S-'9Reg.  45,  Art.  845;  T.  D.  2791. 

•5-'^<^  Letter  from  treasury  department  dated  September  22,  1919;  W. 
T.  S.  1921,  11785. 

;«1  Reg.  45,  Art.  845;  T.  D.  2791;  O.  D.  222,  T.  B.  11-19-392. 

3H2T.  D.  2931;  Reg.  45,  Art.  845  (a);  A.  R.  R.  81,  T.  B.  45-20-1299. 
See  Revenue  Acts  of  1918  and  1921,  §250;  Revenue  Act  of  1916,  §  14  (a). 
Under  the  Revenue  Act  of  1916,  in  the  case  of  a  fiscal  year  corporation, 
return  was  due  within  60  days  after  the  close  of  the  fiscal  year  and  tax 
was  due  within  105  days  after  the  last  due  date  of  the  return  (not 
after  the  date  of  filing),  hence,  for  the  fiscal  year  ended  August  31, 
1918,  the  return  was  due  on  or  before  October  30,  1918,  and  the  tax 
on  or  before  February  12,  1919,  or  on  or  before  the  165th  day  after 
August  31,  1918.  The  provisions  of  the  above  ruling  (Reg.  45,  Art.  845  (a)) 
apply   solely   for   the   purpose   of   computing   invested   capital   and    do   not 


1102  FEDERAL  INCOME   TAX 

Where  a  corporation  has  filed  a  claim  for  assessment  of  its 
1918  tax  by  reference  to  representative  corporations  and  has 
made  payments  on  the  basis  of  50%  of  the  net  income,  the 
claim  not  having  been  acted  upon  when  its  1919  return  is  due, 
the  invested  capital  for  1919  should  be  adjusted  on  the  basis  of 
the  tax  payments  actually  made,  subject,  however,  to  read- 
justment when  the  correct  amount  of  tax  for  1918  is  de- 
termined."33 

Effect  of  Additional  Assessment.  The  rule  stated  in  the 
previous  paragraph  is  in  general  applicable  to  additional  assess- 
ments. It  is  the  essence  of  any  system  of  accrued  accounting 
that  items  of  income  and  outgo  be  estimated  as  they  accrue  and 
that  the  proper  entries  be  made  upon  the  books  at  that  time. 
The  books  for  any  fiscal  period  are  deemed  to  clearly  reflect  the 
history  of  that  period  and  are  not  changed  even  though  sub- 
sequent events  demonstrate  that  certain  accruals,  to  a  minor  de- 
gree, were  incorrectly  estimated.  The  necessary  adjustments 
to  correct  such  errors  are  made  in  the  current  accounts.  It  is 
only  where  major  adjustments  are  necessary  that  it  is  good  ac- 
counting practice  to  make  adjustments  for  past  errors  in  the 
surplus  account.  For  these  reasons  it  has  been  recommended 
that  additional  assessments  of  income  and  excess-profits  taxes, 
for  prior  years  which  are  relatively  small  or  unimportant  be 
considered  paid  from  current  earnings ;  but  that  v/here  the  ad- 
ditional assessment  is  relatively  large  and  important  such  assess- 
ment be  considered  a  liability  of  the  taxable  year  in  question 
and  that  the  necessary  adjustments  of  the  surplus  account  be 
made.  In  such  cases  the  phrase  "due  and  payable"  means  the 
due  date  for  taxes  of  the  taxable  year  and  not  the  date  fixed  for 

affect  the  provisions  of  T.  D.  2797  in  regard  to  the  time  and  manner 
of  paying  taxes  where  corporations  have  filed  returns  for  fiscal  years 
ending  in  1918.  The  rule  stated  in  the  text  is  illustrated  as  follows . 
For  example,  a  corporation  whose  fiscal  year  ended  August  31,  1918, 
is  assessed  a  total  income  and  profits  tax  under  the  1917  Law  of  $250,000 
and  an  additional  tax  under  the  1918  Law  of  $110,000.  The  total  tax 
of  $360,000  would  for  the  purpose  of  computing  invested  capital,  be 
deemed  to  become  due  and  payable  as  follows:  February  12,  1919, 
$250,000;  May  15,  1919,  $20,000;  August  15,  1919,  $90,000.  If,  assum- 
ing the  same  taxes,  the  fiscal  year  ended  September  30,  1918,  the  total 
tax  would  for  the  purpose  of  computing  invested  capital,  be  deemed 
to  become  due  and  payable  as  follows:  February  25,  1919,  $90,000; 
March  15,  1919,  $90,000;  June  15,  1919,  $90,000;  September  15,  1919,  $90,000. 
(See  letter  from  treasury  department  dated  October  27,  1919;  W.  T.  S. 
1921,  11784.) 
333  o.  D.  410,  T.  B.  11-20-788. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1103 

the  payment  of  the  additional  assessment.  In  all  cases  in  which 
the  additional  assessment  is  less  than  5' ',  of  the  original  assess- 
ment or  is  less  than  $5,000  it  will  be  considered  paid  out  of 
current  earnings  and  no  adjustment  of  invested  capital  need 
be  made/'"'^ 

Effect  of  Refund.  Where  a  taxpayer  made  an  overpayment 
of  income  taxes  for  the  year  1917  in  1918,  which  amount  was  re- 
funded to  him  in  the  year  1921,  it  is  held  that  the  amount  of  tax 
overpaid  for  1917  and  refunded  may  be  included  in  the  invested 
capital  of  the  taxpayer  for  1918  and  subsequent  years.^^-^ 

Reduction  of  Reserves.  If  payments  are  made  out  of  any 
reserves  set  up  on  the  books  of  the  company,  which  reserves  are 
in  fact  a  part  of  the  surplus  and  have  been  included  as  invested 
capital  at  the  beginning  of  the  year,  the  invested  capital  is  not 
reduced  by  such  payments,  if  the  payments  are  such  as  may 
properly  be  charged  against  the  net  income  for  the  current 
}^ear  under  the  law.  Thus,  if  a  corporation  is  carrying  a  self- 
insurance  reserve  and  sustains  a  loss  in  1919  due  to  fire  or  other 
casualty,  it  may  deduct  that  loss  against  the  1919  income  al- 
though on  its  books  the  loss  may  be  charged  against  the  re- 
serve. In  such  case  the  reserve  is  not  reduced  for  purposes  of 
invested  capital.  If,  however,  payment  is  made  out  of  the  re- 
serve for  any  expenditure  which  is  not  deductible  from  the  1919 
income  and  does  not  represent  investment  in  a  new  asset  the 
reserve  is  reduced  for  purposes  of  invested  capital.^^^" 

Invested  Capital  for  Fractional  Part  of  Year.  In  the  case  of 
a  corporation  making  a  return  for  a  full  year  of  12  months,  its 
invested  capital  for  the  year  is  the  average  invested  capital  for 
the  year.  In  the  case  of  a  coi^Doration  making  a  return  for  a 
fractional  part  of  a  year,  its  invested  capital  for  such  period  is 
the  same  fractional  part  of  the  average  invested  capital  for  such 
period.'"^  To  illustrate:  A  corporation  was  organized  July  1, 
1918,  and  makes  a  return  for  the  six  months  ending  December 
31,  1918.  The  invested  capital  consists  of  $100,000  paid  in  on 
July  1  and  $100,000  paid  in  on  October  1.  The  average  invested 
capital  for  such  period  would  be  $100,000  plus  92/184  (not* 
92/365)   of  $100,000  or  $50,000,  a  total  of  $150,000.     The  in- 

334  T.  B.  M.  51,  T.  B.  12-19-411. 

335  0.  D.  1079,  T.  B.  43-21-1889. 

336  See  Reg.  45,  Arts.  884,  860. 

337  For  the  purpose  of  §311  (a)  (2)  of  the  1918  Law  it  is  the  full 
average   invested  capital  for  the  period. 


1104  FEDERAL  INCOME   TAX 

vested  capital  for  the  period  for  the  purpose  of  the  tax  would, 
however,  be  184/365  of  $150,000,  or  $75,616.44.'«8 

Invested  Capital  for  Prewar  Period.  The  invested  capital  for 
the  prewar  period  should  in  general  be  determined  in  the  same 
manner  as  for  the  taxable  year.-"'^'*  The  determination  of  in- 
vested capital  for  the  prewar  period  is  important  for  pur- 
poses of  computing  the  war-profits  credit.^^^  Since  the  war- 
profits  tax  is  only  temporary,  being  in  force  for  the  year  1918, 
except  in  the  case  of  corporations  deriving  a  net  income  of  more 
than  $10,000  from  any  government  contract  or  contracts  made 
between  April  6,  1917,  and  Novemiber  11,  1918,  both  dates  in- 
clusive,-"^^!  the  following  discussion  of  invested  capital  for  the 
prewar  period  relates  only  to  the  war-profits  tax  imposed  on  all 
corporations  for  the  year  1918  and  on  corporations  deriving  in- 
comes from  government  contracts,  as  above  indicated,  for 
subsequent  years. 

Adjustment  for  Assets  Differently  Valued  in  Prewar 
Invested  Capital.''''^^  j^  r^^y  ^.^gg  jj^  which  as  a  result  of  a  re- 
organization or  for  any  other  reason  any  asset  in  existence  both 
during  the  taxable  year  and  any  prewar  year  is  included  in  com- 
puting the  invested  capital  for  the  taxable  year,  but  is  not  in- 
cluded in  computing  the  invested  capital  of  such  prewar  year, 
or  is  valued  on  a  difi'erent  basis  in  computing  the  invested  capital 
for  the  two  years,  the  difference  resulting  therefrom  may  not  be 
included  in  determining  the  difference,  10%  of  which  is  added 
to  or  deducted  from  the  war-profits  credit.  In  any  such  case 
the  corporation  is  required  to  make  the  readjustment  required 
by  the  statute,  and  submit  with  its  return  a  full  statement  of 
the  difference  in  such  valuations  and  of  the  facts  which  give  rise 
to  such  difference.-'^^^  This  provision  of  the  statute  may  operate 
in  a  case  where  a  corporation  was  reorganized  after  the  be- 
ginning of  the  prewar  period,  or  consolidated  with  another,  as  a 

338  Reg.  45,  Art.  855,  856.  In  computing  the  tax  under  a  return  for  a 
fractional  part  of  a  period  the  same  purpose  may  sometimes  be  more 
readily  effected  by  using  the  full  invested  capital  and  taking  a  fractional 
part  of  the  result,  as  in  schedule  III  of  form  1120.  In  schedule  IV  of 
the  same  form,  however,  the  fractional  part  of  the  full  average  in- 
vested capital  for  the  period  should  be  used. 

339  Peg.  41,  Art.  51;  as  to  affiliated  corporations  see  p.  1132. 

340  Revenue  Act  of  1918,  §  311. 

341  Revenue  Act  of  1918,  §301   (c). 

342  The  Revenue  Act  of  1917  w^as  silent  on  this  subject,  and  such  adjust- 
ment was  less  important  under  that  law. 

343  Revenue  Act  of  1918,  §330;  Reg.  45,  Art.  934. 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1105 

result  of  which  good  will,  patents  or  other  assets  owned  during 
the  prewar  period  may  have  been  capitalized  for  the  first  time, 
or  the  capital  value  of  which  may  have  been  increased. 

Reorganization  After  January  1,  1911.    In  the  case  of  the 
reorganization,  consolidation  or  change  of  ownership  after  Jan- 
uary 1,  1911,  of  a  trade  or  business  carried  on  during  the  taxable 
year  by  a  corporation,  the  corporation  will,  for  the  purpose  of 
determining  invested  capital    for    the    war-profits    credit,    be 
deemed  to  have  been  in  existence  prior  to  that  date  and  the  net 
income  and  invested  capital  of  such  predecessor  for  all  or  any 
part  of  the  prewar  period  up  to  the  organization  of  the  corpora- 
tion now  carrying  on  such  trade  or  business  will  be  deemed  to 
have  been  the  net  income  and  invested  capital  of  such  corpora- 
tion.    If  the  predecessor  trade  or  business  was  carried  on  by  a 
partnership  or  individual,  the  corporation  must  make  its  return 
of  the  net  income  and  invested  capital  of  such  trade  or  business 
as  nearly  as  may  be  in  the  same  manner  as  if  such  trade  or  busi- 
ness had  been  carried  on  by  a  corporation.     It  should  submit 
with  its  return  a  statement  setting  forth    (a)    the  manner  in 
which  such  trade  or  business  was  carried  on  and  (b)  the  points, 
if  any,  in  which  the  provisions  of  the  statute  and  of  the  regula- 
tions are  not  fully  applicable  to  the  determination  of  the  net  in- 
come or  invested  capital  of  the  predecessor  trade  or  business  for 
the  prewar  period.     In  no  case  shall  the  deduction  from  gross 
income  for  salary  or  compensation  for  personal  services  exceed 
the  salaries  or  compensation  customarily  paid  at  that  time  by 
corporations  or  partnerships  of  similar  size  and  standing  en- 
gaged in  similar  trades  or  businesses  for  similar  services  under 
like  responsibilities.'"^^^ 

:544  Revenue  Act  of  1918,  §330;  Reg.  45,  Art.  932.  This  provision  is 
not  contained  in  the  present  law.  The  1917  Law  contained  a  similar 
provision  applicable  to  "a  trade  or  business  carried  on  by  a  corpora- 
tion, partnership,  or  individual,  although  formally  organized  or  reorganized 
on  or  after  January  2,  1913,  which  is  substantially  a  trade  or  business 
carried  on  prior  to  that  date."  A  company  owning  a  mill,  some  real 
estate  and  some  water  power  rights  and  with  two  outstanding  issues  of 
bonds,  became  insolvent  and  stopped  operations  in  Juno.  1914.  The 
corporation  was  declared  bankrupt  in  September,  1914.  In  March,  1915, 
a  sale  under  the  first  mortgage  was  held  and  the  property  acquired  on  be- 
half of  the  first  mortgage  bondholders  and  a  new  corporation  formed 
by  the  first  mortgage  bondholders  which  took  over  the  assets  of  the 
old  corporation  from  the  trustee,  the  stock  of  the  new  corporation  being 
divided  among  the  first  mortgage  bond  owners  in  proportion  to  their 
ownership  of  bonds.  It  was  held  that  the  business  of  the  new  company 
was   substantially   a   continuation   of  the   trade   or   business   carried   on   by 


1106  FEDERAL  INCOME   TAX 

In  the  case  of  a  reorganization,  the  new  corporation  is  re- 
quired to  base  its  invested  capital  on  the  adjusted  balance  sheet 
of  its  predecessor  as  of  the  date  of  reorganization.  Appreciation 
in  the  value  of  the  assets  so  transferred  from  the  old  organiza- 
tion to  the  new  can  not  be  included  in  the  invested  capital  of 
the  new  corporation.  The  statute,  however,  does  not  prohibit 
the  treatment  of  the  date  of  reorganization  as  the  beginning  of  a 
new  taxable  year.  Consequently,  it  does  not  require  the  ex- 
clusion from  the  invested  capital  of  the  new  corporation  of  sur- 
plus and  undivided  profits  earned  between  the  beginning  of  the 
then  taxable  year  of  the  predecessor  corporation  and  the  be- 
ginning of  the  taxable  year  of  the  new  corporation  .^^^ 

Average  Invested  Capital  for  Prewar  Period.  The  aver- 
age invested  capital  for  the  prewar  period  is  determined  by 
first  ascertaining  the  average  invested  capital  for  each  year  dur- 
ing the  whole  of  which  the  corporation  was  in  existence  and 
averaging  the  sums  so  obtained.^^^ 

Invested  Capital  of  Insurance  Companies.  The  reserve  funds 
of  insurance  companies  the  net  additions  to  which  are  deductible 
from  gross  income ^^'^  can  not  be  included  in  computing  in- 
vested capital.348    The  like  reserve  funds  of  insurance  companies 

its  predecessor  because  of  the  fact  that  the  product  manufactured  by 
the  new  company  was  sold  under  the  same  trade  name  and  produced  in 
the  same  location,  although  the  new  company  had  made  extensive  changes 
in  the  water  power  and  machinery,  had  installed  at  considerable  expense 
some  new  machinery,  had  changed  practically  the  entire  system  of  produc- 
tion, had  formed  new  banking  connections,  and  had  acquired  additional 
funds  through  these  connections  for  the  purpose  of  securing  additional 
working  capital.     (A.  R.  R.  221,  T.  B.  32-20-1124.) 

345  T.  B.  R.  2,  T.  B.  1-19-137. 

346  Revenue   Act  of  1918,  §326    (d). 

347  Revenue  Act  of  1918,  §  234. 

348  Revenue  Act  of  1918,  §§  325,  326  (b)  ;  Reg.  45,  Arts.  870,  569,  as 
amended  by  T.  D.  3153,  T.  B.  17-21-1600.  Under  the  1917  Law  it  was 
held  that  the  invested  capital  of  a  mutual  insurance  company  would  be 
deemed  to  consist  of  the  sum  of  (1)  any  surplus  or  contingent  reserves 
maintained  for  the  general  use  of  the  business,  plus  (2)  any  legal  re- 
serves the  net  additions  to  which  are  included  in  the  net  income  subject 
to  the  tax,  making  due  allowance  for  inadmissible  assets  as  required  by 
the  law.  The  invested  capital  of  a  stock  insurance  company  was  deemed 
to  consist  of  its  capital  stock,  paid-in  or  earned  surplus  and  undivided 
profits,  subject  to  the  restrictive  provisions  regarding  inadmissible  assets, 
and  computed  in  accordance  with  the  provisions  applying  to  the  computa- 
tion of  invested  capital  of  corporations.     (Reg.  41,  Art.  65.) 


WAR-PROFITS   AND  EXCESS-PROFITS   TAX  1107 

other  than  life  insurance  companies  may  be  included  in  com- 
puting invested  capital."'"' 

Invested  Capital  of  Foreign  Corporations.  Inasmuch  as  the 
war-profits  and  excess-profits  tax  in  the  case  of  a  foreign  cor- 
poration is  not  based  on  the  invested  capital  of  the  corpora- 
tion, but  such  corporations  are  assessed  on  the  basis  of  repre- 
sentative corporations,'-"'"  the  rules  for  determining  invested  cap- 
ital ■^■>^  have  no  application  to  foreign  corporations.  For  the 
same  reason,  when  rendering  a  return  of  income  on  Form  1120 
for  a  foreign  corporation,  no  entry  of  invested  capital  should 
be  made  thereon. •■^"'■- 

Invested  Capital  of  Domestic  Corporations  Deriving  Substan- 
tial Income  from  Possessions  of  the  United  States.  The  Rev- 
enue Act  of  1921  provides  for  the  taxation  of  domestic  corpora- 
tions only  with  reference  to  income  from  sources  wathin  the 
United  States.  If  such  domestic  corporations  derive  80%  of 
their  gross  income  for  a  three  year  period  preceding  the  close 
of  the  taxable  year  from  sources  within  a  possession  of  the 
United  States  (excluding  the  Virgin  Islands)  and  50%  of  their 
gross  income  for  such  period  from  the  active  conduct  of  a  trade 
or  business  within  a  possession  of  the  United  States,^'^^^  such 
corporations  are  taxable  under  the  Revenue  Act  of  1921  in  the 

349  Reg.  45,  Art.  870,  as  amended  by  T.  D.  3153,  T.  B.  17-21-1600.  See 
also  Reg.  45,  Art.  549,  as  amended  by  T.  D.  3153.  This  ruling  was  made 
under  the  1918  Law.  Life  insurance  companies  are  now  taxed  in  a  differ- 
ent manner  for  1921  and  insurance  companies  other  than  life  insurance 
companies  and  mutual  insurance  companies  are  now  taxable  in  a  different 
manner  for  1922.     Chapter  11  should  be  consulted  in  this  connection. 

350  See  Revenue  Acts  of  1918  and  1921,  §§327,  328. 

351  Revenue  Acts  of  1918  and  1921,  §326;  Reg.  45,  Arts.  831-870. 

352  Reg.  45,  Arts.  871,  962.  The  1917  Law  provided  that  the  invested 
capital  of  a  foreign  corporation,  or  a  foreign  partnership  or  nonresident 
alien,  would  be  determined  by  taking  that  proportion  of  the  entire  invested 
capital,  as  defined  and  limited  by  the  law,  which  the  net  income  from 
sources  within  the  United  States  bore  to  the  entire  net  income.  (Revenue 
Act  of  1917,  §207;  Reg.  41,  Art.  48.)  As  a  practical  matter  the  treasury 
department  found  it  extremely  difficult  to,  ascertain  the  invested  capital 
of  foreign  corporations  in  this  manner,  and  ruled  that  where  upon  appli- 
cation by  a  foreign  taxpayer  it  was  found  that  the  expense  of  securing 
the  data  necessary  for  the  computation  of  the  invested  capital  would  be 
unreasonable  in  view  of  the  amount  of  tax  involved,  or  that  it  was  im- 
practicable to  determine  either  the  "entire  invested  capital"  or  the  "entire 
net  income,"  assessment  would  be  made  under  §  210  of  that  law  (Reg. 
41,  Art.  52)  as  a  case  in  which  the  invested  capital  could  not  be  satis- 
factorily   determined. 

353  Revenue  Act  of  1921,  §262, 


1108  FEDERAL  INCOME  TAX 

same  manner  as  has  been  stated  of  foreign  corporations  in  the 
preceding  paragraph.ss-i 

War-Profits  Credit.^^^  In  the  case  of  all  domestic  corpora- 
tions the  war-profits  credit  includes  a  specific  exemption  of 
$3,000. 

354  Revenue  Act  of  1921,  §327   (b). 

355  Revenue  Act  of  1918,  §  311 ;  Reg.  45,  Arts.  781-785.  The  war-profits 
credit,  in  that  it  depends  to  some  extent  upon  income  and  invested  capi- 
tal in  the  prewar  period,  corresponds  somewhat  to  the  deduction  allowed 
under  the  1917  Excess-Profits  Law.  Under  that  law,  except  when  the 
income  for  the  prewar  period  could  not  be  satisfactorily  determined,  or 
was  low,  or  when  there  was  no  such  net  income,  the  deduction  in  the 
case  of  a  domestic  corporation  consisted  of  a  sum  of  (1)  an  amount 
equal  to  the  same  percentage  of  invested  capital  for  the  taxable  year 
which  the  average  amount  of  net  income  during  the  prewar  period  was 
of  the  invested  capital  for  the  prewar  period  (except  7%  was  used  if 
such  percentage  was  less  than  7%,  and  9%  was  used  if  such  percentage 
was  more  than  9%,  and  S%  was  used  if  a  corporation  was  not  in  existence 
during  at  least  one  calendar  year  during  the  prewar  period).  To  this 
sum  was  added  the  sum  of  $3,000.  The  same  deduction  was  allowed 
domestic  'partnerships  and  citizen  or  residents  except  that  such  taxpayers 
received  a  specific  exemption  of  $6,000.  Foreign  corporations  and  partner- 
ships and  nonresident  aliens  received  no  specific  exemption  (see  Reg. 
41,  Art.  21;  Revenue  Act  of  1917,  §§203-205).  Where  a  corporation 
was  not  in  existence  during  the  prewar  period  the  Commissioner  had  no 
discretion,  but  was  obliged  to  compute  a  deduction  of  8%  (A.  R.  R.  499, 
T.  B.  20-21-1644).  In  the  case  of  a  trade  or  business  formally  organized 
or  reorganized  on  or  after  January  2,  1913,  but  which  was  substantially 
a  continuation  of  a  trade  or  business  carried  on  prior  to  that  date, 
the  corporation  or  partnership  was  deemed  to  have  been  in  existence, 
or  the  individual  was  deemed  to  have  been  engaged  in  trade  or  business, 
prior  to  that  date;  and  for  the  purpose  of  computing  the  deduction,  the 
net  income  and  invested  capital  of  the  predecessor  was  deemed  to  be 
the  net  income  and  invested  capital  of  the  present  owner  for  the  prewar 
period.  (Reg.  41,  Art.  22.)  When  the  average  amount  of  income  for 
the  prewar  period  could  not  be  satisfactorily  determined,  the  deduction 
allowed  under  the  1917  Law  consisted  of  an  amount  equal  to  the  per- 
centage of  invested  capital  for  the  taxable  year  which  the  average  de- 
duction (determined  as  above  indicated,  without  including  the  specific 
exemptions  of  $3,000  or  $6,000)  for  the  taxable  year  of  representative 
corporations,  partnerships  or  individuals  was  of  their  average  invested 
capital  for  such  year,  plus  $3,000  in  the  case  of  a  domestic  corporation, 
and  $6,000  and  in  the  case  of  a  domestic  partnership  or  citizen  or  resi- 
dent. The  same  computation  of  the  deduction  was  used  where  the  net 
income  for  the  prewar  period  was  low  or  where  there  was  no  net 
income  for  the  prewar  period.  In  any  of  the  above  cases  the  taxpayer 
claiming  the  benefit  of  such  a  deduction  was  required  to  file  a  claim 
in  abatement  of  the  amount  by  which  the  tax  assessed  on  the  7% 
basis  exceeded  the  tax  upon  the  basis  of  the  deduction  finally  determined, 
and  payment  of  the  amount  covered  by  the  abatement  claimed  was  not 
required   until   the   decision"  thereon.     The   Commissioner   might,   however. 


WAR-PROFITS    AND    EXCESS-PROFITS    TAX  1109 

Minimum  War-Profits  Credit.  In  all  cases  the  minimum 
war-profits  credit  is  an  amount  equal  to  10 '^  of  the  invested 
capital  for  the  taxable  year  plus  the  specific  exemption.  This 
minimum  exemption  is  allowed  to  any  corporation  which  had 
no  net  income  for  the  prewar  period  or  whose  net  income  for 
the  prewar  period  was  less  than  10/1  .•'^•''" 

Where  Income  in  Prewar  Period  was  More  than  10%.  If 
the  net  income  of  a  corporation  for  the  prewar  period  was  more 
than  10' f,  the  average  net  income,  determined  by  taking  the 
total  net  income  for  the  prewar  period  and  dividing  by  the  num- 
ber of  years  during  the  whole  of  which  the  corporation  was  in 
existence,  even  though  there  may  have  been  no  net  income  for 
one  or  more  of  such  years,  will  be  taken  as  a  part  of  the  war- 
profits  credit.  To  this  is  added  or  deducted  (depending  upon 
whether  or  not  the  capital  has  been  increased  or  reduced)  10% 
of  the  difference  between  the  average  invested  capital  for  the 
prewar  period  and  the  invested  capital  for  the  taxable  year.^^? 

Corporations  Which  Had  no  Prewar  Period.  If  a  corpora- 
tion had  no  prewar  period,  the  war-profits  credit  is  the  specific 
exemption  plus  an  amount  equal  to  the  same  percentage  of  the 
invested  capital  of  the  taxpayer  for  the  taxable  year  as  the  aver- 
age percentage  of  net  income  to  invested  capital,  for  the  prewar 
period,  of  corporations  engaged  in  a  trade  or  business  of  the 
same  general  class  as  that  conducted  by  the  taxpayer  (but  not 
less  than  10  ^'  of  the  invested  capital  of  the  taxpayer  for  the 
taxable  year).  Such  average  percentage  is  to  be  determined 
by  the  Commissioner  on  the  basis  of  data  contained  in  the  ex- 
cess-profits tax  returns  filed  under  the  Revenue  Act  of  1917.  As 
such  average  percentage  had  not  been  determined  and  published 
at  least  thirty  days  prior  to  the  time  when  the  1918  return  of  the 
taxpayer  was  due,  such  return  was  made  up  by  using  10%  as  a 
deduction,  but  such  average  percentage  when  determined  is  to  be 
used  by  the  Commissioner  in  fixing  the  correct  amount  of  the 
tax.-'^''''^  The  average  percentages  of  prewar  income  to  prewar  in- 
vested capital  of  general  classes  of  corporations,  grouped  as  to 
trades  or  businesses,  has  now  been  published  and  is  known  as  the 

require  a  bond  covering  the  payment  of  such  difference.  (Reg.  41,  Arts.  23, 
49.)  The  provisions  of  this  article  were  waived  in  A.  R.  R.  547,  T.  B. 
27-21-1718. 

.W,  Reg.  45,  Art.  782. 

«'5''>7  Reg.  45,  Art.  781;  see  illustration  No.  1,  Appendix  to  1920  edition. 

358  Revenue  Act  of  1918,  §311    (c). 


1110  FEDERAL  INCOME  TAX 

"Median." 339  This  median  is  final  and  relief  will  not  be  granted 
by  way  of  special  assessment  with  reference  to  representative 
corporations  s'^o  merely  for  the  reason  that  the  application  of  the 
median  does  not  fix  the  relief  to  which  taxpayers  think  they  are 
entitled.'^''^  If  the  majority  of  the  stock  of  any  corporation  which 
had  no  prewar  period  is  owned  or  controlled  at  any  time  during 
the  taxable  year  by  a  corporation  which  had  a  prewar  period, 
this  provision  does  not  apply  and  the  war-profits  credit  will 
consist  of  the  sum  of  the  specific  exemption  of  $3,000  and  an 
amount  equal  to  10%  of  the  corporation's  invested  capital  for 
the  taxable  year.^*''- 

CORPORATIONS  DERIVING  INCOME  FROM  GOVERNMENT  CON- 
TRACTS. In  the  case  of  a  corporation  which  had  no  prewar 
period  and  50%  or  more  of  whose  gross  income  consists  of  gains, 
profits,  commissions,  or  other  income  derived  from  government 
contracts  made  between  April  6,  1917,  and  November  11,  1918, 
both  dates  inclusive,  the  war-profits  credit  will  consist  of  the 
sum  of  the  specific  exemption  and  an  amount  equal  to  10%  of  the 
invested  capital  for  the  taxable  year.^^s 

APPORTIONMENT  OF  WAR-PROFITS  CREDIT  IN  CASE  OF  COR- 
PORATION Reporting  for  Part  of  Year.  If  a  return  is  made 
for  a  period  of  less  than  twelve  months,  the  amount  equal  to  the 
average  net  income  for  the  prewar  period  plus  or  minus  10%  of 
the  difference  between  the  average  invested  capital  for  the  pre- 
war period  and  the  invested  capital  for  the  taxable  year  will  be 
reduced  to  the  same  proportion  thereof  as  the  number  of  months 
in  the  period  is  of  twelve  months.^*'^^ 

Fiscal  Year  Corporations.  In  calculating  a  corporation's 
war-profits  credit  in  the  case  of  a  fiscal  year  the  starting  point 

350  See  the  Appendix  to  the  1920  edition.  The  average  known  as  the 
median  is  by  the  statute  required  to  be  used.  It  is  not  an  arithmetical 
average,  but  is  found  by  taking  the  middle  figure  of  a  series  or  array 
of  figures  arranged  in  order  from  the  lowest  to  the  highest. 

300  Under    §§327-328. 

361  A.  R.  R.  36,  T.   B.   10-20-783. 

3C2  Revenue   Act   of   1918,   §  311    (d)  ;    Reg.   45,    Art.    784. 

303  Revenue  Act  of  1918,  §  311  (d)  ;  Reg.  45,  Art.  784.  '  It  should 
be  noted  that  this  provision  applies  to  all  corporations  which  had  no  pre- 
war period  and  one-half  of  whose  income  is  derived  from  government 
contracts  or  subcontracts.  In  §  327  of  the  law,  the  restriction  is  limited 
to  cases  where  the  government  contracts  provided  for  payment  on  a  cost- 
plus  basis.     See  p.  1119. 

304  Reg.  45,  Art.  781.  The  same  result  is  reached  in  schedule  IV  of 
return  form  1120  by  computing  the  war-profits  credit  for  a  full  year 
and   taking  a   fractional   part   of  the   result. 


WAR-PROFITS    AND    EXCESS- PROFITS    TAX  1111 

for  each  year  is  the  beginning  of  the  fiscal  year  ending  in  1911, 
1912  and  1913,  respectively,  and  the  invested  capital  should  be 
ascertained  as  at  those  dates.  To  these  sums  should  be  added 
any  contributions  of  capital  between  the  beginning  of  each  such 
fiscal  year  and  January  1,  1911,  1912  and  1913,  respectively, 
and  corresponding  deductions  should  be  made  in  respect  of  any 
dividends  and  any  refunds  of  capital  during  those  respective 
periods.  To  these  balances  should  be  added  a  pro  rata  share 
of  the  earnings  of  the  respective  fiscal  years,  and  the  totals  thus 
arrived  at  will  be  deemed  to  be  the  invested  capital  of  the  tax- 
payer at  January  1,  1911,  1912  and  1913,  respectively.  Tax- 
payers should  file  with  their  returns  copies  of  their  balance 
sheets  at  the  beginning  of  each  fiscal  year  and  a  schedule  for 
each  year  showing  the  adjustments  made  in  computing  the  in- 
vested capital  as  at  the  beginning  of  each  calendar  year  during 
the  prewar  period.  Where  a  taxpayer  has  such  accounting 
records  as  will  enable  him  to  prepare  an  accurate  balance  sheet 
showing  the  true  surplus  and  undivided  profits  at  the  beginning 
of  each  one  of  the  prewar  calendar  years  and  an  accurate  income 
account  for  such  years,  he  may  make  the  computation  upon  this 
basis  and  explain  the  method  used  in  such  details  as  will  enable 
the  Commissioner  to  determine  whether  such  basis  is  proper. 
Where  a  taxpayer  has  not  been  in  business  during  the  whole  of 
the  prewar  period,  the  above  methods  will  be  applicable  to  such 
full  calendar  years  during  the  whole  of  which  years  the  tax- 
payer was  in  business."*'''' 

Excess-Profits  Credit.  The' excess-profits  credit  in  the  case  of 
a  domestic  corporation  consists  of  the  specific  exemption  of 
$3,000  plus  an  amount  equal  to  8%  of  the  invested  capital  for  the 
taxable  year,-'^*''* 

Specific  Exemption.  Domestic  corporations  are  allowed  a 
specific  exemption  of  $3,000  to  be  deducted  from  the  net  income, 
but  if  the  tax  is  computed  for  a  period  of  less  than  12  months  the 
specific  exemption  is  reduced  in  proportion.''''"  The  specific  ex- 
emption of  $3,000  is  apportioned  only  in  the  case  where  a  return 
is  made  covering  a  period  of  less  than  12  months.  In  such  a 
case  the  specific  exemption  is  the  same  proportion  of  $3,000  as 

305  T.  B.  R.  16,  T.  B.  5-19-264. 

360  Revenue  Act  of  1918,  §312;  Reg.  45,  Art.  791.  This  is  the  credit 
still  used  in  the  present  law.  (Revenue  Act  of  1921,  §312.)  But  a 
domestic  corporation  taxable  under  §  262  is  not  entitled  to  the  credit 
or  exemption  of  $3,000. 

3C7  Revenue  Acts  of  1918  and  1921,  §305.  See  footnote  366  as  to  domes- 
tic corporations  taxable  under  §  262  of  the  present  law. 


1112  FEDERAL  INCOME   TAX 

the  number  of  months  in  the  period  is  of  12  months,  any  frac- 
tional part  of  a  month  being  counted  as  the  number  of  days  in 
such  part  of  a  month  divided  by  30,  Thus,  in  the  case  of  a  cor- 
poration organized  May  12,  1918,  and  making  a  return  for  the 
period  ending  December  31,  1918,  the  exemption  is  $1,916.67, 
that  is,  the  same  proportion  of  $3,000  as  7  20/30  months  is  of 
12  months.  This  provision  is  inapplicable  where  the  return  is 
made  for  a  full  fiscal  year  beginning  prior  to  January  1,  1918, 
and  ending  after  that  date,  even  though  the  income  for  such 
fiscal  year  is  not  subject  to  full  taxation  under  the  present 
statute.  In  the  case  of  afl[iliated  corporations  only  one  specific 
exemption  is  allowed.^''^'^ 

Net  Income.  Net  income  for  this  tax  is  ascertained  in  general 
upon  the  same  basis  and  in  the  same  manner  as  for  the  purpose 
of  the  income  tax,  except  as  noted  in  this  and  the  following 
paragraphs.^*^^  Thus,  when  a  corporation  may  deduct  the  amount 
of  its  net  operating  loss  for  the  calendar  year  1919,  which  is  in 
excess  of  the  net  income  for  the  calendar  year  1918,  in  com- 
puting net  income  for  the  calendar  year  1920,  the  excess-profits 
tax  is  upon  the  net  income  so  determined.^""  Reference  to  the 
rules  for  estimating  income  for  the  prewar  period  is  given  as 
well  as  the  rules  applying  to  the  taxable  year.  Under  the  excess- 
profits  tax,  however,  no  attention  need  be  paid  to  income  during 
the  prewar  period  but  the  rules  for  that  period  are  given  be- 
cause they  still  apply  to  such  corporations  as  by  reason  of  de- 
riving income  from  government  contracts  of  the  kind  hereinbe- 
fore indicated  continue  to  be  subject  to  the  war-profits  tax  if 
their  income  from  such  contracts  exceeds  the  sum  of  $10,000  in 
the  taxable  year.  Corporations  are  not  allowed  at  this  late  date 
to  adjust  salaries  paid  during  the  prewar  period,  when  such  ad- 
justment is  made  solely  for  the  purpose  of  increasing  the  war- 
profits  credit  for  the  taxable  year.^^i  Value  appreciation  of 
property  taken  up  on  the  books  of  the  taxpayer  and  returned  as 
part  of  his  taxable  income  for  the  year  in  which  the  appreciation 
was  written  up  must  be  excluded  in  computing  prewar  income, 

308  Reg.  45,  Ai-t.  761.  On  return  form  1120  this  apportionment  is 
taken  care  of  by  prorating  items  3  and   8  of   schedule   III. 

Sfiy  It  should  be  noted  that  the  Revenue  Act  of  1921  in  many  respects 
provides  different  rules  for  the  calculation  of  gross  income,  the  deduc- 
tions, and  therefore  net  income.  Net  income  for  the  excess-profits  tax 
imposed  by  the  Revenue  Act  of  1921  is  the  net  income  as  computed 
under  that  act. 

370  o.  D.  928,   T.   B.   21-21-1655. 

371  T.  B.  M.  50,  T.  B.  12-19-410;   O.  D.  184,  T.  B.  8-19-319. 


WAR-PROFITS    AND    EXCESS- PROFITS    TAX  1113 

even  though  an  income  tax  has  been  paid  on  it.3^-=  The  rule  that 
taxes  are  deemed  to  be  paid  out  of  earnings  for  the  year  for 
which  levied,  applies  to  any  year  of  the  prewar  period  as  well  as 
to  the  taxable  year.  In  such  cases  the  amount  or  amounts  pay- 
able in  a  succeeding  year  on  account  of  such  taxes  may  be  in- 
cluded in  the  computation  of  invested  capital  until  due  and  pay- 

able  ^'"^ 

FOR  THE  YEARS  1911  AND  1912.  The  net  income  for  these 
vears  is  determined  upon  the  same  basis  and  in  the  same  man- 
ner as  provided  in  the  1909  Law  except  that  the  tax  as  imposed 
by  that  law  and  paid  by  the  corporation  within  the  year  shall 
be  included.'-^  Including  such  taxes  for  the  years  1911  and 
1912  is  a  slight  advantage  to  the  corporation  in  that  it  in- 
creases the  net  income  for  the  prewar  period  for  the  purpose 
of  the  war-profits  credit.  mio   • 

FOR  THE  Year  1913.  The  net  income  for  the  year  1913  is 
ascertained  on  the  same  basis  and  in  the  same  manner  as  pro- 
vided in  the  1913  Law,  except  that  the  taxes  imposed  by  the  1909 
Law  on  the  corporation  on  its  income  for  1912  and  paid  by  the 
corporation  in  1913  may  be  included,  and  amounts  received  by  it 
as  dividends  upon  the  stock  or  from  the  net  earnings  of  other 
corporations  subject  to  the  tax  imposed  by  the  1913  Law,  must 

be  deducted.-^"' 

AVERAGE  Net  Income  for  the  Prewar  Period.  The  average 
net  income  for  the  prewar  period  is  determined  by  dividing  the 
number  of  years  within  that  period  during  the  whole  of  which 
the  corporation  was  in  existence  into  the  sum  of  the  net  in- 
come for  such  years,  even  though  there  may  have  been  no  net 
income  for  one  or  more  of  such  years.^'-^'"-  Thus,  if  a  corpora- 
tion was  in  existence  during  1912  and  1913  but  derived  no  in- 
come in  1912,  its  income  for  the  year  1913  must  be  divided  by 
two  in  order  to  ascertain  the  war-profits  credit.     But,  on  the 

372  T    B    M.  42,  T.  B.  8-19-335. 

373  See  Reg.  45,  Art.  845;  0.  D.  222,  T.  B.  11-19-392. 

374Revenue  Act  of  1918,  §320  (a)  1;  Reg.  45,  Art.  801  The  ne 
income,  under  the  1917  Law,  of  corporations  for  the  years  1911  and  191j 
was  computed  in  the  same  manner  (Reg.  41,  Art.  29).  The  net  n.come 
of  partnerships  and  individuals  for  1911,  1912  and  1913  was  determined 
in  the  same  manner  as  for  the  taxable  year,  except  that  dividends  from 
taxable  corporations  were  deducted    (Reg.  41,  Arts.  31,  36). 

37.-.  Revenue  Act  of  1918,  §320  (a)  2;  Reg.  45,  Art.  801.  Under  the 
1917  Law  taxes  paid  under  Sections  II  or  IV  of  the  1913  Law  were  also 
included;  otherwise  the  rule  was  the  same    (Reg.  41,  Art    29). 

370  Letter  from  treasury  department  dated  March  24,  1919;  W.  i.  b. 
1921,  11687. 


1114  FEDERAL  INCOME   TAX 

other  hand,  if  the  corporation  had  a  deficit  for  the  year  1912 
and  income  for  the  year  1913,  the  amount  of  the  deficit  need 
not  be  deducted  from  the  net  income  of  1913  in  order  to  ascertain 
the  average  net  income  for  the  prewar  period.s"^  The  three 
years  must  be  used  for  the  purpose  of  establishing  prewar  in- 
come, even  though  they  represent  a  period  of  depression  in  the 
particular  trade  or  business  involved.^"'^ 

For  the  Taxable  Year.  Net  income  for  the  taxable  year  is 
computed  upon  the  same  basis  and  in  the  same  manner  as  pro- 
vided for  income  tax  purposes  under  the  income  tax  law.^'^*'  The 
law  expressly  provides  that  the  net  income  of  a  corporation 
which  is  subject  to  the  income  tax  shall  also  be  subject  to  the  ex- 
cess-profits tax.  This  would  include  income  derived  from  the 
sales  or  dealings  in  the  capital  assets  of  the  taxpayer,3so  but  in 
the  case  of  the  sale  of  mines,  oil  and  gas  wells  a  limitation  is 
placed  upon  the  amount  of  the  excess-profits  tax  to  be  assessed 
with  respect  thereto.^^i 

3""  Letter  from  treasury  department  dated  February  21,  1918.  As  to 
the  prewar  income  of  affiliated  corporations,  see  p.  1135. 

378  A.  R.  R.  618,  T.  B.  39-21-1849.  Special  assessment  by  reference 
to  representative  corporations  may  be  granted  in  such  a  case,  however, 
if  the  depression  constituted  an  abnormal  condition  affecting  the  pi'ewar 
period.     See  p.  1119. 

379  Revenue  Act  of  1918,  §  320   (a)  ;  Reg.  45,  Art.  801.     See  footnote  369. 

380  Letter   from    treasury   department   dated    February   21,   1918. 

381  See  p.  1038.  Under  the  1917  Law  the  net  income  for  purpose  of 
income  tax  and  excess-profits  tax  were  not  identical,  since  for  the  pur- 
pose of  the  latter  tax  corporations  were  expressly  allowed  to  deduct  divi- 
dends. (Reg.  41,  Art.  28.)  Since  the  1917  Law  provided  an  excess- 
profits  tax  at  lower  rates  on  salaries  than  on  income  from  a  business 
employing  invested  capital,  the  treasury  department  held  that  where 
a  corporation  had  paid  its  officers  only  nominal  salaries,  a  reasonable 
allowance  for  salaries  could  be  deducted  for  any  period  prior  to  March 
1,  1918,  if  a  satisfactory  explanation  was  given.  (Letter  from  treas- 
ury department  dated  March  11,  1918.)  Under  the  present  law  there 
seems  to  be  no  need  for  rulings  of  this  character  since  an  excess-profits 
tax  law  has  been  in  force  for  a  length  of  time  sufficient  to  enable  cor- 
porations to  adjust  salaries  and  other  items  which  in  the  past  may 
have  been  merely  nominal  by  reason  of  the  relation  of  the  corporation  to 
its  stockholders.  The  income  of  partnerships  for  the  taxable  year  was 
ascertained  by  deducting  from  the  net  income  as  computed  under  the 
1916  Law  (including  interest  on  United  States  obligations  not  exempt 
from  excess-profits  tax)  (1)  dividends  from  taxable  corporations  and 
interest  paid  to  an  individual  partner  upon  a  bona  fide  loan,  but  not 
"so-called  interest  upon  capital."  (Reg.  41,  Arts.  30,  33;  A.  R.  R.  619, 
T.  B.  39-21-1848.)  Partnerships  were  also  allowed  a  reasonable  deduction 
for  salaries  to  individual  partners  for  any  period  prior  to  March  1,  1918, 
regardless  of  whether  a  previous  agreement  had  been  made,  such  salaries 


WAR-PROFITS    AND    EXCESS-PROFITS    TAX  1115 

Exemption  Granted  by  Merchant  Marine  Act.  The  Merchant 
Marine  Act  of  1920  provides  that  the  owner  of  a  vessel  doc- 
umented under  the  laws  of  the  United  States,  and  operated  in 
foreign  trade,  shall,  for  each  of  the  ten  taxable  years  while  so 
operated,  beginning  with  the  lirst  taxable  year  ending  after 
June  5,  1920,  be  allowed  as  a  deduction  in  computing  net  income 
subject  to  the  war-profits  and  excess-profits  taxes,  an  amount 
equivalent  to  the  net  earnings  of  such  vessel  during  such  tax- 
able year  determined  in  accordance  with  rules  and  regulations  to 
be  made  by  the  United  States  shipping  board.  No  such  owner 
is  entitled  to  such  deduction,  unless  during  the  taxable  year  he  in- 
vests or  sets  aside  in  a  trust  fund  for  investment  in  the  building 
of  shipyards  in  the  United  States  of  new  vessels  of  a  type  and 
kind  provided  by  the  shipping  board,  an  amount  to  be  determined 
by  the  secretary  of  the  treasury  and  certified  by  him  to  the  ship- 
ping board,  equivalent  to  the  war-profits  and  excess-profits  taxes 
that  would  have  been  payable  but  for  such  deduction.    At  least 

being  taxable  to  the  partners  at  the  8%  rate.  (Reg.  41,  Art.  32.)  If 
the  deductions  for  salaries  or  interest  paid  to  individual  partners  were 
availed  of,  corresponding  deductions  were  required  to  be  made  for  the 
prewar  period  (Reg.  41,  Art.  34).  Individuals  employing  merely  a 
nominal  capital  were  required  to  compute  their  net  income  for  the  tax- 
able year  by  adding  together  all  salaries,  wages,  etc.,  constituting  income 
from  a  business  with  merely  a  nominal  capital  (Reg.  41,  Art.  35).  Indi- 
viduals employing  more  than  a  nominal  capital  ascertained  their  net 
income  for  the  taxable  year  by  deducting  from  their  net  income  from 
all  sources  a  deduction  for  salaries  paid  to  themselves  and  any  contribu- 
tions made  by  a  trade  or  business  (as  distinguished  from  those  made  in 
a  personal  capacity).  If  a  salary  deduction  was  made  for  the  taxable 
year,  it  was  required  to  be  made  for  the  prewar  period.  An  individual 
member  of  a  partnership  need  not,  however,  include  his  share  of  the 
partnership  profits,  but  must  include  any  salary  deducted  by  the  partner- 
ship. A  dealer  in  securities  was  required  to  include  interest  on  United 
States  obligations  not  exempt  from  excess-profits  tax  and  a  proportion  of 
dividends  from  foreign  corporations  (Reg.  41,  Arts.  35-41).  In  the  case 
of  nonresident  aliens,  and  foreign  partnerships  and  corporations,  there  was 
included  only  income  from  sources  within  the  United  States  (Reg.  41,  Art. 
26).  Income  derived  from  the  business  of  life,  health,  and  accident  insurance 
combined  in  one  policy  issued  on  a  weekly  premium  payment  plan  was 
exempt  from  the  1917  Excess-Profits  tax,  as  was  also  compensation  to 
officers  and  employees  of  the  United  States,  any  state,  territory,  or  the 
District  of  Columbia,  and  the  income  generally  exempt  from  income 
tax  (Reg.  41,  Art.  25).  An  individual  engaged  in  more  than  one  busi- 
ness the  income  from  which  was  taxable  under  different  provisions  of 
the  law  and  regulations,  might  not  deduct  losses  sustained  in  the  one 
from  gains  or  profits  made  in  the  conduct  and  operation  of  the  other 
for  the  purpose  of  computing  the  excess  profits  tax  for  1917.  (A.  R.  M. 
96,  T.  B.  48-20-1328.) 


1116  FEDERAL  INCOME  TAX 

two-thirds  of  the  cost  of  any  vessel  so  constructed  must  be  paid 
for  out  of  the  ordinary  funds  or  capital  of  the  person  having 
such  vessel  constructed.  During  the  period  of  ten  years  sub- 
sequent to  June  5,  1920,  any  citizen  of  the  United  States  who 
may  sell  a  vessel  documented  under  the  laws  of  the  United 
States,  and  built  prior  to  January  1,  1914,  is  exempt  from  all 
income,  war-profits,  and  excess-profits  taxes  imposed  by  the  Rev- 
enue Act  of  1918  that  would  be  payable  upon  the  proceeds  of  such 
sale,  if  the  entire  proceeds  thereof  are  invested  in  the  building 
of  new  ships  in  American  shipyards,  such  ships  to  be  doc- 
umented under  the  laws  of  the  United  States  and  to  be  of  a  type 
approved  by  the  shipping  board.^ss 

Assessment  Without  Reference  to  Invested  Capital.  In  cer- 
tain cases  it  is  found  difficult  or  impossible  to  determine  the  in- 
vested capital  of  a  corporation.  In  such  cases  and  in  cases  of 
"abnormal  conditions  aff'ecting  the  capital  or  income  of  a  cor- 
poration," without  reference  to  the  difficulty  or  impossibility  of 
determining  invested  capital  in  the  ordinary  manner,  the  excess- 
profits  tax  will  be  computed  on  the  basis  of  the  returns  of  rep- 
resentative corporations  engaged  in  a  like  or  similar  trade  or 
business.^'^'^  Four  cases  in  which  the  tax  will  be  so  determined 
are  enumerated  in  the  law  and  are  discussed  in  the  paragraphs 
below. 

3S2  Merchant  Marine  Act,  1920,  §23;  W.  T.  S.  1921,  11869. 

.383  Revenue  Act  of  1918,  §  327.  In  many  cases  in  which  personal  service 
classification  has  been  claimed  under  the  1918  Law^  or  assessment  as  a 
concern  with  merely  nominal  capital  under  the  1917  Law,  these  claims 
have  been  denied,  but  special  assessment  under  §  210  of  the  Revenue 
Act  of  1917  or  §§  327,  328  of  the  Revenue  Act  of  1918  has  been  granted 
(See  Chapter  9  in  connection  with  these  cases).  Sections  827  and  328  of 
the  1918  Law  correspond  to  the  famous  §  210  of  the  1917  Law  which 
provided  that  when  the  invested  capital  could  not  be  satisfactorily  de- 
termined the  corporation  was  entitled  to  an  excess-profits  deduction  of 
an  amount  equal  to  the  same  proportion  of  its  net  income  for  the  taxable 
year  as  the  proportion  which  the  average  deduction  (excluding  the  specific 
sum  of  $3,000)  for  the  corresponding  year  of  representative  corpora- 
tions bears  to  the  total  income  of  such  representative  corporations  plus, 
in  the  case  of  domestic  corporations,  the  sum  of  $3,000.  This  section 
applied  also  to  partnerships  and  individuals  under  the  1917  Law.  In 
determining  this  proportion  the  net  incomes  of  representative  corpora- 
tions for  the  calendar  year  or  for  fiscal  years  ending  in  the  calendar 
year  were  taken.  In  case  the  corporation  whose  invested  capital  could 
not  be  satisfactorily  determined  made  a  return  for  its  own  fiscal  year 
the  proportion  determined  for  the  calendar  year  ending  during  such 
fiscal  year  was  used.  (Reg.  41,  Art.  24.)  The  rulings  provided  for  a 
computation  of  constructive  invested  capital  in  order  to  apply  the  rates 
to   a  corporation  whose   invested  capital  could  not  be   determined.      (Reg. 


WAR-PROFITS    AND    EXCESS- PROFITS    TAX  1117 

Election  of  Taxpayer.  It  has  been  held  under  the  cor- 
responding section  •^'^^  of  the  Revenue  Act  of  1917  that  while  a 
strict  and  literal  interpretation  of  the  language  gives  the  treas- 
ury department  the  right  to  determine  that  invested  capital  can 
not  be  satisfactorily  determined,  and  therefore  that  the  taxpayer 
should  be  assessed  without  reference  to  invested  capital,  it  is 
manifestly  the  intent  of  the  law  that  the  taxpayer  shall  have  a 
deduction  upon  all  the  statutory  invested  capital  which  he  can 
establish,  and  if  in  any  case  the  taxpayer  is  able  to  show  that  it 
has  statutory  invested  capital  in  excess  of  constructive  capital 
found  upon  application  of  the  special  relief  section  the  taxpayer 
should  not  be  deprived  of  the  right  to  have  assessment  based 
upon  such  statutory  capital  because  there  are  other  items  of  in- 
vested capital  which  can  not  be  determined  and  which  the  tax- 
payer concedes  the  right  of  the  treasury  department  to  ignore. 
This  rule  would  seem  to  apply  under  the  Revenue  Act  of  1918 
and  the  present  law,  except  with  regard  to  foreign  corpora- 
tions-^'"^"" 

Where  Commissioner  Is  Unable  to  Determine  Invested  Capital. 
The  first  case  is  where  the  Commissioner  is  unable  to  determine 
invested  capital  as  defined  in  the  law.  Such  cases  exist,  for 
example,  where  the  books  of  account  of  the  company  have  not 
been  kept  in  proper  form  or  where  it  is  impossible  to  ascertain 
the  values  of  assets  at  the  time  of  acquisition."^*^'"'  Where  the 
books  of  a  corporation  have  been  carefully  kept  and  it  is  possible 
to  ascertain  what  amounts  previously  charged  off  as  excessive 
depreciation  may  be  restored,  the  corporation  is  not  entitled  to 
special  assessment  on  the  ground  that  the  Commissioner  is  un- 

41,  Art.  18.)  Under  the  1918  and  1921  Laws  there  is  no  need  for  con- 
striictive  capital  in  such  cases  since  the  tax  is  now  based  upon  the  ratio 
of  the  amount  of  tax  to  Die  amount  of  net  income  of  representative  cor- 
porations. 

■'^i  Revenue  Act  of  1917,  §  210. 

3S-'  A.  R.  R.  209,  T.  B.  31-20-1111. 

3SG  Revenue  Acts  of  1918  and  1921,  §327  (a).  A.  R.  R.  63G,  T.  B. 
41-21-1865;  A.  R.  R.  338,  T.  B.  51-20-1359.  This  rule  has  special  applica- 
tion where  tangible  property  of  a  value  substantially  in  excess  of  the  par 
value  of  the  stock  paid  therefor  is  turned  over  to  a  company,  but  the 
evidence  as  to  the  exact  value  of  such  property  at  the  date  of  acquisi- 
tion is  difficult  or  impossible  to  obtain  (A.  R.  R.  556,  T.  B.  37-21-1817). 
The  1917  Law  (§  210)  pi'ovided  a  method  which  should  be  followed  in 
all  cases  in  which  the  Commissioner  was  unable  satisfactorily  to  deter- 
mine the  invested  capital.  In  the  language  of  the  1918  and  the  present 
Law  the  word  "satisfactorily"  was  omitted. 


1118  FEDERAL  INCOME   TAX 

;;ble  to  determine  invested  capital  or  on  the  ground  that  any  ab- 
normal condition  affects  capital  or  income.^-'^'' 

Inventions  Turned  Over  to  Corporation  Without  Con- 
sideration. In  a  case  in  which  the  principal  stockholder  turned 
over,  without  consideration,  to  a  close  corporation  an  invention 
in  respect  to  which  a  patent  was  subsequently  granted  after 
some  litigation,  it  has  been  ruled  that  the  company  was  entitled 
to  assessment  with  reference  to  representative  corporations  on 
the  ground  that  the  value  of  the  invention  at  the  time  turned 
over  and  before  commercial  development  could  not  be  sat- 
isfactorily determined.  Had  it  been  possible  satisfactorily  to 
determine  such  value,  the  proper  procedure  would  have  been  to 
recognize  such  value  as  paid-in  surplus.-^'^^ 

In  the  Case  of  Foreign  Corporations.  The  Revenue  Act  of 
1921  and  the  1918  Law  provide  that,  in  the  case  of  foreign  cor- 
porations, the  tax  shall  be  determined  without  reference  to  in- 
vested capital  as  defined  in  the  law.-^'^^  In  the  case  of  a  foreign 
corporation  carrying  on  all  of  its  business  in  the  United  States  it 
does  not  seem  that  the  law  should  prevent  the  corporation  from 
obtaining  such  benefits  as  may  accrue  to  it  from  a  computation 
of  the  credits  with  reference  to  an  invested  capital  determined 
in  the  ordinary  manner,  but  the  language  of  the  provision  that 
the  tax  shall  be  assessed  by  reference  to  representative  corpora- 
tions indicates  an  intent  that  this  method  of  assessment  shall 
apply  to  all  foreign  corporations,  and  the  treasury  department 
has  so  ruled.3^0 

Where  Stock  Has  Been  Issued  for  a  Mixed  Aggregate  of  Tangi- 
ble and  Intangible  Property.  The  provision  of  the  law  that  the  tax 
shall  be  assessed  by  reference  to  representative  corporations 
where  a  mixed  aggregate  of  tangible  property  and  intangible 
property  has  been  paid  in  for  stock  or  for  stock  and  bonds,  does 
not  apply  in  all  cases  where  a  mixed  aggregate  of  tangible  and 
intangible  property  has  been  paid  in  for  stock  or  for  stock  and 
bonds,  but  only  in  such  cases  where  the  Commissioner  is  unable 
satisfactorily  to  determine  the  respective  values  of  the  several 

3S7A.  R.  R.  599,  T.  B.  37-21-1823. 
3S8  A.  R.  R.  70,  T.  B.  17-20-882. 

389  Revenue  Act  of  1918,  326.  See  A.  R.  R.  397,  T.  B.  9-21-1486.  The 
same  rule  applies  to  domestic  corporations  taxable  under  §  262  of  the 
Revenue  Act  of  1921. 

390  Revenue  Act  of  1918,  §327;  Reg.  45,  Art.  871. 


WAR-PROFITS    AND    EXCESS- PROFITS    TAX  1119 

classes  of  property  at  the  time  of  payment,  or  to  distinguish  the 
classes  of  property  paid  in  for  stock  and  for  bonds  re- 
spectively/^-'^ 

Cases  of  Abnormal  Conditions  Affecting  Capital  or  Income. 

In  cases  of  abnormal  conditions  affecting  the  capital  or  income 
of  a  corporation,  assessment  without  reference  to  invested  capi- 
tal is  intended  to  operate  as  a  remedial  measure  as  distinguished 
from  cases  where  it  is  difficult  or  impossible  to  determine  in- 
vested capital.  Such  assessment  is  made  only  upon  application 
by  the  corporation  in  cases  where,  upon  such  application,  the 
Commissioner  finds  (and  so  declares  of  record)  that  the  tax  if 
determined  without  the  benefit  of  this  section  would,  owing  to 
abnormal  conditions  affecting  the  capital  or  income  of  the  cor- 
poration, work  upon  the  corporation  an  exceptional  hardship 
evidenced  by  gross  disproportion  between  the  tax  computed 
without  the  benefit  of  this  section  and  the  tax  computed  by 
reference  to  representative  corporations.  This  provision  does 
not  apply  to  any  case  (1)  in  which  the  tax  based  upon  the  cor- 
poration's invested  capital  is  high  merely  because  the  corpora- 
tion earned  a  high  rate  of  profit  upon  a  normal  invested  capital 
nor  (2)  in  which  50 /f  or  more  of  the  gross  income  of  the  cor- 
poration for  the  taxable  year  consists  of  gains,  profits,  commis- 
sions or  other  income  derived  on  a  cost  plus  basis  from  a  gov- 
ernment contract  or  contracts  made  between  April  6,  1917,  and 
November  11,  1918,  both  dates  inclusive.-'''-    It  may  apply,  how- 

^ai  Revenue  Acts  of  1918  and  1921,  §327  (c).  This  provision  of  the 
law  seems  to  be  a  statutory  declaration  of  the  rule  adopted  by  the  treas- 
ury department  as  a  matter  of  practice,  under  the  19i7  Law.  This 
rule  was  applied  under  the  1917  Law  in  A.  R.  R.  459,  T.  B.  15-21-1568. 
Under  that  law  it  was  ruled  that  assessment  would  be  made  under  §  210 
of  that  law  in  cases  where  the  Secretary  was  unable  to  determine  satis- 
factorily the  respective  values  of  the  several  classes  of  property  at  the 
time  of  payment.     (Reg.  41,  Art.  52.) 

392  Revenue  Acts  of  1918  and  1921,  §327  (d).  The  limitation  stated 
in  (1)  above  is  applicable  to  assessments  under  §210  of  the  1917  Law 
(T.  B.  M.  7,  T.  B.  1-19-119).  Under  the  1917  Law  the  following:  were 
held  to  be  exceptional  cases  which  warranted  assessment  under  §  210  of 
that  law. 

(1)  Where,  through  defective  accounting  or  lack  of  adequate  data, 
it  was  impossible  accurately  to  compute  invested  capital. 

(2)  Where  upon  application  by  a  foreign  taxpayer  the  Secretary  of 
the  Treasury  found  that  the  expense  of  securing  the  data  necessary  for 
the  computation  of  the  invested  capital  would  be  unreasonable  in  view 
of  the  amount  of  tax  involved,  or  that  it  was  impracticable  to  deter- 
mine either  the  "entire   invested  capital"  or  the  "entire  net  income." 

(3)  Long    established    business    concerns    which    by    reason    of    ultra- 


1120  FEDERAL  INCOME  TAX 

ever,  to  a  corporation  deriving  income  from  government  con- 
tracts on  the  "per  unit"  basis.^os  The  limitation  stated  in  (2) 
above  has  been  held  to  be  designed  to  cover  cases  in  which  a  con- 
tractor was  assured  of  a  profit  irrespective  of  cost  and  in  which 
the  government,  rather  than  the  contractor,  assumed  the  risk 
of  loss.  Where  the  unfinished  work  of  a  contractor  was  com- 
rnandeered  by  the  government  and  it  was  agreed  that  he  should 
receive  the  same  compensation  as  he  would  have  received  under 
the  private  contract,  the  fact  that  he  was  subsequently  compen- 
sated on  a  cost-plus  basis  after  the  work  was  completed  does 
not,  in  the  opinion  of  the  committee,  operate  to  change  the  legal 
situation  in  this  respect.^-*"^ 

The  tax  will  not  ordinarily  be  assessed  under  this  provision 
of  law  merely  because  the  corporation's  form  or  manner  of 
organization,  or  the  limitations  as  to  invested  capital  result  in  a 
greater  tax  than  would  otherwise  be  payable. 

Referring  to  the  legislative  history  of  the  Revenue  Act  of 
1918,  it  will  be  noted  that  this  provision  of  the  statute,  as 
enacted  by  the  Senate,  read  as  follows : 

"(e)  Where  the  invested  capital  is  materially  disproportion- 
ate to  the  net  income  as  compared  with  representative  corpora- 
tions engaged  in  a  like  or  similar  trade  or  business  because :  1, 
The   capital   employed,   although   a   material   income-producing 

conservative  accounting  or  the  form  and  manner  of  their  organization 
would  otherw^ise  be  placed  at  a  serious  disadvantage  in  competing  with 
representative   concerns   in   a  like   or   similar  trade   or  business. 

(4)  Where  the  invested  capital  was  seriously  disproportionate  to 
the  taxable  income.  Such  cases  it  was  held  might  arise  through  (a)  the 
realization  in  one  year  of  the  earnings  of  capital  unproductively  in- 
vested during  a  period  of  years  or  the  fruits  of  activities  antedating 
the  taxable  year;  or  (b)  inability  to  recognize  or  properly  allow  for 
amortization,  obsolescence,  or  exceptional  depreciation  due  to  the  war, 
or  to  the  necessity  in  connection  with  the  war  of  providing  plant  which 
would  not  be  wanted  for  the  purpose  of  the  business  after  the  termina- 
tion** of  the  war.  (Reg.  41,  Art.  52.)  The  uses  enumerated  in  this 
article  are  not  to  be  regarded  as  exclusive,  but  the  class  of  cases 
therein  referred  to  is  limited  to  the  cases  enumerated  or  those  "similar 
in  character."  (T.  B.  M.  58,  T.  B.  14-19-441.)  Under  the  1918  and  the 
present  law  the  conditions  described  in  1  and  2  are  expressly  provided 
for;  3  and  4  (a)  will  be  considered  as  creating  "abnormal  conditions 
affecting  the  capital  or  income"  within  the  meaning  of  §  327  (d)  and 
therefore  entitle  the  corporation  to  relief.  The  condition  stated  in  4  (b) 
no  longer  exists  as  the  taxpayer  is  now  enabled  to  recognize  and  properly 
allow   for    am.ortization,    obsolescence    or    exceptional    depreciation. 

393  0.  D.  321,  T.  B.  26-19-599. 

304  A.  R.  M.  89,  T.  B.  45-20-1288. 


WAR-FROFITS    AND    EXCESS-PROFITS    TAX  1121 

factor,  is  very  small  or  is  in  large  part  borrowed.  2.  There  are 
excluded  from  the  invested  capital  as  computed  under  the  pro- 
visions of  Section  326,  intangible  assets  of  recognized  and  sub- 
stantial value  built  up  or  developed  by  the  taxpayer.  3.  The 
net  income  for  the  taxable  year  is  abnormally  high  due  to  the 
realization  in  one  year  of  (a)  gains,  profits,  or  income  earned 
or  accrued  during  a  period  of  years  or  (b)  extraordinary  gains 
or  profit  derived  from  the  sale  of  property  the  principal  value 
of  which  has  been  demonstrated  by  prospecting  or  exploration 
and  discovery  work  done  by  the  taxpayer.  When  the  tax  is  de- 
termined under  this  paragraph  proper  allowance  shall  be  made 
for  the  taxes  which  would  have  been  payable  in  prior  years  if 
the  gains,  profits,  or  income  earned  or  accrued  in  such  years  had 
been  taxed  at  the  rates  then  applicable.  4.  Proper  recognition  or 
allowance  can  not  be  made  for  amortization,  obsolescence,  or 
exceptional  depreciation  due  to  the  present  war,  or  to  the  neces- 
sity in  connection  with  the  present  war,  of  providing  plant 
which  will  not  be  wanted  for  the  purpose  of  the  trade  or  busi- 
ness after  the  termination  of  the  war." 

This  provision  was  stricken  out  by  the  conference  committee 
and  in  its  place  is  inserted  the  vague  phrase  "abnormal  condi- 
tions affecting  the  capital  or  income  of  a  corporation."  ='•'•"'  It 
seems  probable  that  the  instances  enumerated  in  the  Senate  bill 
as  above  quoted  are  contemplated  by  the  phrase  of  the  law  as 
finally  passed — abnormal  conditions  affecting  the  capital  or  in- 
come of  the  corporation — and  that  the  conference  committee 
used  the  broad  language  enacted  in  the  statute  as  finally  passed 
because  of  the  possibility  that  in  defining  the  operation  of  the 
provisions  for  assessment  of  the  excess-profits  tax  by  reference 
to  representative  corporations  it  would  be  limiting  the  Commis- 
sioner in  the  exercise  of  his  discretion  and  possibly  preventing 
him  from  granting  relief  in  many  cases  which  could  not  be 
exactly  anticipated  or  defined  by  Congress  at  the  time  the  law 
was  enacted.  It  is  a  well-established  principle  of  statutory  con- 
struction that  where  the  language  of  the  statute  is  ambiguous 
and  its  meaning  doubtful,  the  bill  as  introduced  and  changes 
made  in  the  frame  of  the  bill  in  the  course  of  its  passage  may 
be  resorted  to  upon  questions  of  legislative  intent.-'""    The  above 

.'{0.")  This  provision  was  in  large  part  a  statutory  enactment  of  the  treas- 
ury department's  previous  liberal  construction  of  §  210  of  the  Revenue 
Act  of  1917.  Compare  the  provision  with  the  regulation  quoted  in  note 
392. 

•■in*!U.  S.  V.  St.  Paul  M.  R.  Co.,  247  U.  S.  310,  318;  Atl.  C.  L.  R.  Co.  v. 
Riverside  Mills,  219  U.  S.  196,  200.     See  also  cases  cited  in  Chapter  47. 


1122  FEDERAL  INCOME   TAX 

language  of  the  Senate  bill  should  be  consulted  in  connection 
with  applications  for  relief  by  way  of  assessment  with  reference 
to  representative  corporations. 

Where  Intangible  Assets  of  Substantial  Value  Are  Ex- 
cluded FROM  Ordinary  Invested  Capital.  Under  the  Revenue 
Act  of  1917  relief  was  given  to  many  long  established  business 
concerns  which,  by  reason  of  ultra-conservative  accounting  or 
the  form  and  manner  of  their  organization,  would  otherwise 
have  been  placed  at  a  serious  disadvantage  in  competing  with 
representative  concerns  in  a  like  or  similar  trade  or  business.^^'' 
As  stated  in  the  foregoing  paragraph,  the  fact  of  ultra-conserv- 
ative accounting  and  the  form  and  manner  of  the  corporation's 
organization  will  not  ordiTiarily  entitle  a  taxpayer  to  special  as- 
sessment-S'-ts  it  seems  clear,  however,  that  the  Revenue  Act  of 
1913  399  contemplates  that  relief  be  granted  where  such  factors 
misrepresent  a  corporation's  true  invested  capital.  Thus,  cases 
in  which  large  sums  have  been  spent  in  advertising,  thus  creat- 
ing a  good  will  or  earning  capacity  far  in  excess  of  recognizable 
invested  capital  are  to  be  regarded  as  cases  in  which  there  are 
abnormal  conditions  affecting  invested  capital.^*^"^'  A  corporation, 
the  capitalization  of  which  did  not  represent  or  include  the  value 
of  certain  good  will  or  patents  actually  turned  over  to  the  com- 
pany and  actually  earning  income  on  which  the  corporation  was 
paying  a  tax,  has  been  held  taxable  under  the  provisions  of  Sec- 
tion 210  of  the  Revenue  Act  of  1917.^"^  A  corporation  which 
clearly  shows  substantial  intangible  value  in  a  business  with 
small  capitalization,  the  success  of  which  business  is  not  de- 
pendent on  personal  services,  except  as  may  be  normally  re- 
quired for  the  management  of  the  property  of  any  company,  has 
been  held  entitled  to  special  assessment  under  the  Revenue  Act 
of  1917.40-  But  the  mere  fact  that  the  taxpayer  can  not  be 
allowed  to  include  in  statutory  invested  capital  the  full  amount 
of  good  will  appearing  upon  its  books,  even  though  such  good 
will  is  less  than  the  actual  value  of  the  good  will  at  the  time 
acquired,  does  not  create  such  an  abnormal  condition  as  to  en- 
title a  corporation  to  special  assessment.'^os 

397  See  Reg.  41,  Art.  52;   A.  R.   R.  464,   T.  B.   17-21-1588. 

398  See  Reg.  45,  Art.  901. 

399  §327   (d) 

400  a.  R.  M.  12,  T.  B.  2-20-679;  A.  R.  R.  338,  T.  B.  51-20-1359. 

401  A.  R.  R.  110,  T.  B.  20-20-945. 

402  A.  R.  R.  332,  T.  B.  50-20-1348. 

403  A.  R.  R.  599,  T.  B.  37-21-1823.     In  this  case,  however,  the  good  will 
appearing    on    the    books    of    the    corporation    represented    a    considerable 


war- profits  and  excess- profits  tax  1123 

Where  Abnormal  Profits  Are  Thrown  into  a  Single  Tax- 
able Year.  The  artificiality  of  the  taxable  year  as  a  unit  of 
time  for  tax  purposes  is  generally  conceded.  The  year  is  taken 
as  a  matter  of  necessity  because  the  very  nature  of  income  de- 
mands that  it  be  measured  by  reference  to  time.^"^  The  taxable 
year  works  fairly  well  as  a  time  unit  in  the  majority  of  cases. 
The  injustices,  inequalities  and  absurdities  resulting  in  extra- 
ordinary cases,  however,  are  generally  conceded.^o^  It  is  well 
known  that  one  of  the  purposes  of  provision  for  assessment  by 
reference  to  representative  corporations  is  to  provide  for  cases 
in  which  a  hardship  of  this  kind  occurs.  Such  hardship  may 
occur,  broadly  speaking,  in  one  of  two  ways. 

In  the  first  place,  it  may*  occur  when  the  income  of  the  taxable 
year  represents  the  "realization  in  one  year  of  the  earnings  of 
capital  unproductively  invested  for  a  period  of  years,  or  the 
fruits  of  activities  antedating  the  taxable  year."^""  The  receipt 
by  a  corporation  of  the  proceeds  of  a  life  insurance  policy  upon 
the  life  of  the  sole  owner  of  its  stock  has  been  held  to  create 
an  abnormal  condition  affecting  the  income  of  the  corporation 
for  the  year  of  receipt."*""  But  the  realization  of  greater  profits 
in  the  taxable  year  than  had  been  realized  in  prior  years  does  not 
in  itself  indicate  the  excess  of  an  abnormal  condition  affecting 
the  income  of  the  taxable  year,  and  this  is  particularly  true  as 
to  the  taxable  years  1917  and  1918  when  profits  were  due  in 
large  measure  to  war  conditions.^"'^  Inefficient  management  dur- 
ing previous  years  followed  by  efficient  management  in  the  tax- 
increase  over  the  good  will  which  had  appeared  upon  the  books  of  a 
predecessor  corporation  upon  a  reorganization,  and  no  evidence  appeared 
that  the  corporation  as  reorganized  possessed  assets  tangible  or  intangible 
of  greater  value  than  the  old  corporation. 

•*•'+ No  one  has  income  at  any  one  point  of  time;  he  has  income  only 
by  reference  to  a  fixed  period  (Trefry  v.  Putnam,  227  Mass.  522,  116  N.  E. 
904). 

405  See  letter  of  former  secretary  of  treasury  to  committee  on  ways 
and  means  of  house  of  representatives  (66th  congress,  1st  session) 
dated  November  3,  1919,  in  which  it  is  said  that  the  annual  accounting 
period,  the  striking  of  a  balance  of  gain  or  loss  every  twelve  months, 
is  merely  an  approximation  resting  upon  convenience  and  fiscal  neces- 
sity, and  that  the  result  shown  is  frequently  unreal,  for  if  a  business 
concern  makes  $20,000  in  1918,  loses  $10,000  in  1919,  and  makes  $5,000 
in  1920,  it  has  not  earned  profits  of  $25,000  in  the  three-year  period, 
but  only  $15,000. 

400  A.  R.  R.  538,  T.  B.  28-21-1730. 

407  A.  R.  R.  335,  T.  B.  50-20-1345. 

408  A.  R.  R.  599,  T.  B.  37-21-1823;  A.  R.  R.  518,  T.  B.  22-21-1668. 


1124  FEDERAL  INCOME   TAX 

able  year  does  not  create  an  abnormal  condition.-"'"  This  kind 
of  a  case  was  specifically  provided  for  in  the  regulations  issued 
under  the  Revenue  Act  of  1917.^^^ 

In  the  second  place,  it  may  also  occur  when  the  income  of  the 
taxable  year  represents  temporary  earnings  inevitably  to  be  re- 
duced by  then  indeterminable  losses  inseparably  connected  with 
the  production  of  such  income.  While  this  class  of  cases  has 
nowhere  been  enumerated  in  a  formal  regulation,  it  seems  to 
be  clearly  analogous  in  principle  to  the  class  of  cases  described  in 
the  above  quotation  and  must  have  arisen  in  the  case  of  many 
corporations  operating  under  long-term,  fixed-price  contracts 
during  the  last  few  years  when  the  cost  of  labor  and  materials 
was  constantly  rising.  It  might  also  arise  in  the  case  of  a  com- 
pany which  liquidated  all  its  business  in  a  particular  year  unless 
the  liquidation  did  not  result  in  a  tax  abnormally  high  as  com- 
pared with  taxes  imposed  upon  representative  concerns  in  the 
same  line  of  business."*^^ 

Payment  of  Inadequate  Salaries  to  Officers.  It  has 
been  held  under  the  Revenue  Act  of  1917  that  failure  to  pay 
salaries  to  officers,  or  the  payment  of  unusually  low  salaries  in 
comparison  with  salaries  paid  to  the  officers  of  competing  con-' 
cerns,  may  create  an  abnormality  of  income  which  will  entitle  a 
corporation  to  special  assessment.^i^ 

Abnormal  Conditions  Affecting  Prewar  Period.  The 
statutory  provision  in  regard  to  "abnormal  conditions"  is  not 
in  terms  limited  in  its  application  to  cases  arising  out  of  ab- 
normal conditions  affecting  the  capital  or  income  of  the  cor- 
poration for  the  taxable  year.  The  words  "capital  or  income  of 
the  corporation"  are  general  words  applicable  to  the  income  or 
capital  of  any  year  and  can  not  be  limited  by  construction  unless 
there  is  a  clear,  necessary,  and  irresistible  implication  from 
other  parts  of  the  statute  that  such  a  limitation  should  be 
made.'*^^'  Furthermore,  in  the  same  subdivision  Congress  has  in 
two  instances  specified  that  the  income  or  profits  referred  to  is 
that  of  the  taxable  year,  although  the  context  made  that  mean- 
ing clear  without  specification.    The  use  of  such  a  limiting  clause 

409  A.  R.  R.  338,  T.  B.  51-20-1539. 

410  Reg.  41,  Art.  52. 

411  T.  B.  M.  53,  T.  B.  15-19-453;  O.  D.  969,  T.  B.  27-21-1720;  see  O.  D. 
395,  T.  B.  5-20-723  and  T.  B.  M.  60,  T.  B.  15-19-454  in  which  it  is  said  that 
the  abnormal  income  may  arise  through  a  sale  of  capital  assets. 

412  A.  R.  R.  326,  T.  B.  47-20-1318;  A.  R.  R.  538,  T.  B.  28-21-1730. 

413  Faw  V.  Marsletter,  3  Cranch.  10,  23;  U.  S.  v.  Coombs,  12  Peters 
72,  80. 


WAR-PROFITS    AND    EXCESS-PROFITS    TAX  1125 

in  two  instances  and  the  absence  of  it  in  the  third  instance  indi- 
cates that  the  words  were  there  used  without  limitation.   There- 
fore, unless  there  is  some  clear  and  necessary  inference  from 
the  other  parts  of  the  statute,  it  seems  evident  that  subdivision 
(d)   includes  cases  of  hardship  caused  by  abnormal  conditions 
affecting  the  capital  or  income  for  the  prewar  period.    The  pre- 
war data  is  used  in  computing  the  war  profits  credit  which  may 
consist  of  (a)  $3,000  plus  the  average  net  income  for  the  prewar 
period  with  an  adjustment  for  change  in  capital;  or  (b)  $3,000 
plus  a  percentage  of  the  invested  capital  for  the  taxable  year 
based  on  the  median  average  established  by  the  prewar  ex- 
perience of  a  general  class  of  trade  or  business.    This  credit  is 
used  by  concerns  having  no  prewar  period;  or  (c)   a  minimum 
war-profits,  credit  of  $3,000  plus  10  ^r  of  the  invested  capital  for 
the  taxable  year.«-^     The  minimum  war-profits  credit  will  not 
raise  a  presumption  that  Congress  intended  to  include  in  Section 
311  all  relief  which  should  be  granted  because  of  abnormal  con- 
ditions existing  in  the  prewar  period,  and  that  there  is  a  clear 
and  necessary  inference  that  Congress  did  not  intend  to  grant 
further  relief  of  the  same  nature  under  Section  327  on  account 
of  the  same  conditions.     The  relief  granted  by  the  maximum 
war-profits  credit  and  special  assessment  are  not  of  the  same 
nature.     The  minimum  war-profits  credit    establishes    certain 
rules  applicable  to  general  classes  and  which  apply  in  all  cases 
whether  hardship  actually  exists  or  not.    It  gives  relief  to  indus- 
tries which  passed  through  a  period  of  depression  in  the  prewar 
years.     It  also  applies  to  concerns  which  earned  less  than  10% 
in  the  prewar  period,  even  though  their  tax  is  not  grossly  dispro- 
portionate to  that  of  their  competitors.     The  "abnormal  condi- 
tions" provision,  on  the  other  hand,  deals  not  with  general  classes 
but  with  specific  instances  and  grants  relief  in  special  cases  ac- 
cording to  the  facts  of  each  case  where,  without  such  relief,  there 
would  be  a  hardship  as  compared  with  representative  concerns 
because   of  some   abnormal  condition   affecting  the  capital   or 
income  of  the  corporation.    The  two  provisions  are  of  a  different 
nature.    The  one  would  give  no  relief  to  a  corporation  belonging 
to  a  class  which  normally  earned  20%  if  that  corporation,  due 
to  some  abnormal  condition  affecting  the  income  of  the  prewar 
period,  earned  only  12%  during  the  prewar  period.     Such  con- 
cerns do  not  receive  even  partial  relief  under  the  minimum  war- 
profits  credit  and  should  be  granted  relief  under  the  "abnormal 

414  Revenue   Act  of   1918,   §311. 


1126  FEDERAL  INCOME   TAX 

conditions"  provision.^is  it  has  been  held  under  the  1917  Law 
that  a  corporation,  which  in  1911  commenced  the  erection  and 
operation  of  a  refinery,  the  building  of  which  and  the  experi- 
mental operation  and  development  work  connected  with  which 
extended  over  several  years,  requiring  the  withdrawal  from 
other  lines  of  the  corporation's  business  of  a  large  share  of  its 
available  capital,  thus  temporarily  curtailing  its  earning  power 
and  reducing  its  profits,  and  thus  rendering  the  prewar  period 
abnormal  and  not  a  true  measure  of  the  corporation's  normal 
average  business,  should  be  assessed  under  the  provision  requir- 
ing the  excess-profits  deduction  to  be  an  amount  equal  to  the 
same  percentage  of  invested  capital  for  the  taxable  year  which 
the  average  deduction  for  such  year  of  representative  corpora- 
tions is  of  the  average  invested  capital  for  such  year  pips,  in  the 
case  of  a  domestic  corporation,  $3,000.'^i6  Under  the  Revenue 
Act  of  1918  this  kind  of  relief  would  seem  to  be  contemplated 
under  the  general  provision  for  assessment  by  reference  to  rep- 
resentative corporations  on  the  ground  that  abnormal  condi- 
tions affected  the  capital  or  income  of  the  prewar  period. 

Statement  to  Be  Filed.  A  corporation  the  income  or  cap- 
ital of  which  is  affected  by  abnormal  conditions  may  make  ap- 
plication for  assessment  by  reference  to  representative  corpora- 
tions, which  application  should  be  attached  to  its  return  in  the 
form  of  a  statement  setting  forth  in  full:  (a)  the  reasons  why 
the  tax  should  be  so  determined;  (b)  the  facts  upon  which  such 
reasons  are  based;  (c)  an  exact  description  of  each  trade  or 
business  or  important  branch  of  a  trade  or  business  carried  on 
by  it;  (d)  a  statement  of  the  invested  capital  and  net  income  for 
each  year  since  the  beginning  of  the  prewar  period;  and  (e)  a 
statement  showing  the  amount  of  gains,  profits,  commissions  or 
other  income  derived  on  a  cost  plus  basis  from  government  con- 
tracts made  after  April  5,  1917,  and  before  November  12,  1918, 
and  sho^ving  the  percentage  which  such  income  is  of  the  total 
income  of  the  corporation.*^''' 

Method  of  Assessment.  Under  the  method  of  assessment  by 
reference  to  representative  corporations  the  tax  will  be  an 
amount  which  bears  the  same  ratio  to  the  net  income  of  the 
taxpayer  (in  excess  of  the  specific  exemption  of  $3,000)  for 
the  taxable  year,  as  the  average  tax  of  representative  corpora- 
tions engaged  in  a  like  or  similar  trade  or  business,  bears  to 

415  0-lOOO-A,  T.  B.  19-20-922,  reversing  O-IOOO. 

416  Revenue  Act  of  1917,  §  205;  A.  R.  R.  104,  T.  B.  20-20-944. 

417  Reg.  45,  Art.  901. 


WAR-PROFITS    AND    EXCESS-PROFITS    TAX  1127 

their  average  net  income  (in  excess  of  the  specific  exemption  of 
$3,000)  for  such  year.  In  the  case  of  a  foreign  corporation  the 
tax  is  computed  without  deducting  the  specific  exemption  of 
$3,000  either  for  the  taxpayer  or  the  representative  corpora- 
tions.*^''  Ilhistration :  If  the  average  net  income  of  representa- 
tive corporations  is  represented  by  $100,000:  the  net  income  in 
excess  of  the  specific  exemption  would  be  $97,000.  If  the  aver- 
age tax  is  found  to  be  $38,800,  the  rate  to  be  applied  to  domestic 
corporations  will  be  38,800^97,000  or  40V''.  Thus,  a  domestic 
corporation  having  a  net  income  of  $60,000  will  deduct  the 
specific  exemption  of  $3,000,  leaving  $57,000 — 40%  of  which  is 
$22,800,  the  amount  of  tax  due  under  this  section.  But  if  the 
corporation  is  a  foreign  corporation  and  has  an  income  of 
$60,000  the  tax  rate  will  be  determined  by  dividing  38,800  by 
100,000  which  decreases  the  percentage  to  38.8  V'-.  But  this  is 
applied  to  the  entire  net  income,  $60,000,  making  the  tax  due 
from  the  foreign  corporation  $23,280,  or  $480  more  than  that 
imposed  on  a  domestic  corporation  with  the  same  net  income. 

In  the  case  of  a  corporation  with  a  fiscal  year  ending  in  1918, 
the  tax  is  computed  first  as  if  the  entire  income  had  been  earned 
during  the  calendar  year  1917  and  second  as  if  such  entire 
income  had  been  earned  during  the  calendar  year  1918.  The 
proper  proportions  of  the  resulting  taxes  are  used  to  determine 
the  tax  for  the  fiscal  year.  "Constructive"  invested  capital  is 
used  only  with  respect  to  the  first  computation,  the  method  with 
respect  to  the  second  computation  being  to  fix  a  tax  bearing  the 
same  ratio  to  net  income  as  the  taxes  of  representative  corpo- 
rations.-*^^ 

Representative  Corporations.  The  representative  corporations 
with  respect  to  which  the  tax  is  to  be  computed  under  this  sec- 

418  Revenue  Acts  of  1918  and  1921,  §328  (a).  This  method  is  much 
simpler  than  that  prescribed  by  §  210  of  the  1917  Law  and  reaches  ap- 
proximately   the    same    result. 

419  Revenue  Act  of  1918,  §  335  (a)  ;  T.  B.  M.  30,  T.  B.  6-19-285.  The 
provisions  of  §  210,  as  interpreted  by  Article  52  of  Regulations  41,  and 
§  327  are  somewhat  different  and  it  is  possible  that  a  corporation  may  be 
entitled  to  special  assessment  under  the  1917  Law  and  not  under  the 
1918  Law,  or  vice  versa.  In  such  case  it  would  seem  that  the  tax  would 
be  computed  as  follows :  First,  as  if  the  entire  net  income  had  been 
earned  during  the  calendar  year  1917,  the  tax  being  computed  thereon 
under  §  210 ;  second,  as  if  the  entire  net  income  had  been  earned  during 
1918,  the  tax  thereon  being  computed  under  §  301.  These  taxes,  one 
computed  by  special  assessment  and  the  other  computed  in  the  ordinary 
manner,  would  then  be  divided  into  their  proper  proportions  to  determine 
the  tax  for  the  fiscal  year. 


1128  FEDERAL  INCOME  TAX 

tion  are  those  corporations  whose  invested  capital  can  be  satis- 
factorily determined  in  the  ordinary  manner  and  which  are,  as' 
nearly  as  may  be,  similarly  circumstanced  with  respect  to  gross 
income,  net  income,  profits  per  unit  of  business  transacted  and 
capital  employed,  the  amount  and  rate  of  war-profits  or  excess- 
profits,  and  all  other  relevant  facts  and  circumstances.^-"  In 
each  case  the  Commissioner  will  determine,  as  nearly  as  may  be, 
the  group  or  class  of  corporations  with  which  the  corporation 
should  be  compared.'^-i 

Ratio  Between  Average  Tax  and  Average  Net  Income.  The 
ratio  between  the  average  tax  and  the  average  net  income  of 
representative  corporations  is  to  be  determined  by  the  Commis- 
sioner in  accordance  with  regulations  prescribed  by  him  with 
the  approval  of  the  secretary .^-- 

Payment  of  1918  Tax  by  Corporations  Applying  for  Special 
Assessment.  In  cases  in  which  the  tax  was  to  be  computed  with- 
out reference  to  the  invested  capital,  the  corporation  was  re- 
quired to  pay  its  tax  for  1918  in  installments  without  the  benefit 
of  special  relief,  if  the  tax  as  so  computed  was  less  than  50%  of 
the  net  income  of  the  taxpayer.  But  if  the  tax  so  computed  was 
50%  or  more  of  the  net  income,  the  installments  to  be  paid  by 
the  corporation  were  required  to  be  computed  in  the  first  instance 
upon  the  basis  of  a  tax  equal  to  50%  of  the  net  income.  The 
actual  ratio  when  ascertained  was  to  be  used  in  determining  the 
correct  amount  of  the  tax.  If  the  correct  amount  of  the  tax 
when  determined  exceeded  50%  of  the  net  income,  any  excess 
of  the  correct  installments  over  the  amounts  actually  paid  became 
due  and  payable  ten  days  after  notice  and  demand  together  with 
interest  at  the  rate  of  one-half  of  1%  per  month  on  such  excess 
from  the  time  the  installment  was  due.  If,  on  the  other  hand,  the 
amount  of  the  tax  was  less,  upon  correct  determination,  than  the 
amount  on  which  installments  had  been  paid,  the  law  impliedly 
provided  that  the  amount  so  paid  should  either  be  credited  to  the 
installments  falling  due  after  final  determination,  or  if  all  the 

420  Revenue  Acts  of  1918  and  1921,  §328    (a). 

421  Reg.  45,. Art.  911.  It  seems  that  the  following  should  be  considered 
in  selecting  representative  corporations:  (1)  a  representative  corpora- 
tion should  be  fairly  representative  of  all  corporations  engaged  in  the 
same  general  line  of  business,  as  that  of  the  corporation  seeking  the 
assessment  under  this  provision  of  the  law;  (2)  it  should  operate  in 
the  same  general  vicinity;  (3)  it  should  approximate  in  gross  sales, 
gross  earnings,  and  net  earnings;  (4)  it  should  approximate  as  to  man- 
ner and  form  of  organization,  especially  financing;  and  (5)  it  should 
have  been  in  business  for  approximately  the  same  length  of  time. 

422  Revenue   Acts  of   1918   and   1921,   §328    (b). 


WAR-PROFITS    AND    EXCESS-PROFITS    TAX  1129 

installments  had  been  paid  before  the  tax  was  finally  determined, 
the  amount  would  be  refunded  in  the  usual  manner.-*-"^  No  in- 
terest, however,  was  payable  to  the  taxpayer  on  excess  amounts 
paid  in  the  first  instance.  It  was  not  permissible  to  file  a  bond  in 
lieu  of  cash  payments  on  a  50' ^  basis,  pending  final  determination 
of  tax  due.^-^  The  treasury  department  required  every  corpo- 
ration of  the  class  claiming  special  assessment  subsequently  to 
assessment  in  the  ordinary  manner  to  file  a  claim  for  abatement 
on  Form  47  for  the  excess  of  50%  of  its  net  income.  No  such 
abatement  claim  was  required,  if  special  assessment  was  claimed 
when  the  return  was  filed.*-^ 

Determination  of  First  Installment  of  Tax  for  1919  in  Special 
Cases.  For  1919  and  subsequent  taxable  years,  in  the  case  of  any 
corporation  other  than  a  foreign  corporation,  the  installments 
should  be  determined  upon  the  basis  of  an  excess-profits  tax  equal 
to  20^;  of  the  net  income  in  excess  of  $3,000,  but  not  in  excess 
of  $20,000,  plus  40%  of  the  net  income  in  excess  of  $20,000.  In 
any  other  special  assessment  case  other  than  the  case  of  a  for- 
eign corporation,  but  including  a  case  where  the  invested  capital 
for  the  taxable  year  can  not  be  accurately  determined,  but  where 
a  minimum  amount  of  invested  capital,  as  to  which  there  is  no 
question,  can  be  determined,  the  installments  should  in  the  first 
instance  be  determined  upon  the  basis  of  a  war-profits  and  excess- 
profits  tax  computed  by  using  the  minimum  invested  capital,  the 
tax  in  any  such  case  not  to  exceed  an  amount  equal  to  50 '^  of 
the  net  income,  and  for  1919  and  subsequent  taxable  years  not 
to  exceed  20%  of  the  net  income  in  excess  of  $3,000,  but  not  in 
excess  of  $20,000,  plus  40%  of  the  net  income  in  excess  of 
$20,000.42« 

Determination  of  Installments  of  Tax  in  the  Case  of  Foreign 
Corporation.  In  the  case  of  a  foreign  corporation  the  install- 
ments of  the  tax  should  in  the  first  instance  be  determined  upon 
the  basis  of  a  war-profits  and  excess-profits  tax  computed  by 

423  Revenue  Act  of  1918,  §  328;  Reg.  45,  Art.  914.  The  treasury  depart- 
ment also  permitted  the  tax  to  be  computed  in  the  first  instance  upon 
the  basis  of  a  minimum  amount  of  invested  capital  as  to  which  there  was 
no  question,  if  this  could  be  determined  and  was  no  less  than  50^c  of 
the  net  income  (Reg.  45.  Art.  912,  amended  by  T.  D.  3235,  T.  B.  42-21-1877). 

424  0.  D.  94,  T.  B.  1-19-136. 

425  0.  D.  356,  T.  B.  31-19-655,  modifying  letter  from  treasury  depart- 
ment dated  October  15,  1919;  W.  T.  S.  1919,  111058.  Interest  would  now 
seem  payable  by  Ihe  government  on  overpayments  (Revenue  Act  of  1921. 

§1324). 

426  Reg.  45,  Art.  912,  as  amended  by  T.  D.  3235,  T.  B.  42-21-1877. 


1130  FEDERAL  INCOME  TAX 

using  its  invested  capital  for  the  taxable  year  1917,  such  tax  for 
any  taxable  year  not  to  exceed  an  amount  equal  to  50%  of  the 
net  income,  and  for  1919  and  subsequent  taxable  years  not  to 
exceed  20%  of  the  net  income  not  in  excess  of  $20,000,  plus  40% 
of  the  net  income  in  excess  of  $20,000.  The  invested  capital  for 
1917  should  be  adjusted  for  any  subsequent  changes  in  its  amount 
due  to  cash  or  property  paid  in  or  withdrawn  or  to  surplus  or 
undivided  profits  of  prior  years  retained  in  the  business  and 
properly  attributable  to  its  business  within  the  United  States. 
If  the  tax  for  1917  was  determined  by  special  assessment  the 
constructive  capital  which  would  result  in  a  tax  equivalent  to  the 
tax  so  determined  should  be  used.  In  the  case  of  a  foreign  cor- 
poration which  was  organized  subsequent  to  the  taxable  year 
1917,  or  which  had  no  income  from  sources  within  the  United 
States  during  1917,  the  installments  of  the  tax  should  in  the  first 
instance  be  determined  upon  the  basis  of  a  war-profits  and  excess- 
profits  tax  equal  to  50%  of  the  net  income,  except  that  for  1919 
and  subsequent  taxable  years  such  installments  be  determined 
upon  the  basis  of  an  excess-profits  tax  equal  to  20%  of  the  net 
income  not  in  excess  of  $20,000,  plus  40%  of  the  net  income  in 
excess  of  $20,000.^27 

No  Credit  Allowable  on  Account  of  Estimate  of  Excess  Pay- 
ment When  Special  Relief  Undetermined.  No  claims  for  credit 
may  be  applied  under  any  circumstances  against  taxes  due  until 
a  definite  determination  has  been  made  by  way  of  special  relief 
and  the  amount  of  tax  due  by  reference  to  representative  cor- 
porations fixed.*28 

Commissioner  to  Keep  Record.  The  Commissioner  is  required 
to  keep  a  record  of  all  cases  in  which  the  tax  is  determined  with- 
out reference  to  invested  capital  containing  the  name  and  address 
of  the  taxpayer,  the  business  in  which  engaged,  the  amount  of 

427  Reg.  45,  Art.  913,  as  amended  by  T.  D.  3235,  T.  B.  42-21-1877.  The 
validity  of  this  ruling  seems  doubtful  in  so  far  as  it  requires  payment  of 
the  1919  excess-profits  tax  by  a  foreign  corporation  upon  the  maximum 
basis  provided  by  §  302  or  upon  the  basis  of  constructive  invested  capital 
for  1917.  The  statute  does  not  provide  for  the  advance  payment  of  any 
excess-profits  tax  for  1919  and  subsequent  years,  the  50%  provisions  being 
limited  to  1918.  All  foreign  corporations  are  taxable  by  reference  to  rep- 
resentative corporations,  and  it  seems  doubtful  whether  they  should  be  re- 
quired to  pay  any  excess-profits  tax  for  1919  and  subsequent  years  until 
assessment  has  been  made  by  the  Commissioner.  This  ruling  will  apply 
under  the  1921  Law  to  domestic  corpoi;ations  taxable  under  §  262  of  that  law. 

428  Letter  from  treasury  department  dated  March  23,  1921;  W.  T.  S. 
1921,  11892. 


WAR- PROFITS    AND    EXCESS-PROFITS    TAX  1131 

invested  capital  and  net  income  shown  by  the  return.^-"'  The 
Commissioner  is  required  to  furnish  a  copy  of  such  record  and 
other  detailed  information  with  respect  to  such  cases  when  re- 
quired by  resolution  of  either  house  of  Congress  without  regard 
to  the  restrictions  usually  imposed  upon  him  with  respect  to  di- 
vulging information  contained  in  income  tax  returns.^"''^ 

Incorporation  of  Business  of  Partnership  or  Individual.  In  the 
case  of  the  ^organization  as  a  corporation  before  July  1,  1919, •^-'^^ 
of  any  business  in  which  capital  is  a  material  income-producing 
factor  and  which  was  previously  owned  by  a  partnership  or  indi- 
vidual, the  net  income  of  such  trade  or  business  from  January  1, 
1918,  to  the  date  of  such  reorganization  might  at  the  option  of 
the  individual  or  partnership  be  taxed  under  the  Revenue  Act 
of  1918  as  the  net  income  of  a  corporation  for  income  tax,  excess- 
profits  and  war-profits  tax  purposes.  No  taxpayer  was  entitled 
to  this  benefit  unless  a  corporation  de  jure  or  de  facto  came  into 
existence  prior  to  July  1,  1919."*^-  If  the  individual  or  partner- 
ship chose  to  adopt  this  method  of  taxation  the  net  income  and 
invested  capital  was  computed  as  if  the  corporation  had  been  in 
existence  on  and  after  January  1,  1918,  and  in  such  cases,  (1) 
amounts  distributed  on  or  after  January  1,  1918,  from  the  earn- 
ings were  taxed  to  the  recipients  as  dividends;  (2)  all  the  pro- 
visions of  the  income  tax  and  the  war-profits  and  excess-profits 
tax  sections  of  the  law  relating  to  corporations  were  applied,  so 
far  as  practicable,  to  such  trade  or  .business ;  (3)  the  trade  or 
business  was  subject  to  the  capital  stock  tax  imposed  by  the 
Revenue  Act  of  1917  and  the  Revenue  Act  of  1918,  as  if  such 
taxpayer  had  been  a  corporation  on  and  after  January  1,  1918, 
with  a  capital  stock  having  no  par  value ;  (4)  the  undistributed 
profits  or  earnings  of  such  taxpayer  were  not  subject  to  the 
surtax.  The  adoption  of  any  other  date  than  January  1,  1918, 
for  such  purpose  was  not  permissible.    This  option  to  be  taxed 

429  The  law  also  requires  this  record  to  show  the  amount  of  invested 
capital  as  determined  under  subdivision  (a)  of  §  328,  but  that  subdi- 
vision does  not  call  for  a  determination  of  invested  capital  and  hence  this 
requirement  is  meaningless. 

•i:w  Revenue  Acts  of  1918  and  1921,  §328   (c). 

431  The  treasury  department  had  no  authority  to  extend  the  time  within 
which  to  effect  this  reorganization  (O.  D.  223,  T.  B.  11-19-393). 

4-'52  o.  1023.  T.  B.  16-20-872.  The  intention  to  incorporate,  the  execution 
and  mailing  of  the  articles  of  incorporation  to  the  Secretary  of  State  on 
June  30,  1919,  the  opening  of  corporate  books  as  at  June  30,  1919,  and  the 
manufacturing  for  one  day  under  the  same  name  used  hitherto,  in  the 
absence  of  other  proof  of  user  prior  to  July  1,  1919,  does  not  justify  the 
inference  that  a  corporation  de  facto  existed  before  July  1,  1919. 


1132  FEDERAL  INCOME  TAX 

as  a  corporation  did  not  apply  to  any  trade  or  business  the  net 
income  of  which  for  the  taxable  year  1918  was  less  than  20  7('  of 
its  invested  capital  for  such  year.^^s  j^  a  case  in  which  the  part- 
nership net  income  was  more  than  20%  of  its  invested  capital 
but  the  net  income  of  the  partnership,  taken  together  with  the 
net  income  of  three  corporations,  99%  of  the  stock  of  which  was 
owned  by  the  partnership,  was  not  over  20%  of  the  invested 
capital  of  the  partnership  and  the  corporation,  but  the  partner- 
ship was  not  denied  the  benefit  of  this  provision.^^^  Partnership 
net  income,  as  above  contemplated,  meant  net  income  after  de- 
ducting salaries  of  partners.*^^  This  provision  did  not  apply 
retroactively  under  the  1917  Law.^^^ 

Conditional  Liberty  Bond  Exemption  of  Reorganized 
Corporation.  If  a  partnership  was  an  "original  subscriber"  to 
Liberty  bonds  of  the  fourth  series  and  was  reorganized  as  a  cor- 
poration prior  to  July  1,  1919,  and  elected  to  be  taxed  as  a  corpo- 
ration from  January  1,  1918,  it  was  considered  as  an  "original 
subscriber"  to  such  Liberty  bonds  within  the  meaning  of  the 
$45,000  exemption  "conditional  on  original  subscription  to,  and 
continued  holding  at  the  date  of  the  tax  return  of,  two-thirds  as 
many  bonds  of  the  Fourth  Liberty  Loan."  The  same  considera- 
tions applied  to  the  $20,000  exemption  "conditional  upon  original 
subscribing  to,  and  continued  holding  at  the  date  of  the  tax  re- 
turn of,  one-third  as  many  notes  of  the  Victory  Liberty  Loan."^^^ 

Affiliated  Corporations.^ss  ^he  invested  capital  of  affiliated  cor- 
porations for  the  taxable  year  is  the  invested  capital  of  the  entire 
group  treated  as  one  unit  operated  under  a  common  control.  As 
a  first  step  in  the  computation  a  consolidated  balance  sheet  should 
be  prepared  in  accordance  with  standard  accounting  practices, 
which  will  reflect  the  actual  assets  and  liabilities  of  the  affiliated 
group.  In  preparing  such  a  balance  sheet  all  intercompany  items, 
such  as  intercompany  notes  and  accounts  receivable  and  payable, 
should  be  eliminated  from  the  assets  and  the  liabilities,  respec- 
tively, and  proper  adjustments  should  be  made  in  respect  of  inter- 

433  Revenue  Act  of  1918,  §330;  Reg.  45,  Art.  933.  This  provision  is  not 
contained  in  the  Revenue  Act  of  1921  in  regard  to  the  excess-profits  tax,  but 
that  law  contains  a  similar  provision  as  to  the  income  tax.  (Revenue  Act 
of  1921,  §229.) 

434  T.  B.  R.  27,  T.  B.  6-19-286. 
.  435  0.  D.  95,  T.  B.  1-19-1381. 

430  a.  R.  R.  618,  T.  B.  39-21-1849. 

437  0.  D.  211,  T.  B.  11-19-373.     See  also  Reg.  45,  Art.  79. 

438  Under  the  Revenue  Act  of  1921,  the  filing  of  consolidated  returns  is 
optional  with  the  taxpayer.     (See  Chapter  10.) 


WAR- PROFITS    AND    EXCESS- PROFITS    TAX  1133 

company  profits  or  losses  rellected  in  inventories  which  at  the 
beginning  or  end  of  the  taxable  year  contain  merchandise  ex- 
changed between  the  corporations  included  in  the  affiliated  group 
at  prices  above  or  below  cost  to  the  producing  or  original  owner 
corporation.  Such  consolidated  balance  sheet  will  then  show  (a) 
the  capital  stock  of  the  parent  or  principal  company  in  the  hands 
of  the  public;  (b)  the  consolidated  surplus  belonging  to  the  stock- 
holders of  the  parent  or  principal  company;  and  (c)  the  capital 
stock,  if  any,  of  subsidiary  companies  not  owned  by  the  parent  or 
principal  company,  together  with  the  surplus,  if  any,  belonging 
to  such  minority  interest.  In  computing  consolidated  invested 
capital  the  starting  point  is  furnished  by  the  total  of  the  amounts 
shown  under  (a),  (b)  and  (c)  above.  This  total  must  be  in- 
creased or  diminished  by  any  adjustments  required  to  be  made 
under  the  provisions  relating  to  invested  capital.^^'-^ 

Intangible  Property  Paid  in.  The  following  rules  govern 
the  inclusion  of  intangible  property  in  invested  capital  of  affil- 
iated corporations:  (1)  in  respect  of  corporations  whose  affil- 
iation is  in  the  nature  of  parent  and  subsidiary  companies,  (a) 
in  the  case  of  intangible  property  bona  fide  paid  in  for  stock 
or  shares  prior  to  March  3,  1917,  there  may  be  included  in  in- 
vested capital  an  amount  not  exceeding  the  actual  cash  value 
of  such  property  at  the  time  paid  in  or  the  par  value  of  the 
stock  or  shares  issued  therefor,  or  in  the  aggregate  25  per  cent, 
of  the  par  value  of  the  total  stock  or  shares  of  the  consolidation 
outstanding  on  March  3,  1917  (detemiined  as  indicated  in 
items  (a)  and  (c)  of  the  preceding  paragraph),  or  in  the  aggre- 
gate 25  per  cent,  of  the  par  value  of  the  total  stock  or  shares 
shown  on  the  consolidated  balance  sheet,  being  the  amount  of  the 
capital  stock  included  in  items  (a)  and  (c)  in  the  preceding 
paragraph,  at  the  beginning  of  the  taxable  year,  whichever  is 
lowest;  and  (b)  in  the  case  of  intangible  property  bona  fide 
paid  in  for  stock  or  shares  on  or  after  March  3,  1917,  there  may 
be  included  in  invested  capital  an  amount  not  exceeding  the 
actual  cash  value  of  such  property  at  the  time  paid  in,  or  the 
par  value  of  the  stock  or  shares  issued  therefor,  or  in  the  ag- 
gregate 25 'r  of  the  par  value  of  the  total  stock  or  shares  shown 
by  the  consolidated  balance  sheet,  being  the  amount  of  the  capi- 
tal stock  included  in  items  (a)  and  (c)  in  the  preceding  para- 
graph outstanding  at  the  beginning  of  the  taxable  year,  which- 
ever is   lowest,      (c)    When   intangible   property   has  been   ac- 

•t39  Reg.  45,  Art.  864. 


1134  FEDERAL  INCOME   TAX 

quired  in  part  before  and  in  part  after  March  3,  1917,  the 
amounts  shall  be  ascertained,  respectively,  under  (a)  and  (b) 
above  and  in  the  aggregate  shall  in  no  case  exceed  257c  of  the 
par  value  of  the  total  stock  or  shares  outstanding  at  the  begin- 
ning of  the  taxable  year  shown  in  the  consolidated  balance  sheet, 
being  the  amount  of  the  capital  stock  included  in  items  (a)  and 
(c)  in  the  preceding  paragraph.  (2)  In  respect  of  corporations 
affiliated  by  reason  of  ownership  by  the  same  interests,  the 
limitations  with  respect  to  the  inclusion  of  intangible  property 
in  invested  capital  set  forth  in  paragraphs  (4)  and  (5)  of  sub- 
division (a)  of  Section  326  of  the  statute  shall  be  applied  to  each 
corporation  separately  and  the  aggregate  of  the  intangible  prop- 
erty, so  valued,  shall  be  included  in  invested  capital  in  the  con- 
solidated return.  In  respect  of  each  of  the  affiliated  corpora- 
tions the  aggregate  of  the  amounts  ascertained  under  the  pro- 
visions of  paragraphs  (4)  and  (5)  shall  in  no  case  exceed  25% 
of  the  outstanding  capital  stock  of  such  corporation  at  the  be- 
ginning of  the  taxable  year.*^o 

Inadmissible  Assets.  Where  adjustment  is  required  in  re- 
spect of  inadmissible  assets,  such  adjustment  must  be  made  on 
the  basis  of  the  consolidated  balance  sheet  with  due  regard  to 
the  adjustments  and  eliminations  set  forth  in  the  preceding 
paragraphs  and  the  general  provisions  relating  to  inadmissible 
assets.4*i 

Stock  of  Subsidiary  Acquired  for  Cash.  When  all  or  sub- 
stantially all  of  the  stock  of  a  subsidiary  corporation  was  ac- 
quired for  cash,  the  cash  so  paid  will  be  the  basis  to  be  used  in 
determining  the  value  of  the  property  acquired.-'^^ 

Stock  of  Subsidiary  Acquired  for  Stock.  Where  stock  of 
a  subsidiary  company  was  acquired  with  the  stock  of  the  parent 
company,  the  amount  to  be  included  in  the  consolidated  invested 
capital  in  respect  of  the  company  acquired  will  be  computed  in 
the  same  manner  as  if  the  net  tangible  assets  and  the  intangible 
assets  had  been  acquired  instead  of  the  stock.  If  in  accordance 
with  such  acquisition  a  paid-in  surplus  is  claimed,  such  claim 
must  be  supported  by  substantially  the  same  sort  of  evidence 
as  is  required  in  the  case  of  a  claim  for  paid-in  surplus  in  re- 
spect of  tangible  property  paid  in  by  a  stockholder  to  a  cor- 
poration as  a  gift  or  at  a  value  definitely  known  or  accurately 

440  Reg.  45,  Art.  865. 

441  Reg.  45,  Art.  866. 

442  Reg.  45,  Art.  867;  T.  D.  2901,  modifying  T.  D.  2662. 


WAR- PROFITS    AND    EXCESS-PROFITS    TAX  1135 

ascertainable  as  of  the  date  of  payment  clearly  and  substantially 
in  excess  of  the  cash  or  other  consideration  paid  by  the  corpora- 
tion therefor,^^'' 

Invested  Capital  for  Prewar  Period.  The  invested  capi- 
tal of  affiliated  corporations  for  the  prewar  period  will  be  com- 
puted on  the  same  basis  as  the  invested  capital  for  the  taxable 
year,  except  that  where  any  one  or  more  of  the  corporations  in- 
cluded in  the  consolidation  for  the  taxable  year  were  in  existence 
during  the  prewar  period,  but  were  not  then  affiliated,  then  the 
average  consolidated  invested  capital  for  the  prewar  period  will 
be  the  average  invested  capital  of  the  corporations  which  were 
affiliated  in  the  prewar  period  plus  the  aggregate  of  the  average 
invested  capital  for  each  of  the  several  corporations  which  were 
not  affiliated  during  the  prewar  period.^^^  The  intent  of  this 
ruling  is  to  determine  affiliation  of  the  prewar  years  by  the 
affiliation  of  the  taxable  years,-*^^* 

Prewar  Net  Income  of  Affiliated  Corporations.  The  con- 
solidated net  income  of  affiliated  corporations  for  the  prewar 
period  will  be  the  average  consolidated  net  income  for  the  pre- 
war years  of  such  of  the  several  corporations  included  in  the 
consolidation  for  the  taxable  year  as  were  affiliated  during  the 
prewar  period  plus  the  aggregate  of  the  average  net  income  for 
each  of  the  corporations  not  affiliated  during  the  prewar  period 
which  were  in  existence  during  all  of  the  prewar  period  or  dur- 
ing at  least  one  full  year  within  the  prewar  period.  The  net 
income  of  a  subsidiary  corporation  organized  during  the  prewar 
period  by  an  existing  corporation  should  also  be  included.^^'^' 
The  expression  "such  of  the  several  corporations  included  in  the 
consolidation  for  the  taxable  year  as  were  affiliated  during  the 
prewar  period"  identifies  the  affiliated  corporations  of  the  pre- 
war period  and  clearly  determines  that  the  corporate  entities 
of  the  consolidated  unit  for  each  of  the  prewar  years  are  those 
corporate  entities  affiliated  in  the  taxable  year.^^" 

National  Bank  Stockholders'  Trustee  Accounts.  It  is 
the  custom  of  national  banks  to  declare  dividends  which  instead 
of  being  paid  to  stockholders,  are  carried  with  their  consent 

443  Reg.  45,  Art.  868;  T.  D.  2901,  modifying  T.  D.  2662.  See  also  Reg.  45, 
Art.  837;  T.  B.  R.  49,  T.  B.  16-19-467. 

444  Reg  45,  Art.  869.  Full  recognition,  however,  must  be  given  to  the  pro- 
visions of  §  330  of  the  1918  Law^,  particularly  the  last  paragraph  thereof, 
and  of  articles  931-934  of  Regulations  45. 

445  A.  R.  M.  116,  T.  B.  12-21-1526. 

446  Reg.  45,  Art.  802. 

447  A.  R.  M.  116,  T.  B.  12-21-1526. 


1136  FEDERAL  INCOME  TAX 

to  a  stockholders'  liability  account  in  the  name  of  a  trustee. 
This  account  may  be  used  for  investment  in  deals  not  coun- 
tenanced by  the  comptroller  of  the  currency.  Although  such 
trustee  account  is  a  liability  to  the  individual  stockholders  and, 
therefore,  from  a  technical  viewpoint,  not  a  part  of  the  invested 
capital  of  the  bank,  even  though  the  bank  include  income  from 
the  reserve  in  its  gross  income,  the  stockholders  constitute  an 
"association"  in  affiliation  with  the  national  bank.  The  amount 
of  the  reserve  is  therefore  to  be  included  in  consolidated  invested 
capital.448 

Balance  Sheet.  Every  corporation  is  required  to  submit  a  bal- 
ance sheet  as  of  the  first  day  of  the  taxable  year  and  also  a 
balance  sheet  as  of  the  close  of  the  taxable  year.  Balance 
sheets  are  required  to  be  made  in  accordance  with  the  books  of 
the  taxpayer  and  changes  in  respect  of  any  items  therein  made 
pursuant  to  the  regulations  are  to  be  explained  in  a  separate 
statement  attached  to  the  balance  sheet  to  which  it  relates."*^^ 

Returns.  Every  corporation  not  expressly  exempt  from  tax 
and  every  personal  service  corporation  must  make  a  return  re- 
gardless of  the  amount  of  its  net  income. ^-^o  Corporations 
which  have  no  taxable  income  for  the  year  have  been  required 
to  fill  out  only  Schedules  A  and  B  of  Form  1120,  which  relate  to 
the  income  tax,  and  the  schedules  in  support  thereof,  and  are 
not  required  tp  furnish  the  other  information  called  for  by  this 
form.451  Excess-profits  tax  returns  are  now  a  part  of  the  income 
tax  returns  of  corporations,  and  are  governed  by  the  same  rules 
as  to  time,  place  and  manner  of  filing. 

448  A.  R.  M.  43,  T.  B.  17-20-881,  overruling  O.  D.  260,  T.  B.  16-19-466.  Of 
course,  as  a  practical  matter  the  national  bank  simply  includes  such  reserve 
in  its  own  invested  capital. 

449  Reg.  41,  Art.  54.  As  to  the  preparation  of  consolidated  balance  sheets, 
see  Chapter  10. 

430  Revenue  Act  of  1921,  §  239;  Reg.  45,  Art.  621.  Under  the  1917  law  no 
return  of  information  with  respect  to  prewar  invested  capital  and  net  income 
was  required  if  the  7%  deduction  was  accepted,  and  in  the  case  of  individ- 
uals or  concerns  with  only  a  nominal  capital.  A  married  woman  might  make 
a  separate  return  (Reg.  41,  Arts.  75,  76).  A  husband  and  wife  might  file 
separate  excess-profits  tax  returns  for  1917,  in  which  the  community  income 
might  be  divided  between  them.  The  invested  capital  of  either  the  husband 
or  the  wife  was  computed  by  adding  that  portion  of  the  invested  capital 
which  was  his  or  her  separate  property  to  one-half  of  that  portion  of  the 
invested  capital  which  was  community  property.  The  full  amount  of  the 
specific  exemption  authorized  by  the  statute  might  be  claimed  by  each. 
(0.  D.  881,  T.  B.  16-21-1581.)    See  Chapter  3. 

451  Letter  from  treasury  department  dated  March  24,  1919;  W.  T   S   1921 
1|851. 


WAR-PROFITS    AND    EXCESS-PROFITS    TAX  1137 

RETURNS  IN  Special  Cases.    Where  a  corporation  computes 
its  war-profits   credit  upon  the  basis   of  the   sum  of    (a)    the 
specific  exemption  and  (b)   an  amount  equal  to  10%  of  the  in- 
vested capital  for  the  taxable  year,  the  items  on  Form   1120, 
which  relate  solely  to  the  net  income  or  to  the  invested  capital 
for  the  prewar  period,  need  not  be  filled  in.^^-     Where  a  cor- 
poration enters  on  its  return  a  war-profits  and  excess-profits 
tax  equal  to  the  amount  of  the  maximum  tax,  the  items  on  Form 
1120,  which  relate  solely  to  the  net  income  for  the  prewar  period 
and  the  items  which  relate  to  the  invested  capital  for  the  pre- 
war period  and  for  the  taxable  year,  need  not  be  filled  in.    Like- 
wise, in  the  case  of  a  foreign  corporation  the  same  items  may  be 
disregarded,  except  that  all  of  schedule  I  on  Form  1120  should 
be  filled  in  and  balance  sheets  as  of  the  beginning  and  the  end 
of  the  taxable  year  for  the  entire  business  of  the  corporation, 
both  within  and  without  the  United  States,  should  be  submitted. 
Corporations  which  have  no  taxable  income  for  the  year  are  re- 
quired to  fill  out  only  schedules  A  and  B  and  the  schedules  in 
support  thereof  on   their    (separate   or  consolidated)    returns 
(Form  1120)  and  are  not  required  to  furnish  the  other  infonna- 
tion  called  for  by  these  returns.''''^3     The  Commissioner  may  at 
any  time  specifically  call  for  all  or  any  part  of  the  information 
which  is  not  so  required  to  be  entered  on  the  return.     In  any 
case,  however,  where  a  claim  is  made  for  assessment  by  refer- 
ence to  representative  corporations  other  than  in  the  case  of  a 
foreign  corporation,  the  corporation  should  fill  out  all  items  of 
the  return  so  far  as  possible  and  submit  a  statement  explaining 
why  it  is  impracticable  to  fill  out  the  entire  return. •^■''■* 

Time  and  Manner  of  Paying  Tax.  The  war-profits  and  excess- 
profits  taxes  are  to  be  paid  at  the  same  times  and  places,  in  the 
same  manner,  and  subject  to  the  same  conditions,  as  provided  in 
the  case  of  payments  of  income  tax ;  that  is,  the  tax  will  be  paid 
in  installments  on  the  dates  specified  with  reference  to  the  in- 
come tax.'*''^ 

•452  Telegram  from  treasury  department  dated  April  10,  1919;  W.  T.  S. 
1919,  11 1022.  Under  the  1917  Law  it  was  held  that  a  return  of  information 
as  to  invested  capital  and  net  income  for  the  prewar  period  would  not  be 
required  if  the  taxpayer  accepted  the  minimum  percentage  of  77c  as  a 
deduction. 

453  Letter  from  treasury  department  dated  March  24,  1919;  W.  T.  S.  1921, 

11851. 

454  Reg.  45,  Art.  962. 

455  Revenue  Acts  of  1918  and  1921,  §  336.  As  to  the  time  and  manner  of 
paying  income  taxes  see  Chapter  35. 


1138  FEDERAL   INCOME  TAX 

Penalties.  All  the  provisions  of  the  income  tax  law  not  in- 
applicable, including  the  provisions  relating  to  penalties,  are 
made  applicable  to  the  filing  of  returns  and  payment  of  war- 
profits  and  excess-profits  taxes.^-''*' 

Administrative    Provisions.      In   general,    the    administrative 

provisions  applicable  to  the  income  tax  law  are  also  applicable  to 

the   administration   of  the   war-profits   and   excess-profits   tax 
law.457 

«6  Revenue  Acts  of  1918  and  1921,  §  336. 

457  Revenue  Acts  of  1918  and  1921,  §  336;  Reg.  41,  Art.  79. 


1 
CHAPTER  44 

THE  CAPITAL  STOCK  TAX 

This  tax  is  popularly  known  as  the  Capital  Stock  Tax  although 
the  statute  describes  it  as  "a  special  excise  tax  with  respect  to 
carrying  on  or  doing  business."  The  present  law  ^  describes  the 
tax  in  the  same  manner  as  did  the  1916  Law  -  and  1918  Law  ^  and 
imposes  a  tax  on  and  after  July  1,  1922,  in  lieu  of  the  tax  imposed 
by  the  1918  Law.  The  tax  is  imposed  upon  every  domestic  ^  cor- 
poration •''  and  upon  every  foreign  ^  corporation  doing  business  in 
the  United  States.  The  Revenue  Act  of  1921  in  imposing  this  tax 
does  not,  like  the  1916  Law,  limit  the  corporations  taxed  to  those 
organized  "for  profit"  and  apparently  applies  to  every  corpo- 
ration having  capital  stock  whether  organized  for  profit  or  not, 
except  those  exempt  from  income  tax  under  section  231  of  the 
Revenue  Act  of  1921  and  except  such  insurance  companies  as  are 
subject  to  the  tax  imposed  by  sections  243  and  246  of  the  same 
law."^  The  tax  is  imposed  "with  respect  to  carrying  on  or  doing 
business"  and  is  payable  in  advance  by  every  taxable  corporation 
engaged  in  business  during  any  part  of  the  preceding  year. 

Definitions.  The  word  "corporation"  is  used  in  this  chapter, 
unless  otherwise  stated,  in  the  sense  defined  in  the  Revenue  Act 
of  1921,  and  includes  a  corporation,  association,  joint-stock  com- 
pany, or  insurance  company .§  The  phrase  "taxable  year,"  as  used 

1  Revenue  Act  of  1921,  §  1000. 

2  Act  of  September  8,  1916,  §  407.  It  has  been  held  that  the  1916  capital 
stock  tax  is  an  excise  tax  upon  a  corporation  with  respect  to  the  carrying 
on  or  doing  business  by  the  corporation,  which  is  a  proper  subject  of  taxa- 
tion on  the  part  of  the  government  (Washington  Water  Power  Co.  v.  U.  S., 
decided  by  the  Court  of  Claims,  Feb.  14,  1921;  T.  D.  3160). 

3  Revenue  Act  of  1918,  §  1000. 

4  The  term  "domestic"  when  applied  to  a  corporation,  means  "created  or 
organized  in  the  United  States,"  (Revenue  Act  of  1921,  §  2),  including  only 
the  states,  the  territories  of  Alaska  and  Hawaii,  and  the  District  of  Colum- 
bia.    (Reg.  50  Rev.,  Art.  8.) 

^  The  term  "corporation"  includes  "associations,  joint-stock  companies  and 
insurance  companies."   (Revenue  Act  of  1921,  §2.) 

*>  The  term  "foreign,"  when  applied  to  a  corporation,  means  created  or 
organized  outside  the  United  States.    (Revenue  Act  of  1921,   §2.) 

7  Revenue  Act  of  1921,  §  1000.  The  1916  Law  provided  expressly  that  cor- 
porations exempt  under  the  provisions  of  §  11  of  the  1916  income  tax  law 
were   also  exempt  for  purposes  of  the  capital  stock  tax. 

8  Revenue  Act  of  1921,  §2;  Reg.  50,  Art.  11. 

1139 


1140  FEDERAL  INCOME  TAX 

in  this  chapter,  means  the  fiscal  year  of  the  government  be- 
ginning on  the  first  day  of  July  of  each  calendar  year  and  ending 
on  the  last  day  of  June  the  year  following.  The  phrases  "preced- 
ing year"  and  "preceding  taxable  year"  mean  the  twelve-month 
period  ending  immediately  prior  to  the  "taxable  year"  as  above 
defined. 

Domestic  Corporations.  The  tax  applies  to  a  domestic  corpo- 
ration if  (a)  it  is  carrying  on  or  doing  business ;  (b)  has  capital 
stock;  (c)  was  engaged  in  business  for  some  part  of  the  pre- 
ceding year  ending  June  30th,  and  (d)  is  neither  a  corporation 
enumerated  as  exempt  for  purpose  of  income  tax,  under  section 
231  of  the  Revenue  Act  of  1921,  nor  an  insurance  company  of  a 
kind  subject  to  the  tax  imposed  by  sections  243  and  246  of  the 
same  Act.  The  1916  Law  provided  that  the  corporation  should 
be  organized  for  profit  and  have  a  capital  stock  represented  by 
shares.  In  this  respect  the  1921  Law  and  the  1918  Law  are 
broader  and  a  corporation  is  liable  to  tax,  whether  it  is  a  creature 
of  statute  or  of  contract  and  whether  or  not  it  is  organized  for 
profit  or  has  a  capital  stock  represented  by  shares.^ 

Associations.  It  should  be  noted  that  the  law  applies  not 
only  to  corporations  but  also  to  all  associations  "organized  in 
the  United  States,"  and  in  this  respect  seems  to  be  broader  in  its 
scope  than  the  1909  Law,  which  was  construed  to  apply  only  to 
corporations,  joint-stock  companies  or  associations  "organized 
under  the  laws  of  the  United  States  or  of  any  state  or  territory 
of  the  United  States  or  under  the  Acts  of  Congress  applicable  to 
Alaska  or  the  District  of  Columbia."  i^  Apparently  it  was  the 
intent  of  Congress  to  make  the  present  as  well  as  the  former 
capital  stock  tax  law  apply  to  associations  which  were  held  not  to 
be  taxable  under  the  1909  Law,  because  not  organized  under  some 
statute.  The  treasury  department  has  ruled  that  associations  and 
joint-stock  companies  include  organizations  by  whatever  name 
known,  which  act  or  do  business  in  an  organized  capacity,  whether 
created  under  and  pursuant  to  state  laws,  agreements,  declara- 
tions of  trust,  or  otherwise,  the  net  income  of  which,  if  any,  is 
distributed  or  distributable  among  the  members  or  shareholders 
on  the  basis  of  the  capital  stock  which  each  holds  or,  where 

9  Revenue  Act  of  1921,  §  1000. 

10  It  was  the  intention  of  Congress  to  embrace  within  the  1909  Law  only 
such  corporations  and  joint-stock  associations  as  were  organized  under  some 
statute  or  derived  from  that  source  some  quality  or  benefit  not  existing  at 
the  common  law.  (Eliot  v.  Freeman,  220  U.  S.  178.)  This  was  a  case  in- 
volving a  so-called  "Massachusetts  Real  Estate  Trust"  which  was  held  not 
to  be  taxable  under  the  1909  Law  but  which  would  seem  to  be  taxable  under 
the  capital  stock  tax  law. 


THE  CAPITAL  STOCK  TAX  1141 

there  is  no  capital  stock,  on  the  basis  of  the  proportionate  share 
of  capital  which  each  has  or  has  invested  in  the  business  or 
property  of  the  organization  J  ^ 

Association  Distinguished  From  Partnership.  An  organ- 
ization the  membership  interests  in  which  are  transferable  with- 
out the  consent  of  all  the  members,  however  the  transfer  may  be 
otherwise  restricted,  and  the  business  of  which  is  conducted  by 
trustees  or  directors  and  officers  without  the  active  participation 
of  all  the  members  as  such,  is  an  association  and  not  a  part- 
nership,i-  A  partnership  bank  conducted  like  a  corporation 
and  so  organized  that  the  interests  of  its  members  may  be  trans- 
ferred without  the  consent  of  the  other  members  is  a  joint-stock 
company  or  association  within  the  meaning  of  the  statute.  A 
partnership  bank  the  interests  of  whose  members  can  not  be  so 
transferred  is  a  partnership.^-^ 

Association  Distinguished  From  Trust.  The  test  of  lia- 
bility in  all  cases  involving  trusts  of  the  Massachusetts  type  is 
whether  the  cestuis  que  trustent  have  by  the  terms  of  the  trust 
agreement  a  voice  in  the  management  or  control  of  the  trust. 
Where  the  trustees  are  in  complete  control  of  the  business,  the 
beneficiaries  having  no  control  except  the  right  of  filling  vacancies 
among  the  trustees  or  of  consenting  to  a  modification  of  the  terms 
of  the  trust  or  of  dissolving  the  trust,  no  association  exists.  If, 
however,  the  cestuis  que  t7'ustent  have  a  voice  in  the  control  or 
management  of  the  business  of  the  trust,  whether  through  the 
right  to  elect  trustees  periodically  or  to  remove  the  trustees  or 
to  restrict  the  trustees  as  to  the  management  of  the  trust  or 
otherwise,  the  trust  is  an  association  within  the  meaning  of  the 
statute.  Where  the  trustees  hold  in  their  own  right  a  sufficient 
number  of  the  certificates  of  beneficial  interest  to  constitute  con- 
trol as  between  the  beneficiaries,  the  trust  will  be  held  to  be  an 
association  regardless  of  the  powers  conferred  upon  the  trustee 
by  the  instrument  creating  the  trust.i* 

Limited  Partnership  as  Partnership.  So-called  limited 
partnerships  of  the  type  authorized  by  the  statutes  of  New  York 
and  most  of  the  states  are  partnerships  and  not  corporations 
within  the  meaning  of  the  statute.  Such  limited  partnerships, 
which  cannot  limit  the  liability  of  the  general  partners,  although 
the  special  partners  enjoy  limited  liability  so  long  as  they  observe 

11  Reg.  50  Rev.,  Art.  3. 

12  Reg.  50  Rev.,  Art.  3. 

13  Reg.  50  Rev.,  Art.  6. 

14  Reg.  50  Rev.,  Art.  7.  See  Crocker  v.  Malley,  249  U.  S.  223.  See  Chapter 
10  for  a  full  discussion  of  this  subject. 


1142  FEDERAL  INCOME   TAX 

the  statutory  conditions,  which  are  dissolved  by  the  death  or  at- 
tempted transfer  of  the  interest  of  a  general  partner,  and  which 
cannot  take  real  estate  or  sue  in  the  partnership  name,  are  so 
like  common-law  partnerships  as  to  render  impracticable  any  dif- 
ferentiation in  their  treatment  for  tax  purposes.  Michigan  and 
Illinois  limited  partnerships  are  partnerships.  A  California  spe- 
cial partnership  is  a  partnership.^^ 

Limited  Partnership  as  Corporation.  On  the  other  hand, 
limited  partnerships  of  the  type  of  partnerships  with  limited  lia- 
bility or  partnership  associations  authorized  by  the  statutes  of 
Pennsylvania  and  of  a  few  other  states  are  only  nominally  part- 
nerships. Such  so-called  limited  partnerships,  offering  opportu- 
nity for  limiting  the  liability  of  all  the  members,  providing  for 
the  transferability  of  partnership  shares,  and  capable  of  holding 
real  estate  and  bringing  suit  in  the  common  name,  are  more  truly 
corporations  than  partnerships  and  must  pay  the  tax  as  corpora- 
tions. In  all  doubtful  cases  limited  partnerships  will  be  treated 
as  corporations  unless  they  submit  satisfactory  proof  that  they 
are  not  in  effect  so  organized.  Michigan  partnership  associations 
are  corporations.  The  liability  of  Virginia  limited  partnerships 
is  determined  in  each  case  from  a  consideration  of  the  certificate 
of  partnership  and  all  pertinent  facts  relative  thereto.i^ 

Foreign  Corporations.  A  foreign  corporation  is  taxable  if  it 
(a)  is  "carrying  on  or  doing  business  in  the  United  States"  during 
the  taxable  year;  (b)  was  engaged  in  business  in  the  United 
States  during  some  part  of  the  preceding  year  ending  June  30th ; 
(c)  is  not  a  corporation  enumerated  in  section  231  of  the 
law  as  exempt  from  income  tax,  or  an  insurance  company 
other  than  a  mutual  insurance  company  and  (d)  has  capital  em- 
ployed in  the  transaction  of  its  business  in  the  United  States.i'^ 
It  is  to  be  noted  that  a  foreign  corporation  is  not  subject  to  this 
tax  merely  because  it  receives  income  from  sources  within  this 
country.  To  be  taxable,  a  foreign  corporation  must  be  carrying 
on  or  doing  business  in  the  United  States  and  must  have  capital 
employed  in  the  transaction  of  such  business.  The  chapter  on 
foreign  corporations,  in  the  foregoing  part  of  this  book,  contains 
decisions  and  rulings  which  define  what  is  "doing  business"  by 
foreign  corporations,  and  such  decisions  and  rulings  have  appli- 
cation to  this  tax.  It  should  be  borne  in  mind,  however,  that  some 
of  the  rulings  with  respect  to  the  taxability  of  foreign  corpora- 
is  Reg.  50  Rev.,  Art.  5.   See  Chapter  8  for  a  full  discussion  of  this  subject. 

16  Reg.  50  Rev.,  Art.  4.   See  Chapter  8  for  a  full  discussion  of  this  subject. 

17  Revenue  Act  of  1921,  §  1000. 


THE  CAPITAL  STOCK  TAX  1143 

tions  under  the  income  tax  law  have  no  appHcation  to  this  law, 
since  this  tax  is  imposed  only  when  the  foreign  corporation  is 
carrying  on  or  doing  business  in  this  country  and  has  capital 
employed  in  the  transaction  of  such  business.is 

Basis  and  Rate  of  Tax.  The  basis  of  the  capital  stock  tax  dif- 
fers accordingly  as  the  taxable  corporation  is  domestic  or  foreign 
or  is  an  insurance  company. 

Domestic  Corporations.    The  basis  of  the  tax  m  the  case  of  al 
domestic  corporations  is  "the  fair  average  value  of  its  capital 
stock  for  the  preceding  year  ending  June  30th."  The  rate  of  tax 
is  $1  for  each  full  $1,000  of  the  fair  average  value  of  the  capital 
stock  in  excess  of  the  prescribed  deduction.    The  tax  is  not  upon 
the  par  value  of  the  capital  stock  but  upon  its  fair  average  value 
for  the  preceding  year  ending  June  30,  or  for  the  period  during 
which  it  has  been  issued  if  less"  than  a  year,  of  the  capital  stock 
outstanding  at  the  date  of  the  incidence  of  the  tax.    It  is  on  an 
entirely  different  basis  from  the  excess-profits  tax  which  is  con- 
cerned with  invested  capital,  and  not  with  the  present  fair  value 
of  the  capital  stock.      Stock  in  the  treasury  of  a  corporation  is 
not  regarded  as  outstanding,  unless  pledged  as  security  for  a 
debt      No  deduction  is  allowed  corporations  organized  m  the 
United  States  for  capital  invested  outside  the  United  States.   If 
such  a  corporation  is  doing  any  business  it  is  taxed  on  its  entire 
capital,  even  though  most  of  it  may  not  be  employed  in  the  busi- 
ness.i^  From  the  total  fair  average  value  of  the  capital  stock,  the 
sum  of  $5,000  is  deductible,  and  the  tax  is  upon  each  full  $1,000  of 
any  balance.    Accordingly,  corporations  the  fair  value  of  whose 
capital  stock  is  not  more  than  $5,000  are  not  subject  to  any  tax. 
However,  for  the  purpose  of  avoiding  errors,  every  corporation 
must  file  a  return,  even  though  the  par  value  or  the  fair  average 
value  of  its  capital  stock  does  not  exceed  $5,000.2o 

FAIR  Average  Value  of  Capital  Stock.  The  law  provides 
that  the  surplus  and  undivided  profits  must  be  included  in  esti- 
mating the  fair  average  value  of  the  capital  stock ;  that  is  to  say, 
the  capital  stock  representing  the  entire  ownership  of  the  prop- 
erty of  the  corporation  necessarily  includes  the  surplus  and  un- 
divided profits.  If  the  fair  average  value  is  determined  from  the 
book  value  they  are  included  in  the  assets ;  if  from  sales,  they  are 
necessarily  taken  into  consideration  in  establishing  the  market 
price;  and  if  from  net  income,  they  are  more  or  less  reflected 

iSLaurentide  Co.,  Ltd.  v.  Durey,  231  Fed.  223,  and  Bryant  &  May,  Ltd.  v. 
Scott,  226  Fed.  875,  are  cases  in  point.     See  page  1155. 

19  Reg.  50  Rev.,  Art.  13. 

20  Reg.  50  Rev.,  Art.  16. 


1144  FEDERAL   INCOME  TAX 

through  the  earnings.^i  Corporations  are  now  required  to  make 
three  exhibits:  Exhibit  A  being  a  condensed  balance  sheet;  Ex- 
hibit B,  quotations  or  outside  sales  prices ;  and  Exhibit  C,  the  an- 
nual income  for  a  period  of  five  years.  The  fair  average  value  of 
the  capital  stock  for  the  purpose  of  determining  the  amount  of 
the  capital  stock  tax  must  not  be  confused  with  the  market  value 
of  the  shares  of  stock  where  it  may  be  necessary  to  determine 
such  value  under  other  provisions  of  the  revenue  laws.  The  fair 
average  value  of  the  capital  stock,  the  statutory  basis  of  the  tax, 
is  not  necessarily  the  book  value  or  the  value  based  on  prices 
realized  in  current  sales  of  shares  of  stock  or  even  the  value, 
determined  by  capitalization  of  earnings,  although  it  may  be 
more  directly  dependent  upon  the  last.  It  should  usually  be 
capable  of  appraisal  by  officers  of  the  corporation  having  a 
special  knowledge  of  the  affairs  of  the  corporation  and  general 
knowledge  of  the  line  of  business  in  which  it  is  engaged.  Pro- 
vision is  accordingly  made  in  Exhibit  C  of  Form  707  (Revised) 
for  the  tentative  determination  of  the  fair  value  of  the  capital 
stock  by  capitalizing  the  net  earnings  of  the  corporation  on  a 
percentage  basis  fixed  by  its  officers  as  fairly  representing  the 
conditions  obtaining  in  the  trade  and  in  the  locality.  But  such 
fair  value,  except  in  the  case  of  insurance  companies,  must  not 
be  set  at  a  sum  less  than  the  reconstructed  book  value  shown 
by  Exhibit  A,  unless  the  corporation  is  materially  affected  by 
extraordinary  conditions  which  support  a  lower  valuation.  In 
any  such  case  a  full  explanation  must  accompany  the  return. 
The  commissioner  will  estimate  the  fair  value  of  the  capital  stock 
in  cases  regarded  as  involving  any  understatement  or  undervalu- 
ation.22 

Exhibit  A :  Condensed  Balance  Sheet.  This  exhibit  fur- 
nishes a  condensed  balance  sheet  as  of  the  closing  date  of  a  fiscal 
year  ending  on  June  30,  or  on  some  date  between  July  1  and 
June  30,  of  the  preceding  year.  In  one  column  the  value  shown 
on  the  books  of  account  is  required  to  be  stated  and  in  a  parallel 

21  Reg.  50  Rev.,  Art.  15. 

22  Reg.  50  Rev.,  Art.  14.  See  Form  707  revised.  Prior  to  July  1,  1918, 
it  was  the  practice  of  the  treasury  department  to  determine  the  fair  aver- 
age value  of  capital  stock  by  means  of  either  (a)  the  average  price  at  which 
stock  had  sold  during  the  preceding  year  or  (b)  by  estimating  the  value 
of  the  capital  stock,  taking  into  consideration  the  surplus  and  undivided 
profits  for  the  preceding  fiscal  year  as  well  as  the  nature  of  the  business, 
its  earning  capacity  and  average  dividends  paid  from  profits  earned  during 
the  preceding  five  years.  Only  in  exceptional  cases  where  the  corporation  had 
no  net  income  or  only  occasional  income  was  the  value  of  the  capital  stock 
predicated  upon  the  value  of  the  assets  of  the  corporation. 


THE  CAPITAL  STOCK   TAX  1145 

column  adjustment  may  be  made  for  any  overstated  or  under- 
stated values  shown  on  the  books  of  account.  In  a  third  column 
the  taxpayer  is  required  to  show  the  difference  between  the 
book  values  and  the  "fair  value."  Any  material  difference  is  to  be 
explained  in  such  manner  as  to  enable  the  commissioner  to  de- 
termine if  the  "fair  value"  is  proper  and  acceptable.  In  making 
adjustments  from  book  values  to  fair  value  it  is  not  necessary 
for  the  taxpayer  to  make  corresponding  adjustments  on  its  books 
of  account.  In  the  event  that  the  taxpayer  holds  in  its  treasury 
any  of  its  own  stock  or  bonds  it  is  required  that  advice  be  given 
as  to  whether  such  stock  or  bonds  are  pledged  or  unpledged. 

Exhibit  B:  Quotations  or  Outside  Sales  Prices.  In  this 
exhibit  the  taxpayer  is  required  to  show  prices  quoted  on  a  recog- 
nized stock  exchange  or  on  the  New  York  Curb,  or  the  prices  at 
which  outside  sales  were  made  if  the  stock  was  not  listed,  for  the 
period  of  twelve  months  ending  with  the  close  of  the  taxpayer's 
last  fiscal  year.  A  statement  of  the  number  of  shares  involved 
and  the  conditions  under  which  sales  were  made  at  other  than 
exchange  quotations  must  accompany  the  return.  Sales  to  em- 
ployees or  directors  for  qualifying  shares,  or  sales  which  were 
restricted  as  to  resale,  or  sales  at  prices  otherwise  specially  in- 
fluenced, are  not  considered  representative  of  the  fair  value  of 
the  entire  capital  stock  and  should  not  be  reported. 

Exhibit  C  :  Annual  Income.  In  this  exhibit  the  taxpayer  is 
required  to  furnish  data  for  the  five  fiscal  years,  ended  with  the 
close  of  the  taxpayer's  last  fiscal  year  or  for  the  period  during 
which  the  corporation  had  been  engaged  in  business,  if  for  a 
shorter  period.  The  net  income  reported  for  the  purpose  of  the 
income  tax  is  required  to  be  stated  in  this  exhibit.  Such  net  in- 
come, however,  may  be  adjusted  by  deductions  or  additions  in 
order  to  reach  the  actual  operating  income.  Among  the  prin- 
cipal items  which  may  require  adjustment  are  stated:  income 
taxes  not  deductible  in  computing  income  subject  to  tax;  losses 
not  fully  deductible;  dividends  from  other  corporations  not  in- 
cluded in  computing  income  subject  to  tax;  income  exempt  for 
purpose  of  the  income  tax;  expenditures  made  for  additions  or 
betterments,  or  reserves  for  such  purposes,  made  against  in- 
come whether  directly  or  through  expenses.  The  adjusted  in- 
come will  be  averaged  for  the  years  reported  and  such  average 
income  capitalized  at  such  percentage  as  the  officers  of  the  com- 
pany making  the  return  from  their  special  familiarity  with  the 
business  know  representative  enterprises  in  their  line  in  their 
locality  must  earn  in  order  to  maintain  their  stock  at  par.  In 
other  words,  if  enterprises  engaged  in  a  similar  business  find  it 


1146  FEDERAL   INCOME   TAX 

necessary  on  the  average  to  earn  8%  on  their  issued  capital 
stock  to  keep  the  value  of  their  stock  at  par,  the  net  income  of 
the  corporation  making  the  report  is  to  be  capitalized  by  dividing 
it  by  .08.23 

Foreign  Corporations.  The  tax  is  at  the  rate  of  $1  for  each 
full  $1,000  of  the  capital  of  a  foreign  corporation  actually  em- 
ployed in  the  transaction  of  its  business  in  the  United  States, 
and  is  in  all  cases  to  be  computed  on  the  basis  of  the  average 
amount  of  capital  so  employed  during  the  preceding  year  ending 
June  30.  The  basis  of  the  tax  is  accordingly  different  from 
that  in  the  case  of  domestic  corporations,  which  pay  a  tax  meas- 
ured by  the  fair  average  value  of  their  capital  stock.  No  de- 
duction from  the  total  fair  average  value  is  allowed  in  com- 
puting the  tax.2^  The  "capital  employed  in  the  transaction  of  its 
business  in  the  United  States"  means  that  portion  of  the  total 
capital,  surplus  and  undivided  profits  of  the  foreign  corporation 
utilized  for  the  purpose  of  doing  business  in  the  United  States.^^ 
The  tax  is  imposed  upon  capital  employed  irrespective  of  its 
nature,  whether  borrowed,  paid  in,  or  earned.-^  Any  surplus  or 
undivided  profits  invested  in  United  States  bonds  or  other  se- 
curities having  no  connection  whatever  with  the  actual  busi- 
ness df  the  corporation  transacted  in  this  country  is  not  "cap- 
ital employed  in  the  transaction  of  its  business  in  the  United 
States."  -'^  Bank  accounts  carried  by  a  foreign  corporation  in  this 
country  are  to  be  considered  in  computing  the  amount  of  capital 
employed  therein  if  the  money  is  carried  on  the  books  of  the  cor- 
poration as  capital  invested  in  its  business  in  this  country,  but 
not  if  the  money  is  kept  here  merely  for  convenience  or  invest- 
ment.2s  A  foreign  corporation  may  have  income  from  sources 
within  the  United  States  for  the  purpose  of  the  income  tax  and 

23  See  Form  707.  It  has  been  held  that  income  and  excess-profits  taxes 
may  be  properly  deducted  from  net  income,  as  reported  under  Exhibit  C, 
even  though  not  actually  paid,  if  the  amount  has  been  definitely  determined 
and  explanations  are  submitted  for  consideration  in  the  final  audit.  (Tele- 
gram from  treasury  department  dated  July  10,  1919;  W.  T.  S.,  1|3126.)  In 
capitalizing  average  net  income  under  Exhibit  C,  no  attention  must  be  paid 
to  changes  in  amount  of  issued  stock  during  income  producing  period. 
(Telegram  from  treasury  department  dated  July  27,  1920;  W.  T.  S.  1921, 
11  3101.) 

24  Reg.  50  Rev.,  Art.  20. 

25  Reg.  50  Rev.,  Art.  18. 

2fi  Telegram  from  treasury  department  dated  October  30,  1919 ;  W.  T.  S. 
1921,  TI3045. 

27  T.  D.  2467. 

28  Letter  from  treasury  department  dated  February  10,  1917;  W.  T.  S. 
1918,  1I313L 


THE  CAPITAL  STOCK  TAX  1147 

yet  not  have  capital  employed  in  the  transaction  of  business  here 
for  the  purpose  of  the  capital  stock  tax.  A  foreign  corporation 
actually  itself  not  doing  business  in  the  United  States  is  not  sub- 
ject to  the  tax,  and  accordingly  the  investment  of  a  part  of  its 
funds  in  United  States  stocks  and  securities  would  not  constitute 
capital  employed  in  its  business  in  the  United  States.  But  if  a 
corporation  does  business  here,  then,  although  the  mere  invest- 
ment of  funds  in  United  States  securities  is  not  such  a  taxable 
employment  of  capital,  such  investment  will  constitute  capital 
employed  in  the  transaction  of  business  in  the  United  States  if 
made  in  a  subsidiary  corporation  which  the  foreign  corporation 
uses  as  an  instrumentality  for  the  successful  conduct  of  its  own 
business  here.  Thus,  funds  of  a  foreign  corporation  invested  in 
the  purchase  of  facilities,  though  apparently  independent,  for 
the  purpose  of  its  business  here,  or  the  purchase  of  stock  and 
securities  of  a  subsidiary  corporation  for  the  same  purpose,  will 
constitute  capital  employed  in  the  transaction  of  business  in  the 
United  States.  A  foreign  corporation  may  not  escape  taxation 
by  organizing  or  purchasing  stock  of  another  corporation  to  own 
the  facilities  which  the  taxpayer  needs  in  its  business.  A 
foreign  corporation  may  employ  capital  in  the  transaction  of  its 
business  in  the  United  States  in  various  ways,  as  for  example,  in 
the  investment  of  funds  in  property  in  the  United  States  used 
in  its  business,  in  stocks,  and  securities  of  subsidiary  corpora- 
tions as  explained  above,  in  bills  and  accounts  receivable  repre- 
senting business  done  in  the  United  States,  in  merchandise  kept 
here  for  sale,  in  materials  manufactured  here,  and  in  deposits 
in  United  States  banks  maintained  for  use  in  business  here,  and 
not  merely  for  convenience  or  investment.  In  general,  approxi- 
mately such  proportion  of  the  entire  capital  of  a  foreign  corpo- 
ration will  probably  be  employed  in  the  transaction  of  its  busi- 
ness in  the  United  States  as  the  gross  amount  of  its  business  in 
the  United  States  bears  to  its  total  gross  business,  but  this  is 
not  always  true,  for  a  corporation  may  conceivably  transact  a 
greater  or  less  volume  of  business  in  one  country  than  in  an- 
other on  the  same  amount  of  capital.-^  The  basis  of  the  tax  is 
the  average  amount  of  capital  employed  in  the  transaction  of 
business  in  the  United  States  during  the  preceding  fiscal  year. 

29  Reg.  50  Rev.,  Art  18  and  19.  In  the  case  of  a  foreign  corporation  it  is 
often  just  as  difficult  to  estimate  the  "gross  amount  of  business  in  the 
United  States"  for  the  purpose  of  calculating  the  proportion  of  its  entire 
capital  employed  here  as  it  will  be  to  determine  in  the  first  instance  the 
proportion  of  capital  employed  in  the  transaction  of  business  in  the  United 
States. 


1148  FEDERAL  INCOME   TAX 

It  will  usually  be  sufficient  to  determine  the  amount  of  capital 
so  employed  at  the  beginning  of  such  year  and  the  amounts  so 
employed  at  the  end  of  such  year  and  to  divide  the  sum  of  such 
amounts  by  two.  However,  where  there  have  been  material 
changes  in  the  amount  of  capital  the  average  amount  should 
be  determined  with  due  regard  to  the  times  at  which  such 
changes  occurred.  The  foreign  corporation  may,  if  desired, 
compute  the  average  amount  of  capital  employed  on  a  monthly 
basis.^o 

Insurance  Companies.  The  present  law  provides  that  the  cap- 
ital stock  tax  shall  not  apply  to  "any  insurance  company  subject 
to  the  tax  imposed  by  section  243  or  246."  The  former  section 
imposes  a  tax  "upon  the  net  income  of  every  life  insurance  com- 
pany" and  the  latter  section  imposes  a  tax  "upon  the  net  income 
of  every  insurance  company  (other  than  a  life  or  mutual  in- 
surance company) ."  The  result  appears  to  be  that  all  insurance 
companies  are  exempt  from  capital  stock  tax  under  the  Revenue 
Act  of  1921,  except  mutual  insurance  companies.^i  The  follow- 
ing paragraphs  describe  the  taxation  of  the  capital  stock  of 
insurance  companies  under  the  Revenue  Act  of  1918. 

30  Reg.  50  Rev.,  Art.  21.  One  of  the  rules  prescribed  by  the  treasury 
department  for  determining  capital  employed  in  the  transaction  of  business 
of  a  foreign  corporation  in  the  United  States  for  the  year  ending  June  30, 
1917,  was  as  follows:  (1)  Take  the  entire  invested  capital  of  the  corpo- 
ration, as  shown  by  its  last  return  within  the  year  ending  June  30  for  the 
purpose  of  the  excess-profits  tax  imposed  by  the  Act  of  October  3,  1917,  or 
if  no  such  excess-profits  tax  return  has  been  made  by  the  corporation,  com- 
pute the  invested  capital  .for  its  fiscal  year  ending  within  the  year  ending 
June  30  in  accordance  with  the  excess-profits  tax  regulations.  (2)  Find 
the  proportion,  expressed  in  percentage,  which  the  net  income  from  sources 
within  the  United  States  bears  to  the  entire  net  income  for  the  fiscal  year 
ending  within  the  year  ending  June  30,  such  income  being  ascertained  upon 
the  same  basis  and  in  the  same  manner  as  for  the  income  and  excess-profits 
taxes.  (3)  Apply  the  percentage  found  in  (2)  to  the  average  invested 
capital  ascertained  in  (1),  the  result  being  the  amount  of  capital  invested 
in  the  United  States.     (Reg.  38  Rev.,  Art.  20.) 

31  Revenue  Act  of  1921,  §  1000  (b). 

The  nature  of  mutual  insurance  is  indicated  by  the  following  language 
of  Lord  Herschel,  quoted  in  Mutual  Insurance  Co.  v.  Herold,  198  Fed.  199, 
209. 

"In  the  case  before  us,  certain  persons  have  associated  themselves  together 
for  the  purpose  of  mutual  insurance;  that  is  to  say,  they  contribute  annu- 
ally to  a  common  fund  out  of  which  payments  are  to  be  made  in  the  event 
of  death  to  the  representatives  of  persons  thus  associated  together.  Those 
persons  are  alone  the  owners  of  the  common  fund,  and  they  alone  are  en- 
titled to  the  management  of  it." 

The  following  statements  are  also  pertinent: 


THE  CAPITAL  STOCK  TAX  1149 

Stock  Insurance  Companies  Under  1918  Law.  Insurance  com- 
panies having  a  capital  stock  as  distinguished  from  mutual  m- 
surance  companies  are  taxable  upon  the  same  basis  as  other 
corporations,  whether  domestic  or  foreign,  except  that  m  com- 
puting the  tax  such  reserve  funds,  which  include  deposits,  as 
they  are  required  by  law  or  contract  to  maintain  or  hold  for  the 
protection  of,  or  payment  to,  or  apportionment  among,  policy- 
holders, are  not  to  be  included.  In  the  case  of  such  companies 
the  tax'will  be  computed  by  deducting  from  the  total  book  value 
of  the  assets  the  amount  of  the  actual  liabilities  and  legal  re- 
serves, unless  the  facts  in  the  case  indicate  that  the  book  value 
of  the  assets  is  substantially  different  from  their  fair  market 
value,  in  which  case  it  is  permissible  to  make  proper  adjustment. 
In  a  case  requiring  such  adjustment  the  market  value  of  the 
shares  of  stock  as  shown  by  Exhibit  B  or  the  net  earnings  of 
the  company  as  shown  by  Exhibit  C  in  Form  707  (Revised) 
should  be  considered,  as  well  as  the  fair  value  of  the  assets.^- 

Mutual  Insurance  Companies  Under  1918  Law.  The  tax  ap- 
plies to  domestic  and  foreign  mutual  insurance  companies.  A 
mutual  protective  association  organized  under  a  statute,  whose 

"The  theory  of  a  mutual  insurance  company,  is  that  the  premium  paid  by 
each  member  for  the  insurance  of  its  property  constitutes  a  common  fund, 
devoted  to  the  payment  of  any.  losses  that  may  occur."  (Union  Insurance  Co. 
V.  Hoge,  21  How.  35,  64.) 

"The  principle  of  mutuality  exists  when  the  persons  constituting  the  com- 
pany contribute  through  cash  or  assessable  premium  notes,  or  both,  as  the 
plan  of  transacting  business  may  provide,  to  a  common  fund  out  of  which 
each  is  entitled  to  indemnity  in  the  case  of  loss  *  *  *•  Persons  so 
associated  are  said  to  be  members  of  the  company.  They  have,  or  may  have, 
a  voice  in  the  management  of  its  affairs,  and  are  practically  both  insurers 
and  insured."  (Spruance  ex  rel.  v.  Farmers  &  Merchants  Insurance  Com- 
pany, 10  Pac.  285,  287.     See  also  State  v.  Willett,  171  Ind.  296,  86  N.  E. 

68,  70.) 

"It  is  of  the  essence  of  mutual  insurance  that  the  excess  in  the  premium 
over  the  actual  cost  as  later  ascertained  shall  be  returned  to  the  policy- 
holders *  *  *.  Mutual  fire,  mutual  marine,  and  mutual  life  insurance  com- 
panies are  analogous  in  that  each  performs  the  service  called  insurance 
wholly  for  the  benefit  of  the  policyholders  and  not,  like  stock  insurance  com- 
panies in  part  for  the  benefit  of  persons  who  as  stockholders  have  pro- 
vided 'working  capital  on  which  they  expect  to  receive  dividends  repre- 
senting profits  from  their  investment.  In  other  words,  these  mutual  com- 
panies are  alike  in  that  they  are  co-operative  enterprises."  (Penn.  Mutual 
Life  Insurance  Co.  v.  Lederer,  252  U.  S.  523.)  See  also  L.  O.  1063,  T.  B. 
19  "1-1626  Of  course,  certain  kinds  of  mutual  insurance  companies  are 
exempt  under  the  provisions  of  §  231  (10).  See  §§1000  (b)  and  231  (10) 
of  the  Revenue  Act  of  1921. 
32  Reg.  50  Rev.,  Art.  22. 


1150  FEDERAL   INCOME   TAX 

only  source  of  revenue  is  the  assessments  paid  by  its  members 
and  whose  net  income  for  each  year  is  paid  into  a  reserve  fund, 
constituting  the  sole  resource  of  the  company,  aside  from  current 
assessments  for  the  payment  of  losses,  is  an  insurance  company 
within  the  meaning  of  the  statute.  A  voluntary  unincorporated 
association  of  employees  formed  for  the  purpose  of  relieving 
sick  and  aged  members  and  the  dependents  of  deceased  members 
is  an  insurance  company,  whether  the  fund  for  such  purpose  is 
created  wholly  by  membership  dues  or  partly  by  contributions 
from  the  employer."^  An  organization  doing  business  on  the 
"inter-indemnity"  or  "reciprocal  insurance"  plan  through  an 
attorney-in-fact  subject  to  direction  of  an  advisory  board  of 
policyholders,  which  requires  advance  deposits  to  cover  the  cost 
of  the  insurance  and  maintains  investments  or  deposits  from 
which  substantial  income  is  derived  is  a  mutual  insurance  com- 
pany subject  to  capital  stock  tax  and  payment  of  tax  on  issuance 
of  insurance  policies.^* 

Domestic  Mutual  Insurance  Companies.  Under  the  1918 
law  the  tax  is  $1  for  each  full  $1,000  of  the  excess  over  $5,000 
of  the  sum  of  (a)  the  surplus  or  contingent  reserves  maintained 
for  the  general  use  of  the  business  and  (b)  any  reserves  the  net 
additions  to  which  are  included  in  net  income  for  the  purpose 
of  the  income  tax,  in  both  cases  figured  as  of  the  close  of  the  last 
taxable  year  of  the  company.  The  net  addition  required  by  law 
to  be  made  within  the  taxable  year  to  reserve  funds,  including 
in  the  case  of  assessment  insurance  companies  the  actual  deposit 
of  sums  with  state  or  territorial  officers  pursuant  to  law  as  addi- 
tions to  guarantee  or  reserve  funds  and,  in  the  case  of  corpora- 
tions issuing  policies  covering  life,  health  and  accident  insurance 
combined  in  one  policy  issued  on  the  weekly  premium  payment 
plan  continuing  for  life  and  not  subject  to  cancellation,  including 
such  portion  of  the  net  addition  not  required  by  law  made  within 
the  taxable  year  to  reserve  funds  as  is  needed  for  the  protection 
of  the  holders  of  such  combination  policies,  is  not  included  in  net 
income  for  the  purpose  of  the  income  tax.^^ 

Foreign  Mutual  Insurance  Companies.  Under  the  1918 
law  the  tax  is  $1  for  each  full  $1,000  of  the  same  proportion  of 

33  Reg.  50  Rev.,  Art.  23.  Revenue  Act  of  1918,  §1000  (c).  Under  the 
1916  capital  stock  tax  law  it  was  held  that  mutual  insurance  companies 
and  other  associations  not  having  capital  stock  represented  by  shares  would 
be  held  exempt  from  the  tax  in  the  absence  of  a  basis  for  the  computa- 
tion thereof  under  that  law.   (T.  D.  2364.) 

34  L.  O.  1063,  T.  B.  19-21-1626. 

35  Reg.  50  Rev.,  Art.  24. 


THE  CAPITAL  STOCK  TAX  1151 

the  sum  of  (a)  and  (b)  in  the  last  paragraph  which  the  reserve 
fund  upon  business  transacted  within  the  United  States  is  of  the 
total  reserve  upon  all  business  transacted,  calculated  as  of  the 
close  of  the  last  taxable  year  of  the  company."^" 

Corporations  Engaged  in  Business  During  Preceding  Year  and 
During  Taxable  Year.  The  tax  being  payable  in  advance  does 
not  apply  to  any  corporation  which  was  not  engaged  in  business 
during  any  part  of  the  fiscal  year  preceding  the  year  for  which 
the  tax  is  due,  but  if  it  was  in  business  even  one  day  of  the  pre- 
ceding year  and  one  day  of  the  taxable  year  it  is  subject  to  the 
tax.  There  is  no  relation  between  the  amount  of  the  tax  payable 
and  the  length  of  time  the  corporation  was  in  business.  A  cor- 
poration engaged  in  business  during  a  part  of  the  preceding  year, 
but  not  engaged  in  business  at  the  beginning  of  the  taxable  year, 
is  not  required  to  make  any  return  if  it  is  dissolved  or  in  process 
of  dissolution,  but  if  it  is  only  temporarily  inactive  and  subse- 
quently during  the  year  re-engages  in  business  it  should  file  a 
return  in  the  month  in  which  it  recommences  business  and  pay 
the  tax  due  from  the  first  of  such  month  to  the  end  of  the  taxable 
year.  A  corporation  organized  and  beginning  corporate  activities 
on  or  after  July  1  is  not  subject  to  tax  for  the  remainder  of  the 
taxable  period  in  which  the  company  was  organized,  unless,  as  of 
July  1,  it  takes  over  the  business  of  an  organization  which  was 
subject  to  capital  stock  tax,  in  which  event  the  new  corporation 
is  required  to  file  a  return  and  pay  the  tax.  In  the  case  of  foreign 
corporations  "engaged  in  business,"  means  the  transaction  of 
any  business  within  the  United  States."^^ 

Inactive  Corporations.  A  domestic  corporation  is  not  taxable 
unless  it  carries  on  or  does  business  in  the  taxable  year.  But  if 
such  corporation  has  paid  the  special  excise  tax  at  the  beginning 
of  the  taxable  year  and  ceases  to  do  business  before  the  close  of 
that  year,  no  refund  is  allowed  for  that  portion  of  the  year  in 
which  the  corporation  does  no  business.-^'^  The  same  rule  applies 
in  respect  of  foreign  corporations,  except  that  the  business  in 
question  must  be  engaged  in  or  carried  on  or  done  in  the  United 
States. 

Carrying  On  or  Doing  Business.  The  basis  of  the  tax  in  the 
case  of  a  domestic  corporation  is  "carrying  on  or  doing  business" 
in  the  capacity  of  a  corporation,  association,  or  insurance  com- 
pany.   The  words  "carrying  on  or  doing  business"  must  be  given 

30  Reg.  50  Rev.,  Art.  35. 

37  Reg.  50  Rev.,  Art.  26. 

38  Reg.  50  Rev.,  Art.  1. 


1152  FEDERAL   INCOME   TAX 

their  ordinary  and  natural  signification.     "Business"  is  a  very 
comprehensive  term  and  embraces  whatever  occupies  the  time, 
attention  or  labor  of  men  for  the  purpose  of  livelihood  or  profit. 
In  other  words,  business  necessarily  involves  the  idea  of  gain. 
The  true  basis  of  distinction  is,  in  the  first  instance,  between — 

(a)  A  corporation  organized  for  the  purpose  of  doing  business 

as  above  defined,  and 

(b)  A  corporation  organized  for  the  sole  purpose  of  owning 

and  holding  property  and  distributing  its  avails ; 
and,  in  the  second  instance,  between — 

(c)  A  corporation  of  Class  (a)  which  is  continuing  the  body 

and  substance  of  the  business  for  which  it  was  organ- 
ized or  is  still  active  and  maintaining  its  organization 
for  the  purpose  of  continued  efforts  in  the  pursuit  of 
profit  or  gain,  and 

(d)  A  corporation  which,  although  included  in  Class  (a),  has 

substantially  retired  from  the  business  for  which  it  was 
organized  and  has  reduced  its  activities  to  the  mere  own- 
ership and  holding  of  property,  distributing  its  avails, 
and  doing  only  the  acts  necessary  to  the  maintenance 
of  its  corporate  existence  and  the  private  management 
of  its  purely  internal  affairs. 
The  distinction  in  each  case  must  depend  upon  the  peculiar 
facts  in  the  case.    Corporations  of  Class  (a)  will  be  presumed  to 
be  subject  to  the  tax  unless  they  submit  proof,  satisfactory  to 
the  commissioner,  that  they  are  not  actually  carrying  on  or  doing 
business.     If  a  corporation  claim  exemption  on  the  ground  that 
it  belongs  to  Class  (b) ,  it  will  be  required  to  file  an  excerpt  from 
its  charter  setting  forth  its  corporate  powers  together  with  a 
full  and  comprehensive  statement  showing  the  nature   of  the 
activities  in  which  it  is  and  has  been  actually  engaged.     If  it 
claim  exemption  on  the  ground  that  it  belongs  to  Class   (d),  it 
will  be  required  to  furnish  a  copy  of  any  amendment  of  its  char- 
ter, resolution  of  its  board  of  directors,  or  other  evidence,  satis- 
factory to  the  commissioner,  showing  that  it  has  reduced  its  ac- 
tivities to  the  mere  ownership  of  property,  receipt  of  its  avails, 
and  the  doing  of  only  what  is  necessary  to  the  maintenance  of  its 
corporate  existence.^^ 

39  Reg.  50  Rev.,  Art.  10.  Von  Baumbach  v.  Sargent  Land  Co.,  242  U.  S. 
503.  It  was  held  in  Associated  Pipe  Line  Co.  v.  U.  S.,  258  Fed.  800,  that 
the  amount  of  business  done  is  immaterial.  On  the  other  hand,  it  has  been 
held  that  the  existence  of  occasional  and  isolated  transactions  does  not  con- 
stitute the  doing  of  business  (Lewellyn  v.  Pittsburg  Co.,  222  Fed.  177; 
Penn.  Collieries  v.  McKeever,   183  N.  Y.  98). 


THE  CAPITAL  STOCK  TAX  1153 

The  meaning  of  the  term  "engaged  in  business"  in  relation  to 
domestic  corporations  was  defined  by  a  number  of  decisions 
under  the  1909  law,  with  particular  reference  to  cases  where 
corporations  had  ceased  to  do  business.  Thus,  it  was  held  that 
where  a  corporation,  originally  organized  for  the  purpose  of 
owning  and  renting  an  office  building,  leased  its  property  for  130 
years,  its  sole  authority  under  its  charter  thereafter  being  to 
hold  the  title  subject  to  the  lease  and  to  receive  and  distribute 
the  rentals  which  might  accrue  under  the  terms  of  the  lease,  or 
the  proceeds  of  any  sale  of  the  land  should  it  be  sold,  it  was  not 
engaged  in  business  within  the  meaning  of  that  law.^o  The 
actual  terms  of  the  lease  will  assist  in  deciding  a  question  of  this 
kind.  In  another  case,  it  was  held  that  a  railroad  corporation 
which  had  leased  its  property  for  a  term  of  years,  and  parted 
with  its  control  and  management,  maintaining,  however,  its  cor- 
porate organization,  collecting  rentals  from  the  lessee,  and  dis- 
tributing the  same  among  its  stockholders,  was  not  engaged  in 
business.  The  mere  receipt  of  interest  and  dividends  from  in- 
vested funds,  bank  balances,  and  the  like,  and  the  distribution 
among  the  stockholders  of  a  corporation,  amount  to  no  more 
than  receiving  the  ordinary  fruits  that  arise  from  the  ownership 
of  property  and  do  not  constitute  doing  business.  The  mere 
ownership  of  undeveloped  coal  or  timber  lands,  without  operat- 
ing them,  does  not  constitute  doing  business. ^^  Where,  however, 
a  corporation  was  organized  to  build  and  lease  property,  the  fact 
that  it  had  leased  all  of  its  property  and  did  nothing  except  col- 
lect and  distribute  the  rents,  did  not  exempt  it  from  the  tax, 
since  such  collection  and  distribution  of  rents  from  the  leased 
property  was  the  business  for  which  it  was  organized.^-'  A  com- 
pany whose  activities  include  something  more  than  the  mere 
holding  of  property  and  the  distribution  of  the  receipts  thereof 
is  "doing  and  engaging  in  business." ^^     These  and  other  deci- 

40Zonne  v.  Minneapolis  Syndicate,  220  U.  S.  187. 

4iMcCoach  V.  Mine  Hill  &  Schuylkill  Haven  R.  R.  Co.,  228  U.  S.  295; 
West  End  Street  Ry.  Co.  v.  Malley,  246  Fed.  625.    Reg.  50,  Art.  19. 

42  Rio  Grande  Junction  Ry.  Co.  v.  U.  S.,  51  Ct.  Cls.  274.  It  will  not  be 
found  easy  to  reconcile  this  case  with  the  case  of  U.  S.  v.  Emery,  237  U.  S. 
28,  where  a  corporation  was  organized  for  the  very  purpose  of  owning  and 
leasing  a  specific  piece  of  property  and  of  receiving  and  distributing  the 
rents  therefrom,  yet  was  held  not  to  be  doing  business. 

43  Von  Baumbach  v.  Sargent  Land  Co.,  242  U.  S.  503.  The  activities  re- 
ferred to  in  this  case  included  selling  and  leasing  property,  selling  stumpage, 
making  explorations,  and  employing  another  company  to  see  that  mining 
operations  were  properly  carried  on  and  that  the  lessees  lived  up  to  their 
engagements. 


1154  FEDERAL  INCOME  TAX 

sions44  will  be  followed  by  the  treasury  department  where  the 
decisions  are  by  the  United  States  Supreme  Court  or,  if  by  the 
lower  courts,  have  been  acquiesced  in  by  the  department. 

The  treasury  department  has  held  the  following  corporations 
to  be  doing  business:  (1)  Corporations  organized  for  the  pur- 
pose of  and  actually  engaged  in  such  activities  as  buying,  selling, 
or  dealing  in  mineral  or  timber  land,  or  other  real  estate ;  leasing 
property,  collecting  rents,  managing  office  buildings,  making 
investments  of  profits;  leasing  lands  and  collecting  royalties, 
managing  wharves,  dividing  profits ;  and  in  some  cases  investing 
the  surplus;  (2)  A  corporation  organized  for  the  purpose  of, 
and  actually  engaged  in,  buying  mineral  or  timber  land  or  other 
real  estate  and  holding  it  with  a  view  to  future  sale  at  an  ad- 
vance; (3)  A  corporation  organized  for  the  purpose  of  owning 
and  leasing  real  estate  which  has  leased  all  of  the  property  under 
its  control  under  the  terms  of  its  lease,  unless  its  activities  have 
been  reduced  to  the  mere  receipt  and  distribution  of  the  avails  of 
the  leases  at  the  actual  cost  of  so  doing.  (If  it  is  still  maintaining 
its  organization  for  the  purpose  of  continued  effort  in  the  pur- 
suit of  profit  and  gain  it  is  doing  business.)  (4)  A  corporation 
owning  or  managing  real  estate  which  leases  all  of  its  property 
but  under  the  terms  of  the  lease  is  required  to  maintain  or  keep 
the  property  in  repair;  (5)  A  corporation  engaged  in  mining 
or  in  developing  and  speculating  in  mineral  lands;  (6)  A  cor- 
poration engaged  in  buying  and  selling  securities  or  other  prop- 
erty even  though  for  a  period  it  makes  no  purchases  or  sales 
because  of  unfavorable  market  conditions;  (7)  A  corporation 
formed  to  take  over  miscellaneous  stocks,  bonds  or  other  prop- 
erty (as  of  an  estate) ,  to  negotiate  sales  of  various  items  from 
time  to  time  as  opportunity  and  judgment  dictate,  and  to  dis- 
tribute the  profits  from  time  to  time  as  liquidation  is  effected, 

4-1  other  cases  arising  under  the  1909  Law  are :  Anderson  v.  Morris  & 
Essex  R.  R.  Co.,  216  Fed.  83;  Cambria  Steel  Co.  v.  McCoach,  225  Fed.  278; 
Jasper,  etc.,  Ry.  Co.  v.  Walker,  238  Fed.  533;  Lewellyn  v.  Pittsburg,  etc. 
R.  R.  Co.,  222  Fed.  177;  McCoach  v.  Continental  Passenger  Ry.  Co.,  233  Fed. 
976;  Miller  v.  Snake  River  Valley  R.  R.  Co.,  223  Fed.  946;  New  York  Cen- 
tral V.  Gill,  219  Fed.  184;  New  York  Mail,  etc.,  Co.  v.  Anderson,  234  Fed. 
590;  Philadelphia,  etc.,  R.  R.  Co.  v.  Lederer,  242  Fed.  492;  Philadelphia 
Traction  Co.  v.  McCoach,  224  Fed.  800;  Public  Service  Electric  Co.  v.  Herold 
229  Fed.  902;  Traction  Companies  v.  Collector  of  Internal  Rev.,  223  Fed. 
984;  Wilkes-Barre,  etc.,  Traction  Co.  v.  Davis,  214  Fed.  511;  Boston  Ter- 
minal Co.  V.  Gill,  246  Fed.  664;  Old  Colony  R.  Co.  v.  Gill,  257  Fed.  220;  As- 
sociated Pipe  Line  Co.  v.  U.  S.,  258  Fed.  800;  State  Line  &  S.  R.  Co.  v. 
Davis,  228  Fed.  246;  Waterbury  Co.  v.  Walsh,  228  Fed.  54;  West  Ry.  Co. 
v.  Malley,  246  Fed.  625;  Chemung  Iron  Co.  v.  Lynch,  269  Fed.  368;  Flint 
V.  Stone-Tracy  Co.,  220  U.  S.  107;  U.  S.  v.  Nipissing  Mines  Co.,  206  Fed.  431. 


THE  CAPITAL  STOCK  TAX  1155 

while  so  engaged;  (8)  A  parent  corporation  which  finances 
or  manages  the  operations  of  its  subsidiaries;  (9)  A  so-called 
holding  company  which,  under  its  charter,  is  authorized  to  and 
does,  in  addition  to  receiving  and  distributing  the  avails  of  the 
property  or  securities,  held  by  it,  finance  the  operations  of  its 
subsidiaries;  (10)  A  corporation  organized  for  the  purpose  of 
taking  over  and  holding  securities,  timber  land,  coal  lands,  or 
other  real  estate,  if  it  makes  investments  or  reinvestments  of 
its  surplus  income  or  funds  in  excess  of  an  amount  necessary 
to  maintain  its  original  investments.'*^ 

Not  "Doing-  Business."  Holding  companies  as  distinguished 
from  parent  corporations,  and  corporations  all  of  whose  prop- 
erty and  business  is  operated  by,  or  is  in  the  hands  of,  a  receiver 
or  the  alien  property  custodian,  are  not  doing  business.  A  hold- 
ing company  is  defined  as  one  whose  corporate  powers  are  lim- 
ited to  the  mere  owning  and  holding  of  property  and  distribution 
of  its  avails,  or  one  which,  although  incorporated  for  the  purpose 
of  doing  business  as  defined  in  the  preceding  paragraph,  has 
substantially  retired  from  the  business  for  which  it  was  organ- 
ized and  has  reduced  its  activities  to  the  mere  ownership  and 
holding  of  property,  distributing  its  avails,  and  doing  only  such 
acts  as  are  necessary  to  the  maintenance  of  its  corporate  exist- 
ence and  the  private  management  of  its  purely  internal  affairs. 
A  holding  company,  as  above  defined,  will  not  be  considered  to 
be  doing  business  by  reason  of  the  reinvestment  of  its  surplus 
income  or  funds  to  the  extent  only  of  maintaining  its  original 
investments."*''' 

Doing  Business  by  Foreign  Corporations.  A  foreign  corpora- 
tion is  "carrying  on  or  doing  business"  in  the  United  States  if  it 
maintains  agents  or  an  office  or  warehouse  here,  or  in  the  case  of 
an  insurance  company  writes  insurance  policies  here  or  in  any 
other  way  enters  the  United  States  for  the  purpose  of  its  busi- 
ness. The  purchase  of  supplies  in  the  United  States  in  the  fur- 
therance of  continued  efforts  in  the  pursuit  of  profit  or  gain  is 
carrying  on  or  doing  business  in  the  United  States.^^    The  mean- 

45  Reg.  50  Rev.,  Art.  11.  The  question  of  "doing  business"  by  a  railroad 
corporation  under  federal  control  is  treated  in  Reg.  50  Rev.,  Arts.  20  and 
21.     See  also  T.  D.  3156;  also  1920  Edition,  p.  730. 

46  Reg.  50  Rev.,  Art.  12.  See  also  Reg.  50  Rev.,  Art.  19.  Reg.  38  Rev., 
Art.  6.  These  regulations  reversed  the  earlier  holding  of  the  treasury  de- 
partment and  were  probably  based  upon  the  case  of  Butterick  Co.  v.  U.  S., 
240  Fed.  539. 

47  Reg.  50  Rev.,  Art.  17. 


1156  FEDERAL  INCOME  TAX 

ing  of  the  term  in  relation  to  foreign  corporations  has  been 
referred  to  in  a  previous  paragraph.^^ 

Exempt  Corporations.  The  special  excise  tax  is  expressly- 
made  inapplicable  to  any  corporation  exempted  for  income  tax 
purposes.^^  As  foreign  corporations  falling  within  the  classes 
enumerated  as  exempt  in  the  income  tax  law  (except  in  the  case 
of  building  and  loan  associations  and  co-operative  banks)  are 
exempt  for  income  tax  purposes/'^o  they  are  also  exempt  from 
this  tax,  if  falling  within  such  enumerated  classes.  All  insur- 
ance companies,  except  mutual  companies,  are  exempt  under  the 
present  law.^i  However,  mutual  hail,  cyclone  or  fire  insurance 
companies,  or  like  organizations  of  a  purely  local  character,  the 
income  of  which  consists  solely  of  assessments,  dues  and  fees 
collected  from  members  for  the  sole  purpose  of  meeting  expenses, 
are  also  exempt.-^-  But  if  a  mutual  insurance  company  derives 
substantial  income  from  investments  of  savings  on  premiums, 
it  is  not  exempt  under  the  provisions  of  section  231  (10)  because 
in  such  a  case  its  income  does  not  consist  "solely  of  assessments, 
dues  and  fees."^''^  A  corporation  paying  this  tax  is  not  on  that 
account  exempt  from  any  occupational  tax.»* 

Tax  Due.  This  tax  is  an  excise  tax  on  the  privilege  of  doing 
business,  similar  to  occupational  taxes  imposed  on  individuals. 
Being  a  privilege  or  occupational  tax,  it  is  payable  annually  in 
advance  for  each  year  beginning  July  1.  Special  taxes,  of  which 
this  is  one,  become  due  on  the  first  day  of  July  in  each  year,  or 
on  commencing  any  trade  or  business  on  which  such  tax  is 
imposed.5'5  The  tax  is  payable  to  the  collector  at  any  time  after 
such  due  date,  but  penalties  for  non-payment  do  not  attach  until 
ten  days  after  notice  and  demand  therefor  have  been  served  by 
the  collector  upon  the  taxpayer.^e 

Returns.  Returns  are  required  to  be  filed  on  or  before  the 
31st  of  July  of  each  year  with  the  collector  of  the  district  in 
which  the  principal  place  of  business  of  the  corporation  is  lo- 

•iS  See  pp.  1142  and  1147. 

49  Revenue  Act  of  1912,  §1000   (b). 

so  Letter  from  treasury  department  dated  December  6,  1916;  L  T.  S.  1918, 
11  1182;  Reg.  38  Rev.,  Art.  12.  This  decision  was  of  course  under  the  1916 
Law,  but  there  seems  no  reason  for  reaching  a  different  conclusion  under 
this  law. 

51  Revenue  Act  of  1921,  §  1000  (b).     See  pp.  1148  and  1150. 

52  Revenue  Act  of  1921,  §  1000  (b)   and  231   (10). 

53  L.  O.  1063,  19-21-1626. 

54  Reg.  50  Rev.,  Art.  41. 

55  Reg.  50  Rev.,  Art.  1. 

50  See  T.  D.  2423  and  Chapter  35  for  ruling  as  to  notice  and  demand. 


THE  CAPITAL  STOCK  TAX  1157 

cated.57  Forms  will  be  sent  to  taxable  corporations  known  to 
collectors,  but  failure  to  receive  a  blank  form  will  not  relieve  a 
corporation  from  the  penalties  prescribed  by  law  for  failure  to 
make  the  return  within  the  time  required.  All  the  information 
called  for  in  the  forms  must  be  given  in  every  case  where  it  is 
procurable.s^ 

In  What  Cases  Required.  A  return  is  required  of  every 
domestic  corporation  engaged  in  business,  regardless  of  the  par 
value,  or  the  actual  value,  of  its  capital  stock,  unless  such  corpo- 
ration was  not  engaged  in  business  during  the  preceding  taxable 
year,  in  which  case  it  proceeds  as  indicated  in  a  paragraph 
below.^'^ 

Extension  of  Time.  If  failure  to  file  a  return  is  due  to  sick- 
ness or  absence,  the  collector  may  allow  such  further  time,  not 
exceeding  30  days,  for  making  and  filing  the  return  as  he  deems 
proper.co  There  is  no  authority  in  the  law  for  granting  an  ex- 
tension for  afiij  reason  beyond  30  days  from  July  31  and  a  cor- 
poration with  a  fiscal  year  ending  on  June  30  will  be  obliged  to 
file  its  capital  stock  return  on  or  before  August  30,  even  though 
it  has  not  yet  filed  its  income  tax  return.  Such  corporations 
should  complete  their  capital  stock  returns  insofar  as  practicable 
and  file  with  them  a  statement  that  unavailable  data  will  be 
furnished  in  a  supplemental  report  as  soon  as  possible.  This 
procedure  will  obviate  any  assertion  of  penalties  and  any  ques- 
tion as  to  what  constitutes  a  reasonable  cause.^^ 

Returns  to  Be  Public  Records.  Returns  filed  pursuant  to 
the  special  excise  tax  law  constitute  public  records,  and  are  open 
to  inspection  in  all  respects  the  same  as  income  tax  returns.^- 

Tentative  Returns.  If  for  reasons,  other  than  absence  or 
sickness,  beyond  the  control  of  the  officers  making  the  return, 

57  Reg.  50  Rev.,  Art.  33;  See  R.  S.  3173  as  re-enacted  by  §1311  of  the 
Revenue  Act  of  1921. 

58  Reg.  50  Rev.,  Art.  31. 

59  Reg.  50,  Art.  23 ;  Reg.  38  Rev.,  Art.  18.  If  a  corporation  claims  exemp- 
tion on  the  ground  that  it  is  not  doing  business,  it  should  complete  the  first 
five  lines  of  Form  707,  attaching  comprehensive  explanation  of  such  grounds. 
(Telegram  from  treasury  department  dated  July  25,  1919;  W.  T.  S.  1919, 
113127.) 

60  Reg.  50  Rev.,  Art.  33.  It  was  decided  under  the  1916  capital  stock  tax 
law  that  the  tax  was  not  illegal  because  assessed  and  collected  in  advance 
(Washing-ton  Water  Power  Co.  v.  U.  S.,  decided  by  Court  of  Claims,  Feb. 
14,  1921,  T.  D.  3160). 

61  Letter  from  treasury  department  dated  July  11,  1919;  W.  T.  S.  1919, 
11113121-3125. 

62  Revenue  Act  of  1921,  §  1000  (c)  ;  Reg.  50  Rev.,  Art.  30;  See  Chapter  34. 


1158  FEDERAL  INCOME  TAX 

it  becomes  impossible  to  file  a  completed  return  within  the  time 
prescribed  by  law,  a  tentative  return  may  be  filed,  thus  avoiding 
penalty  for  failure  to  file  within  the  prescribed  time.  The  filing 
of  a  tentative  return  will  avoid  the  penalty  for  delinquent  filing, 
but  does  not  authorize  the  withholding  of  the  tax.  The  regulations 
do  not  permit  the  filing  of  a  tentative  return  to  stay  indefinitely 
the  filing  of  a  completed  return  and  the  collection  of  the  tax  due ; 
therefore,  a  tentative  return  clearly  marked  "Tentative  return" 
should  be  prepared  in  as  complete  a  manner  as  possible,  includ- 
ing, among  other  information,  a  basis  for  the  computation  of  the 
tax— that  is,  an  estimate  by  the  officers  of  the  corporation  of  the 
approximate  fair  value  of  the  capital  stock  in  order  that  an 
initial  assessment  may  be  made.  When  the  completed  return  is 
filed,  it  should  be  clearly  marked  "Completed  return,"  showing 
that  a  tentative  return  was  filed.  Such  action  will  prevent  dupli- 
cate assessments  and  ordinary  penalties.  In  every  case  a  state- 
ment should  be  attached  to  the  tentative  return,  indicating  the 
approximate  date  the  completed  return  may  be  expected.  Upon 
receipt  of  the  completed  return  any  adjustment  necessary  in  the 
assessment  of  the  correct  tax  due  will  be  made..^^ 

Return  by  Corporation  Claiming  Exemption.  Where  the 
officers  of  a  corporation  are  of  the  opinion  that  it  is  exempt  be- 
cause of  being  an  exempt  organization  under  the  income  tax  law, 
or  on  account  of  not  being  engaged  in  business.  Form  707  (Re- 
vised) should  be  filled  out  and  filed  with  the  collector,  together 
with  a  comprehensive  statement  of  the  reasons  for  claiming 
exemption.  In  such  case  the  fair  value  should  be  reported  on 
page  1  of  the  form,  but  the  tax  not  computed,  notation  "Exemp- 
tion claimed"  being  made  instead.  If  exemption  has  been  al- 
lowed for  the  preceding  taxable  year  and  there  has  been  no 
change  in  the  status  or  conditions  of  the  company  then  the  first 
14  lines  of  Form  707  (Revised)  should  be  completed  and  a  state- 
ment attached  to  the  effect  that  exemption  is  claimed  for  the 
same  reasons  as  for  the  previous  year  and  that  the  same  status 
and  conditions  of  the  company  exist  for  the  taxable  period  in 
question.  In  this  way  the  records  of  the  collectors'  offices  will 
be  complete  and  corporations  will  avoid  requests  for  the  filing 
of  returns  and  unnecessary  correspondence.  The  determination 
of  liability  rests  in  the  first  instance  with  the  commissioner 
and  without  complete  information  it  is  impossible  to  make  a 
decision.^^ 

63  Reg.  50  Rev.,  Arts.  33  and  34. 

64  Reg.  50  Rev.,  Art.  28. 


THE  CAPITAL  STOCK  TAX  1159 

Return  by  Affiliated  Corporation.  Although  under  the 
income  tax  law  consolidated  returns  may  be  filed  in  the  case  of 
affiliated  corporations  for  the  purpose  of  capital  stock  tax  each 
corporation  must  render  a  separate  return  in  complete  form. 
So-called  subsidiary  corporations,  all  or  a  part  of  the  stock  of 
which  is  owned  by  another  corporation,  must  render  separate 
returns,  the  same  as  every  other  corporation.  No  deductions 
from  the  assets  are  permitted  on  account  of  inter-company  bal- 
ances, and  the  shareholdings  must  be  reported  in  the  "Fair 
value"  column  at  their  actual  worth  at  the  time  of  making  the 
return.  No  deduction  is  allowed  in  the  return  of  one  corpora- 
tion for  the  tax  paid  by  another.  If  the  fair  value  is  determined 
by  any  method  other  than  by  Exhibits  A,  B  and  C,  the  following 
requirements  must  be  complied  with :  (a)  The  parent  company 
must  submit  with  its  return  a  list  of  all  subsidiaries  and  the 
districts  in  which  the  returns  were  filed;  (b)  the  return  of  the 
subsidiary  company  must  show  the  name  of  the  parent  company 
and  the  district  in  which  the  return  was  filed;  (c)  the  method 
of  determining  the  fair  value,  if  other  than  by  Exhibits  A,  B 
and  C,  must  be  fully  explained;  (d)  a  copy  of  any  agreement 
existing  between  parent  company  and  subsidiary  must  be  fur- 
nished, or  a  statement  made  that  none  exists;  and  (e)  a  com- 
bined balance  sheet  and  a  combined  net  income  statement  must 
be  submitted  for  consideration  in  connection  with  any  estimate 
of  fair  value  made  on  behalf  of  the  reporting  corporation.^-^ 

Returns  of  Affiliated  Corporations  Based  upon  Consoli- 
dated Report.  In  many  cases,  as  for  instance,  in  the  case  of 
selling  agencies  separate  corporations  are  formed  in  order  prop- 
erly to  handle  certain  business  under  various  state  laws  and  in 
reality  are  branches  or  departments  of  the  parent  corporation. 
The  business  is  controlled  by  the  parent  corporation  and  the 
result  of  operations  is  a  matter  of  bookkeeping.  The  capital  stock 
tax  being  imposed  upon  the  fair  value  of  the  capital  stock  of  cor- 
porations, it  makes  little  difference  by  what  method  such  fair 
value  is  determined.  Therefore,  if  the  fair  value  of  the  capital 
stock  of  affiliated  corporations  cannot  be  determined  independ- 
ently and  such  corporations  are  best  able  to  determine  the  fair 
value  of  the  respective  companies  through  a  consolidated  report, 
such  privilege  is  permitted  by  the  department,  but  it  seems  pref- 
erable to  leave  this  to  the  corporations  interested  subject  to  ap- 
proval by  the  commissioner  rather  than  attempt  to  outline  a  spe- 

65  Reg.  50  Rev.,  Art.  35. 


1160  FEDERAL  INCOME  TAX 

cific  method  that  would  apply  to  all.  Under  all  circumstances, 
however,  separate  returns  are  required  of  all  affiliated  corpora- 
tions, regardless  of  the  basis  used  in  arriving  at  fair  value.*^'^ 

Returns  by  Foreign  Corporations.  A  return  is  required  of  every 
foreign  corporation  engaged  in  business  in  the  United  States, 
irrespective  of  the  amount  of  capital  employed  in  this  country  in 
the  transaction  of  its  business.  The  capital  actually  employed  in 
the  transaction  of  the  business  of  the  foreign  corporation  in  the 
United  States  and  the  tax  payable  thereon  should  be  calculated 
in  accordance  with  the  instructions  on  the  form  (Form  708).^''^ 

Payment  of  the  Tax.  All  assessments  are  made  by  the  com- 
missioner. The  collector,  within  ten  days  after  receiving  any  list 
of  taxes  from  the  commissioner,  gives  notice  to  each  corporation 
liable  to  pay  any  tax  stated  therein,  to  be  left  at  its  place  of  busi- 
ness or  to  be  sent  by  mail,  stating  the  amount  of  such  tax  and  de- 
manding payment  thereof.  All  taxes  are  payable  directly  to  the 
collector  who  has  no  authority  to  extend  time  for  the  payment  of 
the  tax.  The  collector  may  accept  payment  of  the  tax  when  the 
return  is  filed  as  an  "advance  collection,"  subject  to  any  adjust- 
ment later  found  necessary,  but  no  corporation  is  required  to  pay 
the  tax  until  within  ten  days  after  notice  and  demand.  The  tax 
due  from  a  corporation  is  legally  collectible  from  the  stockholder 
or  others  who  have  received  its  assets  on  liquidation.^'"' 

Penalties.  Any  corporation  carrying  on  business  without 
having  paid  the  tax  therein  provided  is  subject  to  a  penalty  of 
not  more  than  $1,000,  besides  being  liable  for  the  payment  of 
such  tax.69 

Administration  of  the  Law.  All  administrative  or  special  pro- 
visions of  the  internal  revenue  laws  including  the  laws  relating  to 
the  assessment  of  taxes,  so  far  as  applicable,  are  extended  to  and 
made  a  part  of  the  Revenue  Act  of  1921  (including  the  Special 

60  Letter  from  treasury  department  dated  June  2,  1919;  W.  T.  S.  1919, 
^3120;  letter  from  treasury  department  dated  November  11,  1919;  W.  T.  S. 
1919,  TI3129. 

67  Reg.  50  Rev.,  Art.  32. 

68  Reg.  50  Rev.,  Art.  36.  For  the  provisions  relating  to  payment  by 
uncertified  checks  and  the  procedure  with  respect  to  dishonored  checks,  see 
Chapter  35  and  Reg.  50  Rev.,  Arts.  39  and  40. 

69  Revenue  Act  of  1921,  §1004;  Reg.  50  Rev.,  Art.  41.  As  to  penalties 
for  failure  to  make  returns,  for  making  false  returns,  and  for  delay  in  pay- 
ing the  tax,  see  §  1302  of  the  Revenue  Act  of  1921,  and  R.  S.  3176  (as 
re-enacted  by  §1311  of  the  Revenue  Act  of  1921),  a  discussion  of  which 
sections  will  be  found  in  Chapter  36.   See  also  Reg.  50  Rev.,  Arts.  42  and  43. 


THE  CAPITAL  STOCK  TAX  1161 

Excise  Tax)  and  every  corporation  liable  to  the  tax  considered  in 
this  chapter  is  required  to  keep  such  records  and  render,  under 
oath,  such  statements  and  returns,  and  comply  with  such  regu- 
lations as  the  commissioner  may  prescribed" 

TO  Revenue  Act  of  1921,  §  1300.  Title  XIII  of  the  Revenue  Act  of  1921 
contains  general  administrative  provisions,  most  of  w^hich  apply  to  the  capi- 
tal stock  tax  as  well  as  to  the  income  and  other  taxes.  This  is  true,  for 
example,  of  §  1303  giving  the  commissioner  general  power  to  make  necessary 
regulations,  §§  1308  and  1309  dealing  with  examination  of  books  and  wit- 
nesses; §  1310  respecting  jurisdiction  of  courts;  §  1315  dealing  with  refunds, 
etc.  Inasmuch  as  reference  to  these  sections  will  be  found  in  other  parts  of 
this  volume,  no  special  discussion  of  them  is  included  at  this  place. 


CHAPTER  45 
THE  STAMP  TAX 

The  present  stamp  tax  is  imposed  under  Title  XI  of  the  Rev- 
enue Act  of  1921,  the  date  of  incidence  of  which,  that  is,  the 
first  day  on  which  the  tax  applied,  was  January  1,  1922.  This 
title  is  practically  a  re-enactment  of  Title  XI  of  the  Revenue  Act 
of  1918  (referred  to  in  this  chapter  as  the  "former"  or  1918 
Law) ,  except  that  the  tax  no  longer  applies  to  bonds  of  indemnity 
and  surety,  or  to  parcel-post  packages.  Various  other  changes 
of  less  importance  will  be  noted  in  the  paragraphs  of  this  chap- 
ter to  which  they  are  applicable.  The  taxes  imposed  by  the 
Revenue  Act  of  1921  are,  in  the  case  of  any  article  upon  which 
a  corresponding  stamp  tax  was  hitherto  imposed  by  law,  in  lieu 
of  such  tax.i  Title  XI  of  the  Revenue  Act  of  1918  became 
effective  on  April  1,  1919,^  and  was  to  some  extent  a  re-enact- 
ment of  the  War  Stamp  Tax  Act  of  1917  (Title  VIII  of  the  Act 
of  October  3,  1917,  referred  to  in  this  chapter  as  the  1917  Law) , 
but  the  two  acts  differ  in  certain  respects.-^  The  Revenue  Act  of 
1918,  like  the  1917  Law,  did  not  contain  Schedule  B  of  the  Ac- 
of  October  22,  1914  (referred  to  in  this  chapter  as  the  1914 
Law),  which  provided  for  a  tax  on  perfumery,  cosmetics  and 
similar  articles  and  chewing-gum  or  substitutes  therefor.  The 
1914  Law  was  preceded  by  the  Act  of  June  13,  1898  (referred 
to  in  this  chapter  as  the  1898  Law)  .* 

General  Scope  of  Present  Law.  The  present  law  taxes  the  fol- 
lowing subjects:  Bonds  of  indebtedness,  the  original  issue  of 
certificates  of  stock  or  of  profits  or  interest  in  property  or  accu- 
mulations of  corporations,  the  sale  or  transfer  of  shares  or 
certificates  of  stock  or  of  profits  or  of  interest  in  property  or 
accumulations  in  corporations,  sales  of  produce  on  exchange, 
drafts  or  checks  (payable  otherwise  than  at  sight  or  on  demand) , 
promissory  notes,  conveyances,  entries  of  goods  at  custom  house, 
entry  for  withdrawal  of  goods  from  custom  bonded  warehouse, 

1  Revenue  Act  of  1921,  §  1100. 

2  Revenue  Act  of  1918,  §  1100. 

3  The  1917  Law  went  into  effect  on  December  1,  1917,  except  as  to  the  tax 
on  playing  cards  which  became  effective  on  October  4,  1917. 

4  Other  Stamp  Tax  Acts  will  likewise  be  referred  to  in  this  chapter  for 
the  sake  of  brevity  by  the  years  of  their  respective  enactments.  For  an 
historical  discussion  of  stamp  tax  legislation  in  the  United  States,  see 
Edwards  v.  Wabash  Ry.  Co.,  264  Fed.  610. 

1162 


THE   STAMP   TAX  1163 

passage  tickets  on  vessels  to  foreign  countries  (except  Canada 
or  Mexico),  proxies,  powers  of  attorney,  playing  cards  and  cer- 
tain insurance  policies."^  The  several  subjects  appear  below  in 
alphabetical  order,  together  with  the  rates  applicable  to  each 
and  rulings  with  respect  to  each.  This  list  includes  a  number 
of  instruments  not  taxable  under  the  present  law  to  which  refer- 
ence is  made  for  the  convenience  of  the  reader  who  may  be 
searching  for  positive  assurance  that  a  particular  instrument 
need  not  be  stamped. 

General  Exemptions.  The  following  are  not  subject  to  stamp 
tax :  (a)  bonds,  notes,  or  other  instruments  issued  by  the  United 
States,  or  by  any  foreign  government,  or  by  any  State,  Territory, 
or  the  District  of  Columbia,  or  local  subdivision  thereof,  or 
municipal  or  other  corporation  exercising  the  taxing  power;  (b) 
bonds  of  indemnity  required  to  be  filed  by  any  person  to  secure 
payment  of  any  pension,  allowance,  allotment,  relief,  or  insur- 
ance by  the  United  States,  or  to  secure  a  duplicate  for,  or  the 
payment  of,  any  bond,  note,  certificate  of  indebtedness,  war- 
savings  certificate,  warrant  or  check,  issued  by  the  United 
States;"^  (c)  stocks  and  bonds  issued  by  co-operative  building  and 
loan  associations  which  are  organized  and  operated  exclusively 
for  the  benefit  of  their  members  and  make  loans  only  to  their 
shareholders,  or  by  mutual  ditch  or  irrigation  companies.'^  Spe- 
cial exemptions  applying  to  various  instruments  specified  in  the 
law  are  referred  to  in  the  paragraphs  dealing  with  such 
instruments. 

Stamps.  Stamps  are  kept  on  sale  by  collectors,  and  stamp 
deputy  collectors  of  internal  revenue  and  postmasters  in  the 
United  States,^  and  are  also  on  sale  at  United  States  depositaries.^ 
Stamps  issued  under  the  1914  and  1917  Laws  were  permitted  to 
be  used  in  paying  stamp  taxes  pursuant  to  the  Revenue  Act  of 
1918."*  Documentary  Stamps  only  must  be  used  upon  papers, 
documents  and  instruments  subject  to  tax  except  as  provided  in 
the  regulations  relating  to  stamp  taxes  on  issue  and  transfers  of 
stock  and  sales  of  products  for  future  delivery .^    Ordinary  post- 

5  Revenue  Act  of  1921,  Title  XI,  Schedule  A. 

6  Revenue  Act  of  1921,  §  1101.  Since  bonds  of  indemnity  and  surety  are 
no  longer  subject  to  stamp  tax,  paragraph  (b)  of  the  text  above  now  seems 
superfluous. 

7  Revenue  Act  of  1921,  §  1101. 

8  Revenue  Act  of  1921,  §  1106;  Reg.  55  Rev.,  Arts.  176-7. 

9  Revenue  Act  of  1921,  §  1107;  Reg.  55  Rev.,  Art  177. 

10  Reg.  55  Rev.,  Art.  182. 

11  Reg.  55  Rev.,  Art.  181. 


1164  FEDERAL  INCOME  TAX 

age  stamps  cannot  be  used  for  the  payment  of  any  internal 
revenue  taxes.^-  Where  documentary  stamps  are  rendered  useless 
by  gumming  or  sticking  together  in  transit  or  otherwise  without 
the  fault  of  the  purchaser,  they  may  be  exchanged  by  a  collector 
for  other  stamps  of  exactly  the  same  quantity  and  denomi- 
nation.i'^ 

Where  Stamps  Are  Affixed.  As  a  rule,  stamps  are  affixed  to 
the  taxable  document  or  instrument,  but  in  some  instances  a  dif- 
ferent rule  prevails,  as  will  appear  in  the  following  paragraphs. 
Stamps  to  be  affixed  to  articles  manufactured  in  a  foreign  coun- 
try and  imported  into  the  United  States  may  be  purchased  and 
forwarded  to  the  place  of  manufacture  and  there  affixed  to  the 
articles  before  the  same  are  packed  for  importation. i^ 

Who  Affixes  Stamps.  It  is  contemplated  that  stamps  shall 
be  affixed  by  the  person  issuing  the  document  or  instrument. 
Thus,  the  maker  of  a  promissory  note  is  primarily  obliged  to 
affix  the  proper  stamp  thereto,  and  likewise,  the  obligor  should 
affix  the  proper  stamp  to  a  bond.  However,  it  is  secondarily  the 
duty  of  a  person  accepting  or  receiving  any  such  document  or 
instrument  to  affix  a  stamp  thereto  ^nd  he  is  subject  to  penalty 
if  he  does  not  do  so.i^  It  has  been  held  that  it  makes  no  differ- 
ence who  affixes  the  stamp,  as  long  as  a  stamp  of  the  proper  de- 
nomination is  affixed  to  the  instrument.  Both  parties  to  a 
taxable  instrument  are  responsible  to  the  Government  for  affix- 
ing and  cancelling  stamps  in  the  required  amount.  The  law  does 
not  prohibit  parties  in  interest  from  entering  into  an  agreement 
as  to  which  of  them  shall  actually  pay  same.^^ 

Cancellation  of  Stamps.  Stamps  are  cancelled  by  the  per- 
son using  or  affixing  the  stamp,  by  writing  or  stamping  thereon 
or  causing  to  be  written  or  stamped  thereon  in  ink  his  initials 
and  the  day,  month,  and  year  on  which  the  stamp  is  used  or 
affixed,  or  by  cutting  and  cancelling  the  stamp  with  a  machine  or 
punch  which  will  affix  the  initials  and  date  as  aforesaid  and  so 
deface  the  stamp  as  to  render  it  unfit  for  reuse.  In  addition, 
stamps  of  the  value  of  10  cents  or  more  are  required  to  be  can- 
celled by  three  parallel  incisions  made  by  some  sharp  instrument 
lengthwise  through  the  stamp  after  the  stamp  has  been  attached 
to  the  instrument,  except  that  this  is  not  required  where  stamps 
are  cancelled  by  perforation.     The  cancellation  by  either  method 

12  Reg.  55  Rev.,  Art.  183. 

13  Reg.  55  Rev.,  Art.  184. 

14  Reg.  55  Rev.,  Art.  178. 

15  Revenue  Act  of  1921,  §  1102  (a). 

16  Reg.  55  Rev.,  Art  171. 


THE   STAMP   TAX  1165 

should  not  so  deface  the  stamp  as  to  prevent  its  denomination 
and  genuineness  from  being  readily  determined. ^^  The  perforat- 
ing machine  may  also  imprint  the  initials  and  date  or  outline  the 
same  in  small  perforations,  thus  effecting  complete  cancellation, 
or  the  initials  and  date  may  be  written  on  the  stamp,  and  several 
perforations,  sufficient  to  prevent  washing  and  resale  of  the 
stamp  may  be  made  with  an  ordinary  hand  punch  before  fixing 
the  stamp  to  the  document.!'^  Where  the  initials  of  a  person, 
firm  or  corporation  have  been  perforated  on  the  stamps  before 
being  used  it  is  sufficient  when  the  stamps  are  actually  attached 
to  the  document  to  stamp  the  same  with  the  full  initials  and  date. 
Where  the  initials  of  a  firm  or  company  have  been  stamped  or 
written  on  a  stamp  it  is  not  required  that  the  individual  employee 
affixing  the  stamp  shall  also  place  his  own  initials  thereon. i'^  It 
has  been  held  that  stamps  on  promissory  notes  were  properly 
cancelled  when  they  were  so  used  and  defaced  that  they  could 
never  be  legally  used  again.-o  It  has  also  been  held  that  the 
failure  to  write  the  initials  of  the  payee's  name  on  a  promissory 
note,  when  he  was  affixing  a  stamp  and  cancelling  the  same  in 
the  presence  of  the  court  before  offering  the  note  in  evidence, 
did  not  affect  its  sufficiency .21  In  a  case  decided  in  1865,--  it  was 
held  that  when  a  bond  was  executed  by  two  obligors,  it  was  suffi- 
cient if  the  stamp  was  attached  and  cancelled  by  one  of  them. 
A  stamp  affixed  to  an  instrument  and  cancelled  can  not  lawfully 
be  removed  therefrom  and  affixed  to  another  instrument  requir- 
ing a  stamp.  Amounts  paid  for  stamps  used  in  excess,  or  on 
instruments  not  actually  effective  and  for  which  a  substitute  is 
prepared  and  stamped,  or  on  instruments  not  subject  to  tax,  may 
be  refunded,  upon  claim  properly  presented  to  the  collector.23 

17  Revenue  Act  of  1921,  §  1104;  Reg.  55  Rev.,  Arts.  179,  180. 

18  T.  D.  2098. 

I!'  Letter  from  treasury  department  dated  December  9,  1914. 

20  Taylor  v.  Duncan,  33  Tex.  (1870)  440. 

21  Foster  v.  Holley's  Adm'rs,  49  Ala.  (1873)  593.  The  court  in  this  case 
does  not  decide  the  question  whether  an  improperly  stamped  note  could  be 
excluded  from  evidence  in  the  state  courts. 

"  Teagarden  v.  Garver,  24  Ind.  399.  In  this  case,  the  court  says :  "The 
object  of  the  Act  of  Congress  is  to  raise  revenue,  and  the  stamps  are  required 
to  be  cancelled  to  prevent  their  use  a  second  time.  This  was  fully  accom- 
plished by  one  of  the  obligors  cancelling  it,  as  required  by  the  Act  of  Con- 
gress." The  court  referred  to  the  doubtful  character  of  the  power  of  the 
federal  government  to  make  a  rule  excluding  improperly  stamped  instru- 
ments from  evidence  in  the  state  courts,  and  the  court's  opinion  indicates 
that  this  doubt  was  a  factor  in  its  decision.     See  p.  1242. 

23  Reg.  55  Rev.,  Art.  170. 


1166  FEDERAL  INCOME  TAX 

Bonds  of  Indebtedness.  Bonds,  debentures  or  certificates  of 
indebtedness,  however  termed,  issued  on  and  after  April  1,  1919, 
by  any  person,-^  are  taxable  at  the  rate  of  5  cents  on  each  $100 
of  face  value  or  fraction  thereof.-'^ 

Where  Stamps  Are  Affixed.  The  necessary  revenue  stamps 
may  be  affixed  either  to  the  bonds  or  to  the  indenture  under 
which  the  bonds  are  issued.  If  the  stamps  are  affixed  to  the 
indenture,  the  bonds  must  bear  a  legend  showing  that  the  proper 
revenue  stamps  have  been  affixed  to  the  indenture  and  duly  can- 
celled. If  the  indenture  provides  for  the  issue  of  bonds  over  a 
period  of  years,  the  necessary  stamps  may  be  affixed  at  the  time 
of  each  issue.-*^  If  temporary  bonds  or  interim  certificates  are 
first  issued,  to  be  later  exchanged  for  permanent  or  definitive 
bonds,  the  stamps  may  be  affixed  to  the  indenture,  in  which  case 
a  statement  that  the  stamps  were  affixed  to  the  indenture  must  be 
printed  or  engraved  on  each  bond.-''  No  additional  tax  is  re- 
quired on  the  definitive  or  permanent  bonds  which,  however, 
should  bear  notation  of  the  fact  that  stamps  in  the  proper  amount 
were  duly  attached  to  the  indenture  or  the  interim  certificates.^^ 

It  has  been  held  that  no  stamp  tax  is  due  on  the  issue  of 
definitive  bonds  after  the  incidence  of  the  stamp  tax  where 
temporary  bonds  evidencing  the  loan  receivable  in  two  install- 
ments were  issued  and  delivered  before  the  incidence  of  the  tax 
to  the  trustee  pending  payment  of  the  two  installments,  receipts 
being  given  to  individual  creditors  on  payment  of  the  first  in- 
stallment, the  second  installment"  being  paid  after  the  incidence 
of  the  tax.29 

Definitions.  Under  the  1914  Law  the  tax  was  imposed  only 
on  bonds  issued  by  corporations  or  associations.  It  is  to  be 
noted  that  the  present  act  imposes  the  tax  on  bonds  issued  by 
persons  which  term  includes  corporations  and  partnerships  as 
well  as  individuals.30  There  is  no  clear  distinction  between 
bonds  of  indebtedness  and  promissory  notes,  and  it  is  sometimes 
difficult  to  determine  whether  an  instrument  should  be  taxed 
under  the  higher  rate  applying  to  bonds  of  indebtedness  or  the 
lower  rate  applying  to  promissory  notes.     An  instrument  which 

24  The  term  person  includes  partnerships  and  corporations  as  well  as  in- 
dividuals.    (Revenue  Act  of  1921,  §  2). 

25  Revenue  Act  of  1921,  Title  XI,  Schedule  A-1. 

26  Reg.  55  Rev.,  Art  6;  letter  from  treasury  department  dated  May  24, 
1919;  W.  T.  S.  1919,  §3777. 

27  Reg.  55  Rev.,  Art.  7. 

28  T.  D.  2164;  T.  D.  2220. 

29  Edwards  v.  Chile  Copper  Company,  273  Fed.  452. 

30  Revenue  Act  of  1921,  Title  XI,  Schedule  A-1. 


THE   STAMP   TAX  1167 

is  styled  a  "bond"  and  which  is  under  seal  will  be  held  subject  to 
tax  as  a  bond  unless  it  is  shown  affirmatively  that  it  is  not  a  bond.^i 
If  the  instrument  is  called  a  note,  but  contains  features  not  usual 
in  or  recognized  as  appertaining  to  the  promissory  note  gener- 
ally known  to  commerce,  it  is  held  in  department  practice  to  be 
taxable  as  a  bond.     Thus,  under  the  1914  Law  it  was  held  that 
an  instrument  designated  as  a  "gold  note"  issued  in  the  amount 
of  $1,000,  with  interest  coupons  attached,  and  contaming  a  prom- 
ise by  a  corporation  to  pay  a  certain  sum  of  money  to  the  holder 
thereof  under  certain  terms  and  conditions  prescribed  by  the 
indenture  of  trust,  was  more  in  the  nature  of  a  bond  or  certificate 
of  indebtedness  than  a  promissory  note  and  was,  therefore,  held 
taxable  as  a  bond.^^^     instruments  containing  the  essential  fea- 
tures of  a  promissory  note,  but  issued  by  corporations  m  series 
under  a  trust   indenture,   either   in   registered   form   or   with 
coupons  attached,  embodying  provisions  for  acceleration  of  ma- 
turity in  the  event  of  any  default  by  the  obligor,  for  optional 
registration  in  the  case  of  bearer  bonds,  for  authentication  by  the 
trustee,  and  sometimes  for  redemption  before  maturity,  or  simi- 
lar provisions,  are  held  to  be  bonds  within  the  meaning  of  the 
statute,  whether  called  bonds,  debentures  or  notes.^s      The  tax 
applies  to  bonds  of  indebtedness  executed  by  the  obligor  and 
delivered  to  a  bank  or  trust  company  as  security  for  the  payment 
of  an  obligation.'^^     Bonds  issued  by  life  insurance  companies  m 
satisfaction  of  insurance  policies  are  subject  to  tax.^'' 

BONDS  Given  in  a  Penal  Sum.  An  instrument  under  seal 
conditioned  in  a  penal  amount  for  the  payment  of  a  sum  of 
money,  such  as  often  accompanies  mortgages,  is  a  bond  for  stamp 
tax  purposes.30  When  a  bond  conditioned  for  the  repayment  or 
payment  of  money  is  given  in  a  penal  sum  greater  than  the  debt 
secured,  the  tax  is  based  upon  the  amount  secured  and  not  upon 
the  amount  of  the  bond.^^ 

Business  Property  Investment  Bonds.  Certificates  com- 
monly known  as  business  property  investment  bonds  are  not 
subject  to  tax  as  bonds,  debentures,  or  certificates  of  indebted- 
ness, but  are  taxable  as  certificates  of  interest  in  property .^s 

31  Reg.  55  Rev.,  Art.  10. 

32  T.  D.  2257.     See  definition  under  Promissory  Notes,  p.  1213. 

33  Reg-.  55  Rev.,  Art.  8;  T.  D.  2713. 

34  Reg.  55  Rev.,  Art.  16. 

35  Reg.  55  Rev.,  Art.  18. 

36  Reg.  55  Rev.,  Art  3;  T.  D.  2713. 

37  Revenue  Act  of  1921,  Title  XI,  Schedule  A-1. 

38  Reg.  55  Rev.,  Art.  11.     See  pp.  1175  and  1189. 


1168  FEDERAL  INCOME   TAX 

Exempt  Bonds.  An  instrument  which  merely  represents  the 
assignment  of  interest  in  a  bond  accompanying  a  mortgage  is  not 
taxable. 3*^  Bonds  issued  by  school  districts  for  school  purposes 
are  exempt  from  tax.^o  Certificates  of  deposit  issued  by  banks 
and  trust  companies  are  held  not  to  be  taxable.'*! 

Issue  of  Bonds.  Delivery  is  essential  to  constitute  an  issue 
of  bonds.^-  It  seems  generally  that  the  delivery  of  the  bond 
establishes  the  date  of  issue.  Thus,  it  was  held  under  the  1914 
Law  that  bonds  certified  and  delivered  by  a  trustee  after  the 
incidence  of  the  tax  were  taxable  although  subscribed  and  paid 
prior  thereto.  Under  the  1898  Law  it  seems  to  have  been  held 
that  a  bond  was  issued  when  delivery  was  made  and  the  corpora- 
tion received  a  benefit  or  a  consideration  therefor.'*^  The  date 
of  renewal  would  be  the  date  of  issue  for  the  purpose  of  the  tax 
on  a  renewal  of  bonds.^^  Bonds  issued  by  a  domestic  corporation 
in  this  country  for  sale  to  purchasers  in  a  foreign  country  have 
been  held  to  be  issued  here  for  the  purpose  of  the  tax,  but  bonds 
issued  and  sold  by  a  domestic  corporation  in  a  foreign  country 
have  not  been  required  to  be  stamped  on  the  ground  that  the 
Government  had  no  means  of  enforcing  the  statute  in  such  case.*-^ 
It  has  been  ruled  that  bonds  executed  by  a  foreign  corporation  in 
a  foreign  country,  certified  to  by  a  trustee  in  the  United  States, 
given  for  part  of  the  purchase  price  of  timber  located  in  the 
foreign  country,  and  delivered  in  the  United  States  are  subject 
to  tax.^6 

Transfer  of  Bonds.  No  tax  is  imposed  upon  the  transfer  of 
bonds,  debentures  or  certificates  of  indebtedness  from  one  holder 
to  another. 

Renewal  of  Bonds.  Every  renewal  of  a  bond,  debenture  or 
certificate  of  indebtedness  is  taxed  as  a  new  issue."*^  A  renewal 
after  April  1,  1919,  of  an  instrument,  issued  prior  thereto,  will 

39  Reg.  55  Rev.,  Art.  12. 
*o  Reg.  55  Rev.,  Art.  19. 

41  Reg.  55  Art.  13;  T.  D.  2054;  letter  from  treasury  department  dated 
November  16,  1917;  W.  T.  S.  1919,  Tj  3550.  Such  certificates  were  not  taxed 
under  the  1914  Law.    See  p.  1189. 

42  Reg.  55  Rev.,  Art.  1. 

43  Volume  1,  Treasury  Decisions  No.  20156. 

44  Every  renewal  is  taxed  as  a  new  issue.  Revenue  Act  of  1921,  Title  XI, 
Schedule  A-1. 

45  Letter  from  treasury  department  dated  May  15,  1915. 

46  Reg.  55  Rev.,  Art.  17. 

47  Revenue  Act  of  1921,  Title  XI,  Schedule  A-1. 


THE   STAMP   TAX  1169 

require  the  necessary  revenue  stamps. ^'^  An  agreement  extend- 
ing a  mortgage  upon  maturity,  where  a  bond  is  secured  by  the 
mortgage  and  such  agreement  operates  to  renew  the  bond,  sub- 
jects the  latter  to  stamp  tax  as  a  renewal.-''*  An  agreement  be- 
tween the  holder  of  a  bond  and  the  present  owner  of  a  parcel  of 
real  estate,  extending  maturity  of  a  mortgage  bond  executed  by 
a  former  owner,  operates  as  a  renewal,  and  such  renewal  is 
subject  to  tax.  If  in  addition  a  new  bond  is  given  for  the  same 
indebtedness,  it  also  is  subject  to  tax.^o 

Bonds  of  Indemnity  and  Surety.  Bonds  of  indemnity  and 
surety  are  not  subject  to  stamp  tax  under  the  Revenue  Act  of 
1921.  For  a  discussion  of  the  taxation  of  such  bonds  under  the 
1918  Law  the  reader  is  referred  to  the  1920  edition  of  this  book. 

The  following  is  the  provision  of  the  1918  Law^i  taxing  such 
bonds : 

Bonds,  indemnity  and  surety:  On  all  bonds  executed  for  in- 
demnifying any  person  who  shall  have  become  bound  or  engaged 
as  surety,  and  on  all  bonds  executed  for  the  due  execution  or 
performance  of  any  contract,  obligation,  or  requirement,  or  the 
duties  of  any  office  or  position,  and  to  account  for  money  received 
by  virtue  thereof,  and  on  all  policies  of  guaranty  and  fidelity  in- 
surance, including  policies  guaranteeing  titles  to  real  estate  and 
mortgage  guarantee  policies,  and  on  all  other  bonds  of  any  de- 
scription, made,  issued,  or  executed,  not  otherwise  provided  for 
in  this  schedule,  except  such  as  may  be  required  in  legal  proceed- 
ings, 50  cents :  Provided,  That  where  a  premium  is  charged  for 
the  issuance,  execution,  renewal  or  continuance  of  such  bond  the 
tax  shall  be  1  cent  on  each  dollar  or  fractional  part  thereof  the 
premium  charged:  Provided  further,  That  policies  of  reinsur- 
ance shall  be  exempt  from  the  tax  imposed  by  this  subdivision. 

Building  and  Loan  Associations.  Stocks  and  bonds  issiijed  by 
co-operative  building  and  loan  associations  which  are  organized 
and  operated  exclusively  for  the  benefit  of  their  members  and 
make  loans  only  to  their  shareholders,  are  not  subject  to  the 
tax.52  This  provision  of  the  law  seems  to  exempt  stock  of  such 
associations  from  the  tax  on  original  issue  and  also  from  the  tax 

48  Reg.  55  Rev.,  Art.  2 ;  Letter  from  treasury  department  dated  December- 
11,  1917;  W.  T.  S.  1919,  ^3548. 

49  Reg.  55  Rev.,  Art.  4.  See  Appeal  of  C.  Bolte,  18  Haw.  241;  In  re.  O.  R.  & 
L.  Co.,  19  Haw.  544. 

50  Reg.  55  Rev.,  Art.  5. 

51  Revenue  Act  of  1918,  Title  XI,  Schedule  A-2. 

52  Revenue  Act  of  1921,  §  llOJ ;  Reg.  40  Rev.,  Art.  5. 


1170  FEDERAL  INCOME  TAX 

on  sales  or  transfers.  Any  instruments  other  than  certificates 
of  stock  and  bonds  are  not  exempt.^^ 

Bonds  Given  by  United  States,  Foreign  Governments  and 
Political  Subdivisions.  All  bonds  given  by  the  United  States, 
or  by  any  Foreign  Government,  or  by  any  state,  territory,  or  the 
District  of  Columbia,  or  local  subdivision  thereof,  or  municipal 
or  other  corporation  exercising  the  taxing  power  are  exempt 
from  taxation.54 

Capital  Stock,  Issue.  Although  the  heading  of  this  paragraph 
is  that  used  in  the  statute,  the  language  of  the  law  is  that  the  tax 
shall  be  imposed  "on  each  original  issue,  whether  on  organization 
or  reorganization,  of  certificates  of  stock,  or  of  profits,  or  of 
interest  in  property  or  accumulations,  by  any  corporation."  The 
rate  is  5  cents  on  each  $100  of  face  value  or  fraction  thereof 
except  where  the  certificate  is  issued  without  face  value,  in  which 
case  the  tax  is  5  cents  per  share  unless  the  actual  value  is  in 
excess  of  $100  per  share,  in  which  case  the  tax  is  5  cents  on  each 
$100  of  actual  value  or  fraction  thereof,  or  unless  the  actual  value 
is  less  than  $100  per  share,  in  which  case  the  tax  is  1  cent  on 
each  $20  of  actual  value,  or  fraction  thereof .^s  The  stamps  rep- 
resenting this  tax  must  be  ordinary  documentary  stamps  and  are 
required  by  the  law  to  be  attached  to  the  stock  books  and  not  to 
the  certificates  where  issued.^*'  Where  the  blank  stock  certifi- 
cates are  not  kept  in  a  stock  certificate  book  the  stamps  should 
be  aflftxed  to  the  books  of  record  in  which  the  issue  of  stock  is 
recorded.^''^ 

Contract  to  Issue  Stock.  It  has  been  held  by  the  Treasury 
Department  that  no  stamps  are  required  to  be  affixed  to  a  con- 
tract or  agreement  by  'a  corporation  to  issue  stock.^^  Under  a 
later  ruling,  however,  stock  is  deemed  to  be  issued  when  it  is 
subscribed  for  and  the  subscription  is  accepted  by  the  corpora- 
tion regardless  of  the  time  of  delivery  of  the  certificate.^^    It  is 

53  Under  the  1914  Law  it  was  held  that  notes  given  to  or  by  such  associa- 
tions were  taxable  (T.  D.  2112). 

54  Revenue  Act  of  1921,  §  1101.   See  T.  D.  2072. 

55  Under  the  1918  Law,  where  certificates  were  issued  without  face  value 
the  tax  was  5  cents  per  share,  unless  the  actual  value  was  in  excess  of  $100 
in  which  case  they  were  taxed  as  under  the  present  law   (Revenue  Act  of 

1918,  Title  XI,  Schedule  A-3). 

56  Revenue  Act  of  1921,  Title  XI,  Schedule  A-4;  Reg.  40  Rev.,  Arts.  2,  3, 
7,  8,  37. 

57  Letter  from  treasury  department  dated  November  20,  1917 ;  W.  T.  S. 

1919,  TI  3589. 

58  T.  D.  2599. 

59  Reg.  40  Rev.,  Arts.  1,  33;  Letter  from  treasury  department  dated  March 
25,  1920;  W.  T.  S.  1921,  1[  3614. 


THE    STAMP    TAX  1171 

to  be  noted  that  the  statute  fixes  a  tax  upon  the  issue  of  certifi- 
cates of  stock,  etc.,  and  the  later  ruling  of  the  Treasury  Depart- 
ment indicated  above  seems  to  be  an  unwarranted  construction 
of  the  act.''"  It  has  been  held  that  the  "issue"  of  stock  generally 
means  the  issue  of  the  certificates. ''^  But  the  word  "issued"  has 
been  held  in  other  connections  to  have  no  technical  meaning,  and 
stock  has  been  held  to  be  "issued"  even  though  no  certificates 
therefor  have  been  made  out  or  delivered.*^- 

Original  Issue.  The  tax  on  the  issue  of  capital  stock  is  laid 
upon  an  excise  or  privilege  of  the  corporation  employed  for  its 
benefit. '■'•^  The  tax  is  laid  upon  the  stock  which  a  company  origi- 
nally issued  and  not  upon  certificates  creating  no  addition  to  the 
total  stock  liability  of  the  company.  Where  stock  is  issued  with 
the  right  of  conversion,  and  upon  the  exercise  of  this  right  stock 
of  a  different  kind  is  issued  to  the  stockholder  so  that  in  a  sense 
the  capitalization  of  the  company  is  reclassified,  no  benefit  ac- 
crues to  the  company  and  the  transaction  constitutes  essentially 
nothing  but  an  adjustment  among  the  existing  stockholders  of 
rights  which  always  attached  to  the  original  stock  issue  by  virtue 
of  the  privileges  of  the  charter  of  the  corporation. 

The  issue  by  a  corporation  of  certificates  of  preferred  stock  in 
lieu  of  outstanding  certificates  of  common  stock,  or  vice  versa,  or 
the  issue  of  certificates  of  preferred  stock  of  one  kind  in  lieu  of 
certificates  of  preferred  stock  of  another  kind,  without  other 
consideration  and  without  change  in  the  amount  of  the  author- 
ized capital  stock  of  the  corporation,  is  not  subject  to  tax.'^'^    In 

60  See  Malley  v.  Bowditch,  259  Fed.  809,  in  which  the  court  says  in  sus- 
taining the  constitutionality  of  the  1914  Law  that  "the  stamp  tax  is  con- 
tingent upon  the  original  issue  of  a  certificate  of  stock,  just  as  a  stamp  tax 
on  checks  is  contingent  upon  the  issuing  of  checks."  See  also  Edwards  v. 
Wabash  Ry.  Co.,  264  Fed.  610. 

fii  Edwards  v.  Wabash  Ry.  Co.,  264  Fed.  610. 

fi2  Flour  City  Nat.  Bank  v.  Shire,  88  (N.  Y.)  App.  Div.  401,  84  N.  Y. 
Supp.  810,  affirmed  179  N.  Y.  587,  72  N.  E.  1141;  Amer.  Pig  Iron  Co. 
V.  State  Board,  56  N.  J.  L.  389,  29  Atl.  160.  In  the  latter  case  the  court 
said:  "The  word  'issued,'  as  used  in  this  connection,  has  no  technical  mean- 
ing. 'To  issue,'  as  defined  by  lexicographers,  signifies  to  send  out;  to  put 
in  circulation.  In  a  popular  sense,  a  corporation  engaged  in  organization 
is  said  to  issue  stock  when  it  obtains  subscriptions  for  it,  and  in  the  construc- 
tion of  tax  laws  words  are  to  be  interpreted  in  their  popular  sense." 

63  It  has  been  stated  that  the  1914  stamp  tax  law  is  not  a  franchise  tax  or 
a  corporation  tax,  but  a  stamp  tax  or  document  tax.  (Malley  v.  Bowditch. 
259  Fed.  809,  approved  in  Edwards  v.  Wabash  Ry.  Co.,  264  Fed.  610.) 

64  Reg.  40  Rev.,  Art.  5,  as  amended  by  T.  D.  3118. 


1172  FEDERAL  INCOME   TAX 

other  words,  upon  any  reorganization,^^  only  an  original  issue 
creating  a  new  and  further  stock  liability  is  subject  to  the  stamp 
tax  upon  the  issue  of  capital  stock.  The  tax  is  designed  to 
apply  to  the  privilege  of  issuing  stock  in  return  for  property 
against  which  the  stock  is  first  put  out  as  an  equivalent,  and  not 
to  apply  to  subsequent  issues  based  upon  mere  conversions,  sub- 
divisions, or  re-classifications  of  the  original  total.^^ 

A  corporation  had  an  original  authorized  capital  stock  of 
$7,000,000  divided  as  follows:  First  preferred  stock  of  $1,000,- 
000,  second  preferred  stock  of  $1,500,000  and  common  stock, 

65  The  term  "reorganization"  includes  those  business  arrangements  where- 
by the  stock  and  bonds  of  a  corporation  are  readjustment  as  to  amount,  in- 
come, or  priority,  or  the  property  is  sold  to  a  new  corporation  for  new  stock 
and  bonds,  or  is  sold  by  the  foreclosure  of  a  mortgage  upon  it  to  a  purchaser 
who  buys  for  himself  and  his  associates,  and  the  various  proceedings  and 
transactions  by  which  a  succession  of  corporations  is  brought  about,  and  also 
the  proceedings  by  which  existing  corporations  are  continued  under  a  differ- 
ent organization  without  the  creation  of  a  new  corporation.  (Reg.  40  Rev., 
Art.  33,  as  amended  by  T.  D.  3118;  See  also  Sol.  Op.  71;  W.  T.  S.  1921, 
1l  4114.) 

60  Reg.  40  Rev.,  Arts.  4  and  5 ;  Wabash  Railroad  Co.  v,  Edwards,  264 
Fed.  610.  The  decision  in  this  case  was  based  upon  the  1917  Law  and  over- 
ruled T.  D.  2752  dated  August  20,  1918,  by  which  it  was  held  that  the  tax 
applied  in  the  cases  stated  in  the  text  above,  and  also  that  it  applied  to  the 
issue  of  preferred  and  common  stock  whether  or  not  exchanged  for  old 
stock  upon  a  reorganization  of  a  corporation,  under  §  24  of  the  New  York 
Stock  Corporation  Law  for  the  purpose  of  issuing  stock  without  par  value. 
The  decision  would  not  seem  to  affect  that  part  of  T.  D.  2752  or  that  part  of 
Reg.  40  Rev.,  Art.  4,  which  ruled  that  the  tax  applied  to  the  issue  of  stock 
of  either  corporation  in  addition  to  its  already  existing  stock  upon  a  merger 
of  trust  companies  under  §§  487  to  496  of  the  New  York  Banking  Law,  and 
to  the  new  issue  of  stock  by  a  consolidated  corporation  in  exchange  for  stock 
of  the  consolidating  corporations.  The  broad  statement  in  Reg.  40  Rev., 
Art.  4,  that  the  issue  of  certificates  of  stock  upon  reorganization  by  a  cor- 
poration is  subject  to  tax,  is  modified  by  this  decision.  The  court  found  its 
decision  largely  upon  the  statutory  rule  of  construction  that  a  taxable 
statute  is  to  be  strictly  construed  against  the  government  and  in  favor  of 
the  taxpayer.  (See  p.  1268.)  And  upon  the  further  consideration  that  the 
1917  Law  was  a  re-enactment  of  a  statute  which  had  received  a  settled  ad- 
ministrative construction  by  virtue  of  T.  D.  20694,  dated  February  7,  1899, 
issued  under  the  Spanish  War  Revenue  Act  of  June  13,  1898,  followed  for 
many  years  until  the  enactment  of  T.  D.  2752.  In  its  opinion  the  court  said: 
"And  the  tax  is  laid,  not  on  each  stock  certificate  that  is  issued,  but  on  each 
original  issue  of  certificates.  The  language  is  used  to  indicate  the  first  issu- 
ance of  the  stock,  and  this  is  emphasized  by  the  use  of  the  words,  in  the 
same  connection  'whether  on  organization  or  reorganization.'  When  a  corpo- 
ration issued  for  the  first  time  a  certificate  of  the  stock,  that  certificate  is 
an  original  issue.  The  tax  is  placed  on  the  original  issue.  The  word  'orig- 
inal' is  defined  by  Webster  as  'pertaining  to  the  origin  or  beginning;  pre- 
ceding all;  first  in  order.'  " 


THE   STAMP   TAX 


1173 


$4  500,000.    In  March,  1920,  the  charter  was  amended  to  reduce 
the  authorized  capital  stock  of  $5,250,000,  divided  as  follows: 
Preferred  stock,  $1,500,000;  common  stock,  $3,750,000,  and  new 
certificates  were  prepared  showing  the  change  in  capitalization. 
At  this  time  all  of  the  first  preferred  stock  had  been  retired, 
and  there  was  outstanding  of  the  original  issue  $4,500,000,  made 
up  as   follows:     Second  preferred  stock,   $1,500,000;   common 
stock,  $3,000,000.    The  outstanding  second  preferred  stock  was 
non-cumulative  and  bore  6  per  cent,  interest  and  had  a  par  value 
of  $50  per  share.    The  outstanding  common  stock  also  had  a  par 
value  of  $50  per  share.    The  new^  preferred  stock  was  8  per  cent, 
cumulative  stock  and  had  a  par  value  of  $100  per  share,  and  the 
new  common  stock  was  of  a  par  value  of  $100  per  share.    The 
new  preferred  stock  was  exchanged  for  the  outstanding  second 
preferred  stock  at  the  ratio  of  1  share  for  2,  and  the  new  com- 
mon stock  was  exchanged  for  the  old  at  the  same  ratio.     The 
Treasury  Department  took  the  view  that   the  new   issue  was 
subject  to  stamp  tax.     The  new  stock  issued  was  stock  which 
had  never  before  been  issued  and  was  under  an  authorization  not 
theretofore  existing,  but  which  arose  out  of  the  amendment  of 
the  charter.    It  constituted  an  original  issue  on  reorganization. 
The   total    authorized    capitalization    of    the    corporation    was 
changed  and  each  share  of  the  new  stock,  whether  common  or 
preferred,  represented  a  fractional  interest  in  a  different  capital 
stock.     A  new  series  of  certificates  was  issued  showing  the 
change  in  the  authorized  capitalization  and  substituted  for  the 
outstanding  certificates  of  the  former  corporation.    The  new  pre- 
ferred stock  was  cumulative  convertible  stock  bearing  8  per  cent, 
interest ;  the  stock  for  which  it  was  substituted  was  non-cumu- 
lative convertible  stock  bearing  6  per  cent,  interest;  and  the 
common  stock  in  the  reorganized  corporation  was  issued  subject 
to  these  different  charges.^^ 

Stock  certificates  issued  in  lieu  of  original  certificates  in  a  case 
where  a  corporation  had  changed  its  name  are  not  taxable  as  an 
original  issue,<'S  and  temporary  or  interim  stock  certificates 
issued  before  the  permanent  issues  are  taxable  as  original  issue, 
but  the  subsequent  exchange  of  such  temporary  certificates  for 
definitive  stock  certificates  to  the  same  owner  is  not  subject  to 
any  tax.«o  The  issue  of  certificates  of  stock  of  a  smaller  denomi- 
nation in  exchange  for  outstanding  certificates,  where  there  is 

67  Sol.  Op.  71;  W.  T.  S.  1921,  ^4007. 

cSReg.  40  Rev.,  Art.  5. 

69  Reg.  40  Rev.,  Art.  5 ;  T.  D.  2584 ;  Reg.  40  Rev.,  Art.  4. 


1174  FEDERAL  INCOME  TAX 

no  change  in  ownership  or  in  the  total  amount  of  stock  issued,  is 
not  subject  to  taxjo 

The  issue  upon  a  merger  of  corporations  of  certificates  of  stock 
of  the  same  kind  in  substitution  for  the  old  certificates  of  stock 
is  not  subject  to  taxJ^  The  foregoing  regulation  has  been  held  to 
exempt  stock  of  the  merging  corporation  (continuing  corpora- 
tion) from  the  original  issue  tax  when  exchanged  for  the  old  cer- 
tificates of  stock  of  such  corporation,  but  not  when  exchanged 
for  the  old  certificates  of  stock  of  the  merged  corporation  or  cor- 
porationsJ- 

It  was  held  under  the  1914  Law  that  where  bonds  had  been 
issued  with  the  privilege  of  exchanging  same  for  certificates  of 
stock  and  the  option  was  exercised  after  the  incidence  of  the  tax, 
the  stock  certificates  then  issued  were  taxable  as  original  issue 
unless  prior  to  the  incidence  of  the  tax  the  certificates  in  question 
had  been  issued  and  were  held  in  trust  for  the  purchaser  of  the 
bonds,  in  which  case  the  rate  of  tax  on  transfers  of  stock  was 
applicableJ^ 

Certificates  of  Stock.  The  present  law  applies  to  the  issue 
of  (1)  certificates  of  stock,  (2)  certificates  of  profit,  and  (3)  cer- 
tificates of  interest  in  property  or  accumulations,  issued  by  any 
corporation^^  The  1917  Law  applied  only  to  certificates  of  stock. 
Under  the  1914  Law,  which  taxed  certificates  of  profit  "or  any 
certificate  or  memorandum  showing  an  interest  in  the  property 
or  accumulations  of  any  association,  company  or  corporation, 
*  *  *  "  it  was  held  that  certificates  issued  by  trustees  to  per- 
sons who  had  deposited  certain  securities,  such  certificates  issued 
by  the  trustees  showing  such  persons  to  be  entitled  to  a  part  of 
the  dividends,  etc.,  accruing  on  account  of  the  securities  depos- 
ited, were  taxable  as  certificates  of  profits.'^^  Under  the  present 
law  it  seems  that  certificates  evidencing  an  interest  in  profits  or 
accumulations  are  not  taxable  unless  issued  by  a  "corporation," 
as  that  term  is  used  in  the  law,  but  the  Treasury  Department  has 
ruled  that  the  issue  to  the  beneficiary  of  certificates  covering 
shares  in  the  nature  of  shares  of  stock,  wher^  a  number  of  per- 
sons pool  their  individual  properties  and  appoint  trustees  having 
a  definite  term  of  office  for  the  purpose  of  managing  it  and  retain 

70  Reg.  40  Rev.,  Art.  5. 
■J"!  Reg.  40  Rev.,  Art.  5. 

72  0.  D.  83;  Ruling  No.  198,  March,  1921;  W.  T.  S.  1921,  ^4030. 

73  T.  D.  2155. 

74  Revenue  Act  of  1921,  Title  XI,  Schedule  A-2;  see  Reg.  40  Rev.,  Art.  33. 

75  Reg.  40  Rev.,  Art.  4 ;  Letter  from  treasury  department  dated  July  26, 
1916;  W.  T.  S.  1916,  p.  353. 


THE   STAMP   TAX  1175 

certain  rights  of  control  over  the  property  and  a  voice  in  the 
selection  of  the  trustees  who  are  authorized  to  issue  the  certifi- 
cates, is  subject  to  taxJ^ 

Issued  by  Any  Corporation.  The  temn  "corporation,"  as 
defined  in  Section  2  of  the  law,  includes  associations,  joint-stock 
companies,  and  insurance  companiesJ'^  It  has  been  held  that  the 
tax  applies  to  the  issue  of  certificates  of  shares  in  so-called  Mas- 
sachusetts trusts  and  other  unincorporated  associations^^ 

Stock  of  Domestic  Corporations.  The  tax  attaches  to  the 
issue  of  certificates  of  stock  by  a  domestic  corporation,  no  matter 
where  the  certificates  are  actually  delivered.'*'^ 

Stock  of  Foreign  Corporations.  Certificates  of  stock  of  for- 
eign corporations  sold  or  delivered  within  the  United  States  are 
subject  to  the  same  tax  as  certificates  of  stock  of  domestic  cor- 
porations. Stock  of  a  corporation  organized  in  a  foreign  coun- 
try, issued  in  the  United  States,  is  subject  to  the  tax  on  original 
issue.^° 

Business  Property  Investment  Bonds.  The  issue  by  a  cor- 
poration of  business  property  investment  bonds,  or  other  instru- 
ments, wherein  it  is  certified  that  the  holder  thereof  is  the  owner 
of  an  interest  in  specified  real  property  the  legal  title  to  which 

'•5  Reg.  40  Rev.,  Art.  4. 

~  See  Reg.  40  Rev.,  Art.  4. 

■^8  T.  D.  2752.  It  has  been  held  that  the  1914  Law  does  not  impose  a  fran- 
chise tax  or  a  corporation  tax  but  imposes  a  stamp  or  document  tax; 
that  it  follows  from  this  consideration  that  whether  the  share  capital  is 
fixed  by  agreement  or  under  statutory  authority  is  immaterial  and  that  the 
tax  applies  to  certificates  of  shares  issued  by  a  manufacturing  company 
organized  in  the  form  of  a  trust  under  the  common  law  and  deriving  none 
of  its  rights,  benefits  or  qualifications  from  any  statute,  and  which  was  not 
an  ordinary  common  law  I'eal  estate  trust.  In  other  words,  the  word  "stock" 
is  to  be  interpreted  in  connection  with  the  accompanying  words  of  the  statute 
"association,  company,  or  corporation."  It  is  a  term  not  peculiar  to  corpo- 
rations, but  equally  applicable  to  the  share  capital  or  fund  created  by  or  in 
accordance  with  an  agreement  for  the  formation  of  an  unincorporated  asso- 
ciation or  company.  The  difference  between  corporations  and  unincorpo- 
rated associations  being  immaterial  to  the  imposition  of  a  stamp  tax  on 
documents,  the  different  modes  of  realizing  on  the  shares  by  the  certificate 
holders  is  also  immaterial.  (Malley  v.  Bowditch,  259  Fed.  809;  Edwards 
V.  Wabash  Ry.  Co.,  264  Fed.  610.)  See  also  Crocker  v.  Malley,  249  U.  S. 
223.  For  a  full  discussion  of  the  distinction  between  a  "trust"  and  an  "as- 
sociation," see  Chapter  10. 

79  Reg.  40  Rev.,  Art.  4 ;  Letter  from  treasury  department  dated  July  24, 
1918;  W.  T.  S.  1919,  ^  3588.  This  ruling  was  made  in  the  case  of  stock  issued 
in  Cuba  by  a  Delaware  corporation,  all  of  whose  operations  were  carried  on 
in  Cuba.     See  p.  1168  as  to  bonds. 

80  T.  D.  2073. 


1176  FEDERAL  INCOME   TAX 

has  been  previously  conveyed  to  a  trustee  and  whereby  the  cor- 
poration issuing  the  same  agrees  to  manage  the  property  and 
distribute  the  proceeds  in  a  certain  manner  is  subject  to  tax.'^^ 

Joint-Stock  Land  Banks.  The  issue  of  certificates  of  stock 
by  joint-stock  land  banks  is  subject  to  the  stamp  tax.'*- 

PuRCHAsiNG  Business  or  Assets.  The  issue  by  a  corporation 
of  stock  in  exchange  for  property,  real  or  personal,  or  for  the 
purpose  of  purchasing  the  business  or  assets  of  another  concern, 
is  subject  to  tax.^^ 

Stock  Dividends  and  Fractional  Scrip  Certificates.  The 
issue  of  stock  dividends  and  fractional  scrip  certificates  is  subject 
to  tax.^^  Where  scrip  certificates  for  fractional  shares  of  stock 
having  a  par  value  of  $100  per  share  are  issued  the  tax  is  at  the 
rate  of  five  cents  for  each  certificate  issued  and  not  at  the  rate  of 
five  cents  for  each  share  of  the  total  number  of  shares  repre- 
sented by  the  aggregate  amount  of  scrip  certificates  issued.^-^ 

Federal  Land  Banks.  The  issue  of  certificates  of  stock  by 
Federal  Land  banks  is  not  subject  to  tax.s^ 

Rights  to  Subscribe  to  Stock.  The  issue  of  "rights"  to  sub- 
scribe for  the  stock  by  any  corporation,  joint-stock  company  or 
association  evidenced  by  warrants  is  not  subject  to  tax.^''' 

Voting  Trust  Certificates.  The  tax  does  not  apply  to  the 
issue  of  voting  trust  certificates  representing  stock  certificates 
already  issued.^^ 

Measure  of  Tax.  The  tax  is  measured,  not  by  the  amount 
paid  in  on,  or  for  the  stock,  but  by  the  face  or  par  value  of  the 
stock,  in  the  case  of  shares  having  a  face  or  par  value.  The  tax  is 
imposed  on  the  face  or  par  value  of  the  certificate  and  not  upon 
the  par  value  of  each  share.  Thus,  a  certificate  representing  10 
shares  of  a  par  value  of  $10  each  would  be  taxable  as  having  a 
face  or  par  value  of  $100.  In  the  case  of  shares  having  no  face 
or  par  value  the  tax  is  5  cents  per  share,  unless  the  actual  value 
is  in  excess  of  $100  per  share,  in  which  case  the  tax  is  5  cents  on 
each  $100  of  actual  value  or  fraction  thereof,  or  unless  the  actual 

81  Reg.  40  Rev.,  Art.  4. 

82  Reg.  40  Rev.,  Art.  4. 

83  Reg.  40  Rev.,  Art.  4. 

84  Reg.  40  Rev.,  Art.  4. 

85  Telegram  from  treasury  department  dated  January  9,  1920;  W.  T.  S. 
1921,113565. 

86  Reg.  40  Rev.,  Art.  5. 

87  Reg.  40  Rev.,  Art.  5. 

88  Reg.  40  Rev.,  Art.  5;  T.  D.  2752. 


THE   STAMP   TAX  1177 

value  is  less  than  $100  per  share,  in  which  case  the  tax  is  1  cent 
on  each  $20  of  actual  value  or  fraction  thereof."^'-' 

Shares  Without  Par  Value.  The  actual  value  of  shares 
without  par  or  face  value  is  a  question  of  fact.  For  the  purpose 
of  this  tax  it  may  be  determined  by  the  statement  of  the  company 
and  the  consideration  involved  in  the  issue  of  such  stock,^*^  or 
may  be  determined  by  the  market  price  or  otherwise.^i 

It  has  been  ruled  under  the  former  law  that  the  issue  of  a 
greater  number  of  shares  of  no  par  value  stock  in  lieu  of  a 
smaller  issue  of  such  shares,  previously  made,  without  any 
change  in  the  amount  of  the  capital  assets  of  the  issuing  corpora- 
tion, is  subject  to  stamp  tax  in  the  amount  of  the  difference  be- 
tween the  tax  computed  upon  such  issue  and  the  tax  computed 
upon  the  issue  which  it  replaces.'-^-  The  issue  on  reorganization 
of  a  number  of  shares  of  no  par  value  for  each  share  of  par 
value  stock  outstanding,  without  change  in  the  amount  of  the 
authorized  working  capital,  is  subject  to  stamp  tax  in  the  amount 
of  the  difference  between  the  tax  computed  upon  such  issue  and 
the  tax  computed  upon  the  issue  which  it  replaces.^-'* 

Capital  Stock,  Sales  and  Transfers.  The  law  provides  for  a 
tax  on   (a)  all  sales,  (b)  agreements  to  sell-'^  or  memoranda  of 

S9  Revenue  Act  of  1921,  Title  XI,  Schedule  A-2.  Under  the  1918  Law, 
in  the  case  of  certificates  issued  without  face  value  the  tax  was  5  cents  per 
share  unless  the  actual  value  was  in  excess  of  $100  per  share  in  which  case 
the  tax  was  5  cents  on  each  $100  of  actual  value  or  fraction  thereof  (Reve- 
nue Act  of  1918,  Title  XI,  Schedule  A-3). 

so  Letter  from  treasury  department  dated  November  26,  1917 ;  W.  T.  S. 
1919,  113592;  Reg.  40  Rev.,  Art.  3. 

ai  T.  D.  2752. 

9^  Reg.  40  Rev.,  Art.  4,  as  amended  by  T.  D.  3118. 

93  Telegram  from  treasury  department  dated  February  21,  1921 ;  W.  T.  S. 
1921,  TI4003. 

94  The  term  "agreement  to  sell"  includes  options,  calls  in  "puts  and  calls," 
offers,  indemnities  and  privileges,  and  contracts,  either  in  writing  or  by 
parol,  to  sell  on  the  deferred  or  partial  payment  plan  (Reg.  40  Rev.,  Art. 
33).  In  holding  that  a  "call"  was  an  "agreement  to  sell"  under  the  1898  Law 
the  Supreme  Court  in  Treat  v.  White,  181  U.  S.  264,  pointed  out  the  dis- 
tinction between  an  "agreement  to  sell"  and  an  "agreement  of  sale"  as  fol- 
lows: "That  there  is  a  difference  between  an  agreement  to  sell  and  an  agree- 
ment of  sale  is  clear.  The  latter  may  imply,  not  merely  an  obligation  to  sell, 
but  an  obligation  on  the  part  of  the  other  party  to  purchase,  while  an  agree- 
ment to  sell  is  simply  an  obligation  on  the  part  of  the  vendor  or  promisor  to 
complete  his  promise  of  sale.  That  congress  recognized  the  difference  be- 
tween these  two  terms  is  evident,  because  in  the  very  next  paragraph  of 
Schedule  A  it  provides,  in  reference  to  merchandise,  for  a  stamp  'upon  each 
sale,  agreement  of  sale,  or  agreement  to  sell.'  That  no  stamp  duty  was  im- 
posed on  agreements  to  buy   (or,  in  the  vernacular  of  the  stock  exchange, 


1178  FEDERAL  INCOME  TAX 

sales  or  deliveries  of  or  transfers  of  legal'*'  title  to  shares  or  cer- 
tificates of  stock  in  any  association,  company  or  corporation.^^ 
The  tax  is  imposed  whether  or  not  the  stock  is  represented  by 
certificates,'*'^  and  also  whether  or  not  the  sale  or  transfer  is 
shown  by  the  books  of  the  association,  company  or  corporation, 
or  is  made  by  assignment  in  blank,  or  by  any  delivery,  or  by  any 
paper  or  agreement  or  memorandum  or  other  evidence  of  trans- 
fer or  sale,  whether  entitling  the  holder  in  any  manner  to  the 
benefit  of  such  stock  ^^  or  not.  In  the  case  of  stock  having  a  par 
or  face  value,  the  amount  of  the  tax  is  2  cents  on  each  $100  or 
fraction  thereof  of  the  total  par  or  face  value  of  the  shares  or 
certificates  involved  in  the  sale  or  agreement  to  sell,  whether 
such  aggregate  par  or  face  value  is  greater  or  less  than  $100; 
e.  g.,  where  the  total  par  or  face  of  the  shares  involved  in  the 
transaction  is  $100  or  less,  the  tax  is  2  cents;  where  such  value 
is  in  excess  of  $100,  the  tax  is  2  cents  on  each  $100  or  fraction 
thereof.  Where  one  certificate  represents  several  shares  (how- 
ever large  the  number  of  shares)  on  the  transfer  of  such  certifi- 
cate the  tax  is  computed  upon  its  face  value  and  not  on  the  face 
value  of  each  separate  share  of  stock,  or  of  profits,  or  of  interest 
in  property  or  accumulations ;  e.  g.,  on  the  transfer  of  one  certifi- 
cate representing  500  shares,  par  value  $5,  the  face  value  of  the 
certificate  being  $2,500,  the  stamp  tax  is  50  cents.^^ 

In  the  case  of  shares  of  stock  without  par  or  face  value,  the 
tax  is  2  cents  on  the  transfer  or  sale  of,  or  agreement  to  sell,  each 
share.  The  tax  is  measured,  not  by  the  amount  paid  in,  on,  or 
for,  the  stock,  but  by  the  face  or  par  value  of  the  stock  in  the 
ease  of  shares  having  a  face  or  par  value,  and  by  the  number  of 
shares  in  the  case  of  shares  having  no  face  or  par  value.^^^^ 

'puts')  furnishes  no  ground  for  denying  the  validity  of  the  stamp  duty  on 
agreements  to  sell." 

95  The  word  "legal"  was  first  introduced  in  the  1917  Law  and  was  not  con- 
tained in  the  Act  of  October  22,  1914.  (See  Reg.  40  Rev.,  Art.  33.)  Cf. 
§  270  of  the  New  York  State  Tax  Law  and  the  case  of  Travis  v.  Ann  Arbor 
Co.,  180  N.  Y.  App.  Div.  799,  168  N.  Y.  Supp.  53,  affirmed  227  N.  Y.  640, 
126  N.  E.  923. 

s*"'  The  law  uses  the  word  "corporation"  but  see  the  definition  of  this  term 
in  Revenue  Act  of  1921,  §  2. 

9"  Reg.  40  Rev.,  Art.  12;  T.  D.  2752. 

»8  The  Act  of  October  22,  1914,  also  read :  "or  to  secure  the  future  pay- 
ment of  money  or  for  the  future  transfer  of  any  stock." 

99  Reg.  40  Rev.,  Art.  11. 

100  Revenue  Act  of  1921,  Title  XI,  Schedule  A-3.  Under  the  1918  Law, 
where  the  actual  value  of  shares  without  par  or  face  value  was  in  excess 
of  $100,  the  tax  was  2  cents  on  each  $100  of  actual  value  or  fraction  thereof. 
(Revenue  Act  of  1918,  Title  XI,  Schedule  A-4.) 


THE   STAMP    TAX  1179 

Affixing  and  Cancellation  of  Stamps.  In  the  case  of  the 
issue  of  shares  of  stock,  whether  on  organization  or  reorganiza- 
tion, the  stamps  representing  the  tax  should  be  affixed  to  the 
stock  books  and  not  to  the  certificates  issued.  In  the  case  of  a 
sale  before  certificates  are  issued,  where  the  evidence  of  transfer 
is  shown  only  by  the  books  of  the  corporation,  the  stamps  should 
be  placed  on  such  books.  In  case  the  change  of  ownership  is 
effected  by  transfer  or  delivery  of  the  certificate,  i.  e.,  where  the 
name  of  the  transferee  is  inserted  in  the  indorsement  or  power 
of  attorney  on  the  back  of  the  certificate,  the  stamp  should  be 
affixed  to  such  certificate  and  cancelled  by  the  person  making  the 
sale.  In  case  of  agreement  to  sell,  or  w^here  the  transfer  is  by 
delivery  of  the  certificate  assigned  in  blank,  the  stamp  should  be 
affixed  to  the  bill,  memorandum,  or  agreement  to  sell,  and  can- 
celled by  the  seller. ^^^ 

It  has  been  held  by  a  state  court  under  both  the  New  York 
State  tax  on  transfers  of  stock  and  the  Federal  Act  on  stock 
transfers  that  in  the  case  of  an  agreement  to  transfer  stock  such 
laws  are  complied  with  if  the  requisite  stamps  be  affixed  and  can- 
celled at  the  time  the  transfer  is  accomplished.^'^- 

In  no  event  should  any  transfer  agent  or  corporation  accept  or 
transfer  any  shares  of  stock  or  certificates  unless  stamps  for  all 
transfer  tax  required  thereon  have  been  properly  affixed  either  to 
the  certificates  of  stock  or  memoranda  of  sale,  as  the  case  may 
be,  and  duly  cancelled.  The  person  using  or  affixing  the  stamp 
should  write  or  stamp  thereon,  in  ink,  his  initials  and  the  day, 
month,  and  year  on  which  the  same  shall  be  affixed,  or,  by  cutting 
or  cancelling  with  a  machine  or  punch,  affix  his  initials  and  the 
date  as  aforesaid,  and  so  deface  such  stamp  as  to  render  it  unfit 
for  reuse.  In  addition  to  the  foregoing,  stamps  of  the  value  of  10 
cents  or  more  should  have  three  parallel  incisions  made  with 
some  sharp  instrument  lengthwise  through  the  stamp  after  the 
same  has  been  attached  to  the  certificate,  or  bill,  or  memoran- 
dum, or  other  evidence  of  sale  or  transfer,  unless  the  stamps  are 
cancelled  by  perforation.  The  cancellation  by  either  method 
should  not  so  deface  the  stamp  as  to  prevent  its  denomination 
and  genuineness  from  being  readily  determined.^'^'^ 

101  Reg.  40  Rev.,  Art.  37. 

l02Smythe  v.  Pure  Ice  Co.,  193  App.  Div.  (N.  Y.)  479;  Phelps-Stokes 
Estates  v.  Nixon,  22  N.  Y.  93,  118  N.  E.  241;  Waddle  v.  Cabana,  220  N.  Y. 
18,  114  N.  E.  1054;  Bean  v.  Flint,  204  N.  Y.  153,  97  N.  E.  490. 

103  Reg.  40  Rev.,  Art.  37;  Letter  from  treasury  department  dated  May  22, 
1918;  W.  T.  S.  1919,  ^3600. 


1180  FEDERAL  INCOME  TAX 

Shares  Without  Par  Value.  The  law  provides  that  the  tax 
shall  be  imposed  at  the  rate  of  2  cents  a  share  on  shares  without 
par  or  face  value.i^^ 

When  Tax  Accrues.  The  stamp  tax  on  sales  or  transfers  of 
stock  accrues  at  the  time  of  making  the  sale  or  agreement  to  sell 
or  memorandum  of  sale,  or  delivery  of  or  transfer  of  the  legal 
title  to  shares,  or  certificates  of  stock,  or  of  profits,  or  of  interest 
in  property  or  accumulations  in  any  corporation,  joint-stock 
company,  or  association,  or  of  the  right  to  subscribe  for  or  to 
receive  such  shares  or  certificates,  regardless  of  the  time  or  man- 
ner of  the  delivery  of  the  certificate  or  agreement  or  memoran- 
dum of  sale.i^s 

Where  Title  to  the  Stock  Passed  Prior  to  the  Incidence 
OF  THE  Tax.  No  tax  is  imposed  upon  the  transfer  of  such  stock 
on  the  books  of  a  corporation  although  made  after  the  date  on 
which  the  tax  was  first  imposed.io*^ 

Tax  Paid  but  Once.  Where  shares  of  stock  are  sold  and  the 
tax  has  been  paid  and  stamps  afiixed  to  a  bill  or  memorandum  of 
sale,  stamps  are  not  again  required  when  the  transfer  is  made 
on  the  books  of  the  company  from  the  name  of  the  party  selling 
to  the  name  of  the  purchaser.^*'''' 

Shares  or  Certificates  of  Stock.  The  law  imposes  this  tax 
on  all  sales,  or  agreements  to  sell,  or  memoranda  of  sales  or  de- 
liveries of,  or  transfers  of  legal  title  to  "shares  or  certificates  of 
stock  or  of  profits  or  of  interest  in  property  or  accumulations  in 
any  corporation,  or  to  rights  to  subscribe  for  or  to  receive  such 
shares  or  certificates."  ^^^ 

Stock  of  Domestic  Corporations.  The  tax  attaches  to  the 
transfer  of  stock  on  the  books  of  a  domestic  corporation,  no  mat- 
ter where  the  sale  is  made  or  the  stock  certificates  are  deliv- 
ered.109 

104  Revenue  Act  of  1921,  Title  XI,  Schedule  A-3.  Under  the  1918  Law  if 
the  actual  value  of  such  shares  was  in  excess  of  $100  the  tax  was  2 
cents  on  each  $100  of  actual  value  or  fraction  thereof  (Revenue  Act  of  1918, 
Title  XI,  Schedule  A-4). 

if>r.  Reg.  40  Rev.,  Art.  9. 

I0f>  Letter  from  treasury  department  dated  November  30,  1917;  W.  T.  S. 
1919,  TI  3590.   This  was  also  the  rule  under  the  1914  Law. 

107  Reg.  40  Rev.,  Art.  13;  T.  D.  2073. 

108  Revenue  Act  of  1921,  Title  XI,  Schedule  A-3. 

100  Reg.  40  Rev.,  Art.  12;  Letter  from  treasury  department  dated  July  24, 
1918;  W.  T.  S.  1919,  H  3588.  This  ruling  was  made  in  the  case  of  stock  trans- 
ferred in  Cuba  by  a  Delaware  corporation,  all  of  whose  operations  were  car- 
ried on  in   Cuba. 


THE   STAMP   TAX  1181 

Stock  of  Foreign  Corporations.  When  certificates  of  stock 
of  a  foreign  corporation  are  sold  or  delivered  within  the  terri- 
torial jurisdiction  of  the  United  States  they  are  subject  to  the 
same  tax  as  certificates  of  stock  of  a  domestic  corporation. 'lo 

Trusts.  The  tax  on  the  transfer  of  capital  stock  has  been  held 
to  apply  to  the  transfer  of  shares  in  so-called  Massachusetts 
Trusts  and  other  unincorporated  associations. ^^^  In  rulings 
issued  under  the  1918  Law  it  is  held  that  the  sale  or  transfer 
of  certificates  issued  by  trustees,  where  such  trustees  are  ap- 
pointed for  a  definite  period  and  the  declaration  of  trust  provides 
that  the  beneficiaries  (termed  "stockholders")  shall  hold  annual 
meetings  for  the  election  of  new  trustees  to  fill  the  vacancies 
thus  accruing,  the  beneficiaries  thus  reserving  to  themselves 
control  over  the  persons  delegated  to  conduct  their  affairs  and  a 
voice  in  the  business  is  subject  to  tax;  but  that  the  sale  or  trans- 
fer of  certificates  issued  by  trustees,  where  such  trustees  are 
legally  appointed  for  the  entire  period  of  the  trust  and  the  bene- 
ficiaries retain  no  substantial  control  over  the  affairs  of  the  trust, 
but  delegate  their  proprietary  functions  to  others,  any  further 
control  on  their  part  depending  upon  contingencies,  their  rights 
being  limited  to  filling  vacancies  caused  by  death,  resignation  or 
disability  is  not  subject  to  tax.i^^ 

Transfer  of  Stock  Before  Issue  of  Certificate.  The  exist- 
ence of  a  stock  certificate  is  not  essential  in  order  to  make  the 
transfer  of  shares  subject  to  the  tax.  A  transfer  affecting  a 
change  of  ownership  of  the  share,  whether  made  before  or  after 
the  issuance  of  the  original  certificate,  is  taxable.  Thus,  the  sale 
or  transfer  of  temporary  or  interim  certificates  and  the  transfer 
of  the  interest  of  a  subscriber  for  stock,  however  such  interest 
may  be  evidenced  or  conditioned  upon  further  payments,  are 
subject  to  tax.^13  Under  the  1914  Law  it  was  held  that  transfers 
of  subscription  warrants  entitling  the  holder  to  certificates  of 
stock  were  taxable  as  transfers  of  stock. ii^ 

Rights  to  Receive  or  Subscribe  for  Stock.  Under  the  pres- 
ent law,  transfers  of  rights  to  subscribe  for  or  to  receive  shares 
or  certificates  of  stock  (or  of  profits  or  interest  in  property  or 

no  Reg.  40  Rev.,  Art.  12;  T.  D.  2073. 

111  T.  D.  2752. 

112  Reg.  40  Rev.,  Arts.  12,  13.  For  a  full  discussion  of  the  distinction  be- 
tween a  "trust"  and  an  "association"  see  Chapter  10. 

113  Reg.  40  Rev.,  Art.  12;  T.  D.  2752;  T.  D.  2599. 

m  Letter  from  treasury  department  dated  July  8,  1915. 


1182  FEDERAL  INCOME  TAX 

accumulations)  in  any  corporation  whether  or  not  evidenced  by 
warrants  are  expressly  made  subject  to  tax.^i^ 

Where  one  corporation  sold  to  another  corporation  certain 
property  in  consideration  of  the  issuance  to  it  of  a  fixed  number 
of  shares  of  the  capital  stock  of  the  purchasing  corporation,  and 
thereafter,  prior  to  the  actual  issuance  of  the  stock  certificates, 
the  vendor  corporation  authorized  the  vendee  corporation  to  issue 
the  shares  direct  to  the  stockholders  of  the  vendor  corporation, 
the  resolution  of  the  board  of  directors  of  the  vendor  corpora- 
tion conveying  the  authority  is  a  transfer  of  the  right  to  receive 
such  shares,  and  the  transaction  is  subject  to  the  stamp  tax.^i^ 

Rights  to  Receive  Stock  Dividends.  The  transfer  of  a  right 
to  receive  a  stock  dividend  already  declared  is  taxable.^^^ 

Voting  Trust  Certificates.  It  has  been  held  that :  (1)  The 
transfer  of  stock  from  stockholders  to  voting  trustees  is  subject 
to  tax,  (2)  the  receipt  of  the  certificates  given  by  the  voting 
trustees  to  the  stockholders  is  not  subject  to  tax,  (3)  any  sale  or 
transfer  of  such  voting  trust  certificates  by  the  owner  is  subject 
to  tax,  (4)  the  transfer  by  the  voting  trustees  to  the  stockholders 
at  the  termination  of  the  voting  trust  agreement  is  subject  to 
tax.118 

Stockholders'  Committees.  A  transfer  of  stock  by  individ- 
ual stockholders  to  a  committee  of  stockholders  under  a  deposit 
agreement  is  subject  to  the  stock  tr:ansfer  tax.i^^  Transfers  of 
certificates  of  stock  to  stockholders'  committees  for  the  protec- 
tion of  stockholders  pending  the  receivership  of  a  corporation 
are  subject  to  tax.^-o 

Loan  of  Certificates  of  Stock.  The  present  law  provides 
that  no  stamp  tax  shall  be  imposed  upon  mere  loans  of  stock  nor 
upon  the  return  of  stock  so  loaned.^-i  The  transfer  of  shares  or 
certificates  of  stock  in  any  corporation  made  by  the  person  loan- 

115  Revenue  Act  of  1921,  Title  XI,  Schedule  A-3;  Reg.  40  Rev.,  Arts.  12, 
33.  Letter  from  treasury  department  dated  February  26,  1920;  W.  T.  S. 
1921,  113572;  Letter  from  treasury  department  dated  March  25,  1920;  W. 
T.  S.  1921,  113614. 

nr,  Marconi  Wireless  Telegraph  Company  of  America  v.  Duffy,  273  Fed. 
197. 

117  Reg.  40  Rev.,  Art.  12;  T.  D.  2752. 

lis  Reg.  40  Rev.,  Art.  12;  Reg.  No.  40,  Part  1,  Art.  1;  Letter  from  treasury 
department  dated  May  22,  1918;  W.  T.  S.  1919,  If  3600. 

ii!' Letter  from  treasury  department  dated  April  30,  1918;  W.  T.  S.  1919, 
II  3598. 

120  Letter  from  treasury  department  dated  January  28,  1919;  W.  T.  S. 
1919,  TI3599. 

121  Revenue  Act  of  1921,  Title  XI,  Schedule  A-3. 


THE   STAMP   TAX  1183 

ing  stock  to  another  borrowing  the  stock  to  effect  a  sale,  and  also 
the  transfer  of  shares  or  certificates  of  stock  from  a  borrower 
returning  them  to  a  lender  in  fulfillment  of  the  borrower's  obli- 
gation to  buy  in  and  return  stock,  are  not  subject  to  tax  under 
the  present  law.^--  Under  the  1918  Law  it  was  held  that  in  a  so- 
called  short  sale  transaction  there  were  four  taxable  sales  or 
transfers :  (1)  The  sale  of  stock  by  the  person  making  the  short 
sale;  (2)  the  transfer  from  the  lender  of  stock  to  the  person 
making  the  short  sale  so  that  he  may  make  delivery  of  the  stock 
sold;  (3)  the  purchase  by  the  borrower  of  stock  to  return  to  the 
lender;  (4)  the  transfer  from  the  borrower  to  the  lender  of 
shares  to  replace  those  borrowed.^-^  Under  the  present  law  only 
transactions  (1)  and  (3)  will  be  taxable. 

Transfers  to  and  by  Fiduciaries.  Transfers  of  legal  title 
are  taxable,  whether  or  not  the  transferee  acquires  any  bene- 
ficial interest  in  the  stock  transferred.  Thus,  transfers  from  one 
trustee  to  another  trustee  under  the  same  trust  are  subject  to 
tax  124  and  transfers  from  an  executor  or  administrator  to  a 
trustee,  and  transfers  from  a  trustee  to  the  beneficiary  under  the 
trust  are  taxable,  under  the  present  law.^^o 

Transfers  of  stock  from  one  group  of  trustees  to  another 
group,  although  one  or  more  of  the  trustees  remains  the  same,  is 
subject  to  tax.  If  transfer  of  title  results  wholly  from  operation 
of  law,  however,  such  transfer  is  not  subject  to  stamp  tax.i^e 
When  stock  stands  in  the  name  of  two  or  more  trustees,  the 
nominal  transfer  of  such  stock  to  the  surviving  trustee  or  trus- 

1"  Such  transfers  were  held  to  be  taxable  under  the  1918  Law.  Reg.  40 
Rev.,  Art.  12. 

123  T.  D.  2685.  Under  the  1914  Law,  certificates  so  loaned  were  not  held 
taxable.    (T.  D.  2182.) 

124  Reg.  40  Rev.,  Art.  12;  Letter  from  treasury  department  dated  July  12, 
1918;  W.  T.  S.  1919,  •!  3601. 

1-"' Reg.  40  Rev.,  Art.  12;  Letter  from  treasury  department  dated  July  1, 
1919;  W.  T.  S.  1919,  Tj  3974.  Under  the  1914  Law  it  was  held  that  transfers 
from  a  deceased  to  his  executor  or  administrator  were  not  taxable.  Trans- 
fers from  a  trustee  to  a  substitute  trustee  were  not  taxable.  Transfers 
from  an  executor  or  administrator  to  a  trustee  were  taxable  as  were  also 
transfers  from  the  trustee  to  the  beneficiary  under  the  trust.  It  is  to  be 
noted  that  the  words  "legal  title  to"  have  been  added  to  the  Act  of  Oc- 
tober 3,  1917  (see  note  95  of  this  chapter),  and  therefore  the  fact  that 
the  trustee  or  nominee  who  transfers  stock,  and  the  party  to  whom  title  is 
.transferred,  both  represent  the  same  estate  or  beneficiary,  does  not  affect 
the  question,  so  long  as  the  legal  title  is  transferred.  (Letter  from  treasury 
department  dated  July  12,  1918;  W.  T.  S.  1919,  113601.) 

1213  Letter  from  treasury  department  dated  February,  1921;  W.  T.  S.  1921, 
114002. 


1184  FEDERAL  INCOME  TAX 

tees  upon  the  death  of  one  of  the  trustees  is  not  subject  to  the 
stamp  tax.!-"^  j-^  y^^l^  been  ruled  that  where  new  trustees  are 
appointed  under  the  Massachusetts  Law^^s  the  transfer  of  stock 
from  the  names  of  the  retiring  trustees  to  the  succeeding  trus- 
tees is  not  subject  to  stamp  tax  since  the  newly  appointed 
trustees  acquire  title  to  the  trust  estate  by  virtue  of  their  ap- 
pointment and  without  any  formal  conveyance.^^o 

Transfers,  however,  of  stock  standing  in  the  name  of  a  de- 
ceased person  to  his  executor  or  administrator  are  not  taxable.i'^'O 

Transfers  to  or  by  Alien  Property  Custodian.  A  transfer 
to  the  Alien  Property  Custodian  of  shares  or  certificates  of  stock 
in  an  American  corporation  in  compliance  with  a  demand  made 
by  him  under  authority  of  the  Trading  with  the  Enemy  Act  is 
the  performance  of  a  mandatory  obligation,  not  voluntarily  as- 
sumed, but  imposed  by  the  paramount  authority  of  the  Govern- 
ment and  is  therefore  held  not  subject  to  the  stamp  tax.  A  sale 
by  the  Alien  Property  Custodian  of  shares  or  certificates  of  stock 
under  the  authority  of  the  Trading  with  the  Enemy  Act,  his 
agreement  so  to  sell,  and  his  transfer  of  legal  title  to  certificates 
or  shares  so  sold  by  him  are  held  to  be  governmental  acts  in  the 
administration  of  the  Trading  with  the  Enemy  Act  and  therefore 
not  subject  to  the  stamp  tax.^^^ 

Brokers'  Individual  Sales.  The  sale,  or  agreement  to  sell, 
shares  of  stock  made  by  a  broker,  directly  or  indirectly,  for  him- 
self, and  the  sale  or  transfer  of  stock  by  a  broker  at  a  price 
diff'erent  from  that  at  which  he  accounts  to  his  selling  customer, 
are  subject  to  tax.1^2 

Gifts.  The  transfer  of  stock  in  pursuance  of  a  gift,  bequest, 
or  conveyance  by  trustees  is  subject  to  the  tax.^^^ 

Other  Transfers  Where  Change  of  Legal  Title  Only 
Takes  Place.  It  has  been  recently  held  under  the  Stock  Trans- 
fer Tax  Law  of  New  York  (the  language  of  which  is  similar  to 
that  of  the  federal  law)  that  stock  transfer  taxes  accrue  upon 
the  cancellation  and  surrender  of  a  stock  certificate  standing  in 
the  name  of  an  accommodation  holder    (nominal  stockholder) 

12T  Letter  from  treasury  department  dated  March  31,  1921;  W.  T.  S. 
1921,  TI4026. 

12S  Chapter  147,  §  6,  Revised  Laws  of  Massachusetts. 

129  Letter  from  treasury  department  dated  May  4,  1921;  W.  T.  S.  1921, 
T[  4042. 

130  Reg.  40  Rev.,  Art.  13;  Letter  from  treasury  department  dated  July  1,' 
1919;  W.  T.  S.  1919,  113974. 

131  Reg.  40  Rev.,  Art.  13;  T.  D.  2786. 

132  Reg.  40  Rev.,  Art.  12. 

133  Reg.  40  Rev.,  Art.  12. 


THE   STAMP   TAX  1185 

and  the  making'  out  of  a  new  certificate  in  the  place  thereof  in 
the  name  of  another  accommodation  holder,  and  the  endorse- 
ment of  the  new  certificates  in  blank  by  the  latter,  the  actual 
ownership  of  the  stock  at  all  times  remaining  in  the  same  person. 
As  there  were  two  transfers  of  the  legal  title,  two  taxable  trans- 
fers took  place  and  a  tax  was  required  to  be  paid  on  each.^^^ 

Formal  Transfers  Where  No  Change  of  Title  Takes 
Place.  The  statute  does  not  contemplate  a  tax  unless  there  is  a 
transfer  of  legal  title  to  shares  or  certificates.  Therefore,  the  tax 
on  transfers  of  stock  is  not  applicable  to  the  surrender  of  old 
stock  in  exchange  for  new  stock  pursuant  to  a  reorganization  of 
a  corporation.^'^''  The  tax  on  transfers  of  stock  does  not  attach 
to  the  exchange  of  stock  certificates  of  the  merged  corporation 
for  stock  certificates  of  the  merging  corporation  at  the  time  and 
as  a  part  of  the  merger  nor  to  the  substitution  of  new  certificates 
for  certificates  representing  old  stock  of  the  merging  corpora- 
tion.i"'*^  Where,  however,  as  under  Section  15  of  the  New  York 
Stock  Corporation  Law,  providing  for  the  merger  of  ordinary  cor- 
porations, the  acquisition  of  the  stock  of  the  corporation  to  be 
merged  is  a  condition  precedent  to  the  merger,  then  the  transfer 
of  such  stock  to  the  merging  corporation  prior  to  the  actual  mer- 
ger is  taxable. !•"  In  the  case  of  a  consolidated  corporation  issu- 
ing stock  in  exchange  for  the  stock  of  consolidating  corporations 
the  surrender  of  the  stock  of  the  consolidating  corporations  in 
exchange  for  the  stock  issued  by  the  consolidated  corporation  is 
not  a  taxable  transfer.^'^'^  The  tax  does  not  apply  to  the  surren- 
der of  certificates  in  exchange  for  other  certificates  representing 
the  same  or  new  stock,  provided  they  are  issued  to  the  same  hold- 
gj.  139  The  transfer  of  stock  among  the  assets  of  the  old  corpora- 
tion to  a  new  corporation  in  a  reorganization  is  subject  to  tax.    If 

134  New  York  State  Tax  Law,  §  270.  Travis  v,  Ann  Arbor  Co.,  180  N.  Y. 
App.  Div.  799,  168  N.  Y.  Supp.  53,  affirmed  227  N.  Y.  640,  126  N.  E.  923. 
The  court  said  in  this  case:  "The  application  of  any  other  rule  wouM  be 
opposed  to  the  plain  wording  of  the  statute,  and  furnish  in  many  cases  an 
easy  method  of  evasion  of  the  tax." 

135  Reg.  40  Rev.,  Art.  13;  T.  D.  2752;  letter  from  treasury  department 
dated  June  10,  1916.  This  is  true  in  the  case  of  a  reorganization  under  §  24 
of  the  New  York  Stock  Corporation  Law  for  the  purpose  of  issuing  stock 
without  par  value.  For  a  definition  of  the  term  "reorganization"  see  note 
65.  ]  j  iSj' 

13G  Reg.  40  Rev.,  Art.  13;  T.  D.  2752.    This  is  true  in  the  case  of  a  merger 
of  ti'ust  companies  under  §§  487  to  496  of  the  New  York   Banking  Law. 
137  T.  D.  2752;  Reg.  40  Rev.,  Art.  12. 
13S  Reg.  40  Rev.,  Art.  13;  T.  D.  2752. 
139  Reg.  40  Rev.,  Art.  13;  T.  D.  2752. 


1186  FEDERAL   INCOME   TAX 

the  new  stock  is  issued  to  the  old  corporation  the  transfer  of  that 
stock  from  the  old  corporation  to  its  stockholders  is  subject  to 
tax.  If  the  old  stock  is  surrendered  to  the  new  corporation  and 
constitutes  it  a  corporate  stockholder,  that  surrender  is  tax- 
able.140 

Stock  Redeemed  by  the  Issuing  Corporation.  The  tax  on 
the  transfer  of  capital  stock  does  not  apply  to  the  surrender  of 
stock  certificates  for  retirement  and  redemption  for  cash.  If, 
however,  the  corporation  buys  some  of  its  own  stock  and  trans- 
fers it  to  itself,  whether  or  not  it  intends  eventually  to  cancel  it, 
the  transfer  to  the  corporation  is  subject  to  tax.  The  test  is 
whether  the  immediate  transaction  results  in  the  extinction  of 
the  stock  or  investing  title  to  it  in  the  corporation.!^^ 

Deposit  of  Stock  Certificates  as  Collateral  Security.  No 
tax  is  intended  to  be  imposed  upon  an  agreement  evidencing  a 
deposit  of  stock  certificates  as  collateral  security  for  money 
loaned  thereon,  which  certificates  are  not  actually  sold,  nor  upon 
the  delivery  or  transfer  or  retransfer  for  such  purpose  of  such 
stock  certificates  so  deposited.  In  each  such  case,  however,  the 
person  making  a  transfer  of  such  certificates  as  collateral  security 
must  make  and  sign  a  statement  of  the  facts  and  attach  it  to  the 
certificate."^  Under  the  1914  law  it  was  held  that  no  tax  was  im- 
posed on  stock  deposited  as  collateral  until  complete  title  to  the 
certificates  of  stock  was  acquired  by  the  pledgee.i-^^  This  seems 
also  to  be  the  rule  under  the  present  law. 

Transfers  to  or  by  a  Broker.  No  tax  is  imposed  upon  deliv- 
eries or  transfers  to  a  broker  for  sale,  nor  upon  deliveries  or 
transfers  by  a  broker  to  a  customer  for  whom  and  upon  whose 
order  he  has  purchased  the  same,  but  such  deliveries  or  trans- 
fers must  be  accompanied  by  a  certificate  setting  forth  the 
facts.144 

140  Letter  from  treasury  department  dated  February  26,  1920;  W.  T.  S. 
1921,  113567. 

141  Reg.  40  Rev.,  Arts.  12,  13;  T.  D.  2752;  letter  from  treasury  department 
dated  June  20,  1918;  W.  T.  S.,  1919,  ^3597.  Letter  from  treasury  depart- 
ment dated  February  26,  1920;  W.  T.  S.,  1921,  Ij  3572.  Under  the  1914  Law 
it  was  held  that  where  stock  was  redeemed  by  a  corporation  the  transfer 
from  the  stockholder  to  the  corporation  was  subject  to  tax  whether  or  not 
the  stockholder  merely  surrendered  the  certificate  for  cancellation  or  exe- 
cuted the  assignment  on  the  back  of  the  certificate.  (Letter  from  treasury 
department  dated  January  20,  1916.) 

142  Revenue  Act  of  1921,  Title  XI,  Schedule  A-3.  See  Reg.  40  Rev.,  Art. 
13;  Reg.  No.  40,  Part  I,  Art.  5. 

143  Letter  from  treasury  department  dated  December  28,  1915. 

144  Revenue  Act  of  1921,  Title  XI,  Schedule  A-3;  Reg.  40  Rev.,  Art.  13. 
A  rubber  stamp  with  the  name  of  the  firm  and  address  may  be  used  in  mak- 


THE   STAMP   TAX  1187 

Certificate  by  Broker.  The  following  forms  have  been  pre- 
scribed for  the  use  of  brokers:  (a)  (in  the  case  of  a  transfer  to  a 
broker)  "We  hereby  certify  that  we  have  no  ownership  or  inter- 
est, in  *  *  *  shares  of  the  stock  above  transferred,  the  transfer 
by  the  owner  to  us  being  merely  for  the  purpose  of  sale,"  (b)  (in 
the  case  of  a  transfer  by  a  broker)  "We  hereby  certify  that  the 
transfer  of  *  *  *  of  the  within  shares  to  the  names  indicated 
by  the  star  is  made  solely  to  complete  the  purchase  made  by  us 
for  our  customer,  and  we  have  no  ownership  or  interest  therein." 
No  broker  who  has  filed  a  certificate  under  the  foregoing  clause 
(a)  of  this  ruling  should  file  a  certificate  under  the  foregoing 
clause  (b)  with  reference  to  the  transfer  of  any  shares  of  stock 
covered  by  the  certificates  filed  by  him  under  clause  (a)  .^^^ 

"Calls."  A  "call"  is  an  agreement  to  sell  and  is  taxable;  but 
a  transfer  of  a  certificate  of  stock  pursuant  to  the  "call"  is  not 
taxable,  being  only  a  fulfillment  of  the  original  agreement.  The 
seller  should  execute  and  attach  to  the  certificate  of  stock  his 
certificate,  which  should  be  accepted  by  the  transfer  agent  and 
should  be  preserved  by  him  for  inspection  of  the  revenue  oflficer. 
The  certificate  here  prescribed  should  be  in  the  following  form: 

We  hereby  certify  that  the  transfer  of shares  of  the 

within  stock  of has  been  made  pursuant  to 

a  "call",  and  that  the  federal  stock  transfer  stamps  for  the  trans- 
action are  affixed  to  such  "call",  which  is  in  our  possession.!^*' 

Transfer  to  Clearing  House.  No  tax  is  imposed  upon  trans- 
fers or  deliveries  to  a  clearing  house  for  the  sole  purpose  of  clear- 
ing or  adjusting  accounts  between  members,  where  no  beneficial 
interest  is  vested  in  said  clearing  house  or  clearing  association 
and  there  has  been  no  change  of  title  or  interest.!^" 

Inconsistent  By-Laws,  Rules,  or  Customs  of  Exchange. 
No  provisions,  by-laws,  rules  or  customs  of  any  exchange  or  sim- 
ilar institution  inconsistent  with  any  requirement  or  provision 
of  the  Revenue  Act  of  1918  or  any  regulations  made  thereunder, 
nor  any  collateral  additional  agreement  or  understanding,  either 
verbal  or  written,  respecting  the  subject-matter  of  sales  or  trans- 
fers of  certificates,  or  the  settlement  or  fulfillment  thereof,  which 
are  inconsistent  or  in  conflict  with  any  requirement  of  said  act  or 

ing  such  certificates  (telegrams  from  treasury  department  dated  April  19, 
1921;  W.  T.  S.  1921,  114036). 

145  Reg.  40  Rev.,  Art.  13;  Reg.  No.  40,  Part  I,  Art.  5. 

140  Reg.  40   Rev.,  Art.  13. 

14"  Reg.  40  Rev.,  Art.  13;  Reg.  No.  40,  Part  I,  Art.  5.  A  clearing  house 
need  not  be  incorporated  and  may  be  a  part  or  department  of  an  exchange 
or  an  independent  body  (Reg.  40  Rev.,  Art.  33).     See  p.  1225. 


1188  FEDERAL  INCOME  TAX 

regulations  will  exempt  any  person  from  the  payment  of  the  tax 
imposed  on  sales  or  transfers  of  stock. ""^ 

Sale  of  Stamps.  The  ruling  of  the  Treasury  Department  in 
regard  to  the  sale  of  stock  transfer  stamps  is  given  elsewhere  in 
this  book."9 

Registration  of  Stock  Brokers.  Stock  brokers,  transfer 
agents  and  clearing  houses  are  required  to  register  with  the  col- 
lector of  internal  revenue  and  to  keep  records  of  sales  and  trans- 
fers as  is  more  fully  set  forth  in  a  subsequent  part  of  this  chap- 
ter.150 

Certificates  of  Profits.  The  1898  Law  and  the  1914  Law  taxed 
the  original  issue  of  a  "certificate  of  profits,  or  any  certificate  or 
memorandum  showing  an  interest  in  the  property  or  accumula- 
tions of  any  association,  company,  or  corporation,  and  on  all 
transfers  thereof."  The  1917  Law  was  silent.  The  present  law, 
like  the  1918  Law,  taxes  the  original  issue  of  "certificates  of  *  *  * 
profits,  or  of  interest  in  property  or  accumulations,  by  any  cor- 
poration"i-Ji  and  the  sale  or  transfer  of  legal  title  to  "certificates 
*  *  *  of  profits  or  of  interest  in  property  or  accumulations  in 
any  corporation."  i^-  In  the  present  law  the  term  "corporation" 
includes  associations,  joint-stock  companies,  and  insurance  com- 
panies. It  seems,  therefore,  that  certificates  of  profits  or  interest 
in  property  or  accumulations  are  not  taxed  on  original  issue  un- 
less issued  by  a  corporation,  association,  joint-stock  company  or 
insurance  company,  but  the  sale  or  transfer  thereof  may  be. 
taxed,  if  the  certificate  evidences  an  interest  in  the  profits,  prop- 
erty or  accumulations  of  a  corporation,  association,  joint-stock 
company  or  insurance  company,  regardless  of  who  may  have 
issued  it.  Thus,  voting-trust  certificates  are  not  taxable  on  orig- 
inal issue,  if  they  are  issued  by  a  trustee,  but  are  subject  to  the 
tax  on  transfers  when  sold  or  transferred  by  the  owner.i^-^  Un- 
der the  1914  Law  it  was  held  that  certificates  issued  by  trustees 
to  persons  who  had  deposited  certain  securities,  showing  such 
persons  to  be  entitled  to  a  part  of  the  dividends  accruing  on  ac- 
count of  the  securities  deposited  were  liable  to  the  tax  upon  cer- 
tificates of  profit.i^^ 

148  Reg.  40  Rev.,  Art.  14. 

149  See  pp.  1235,  1238. 

150  See  pp.  1224,  1236. 

151  Revenue  Act  of  1921,  Title  XI,  Schedule  A-2. 

152  Revenue  Act  of  1921,  Title  XI,  Schedule  A-3. 

153  Reg.  40  Rev.,  Arts.  5  (e),  12  (d).  See,  hovs^ever,  Reg.  40  Rev.,  Art. 
4   (b),  and  the  discussion  upon  this  point  at  pp.   1174,   1176,   1181. 

154  Letter  from  treasury  department  dated  July  26,  1916. 


THE   STAMP   TAX  1189 

Business  Property  Investment  Bond.  A  business  property 
investment  bond  wherein  it  is  certified  that  the  holder  thereof  is 
the  owner  of  an  interest  in  certain  specified  real  property,  legal 
title  to  which  has  previously  been  conveyed  to  a  trustee,  and 
whereby  the  corporation  issuing  the  same  agrees  to  manage  the 
property  and  distribute  the  proceeds  in  a  certain  manner,  is  not 
subject  to  tax  as  a  bond,  debenture,  or  certificate  of  indebtedness, 
but  as  a  certificate  of  interest  in  property.^^J 

Certificates  of  Deposit.  A  certificate  of  deposit  is  not  subject 
to  tax  as  a  promissory  note.^^c  Certificates  of  deposit  issued  by 
banks  and  trust  companies  are  not  considered  to  be  taxable  as 
certificates  of  indebtedness,  whether  or  not  they  are  time  certif- 
icates, or  contain  a  clause  reserving  the  right  of  thirty  days'  no- 
tice of  payment. ^•'^'^ 

Morris-Plan  Banks.  Any  instrument  which  is  actually  a  cer- 
tificate of  deposit  issued  by  a  bank  is  exempt  from  stamp  tax, 
regardless  of  whether  it  is  negotiable  or  non-negotiable  or  wheth- 
er it  is  payable  on  demand  or  at  some  specified  time.  Certificates 
of  deposit  issued  by  banks  or  organizations  operating  upon  the 
Morris  plan  are  not  subject  to  stamp  tax.^'''* 

Certificates  of  Indebtedness.  A  "certificate  of  indebtedness" 
is  primarily  any  instrument  acknowledging  liability  for  the  pay- 
ment of  money,  not  in  the  recognized  form  of  a  promissory  note 
or  bill  of  exchange.!'''*  The  term  "certificate  of  indebtedness"  in- 
cludes only  instruments  having  the  general  character  of  invest- 
ment securities,  as  distinguished  from  instruments  evidencing 
debts   arising  in   ordinary   transactions   between   individuals.!"''" 

Trust  certificates,  commonly  known  as  "Car  Trust  Certificates" 
issued  under  the  Pennsylvania  plan  have  been  held  to  be  subject 
to  stamp  tax  as  "certificates  of  indebtedness."  ^^^  See  Bonds  of 
Indebtedness. 

Scrip-Dividend  Certificates  or  Warrants.  Scrip-dividend 
certificates  or  warrants  are  taxable  as  certificates  of  indebted- 
ness.!''^- 

155  Reg.  55  Rev.,  Art.  11. 

156  Reg.  55  Rev.,  Art.  62. 

i">7  Letter  from  treasury  department  dated  November  16,  1917;  W.  T.  S. 
1919,  ^  3550. 

158  Reg.  55  Rev.,  Art.  13. 

159  T.  D.  2713. 

ICO  T.  D.  2919;  Reg.  55  Rev.,  Art.  4. 

161  Fidelity  Trust  Company  v.  Lederer,  U.  S.  Dist  Ct.,  Eastern  Dist.  of 
Pennsylvania,  decided  July  14,  1921. 

162  Reg.  55  Rev.,  Art.  9. 


1190  FEDERAL  INCOME  TAX 

Certificates  of  Indebtedness  Issued  by  Receivers.  A  cer- 
tificate of  indebtedness  issued  under  order  of  a  Federal  court 
by  a  receiver  is  subject  to  tax.i*^^ 

Conditional  Bills  of  Sale.  Conditional  bills  of  sale  used  in 
sale  of  merchandise  on  the  installment  plan  are  not  certificates  of 
indebtedness  within  the  meaning  of  the  law,  and  are  not  subject 
to  stamp  tax,  unless  in  the  form  of  promissory  notes.i*^^ 

Certificates  Generally.  No  tax  is  imposed  under  the  present 
law  on  certificates  of  incorporation,  certificates  of  damage  and 
certificates  generally. 

Checks.  No  tax  is  imposed  on  checks  payable  at  sight  or  on 
demand.  Only  drafts  or  checks  expressly  payable  otherwise  than 
at  sight  or  on  demand  are  taxable.i^s    See  Promissory  Notes. 

Contracts.  No  tax  is  imposed  by  the  present  law  on  contracts 
as  such.i"^' 

Conveyances.  The  law  taxes  any  deed,  instrument  or  writing, 
whereby  any  lands,  tenements,  or  other  realty  sold  shall  be 
granted,  assigned,  transferred  or  otherwise  conveyed  to,  or 
vested  in,  the  purchaser  or  purchasers,  or  any  other  person  or 
persons  by  his,  her  or  their  direction.  The  tax  is  based  upon  the 
consideration  or  value  of  the  interest  or  property  conveyed,  ex- 
clusive of  the  value  of  any  lien  or  incumbrance  remaining  thereon 
at  the  time  of  sale.^^'^  The  rate  is  as  follows :  When  such  consid- 
eration or  value  does  not  exceed  $100,  no  tax;  exceeding  $100  and 
not  exceeding  $500,  50  cents ;  for  each  additional  $500  or  fraction- 
al part  thereof,  50  cents.  The  rates  were  the  same  under  the 
1918  Law.  The  tax  does  not  apply  to  any  instrument  or  writing 
given  to  secure  a  debt.^^^ 

Who  Affixes  Stamps.  The  person  who  makes,  signs  or  issues 
the  deed  (i.  e.,  the  grantor)  is  required  to  affix  the  stamps  there- 
to and  becomes  primarily  liable  to  penalty  if  stamps  in  a  sufficient 
amount  based  upon  the  actual  value  of  the  consideration  given 
are  not  so  affixed.i^^  The  law  also  prohibits  any  person  from  ac- 
cepting such  instruments  unless  they  are  properly  stamped.  The 
grantee  in  a  deed  is  liable  for  the  tax  as  well  as  the  grantor.i'^o 

163  Reg.  55  Rev.,  Art.  15. 

164  Reg.  55  Rev.,  Art.  14. 

165  Reg.  55  Rev.,  Art.  63. 

166  T.  D.  2599. 

167  Revenue  Act  of  1921,  Title  XI,  Schedule  A-6.  See  Central  Trust  Co. 
v.  Columbus,  etc.,  Co.,  92  Fed.  919. 

168  Revenue  Act  of  1921,  Title  XI,  Schedule  A-6. 

169  Reg.  55  Rev.,  Art.  66;  T.  D.  2115;  T.  D.  2283. 

170  Reg.  55  Rev.,  Art.  66. 


THE   STAMP   TAX  1191 

Where  a  purchaser  has  accepted  an  unrecorded  deed  he  may  be 
compelled  to  pay  the  required  tax  before  having  the  deed  re- 
corded, or  prosecuted  under  Section  1102  of  the  law.^^^  In  a  case 
where  the  referee  at  a  foreclosure  sale  did  not  affix  the  stamps 
required  by  law  but  the  purchaser  affixed  such  stamps  under  pro- 
test before  recording  the  deed,  it  was  held  that  the  grantee,  ven- 
dee or  any  other  person  participating  in  the  making  or  issuing  of 
a  paper  without  revenue  stamps  may  be  required  to  pay  the  tax 
thereon  and  is  liable  for  failure  to  do  so.^^^ 

Where  Stamps  Are  Affixed.  The  stamps  should  be  affixed 
on  the  deed  or  other  instrument  conveying  the  real  estate. i'^^ 

When  Tax  Accrues.  The  time  of  delivery  of  a  deed  convey- 
ing real  estate  determines  its  taxability.  Deeds  executed  and 
delivered  on  or  after  April  1,  1919,  conveying  property  in  pursu- 
ance of  a  contract  made  prior  to  that  time  are  taxable,  and  deeds 
executed  and  delivered  prior  to  such  date  are  not  taxablej^"^-* 
even  though  they  are  recorded  after  that  date.^^^  The  same  rule 
applies  to  similar  deeds  delivered  prior  to  April  1,  1919,  and  tax- 
able under  the  1917  Law.  A  deed  dated  prior  to  April  1,  1919, 
but  delivered  subsequent  to  that  date,  is  taxable.  If  delivered 
between  December  1,  1917,  and  April  1,  1919,  it  is  taxable  under 
the  1917  Law.i'^*'  Deeds  in  escrow  become  subject  to  stamp  tax 
upon  delivery  to  the  grantee.  If  delivered  between  December  1, 
1917,  and  April  1,  1919,  they  are  taxable  under  the  1917  Law;  if 
delivered  on  or  after  April  1,  1919,  they  are  taxable  under  the 
Revenue  Act  of  1918."7  Deeds  delivered  after  the  incidence  of 
the  tax  must  be  stamped  although  they  may  have  been  dated, 
executed  and  acknowledged  prior  thereto  and  even  though  de- 
livered prior  thereto  to  a  third  party  for  account  of  the  grantee 
named  in  the  deed,  if  delivery  by  such  party  to  the  grantee  is 
made  after  the  incidence  of  the  tax."*^  A  conveyance  of  property 
subject  to  an  equity  of  redemption  is  taxable  when  made,  not 
when  the  time  for  the  equity  of  redemption  has  expired.^™ 

Consideration  or  Value.  The  tax  is  imposed  upon  the  full 
amount  of  consideration  or  value  although  payments  may  have 

l"l  See  p.  1239.  See  letter  from  treasury  department  dated  May  27,  1918; 
W.  T.  S.  1919,^3717. 

172  T.  D.  2310;  Home  Title  Insurance  Company  v.  Keith,  230  Fed.  905. 

173  Reg.  55  Rev.,  Art.  68;  T.  D.  2599. 

174  Reg.  55  Rev.,  Art.  71;  T.  D.  2115. 

175  T.  D.  2115. 

176  Reg.  55  Rev.,  Art.  72. 

177  Reg.  55  Rev.,  Art.  73;  T.  D.  2115;  Vol  2,  T.  D.  (1898)  No.  20,096. 

178  T.  D.  2042. 

179  Reg.  55  Rev.,  Art.  78. 


1192  FEDERAL  INCOME   TAX 

been  made  upon  the  installment  plan  prior  to  the  incidence  of  the 
tax.iso  When  the  consideration  for  a  conveyance  of  lands,  tene- 
ments or  other  real  property  is  left  open,  to  be  fixed  by  future 
contingencies,  the  actual  value  at  the  time  of  conveyance  is  the 
measure  of  the  tax  upon  the  deed,  instrument  or  writing  whereby 
the  conveyance  is  made.i'^i  Quit-claim  deeds  are  taxable  accord- 
ing to  the  value  of  the  interest  conveyed.!^-  Stock  in  a  corpora- 
tion is  a  valuable  consideration  for  the  transfer  of  real  property, 
and  a  deed  conveying  real  estate  to  a  corporation  for  such  con- 
sideration is  taxable.i^^ 

The  conveyance  of  real  property  in  a  reorganization  from  the 
old  corporation  to  the  new  organization  in  consideration  of  the 
issue  of  new  stock  to  the  old  corporation  or  to  its  stockholders 
is  subject  to  stamp  tax  on  the  basis  of  the  value  of  the  prop- 

gj.^y  184 

A  conveyance  of  real  estate  by  co-owners  to  a  corporation  or- 
ganized for  convenience  in  handling  the  property,  made  in  con- 
sideration of  the  issue  to  them  of  the  corporation's  capital  stock, 
is  subject  to  tax.i^^  a  deed  from  a  corporation,  the  entire  capital 
stock  of  which  is  owned  by  another  corporation,  conveying  real 
estate  to  the  latter  in  consideration  of  the  payment  by  the 
grantee  of  all  obligations  of  the  grantor  is  subject  to  tax.^^e  xhe 
value  of  the  interest  in  the  property  conveyed  determines  the 
amount  of  the  tax.^"^'  A  conveyance  of  land  in  consideration  of 
life  maintenance  is  taxable,  the  tax  to  be  measured  by  the  value 
of  the  property  or  interest  conveyed.^^^  Where  a  deed  states  that 
the  transfer  is  made  for  a  nominal  consideration  the  tax  must  be 
computed  upon  the  actual  value  of  the  interest  or  property  con- 
veyed.i^^  Conveyances  of  realty,  not  in  connection  with  a  sale,  to 
trustees  or  other  persons  without  consideration  are  not  taxable.i'^o 
Taxes  and  assessments  which  have  become  a  lien  on  real  estate 
by  operation  of  statute  and  which  are  not  paid  at  the  time  of  sale 
are  deductible  from  the  consideration  in  computing  the  stamp 

180  T.  D.  2279. 

181  Reg.  55  Rev.,  Art.  67. 

182  Reg.  55,  Art.  82;  T.  D.  20,232. 

183  Reg.  55,  Art.  81. 

184  Letter  from  treasury  department  dated  February  26,  1920;  W.  T.  S. 
1921,  ^3567. 

185  Reg.  55,  Art.  101. 

186  Reg.  55,  Art.  107. 

187  T.  D.  2278. 

188  Reg.  55,  Art.  79. 

189  T.  D.  2115. 

190  Reg.  55,  Art.  95. 


THE   STAMP   TAX  1193 

tax.i»i  Where  a  parent  company  decided  to  dissolve  some  of  its 
subsidiaries  and  to  take  over  their  real  property,  deeds  of  con- 
veyance having  been  prepared  for  a  nominal  consideration,  no 
actual  consideration  passing  to  the  subsidiary  companies,  it  has 
been  ruled  that  such  deeds  are  not  subject  to  stamp  tax.i-^- 

Realty  Sold.  The  law  provides  that  deeds  whereby  any  realty 
sold  shall  be  conveyed  to  another  are  taxable.  Hence,  it  seems 
that  if  the  realty  is  not  sold,  no  stamps  need  be  affixed  to  the 
deed.  The  word  "sold"  is  used  in  its  ordinary  and  popular  mean- 
ing,i»3  and  imports  the  transfer  of  the  absolute  or  general  title 
for  a  valuable  consideration  or  price.^^^  Deeds  on  an  exchange  of 
property  are,  however,  subject  to  tax  which  should  in  each  case 
be  computed  on  the  basis  of  the  actual  value  of  the  interest  on 
the  property  conveyed,  the  amount  of  any  pre-existing  lien  or 
encumbrance  which  is  not  removed  by  the  sale  being  deduct- 
ible.i^'^  Deeds  that  are  only  confirmatory  and  which  do  not  vest 
title  not  already  vested  are  not  taxable.^^^ 

Contracts  for  the  sale  of  real  property  are  not  taxable  unless 
they  vest  title.i^" 

The  following  kinds  of  deeds  are  also  not  taxable:  (1)  Quit- 
claim deeds  given  for  no  consideration,  or  merely  for  the  nominal 
consideration  of  $1.00,  for  the  purpose  of  correcting  flaws  in 
title,i»s  (2)  partition  deeds  which  are  operative  in  defining  boun- 
dary lines  or  in  showing  by  location  the  interests  of  the  tenants- 
in-common,i-»f'  unless  a  consideration  passes  between  the  parties 
by  reason  of  one  or  more  of  them  taking  under  the  division  a 
share  of  real  estate  of  greater  value  than  his  individual  interest, 
in  which  event  stamp  tax  attaches  to  the  deeds  conveying  such 
greater  shares,  calculated  upon  the  value  of  such  consideration,-oo 
(3)  deeds  of  release,-"^  (4)  deeds  of  trust,-02  (5)  deeds  issued  to 
cover  pure  and  bo7ia  fide  gifts  of  property  from  husband  to  wife 

1»1  Reg.  55,  Art.  109. 

i!i- Letter  from  treasury  department  dated  April  18,  1919;  W.  T.  S    1919 
113770. 

w-"^  See  p.  1262. 

194  Reg.  55  Rev.,  Art.  70. 

105  Reg.  55  Rev.,  Art.  75;  T.  D.  2599;  T.  D.  2111. 

i««Reg.  55  Rev.,  Art.  97;  Circular  No.  503,  2d  revision.    Compilation  of 
decisions  for  year  1899,  p.  293. 
1»7  Reg.  55  Rev.,  Art.  98. 

195  Reg.  55  Rev.,  Art.  82;  T.  D.  2115. 

199  T.  D.  2115. 

200  Reg.  55  Rev.,  Art.  94. 

201  Reg.  55  Rev.,  Art.  84;  T.  D.  2115. 

202  Reg.  55  Rev.,  Art.  84;  T.  D.  2115. 


1194  FEDERAL  INCOME  TAX 

or  from  parent  to  child,  or  from  an  individual  to  a  municipality  or 
other  political  subdivision,  or  to  the  United  States,  wherein  the 
consideration  named  is  "natural  love  and  affection  and  $1.00," 
"desire  to  promote  public  welfare  and  $1.00,"  or  "$1.00  and  other 
valuable  consideration, "203  (6)  deeds  not  granting,  assigning, 
transferring  or  conveying  to  the  purchasers  any  lands,  tene- 
ments, or  other  realty,  but  only  the  right  to  sepulture  or  burial,  to 
erect  monuments,  etc.,-^^  (7)  deeds  of  reconveyance  by  an  agent 
to  an  undisclosed  principal  if  no  consideration,  or  a  nominal  con- 
sideration of  $1.00  only  is  given,20j  (8)  deeds  executed  by  debtors 
covering  assignments  of  property  to  trustees  to  be  held  for  the 
benefit  of  creditors,^^^  (9)  deeds  given  by  a  husband  and  wife  to  a 
"straw  man"  who  immediately  executes  a  deed  reconveying  the 
property  to  the  husband  or  wife,  if  no  valuable  consideration,  or 
merely  the  nominal  consideration  of  $1.00  is  given,  and  likewise 
the  deeds  of  reconveyance,-"'^  (10)  deeds  transferring  title  to 
property  to  building  and  loan  association  for  the  purpose  of  secur- 
ing a  loan  on  the  property  so  conveyed,  which  property  is  imme- 
diately reconveyed  to  its  owner,  and  likewise  the  deeds  of  re- 
con  veyance,2os  (11)  conveyances  of  property  of  a  copartnership, 
in  the  hands  of  receivers,  back  to  the  owners  after  administration 
of  the  estate,209  (12)  deeds  by  an  executor  to  devisees,  conveying 
specific  parcels  of  real  estate,  devised  to  them  in  common,  unless 
a  consideration  passes  between  the  devisees  by  reason  of  some 
of  them  taking  a  greater  share  in  the  real  estate  than  that  to 
which  entitled  under  the  will,  in  which  event  tax  attaches  to  the 
deeds  conveying  such  greater  shares,  and  is  calculated  upon  the 
amount  of  value  of  such  consideration,2io  (13)  conveyances  to  a 
trustee  without  valuable  consideration  or  from  a  trustee  to  a 
cestui  que  trust  without  valuable  consideration,^!!  (14)  a  convey- 
ance of  real  estate  by  a  corporation  without  valuable  considera- 
tion to  an  owner  of  all  its  capital  stock  in  consequence  of  its  dis- 

203  Reg.  55  Rev.,  Art.  88;  T.  D.  2115. 

204  Reg.  55  Rev.,  Art.  87;  T.  D.  19,838. 

205  T.  D.  2115;  Reg.  55  Rev.,  Art.  92. 

206  Reg.  55  Rev.,  Art.  89;  T.  D.  2115.  When,  however,  the  trustee  sells  or 
conveys  such  property  either  to  the  creditor,  or  any  other  person,  the  deeds 
executed  by  him  are  taxable.   Reg.  55  Rev.,  Art.  89;  T.  D.  2115. 

207  Reg.  55  Rev.,  Art.  91 ;  T.  D.  2115. 

208  Reg.  55  Rev.,  Art.  90;  T.  D.  2115.  But  deeds  of  building  and  loan  as- 
sociations are  taxable.    (Reg.  55,  Art.  80.) 

209  Reg.  55  Rev.,  Art.  93. 

210  Reg.  55  Rev.,  Art.  102. 

211  Reg.  55  Rev.,  Art.  105. 


THE   STAMP   TAX  1195 

solution.-i-  Where  an  officer  of  a  corporation  purchases  real 
estate  from  the  corporation,  conveyance  being  first  made  to  a 
third  party  as  part  of  the  same  transaction,  the  property  is  con- 
veyed by  the  third  party  to  the  officer,  the  conveyance  to  the 
third  party  is  subject  to  tax,  while  the  conveyance  from  the 
third  party  is  not  subject  to  tax.213 

Conveyance  of  Dower.  In  states  v^here  common-law  dower 
still  exists  an  instrument  purporting  to  convey  the  inchoate  right 
of  dower  of  a  wife  or  the  consummate  right  of  dower  of  a  widow, 
prior  to  assignment  of  dower,  is  not  subject  to  stamp  tax;  but 
an  instrument  conveying  the  estate  acquired  by  a  widow  upon 
assignment  of  dower  is  subject  to  tax.  Where  by  statute  dower 
has  been  abolished  and  a  different  interest  in  the  husband's  real 
property  conferred  upon  the  wife  in  lieu  thereof,  the  taxability 
of  an  instrument  purporting  to  convey  such  an  interest  prior  to 
its  assignment  will  be  determined  by  the  nature  of  the  wife's 
interest,  and  the  statutes  and  decisions  of  the  particular  state  in 
which  the  real  estate  is  located  must  be  consulted.^i^ 

Incumbrance  on  Property  at  the  Time  of  Sale.  The  con- 
sideration or  value  on  which  the  tax  is  based  is  exclusive  of  the 
value  of  any  lien  or  incumbrance  remainmg  thereon  at  the  time 
of  sale.  The  words  in  italics  were  not  contained  in  the  former 
law  and  were  inserted  to  limit  the  exclusion  to  liens  or  incum- 
brances other  than  purchase  money  mortgages.  In  determining 
the  amount  of  incumbrances  upon  real  estate  being  transferred, 
no  consideration  is  to  be  given  to  new  incumbrances  placed  upon 
same  at  the  time  of,  or  after,  the  sale.  Incumbrances  placed  on 
the  property  in  connection  with  and  as  a  result  of  the  sale  or 
transfer,  as  well  as  notes  for  deferred  payments,  cannot  be  de- 
ducted in  determining  the  amount  on  which  the  tax  is  calculated. 
Only  incumbrances  which  rest  on  the  property  before  the  sale 
and  which  are  not  removed  by  the  sale  are  to  be  taken  into  con- 
sideration.215 

Abstracts  of  Title.    Abstracts  of  title  are  not  taxable.^i^ 
Contracts  to  Convey.    A  contract  for  the  sale  of  real  estate, 

making  provision  for  future  delivery  by  deed,  is  not  subject  to 

stamp  tax.-^^ 

212  Reg.  55  Rev.,  Art.  103. 

213  Reg.  55  Rev.,  Art.  110. 

214  Reg.  55  Rev.,  Art.  76. 

215  Reg.  55  Rev.,  Art.  G8;  T.  D.  2599. 

216  Reg.  55  Rev.,  Art.  99. 

217  Reg.  55  Rev.,  Arts.  83,  98;  T.  D.  2599;  T.  D.  2115. 


1196  FEDERAL  INCOME  TAX 

Mining  Deeds.  Deeds  conveying  mines  are  taxable.^i^  A  con- 
veyance of  a  mine  located  on  unpatented  land  is  subject  to  taxa- 
tion.2i'J  This  ruling  was  made  under  the  1898  Law.  Under  the 
1914  Law,  it  was  held  by  the  Treasury  Department  in  an  informal 
ruling  that  deeds  to  mining  claims  prior  to  the  issue  of  the  patent 
were  taxable  upon  transfer  as  conveyances  of  real  property.  The 
tax  should  be  computed  upon  the  interest  in  the  property  con- 
veyed which  would  be  the  market  value  of  the  stock  issued  there- 
for, or  if  it  had  no  market  value,  the  cash  value  of  the  mining 
claim."*^ 

Conveyance  by  Mortgagor  to  Mortgagee.  A  conveyance  by 
a  defaulting  mortgagor  to  the  mortgagee  in  consideration  of  the 
cancellation  of  mortgage  debt  is  subject  to  tax  calculated  upon 
the  amount  of  the  mortgage  debt  plus  unpaid  accrued  interest.~i 

Timber  Deeds.  Standing  timber  is  ordinarily  held  to  be  real 
estate.  The  question  of  whether  or  not  a  particular  instrument 
of  grant  is  taxable  depends  on  whether  or  not  the  subject  matter 
of  the  grant  is  real  estate.  What  is  real  estate  is  determined  by 
the  law  of  the  state  in  which  the  property  conveyed  is  situated.-- 
It  is  held  that  a  timber  deed  transferring  timber  upon  a  tract  of 
land  is  a  deed  of  realty  and  as  such  is  taxable,  unless  timber  is 
not  real  estate  under  the  laws  of  the  state  in  which  the  property 
is  located.--'^ 

Leases.  Leases  of  real  property  are  not  subject  to  tax.'--^ 
Operating  leases  of  oil  and  mining  properties,  long-term  mining 
leases,  etc.,  which  in  themselves  convey  no  title  to  or  interest  in 
real  property,  are  exempt  from  taxation.—^ 

Options.  No  tax  is  imposed  upon  ai^  option  for  the  purchase 
of  real  property .^26 

Deeds  Given  by  and  to  United  States  and  Political  Subdi- 
visions. Deeds  executed  by  the  United  States  or  by  any  state, 
county,  town  or  other  municipal  corporation,  are  not  taxable.227 
Deeds  executed  by  a  state,  county,  or  municipal  officer  conveying 

218  Reg.  55  Rev.,  Art.  77. 

219  Vol.  1,  Treas.  Dec.   (1899),  No.  20,986. 

220  Letter  from  treasury  department  dated  August  3,  1916. 

221  Reg.  55  Rev.,  Art.  104. 

222  Reg.  55  Rev.,  Art.  76. 

22s  Letter  from  treasury  department  dated  Feb.  15,  1918;  W.  T.  S.  1919, 
^3714. 

224  Reg,  55  Rev.,  Art.  100. 

225  T.  D.  2155;  T.  D.  2599. 

226  Reg.  55  Rev.,  Art.  83;  T.  D.  2115. 

227  T.  D.  2283.    See  Revenue  Act  of  1921,  §  1101. 


THE   STAMP   TAX  1197 

realty  sold  for  non-payment  of  taxes  are  not  subject  to  tax.--"* 
Deeds  conveying  to  a  state  real  estate  purchased  by  it  are  not 
subject  to  tax.--'  A  conveyance  of  real  estate  sold  to  the  United 
States  Government  is  subject  to  tax.-'^*^ 

Deeds  Given  by  Officers  of  Courts.  Stamps  should  be  at- 
tached to  masters'  deeds  made  pursuant  to  decrees  of  the  United 
States  District  Courts.  The  execution  of  such  conveyances  is  not 
a  judicial  function,  the  title  to  the  land  being  conveyed  to  the 
purchaser  at  the  foreclosure  sale  through  the  master  instead  of 
the  defendant  himself  making  the  sale.  The  cost  of  such  stamps 
should  be  taxed  as  a  part  of  the  cost  of  the  case.-'-'i  The  stamp 
tax  on  a  deed  of  real  property  executed  by  a  sheriff,  referee,  or 
commissioner  to  a  mortgagee  who  bids  in  a  property  at  a  fore- 
closure to  satisfy  the  mortgage  should  be  computed  upon  the 
amount  bid  for  the  property,  plus  the  costs  if  paid  by  the  pur- 
chaser.2-^-  Deeds  executed  by  masters  in  chancery,  sheriffs, 
clerks  of  courts,  etc.,  to  cover  transfers  of  property  so4d  under  a 
foreclosure  or  execution  are  subject  to  tax.  The  grantee  or  ven- 
dee may  be  required  to  pay  the  tax  or  cost  of  revenue  stamps  may 
be  included  in  the  expense  of  the  foreclosure  sale.-"^  Judgments 
or  decrees  of  the  State  court  operating  to  transfer  title  to  real 
estate  are  not  taxable  as  conveyances.--^^ 

Conveyance  to  or  by  Alien  Property  Custodian.  A  con- 
veyance of  realty  to  the  Alien  Property  Custodian  in  compliance 
with  a  demand  made  by  him  under  authority  of  the  Trading  with 
the  Enemy  Act  is  held  not  subject  to  the  stamp  tax  for  the 
reason  that  such  a  conveyance  is  the  performance  of  a  manda- 
tory obligation,  not  voluntarily  assumed,  but  imposed  by  the  par- 
amount authority  of  the  government,  and  for  the  further  reason 
that  it  is  not  a  conveyance  of  "realty  sold."  A  conveyance  by 
the  Alien  Property  Custodian  of  realty  sold  by  him  under  author- 
ity of  the  Trading  with  the  Enemy  Act  is  held  not  to  be  subject  to 
the  stamp  tax  for  the  same  reason,  and  for  the  further  reason 

228  Reg.  55  Rev.,  Art.  85. 

229  Reg.  55  Rev.,  Art.  86. 

230  Reg.  55  Rev.,  Art.  106. 

231  T.  D.  2111;  T.  D.  2253;  Crawford  v.  New  South  Farm  and  Home  Co., 
231  Fed.  999.  This  case  was  decided  under  the  1914  Law  and  it  was  held 
that  the  decision  in  Farmers  Loan  and  Trust  Company  v.  Council  Bluffs 
Gas  and  Electric  Company,  90  Fed.  806,  decided  under  the  1898  Law,  was 
applicable. 

232  Reg.  55  Rev.,  Art.  69. 

233  Reg.  55  Rev.,  Art.  74. 

234  Reg.  55  Rev.,  Art.  108. 


1198  FEDERAL   INCOME   TAX 

that  it  is  an  instrument  issued  by  the  United  States  in  the  exer- 
cise of  a  strictly  governmental  function.^^^ 

Property  in  a  Foreign  Country.  A  deed  conveying  real 
estate  lying  in  countries  which  are  not  United  States  territory  is 
not  subject  to  tax  although  the  grantor  and  grantee  may  both 
be  citizens  and  residents  of  the  United  States.^ss 

Debentures.  The  term  "debenture"  ordinarily,  although  not 
necessarily,  refers  to  an  unsecured  bond.-'^'  See  Bonds  of  Indebt- 
edness. 

Drafts.  Drafts  drawn  at  sight  or  on  demand  are  not  tax- 
able.-3s  But  drafts  drawn  otherwise  than  at  sight  are  generally 
taxable.  The  taxability  of  a  draft  is  determined  by  the  face  or 
form  of  the  instrument  and  not  by  any  understanding  between 
the  maker  and  the  drawee.^s^  For  the  rate  of  tax  and  a  discus- 
sion of  the  rulings  regarding  taxable  drafts  see  Promissory 
Notes. 

Entry  fer  Withdrawal  of  Goods  or  Merchandise  from  Customs 
Bonded  Warehouse.  The  tax  on  instruments  of  this  character  is 
50  cents.2^0  Under  the  1914  Law  it  was  held. that  withdrawals 
for  exportation  were  not  taxable  in  view  of  the  constitutional 
provision  prohibiting  taxation  upon  exports.^^i  It  was  also  held 
that  where  entries  were  filed  in  duplicate,  triplicate,  etc.,  a  stamp 
was  required  on  the  original  copy  only.-^- 

Entry  of  Goods,  Wares  or  Merchandise  at  Customhouse.  The 
law  provides  that  entry  of  any  goods,  wares  or  merchandise  at 
any  customhouse,  either  for  consumption  or  warehousing,  shall 
be  taxed  as  follows:  Not  exceeding  $100  in  value,  25  cents;  ex- 
ceeding $100  and  not  exceeding  $500  in  value,  50  cents ;  exceeding 
$500  in  value,  one  dollar.^^s  Customhouse  entries  made  by  United 
States  officials  traveling  as  such  on  Government  funds  are  not 
taxable.  Likewise  entries  made  by  all  representatives  of  foreign 
countries  in  their  official  capacity  are  by  comity  exempt.^*^ 

235  T.  D.  2786. 

230  Reg-.  55  Rev.,  Art.  96;  Volume  2,  T.  D.  (1898)  No.  21,562.  This  was 
also  the  rule  under  the  act  of  October  22,  1914. 

237  t.  D.  2713. 

238  Revenue  Act  of  1921,  Title  XI,  Schedule  A-5;  Reg.  55  Rev.,  Art  33. 

239  See  p.  1217. 

240  Revenue  Act  of  1921,  Title  XI,  Schedule  A-8;  Reg.  55  Rev.,  Art.  112. 

241  T.  D.  35,007.  See  U.  S.  v.  Hvoslef,  237  U.  S.  1,  and  paragraph  on  Con- 
stitutionality of  Stamp  Taxes. 

242  T.  D.  (Customs)  35,040.  See  Wright  v.  Michigan  Central  Co.,  130  Fed. 
843. 

243  Revenue  Act  of  1921,  Title  XI,  Schedule  A-7. 

244  Reg.  55  Rev.,  Art.  111.  It  vi^as  so  held  under  the  1914  Law.  (T.  D.  Cus- 
toms, 3572.) 


THE   STAMP    TAX  1199 

Foreign  Insurance  Policies.  A  tax  of  3  cents  on  each  dollar 
or  fractional  part  thereof  of  the  premium  charged  is  imposed  on 
each  policy  of  insurance  or  certificates,  binder,  covering,  note, 
memorandum,  cablegram,  letter  or  other  instrument  by  whatever 
name  called  whereby  insurance  is  made  or  renewed  upon  property 
within  the  United  States  (including  rents  and  profits)  against 
peril  by  sea  or  on  inland  waters  or  in  transit  on  land  (including 
trans-shipments  and  storage  at  termini  or  way  points)  or  by 
fire,  lightning,  tornado,  windstorm,  bombardment,  invasion,  in- 
surrection or  riot,  issued  to  or  for  or  in  the  name  of  a  domestic 
corporation  or  partnership  or  an  individual  resident  of  the  United 
States  by  any  foreign  corporation  or  partnership  or  any  individ- 
ual not  a  resident  of  the  United  States,  when  such  policy  or  other 
instrument  is  not  signed  or  countersigned  by  an  officer  or  agent 
of  the  insurer  in  a  state,  territory,  or  district  of  the  United 
States  within  which  such  insurer  is  authorized  to  do  business. 
Policies  of  re-insurance  are  exempt  from  this  tax-^'' 

Definitions.  The  following  terms  are  defined  as  indicated 
below:  (a)  "insurer"  includes  any  person,  copartnership,  asso- 
ciation, or  corporation  transacting  the  business  of  insurance,  and 
also  any  agent  or  broker,  wherever  applicable;  (b)  "insurance" 
includes  every  manner  of  providing  indemnity  against  risks  upon 
property  of  any  description  (including  rents  and  profits)  from 
peril  by  sea  or  inland  waters  or  in  transit  on  land  (including 
trans-shipments  and  storage  at  termini  or  way  points)  or  by  fire, 
lightning,  tornado,  windstorm,  bombardment,  invasion,  insur- 
rection, or  riot ;  (c)  "policy  of  insurance"  includes  any  instrument 
by  whatever  name  the  same  is  called  whereby  insurance  is  made 
or  renewed  by  the  insurer,  as  policies,  binders,  certificates,  open 
policies,  covering  notes,  memoranda,  cablegrams  or  letters ;  (d) 
"other  instrument"  includes  any  instrument  by  which  insurance 
is  made  or  renewed,  i.  e.,  by  which  the  relationship  of  insurer 
and  insured  is  created  or  evidenced,  whether  it  be  a  letter  of  ac- 
ceptance, cablegram,  or  other  instrument  by  whatever  name 
called ;  (e)  the  expression  "whereby  insurance  is  made  or  re- 
newed" includes  any  evidence  or  confirmation  of  a  binding  con- 
tract of  insurance  whereby  a  risk  is  assumed  by  the  insurer ;  (f ) 
"issue"  means  the  act  whereby  insurance  is  made  or  renewed 
or  in  any  manner  becomes  a  binding  contract  effective  for  in- 
surance; (g)  "premium  charged"  means  the  total  premium  pay- 
able during  the  life  of  a  contract  of  insurance  and  shall  include 
any  additional  assessment  or  charge  in  the  nature  of  a  premium 
which  may  be  assessed  or  charged  during  the  life  of  a  contract  of 

245  Revenue  Act  of  1921,  Title  XI,  Schedule  A-13. 


3200  FEDERAL  INCOME  TAX 

insurance,  whether  payable  in  one  sum  or  in  installments  and 
however  paid  (and  though  never  paid  if  the  contract  of  insurance 
be  delivered  and  accepted  or  otherwise  becomes  binding  upon  the 
insurer)  ;  (h)  "premium"  means  the  agreed  price  for  assuming 
and  carrying  the  risk.  It  includes  all  that  is  received  by  the  un- 
derwriter therefor  and  is  in  fact  the  total  consideration  receivable 
for  underwriting  the  risk,  whether  in  one  sum  or  in  installments, 
during  the  life  of  the  policy;  (i)  "United  States"  includes  the 
States  of  the  United  States,  the  Territories  of  Alaska  and 
Hawaii,  and  the  District  of  Columbia.-^*^ 

Effective  Date.  Policies  of  insurance  which  are  issued  and 
accepted  on  and  after  April  1,  1919,  regardless  of  when  the  in- 
surance thereunder  becomes  effective,  are  subject  to  tax;  but 
policies  which  were  issued  and  accepted  prior  to  April  1,  1919, 
if  issued  in  the  usual  course  of  business  and  according  to  general 
custom  and  not  for  the  purpose  of  evading  the  tax,  are  not  sub- 
ject to  tax.2^^ 

Persons  Liable  to  Tax.  The  insurer,  the  agent,  or  broker, 
effecting,  accepting,  placing  or  soliciting  the  insurance,  and  also 
the  insured  are  each  liable  for  the  tax,-^'^ 

What  Instruments  Must  Bear  a  Stamp.  The  stamp  must 
be  affixed  to  the  first  instrument  by  which  the  insurance  is  made 
or  renewed,  i.  e.,  by  which  the  relationship  of  insurer  and  in- 
sured is  created  or  evidenced,  whether  it  be  a  letter  of  accept- 
ance, cablegram,  or  other  instrument  by  whatever  name  called. 
In  the  case  of  so-called  "open  policies"  or  "open  cargo  covers," 
where  the  amount  of  the  premium  is  not  definitely  determined  at 
time  of  issuance,  the  stamps  may  be  affixed  to  the  receipts  for 
monthly  or  other  payments  if  proper  notation  be  made  upon 
such  receipts  identifying  the  original  instruments  to  which  they 
apply.  In  the  case  of  a  binder  or  other  instrument  whereby  in- 
surance is  made  or  renewed,  issued  without  agreement  as  to 
the  premium  to  be  charged,  stamps  must  be  affixed  when  the 
amount  of  the  premium  is  determined.-^^ 

Insured  to  Retain  Policy  for  Two  Years.  The  person 
having  control  or  possession  of  a  policy  of  insurance  or  other 
instrument  to  which  documentary  stamps  shall  be  affixed  accord- 
ing to  law  shall  retain  such  instrument  for  the  period  of  two 
years  from  the  date  of  issuance  thereof,  for  the  purpose   of 

246  Reg.  55  Rev.,  Art.  156. 

247  See  Reg.  55  Rev.,  Art.  156. 

248  Reg.  55  Rev.,  Art.  157;  Reg.  55  Rev.,  Art.  158. 

249  Reg.  55  Rev.,  Art.  159. 


THE   STAMP   TAX  1201 

enabling  internal  revenue  officers  to  verify  the  fact  that  payment 
of  the  full  amount  of  tax  due  thereon  has  been  made.-"'" 

Subsequent  Instrument  Shall  Indicate  Prior  Document 
TO  Which  Stamps  Are  Affixed.  Any  policy  of  insurance  or 
other  instrument  which  is  subsequent  to  or  which  confirms  a 
contract  of  insurance  that  is  created  or  evidenced  by  any  prior 
instrument  by  which  insurance  was  originally  made  or  renewed, 
should  bear  a  notation  designating  such  prior  instrument  (here- 
inafter referred  to  as  the  original  instrument)  and  showing  that 
the  proper  stamps  have  been  affixed  thereto  and  cancelled.  By 
this  is  meant  that,  if  a  letter,  cablegram,  or  other  instrument 
is  so  worded  that  it  establishes  or  evidences  a  contractual  rela- 
tion between  the  insurer  and  the  insured,  executed  or  executory, 
by  which  insurance  is  made  or  renewed,  or  by  which  the  relation- 
ship of  insurer  and  insured  is  created  or  evidenced,  such  instru- 
ment shall  be  construed  as  the  original  instrument,  and  must 
have  stamps  of  the  proper  amount  affixed  to  it,  and  any  policy 
or  other  instrument  which  is  subsequent  to  or  which  confirms 
such  original  instrument  must  bear  thereon  the  notation  above 
indicated.--5i 

Subsequent  Instruments  That  Must  Be  Stamped.  In  case 
an  instrument  subsequent  to  the  original  instrument  provides 
for  the  payment  of  a  premium  greater  than  the  premium  pro- 
vided for  in  the  original  instrument,  such  subsequent  instrument 
must  have  affixed  thereto  stamps  equal  to  the  tax  imposed  upon 
the  additional  premium  charged  therein;  also  such  subsequent 
instrument  must  bear  notation  of  the  stamps  affixed  to  the  orig- 
inal instrument.  The  same  rules  apply  to  any  riders,  endorse- 
ments, or  other  forms  attached  to  or  forming  a  part  of  any 
original  or  subsequent  instrument  where  such  rider,  endorse- 
ment, or  other  form  provides  for  the  payment  of  a  premium 
greater  than  theretofore  charged.^^^ 

Unstamped  Instruments  and  Those  Bearing  No  Notation 
OF  Stamping.  Failure  (a)  to  stamp  the  original  instrument  by 
which  insurance  is  made  or  renewed,  whether  it  be  a  letter  of 
acceptance,  cablegram,  or  other  instrument  by  whatever  name 
called,  or  (b)  to  indicate  that  such  original  instrument  was 
properly  stamped  on  any  policy  or  other  instrument  which  is 
subsequent  to  or  which  confirms  the  contract  of  insurance  that 
is  created  or  evidenced  by  any  prior  instrument  by  which  insur- 

250  Reg.  55  Rev.,  Art.  160. 

251  Reg.  55  Rev.,  Art.  161. 

252  Reg.  55  Rev.,  Art.  162. 


1202  FEDERAL  INCOME   TAX 

ance  was  made  or  renewed,  will  be  held  to  raise  a  presumption 
of  an  intent  to  evade  the  payment  of  tax.^^s 

Measure  of  Tax.  The  tax  is  measured  by  total  premium  paid, 
including  any  additional  assessment  or  charge  in  the  nature  of 
a  premium  on  each  policy  of  insurance  or  other  instrument  by 
which  insurance  is  made  or  renewed,  and  is  at  the  rate  of  3  cents 
on  each  dollar  Or  fractional  part  thereof  of  such  premium;  for 
example,  upon  a  premium  charge  of  $10.10  the  tax  imposed  is 
33  cents,  being  3  cents  for  each  dollar  and  3  cents  for  the  frac- 
tional part  of  a  dollar.^s* 

Insurance  on  Commodities  Exported.  No  tax  is  imposed 
upon  the  premiums  charged  for  insurance  issued  to  cover  com- 
modities which  are  in  the  actual  process  of  exportation  and  which 
have  begun  their  voyage  or  preparation  for  the  voyage  from  the 
United  States.  If  a  policy  or  other  instrument  is  issued  covering 
both  export  and  non-export  property,  the  tax  will  be  computed 
upon  the  full  amount  of  the  premium  charged,  unless  such  in- 
strument clearly  indicates  the  property  for  export  and  the  pre- 
mium charged  for  the  insurance  thereon.^ss 

Movable  Property.  Movable  property  such  as  rolling  stock 
of  railroads,  ships,  vessels,  barges,  and  other  similar  movable 
property,  is  held  to  be  property  within  the  United  States  if  the 
principal  place  of  business  of  the  corporation  or  partnership,  own- 
ing and  controlling  the  same,  is  located  within  the  United  States, 
or  in  the  case  of  an  individual,  if  he  resides  in  the  United  States, 
unless  such  property  is  permanently  located  without  the  United 
States  for  the  purpose  of  ordinary  use.  The  nation  of  registry  of 
a  vessel  has  no  bearing  upon  the  location  of  the  property  in  the 
same.256 

Credits  and  Refunds.  In  case  a  policy  of  insurance  or  other 
instrument  is  issued  and  accepted  by  the  insured,  and  afterwards, 
for  any  reason,  such  insurance  does  not  become  effective,  the 
value  of  the  stamps  affixed  thereto  will  be  refunded  upon  a  proper 
claim  presented  to  the  collector.257 

Penalties.  In  addition  to  other  penalties  provided  by  the 
Revenue  Act  of  1921,258  there  is  imposed  a  penalty  of  double  the 
amount  of  the  tax  upon  (a)  any  person  to  or  for  whom  or  in 
whose  name  any  such  policy  or  other  instrument  is  issued,  or  (b) 

253  Reg.  55  Rev.,  Art.  163. 

254  Reg.  55  Rev.,  Art.  164. 

255  Reg.  55  Rev.,  Art.  165. 

256  Reg.  55  Rev.,  Art.  166. 

257  Reg.  55  Rev.,  Art.  167. 

258  §  1102. 


THE   STAMP   TAX  1203 

any  solicitor,  agent,  or  broker  acting  for  or  on  behalf  of  such 
person  in  the  procurement  of  any  such  poHcy  or  other  instrument, 
who  fails  to  affix  the  proper  stamps  to  such  poKcy  or  other  in- 
strument, with  intent  to  evade  the  tax.-"''J 

Returns.  No  monthly  return  or  monthly  statement  showing 
a  list  of  policies  or  other  instruments  by  which  insurance  was 
made  or  renewed  upon  property  located  in  the  United  States  by  a 
foreign  corporation  or  partnership  or  non-resident  individual  is 
now  required  from  any  person  to  or  for  whom  or  in  whose  name 
such  policy  or  other  instrument  is  issued,  or  from  the  solicitor 
or  broker  acting  directly  or  indirectly  for  or  on  behalf  of  such 
person,  but  each  person,  solicitor,  or  broker  accepting,  placing, 
or  soliciting  such  policy  or  other  instrument  is  required  to  keep 
a  record  of  each  policy  or  other  instrument  subject  to  the  tax 
imposed  by  this  subdivision  by  which  he  has  directly  or  indirectly 
made,  placed,  solicited,  or  assisted  in  the  making  or  renewal  of, 
such  insurance,  or  for  which  he  has  paid  or  received  compensa- 
tion, and  shall  be  prepared  to  furnish  full  information  to  the 
Commissioner  at  any  time  upon  demand.-^^ 

Leases.  Leases  are  not  taxed  under  this  law.^^i 
Mortgages.  Mortgages  are  not  taxed  under  this  law. 
Mutual  Ditch  and  Irrigating  Companies.  Stocks  and  bonds 
issued  by  mutual  ditch  or  irrigation  companies  are  not  taxable.^cs 
The  law  seems  to  exempt  stock  of  such  companies  from  the  tax 
on  the  issue  thereof,-^"'"  and  also  from  the  tax  on  sales  or  trans- 
fers. The  exemption  does  not  extend  to  notes  or  any  other  in- 
struments except  certificates  of  stock  and  bonds. 

Parcel-Post  Packages.  Parcel-post  packages  are  not  subject 
to  stamp  tax  under  the  Revenue  Act  of  1921.  For  a  discussion  of 
the  taxation  thereof  under  the  1918  Law  see  the  1920  edition  of 
this  book. 

Passage  Tickets.  The  tax  on  passenger  tickets  is  only  imposed 
on  tickets  sold  or  issued  in  the  United  States  for  passage  by  any 
vessel  to  a  port  or  place  not  in  the  United  States,  Canada  or 
Mexico.-^^  Such  tickets  are  required  to  be  stamped  whether  they 
are  one-way  or  round-trip.  No  tax  is  imposed  on  tickets  costing 
$10  or  less.    The  rate  is  one  dollar  if  the  cost  of  the  ticket  does 

259  Reg.  55  Rev.,  Art.  168;  Revenue  Act  of  1921,  Title  XI,  Schedule  A-13. 

200  Reg.  55  Rev.,  Art.  166. 

201  Reg.  55,  Art.  100. 

262  Revenue  Act  of  1921,  §  1101. 

263  See  Reg.  40  Rev.,  Art.  5. 

264  Passage  tickets  sold  or  issued  in  the  United  States  for  passage  by  any 
vessel  to  a  part  or  place  in  Newfoundland  are  subject  to  tax  (Reg.  55  Rev., 
Art.  119). 


1204  FEDERAL  INCOME  TAX 

not  exceed  $30 ;  $3  if  the  cost  of  the  ticket  exceeds  $30  and  does 
not  exceed  $60,  and  $5  if  the  cost  of  the  ticket  exceeds  $60.-*^^ 
Where  a  single  ticket  is  issued  for  transportation  for  more  than 
one  passenger  the  ticket,  coupon,  or  prepaid  order  must  be 
stamped  at  the  proper  rate  for  each  passenger  based  on  the  num- 
ber of  passengers,  and  the  total  amount  paid  for  the  transporta- 
tion.266  It  is  the  duty  of  the  person  selling  the  ticket  to  affix  the 
stamp  to  the  ticket  or  paper  which  evidences  the  sale  and  cancel 
the  stamp.-*'''' 

Tickets  Subject  to  Tax.  Passage  tickets  issued  to  private 
individuals  traveling  on  vessels  operated  privately  or  by  any  Gov- 
ernment are  taxable.-*''^  Passage  tickets  to  Porto  Rico  or  the 
Philippine  Islands  are  taxable.-'''-^  Passage  tickets  issued  in  the 
United  States  to  ports  not  in  the  United. States,  Canada  or  Mexico 
on  exchange  orders  purchased  in  Canada  or  Mexico  in  connection 
with  through  transportation  from  points  in  Canada  or  Mexico 
are  subject  to  tax.-'^^  Passage  tickets  issued  in  the  United  States 
to  ports  not  within  the  United  States,  Canada  or  Mexico  on  ex- 
change orders  purchased  other  than  in  the  United  States,  Canada 
or  Mexico,  are  subject  to  tax.^^i 

Tickets  Not  Subject  to  Tax.  Prepaid  orders  for  passage 
tickets  are  not  subject  to  tax.^'^-  Passage  tickets  issued  to 
Hawaii  or  Alaska  are  not  taxable.-^^  Passage  tickets  sold  in  the 
United  States  from  ports  not  within  the  United  States,  Canada 
or  Mexico,  to  a  port  in  the  United  States,  Canada  or  Mexico,  are 
not  subject  to  tax  unless  sold  as  a  part  of  a  round  trip  or  through 
ticket  from  a  port  in  the  United  States,  Canada  or  Mexico.^'^'^ 

Passage  Tickets  Issued  to  Federal  and  State  Officials 
and  Foreign  Representatives.  Passage  tickets  issued  to  United 
States  Government  officials,  employees,  military  and  naval  forces, 
as  well  as  officials  of  states  and  their  political  subdivisions, 
traveling  in  the  course  of  their  duty  as  such  on  vessels  operated 
by  private  parties  or  by  any  government  are  not  taxable  when 
the  amount  of  the  passage  is  paid  for  by  the  United  States 
Government,  state  or  political  subdivision  thereof.     Ambassa- 

265  Revenue  Act  of  1921,  Title  XI,  Schedule  A-9. 
26C  T.  D.  2067. 

267  T.  D.  2067. 

268  Reg.  55  Rev.,  Art.  114. 

269  Reg.  55  Rev.,  Art.  115. 

270  Reg.  55  Rev.,  Art.  118. 

271  Reg.  55  Rev.,  Art.  119. 

272  Reg.  55  Rev.,  Art.  117. 

273  Reg.  55  Rev.,  Art.  116. 

274  Reg.  55  Rev.,  Art.  120. 


THE   STAMP   TAX  1205 

dors,  ministers  and  properly  accredited  diplomatic  represent- 
atives of  any  foreign  government  to  the  United  States  are  ex- 
empt from  the  payment  of  taxes  on  such  passage  tickets.  All 
other  foreign  agencies  not  specifically  mentioned  above  are  sub- 
ject to  the  tax.-^'^ 

Playing  Cards.  A  tax  of  8  cents  per  pack  is  imposed  upon 
every  pack  of  playing  cards  containing  not  more  than  fifty-four 
cards,  manufactured  or  imported,  and  sold  or  removed  for  con- 
sumption or  sale.  This  rate  became  effective  on  April  1,  1919.-'c 
It  has  been  held  that  the  statute  imposing  a  tax  on  playing  cards 
requires  that  each  pack  of  cards  shall  show  a  stamp  denoting  a 
payment  of  the  tax,  and  a  dealer,  therefore,  may  not  reassemble 
the  cards  from  the  packs  on  which  the  stamp  tax  has  been  paid 
and  then  offer  the  reassembled  packs  for  sale  in  new  wrappings 
without  restamping.-'^  Every  manufacturer  or  importer  of  play- 
ing cards  will  be  required  to  render  a  monthly  report,  under 
oath,  on  Form  749,  in  duplicate,  showing  the  number  of  cards 
on  hand  at  the  first  of  the  month,  the  number  manufactured  or 
received,  likewise  the  number  withdrawn,  tax  paid,  or  free  of 
tax  for  export  or  use  of  the  United  States,  and  the  number  on 
hand  at  the  end  of  the  month,  together  with  like  information  rela- 
tive to  the  value  of  stamps  received  and  used  during  the  month. 
The  report  should  be  rendered  on  the  last  day  of  the  month,  or 
on  or  before  the  10th  day  of  the  succeeding  month.  Blank  re- 
turns, Form  749,  may  be  procured  from  collectors.2<s 

Powers  of  Attorney.  Powers  of  attorney  are  taxable  instru- 
ments under  this  law  if  they  are  such  that  they  grant  authority 
to  do  or  perform  some  act  for  or  in  behalf  of  the  grantor,  which 
authority  is  not  otherwise  vested  in  the  grantee.  The  tax  at- 
taches to  or  is  imposed  on  the  instrument  itself  and  is  not  meas- 
ured by  the  number  of  persons  joining  therein.-"^  A  power  of 
attorney  containing  a  power  of  substitution  requires  only  one 
stamp. -^"    Where  the  original  power  of  attorney  has  been  prop- 

275  Reg.  55  Rev.,  Art.  113;  Vol.  2,  T.  D.  (1898),  No.  20,196. 

2T6  Revenue  Act  of  1918,  Title  XI,  Schedule  A-13;  Revenue  Act  of  1921, 
Title  XI,  Schedule  A-12.  The  Act  of  August  28,  1894,  imposed  a  tax  of  2 
cents  per  pack  on  playing  cards.'  The  Act  of  October  3,  1917,  imposed  an 
additional  tax  of  5  cents  per  pack,  or  a  total  of  7  cents  on  each  pack.  The 
1918  Law  amended  the  former  laws  and  provided  a  tax  of  8  cents  per  pack, 
being  the  same  rate  as  provided  by  the  present  law,  as  indicated  in  the  text 
above.    (T.  D.  2817.) 

277  U.  S.  v.  Neustaedter,  149  Fed.  1010;  Reg.  55  Rev.,  Art.  149. 

278  T.  D.  2817. 

279  Revenue  Act  of  1921,  Title  XI,  Schedule  A-11.   Reg.  55  Rev.,  Art.  130. 

280  T.  D.  2134. 


1206  FEDERAL  INCOME  TAX 

erly  stamped  and  a  copy  of  it  has  been  printed  on  a  card  (Form 
272)  provided  by  the  Government,  and  the  card  is  filed  in  the 
executive  departments  of  the  Government  or  with  a  collector, 
such  copy  is  not  subject  to  tax.^si  The  rate  of  tax  on  powers  of 
attorney  is  25  cents.  The  law  expressly  provides  that  no  stamps 
shall  be  required  on  any  papers  necessary  to  be  used  for  the 
collection  of  claims  from  the  United  States  or  from  any  state  for 
pensions,  back  pay,  bounty  or  for  property  lost  in  the  military 
and  naval  service.-"^-  Powers  of  attorney  required  in  bankruptcy 
cases  are  also  expressly  exempted.^-'*-^  Powers  of  attorney  con- 
tained in  the  application  of  those  who  become  members  of  or 
policyholders  in  mutual  insurance  companies  doing  business  on 
the  inter-insurance  or  reciprocal  indemnity  plan  through  an  at- 
torney in  fact,  are  declared  by  the  law  to  be  exempt.^s^  The 
powers  of  attorney  enumerated  in  the  paragraphs  immediately 
following  are  also  exempt. 

Warrant  of  Attorney  in  a  Lease.  A  warrant  of  attorney, 
embodied  in  a  lease  is  not  taxable.^ss 

Authorizing  Federal  Official  to  Sell  United  States 
Bonds  in  Case  of  Default,  Powers  of  attorney  given  by  per- 
sons who  deposit  United  States  Liberty  bonds  or  other  bonds  of 
the  United  States  as  security  in  lieu  of  surety  or  sureties  on  penal 
bonds  under  the  provisions  of  the  Revenue  Acts  of  1918  and 
1921,  authorizing  the  official  having  authority  to  approve  such 
penal  bonds  to  collect  or  sell  such  United  States  bonds  so  de- 
posited in  case  of  any  default  in  the  performance  of  any  of  the 
conditions  or  stipulations  of  such  penal  bonds,  are  not  subject 
to  the  stamp  tax.-^s 

Authorizing  Officer  of  Federal  Reserve  Bank  to  Assign 
United  States  Bonds  Deposited  as  Security.  A  power  of  at- 
torney executed  by  a  bank  authorizing  a  designated  officer  of  a 
Federal  Reserve  Bank  to  assign  United  States  bonds  deposited 
with  the  Federal  Reserve  Bank  and  designed  to  protect  it  in 
event  of  default  in  payment  of  a  loan  is  not  taxable. 

281  Reg.  55,  Art.  145. 

282  Revenue  Act  of  1921,  Title  XI,  Schedule  A-11. 

283  This  express  exemption  seems  to  have  been  introduced  in  the  1917  Law 
as  a  result  of  the  decisions  in  the  cases  of  In  re  Hawley,  220  Fed.  372,  which 
held  that  a  general  letter  of  attorney  in  bankruptcy  was  taxable  under  the 
1914  Law,  and  In  re  Capitol  Trading  Company,  229  Fed.  806,  which  held 
bankruptcy  powers  of  attorney  taxable  under  the  1914  Law. 

284  Revenue  Act  of  1921,  Title  XI,  Schedule  A-11. 

285  Reg.  55  Rev.,  Art.  141. 

286  Reg.  55  Rev.,  Art.  147. 


THE   STAMP   TAX  1207 

Powers  of  attorney  given  by  persons  who  deposit  United 
States  Liberty  bonds  or  other  bonds  of  the  United  States  as  se- 
curity in  lieu  of  surety  or  sureties  on  penal  bonds  under  the  pro- 
visions of  the  Revenue  Acts  of  1918  and  1921-'^'  authorizing  the 
officials  having  authority  to  approve  such  penal  bonds  to  collect 
or  sell  such  United  States  bonds  so  deposited  in  case  of  any  de- 
fault in  the  performance  of  any  of  the  conditions  or  stipulations 
of  such  penal  bonds,  are  not  subject  to  the  stamp  tax.^ss 

Authorizing  Deputy  to  Have  Access  to  Safe.  A  power  of 
attorney  authorizing  a  deputy  to  have  access  only  to  safe  or 
safety  deposit  box  is  not  subject  to  tax,  but  a  power  of  attorney 
to  have  access  and  control  over  its  contents  is  subject  to  tax,2S9 

Executed  or  Accepted  in  Foreign  Country.  A  power  of 
attorney  executed  and  mailed  within  the  United  States  to  a  for- 
eign point  is  subject  to  tax,  but  a  power  executed  in  a  foreign 
country  and  mailed  there  to  an  agent  in  the  United  States  is  not 
subject  to  tax.290 

Formal  Powers  of  Attorney.  Powers  of  attorney  which  are 
merely  formal  and  grant  no  authority  which  is  not  otherwise 
vested  in  the  grantee  are  not  taxable.  Thus,  it  has  been  held  that 
no  tax  is  imposed  upon  powers  of  attorney  in  the  following  cases : 

Contained  in  Assignments  for  Valuable  Consideration, 
Conferring  No  Authority  Upon  Assignee  Not  Implied  by 
THE  Assignment,  Not  Taxable.  An  assignment,  for  a  valuable 
consideration,  of  debts,  wages,  mortgages,  bond,  etc.,  ordina- 
rily transfers  to  the  assignee  all  the  rights  of  the  assignor  and  the 
remedies  necessary  for  their  enforcement,  and  the  assignee  ac- 
quires no  further  rights  by  the  means  of  a  power  of  attorney 
clause  in  the  assignment  than  are  conveyed  by  the  instrument 
itself,  and  such  pro  forma  power  of  attorney  is  therefore  not 
taxable.291 

Assignment  of  Insurance  Policies.  No  stamp  tax  is  im- 
posed upon  the  power  of  attorney  contained  in  a  transfer  by  as- 
signment, absolute  or  as  collateral  security,  of  an  interest  in  a 
contract  of  insurance,  if  the  power  of  attorney  grants  authority 
to  do  or  perform  only  such  acts  for  or  in  behalf  of  the  assignor 
as  are  otherwise  vested  in  the  assignee.-^^ 

287  §  1320. 

288  Reg.  55  Rev.,  Art.  147. 
280  Reg.  55  Rev.,  Art.  146. 
290  Reg.  55  Rev.,  Art.  142. 
2«i  Reg.  55  Rev.,  Art.  137. 

292  Reg.  55  Rev.,  Art.  134;  T.  D.  2599. 


1208  FEDERAL  INCOME  TAX 

To  Pay  Poll  Taxes.  Powers  of  attorney  issued  in  accordance 
with  the  provisions  of  the  state  statutes  authorizing  a  person  to 
pay  a  poll  tax  of  an  individual  are  not  required  to  be  stamped.^^^ 

Power  of  Sale.  The  power  of  sale  generally  embodied  in  a 
mortgage,  real  or  chattel,  authorizing  and  empowering  the  mort- 
gagee himself  upon  default  to  make  a  public  sale  of  the  property 
affected  and  to  convey  the  title  to  the  purchaser  at  such  sale,  free 
from  all  rights  or  equity  of  redemption,  thus  avoiding  the  neces- 
sity of  resorting  to  the  courts  for  foreclosure,  differs  from  a 
power  of  attorney  in  many  respects,  one  of  which  is  that  the 
latter  always  creates  an  agency  or  a  representative  relation, 
whereas  a  mortgagee  under  a  power  of  sale  acts  on  his  own  be- 
half and  for  his  own  benefit.  Such  power  of  sale  is  not  taxable 
as  a  power  of  attorney.^^^ 

Authority  to  Secretary  of  Corporation  to  Transfer 
Stock.  An  instrument  authorizing  the  secretary  to  transfer 
stock  on  the  books  of  a  corporation  is  not  taxable  as  a  power 
of  attorney,  but  an  instrument  appointing  an  attorney  in  fact 
to  transfer  stock  on  the  books  of  a  corporation  is  taxable.-^^ 

Pro  Forma  Power  of  Attorney  to  Transfer  Bonds  or 
Stocks  on  Books  of  Corporation,  Printed  on  Bond  or  Stock 
Certificate.  The  pro  forma  power  of  attorney  to  transfer 
bonds  or  stocks  on  the  books  of  a  corporation,  embodied  in  the 
assignment  printed  on  the  back  of  the  bond  or  stock  certificate,  is 
not  subject  to  tax.296 

Authorizing  Vendee  of  Shares  of  Stock  to  Transfer 
Same.  A  power  of  attorney  by  which  a  person  executing  the  in- 
strument sells,  assigns  and  transfers  shares  of  stock  and  appoints 
the  vendee  agent  for  the  transfer  is  not  subject  to  the  tax.^^^ 

Granted  by  Corporation.  Where  a  corporation  by  resolution 
of  its  Board  of  Directors  has  empowered  an  officer  thereof  to  sell, 
assign  or  transfer  stock  or  bonds  standing  in  the  name  of  the  cor- 
poration, or  to  perform  any  act  in  the  name  of  the  corporation, 
such  authority  is  not  taxable  as  a  power  of  attorney  for  the  rea- 
son that  it  is  necessary  for  a  corporation  to  perform  its  corpo- 
rate acts  through  one  of  its  officers.  If,  however,  a  person  other 
than  an  officer  of  the  corporation  acting  in  his  official  capacity 
is  given  this  authority,  the  power  of  attorney  so  granted  is  tax- 

293  T.  D.  2269. 

294  Reg.  55  Rev.,  Art.  33;  T.  D.  2196. 

295  Reg.  55  Rev.,  Art.  138. 

296  Reg.  55  Rev.,  Art.  139;  T.  D.  2085;  T.  D.  2134. 
207  Reg.  55  Rev.,  Art.  144. 


THE   STAMP   TAX  1209 

able.^'JS'  A  general  power  of  attorney  granted  by  a  Board  of 
Directors  to  a  person  other  than  an  officer  of  a  corporation  acting 
in  his  official  capacity  for  the  purpose  of  representing  the  cor- 
poration in  transactions  of  a  like  kind  and  nature,  such  as  con- 
veying land  or  acknowledging  deeds,  is  considered  by  the  Treas- 
ury Department  as  specific  authority  for  each  individual  trans- 
action, and  a  revenue  stamp  is  required  on  each  instrument 
executed  under  the  power  of  attorney.--'^ 

Judgment  Notes.  Where  judgment  notes  contain  a  clause 
authorizing  any  attorney  at  law  to  confess  judgment  in  favor  of 
the  holder  of  the  note,  such  authorization  is  held  not  taxable  as  a 
power  of  attorney.  The  instrument  is  held  to  be  a  warrant  of 
attorney  instead  of  a  power  of  attorney. "'"^ 

From  Corporations  to  Resident  Agents.  Powers  of  attor- 
ney executed  by  corporations  to  resident  agents  authorizing  the 
latter  to  accept  service  of  process  are  taxable.-'^oi 

To  Sell  or  Transfer  Government  Bonds.  A  power  of  attor- 
ney to  sell  or  transfer  Government  Bonds  is  taxable.^o- 

To  Sell,  etc.,  Shares  of  Capital  Stock.  A  power  of  attor- 
ney to  sell,  assign  and  transfer  shares  of  capital  stock  is  subject 
to  tax  unless  it  is  given  in  connection  with  a  deposit  of  the 
stock  as  security  for  a  loan.-^os 

When  Tax  Accrues.  The  tax  on  a  power  of  attorney  is  due 
when  the  instrument  is  executed  and  delivered,  and  not  when 
the  power  is  exercised.^"^  Delivery  includes  depositing  the  in- 
strument in  the  mails.  Powers  of  attorney  executed  and  de- 
livered prior  to  April  1,  1919,  are  not  taxable  even  though  used 
subsequent  to  that  date,  except  such  as  are  taxable  under  the 
1917  Law.-'O'"^ 

Produce,  Sales  of,  on  Exchange.  The  tax  is  imposed  upon  (a) 
sales  of,  (b)  agreements  of  sale,  and  (c)   agreements  to  selP"*' 

2!»S  Reg.  55  Rev.,  Art.  131. 
2fl9  Reg.  55  Rev.,  Art.  132. 

300  Treat  v.  Tolman,  113  Fed.  892;  Reg.  55  Rev.,  Art.  140;  T.  D.  2081. 

301  Reg.  55  Rev.,  Art.  135. 

302  Reg.  55  Rev.,  Art.  136. 

303  Reg.  55  Rev.,  Art.  143. 

3ft4Reg.  55  Rev.,  Art.  129;  T.  D.  2134. 

305  Reg.  55  Rev.,  Art.  148. 

30CSee  Treat  V.  White,  181  U.  S.  264,  and  note  62.  The  term  "sale"  or 
"contract  of  sale"  includes  all  sales,  or  agreements  of  sale,  or  agreements 
to  sell,  including  so-called  transfers  or  "scratch  sales";  the  term  "agreement 
of  sale,"  or  "agreement  to  sell,"  includes  options,  calls  in  "puts  and  calls," 
offers,  indemnities,  and  privileges.     (Reg.  40  Rev.,  Art.  33.) 


1210  FEDERAL  INCOME  TAX 

for  future  delivery^o'''  any  product  or  merchandise  at  or  under 
the  rules  or  usages  of^^^  any  Exchange  or  Board  of  Trade,  or 
other  similar  place.'^"^  In  a  case  arising  under  the  1914  Law  it 
was  held  that  offers  to  sell  grain  made  subject  to  deferred  ac- 
ceptance, only  a  small  percentage  of  which  developed  into  sales 
and  on  which  the  brokers  received  only  $10  for  each  ten  thou- 
sand bushels  sold,  were  taxable  on  the  basis  of  the  total  price  on 
which  the  seller  agreed  to  sell  rather  than  the  basis  of  what 
the  buyer  was  to  receive;  and  also  that  the  tax  was  imposed  on 
each  sale  or  agreement  to  sell  any  grain,  though  during  the  day 
several  distinct  and  separate  sales  were  made  of  the  same  grain 
and  at  the  close  of  the  day  the  only  memoranda  made  showed 
a  transfer  from  the  original  seller  to  the  last  buyer.^i^  So-called 
transferred  or  scratch-sales  are  no  longer  taxed,  being  ex- 
pressly stated  not  to  be  included.'^ii  Neither  are  pass-outs  sub- 
ject to  tax.312  No  bill,  memorandum,  agreement  or  other  evi- 
dence of  a  sale,  or  agreement  of  sale,  or  agreement  to  sell,  in 
case  of  cash  sales  of  products  or  merchandise  for  immediate  or 
prompt  delivery  which  in  good  faith  are  actually  intended  to  be 
delivered  are  subject  to  this  tax.  When  the  seller  of  commodities 
subject  to  this  tax  has  paid  the  tax,  he  may  transfer  his  con- 
tracts to  a  clearing  house  without  paying  a  tax  on  such  trans- 
fer if  the  transfer  does  not  vest  any  beneficial  interest  in  such 
clearing  house  association,  but  is  made  for  the  sole  purpose  of 
enabling  the  clearing  house  association  to  adjust  and  balance 
the  accounts  of  its  members  on  their  several  contracts.     The 

307  The  act  of  October  22,  1914,  provided  for  a  tax  on  agreements  either 
for  present  or  future  delivery  but  made  an  express  exemption  to  cover  cases 
where  products  or  merchandise  were  actually  delivered  at  the  time  of  sale 
or  were  in  vessel,  boat  or  car  and  actually  in  the  course  of  transportation. 

308  The  words  "or  under  the  rules  or  usages  of"  were  added  by  the  Reve- 
nue Act  of  1918,  Title  XI,  Schedule  A-5. 

309  Revenue  Act  of  1921,  Title  XI,  Schedule  A-4;  Reg.  40  Rev.,  Art.  22. 

310  Calkins  v.  Smietanka,  240  Fed.  138. 

311  Reg.  40  Rev.,  Art.  23.  So-called  transferred  or  scratch  sales  were  ex- 
pressly included  in  the  1917  Law  (Act  of  October  3,  1917,  §  807,  Schedule 
A-5).  They  were  not  mentioned  expressly  in  the  1914  Law.  The  term  "trans- 
ferred or  scratch  sale"  includes  "pass-outs"  or  those  transactions  in  which  a 
person  buys  from  another  a  certain  quantity  of  any  product,  at  a  certain 
price,  and  at  the  same  session  of  an  exchange,  sells  to  a  third  person  the 
same  quantity  of  the  same  product  at  the  same  price,  and  eliminates  himself 
by  instructing  the  person  from  whom  he  bought  to  deliver  such  product  to 
the  person  to  whom  he  sold ;  but  no  transaction  in  which  a  broker  or  a  com- 
mission member  of  an  exchange  receives  a  commission  greater  than  that 
charged  to  a  person  who  executes  his  own  contracts  shall  be  deemed  to  be 
a  "transfer"  (or  a  "scratch  sale".)      (Reg.  40  Rev.,  Art.  33.) 

312  Reg.  40  Rev.,  Art.  23. 


THE   STAMP   TAX 


1211 


rate  is  as  follows:  2  cents  for  each  $100  or  fraction  thereof 
in  value  of  the  merchandise  covered  by  the  sale  or  agreement 
of  sale  or  agreement  to  se\W'^  It  is  provided  by  the  Revenue 
Act  of  1921  that  the  above  provisions  taxing  sales  of  produce 
shall  not  affect  but  shall  be  in  addition  to  the  provisions  of  the 
"United  States  Cotton  Futures  Act,"  approved  August  11,  1916, 
as  amended,  and  "The  Future  Trading  Act,"  approved  August 
24,  1921.31^ 

When  Tax  Accrues.  The  stamp  tax  on  sales  of  products  and 
merchandise  for  future  delivery  accrues  immediately  upon  the 
making  of  the  sale,  agreement  of  sale,  or  agreement  to  sell,  and 
is  in  no  wise  dependent  upon  the  manner  of  delivery  of  the 
product.^i^ 

Immediate  or  Prompt  Delivery.  Cash  sales  of  products  or 
merchandise  for  immediate  or  prompt  delivery  which  in  good 
faith  are  actually  intended  to  be  delivered  are  not  taxable.^ic 
"Immediate  or  prompt  delivery"  is  held  to  mean  delivery  at 
once  or  as  soon  as  practicable,  and  in  any  event  within  twenty 
days  from  the  date  of  sale  or  agreement  of  sale  or  agreement 
to  sell.-'^i^  Every  sale  or  agreement  not  evidenced  by  a  memo- 
randum or  contract  expressly  requiring  immediate  or  prompt 
delivery  within  the  above  definition  is  deemed  to  be  for  future 
delivery.  In  all  cases  in  which  the  Commissioner  is  not  satisfied 
from  the  evidence  submitted  to  him  that  the  transaction  was  in 
good  faith  intended  to  be  followed  by  immediate  or  prompt  de- 
livery, within  the  above  definition,  the  seller  will  be  required  to 
pay  the  tax  as  on  a  sale  for  future  delivery .^is 

Exchange  or  Board  of  Trade.  The  law  taxes  only  sales  at 
or  under  the  rules  or  usages  of  an  exchange  or  board  of  trade 
or  other  similar  place.^i^  The  term  "exchange,"  except  where 
it  is  plain  from  the  context  that  a  different  meaning  is  intended, 
includes  each  and  every  agency,  board  of  trade,  bourse,  auction 
place,  or  other  meeting  place,  whether  under  shelter  or  in  the 
open,  at  which  products  or  merchandise  are  publicly  bought, 
sold,  bid  for,  offered,  or  exchanged,  for  future  delivery,  or  con- 
tracts for  such  future  delivery  are  made,  either  between  mem- 
bers of  such  exchange,  or  between  members  and  non-members, 

313  Revenue  Act  of  1921,  Title  XI,  Schedule  A-4;  Reg.  40  Rev.,  Art.  21. 

314  Revenue  Act  of  1921,  Title  XI,  Schedule  A-4. 

315  Reg.  40  Rev.,  Art.  20. 

3ifi  Revenue  Act  of  1921,  Title  XI,  Schedule  A-4;  Reg.  40  Rev.,  Art.  22 

317  Reg.  40  Rev.,  Art.  33. 

siSReg.  40  Rev.,  Art.  22;  Reg.  No.  40,  Part  II,  Art.  4. 

319  Revenue  Act  of   1921,  Title  XI,  Schedule  A-4. 


1212  FEDERAL   INCOME  TAX 

patrons,  and  the  public;  and  includes  places  at  which  there  is 
only  one  manager  or  firm,  who  controls  all  the  sales  and  pur- 
chases at  that  particular  place  or  where  no  actual  delivery  of  the 
products  or  merchandise  is  contemplated,  and  all  incorporated 
and  unincorporated  associations  of  individuals,  partnerships, 
and  corporations  engaged  in  the  business  of  publicly  selling, 
buying,  or  exchanging  products  or  merchandise  for  future  de- 
livery .^20 

Transfers  to  Clearing  House.  Sellers  of  products,  merchan- 
dise or  commodities  having  paid  the  tax  provided  by  law  may 
transfer  such  contracts  to  a  clearing  house  association,  and 
such  transfer  is  not  taxable  within  the  provisions  of  the  Act, 
provided  that  the  transfer  does  not  vest  any  beneficial  interest  in 
the  clearing  house  association  and  is  made  for  the  sole  pur- 
pose of  enabling  such  clearing  house  association  to  adjust  and 

320  Reg.  40  Rev.,  Art.  33.  Reg.  No.  40,  Part  2,  Art.  1.  For  a  detailed  con- 
sideration of  the  nature  of  an  exchange  or  board  of  trade,  see  the  case  of 
Nicol  V.  Ames,  173  U.  S.  509.  This  case  went  so  far  as  to  hold  the  Union 
Stock  Yards  to  be  a  "similar  place"  within  the  meaning  of  the  1898  Law. 
No  sales  or  purchases  of  stocks  were  made  by  members  of  the  Union  Stock 
Yards  Company  as  such.  Anyone  was  accorded  the  right  to  bring  his  cattle 
to  the  stock  yards  upon  payment  of  the  regular  fees  and  compliance  with 
the  regulations  made  by  the  company,  and,  having  brought  his  cattle,  he 
had  the  right  accorded  him  by  the  company  to  have  them  kept,  fed,  watered, 
etc.,  and  to  sell  them  himself  or  by  a  commission  merchant,  who  did  not  need 
to  be  a  member  of  the  Stock  Yards  Company.  The  court  said:  "It  is  plain 
to  be  seen  that  the  privilege  or  facility  for  a  sale  of  the  cattle  or  other  stock 
at  the  yards  of  such  company  is  of  precisely  the  same  nature  and  character 
as  that  which  exists  at  an  exchange  or  board  of  trade  which  is  so  described 
in  terms.  That  the  sales  are  made  by  the  owners  of  the  cattle  or  by  com- 
mission merchants  who  are  not  members  of  the  stock-yards  company,  is  not 
material.  The  facilities  for  a  sale  exist  and  are  made  use  of  in  each  case, 
and  are  in  truth  the  same  in  each.  A  perusal  of  the  facts  contained  in  the 
record  in  the  case  shows  that  those  yards  answer  all  the  purposes  ol  an  ex- 
change or  board  or  trade,  and  that  they  in  truth  amount  in  substance  to 
the  same  thing.  The  differences  existing  between  them  are  unsubstantial 
so  far  as  this  point  is  concerned.  The  sales  at  that  place  are  accomplished 
with  a  facility  which  it  is  plain  could  not  exist  but  for  the  conditions  and 
advantages  afforded  by  the  use  of  those  yards.  The  owner  of  the  cattle 
who  brings  them  to  the  yards  and  avails  himself  of  the  privilege  of  selling 
them  at  that  place  does  without  doubt  make  use  of  a  privilege  which  everyone 
knows  is  an  advantage  sufficient  to  constitute  a  material  difference  between 
a  sale  at  the  yards  and  a  sale  elsewhere.  This  advantage,  although  one  which 
any  person  could  use,  is  yet  of  precisely  the  same  nature  as  that  existing 
in  the  case  of  an  exchange  or  board  of  trade,  and  it  is  therefore  a  similar 
place  within  the  meaning  of  the  statute.  Being  a  similar  place,  the  reasons 
stated  in  the  foregoing  cases  apply  with  equal  force  here  and  demand  the 
same  judgment." 


THE   STAMP   TAX 


1213 


balance  the  accounts  of  its  members  on  their  several  contracts.^21 
A  clearing  house  is  defined  to  be  any  incorporated  or  unincor- 
porated association  or  committee  carried  on  for  the  purpose  of 
clearing,  settling  and  adjusting  transactions  in  purchasing,  sell- 
ing or  delivering  products  or  merchandise,  whether  such  clear- 
ing house  be  a  part  or  department  of  an  exchange  or  an  inde- 
pendent body.'^-- 

INCONSISTENT    BY-LAWS,    RULES    OR    CUSTOMS    OF    EXCHANGE. 

No  provisions,  by-laws,  rules,  or  customs  of  any  exchange, 
board  of  trade,  or  similar  institution  or  place  of  business  which 
are  inconsistent  or  in  conflict  with  any  requirement  or  provision 
of  the  law,  or  any  regulations  made  thereunder,  or  any  collateral, 
or  additional  agreement,  verbal  or  written,  respecting  the  subject- 
matter  of  such  contract  or  the  settlement  or  fulfillment  thereof 
which  is  inconsistent  or  in  conflict  with  any  requirement  of  said 
act  or  regulations,  will  exempt  any  person  from  the  payment  of 
tax  on  sales  of  produce  on  an  exchange.-'^-^^ 

Sale  of  Stamps.  The  ruling  of  the  Treasury  Department  in 
regard  to  the  sale  of  stamps  to  be  attached  to  sales,  agreements 
of  sale,  or  agreements  to  sell  products  or  merchandise  is  given 
elsewhere  in  this  book.'^-^ 

Registration  and  Records.  All  persons  engaged  in  the  busi- 
ness of  making  contracts  of  sale  on  any  exchange  and  all  clearing 
houses  and  members  of  exchanges  are  required  to  register  and 
keep  records  of  transactions  subject  to  the  tax.  The  rulings  in 
this  respect  are  referred  to  more  fully  in  a  subsequent  part  of 
this  chapter.^s'^ 

Promissory  Notes.  The  law  provides  that  the  tax  on  promissory 
notes,  and  for  each  renewal  of  the  same,  for  a  sum  not  exceed- 
ing $100  shall  be  2  cents ;  and  for  each  additional  $100  or  frac- 
tional part  thereof  2  cents.  Drafts  or  checks  expressly  payable 
otherwise  than  at  sight  or  on  demand  are  also  taxable  at  th-3 
same  rate.-'^-^' 

The  stamp  tax  on  a  promissory  note  is  measured  by  the  amount 
of  the  principal  obligation  without  regard  to  the  form  in  which 
the  obligation  to  pay  interest  is  expressed.^^T 

321  Revenue  Act  of  1921,  Title  XI,  Schedule  A-4;  Reg.  40  Rev.,  Art.  23. 

322  Reg.  40  Rev.,  Art.  33;  Reg.  No.  40,  Part  II,  Arts.  1-4. 

323  Reg.  40,  Art.  24. 

324  See  p.  1238. 
32.5  See  p.  1231. 

320  Revenue  Act  of  1921,  Title  XI,  Schedule  A-5;  Reg.  55,  Art.  63. 
327  Reg.  55  Rev.,  Art.  48   (b). 


1214  FEDERAL  INCOME  TAX 

Who  Affixes  Stamp.  The  person  who  makes  or  issues  a 
promissory  note  is  required  by  the  law  to  place  the  stamp  upon 
the  same  and  cancel  it.  If  he  does  not  do  so  the  holder  or  owner 
may  affix  and  cancel  the  stamp  as  agent  for  the  maker.  The 
drawee,  payee  or  endorsee  should  see  that  the  tax  is  paid  before 
or  at  the  time  of  acceptance  or  delivery ."-s  The  question  of  who 
shall  pay  for  the  stamp  is  a  matter  of  adjustment  between  the 
parties.329  jf  ^  draft  is  presented  to  the  drawee  for  acceptance 
and  discount  by  him,  stamps  must  be  first  affixed  by  the  drawer, 
for  the  acceptance  and  delivery  are  simultaneous.  The  payee  or 
the  indorsee  from  the  drawer  must  see  to  it  that  the  drawer,  as 
the  person  "who  makes,  signs  or  issues"  the  draft,  pays  the  tax 
before  delivery.  "Accept"  is  used  in  the  penal  provision  in  Sec- 
tion 1102  in  the  general  sense  of  "receive,"  not  in  the  special  sense 
peculiar  to  drafts.  No  drawee  accepting  an  unstamped,  unde- 
livered draft  would  violate  the  law ;  but  if  the  draft  has  already 
become  taxable  because  of  a  prior  delivery,  the  acceptor  must  be 
sure  that  stamps  are  affixed.^'^^ 

Renewal  of  Notes.  A  renewal  after  the  incidence  of  the  tax 
of  a  note  issued  prior  thereto  is  subject  to  tax.^^i  Any  writing  or 
instrument  however  designated  which  operates  as  a  renewal  of  a 
promissory  note  is  taxable.^^^  a  written  agreement,  either  at- 
tached or  unattached  to  a  promissory  note  or  in  the  form  of  an 
endorsement  on  the  note,  such  as  "renewed"  or  "extended"  to  a 
certain  date,  evidencing  payment  and  acceptance  of  interest  in 
advance  to  a  time  certain,  subsequent  to  maturity,  constitutes  a 
renewal  of  the  note  and  is  subject  to  tax  as  such.^^''  Mere  suspen- 
sion of  payment  or  forbearance  is  not  taxable.^s^  Part  payment 
of  a  note  after  it  becomes  due,  or  payment  of  accrued  interest 
after  maturity,  the  note  being  allowed  to  run  and  the  holder 
neither  losing  nor  postponing  his  right  of  action,  is  merely  in  the 

328  Reg.  55  Rev.,  Art.  48. 
320  Reg.  55,  Art.  35. 

330  T.  D.  2682. 

331  Revenue  Act  of  1921,  Title  XI,  Schedule  A-5.  Letter  from  treasury 
department  dated  December  11,  1917;  W.  T.  S.  1918,  Tj   3679. 

332  Reg.  55  Rev.,  Art.  51. 

333  Reg.  55  Rev.,  Art.  60.     The  following  endorsement  will  operate  under 

this  rule  as  a  renewal :    "19 — .    Received  six  months  interest  to ,19 — , 

$ ."  , 

The  stamps  should  be  affixed  to  the  extension  agreement  and  not  to  the 
original  note  (letter  from  treasury  department  dated  March  31,  1921; 
W.  T.  S.  1921,  114027). 

334  Reg.  55  Rev.,  Art.  57. 


THE   STAMP   TAX  1215 

nature  of  a  forbearance  and  is  not  taxable  as  a  renewal,"^''''  A 
'  contract  or  agreement  extending  either  a  chattel  or  real  estate 
mortgage  is  not  taxable,  but  if  such  extension  effects  the  renewal 
of  promissory  notes,  either  embodied  in  the  mortgage  or  given  in 
connection  with  the  mortgage,  the  renewal  of  such  notes  is  tax- 
able.336 

Transfer  of  Notes.  No  stamp  is  required  upon  the  transfer 
by  indorsement  of  promissory  notes. 

Definition  of  Promissory  Notes.  A  promissory  note  is  an 
unconditional  promise  in  writing  made  by  one  person  to  another, 
signed  by  the  maker,  engaging  to  pay  on  demand  or  at  a  fixed  or 
determinable  future  time,  a  sum  certain  in  money  to  such  other 
person  or  to  order  or  to  bearer,  free  from  restrictions  as  to  regis- 
tration or  transfer,  and  usually  without  coupons.-'-'''"  The  term 
"promissory  notes,"  as  used  in  the  statute  includes  those  payable 
on  demand.s-^s  Promissory  notes  given  for  security  only  are  tax- 
able.-"^3o  Whether  or  not  an  instrument  is  taxable  as  a  promissory 
note  depends  upon  its  form  and  not  upon  its  use.  Thus,  a  receipt 
given  by  a  loan  company  for  property  received  as  security  for  a 
debt  is  not  a  promissory  note;  but,  if  in  the  receipt  there  is  in- 
cluded a  promise  to  pay  a  certain  sum  of  money  at  a  specified  time, 
with  interest,  for  value  received,  such  a  provision  in  the  opinion  of 
the  Treasury  Department  is  a  valid  promissory  note,  upon  which 
the  maker  would  be  liable  in  a  suit  at  law,  and  is  taxable.^^^*^  Pol- 
icy loan  and  premium  extension  agreements  which  contain  an 
unqualified  promise  to  pay  a  specified  sum  of  money  at  a  certain 
date  are  subject  to  stamp  tax  as  promissory  notes.  Where  the 
sole  remedy  of  payee  in  case  of  nonpayment  of  the  premiums  or 
loans  is  to  reduce  or  cancel  the  rights  of  the  insured,  tax  does 
not  accrue.2^1  In  the  case  of  contracts  for  the  purchase  of  pianos, 
machinery,  and  other  merchandise,  there  is  sometimes  included, 
among  other  conditions  and  provisions,  an  agreement  to  pay  the 
vendor  a  stipulated  sum  of  money  at  a  certain  time,  with  interest, 
for  value  received.  If  this  agreement  is  in  form  and  effect  a 
good  and  valid  promissory  note,  upon  which  the  maker  would  be 
liable  in  a  suit  at  law,  such  promissory  note  is  taxable.    If,  how- 

:«5  Reg.  55  Rev.,  Art.  59.     Letter  from  treasury  department  dated  June 
14,  1918;  W.  T.  S.  1918,  Tj  3742.     See  T.  D.  2265. 

336  Reg.  55  Rev.,  Art.  52;  T.  D.  2170. 

337  Reg.  55  Rev.,  Art.  48. 

338  Reg.  55  Rev.,  Art.  49. 

339  Reg.  55  Rev.,  Art.  50. 

340  T.  D.  2170. 

341  Reg.  55  Rev.,  Art  61 ;  T.  D.  2599. 


1216  FEDERAL   INCOME   TAX 

ever,  the  contract  merely  provides  for  the  payment  of  the  pur- 
chase price  in  installments  and  enumerates  the  dates  upon  which 
such  payments  are  due,  stating,  as  many  of  the  contracts  do, 
that  in  default  of  payment  the  vendor  may  take  the  property, 
such  agreement  is  not  a  promissory  note.-^^-  It  is  often  difficult 
to  make  a  distinction  between  promissory  notes  and  bonds  of 
indebtedness.  Although  in  a  broad  sense  many  notes  are  bonds 
and  many  bonds  are  notes,  obviously  Congress  did  not  intend  to 
tax  the  same  instrument  under  two  heads.^^^  An  instrument, 
not  under  seal,  containing  a  simple  promise  to  pay  a  sum  of 
money  at  a  specified  time,  such  as  is  common  in  everyday  com- 
mercial use,  is  a  promissory  note.^^^  It  has  been  held,  however, 
that  the  fact  that  a  promissory  note  is  under  seal  does  not  make 
it  taxable  as  a  bond.-^^^  A  short  term  instrument,  although  is- 
sued by  a  corporation  under  a  trust  indenture,  may  be  regarded 
as  a  note  if  every  instrument  of  such  issue  both  (a)  is  payable 
to  bearer  and  incapable  of  registration  and  (b)  lacks  interest 
coupons,  and  so  requires  presentation  upon  each  payment  of 
interest.3^*'  Thus,  the  fact  that  a  note  may  be  secured  by  a  mort- 
gage or  issued  under  a  deed  of  trust  does  not  necessarily  make 
it  taxable  as  a  bond.  One  distinction  between  bonds  and  promis- 
sory notes  seems  to  be  the  time  for  which  the  note  or  bond  is 
to  run.  Promises  to  pay  within  a  comparatively  short  period  of 
time,  such  as  one  year  or  two  years,  are  usually  held  to  be  tax- 
able as  notes  while  promises  to  pay  at  the  end  of  a  longer  period 
are  considered  more  in  the  nature  of  bonds  or  certificates  of 
indebtedness. 

Coupons  attached  to  bonds,  debentures,  or  certificates  of  in- 
debtedness issued  by  any  individual,  partnership,  or  corporation, 
or  to  instruments,  however  termed,  issued  by  a  corporation  and 
known  generally  as  corporate  securities  (all  of  which  are  subject 
to  tax  as  bonds  of  indebtedness)  are  not  subject  to  tax  if  they 
impose  no  obligations  not  imposed  by  the  principal  instrument. 
Interest  coupons  attached  to  promissory  notes,  as  distinguished 
from  the  securities  enumerated  above,  if  they  are  themselves 
promissory  notes,  separable  from  the  principal  obligation  and 
negotiable  independently  of  it,  are  subject  to  tax,  even  though 

342  T.  D.  2170. 

343  T.  D.  2713.     See  Paragraph  on  Bonds  of  Indebtedness. 

344  T.  D.  2713.     See  Paragraph  on  Bonds  Given  in  Penal  Sum. 

345  T.  D.  21815.     (Act  of  June  13,  1898.) 
340  T.  D.  2713. 


THE   STAMP   TAX  1217 

they  impose  no  obligation  not  imposed  by  the  principal  instru- 
ment."'^^ 

Checks  or  Drafts  Payable  Otherwise  Than  at  Sight  or 
ON  Demand.  The  liability  of  an  instrument  to  stamp  tax,  as 
well  as  the  amount  of  such  tax,  is  determined  by  the  form  and 
face  of  the  instrument,  and  cannot  be  effected  by  proof  of  facts 
outside  of  the  instrument  itself.-'^"'  Unless  the  statute  expressly 
so  provides,  drafts,  acceptances,  overdrafts,  and  postdated 
checks  are  not  taxable  as  promissory  notes,  even  though  they 
perform  some  of  the  functions  of  a  promissory  note.  It  is  no 
doubt  in  view  of  the  decision  above  quoted  that  drafts  and 
checks  payable  otherwise  than  at  sight  or  on  demand  are  by  the 
present  law  expressly  included  in  the  same  category  as  promis- 
sory notes.  The  general  rule  is  that  a  draft  or  check  delivered 
within  the  United  States  is  subject  to  the  tax  if  expressed  to  be 
payable  otherwise  than  at  sight  or  on  demand.''^''  So-called  trade 
acceptances  are  taxable  in  the  same  manner  as  ordinary  time 
drafts.'^™  Drafts  directly  against  an  actual  shipment  are  tax- 
able in  the  same  manner  as  other  domestic  time  drafts.-''"^^  Drafts 
drawn  at  sight  or  on  demand  with  a  notation  thereon  to  "hold 
for  arrival  of  goods,"  or  payable  "on  arrival  of  car,"  or  words 
of  like  effect,  are  taxable  as  drafts  drawn  otherwise  than  at  sight 
or  on  demand."'^"'-  Any  notation  appearing  on  such  drafts,  or  on 
a  bill  of  lading  or  other  papers  accompanying  same,  including 
collection  letter,  which  defers  the  time  of  payment,  renders  the 
draft  taxable.-'^''''^  But  a  sight  draft  accompanied  by  instructions 
outside  the  instrument,  as  "Do  not  present  until  arrival  of  car" 

•"5-17  Reg.  55  Rev.,  Art.  58.  T.  D.  2101.  Kenosha  v.  Lamson,  9  Wall  477; 
Lexington  v.  Butler,  14  Wall.  282. 

••i+^  U.  S.  V.  Isham,  17  Wall.  496.  Reg.  55  Rev.,  Art.  37.  In  Granby  Co.  v. 
Webster,  98  F'ed.  604,  decided  under  the  1898  Law,  the  court,  following 
U.  S.  v.  Isham  (supra)  explains  the  rule  as  follows:  "Were  it  necessary 
to  inquire  into  all  the  circumstances  attending  the  execution  of  an  order  for 
the  payment  of  money,  before  it  can  be  ascertained  whether  it  be  liable  to 
the  stamp  tax,  endless  delay  would  be  occasioned.  The  purpose  of  the  tax 
— the  prompt  relief  of  the  treasury — would  be  defeated."  Under  the  1914 
Law  it  was  held  that  in  view  of  the  decision  in  U.  S.  v.  Isham,  drafts,  ac- 
ceptances, overdrafts,  and  post-dated  checks  were  not  taxable  as  promissory 
notes,  even  though  they  were  used  in  such  a  way  as  to  perform  some  of  the 
functions  of  a  promissory  note.     (T.  D.  2170.) 

•■540  Reg.  55  Rev.,  Art.  63;  T.  D.  2682. 

^••■'>o  Reg.  55  Rev.,  Art.  39. 

351  Reg.  55  Rev.,  Art.  40. 

352  Reg.  55  Rev.,  Art.  37. 

3-t3  Letter  from  treasury  department  dated  February  20,  1918;  W.  T.  S. 
1919,  11  3698.    T.  D.  2682. 


1218  FEDERAL  INCOME  TAX 

or  some  such  memorandum,  is  not  taxable.-'-^^  And  a  sight  draft 
accepted  and  paid  by  the  collecting  bank  for  the  drawee,  which 
holds  it  and  charges  interest  until  the  drawee  takes  it  up,  is  not 
taxable.355  A  draft  might  be  drawn  stating  no  time  for  pay- 
ment, which  would  class  it  as  a  sight  draft,  and  be  accepted  at 
ninety  days,  which  would  change  its  nature.35*5  If  negotiated  or 
delivered  before  acceptance  the  holder  would  be  obliged  to  stamp 
it  on  acceptance,  in  default  of  which  both  he  and  the  acceptor 
would  be  liable  for  the  statutory  penalty.-^'  For  the  purposes 
of  the  tax  there  is  no  difference  in  the  treatment  of  ordinary  bills 
of  exchange,  trade  acceptances,  and  bankers'  acceptances,  as 
defined  by  the  regulations  of  the  Federal  Reserve  Board."'-^^  The 
general  rule  is  that  a  taxable  draft  or  check  becomes  subject  to 
tax  concurrently  with  its  delivery  or  acceptance.'^^'-^  In  case  of 
a  draft  the  rule  means  that  the  tax  attaches,  not  when  it  is 
signed  by  the  drawer,  or  presented  to  the  drawee  for  acceptance, 
but  when  it  is  delivered  to  or  accepted  by  the  payee,  if  drawn 
to  a  third  person,  or  negotiated  by  the  drawer,  if  drawn  to  his 
order.  If  a  draft  was  drawn  before  the  passage  of  the  law,  but 
not  delivered,  accepted,  or  negotiated  until  afterward,  the  tax 
is  payable.3*^o 

Drafts  Drawn  Against  Exports.  In  view  of  the  constitu- 
tional prohibition  against  a  restriction  of,  or  any  tax  on,  exports, 
drafts  with  bills  of  lading  attached  covering  goods  in  the  course 
of  exportation  or  drafts  drawn  in  this  country  directly  covering 
exports  to  foreign  countries  and  which  constitute  an  inherent, 
bona  fide  and  necessary  part  of  the  process  of  exportation  are 
exempt  from  the  stamp  tax.-^^'^  This  exemption  does  not  depend 
on  whether  or  not  the  time  which  the  draft  has  to  run  will  ex- 
pire before  or  after  the  ocean  shipment. 

Where  the  exporter  draws  a  time  draft  upon  the  buyer  abroad 
for  the  sale  price  of  the  merchandise  and  presents  this  draft, 
accompanied  by  the  shipping  documents,  to  his  bank  for  discount, 

354  Reg.  55  Rev.,  Art.  37;  T.  D.  2682. 

355  T.  D.  2682. 

35C  Reg.  55  Rev.,  Art.  38. 

357  T.  D.  2682. 

358  T.  D.  2682. 

359  Reg.  55  Rev.,  Art.  34. 
3C0  T.  D.  2682. 

301  Reg.  55  Rev.,  Art.  41;  T.  D.  2682;  letter  from  treasury  department 
dated  April  13,  1918;  W.  T.  S.  1919,  113711.  Letter  from  treasury  depart- 
ment dated  January  24,  1918;  W.  T.  S.  1919,  113710.  See  U.  S.  v.  Hvoslef, 
237  U.  S.  1.  Compare  with  Simpson  v.  Treat,  126  Fed.  1003.  See  para- 
graph on  the  Constitutionality  of  Stamp  Taxes,  p.   1245. 


THE    STAMP   TAX  1219 

the  draft  is  not  subject  to  stamp  tax.  It  sometimes  happens 
that  the  exporter  is  unable  to  negotiate  a  draft  drawn  by  him 
in  the  manner  above  set  forth  and,  so  that  he  may  receive  the 
full  value  for  the  same,  he  may  be  able  to  obtain  a  loan  or  ad- 
vance in  some  form  from  his  bank  which  will  take  the  draft  in 
question  for  collection.  In  such  case  the  exporter  may  give  his 
note  to  the  bank  secured  by  the  draft,  or  instead  of  borrowing 
money  from  the  bank  and  giving  his  note  therefor,  he  may  draw 
a  second  draft  payable  at  a  future  date  upon  his  bank,  payment 
for  which  second  draft  is  to  be  liquidated  by  the  payment  of  the 
draft  drawn  upon  the  foreign  buyer.  Methods  of  financing  simi- 
lar to  those  outlined  above  are  used  in  connection  with  exporta- 
tions  of  merchandise  where  the  original  documents  forwarded 
abroad  are  not  accompanied  by  drafts  upon  the  buyers,  but  are 
either  forwarded  against  sales  previously  made  or  on  consign- 
ment to  be  sold  either  on  arrival  or  to  await  better  market 
conditions.  The  exporter  either  borrows  money  from  his  bank 
and  gives  his  note,  or  draws  his  draft  upon  his  bank  payable  at 
a  future  date,  with  the  understanding  that  the  proceeds  of  the 
sale  of  the  merchandise  are  paid  into  the  collecting  bank  abroad 
for  the  account  of  the  bank  making  the  loan  or  discounting  the 
draft  of  the  exporter  in  the  United  States,  such  proceeds  from 
time  to  time  to  be  used  in  Hquidating  such  loan  or  advance.  It 
has  been  held  that  the  drafts  and  notes,  including  renewals 
thereof,  employed  in  transactions  such  as  above  outlined  do  not 
directly  cover  exports  to  a  foreign  country  and  do  not  constitute 
an  inherent,  necessary  and  bo7ia  fide  part  of  the  actual  process 
of  exportation  and  are,  therefore,  subject  to  stamp  tax.-^''-  Where 
a  taxpayer  sold  and  shipped  goods  to  a  Cuban  firm  in  Cuba  on 
open  account  and  the  Cuban  firm,  after  making  a  small  cash  pay- 
ment, offered  to  give  its  acceptance  for  the  balance  due  on  ac- 
count of  goods  shipped  it  has  been  held  that  this  draft,  which 
is  not  accompanied  by  shipping  documents,  is  subject  to  stamp 
tax.363 

Time  drafts  drawn  against  the  proceeds  of  a  draft  against 
exports  are  taxable.  A  time  draft  drawn  on  a  domestic  bank 
for  the  purpose  of  securing  money  to  purchase  goods  to  be  ex- 
ported is  subject  to  tax  regardless  of  the  fact  that  a  contract 
for  the  sale  of  the  goods  existed  at  the  time  the  draft  is  drawn. ""^ 

3«2  Letter  from  treasury  department  dated  September  21,  1920;  W.  T.  S. 
1921,  ^3792. 

3(>3  Letter  from  treasury  department  dated  November  4,  1921;  W.  T.  S. 
1921,  114065. 

3<M  Reg.  55  Rev.,  Art.  42. 


1220  FEDERAL  INCOME  TAX 

A  time  draft  directly  covering  a  sale  for  export  to  a  foreign 
buyer  and  drawn  on  a  domestic  bank  as  the  authorized  acceptor 
of  the  foreign  buyer  is  exempt  from  stamp  tax.  A  time  draft 
drawn  by  or  on  an  exporter  or  on  his  bank  in  payment  for  export 
shipments  made  by  the  manufacturer  on  the  exporter's  order  is 
subject  to  stamp  tax.-'*'-^  Time  drafts  not  covering  exports  drawn 
and  delivered  or  accepted  in  the  United  States  and  payable  in 
foreign  countries  are  taxable.^^G  A  draft  drawn  against  a  foreign 
steamship  company  covering  a  bill  for  bunker  coal  furnished  in 
this  country  is  taxable  since  such  a  sale  of  coal  is  held  to  be  a 
domestic  sale  and  not  an'export.^""  Stamp  tax  attaches  to  time 
drafts  covering  articles  shipped  from  the  United  States,  Hawaii, 
and  Alaska  to  Canal  Zone,  if  the  drafts  are  delivered  within  the 
United  States,  Hawaii,  or  Alaska.^^'s  stamp  tax  does  not  attach 
to  time  drafts  covering  shipments  to  the  Virgin  Islands,  Philip- 
pines, and  Porto  Rico,  because  of  express  legislation  exempting 
shipments  to  these  dependencies.^^o 

Time  Drafts  Covering  Shipments  from  Virgin  Islands, 
Philippines  and  Porto  Rico.  Time  drafts  drawn  against  ship- 
ments from  the  Virgin  Islands,  the  Philippines,  and  Porto  Rico, 
into  the  United  States,  are  subject  to  stamp  tax  if  delivery  or 
acceptance  of  said  drafts  first  takes  place  within  the  United 
States,  Alaska,  or  Hawaii.-"'^'' 

Drafts  Delivered  in  Foreign  Countries.  The  general  rule 
is  that  a  taxable  draft  or  check  becomes  subject  to  the  tax  con- 
currently with  its  acceptance  or  delivery  within  the  territorial 
jurisdiction  of  the  United  States  (including  the  states,  the  Dis- 
trict of  Columbia,  Hawaii,  and  Alaska) ,  whichever  is  prior.  The 
rule  means  that  the  tax  does  not  attach  to  a  draft  drawn  here, 
but  delivered  and  accepted  abroad,  but  does  attach  to  a  draft 
drawn  abroad  and  delivered  or  accepted  here.-"'"!  Where  drafts 
are  drawn  outside  the  United  States  and  acceptance  or  delivery 
made  within  the  United  States  but  payable  in  terms  of  foreign 
currency,  the  stamp  tax  should  be  computed  at  the  rate  of  ex- 
change at  the  time  and  place  of  such  delivery  or  acceptance."^'- 

•'?«■'•  Reg.  55  Rev.,  Art  43. 

30*i  Reg.  55  Rev.,  Art.  44. 

:<«7  0.  D.  87:  Ruling  No.  202,  March,  1921;  W.  T.  S.  1921,  1|  4034. 

3'«  Reg.  55  Rev.,  Art.  45. 

3'!«  Reg.  55  Rev.,  Art.  46.     • 

3T0  Reg.  55  Rev.,  Art.  47. 

•■'"1  Reg.  55  Rev.,  Art.  34.  Telegram  from  treasury  department  dated 
April  14,  1919;  W.  T.  S.  1919,  113769. 

372  Letter  from  treasury  department  dated  September  20,  1921 ;  W.  T.  S. 
1921,  11  4064. 


THE   STAMP   TAX  1221 

In  general,  a  draft  sent  through  the  mail  is  delivered  when 
and  where  deposited  in  the  mail  addressed  to  the  payee  or  the 
indorsee  from  the  drawer.-'^-'  If  a  draft  drawn  abroad,  on  a 
foreign  drawee,  with  a  foreign  payee,  passes  through  a  bank  here 
in  the  course  of  collection,  no  tax  is  payable  unless  it  should  be 
delivered  by  an  agent  of  the  drawer  to  an  agent  of  the  payee 
within  the  United  States/'^"-* 

Notes  Drawn  in  Foreign  Countries.  A  promissory  note 
drawn  in  a  foreign  country,  and  placed  in  the  mails  in  that  coun- 
try for  delivery  to  a  person  residing  in  the  United  States,  is  not 
required  to  be  stamped.  Delivery  of  commercial  paper  is  neces- 
sary for  its  completion  and  by  the  weight  of  authority  such  an 
instrument  is  delivered  when  placed  in  the  mails.  The  laws  of 
the  foreign  country,  therefore,  would  determine  the  validity  of 
the  contract,  even  if  the  instrument  is  made  payable  in  the 
United  States.  On  the  other  hand,  a  promissory  note  drawn  in 
the  United  States  and  placed  in  the  mails  for  delivery  to  a  person 
residing  in  a  foreign  country  is  taxable,  for  the  reason  above 
stated.^"* 

Notes  Secured  by  Pledge  of  United  States  Securities.  No 
stamp  tax  is  required  or  imposed  upon  a  promissory  note  se- 
cured by  the  pledge  of  bonds  or  obligations  of  the  United  States 
issued  after  April  24,  1917,  or  secured  by  the  pledge  of  a  promis- 
sory note  which  itself  is  secured  by  the  pledge  of  such  bonds 
or  obligations,  provided,  that  in  either  case  the  par  value  of  such 
bonds  or  obligations  does  not  exceed  the  amount  of  such  note.'"^ 
The  bonds  mentioned  include  Liberty  Bonds  as  well  as  other 
United  States  bonds  and  printed  obligations.-^"  The  Treasury 
Department  has  ruled  that  promissory  notes  secured  by  certifi- 
cates of  indebtedness  issued  by  the  Director  General  of  Railroads 

ST-'!  Revenue  Act  of  1921,  Title  XI,  Schedule  A-5,  contains  the  expression 
"upon  their  acceptance  or  delivery  within  the  United  States,  whichever  is 
prior."  The  1917  Law  was  silent  in  this  respect.  See  Reg.  55  Rev.,  Arts 
33,  34,  modifying  T.  D.  2682. 

:?74  Reg.  55  Rev.,  Art.  36;  T.  D.  2682. 

375  Reg.  55  Rev.,  Arts.  64,  65;  T.  D.  2170.     See  also  T.  D.  2682. 

"•"<i  Revenue  Act  of  1921,  Title  XI,  Schedule  A-5.  This  provision  is  now 
expressly  included  in  the  Stamp  Tax  Act,  its  substance  having  formerly  been 
contained  in  T.  D.  2701,  based  upon  the  War  Finance  Corporation  Act, 
Title  3,  301. 

377  T.  D.  2701.  War  Finance  Corporation  Act,  Title  3,  301;  Revenue  Act 
of  1921,  Title  XI,  Schedule  A-5. 


1222  FEDERAL   INCOME  TAX 

are  exempt  from  stamp  tax;^^^  and  that  promissory  notes  secured 
by  bonds  of  the  War  Finance  Corporation  are  subject  to  tax.^'^'' 

■Notes  Issued  by  Government.  The  law  provides  that  no 
bond,  note  or  other  instrument  issued  by  the  United  States  or  by 
any  foreign  government  or  by  any  state,  territory,  or  the  District 
of  Columbia  or  local  subdivision  thereof,  or  municipal  or  other 
corporation  exercising  the  taxing  power,  shall  be  subject  to  tax.s'^o 
Bank  notes  issued  for  circulation  are  also  expressly  exempted 
from  the  tax.-^^^i 

Promissory  notes  given  to  Federal  land  banks  and  joint-stock 
land  banks  when  secured  by  first  mortgages,  and  promissory 
notes  issued  by  Federal  land  banks  are  exempt  from  stamp  tax. 
Promissory  notes  issued  by  joint-stock  land  banks  are  subject 
to  stamp  tax.^^2 

Promissory  notes  issued  by  the  Food  Administration  Grain 
Corporation  are  subject  to  stamp  tax.'^'*-^ 

Proxies.  The  tax  is  imposed  on  every  proxy  for  voting  at 
any  election  of  officers^s*  or  for  voting  at  any  meeting  for  the 
transaction  of  business  of  any  corporation.  The  term  "corpora- 
tion" is  defined  to  include  associations,  joint-stock  companies  and 

•j"8  Reg.  55  Rev.,  Art.  56;  letter  from  treasury  department  dated  May  10, 
1919;  W.  T.  S.  1919,  1|  3776. 

370  This  ruling  seems  contrary  to  the  purpose  of  the  statute.  The  ex- 
emption referred  to  at  beginning  of  the  above  paragraph  was  taken  from 
the  War  Finance  Corporation  Act,  as  stated  in  note  376,  and  seems  to 
have  been  intended  to  apply  to  War  Finance  Corporation  bonds.  In  this 
connection  the  following  definition  of  the  term  "obligation  or  other  security 
of  the  United  States,"  from  R.  S.  5414,  referring  to  offenses  against  the 
currency,  etc.  "The  words  'obligation  or  other  security  of  the  United 
States'  shall  be  held  to  mean  all  bonds,  certificates  of  indebtedness,  national- 
bank  currency,  coupons,  United  States  notes,  treasury  notes,  gold  certificates, 
silver  certificates,  fractional  notes,  certificates  of  deposit,  bills,  checks  or 
drafts  for  money,  drawn  by  or  upon  authorized  officers  of  the  United  States, 
stamps  and  other  representatives  of  value,  of  whatever  denomination,  which 
have  been  or  may  be  issued  under  any  Act  of  Congress,"  is  interesting  and 
seems  broad  enough  to  include  War  Finance  Corporation  Bonds.  There 
seems  to  be  no  valid  distinction  between  certificates  of  indebtedness  issued  by 
the  director  general  of  railroads  and  War  Finance  Corporation  Bonds  for 
purposes  of  this  exemption. 

■i^"  Revenue  Act  1921,  §  1101;  Reg.  55  Rev.,  Art.  54. 

■'^^  Revenue  Act  of  1921,  Title  XI,  Schedule  A-5. 

■^^-  Reg.  55  Rev.,  Art.  53. 

38:^  Telegram  from  treasury  department  dated  April  14,  1919 ;  W.  T.  S. 
1919,  TI3768.  Telegram  from  treasury  department  dated  April  10,  1919: 
W.  T.  S.  1921,  113819. 

384  Directors  of  a  corporation  are  officers  within  the  meaning  of  the  clause 
imposing  a  tax  on  proxies  for  voting  at  the  election  for  officers  of  an  incor- 
porated company.     (Reg.  55,  Art.  123.) 


THE   STAMP    TAX  1223 

insurance  companies."'^''  Under  the  1914  Law  the  tax  was  only  on 
proxies  for  voting  at  any  election  of  officers.  The  present  law, 
as  well  as  the  1917  and  1918  Laws,  taxes  all  proxies  used  at  meet- 
ings for  the  transaction  of  business.  The  tax  is  10  cents  on  each 
proxy.  A  proxy  for  voting  at  any  election  for  officers  of  a  corpo- 
ration and  authorizing  the  proxy  to  act  in  such  capacity  upon  all 
questions  or  matters  presented  at  a  stockholders'  meeting,  is  sub- 
ject to  tax  of  10  cents  only.-'*""  Proxies  for  voting  at  any  election 
of  officers,  or  meeting  for  the  transaction  of  business  of  any  reli- 
gious, educational,  charitable,  fraternal,  or  literary  societies,  or 
public  cemeteries,  are  expressly  exempt. ■'■'^'  Proxies  for  the  pur- 
pose of  voting  the  stock  of  building  and  loan  associations  are 
taxable.'^'*'^ 

Proxies  Signed  by  Two  or  More  Stockholders.  The  stamp 
tax  on  proxies  attaches  to  the  instrument  and  is  not  measured 
by  the  number  of  grantors  and  grantees.'*^''  A  power  of  substi- 
tution contained  in  a  proxy  would  seem  not  to  be  taxable  either 
on  the  ground  that  it  is  a  proxy  or  on  the  ground  that  it  is  a 
power  of  attorney. 

When  Tax  Accrues.  It  seems  that  the  proxy  need  not  be 
stamped  until  it  is  accepted  by  the  person  to  whom  it  is  issued, 
but  must  be  stamped  before  it  can  be  used.  Thus,  it  has  been 
held  that  a  power  of  attorney  or  proxy  executed  by  a  person 
residing  in  a  foreign  country  to  a  person  residing  in  this  country 
is  taxable,  as  the  instrument  is  not  operative  and  effective  until 
accepted  by  the  person  in  this  country  to  whom  it  is  issued. 
Powers  of  attorney  and  proxies  executed  by  a  person  residing  in 
the  United  States  to  a  person  in  a  foreign  country  are  not  tax- 
able.''^^'  Powers  of  attorney  or  proxies  executed  and  accepted 
before  the  incidence  of  the  tax  are  not  taxable,  even  though  used 
after  the  incidence  of  the  tax.-^^^ 

Who  May  Affix  Stamps.  Where  proxies  are  sent  out  by  cor- 
porations to  be  executed  and  returned  to  the  corporation  or  to 
the  person  named  in  the  proxy,  such  proxies  may  be  stamped 
after  execution  and  delivery  by  the  person  receiving  the  same 
as  the  agent  of  the  person  executing  the  proxy .•'••'-     The  stamp 

•■'S'^Reg.  55,  Arts.  126-127. 

••5S«i  Reg.  55  Rev.,  Art.  126. 

3ST  Revenue  Act  of  1921,  Title  XI,  Schedule  A-11. 

;5'^s  Reg.  55  Rev.,  Art.  124. 

;^«t  Reg.  55  Rev.,  Art.  121,  modifying  T.  D.  2129. 

?.90  T.  D.  2129. 

»»i  Reg.  55  Rev.,  Art.  125. 

3S>-'  Reg.  55  Rev.,  Art.  128;  T.  D.  2067. 


1224  FEDERAL   INCOME   TAX 

may  be  affixed  and  cancelled  either  by  the  party  who  executes 
the  proxy  or  by  the  party  to  whom  the  proxy  is  given.""'-'  Where 
the  stamp  is  affixed  by  an  officer  or  employee  of  the  corporation 
it  is  sufficient  to  cancel  the  stamp  by  writing  thereon  the  initials 
of  the  officer  or  employee  or  the  initials  of  the  corporation  and 
by  incision  or  perforation  if  the  stamp  has  a  value  of  10  cents  or 

Rights  to  Receive  Stock  Dividends.  Such  rights  are  taxable 
as  certificates  of  profits. •'■•■"  See  Capital  Stock,  Sales  and  Trans- 
fers above. 

Rights  to  Subscribe  for  Stock.  Under  the  present  law,  rights 
to  subscribe  for  stock  or  to  receive  shares  or  certificates  of  stock 
(or  of  profits  or  interest  in  property  or  accumulations)  in  any 
corporation  are  expressly  made  subject  to  tax.^-'*''  See  Capital 
Stock,  Sales  and  Transfers  above. 

Security  Agreements  and  Applications  for  Loans.  Neither  a 
security  agreement  signed  by  a  prospective  borrower  of  a  bank, 
empowering  the  bank  to  apply  any  securities,  money,  or  other 
property  of  the  prospective  borrower  in  the  hands  of  the  bank  to 
satisfy  the  debt  of  the  borrower  to  the  bank,  nor  the  form  of 
application  for  the  loan,  is  included  in  the  classes  of  instruments 
made  subject  to  stamp  tax  under  Schedule  A  of  Section  1107, 
and  neither  is  therefore  subject  to  such  tax.-^^^ 

Voting  Trust  Certificates.  The  issue  of  voting  trust  certifi- 
cates is  not  subject  to  the  stamp  tax-"'"^  but  the  transfer  of  such 
certificates  is  subject  to  the  tax,^^^  See  Capital  Stock;  Issue,  and 
Capital  Stock ;  Sales  and  Transfers ;  above. 

Records  Required  in  Case  of  Sales  and  Transfers  of  Stock. 
The  following  ruling  was  made  under  the  1918  Law:  Every 
person  who  makes  an  agreement  to  sell  or  transfer  title  to 
shares  of  stock  by  delivery  of  certificates  assigned  in  blank, 
shall  as  a  part  of  such  transaction  promptly  make  and  deliver 
to  the  buyer  a  bill  or  memorandum  of  such  sale  or  agreement  to 
sell,  duly  signed  by  the  seller  or  his  agent,  to  which  the  requisite 
stamps  shall  be  affixed  and  canceled,  which  bill  or  memorandum 
shall  show  the  date  of  the  transaction,  the  names  of  the  seller 
and  buyer  and  the  name  and  number  of  shares  of  stock,  and  the 

3S3Reg.  55  Rev.,  Art.  122;  T.  D.  2129. 

394  Letter  from  treasury  department  dated  January  8,  1915. 

393  Reg.  40  Rev.,  Art.  12. 

39fi  Revenue  Act  of  1921,  Title  XI,  Schedule  A-3;  Re^.  40  Rev..  Art.  12. 

397  See  T.  D.  2599.  '     ' 

:«s  Reg.  40  Rev.,  Art.  5. 

399  Reg.  40  Rev.,  Art.  12. 


THE   STAMP    TAX  ,  1225 

price  per  share  and  the  tax  paid  thereon,  and  in  the  case  of  a 
transaction  made  on  an  exchange  shall  bear  a  number  upon  the 
face  thereof  and  have  printed  and  written  in  ink  thereon  the 
words  "Subject  to  the  Revenue  Act  of  1918  and  regulations 
made  in  accordance  therewith."  No  more  than  one  such  bill  or 
memorandum  made  by  the  seller  on  any  given  date  shall  bear  the 
same  number:  Provided,  however,  that  no  single  transaction 
or  purchase  or  sale  that  is  made  upon  an  exchange  by  one  mem- 
ber to  another  member  shall  require  to  be  evidenced  by  more 
than  one  stamped  memorandum  of  sale  or  agreement  to  sell.^"" 

Definitions.  The  term  "exchange"  includes  each  and  every 
agency,  office,  room,  or  other  place  of  assembly  whether  under 
shelter  or  in  the  open,  at  which  stock,  rights,  warrants,  interests 
in  property,  or  in  profits,  or  in  accumulations,  by  corporations, 
are  publicly  bought,  sold,  bid  for,  offered  or  exchanged  between 
persons  there  assembled,  in  behalf  of  themselves  or  others. 
The  term  "clearing  house"  includes  every  corporation  or  asso- 
ciation, whether  incorporated  or  not,  of  individuals,  partnerships 
or  corporations  wholly  or  partly  engaged  in  the  business  of  clear- 
ing, settling,  or  adjusting  transactions  in  the  purchase,  sale, 
receipt,  or  delivery  of  shares  of  stock,  whether  or  not  the  same  be 
a  part  or  department  of  any  exchange  or  an  independent  body.^"^ 

Records  of  Sales  or  Transfers  of  Stock,  (a)  All  persons 
who  are  wholly  or  partly  engaged  m  the  business  of  buying, 
selling  or  transferring  shares  of  stock,  whether  at  public  or 
private  sale,  or  whether  or  not  they  are  members  of  an  exchange, 
including  persons  engaged  in  transactions  known  as  "matched," 
or  "on-order,"  or  "pass-outs,"  or  "give-ups,"  or  settled  directly 
between  the  seller  and  buyer,  or  cleared  or  adjusted  through  a 
clearing  house  or  otherwise,  or  engaged  in  accepting  and  pro- 
curing the  transmission  of  orders  for  purchase  or  sale  of  shares 
of  stock  shall  keep  a  record  showing: 

^"•>  Reg.  40  Rev.,  Art.  15;  Reg.  No.  40,  Part  I,  Art.  6.  In  McClain  v. 
Fleishman,  106  Fed.  880,  a  stock  broker  entered  into  agreement  with  his 
customers  to  buy  and  sell  stocks  on  a  fixed  price  for  future  delivery.  Each 
of  such  agreements  was  evidenced  by  the  written  memoranda  properly 
stamped  in  accordance  with  the  1898  Law.  The  transfers  were  purely  spec- 
ulative, conducted  on  margins  and  no  actual  delivery  was  contemplated  by 
the  parties,  settlement  being  made  by  a  payment  of  differences  and  the  sur- 
render of  the  written  memoranda.  It  was  held  that  such  settlements  did 
not  involve  agreements  for  a  resale  of  the  stocks  requiring  new  memoranda 
to  be  made  and  stamped,  the  court  having  no  authority  to  infer  such  agree- 
ments contrary  to  the  fact  for  the  purpose  of  extending  statutory  pro- 
visions to  transactions  not  within  its  terms. 

4"!  Reg.  40  Rev.,  Art.  33. 


1226  FEDERAL  INCOME  TAX 

(1)  Date  of  transaction. 

(2)  Line  number  (if  at  an  exchange). 

(3)  Name  of  broker  or  salesman  who  executed  the  order. 

(4)  Name  of  party  to  whom  sold,  or  from  whom  bought. 

(5)  Number  of  shares  dealt  in. 

(6)  Name  or  description  of  stock. 

(7)  Price  of  stock,  if  without  face  or  par  value. 

(8)  Amount  (or  total  market  value)  of  stock. 

(9)  Face  or  par  value  of  stock  per  share. 

(10)  Tax  paid  on  shares  having  face  or  par  value. 

(11)  Tax  paid  on  shares  without  face  or  par  value. 

(12)  State  tax  paid,  if  any.     (Optional.) 

(13)  Total  amount  to  ledger.     (Optional.) 

(14)  Folio  number.     (Optional.) 

(15)  Name  of  customer  for  whom  sold  or  transferred,  or  for 

whom  bought  or  transferred. 

(16)  Number  of  shares  loaned  or  borrowed. 

(17)  Number  of  borrowed  or  loaned  shares  returned. 

(18)  Method  of  settlement  or  adjustment. 

(b)  Persons  keeping  such  records  may  incorporate  therein 
additional  columns  that  will  be  of  use  to  them,  such  columns  to 
be  placed  so  as  not  to  interfere  with  the  columns  and  headings 
hereby  prescribed.  These  records  must  be  in  book  form,  and  all 
entries  therein  must  be  legibly  written  in  ink  and  the  records 
kept  for  a  period  of  at  least  two  years.  Such  record  forms  will 
not  be  supplied  by  the  department. 

(c)  The  form  of  record  required  is  known  as  Form  A. 

(d)  Provided,  however,  that  brokers  known  as  strictly  "floor 
brokers,"  or  "two  dollar  men,"  or  "room  traders,"  in  lieu  of  the 
foregoing  record,  whether  their  transactions  are  settled  directly 
between  seller  and  buyer  or  by  "matched,"  "on-order,"  "pass- 
out,"  or  "scratch  sale,"  or  "give-up,"  or  any  other  kind  of  sale 
or  purchase,  or  are  cleared  through  a  clearing  house  or  otherwise, 
shall  keep  a  record  showing: 

(1)  The  date  of  the  transaction. 

(2)  The  name  of  the  seller. 

(3)  The  name  of  the  purchaser. 

(4)  The  name  of  the  stock. 

(5)  The  number  of  shares. 

(6)  The  par  or  face  value  of  the  shares. 

(7)  The  price,  if  the  stock  has  no  par  value. 

(8)  Whether  the  transaction  is  "matched,"  "on-order,"  "pass- 

out,"  "scratch  sale,"  or  "give-up." 

(9)  Name  of  person  to  whom  "given-up." 


THE   STAMP   TAX  1227 

(e)  Provided  further,  that  persons  engaged  in  accepting  and 
procuring  the  transmission  of  orders  for  the  purchase  or  sale  of 
shares  of  stock  to  be  executed  at  a  brokerage  office  or  an  ex- 
change, board  of  trade,  or  similar  place,  shall  keep  a  record 
showing: 

(1)  Date  of  acceptance  and  transmission  of  order. 

(2)  Name  of  person  from  whom  accepted. 

(3)  Name  and  address  of  person  to  whom  transmitted. 

(4)  Name  of  stock. 

(5)  Par  value  of  stock. 

(6)  Number  of  shares. 

(7)  Whether  purchase  or  sale. 

(8)  Price. 

(9)  Whether  order  was  executed  at  an  exchange ;  and,  if  so. 

what  exchange. 

(10)   Date  of  execution  of  order.^^*- 

INTRAOFFICE  BORROWING  OF  STOCK.  The  Revenue  Act  of  1921 
provides  that  no  stamp  tax  shall  be  imposed  upon  mere  loans 
of  stock  nor  upon  the  return  of  stock  so  loaned.^'^-'"  This  provision 
was  not  contained  in  the  Revenue  Act  of  1918  and  the  following 
rulings  were  made  under  that  law:  Intraoffice  borrowing  of 
stock  is  necessitated  by  a  number  of  conditions,  including  actual 
short  sales  made  and  nominal  short  sales,  such  as  the  sale  of 
stock  which  is  in  transit  or  in  the  possession  of  branch  offices, 
which  is  not  received  in  due  time  to  make  delivery.  To  make 
the  required  delivery  in  such  a  case  the  broker,  assuming  he  has 
in  his  possession  the  kind  of  stock  required  (placed  with  him 
for  sale  or  purchase  by  him  for  customers),  borrows  such  stock 
and  makes  the  necessary  delivery.  The  stock  so  borrowed  is 
not  taken  from  any  given  account  and  the  actual  ownership 
thereof  would,  perhaps,  be  impossible  to  trace.  It  is  taken  from 
a  general  pool  in  which  virtually  all  the  stock  of  the  office  is  held 
and  the  pool  credited  accordingly.  When  the  physical  stock  ar- 
rives or  is  purchased  and  is  replaced,  the  pool  is  debited  and  the 
particular  stock  involved  balanced.  This  is  usually  the  only  office 
record  kept  of  these  transactions.  It  is  understood  that  in  all 
or  in  most  intraoffice  borrowings  it  is  the  pool  that  is  involved 
and  not  the  individual  accounts  of  customers  or  clients. 

Under  the  circumstances  it  would  be  meaningless  to  affix 
stamps  to  ledger  accounts.  It  would  also  be  inadvisable  to  affix 
stamps  to  the  account  kept  with  the  pool  for  the  reason  that 

402  Reg,  40  Rev.,  Art  16. 

403  Revenue  Act  of  1921,  Title  XI,  Schedule  A-3. 


1228  FEDERAL  INCOME   TAX 

the  record  is  not  sufficiently  detailed,  although  such  account  is 
of  considerable  value  in  checking  taxable  transactions. 

The  following  method  of  collecting  the  tax  was  first  suggested 
by  the  Treasury  Department:  A  ticket  or  memo  should  be 
executed  covering  each  transaction  of  stock  borrowed  and  the 
stamps  affixed  thereto.  This  ticket  should  show  the  date  when 
the  stock  is  taken  from  the  pool,  the  name  of  the  person  for 
whose  account  the  stock  is  borrowed,  a  description  of  the  stock, 
and  the  number  of  shares.  This  ticket  should  bear  a  serial 
number  and  should  be  filed  with  other  similar  tickets  consecu- 
tively in  the  broker's  office;  these  tickets  should  be  retained  for 
two  years.'^o^ 

The  following  method  was  later  suggested  as  protecting  the 
Government  and  likely  to  be  more  acceptable  to  the  broker: 

A  book  of  record  may  be  kept  consisting  of  loose  or  fixed  leaves 
containing  three  columns,  headed  as  follows :  Column  1 — Name 
of  customer  for  whose  account  the  stock  is  borrowed  and  de- 
scription of  the  stock.  Column  2 — Date  borrowed.  Column  3 — 
Date  replaced.  This  record  may  be  a  running  record,  but  care 
should  be  exercised  to  permit  sufficient  space  for  affixing  thereto 
the  stamps  due.  The  heading  and  specimen  line  of  such  a  record 
would  appear  thus: 
Name  of  Customer  and  Stock     Date  borrowed         Date  returned 

A.  Smith,  100  shares  U.  P.         May  1,  1921  *         May  5,  1921 
*  Stamp  and  cancellation 

Where  intraoffice  transactions  to  be  tax  paid  are  shown  in 
similar  detail  by  books  or  records  already  kept  by  the  broker, 
and  it  is  practicable  and  desirable  to  do  so,  he  may  be  instructed 
to  affix  the  proper  stamps  to  those  books  or  records  in  the  tax- 
payment  both  of  past  and  of  current  transactions,  rather  than 
be  required  to  introduce  a  new  record  or  to  follow  the  method 
first  suggested.  The  stamp  tax  on  these  intraoffice  transactions 
is  incurred  when  they  are  made  and  is  properly  to  be  paid  by 
stamps  affixed  at  the  time  of  making.  It  would  therefore  not 
be  a  proper  procedure  for  the  broker  to  file  a  report  with  stamps 
affixed  thereto  at  the  end  of  the  month  or  of  a  period,  in  tax- 
payment  of  past  transactions  shown.  Where  such  a  report  con- 
stituted a  current  record  with  stamps  currently  affixed  it  should 
be  retained  in  the  broker's  office  for  a  period  of  two  years.'^""' 

Returns  by  Persons  Making  Sales,  (a)  All  persons  who 
are  wholly  or  partly  engaged  in  the  business  of  buying,  selling 
or  transferring  shares  of  stock,  whether  such  sales,  purchases, 

404  0.  D.  87,  Ruling  No.  202,  March,  1921 ;  W.  T.  S.  1921,  1|  4031.  • 

405  0.  D.  136,  Ruling  No.  260,  June,  1921;  W.  T.  S.  1921,  114053. 


THE   STAMP   TAX  1229 

or  transfers  shall  be  made,  cleared,  settled,  or  adjusted  through 
a  clearing  house,  or  otherwise,  are  required  on  or  before  the  fif- 
teenth day  of  each  month,  and  at  any  other  time  designated  by 
the  Commissioner,  to  render  under  oath  a  true  return  of  all  such 
sales  to  the  Commissioner  for  the  preceding  month  or  for  any 
other  period  designated  by  the  Commissioner,  containing  in 
detail  the  following  data  and  information: 

(1)  The  month  for  which  the  return  is  made. 

(2)  The  name  and  address  of  the  person,  partnership,  corpo- 

ration, or  association  making  the  return. 

(3)  The  number  of  shares  sold,  loaned,  and  borrowed  returned, 

and  tax  paid  as  follows: 

(a)  Par  value  shares  through  clearing  house. 

(b)  Par  value  shares  ex-clearing  curb,  over  the  counter. 

(c)  No  par  value  shares,  market  value  $100.00  or  less 

through  clearing  house. 

(d)  No  par  value  shares,  market  value  over  $100.00  or 

less  ex-clearing  house,  curb,  over  the  counter. 

(e)  No   par  value   shares,   market  value   over   $100.00 

through  clearing  house. 

(f)  Market  value  no  par  value  shares,  market  value  of 

$100.00  through  clearing  house. 

(g)  No  par  value  shares,  market  value  over  $100.00  ex- 

clearing  house,  curb,  over  the  counter. 

(h)  Market  value  no  par  value  shares,  market  value  over 
$100.00  ex-clearing  house,  curb,  over  the  counter. 

(i)  Transfers,  calls,  rights,  when  as  and  if  issued,  con- 
tracts and  miscellaneous. 

(4)  Number  of  shares  cross  trades. 

(5)  The  amount  of  tax  paid. 

(6)  The  amount  of  stamps  on  hand  on  the  first  day  of  the 

month,  or  other  period. 

(7)  The  amount  of  stamps  purchased  during  the  month,  or 

other  period. 

(8)  The  amount  of  stamps  on  hand  on  the  last  day  of  the 

month  for  which  return  is  being  made. 

(b)  Provided  that  brokers  known  strictly  as  "floor  brokers," 
or  "two-dollar  men"  or  "traders"  in  lieu  of  the  foregoing  return 
shall  render  a  return  only  as  to  such  sales  as  were  not  "given 
up"  to  or  cleared  through  some  other  broker  including  direct 
settlements,  "pass-outs,"  or  "scratched  sales." 

(c)  Provided  further  that  in  the  event  any  broker  who  has 
not  closed  business  shall  make  no  sales  of  stock  during  any  one 


1230  FEDERAL  INCOME  TAX 

month  he  shall  file  with  the  Commissioner  a  statement  to  that 
effect  in  lieu  of  a  return.'*'^'^ 

Returns  by  Clearing  Houses,  (a)  If  any  person,  who  nego- 
tiates sales  or  transfers  of  stock  on  a  stock  exchange,  shall 
appoint  in  writing  the  clearing  house  for  the  exchange  upon 
which  such  sales  or  transfers  are  made  his  agent  for  the  purposes 
hereinafter  indicated,  and  shall  make  to  such  clearing  house  a 
written  return,  statement,  or  sheet,  on  each  business  day,  con- 
taining a  full  disclosure  of  all  such  transactions,  both  clearable 
and  non-clearable,  of  the  preceding  day,  in  shares  of  stock  that 
are  listed  or  permitted  to  be  dealt  in  by  such  member  on  such  ex- 
change, and  also  showing  which,  if  any,  of  such  stocks  are 
loaned  or  borrowed  or  returned,  then  in  that  event  such  return, 
statement,  or  sheet,  delivered  to  the  clearing  house,  shall  be 
deemed  to  be  the  bill  or  memorandum  of  sale  or  agreement  to 
sell,  required  under  subdivision  3,  Schedule  A,  Revenue  Act  of 
1921,  and  such  clearing  house  is  hereby  authorized  to  affix  to 
such  return,  statement,  or  sheet  the  amount  of  stamps  required 
for  each  sale  or  agreement  to  sell  or  memorandum  of  sale  or 
delivery  or  transfer  of  the  stock  indicated  thereon,  and  to 
cancel  the  stamp  so  affixed,  (b)  The  affixing  and  cancellation  of 
such  stamps  by  the  clearing  house  shall  be  held  to  be  the  act  of  the 
person  making  such  sale  or  agreement  to  sell,  or  memorandum 
of  sale,  or  delivery  or  transfer  of  such  stock;  or  if  such  person 
and  clearing  house  so  elect,  such  person  shall  affix  and  cancel 
such  stamps  before  delivering  such  clearing  house  sheets  or 
memoranda  of  sales  to  the  clearing  house,  but  such  clearing 
house  shall  not  accept  such  clearing  house  sheet  or  memoranda 
unless  stamps  for  all  transfer  tax  required  to  be  affixed  are  at- 
tached thereto  and  properly  canceled,  (c)  The  returns,  state- 
ments, or  sheets  made  to  the  clearing  house  shall  in  respect  of 
each  sale  show  the  date  thereof,  the  name  of  the  seller,  the  name 
of  the  buyer,  the  amount  of  the  sale,  and  the  name  of  the  stock, 
or  certificates,  or  other  things  traded  in,  but  a  return  for  more 
than  one  sale  may  be  made  upon  the  same  return,  statement 
or  sheet;  and  no  settlement  of  differences  or  other  dealings 
between  members  shall  be  permitted  that  will  interfere  with 
the  full  disclosure  of  the  whole  transaction,  (d)  Said  clearing 
house  shall  preserve  the  returns,  statements,  or  sheets  so  made 
and  stamped  for  at  least  two  years,  (e)  Such  return,  state- 
ment, or  sheet  to  the  clearing  house  shall  not  relieve  the  seller 
from  making  and  delivering  to  the  buyer  the  bill  or  memorandum 

406  Reg.  40  Rev.,  Art.  17,  as  amended  by  T.  D.  3103. 


THE   STAMP   TAX  1231 

required  by  Article  15  of  Regulations  40  (Revised),  (f)  When 
a  clearing  house  carries  upon  its  sheets  or  records  information 
or  reports  of  transactions  showing  the  transfer  by  one  of  its 
members  of  an  account  of  a  customer  without  change  of  owner- 
ship of  the  securities  of  the  customer,  there  shall  be  kept  by 
the  members  of  such  clearing  house  or  body  concerned  in  such 
transaction  a  record  showing  the  particulars  of  such  trans- 
action.-*"" 

Stock  Transfer  Stamps,  (a)  Ordinary  documentary  stamps 
with  the  words  "Stock  transfer"  overprinted  thereon,  known  as 
"Stock  transfer  stamps,"  shall  be  affixed  to  all  sales  or  agree- 
ments, to  sell,  or  memoranda  of  sales,  or  deliveries  of  or  transfers 
of  legal  title  to  shares  or  certificates  of  stock  or  of  profits,  or  of 
interest  in  property  or  accumulations  of  a  corporation,  joint- 
stock  company,  or  association,  and  all  "warrants,"  rights,  and 
other  securities,  made  at  exchanges  or  similar  places,  (b)  Or- 
dinary documentary  stamps  may  be  affixed  to  sales,  agreements 

to  sell,  or  memoranda  of  sales  not  made  at  exchanges  or  similar 
places.^^8 

Records  and  Returns  Required  in  Case  of  Sales  of  Produce  on 
Exchange,  (a)  Every  person  who  makes  sales,  or  agreements  of 
sale,  or  Agreements  to  sell,  any  products  or  merchandise  at  or 
under  the  rules  or  usages,  of  any  exchange,  board  of  trade,  or 
similar  place,  for  future  delivery,  shall  deliver  to  the  buyer  bill, 
memorandum,  or  other  evidence  of  such  sale,  agreement  of  sale, 
or  agreement  to  sell,  to  which  there  shall  be  affixed  a  lawful 
stamp  in  value  equal  to  the  amount  of  the  tax  on  such  sale,  (b) 
Such  bill,  memorandum,  or  other  evidence  duly  stamped  shall 
be  kept  by  the  buyer  for  two  years,  unless  otherwise  prescribed 
by  regulation,  (c)  No  single  sale  or  agreement  of  sale,  or 
agreement  to  sell,  made  upon  an  exchange  by  one  member  for 
another  need  be  evidenced  by  more  than  one  stamped  bill, 
memorandum,  or  agreement. ^"^^ 

Clearing  House  as  Agent,  (a)  If  any  person  who  makes 
sales,  agreements  of  sale,  or  agreements  to  sell  any  products  or 
merchandise  at  or  under  the  rales  or  usages  of  any  exchange, 
board  of  trade,  or  similar  place,  for  future  delivery,  shall  in 
writing  appoint  the  clearing  house  for  the  exchange  upon  which 
such  sales  are  made,  his  agent  for  the  purposes  hereinafter 
named,  such  clearing  house  being  approved  by  the  Commissioner, 

407  Reji'.  40  Rev.,  Art.  18.     For  a  definition  of  the  term  "clearing  house" 
and  "exchange"  see  Reg.  40  Rev.,  Art.  33.     See  p.  1225. 
4n.s  Res.  40  Rev.,  Art.  19. 
400  Reg.  45  Rev.,  Art.  25. 


1232  FEDERAL   INCOME  TAX 

and  shall  make  a  written  return  or  sheet  of  each  sale  to  such 
clearing  house  in  accordance  with  the  regulations,  such  return 
or  sheet  shall  be  deemed  to  be  the  bill,  memorandum,  or  other 
evidence   required  by  the   regulations   to   be   delivered   by  the 
seller  to  the   buyer,   and   the  clearing  house  is   authorized  to 
affix  to  such  return  or  sheet  the  amount  of  the  stamps  required 
for  each  sale,  agreement  of  sale,  or  agreement  to  sell  as  indi- 
cated thereon,  and  to  cancel  the  stamps  so  affixed,     (b)    The  af- 
fixing and  canceling  of  such  stamps  by  the  clearing  house  shall 
be  held  to  be  the  act  of  the  person  making  such  contract  of 
sale,    (c)    If  the  person  making  such  sale  and  the  clearing  house 
so  elect,  the  seller  may  affix  the  stamps  to  the  clearing  house 
return  or  sheet  and  cancel  the  same  before  or  at  the  time  of 
delivery  to  the  clearing  house.    The  clearing  house  shall  in  no 
event  accept  such  bill,  memorandum  of  sale,  or  clearing  house 
return  or  sheet  unless  stamps  for  all  the  tax  required  to  be  paid 
thereon  are  attached  and  properly  canceled,     (d)    The  returns 
or  sheets  of  sales  so  made  to  the  clearing  house  shall  in  respect 
of  each  sale,  set  forth  the  date,  the  name  of  the  seller,  the  name 
of  the  purchaser,  the  amount  of  the  sale,  the  matter  or  things 
to  which  it  refers  and  the  tax  paid  thereon,  but  a  return  for 
more  than  one  sale  may  be  made  on  the  same  paper  or  sheet 
(e)    The  clearing  house  shall  preserve  for  a  period  of  not  less 
than  two  years,  each  bill,  memorandum  or  return,  or  sheet  made 
to  it  by  such  person,      (f)    Every  clearing  house  shall  include 
in  its  monthly  return  to  the  Commissioner  a  statement  of  the 
amount  of  stamps   so  affixed  and  canceled  on  the   returns  or 
sheets  of  each  person,     (g)    The  making  of  such  return  by  the 
clearing  house  shall  not  relieve  any  person  making  such  sale,  or 
agreement   of    sale,    or   agreement   to    sell,    from    making   the 
monthly  return  of  his  transactions  required  by  the  regulations.'*^" 
Records  to  Be  Kept  by  Buyers  and  Sellers,     (a)  All  per- 
sons who  make  sales  or  agreements  of  sale  of,  or  agreements  to 
sell   (including  so-called  "transferred  or  scratch"  sales,  "pass- 
outs,"  "pair-off s,"  "matched  trades,"  or  "give-ups")   any  prod- 
uct or  merchandise  at,  or  under  the  rules  or  usages  of,  any 
exchange  for  future  delivery,  or  are  engaged  in  the  business  of 
accepting  and   transmitting  orders   for   the   purchase   of   such 
products  or  merchandise  to  be  executed  at,  or  under  the  rules 
or  usages  of  any  exchange  for  future  delivery,  shall  keep  a  rec- 
ord showing:   (1)   Date  of  contract.     (2)   Name  of  person  exe- 
cuting contract    (floor  broker).     (3)    To  whom   sold   or   from 

«0  Reg.  40  Rev.,  Art.  26.     See  Reg.  40  Rev.,  Art.  29. 


THE   STAMP    TAX  1233 

whom  bought  (name  and  address).  (4)  Whether  transaction 
is  a  purchase  or  sale.  (5)  Quantity  of  product  or  merchandise 
involved,  whether  in  tons,  pounds,  bales,  bushels,  bags,  mats, 
barrels,  gallons,  or  whatever  other  unit  of  weight  or  measure 
is  used.  (6)  Name  of  product  or  merchandise,  including  (if 
not  a  basis  grade)  grade,  type,  sample,  or  description.  (7) 
Whether  contract  is  a  "basis-grade,"  "deferred  acceptance,"  or 
whatever  kind  of  contract.  (8)  Price  specified  per  ton,  pound, 
bale,  bushel,  bag,  mat,  barrel,  gallon,  or  whatever  other  unit  of 
weight  or  measure  is  used.  (9)  Tax  paid.  (10)  Customer 
(name  and  address).  (11)  Origin  of  order  (whether  domestic 
or  foreign).  (12)  Month  or  time  specified  in  contract  for  de- 
livery. (13)  Date  of  settlement.  (14)  Method  of  settlement 
or  adjustment,  (b)  Provided,  that  "floor  brokers,"  or  "two- 
dollar  men,"  or  "room  traders,"  in  lieu  of  the  foregoing  records 
shall  keep  a  record  showing:  (1)  Date  of  transaction.  (2) 
Name  of  person  who  executed  the  order,  if  other  than  the  floor 
broker.  (3)  Name  of  seller.  (4)  Name  of  buyer.  (5)  Quantity 
of  product  or  merchandise  involved  in  the  transaction.  (6) 
Name  of  product  or  merchandise,  including  (if  not  a  basis- 
grade  contract)  grade,  type,  sample,  or  description.  (7) 
Whether  the  contract  is  a  basis-grade  contract.  (8)  Price.  (9) 
Time  specified  in  contract  for  delivery.  (10)  Name  of  persons 
to  whom  "given  up,"  "paired  off,"  "transferred  or  scratched," 
or  "passed-out."  (c)  And  other  transactions  than  those  specified 
in  this  proviso  made  by  "floor  brokers,"  "two-dollar  men,"  or 
"room  traders,"  shall  be  kept  on  the  first  form  described  in  this 
paragraph,  (d)  Persons  who  use  either  of  such  forms  may  in- 
corporate additional  columns  which  may  be  of  use  to  them,  such 
columns  to  be  so  placed  as  not  to  interfere  with  the  columns  and 
headings  herein  prescribed,  (e)  Such  record  forms  will  not  be 
supplied  by  the  department,  (f)  The  foregoing  records  shall 
be  legibly  written  in  ink,  and  contracts  of  sale  for  future  deliv- 
ery of  two  or  more  distinct  products  or  merchandise  shall  be 
kept  separate.  Each  person  who  executes  or  makes  such  con- 
tracts of  sale  shall  preserve  the  books,  bills,  memoranda,  "sales 
tickets,"  or  trading  cards  of  all  transactions,  and  the  purchaser 
shall  preserve  the  bill,  memorandum,  agreement,  or  evidence 
of  sale  to  which  the  stamps  are  affixed  for  the  period  of  two 
years,  that  they  may  be  readily  inspected  by  the  revenue  officer, 
(g)  The  form  of  record  required  is  known  as  Form  B.^^i 

411  Reg.  40  Rev.,  Art.  27. 


1234  FEDERAL  INCOME  TAX 

Records  to  Be  Kept  by  Clearing  Houses,  (a)  All  persons 
who  acted  in  the  capacity  of  a  clearing  house  shall  keep  a 
record  showing:  (1)  Name  of  person  for  whom  each  contract 
is  cleared.  (2)  Date  when  contract  was  made.  (3)  Whether 
the  transaction  is  a  purchase  or  sale.  (4)  Quantity  of  product, 
or  merchandise,  involved,  whether  in  tons,  pounds,  bales,  bush- 
els, bags,  mats,  barrels,  gallons,  or  other  unit  of  weight  or 
measure,  as  the  case  may  be.  (5)  Name  of  product,  or  mer- 
chandise, including  (if  not  a  "basis-grade"  contract)  grade, 
type,  sample,  or  description.  (6)  Whether  the  contract  is  a 
"basis-grade"  contract.  (7)  Time  specified  in  contract  for  de- 
livery. (8)  Date  of  settlement.  (9)  Method  of  actual  settle- 
ment, (b)  Records  of  sales  for  future  delivery  of  two  or  more 
distinct  products  or  merchandise  must  be  kept  separate,  (c) 
The  clearing  house  shall  preserve  such  records  for  the  term  of 
two  years,  (d)  Such  record  forms  will  not  be  supplied  by  the 
department.412 

Returns  of  Transactions,  (a)  All  persons  who  make  con- 
tracts of  sale  or  purchase  of  any  product  or  merchandise,  at 
or  under  the  rules  or  usages  of  any  exchange,  board  of  trade,  or 
other  similar  place  of  business,  for  future  delivery,  whether  such 
contracts  shall  be  cleared  and  adjusted  through  a  clearing 
house  or  directly  between  the  seller  and  buyer,  or  otherwise, 
shall  on  or  before  the  fifteenth  day  of  each  month,  or  at  any 
other  time  required  by  the  Commissioner,  make  a  return  in  writ- 
ing to  the  Commissioner,  for  the  preceding  month  of  any  other 
period,  verified  before  some  officer  authorized  to  administer 
oaths,  showing  (1)  The  number  of  contracts  of  sale  and  pur- 
chase of  each  product  or  merchandise  brought  forward  from  the 
preceding  month  or  period.  (2)  The  number  of  contracts  of 
sale  and  purchase  of  each  product  or  merchandise  on  each  day 
during  the  current  month  or  period.  (3)  The  months  in  which 
the  products  or  merchandise  are  to  be  delivered.  (4)  The 
method  of  settlement  of  each  contract,  i.  e.,  whether  by  "actual 
delivery,"  "notice,"  "ring,"  "direct,"  "transfer,"  "scratch  sale," 
"pass  out,"  "matched,"  "pair  off,"  "set-off,"  "give  up,"  through 
a  clearing  house  or  otherwise.  (5)  The  tax  paid  thereon.  (6) 
The  number  of  contracts  both  of  purchase  and  sale  carried 
forward  at  the  end  of  the  month  or  period.  (7)  The  amount  of 
stamps  on  hand  at  beginning  of  month  or  period.  (8)  The 
amount  of  stamps  purchased  during  month  or  period.  (9) 
The  amount  of  stamps  used  during  month  or  period.     (10)    Bal- 

412  Reg.  40  Rev.,  Art.  28. 


THE   STAMP   TAX  1235 

ance  of  stamps  on  hand  at  end  of  month  or  period.  (11) 
The  origin  of  the  order  or  the  contracts,  whether  domestic  or 
foreign.  (b)  Provided,  that  "floor  brokers,"  or  ''two-dollar 
men,"  or  "room  traders"  may  omit  from  their  returns  infonna- 
tion  called  for  under  paragraphs  marked  (1),  (6),  and  (11). 
But  in  the  event  such  "floor  brokers,"  "two-dollar  men,"  or  "room 
traders"  shall  make  or  settle  transactions  in  any  other  way 
than  by  "transferred  or  scratch  sales,"  "give  ups,"  or  "pass 
outs,"  they  shall  make  the  full  returns  prescribed  in  this  para- 
graph, (c)  Such  returns  shall  be  made  upon  forms  to  be 
furnished,  upon  application,  by  the  Collector  of  Internal  Rev- 
enue, of  the  districts  in  which  the  exchange,  board  of  trade,  or 
other  similar  place  is  located.  ^^'^ 

Returns  by  Clearing  Houses,  (a)  Every  clearing  house 
shall  on  or  before  the  fifteenth  day  of  each  month,  and  at  such 
other  times  as  required  by  the  Commissioner,  make  return 
in  writing,  under  oath,  to  the  Commissioner,  for  the  preceding 
month  or  other  period,  showing  (1)  The  number  of  open  con- 
tracts "long"  and  "short"  brought  forward  for  each  member 
from  the  preceding  month.  (2)  The  number  of  contracts  bought 
and  sold  by  each  member  of  the  association.  (3)  The  number 
of  tons,  pounds,  bales,  bushels,  bags,  mats,  barrels,  or  gallons, 
or  other  units  of  weight  or  measure  involved  in  such  contracts, 
as  the  case  may  be.  (4)  The  month  in  which  such  product, 
merchandise,  or  commodity  is  to  be  delivered.  (5)  The  method 
of  settlement  of  said  contracts,  i.  e.,  whether  by  "set  off,"  "no- 
tice," or  "delivery,"  or  by  what  method.  (6)  Total  tax  paid 
by  each  member  of  the  exchange.  (7)  The  number  of  open 
contracts  "long"  and  "short"  carried  forward  for  each  mem- 
ber to  the  following  month,  (b)  Such  returns  shall  be  made 
upon  forms  to  be  furnished,  upon  application,  by  the  collector 
of  internal  revenue  of  the  district  in  which  the  clearing  house 
is  situated.^i^ 

Stamps  May  Be  Affixed  to  Returns,  (a)  If  any  exchange 
shall  by  proper  resolution  request  the  Commissioner  to  permit 
the  members  of  such  exchange  to  affix  the  requisite  amount  of 
stamps  on  the  returns  made  by  such  members  to  the  Commis- 
sioner of  all  transactions  made  by  such  member  at  such  ex- 
change and  cancel  such  stamps,  and  shall  file  with  the  Com- 
missioner a  copy  of  the  charter  and  by-laws  of  such  exchange 
accompanied   with   a   list   of  the   names   and  addresses   of   the 

413  Reg.  40  Rev.,  Art.  29. 

414  Reg.  40  Rev.,  Art.  30. 


1236  FEDERAL  INCOME  TAX 

officers  and  members  of  such  exchange,  designating  those  of 
such  members  who  are  active  and  those  who  are  inactive  on 
the  exchange,  then  upon  approval  of  such  resolution  by  the 
Commissioner,  instead  of  affixing  the  stamps  to  the  bill  or  mem- 
orandum of  sale  as  now  required,  it  shall  be  lawful  for  the 
members  of  such  exchange  to  affix  the  amount  of  stamps  on 
such  returns  as  shall  represent  the  aggregate  amount  of  tax 
due  on  all  sales,  agreements  of  sale,  or  agreements  to  sell,  made 
by  such  member  during  the  preceding  month  or  other  period 
designated  by  the  Commissioner  and  such  stamps  shall  be  can- 
celed by  such  member  in  the  manner  prescribed  in  the  regu- 
lations, (b)  Such  returns,  duly  stamped,  shall  be  filed  and  pre- 
served for  two  years,  (c)  The  stamping  and  filing  of  such  re- 
turns shall  not  in  any  way  relieve  the  members  of  such  exchange 
from  making  and  delivering  to  the  buyer  the  memorandum  or 
bill  of  sale  prescribed  by  law  and  the  regulations,  nor  the  buyer 
from  the  necessity  of  preserving  the  same  for  the  term  of  two 
years.^i'^ 

Future  Delivery  Stamps.  The  stamps  to  be  used  on  sales, 
agreements  of  sale,  or  agreements  to  sell  products  or  merchan- 
dise at  or  under  the  rules  or  usages  of  any  exchange,  or  board 
of  trade,  or  other  similar  place,  for  future  delivery  shall  be  the 
ordinary  documentary  stamps  with  the  words  "Future  deliv- 
ery" overprinted  thereon,  and  they  shall  be  known  as  "Future 
delivery  stamps."  ^^^ 

Registration  of  Brokers,  etc.  (a)  Every  person  engaged,  in 
whole  or  in  part,  in  any  of  the  following  businesses  or  activi- 
ties shall  file  a  statement  for  registration  with  the  collector  of 
internal  revenue  of  the  district  in  which  his  principal  office  or 
place  of  business  is  located :  (1)  Persons  engaged  in  negotiating, 
making,  or  recording  sales,  agreements  to  sell,  deliveries  or 
transfers  of  shares  or  certificates  of  stock,  or  rights,  or  war- 
rants, or  certificates  of  beneficial  interest  in  profits,  property, 
or  accumulations  of  a  corporation.  (2)  Persons  conducting  or 
transacting  a  stock  brokerage  business.  (3)  Persons  accepting 
or  procuring  the  transmission  of  orders  for  the  purchase  or 
sale  of  transfer  of  stocks,  rights,  warrants,  certificates  of  bene- 
ficial interest,  or  interests  in  property,  profits  or  dividends,  to 
be  executed  at  a  stock  brokerage  office  or  an  exchange  or  sim- 
ilar place.  (4)  Persons  engaged  in  the  business  of  transferring 
stock  other  than  their  own.      (5)    Persons  engaged  in  making 

415  Reg.  40  Rev.,  Art.  31. 
«6  Reg.  40  Rev.,  Art.  32. 


THE   STAMP   TAX  1237 

sales  or  agreements  of  sale  of,  or  agreements  to  sell,  any  prod- 
ucts or  merchandise  at,  or 'under  the  rules  or  usages  of,  any 
exchange,  for  future  delivery;  or  engaged  in  the  business  of 
accepting  or  procuring  the  transmission  of  orders  for  such  con- 
tracts of  sale  to  be  executed  at  an  exchange,  or  under  the  rules 
or  usages  of  an  exchange,  for  future  delivery.  (6)  Persons 
engaged  in  conducting  an  exchange  or  clearing  house  or  clear- 
ing association  for  the  clearing,  adjusting,  and  settling  trans- 
actions made  on  exchanges  or  similar  places:  Provided,  That 
in  case  the  person  conducting  such  an  exchange  has  a  depart- 
ment connected  therewith  engaged  in  clearing,  adjusting,  and 
settling  the  transactions  made  on  such  exchange,  he  shall  so  state 
and  shall  give  the  names  and  addresses  of  the  superintendent 
and  secretary  of  each  such  clearing  house  division  or  committee. 

(b)  If  the  person  required  to  file  a  statement  for  registration  is 
also  a  member  of  an  exchange,  a  seat  on  which  is  worth  $2,000 
or  more,  he  shall  state  the  average  value  of  such  seat  for  the 
year  ending  June  30   immediately   preceding  his   registration, 

(c)  In  the  case  of  a  partnership  of  which  two  or  more  mem- 
bers are  members  of  exchanges,  the  names  of  such  members 
and  of  each  exchange  in  which  memberships  are  held  shall  be 
stated,  together  with  the  price  of  a  seat  on  each  exchange,  (d) 
The  statement  above  required  shall  be  verified  on  oath  by  the 
person  required  to  make  such  statement,  or  by  the  president  or 
secretary  of  a  corporation,  association,  or  clearing  house,  and 
shall  set  forth  specifically  the  character  of  the  business  to  be 
conducted  and  the  full  name  and  address  of  each  person  or 
member  of  a  partnership  engaged  in  such  business :  Provided, 
that  in  the  case  of  a  corporation  or  association,  the  statement 
for  registration  shall  set  forth  the  date  and  place  of  incorpora- 
tion and  the  principal  office  or  place  of  business  both  within 
and  without  the  State  where  incorporated,  and  the  names  and 
addresses  of  the  chief  officer  and  secretary  of  such  corporation, 
and  be  accompanied  with  a  list  of  the  members  and  their  ad- 
dresses, (e)  Each  exchange  or  clearing  house  shall  also  file 
with  such  collector  a  copy  of  its  constitution,  charter,  or  agree- 
ment of  association  and  by-laws,  rules  and  regulations,  and  all 
amendments  thereto  as  the  same  may  from  time  to  time  be 
adopted,  and  the  names  and  addresses  of  new  members  as 
from  time  to  time  admitted  to  membership,  (f )  If  the  person  or 
corporation  required  to  file  such  statement  has  been  licensed 
under  the  laws  of  any  State  or  under  any  other  provision  of 
Federal  law  the  date  and  place  at  which  such  license  was  issued 
shall  be  stated,     (g)  In  case  a  person  registered  as  required  by 


]238  FEDERAL  INCOME  TAX 

the  regulations  shall  suspend  or  close  his  business  before  the  end 
of  the  year  for  which  he  is  registered,  he  shall  file  in  the  office  of 
the  collector  of  internal  revenue  in  which  he  is  registered  a  cer- 
tificate to  that  effect,  giving  the  date  on  which  he  suspended  or 
closed  his  business,  (h)  Such  statement  for  registration  shall  be 
made  on  a  form  to  be  furnished  upon  application  to  the  collector 
of  internal  revenue.'^^'^ 

Record  of  Registration  Kept  by  Collector,  (a)  Every  col- 
lector shall  file  and  preserve  each  statement  for  registration  filed 
with  him  in  accordance  with  the  regulations,  and  shall  issue  to 
each  person,  partnership,  exchange,  clearing  house  or  corpora- 
tion a  certificate  of  registration,  showing  the  date  of  issue,  the 
name  of  the  person,  or  exchange,  clearing  house,  or  corporation, 
conducting  the  business,  the  nature  of  the  business  for  which  the 
license  is  granted,  and  the  date  of  expiration  of  said  registry, 
which  certificate  of  registration  shall  be  signed  by  the  collector, 
and  shall  be  posted  in  some  prominent  place  in  the  office  of 
said  person,  partnership,  exchange,  clearing  house,  or  corpo- 
ration during  the  period  for  which  it  is  issued,  (b)  If  such 
business  is  conducted  at  more  than  one  place,  a  certificate  shall 
be  posted  in  each  place  of  business.^^^ 

Sale  of  Stamps,  (a)  No  person  other  than  a  Collector  of  Inter- 
nal Revenue,  or  duly  authorized  deputy  collector  of  Internal  Rev- 
enue, Assistant  Treasurer,  or  designated  United  States  depositary 
shall  sell  or  expose  for  sale,  give  away,  traffic  in,  trade,  barter, 
lend,  borrow,  or  exchange  any  stamps,  issued  pursuant  to  the 
regulations :  Provided,  That  any  person  or  corporation  which  has 
been  duly  appointed  and  constituted  and  is  acting  agent  of  any 
State  for  the  sale  of  stock  transfer  stamps  of  such  State,  may 
upon  giving  bond  in  a  sum  to  be  fixed  by  the  Commissioner,  sell 
United  States  stamps  issued  pursuant  to  the  regulations  when 
approved  and  authorized  by  the  Commissioner,  (b)  No  person 
shall  buy,  receive,  or  have  in  his  possession  or  under  his  control, 
any  stamps  issued  pursuant  to  the  regulations,  unless  such 
stamps  have  been  purchased  directly  from  the  Collector  of  Inter- 
nal Revenue,  or  duly  authorized  Deputy  Collector  of  Internal 
Revenue,  Assistant  Treasurer  designated  United  States  deposi- 
tary, or  a  designated  agent  for  the  sale  of  State  stock  transfer 
stamps  authorized  by  the  Commissioner,  in  the  district  in  which 
the  stamps  are  to  be  used,  (c)  All  requisitions  for  stamps  to  be 
used  under  these  regulations  shall  be  made  in  writing  on  a  form 
prescribed  by  the  Commissioner  to  the  Collector  of  Internal  Rev- 

417  Reg.  40  Rev.,  Art.  34. 

418  Reg.  40  Rev.,  Art.  35. 


THE   STAMP   TAX  1239 

enue  or  duly  authorized  Deputy  Collector  of  Internal  Revenue, 
Assistant  Treasurer  or  designated  United  States  depositary  or 
state  agent  authorized  by  the  Commissioner,  in  the  Internal  Rev- 
enue district  in  which  the  stamps  are  to  be  used,  giving  the  date 
thereof,  the  number  and  denomination  of  stamps  applied  for  and 
the  name  and  address  of  the  purchaser,  and  shall  be  signed  in 
ink  by  the  person  receiving  such  stamps,     (d)  If  the  requisition 
for  such  stamps  shall  be  made  to  any  Assistant  Treasurer  or 
designated  United   States   depositary   or  duly  authorized   state 
agent  for  sale  of  state  stock  transfer  stamps,  such  Assistant 
Treasurer  or  designated  United  States  depositary  or  duly  author- 
ized state  agent  shall  keep  a  record  thereof,  and  at  the  end  of 
each  month  shall  file  with  the  Collector  of  Internal  Revenue  of 
the  district  a  statement  setting  forth  the  number,  denomination, 
and  amount  of  all  stamps  on  hand  at  the  beginning  of  each 
month,  the  number,  denomination  and  amount  sold  during  the 
month,  and  the  number,  denomination  and  amount  on  hand  at 
the  end  of  the  month,  accompanied  by  the  requisitions,  filed  by 
each  purchaser,  and  on  or  before  the  fifteenth  day  of  each  month 
shall  pay  over  to  such  Collector  of  Internal  Revenue  all  money 
received  from  sales  of  such  stamps  for  the  preceding  month,  tak- 
ing his  receipt  therefor,     (e)  The  Collector  of  Internal  Revenue 
shall  keep  the  requisitions  for  stamps  sold  by  him  and  those  sold 
by  such  Assistant  Treasurer,  designated  United  States  depos- 
itary or  authorized  state  agent  separate  and  apart  from  all  other 
requisitions  for  stamps  and  shall  preserve  them  in  his  office  for  a 
period  of  two  years.^-" 

Penalties.  Several  penalties  are  provided  in  Title  XI  of  the 
Revenue  Act  of  1921,  which  are  dealt  with  in  the  following  par- 
agraphs. The  act,  omission,  or  failure  of  any  official,  agent  or 
other  person  or  corporation,  employed  by  any  person,  partner- 
ship, company,  association  or  corporation,  within  the  scope  of 
his  employment  or  oflice,  will  in  every  case  be  deemed  also  the 
act,  omission,  or  failure  of  such  principal.^-'' 

Issuing  or  Accepting  Unstamped  Instruments.  Anyone 
who  makes,  signs,  issues  or  accepts  an  instrument  without  the 
full  amount  of  the  tax  being  paid  thereon  is  guilty  of  a  mis- 
demeanor punishable  by  a  fine  of  not  more  than  $100  for  each 
offense.^" 

4-'i»  Reg-.  40  Rev.,  Art.  39. 

•*-■'  Reg-.  40  Rev.,  Art.  33. 

-I--'  Revenue  Act  of  1921,  §  1102.  The  word  "accept"  is  used  in  this  sec- 
tion in  the  general  sense  of  "receive,"  not  in  the  special  sense  peculiar  to 
drafts.     (T.  D.  2682.) 


1240  FEDERAL   INCOME  TAX 

Selling  Playing  Cards  Without  Paying  the  Tax.  Anyone 
who  manufactures  and  imports  or  sells  any  playing  cards,  pack- 
age or  other  article  without  the  full  amount  of  tax  being  paid 
thereon  is  guilty  of  a  misdemeanor  punishable  by  a  fine  of  not 
more  than  $100  for  each  offense.^-^' 

Failure  to  Cancel  Stamps.     Anyone  who  makes  use  of  a 

stamp  without  cancelling  or  obliterating  the  same  is  guilty  of  a 

misdemeanor  punishable  by  a  fine  of  not  more  than  $100  for  each 
offense.^24 

Fraudulent  Removal  or  Reuse  of  Stamps.  The  penalty  for 
fraudulent  removal  or  reuse  of  a  stamp  or  having  possession  of 
washed,  restored  or  altered  stamps  removed  from  any  instru- 
ment is  a  fine  of  not  more  than  $1,000  or  imprisonment  for  not 
more  than  five  years,  or  both,  and  the  reused,  cancelled  or  coun- 
terfeit stamp  together  with  the  document,  package  or  article 
upon  which  it  is  placed  or  impressed  may  be  forfeited  to  the 
United  States.^^s 

Transferring  Stock  Without  Paying  Tax.  Any  person 
liable  to  pay  the  tax  on  sales  or  transfers  of  capital  stock  or  cer- 
tificates of  profits  or  any  one  acting  as  agent  or  broker  for  such 
person,  who  makes  any  sale,  or  in  pursuance  of  a  sale  delivers  any 
certificate  or  evidence  of  the  sale  of  any  stock,  interest  or  right  or 
bill  or  memorandum  thereof,  without  the  proper  stamps  affixed 
thereto  with  intent  to  evade  the  law  is  guilty  of  a  misdemeanor 
punishable  by  a  fine  of  not  more  than  $1,000,  or  by  imprisonment 
for  not  more  than  six  months,  or  both.^^o 

Making  Sales  of  Produce  Without  Paying  Tax.  Any  per- 
son liable  to  pay  the  tax  on  sales  of  produce  on  any  exchange  or 
anyone  acting  as  agent  or  broker  for  such  person,  who  makes  any 
sale,  or  agreement  of  sale  or  agreement  to  sell,  or  pursuant  there- 

423  Revenue  Act  of  1921,  §1102.  The  Act  of  August  28,  1894,  also  im- 
posed the  following  penalties:  §39.  Adhesive  stamps  to  be  affixed  to  each 
package  and  canceled  by  the  person  using  the  stamp.  Penalty,  $50.00.  §  40. 
Manufacturer  to  register  with  the  collector  of  the  district.  Failure  to  reg- 
ister, penalty,  $50.00.  §  42.  Penalty  for  counterfeiting,  defacing,  or  re- 
moving stamp  or  illegal  use  of  the  same,  fine  of  $1000.00,  5  years'  imprison- 
ment, or  both,  at  the  discretion  of  the  court.  §  4.3.  Penalty  for  removal  or 
sale  of  playing  cards  (except  for  export)  without  having  stamps  affixed, 
$50.00.  §  44.  Manufacturer  removing  or  reusing  any  stamp,  wrapper,  or 
cover  for  the  purpose  of  evading  the  tax  liable  to  a  fine  of  $50.00  and  for- 
feiture. §  45.  Penalty  for  selling  or  exposing  for  sale,  removing,  or  con- 
cealing playing  cards  without  having  affixed  the  stamp  thereto,  $50.00  and 
forfeiture.     (See  T.  D.  2817.) 

424  Revenue  Act  of  1921,  §  1102. 
42".  Revenue  Act  of  1921,  §  1103. 

42fi  Revenue  Act  of  1921,  Title  XI,  Schedule  A-3. 


THE   STAMP   TAX 


1241 


to  delivers  any  products  or  merchandise  without  a  bill,  mem- 
orandum or  other  evidence  thereof,  or  who  delivers  such  bill, 
memorandum  or  evidence,  without  having  the  proper  stamps 
affixed  thereto,  is  guilty  of  a  misdemeanor  punishable  by  a  fine 
of  not  more  than  $1,000,  or  by  imprisonment  for  not  more  than 
six  months,  or  both."*-' 

Failure  to  Stamp  Insurance  Policies.  Any  person  to  or  tor 
whom  or  in  whose  name  any  insurance  policy,  taxable  under  Title 
XI  is  issued,  or  any  solicitor,  agent  or  broker  acting  for  or  m 
behalf  of  such  person  in  the  procurement  of  any  such  policy, 
for  failure  to  affix  the  proper  stamps  with  intent  to  evade  the  tax, 
in  addition  to  other  penalties  provided  herefor,  will  be  obliged  to 
pay  a  fine  of  double  the  amount  of  the  tax.-^-^ 

Other  Penalties.  The  present  law  contains  no  provision  that 
an  unstamped  instrument  shall  be  void  or  shall  not  be  admitted 
as  evidence  in  the  courts  or  shall  not  be  placed  on  record.  But 
Sections  13  14  and  15  of  the  Act  of  June  13,  1898,  as  amended  by 
the  Act  of  March  2,  1901,  are  held  by  the  Treasury  Department 
to  be  still  in  force,  and  to  apply  to  deeds  to  the  extent  that  they 
forbid  the  record  and  admission  in  evidence  of  unstamped  deeds 
and  require  their  presentation  to  the  collector  of  the  district  for 
validation  ^•-•'  Section  13  makes  prevision  for  the  stamping  of 
documents  issued  without  stamps;  Section  14  that  unstamped  in- 
struments are  not  admissible  in  evidence;  and  Section  15  that  un- 
stamped instruments  shall  not  be  recorded.^^o 

This  view  of  the  Treasury  Department  has  been  upheld  by  a 
Federal  District  Court^-^i  but  in  a  recent  case^^o  decided  by  the 
United  States  Supreme  Court  it  has  been  held  that  Sections  13, 
14  and  15  of  the  1898  Law  have  no  application  under  the  1914 
Law  This  case  appears  to  be  conclusive  with  respect  to  the  1918 
and  1921  Laws  as  well  as  to  the  1914  Law.     The  court  said  m 

part:  .  +u  f  -i-v, 

"As  to  the  absence  of  revenue  stamps,  it  is  true  that  tne 
deeds  showing  title  in  some  of  the  plaintiff  s— they  were  produced 
in  evidence  over  the  defendant's  objection— were  without  the 
stamps  required  by  the  act  of  October  22,  1914,  c.  331,  Sec.  22, 

427  Revenue  Act  of  1921,  Title  XI,  Schedule  A-4. 

428  Revenue  Act  of  1921,  Title  XI,  Schedule  A-13;  T.  D.  2891 

429  Letter  from  treasury  department  dated  May  27,  1918;  W.  1.  b  lyiy, 
113717  §§2  4  6  12,  18,  20,  21,  22,  23,  24,  25,  Schedule  A,  Schedule  B, 
§§  27,  28,  29  'and  50,  of  the  Act  of  June  13,  1898,  were  expressly  repealed  by 
the  Act  of  April  12,  1902.     (32  Stat.  96.) 

430  The  sections  are  printed  in  full  at  the  end  of  this  book. 
4.'ii  U.  S.  V.  Masters,  264  Fed.  250. 

432  Cole  et  al.  v.  Ralph,  252  U.  S.  286. 


1242  FEDERAL  INCOME  TAX 

Schedule  A,  38  Stat.  762.  But  this  neither  invalidated  the  deeds 
nor  made  them  inadmissible  as  evidence.  The  relevant  provi- 
sions of  that  act,  while  otherwise  following  the  language  of 
earlier  acts,  do  not  contain  the  words  of  those  acts  which  made 
such  an  instrument  invalid  and  inadmissible  as  evidence  while 
not  properly  stamped.  Those  words  were  carefully  omitted,  as 
will  be  seen  by  contrasting  Sees.  6,  11,  12  and  13  of  the  act  of 
1914  with  Sees.  7,  13,  14  and  15  of  the  act  of  1898,  c.  448,  30 
Stat.  454.  From  this  and  a  comparison  of  the  acts  in  other  par- 
ticulars it  is  apparent  that  Congress  in  the  later  act  departed 
from  its  prior  practice  of  making  such  instruments  invalid  Qr  in- 
admissible as  evidence  while  remaining  unstamped  and  elected  to 
rely  upon  other  means  of  enforcing  this  stamp  provision,  such 
as  the  imposition  of  money  penalties,  fines  and  imprisonment. 
The  decisions  upon  which  the  defendant  relies  arose  under  the 
earlier  acts  and  were  based  upon  the  presence  in  them  of  what 
studiously  was  omitted  from  the  later  one." 

Excluding  Unstamped  Documents  in  State  Courts.  There 
is  some  conflict  of  authority  on  the  question  whether  the  federal 
government  has  any  authority  under  the  constitution  to  pre- 
scribe rules  of  evidence  for  the  state  courts,  and  to  preclude  the 
acceptance  in  evidence  of  unstamped  or  improperly  stamped  in- 
struments in  the  state  courts.  There  are  cases  "holding  expressly 
that  the  federal  government  has  such  power,  or  holding  to  the 
same  effect  by  excluding  unstamped  or  improperly  stam.ped  docu- 
ments,433  but  the  weight  of  authority  and  the  best  considered 
cases  seem  to  establish  a  contrary  rule.^''^  One  of  the  best  state- 
ments on  the  subject,  contained  in  a  Georgia  case,*^^  which  arose 
under  the  1898  Law,  of  which  the  above  sections  13,  14  and  15 
once  formed  a  part,  reads  as  follows:  "We  fully  recognize  the 
power  of  Congress  to  levy  and  collect  taxes  for  the  support  of  the 

433  Chartiers  etc.  Co.  v.  McNamara,  72  Pa.  St.  278;  Hoops  v.  Dunham,  41 
Ga.  109. 

434  Peo.  ex  reL  Barbour  v.  Gates,  43  N.  Y.  40;  Moore  v.  Moore,  47  N.  Y. 
467;  Rowe  v.  Bowman,  183  Mass.  488,  67  N.  E.  636;  Davis  v.  Evans,  133 
N.  C.  320,  45  S.  E.  643;  Cassidy  v.  St.  Germain,  22  R.  I.  53,  46  Atl.  35; 
Garland  v.  Gaines,  73  Conn.  662,  49  AtL  19;  Clemens  v.  Conrad,  19  Mich. 
170;  Sammons  v.  Halloway,  21  Mich.  162;  Craig  v.  Dimock,  47  111.  308; 
Duffy  V.  Hobson,  40  Cal.  240;  Pargoud  v.  Richardson,  30  La.  Ann.  1286; 
Knox  v.  Rossi,  25  Nev.  96,  57  Pac.  179,  48  L.  R.  A.  305  (note).  Many  more 
cases  could  be  cited  to  the  same  effect,  but  the  above  are  leading  cases,  and 
it  is  believed  that  they  will  furnish  a  guide  to  a  complete  list  of  the  au- 
thorities. 

435  Small  V.  Slocumb,  112  Ga.  279,  37  S.  E.  481.  This  case  contains  an 
exhaustive  examination  of  the  authorities,  and  expressly  disapproves  of 
Chartiers  etc.  Co.  v.  McNamara,  72  Pa.  St.  278. 


THE   STAMP   TAX 


1243 


government.    We  fully  recognize  its  power  to  do  this  by  the  im- 
position of  stamp  duties,  and  to  prescribe  penalties  for  their 
nonpayment.    We  also  recognize  its  power  to  regulate  the  prac- 
tice and  procedure  and  to  provide  rules  of  evidence  in  courts 
established  under  the  constitution  of  the  United  States.     After 
much   reflection   and  a  careful   and   thorough   investigation   of 
cases  in  the  courts  of  other  states,  we  have  come  to  the  con- 
clusion, however,  that  Congress  has  no  power  to  prescribe  rules 
of  evidence  for  a  state  court.    Under  our  system  of  government, 
the  states  retained  all  powers  of  sovereignty  which  were  not 
granted  to  the  general  government  by  the  constitution.     They 
had  the  power  to  create  and  establish  their  own  courts,  and  to 
regulate  the  practice  and  procedure,  and  to  prescribe  rules  of 
evidence  therein.     There  is  nothing  in  the  constitution  of  the 
United  States,  which  expressly  or  by  implication  gives  to  Con- 
gress the  power  to  prescribe  rules  of  evidence  for  the  courts  of 
the  states.     Of  course  Congress,  having  the  power  to  impose 
stamp  duties,  has  the  power  to  provide  for  the  enforcement  of 
their  payment  by  any  necessary  and  proper  means.     But  while 
to  make  unstamped  instruments  inadmissible  in  evidence  in  State 
courts  would  doubtless  aid  in  compelling  the  payment  of  the 
tax,  we  think  that  such  a  method  of  collection  is  neither  neces- 
sary nor  proper,  and  is  therefore  not  within  the  power  of  Con- 
gress.   The  act  of  1898  subjects  to  a  penalty  any  one  who  fails 
or  refuses  to  comply  with  the  provisions  as  to  stamping  written 
instruments,  and  the  Federal  courts  have  ample  machinery  for 
the  enforcement  of  this  penalty.     No  other  method  of  enforce- 
ment would  seem  to  be  necessary,  but,  even  if  it  were,  Congress 
has  power  to  provide  that  no  unstamped  instrument  shall  be 
received  in  evidence  in  any  of  the  Federal  courts.    An  attempt  to 
extend  this  provision  so  as  to  make  it  applicable  to  the  courts  of 
the   several   states   can   not,   therefore,   be   defended   upon   the 
ground  that  it  is  necessary.    Nor  do  we  think  it  a  proper  means 
of  enforcing  the  stamp  act  to  interfere  with  courts  peculiarly 
within  the  control  of  the  several  states,  by  declaring  what  shall 
or  shall  not  be  used  as  evidence  in  them,  or  to  seek  to  make  the 
state  courts  punish  a  failure  to  comply  with  the  federal  stamp 
act  by  refusing  to  allow  unstamped  documents  to  be  used  as 
evidence  in  them."     These  state  decisions  have  no  application 
to  Federal  courts,  where  the  laws  of  Congress,  prescribing  rules 
of  evidence,  must  be  observed.  •••''     And  it  has  been  held  that 
even  though  a  deed  improperly  stamped  is  admissible  in  evidence 
in  the  state  courts,  a  purchaser  at  a  judicial  sale  is  entitled  to  a 

430  Sackett  v.  M'Caffrey,  131  Fed.  219. 


1244  FEDERAL  INCOME  TAX 

deed  which  will  defend  his  title  in  any  tribunal  where  it  is  at- 
tacked or  where  he  is  called  upon  to  assert  it,  and  that  a  referee 

to  sell  must  affix  the  required  stamps  to  his  deed  to  such  pur- 
chaser.^sT 

Voiding  Instruments  for  Failure  to  Stamp.  It  is  held  that 
a  deed,  note  or  other  instrument  is  not  rendered  absolutely  void 
by  a  failure,  to  stamp  it  properly,^3s  i^^t  it  is  also  held  that  such 
deed,  note,  or  other  instrument,  is  rendered  void  if  the  omission 
to  stamp  the  same  is  wilful  or  with  intent  to  evade  the  tax.'^so 
The  point  is  in  some  confusion  and  no  general  rule  can  be  safely 
formulated.  It  has  been  held  by  a  state  court  that  a  note  which 
lacks  the  stamping  required  by  the  1916  and  1918  Federal  Laws 
is  not  "complete  and  regular  on  its  face"  and  the  purchaser  of 
such  a  note  is  not  a  holder  in  due  course.^^^ 

Suits  for  Collection  of  Stamp  Taxes.  Following  the  rule  that 
the  government  may  recover  duties  upon  imports  as  a  personal 
indebtedness  of  the  importer,  it  has  been  held  under  the  1898 
Law  that  there  is  nothing  in  the  nature  of  a  stamp  tax  which 
per  se  negatives  either  the  personal  obligation  otherwise  to  be 
derived  from  the  words  imposing  the  tax,  or  its  collection  by 
action;  (2)  the  stamp  is  only  the  evidence,  and  its  purchase  the 
convenient  means,  of  payment,  so  that  when  a  statute  says  that 
a  person  shall  25a?/,  it  obviously  imposes  upon  that  person  a  duty 
to  pay  which  may  be  enforced  through  the  ordinary  means 
adapted  to  the  recovery  of  a  definite  sum  due,  unless  that  course 
is  clearly  prohibited;  (3)  the  penalties  contained  in  the  act  were 
provided  to  induce  the  payment  of  the  tax  and  not  as  a  substi- 
tute for  payment,  and  such  provisions  do  not  preclude  the  idea 
of  personal  liability;  (4)  the  punitive  provisions  invalidating 
unstamped  instruments  ofl'er  an  escape  through  a  voluntary  pay- 
ment and  therefore  do  not  deprive  the  government  of  the  right 
to  compel  payment  by  action;  (5)  the  act  itself  provides  by  ref- 
erence to  the  Revised  Statutes  and  the  administrative,  special 
or  stamp  provisions  of  law  that  payment  may  be  enforced  by 
action. 441 

4"TLoring  v.  Chase,  26  Misc.  318;  56  N.  Y.  Supp.  312. 

«s  Moore  v.  Moore,  47  N.  Y.  467;  Goodwine  v.  Wands,  25  Ind.  101;  Adams 
V.  Dale,  29  Ind.  273;  D'Armond  v.  Dubose,  22  La.  Ann.  131. 

430  Dowell  V.  Applegate,  7  Fed.  881 ;  Rowe  v.  Bowman,  183  Mass.  488,  67 
N.  E.  636;  Cassidy  v.  St.  Germain,  22  R.  I.  53,  46  Atl.  35;  Hooper  v. 
Whitaker,  130  Ala.  324,  30  So.  355;  Harvey  v.  Wieland,  115  la.  564,  88 
N.  W.  1077;  Ohio  R.  June.  R.  R.  Co.  v.  Penna.  Co.,  222  Pa.  St.  573,  72  Atl. 
271. 

440  Lutton  V.  Baker,  187  la.  753,  174  N.  W.  599. 

441  U.  S.  V.  Chamberlin,  219  U.  S.  250. 


THE   STAMP   TAX 


1245 


Constitutionality  of  Stamp  Taxes.     The   constitutionality  of 
various  stamp  tax  acts  lias  only  been  attacked  on  certain  grounds 
and  in  reference  to  particular  clauses,  and  no  general  deduction 
can  be  made  as  to  the  constitutionality  of  the  present  statute 
in  toto.     In  one  of  the  leading  cases  on  the  subject -5^-  it  was 
decided  that  the  1898  Law  was  valid,  in  so  far  as  it  placed  a 
stamp  tax  upon  sales,  agreements  of  sale,  or  agreements  to  sell 
any  products  or  merchandise  at  any  exchange  or  board  of  trade, 
or  other  similar  place,  either  for  present  or  future  delivery.    The 
court  held  that  the  tax  was  not  a  direct  tax,  but  a  duty  or  excise 
tax  laid  upon  the  privilege  or  opportunity  afforded  by  boards  of 
trade  or  exchanges  for  the  transaction  of  business,  although  the 
amount  of  the  tax  was  measured  by  the  value  of  the  property 
sold ;  and  that  it  was  immaterial  that  the  tax  could  not  be  added 
to  the  price  of  the  thing  sold.    The  tax  was  also  held  to  be  uni- 
form both  in  the  geographical  sense  and  in  the  sense  that  it  taxed 
all  taxpayers  similarly  situated,  since  there  was  a  reasonable 
basis  of  classification  in  taxing  all  sales  on  exchanges.    The  court 
ruled  further  that  the  tax  was  not  invalid  or  discriminatory  (a) 
because  it  applied  only  to  sellers  and  not  to  purchasers  (b)  be- 
cause  it   did   not   tax   the   same   privilege   when    used   for   all 
purposes,  and  (c)  because  it  required  a  person  selling  property 
in  intra-state  commerce  to  make  a  memorandum,  this  being  a 
proper  means  for  the  collection  of  the  tax  and  a  legislative  ques- 
tion.   The  stamp  tax  on  a  memorandum  or  contract  of  sale  of  a 
certificate  of  stock  imposed  by  the  1898  Law  was  held  not  to  be 
a  direct  tax,  but  to  fall  within  the  class  of  duties,  imposts  and 
excises  permitted  under  the  first  clause  of  Section  8  of  Article  1 
of  the  Constitution.^-'^    It  has  been  held  that  the  statute  ^'^  giving 
the  Commissioner  of  Internal  Revenue  power  to  require  persons, 
who  fail  or  refuse  to  make  proper  returns  for  stamp  tax  as  well 
as  other  tax  purposes,  to  produce  their  books,  is  not  unconstitu- 
tional, since  an  order  to  produce  books  is  not  violative  of  the 
rights  of  a  witness,  though  such  rights  may  be  invaded  after  his 
appearance.^^-'    In  a  recent  case^^*5  jt  was  contended  that  the  1914 
Law  was  unconstitutional  and  void  if  it  imposed  a  tax  of  any 

442  Nicol  V.  Ames,  173  U.  S.  509. 

443  Thomas  v.  U.  S.,  192  U.  S.  363.  For  a  full  discussion  of  the  subject 
see  the  opinion  of  the  lower  court,  115  Fed.  207. 

444  R.  S.  §  3173. 

44-,  Calkins  v.  Smietanka,  240  Fed.  138. 

44r.  Home  Title  Ins.  Co.  v.  Keith.  230  Fed.  905.  This  case  contains  a 
lengthy  discussion  of  the  authorities  holding  in  favor  of  the  constitutionality 
of  the  statute. 


1246  FEDERAL   INCOME  TAX 

kind  upon  the  deed  given  by  a  referee  in  pursuance  of  the  order 
and  as  a  part  of  the  procedure  of  a  State  Court.  It  was  held  that 
the  Act  was  not  invahd  in  this  respect  as  imposing  a  tax  on  the 
state's  exercise  of  its  governmental  functions,  since  the  tax  im- 
posed was  an  excise  tax  on  the  business  transaction  involved  in 
the  purchase  of  the  land  from  the  referee  and  its  transfer  to  the 
purchaser,  and  that  the  transfer  was  in  its  nature  the  same  as 
any  transfer  from  one  individual  to  another.  But  the  1898  Law 
so  far  as  it  attempted  to  impose  a  tax  on  charter  parties  used 
exclusively  for  the  carriage  of  cargo  from  ports  in  the  United 
States  to  foreign  ports,  was  held  to  be  a  direct,  and  not  inci- 
dental, tax  on  exports  or  exportation  and,  therefore,  in  this  re- 
spect unconstitutional."^^^  It  is  probable  that  the  present  law 
would  not  be  upheld  if  it  were  construed  in  any  way  to  place  a 
tax  upon  exports  or  exportation.^^"*  And  it  seems  that  any  con- 
struction of  Sections  13,  14  and  15  of  the  1898  Law,  which  are 
held  to  be  still  in  force,^^^  whereby  unstamped  or  improperly 
stamped  deeds,  notes  or  other  instruments,  were  denied  admis- 
sion in  evidence  in  State  courts  would  render  the  section  uncon- 
stitutional as  an  attempt  on  the  part  of  the  federal  government 
to  prescribe  rules  of  evidence  for  the  State  courts.^"*^  Conse- 
quently such  sections  probably  apply  only  to  the  federal  courts, 
since  it  is  a  well-known  rule  of  statutory  construction  that  where 
a  statute  admits  of  two  constructions,  one  of  which  presses 
it  beyond  constitutionality  and  the  other  of  which  brings  it 
within  constitutionality  or  avoids  the  question,  the  courts  tend 
to  adopt  the  latter  interpretation. ^-^i  An  amendment  to  the  stock 
transfer  act  of  New  York  imposing  a  tax  of  2  cents  "o7i  each 
share  of  one  hundred  dollars  of  face  value  or  fraction  thereof" 

447  U.  S.  V.  Hvoslef,  237  U.  S.  1.  Compare  with  Simpson  v.  Treat,  126 
Fed.  1003. 

448  See  T.  D.  2682.  Letter  from  treasury  department  dated  April  13,  1918; 
W.  T.  S.  1918,  §3707;  letter  from  treasury  department  dated  January  24, 
1918;  W.  T.  S.  1918,113683. 

440  Letter  from  treasury  department  dated  May  27,  1918;  W.  T.  S.  1918, 
H  3723. 

4'">n  See  paragraph  on  Excluding  Unstamped  Documents  in  State  Courts,  p. 
1242. 

451  See  paragraph  Construction  Which  Will  be  Constitutional  in  the 
chapter  on  Construction  of  the  Law.  In  Sackett  v.  McCaffrey,  131  Fed. 
219,  the  court  declined  to  discuss  the  correctness  of  the  state  decisions 
adopting  the  interpretations  of  §§  13,  14,  and  15  of  the  Act  of  June  13,  1898, 
which  restrict  the  prohibition  against  the  admission  of  unstamped  docu- 
ments as  evidence  to  the  federal  courts  and  thus  saves  the  sections  from 
unconstitutionality. 

451  Peo.  V.  Mensching,  187  N.  Y.  8. 


THE   STAMP   TAX  1247 

instead  of  "on  each  one  hundred  dollars  of  face  value  or  fraction 
thereof"  as  provided  in  the  original  law,  was  held  unconstitu- 
tional on  the  ground  that  such  amendment  taxed  the  sale  of  all 
shares  of  the  face  value  of  one  hundred  dollars  and  also  all  shares 
of  the  face  value  of  any  fraction  of  one  hundred  dollars,  the 
words  "fraction  thereof"  being  held  to  relate  to  "share"  rather 
than  to  "one  hundred  dollars";  and  that  therefore  the  tax  was 
measured  by  the  number  of  shares  regardless  of  face  value 
instead  of  the  face  value  of  the  shares ;  that  all  corporate  shares 
were  placed  in  a  class,  but  all  members  of  the  class  were  not 
treated  alike;  that  the  statute  bore  heavily  upon  some  and 
lightly  upon  others  in  the  same  situation  without  method  or 
order  or  reason  and  resulted  in  arbitrary  or  accidental  selection 
rather  than  classification.  While  wide  latitude  in  classification 
is  possessed  by  the  legislature,  this  power  is  not  without  the 
limitation  that  any  classification  adopted  must  have  some  basis, 
reasonable  or  unreasonable,  other  than  mere  accident,  whim  or 
caprice  and  must  not  result  in  an  arbitrary  discrimination  in 
favor  of  one  as  against  another  of  the  same  class.  So  far  as  the 
tax  on  the  issue  and  sales  or  transfers  of  certificates  or  shares 
without  par  or  face  value  of  which  the  actual  value  does  not 
exceed  $100  per  certificate  or  share  is  concerned,  the  Revenue 
Act  of  1918,  like  the  above  unconstitutional  amendment  imposes 
a  tax  without  reference  to  the  actual  value  of  the  certificates  or 
shares  issued  or  transferred  and  in  many  cases  would  seem  to 
constitute  arbitrary  selection  rather  than  constitutional  classifi- 
cation.^''- In  construing  the  1914  Law  as  imposing  a  tax  upon 
the  issue  of  certificates  of  shares  issued  by  a  manufacturing 
company  organized  in  the  form  of  a  trust  under  the  common  law 
and  deriving  none  of  its  rights,  benefits  or  qualifications  from 
any  statute,  and  which  was  not  an  ordinary  common  law  real 
estate  trust,  the  Court  has  sustained  the  constitutionality  of  the 
law,  holding  it  not  invalid  on  the  theory  that  it  was  inapplicable 
to  other  associations.  The  tax  was  stated  to  be  merely  on  muni- 
ments of  title  so  that,  if  other  associations  did  not  issue  such 
muniments  of  title,  they  were  accordingly  not  taxable.^''^'* 

Payment  Under  Protest  and  Duress.  The  general  rule  of  law, 
that  a  voluntary  payment  of  money  cannot  be  recovered,  applies 
to  stamp  taxes.  A  person,  therefore,  who  wishes  to  recover  the 
amount  of  any  stamp  tax,  which  he  considers  illegally  exacted, 
should  pay  the  tax  under  protest  and  such  payment  should  be 

^-'^Malley  v.  Bowditch,  259  Fed.  809;  Edwards  v.  Wabash  Ry.  Co.,  2fi4 
Fed.  610. 

453  Chesbrough  v.  U.  S.,  192  U.  S.  253. 


1248  FEDERAL  INCOME   TAX 

involuntary  and  under  duress.  Stamp  taxes  paid  under  protest 
or  with  notice  that  the  payer  contends  that  they  are  illegal  and 
intends  to  institute  suit  to  compel  their  repayment,  may  on  occa- 
sion be  recovered,  although  generally  speaking  even  a  protest  or 
notice  will  not  avail  if  the  payment  be  made  voluntarily  with 
full  knowledge  of  the  circumstances  and  without  any  coercion  by 
the  actual  or  threatened  exercise  of  power  possessed  by  the  party 
exacting  or  receiving  the  payment  over  the  person  or  property 
of  the  party  making  the  payment  from  which  the  latter  has  no 
other  means  of  immediate  relief  than  such  payment.  The  rule 
is  firmly  established  that  stamp  taxes  voluntarily  paid  cannot 
be  recovered  back  and  that  payments  with  knowledge  and  with- 
out compulsion  are  voluntary.  Thus,  in  a  case^-^^  in  which  cer- 
tain stamps  were  purchased  from  the  collector  who  was  not 
informed  when  the  purchase  was  made  of  the  particular  purpose 
and  who  was  given  no  intimation  of  any  claim  that  the  purchaser 
was  acting  under  duress,  recovery  was  denied  even  though  the 
purchaser  affixed  the  stamps  in  order  to  complete  the  transaction 
between  himself  and  the  vendee  named  in  the  deed  to  be  stamped 
and  to  obtain  the  consideration  for  the  property  transferred.  It 
was  held  that  this  transaction,  while  it  might  have  constituted 
duress  as  between  the  parties  to  the  deed,  was  a  matter  with 
which  the  collector  had  nothing  to  do  and  that  the  payment  to 
the  collector  for  the  stamps  was  purely  voluntary.  The  written 
application  to  the  Commissioner  to  recover  the  amount  paid  for 
the  stamps  was  held  not  to  be  the  statutory  equivalent  of  a  com- 
mon-law protest  or  notice  of  suit.  While  the  Commissioner  under 
the  Revised  Statutes"***  might  have  refunded  the  amount  of  such 
tax,  an  appeal  was  not  permitted  from  his  refusal  to  refund 
because  it  was  not  a  ruling  either  specific  or  resulting  from  a 
demand,  to  which  the  taxpayer  yielded  under  the  protest  and 
with  notice,  and  from  which  he  appealed  to  the  Commissioner  of 
Internal  Revenue.  Likewise,  where  a  stamp  tax  was  paid  on 
manifests  of  cargoes  on  certain  vessels  bound  to  foreign  ports  as 
required  by  the  1898  Law,  no  information  having  been  given  to 
the  person  from  whom  the  stamps  were  bought  of  the  particular 
purpose,  or  claim  made  to  the  collector  or  Commissioner  that  the 
tax  was  unconstitutional,  and  no  claim  having  been  made  to  the 
collector  of  the  port  of  New  York  that  the  taxpayer  was  acting 
under  restraint  and  yielding  only  to  enable  his  ship  to  depart, 
recovery  was  denied  because  the  tax  was' not  paid  under  duress, 
even  though  clearance  papers  could  not  be  procured  without  the 

*-^  R.  S.  §  3220. 


THE   STAMP   TAX  1249 

deliver^'  to  the  collector  of  the  port  of  outward  foreign  manifests 
of  cargo  properly  stamped,  and  even  though  the  master  of  a 
vessel  failing  to  deliver  the  proper  manifest  and  to  obtain  a 
clearance,  was  subject  to  a  penalty.*"*-^ 

Injunctive  Relief.  The  general  rule  that  a  taxpayer  may  not 
resort  to  a  suit  to  restrain  the  assessment  or  collection  of  any 
tax  applies  to  stamp  taxes,  and  a  taxpayer  is  not  entitled  to  an 
injunction  to  restrain  the  Commissioner  of  Internal  Revenue 
from  assessing  the  taxes  on  sales  of  grain  to  which  no  stamps 
have  been  affixed,  the  only  remedy  to  the  taxpayer  in  such  case 
being  by  suit  to  recover  the  tax.^^e 

*55  u.  S.  V.  N.  Y.  &  Cuba  etc.  Co.,  200  U.  S.  488. 

<56  Calkins  v.  Smietanka.  240  Fed.  138.     See  R.  S.  §§  3224.  3226. 


CHAPTER   46 

TAX   ON   EMPLOYMENT    OF    CHILD   LABOR 

This  tax  was  a  new  feature  of  the  internal  revenue  laws  of 
the  United  States,  first  introduced  by  the  Revenue  Act  of  1918 
and  continued  without  change  by  the  Revenue  Act  of  1921,  de- 
signed to  effect  the  abandonment  of  child  labor  in  the  estab- 
lishments specified  in  the  law.i  The  rulings  on  this  subject 
in  addition  to  Regulations  46,  are  in  the  form  of  letters  and 
are  compiled  in  "Child  Labor  Tax  Rulings,"  revised  September, 
1920.       ' 

Effective  Date  of  the  Act.  The  tax  went  into  effect  beginning 
sixty  days  after  the  passage  of  the  Revenue  Act  of  1918.-  The 
Revenue  Act  of  1918  was  signed  by  the  President  on  February 
24,  1919,  and  the  effective  date  was  therefore  April  25,  1919. 
The  first  taxable  year,  that  is,  the  taxable  year  1919,  consisted 
of  the  period  between  April  25,  1919,  and  December  31,  1919, 
both  inclusive,  or  any  fiscal  year  ending  within  the  same  period.^ 

Persons  to  Whom  the  Tax  Applies.  The  tax  applies  to  any 
individual,  corporation,  partnership,  association,  joint-stock 
company,  or  insurance  company  operating  a  (1)  mine,  (2)  quar- 
ry, (3)  mill,  (4)  cannery,  (5)  workshop,  (6)  factory  or  (7) 
manufacturing  establishment  situated  in  the  United  States  (ex- 
cept only  a  boys'  or  girls'  canning  club  duly  recognized  by  a 
state  agricultural  department  or  United  States  agricultural  de- 
partment) .^ 

Mill,  Cannery,  Workshop,  Factory  or  Manufacturing  Estab- 
lishment. In  the  case  of  these  establishments  the  tax  applies  if 
(a)  any  child  between  the  ages  of  14  and  16  (presumably  both 
ages  inclusive)  has  been  employed  or  permitted  to  work  more 
than  eight  hours  in  any  day  or  more  than  six  days  in  any  week 
or  before  six  o'clock  a.  m.  or  after  seven  o'clock  p.  m. ;  and  (b) 
if  any  child  under  the  age  of  fourteen  has  been  employed  or  per- 
mitted to  work  at  all.''  The  term  "workshop,  factory,  or  manu- 
facturing establishment"   includes   bakeries,   blacksmith   shops, 

1  Revenue  Act  of  1921,  Title  XII;  Revenue  Act  of  1918,  Title  XIL 

2  Revenue  Act  of  1918,  §  1207. 
•■>  Reg.  46,  Art.  5. 

^Revenue  Act  of  1921,  §1200;  Revenue  Act  of  1918,  §1200;  Reg.  46, 
Art.  2. 

•"•Revenue  Act  of  1921,  §1200;  Revenue  Act  of  1918,  §1200;  Reg.  46, 
Art.  3.     The  term  "under  the  age  of  fourteen  years"  is  meant  to  include  all 

1250 


TAX    ON    EMPLOYMENT    OF   CHILD    LABOR  1251 

boxmaking  establishments,  steam  laundries,  and  stonecutting." 
The  term  "manufacturing  establishment"  includes  bottling 
plants,  gas  companies,"  ice  factories,'^  meat  markets  engaged 'in 
the  manufacture  of  meats  for  local  trade,  newpaper  publishing 
plants  or  companies,''  timber  cutting  in  woods  and  logging  force 
operations  connected  with  the  operation  of  a  manufacturing 
establishment. 1"  The  following  are  not  included  within  these 
terms:  drug  store  (retail)  ;  express  companies;  grocery  stores 
(retail)  ;  mercantile  stores  not  connected  with  taxable  establish- 
ments ;  moving  picture  business,  either  in  studio  or  out  of  doors ; 
telegraph  offices,  in  respect  of  boys  and  messengers;  telephone 
companies;  trust  and  title  companies;  tobacco  plantations  (cut- 
ting and  stringing  tobacco  leaves)  ;  commissaries  operated  by 
sawmills."  Some  additional  rulings  in  particular  industries  are 
indicated  below. 

Employment  in  General  and  Factory  Offices.  The  terms 
workshop,  factory,  or  manufacturing  establishment  as  used  in 
the  Child  Labor  Tax  Law,  clearly  mean  the  premises  on  which 

children  who  have  not  yet  reached  their  fourteenth  year.  The  term 
"eight  hours  in  any  day"  means  the  actual  period  of  employment  and  shall 
be  reckoned  from  the  time  the  child  is  required  or  allowed  to  be  at  the 
place  of  employment  until  he  or  she  stops  work  for  the  day,  exclusive  of 
one  continuous  period  of  a  definite  length  of  time  during  which  the  child 
is  off  work  and  not  subject  to  call  for  duty  of  any  kind.  The  term  "six 
days  in  any  week"  means  six  consecutive  days,  no  one  of  which  shall 
consist  of  more  than  eight  hours  of  working  time.  A  "day"  must  not  be- 
gin before  6  o'clock  a.  m.  and  must  not  extend  beyond  7  o'clock  p.  m.  (Reg. 
46,  Art.  1.) 

6  Letters  from  treasury  department  dated  June  14,  1919;  April  1,  1919; 
June  9,  1919;  and  August  2,  1919,  respectively. 

7  The  employment  of  boys  between  14  and  16  years  to  light  and  ex- 
tinguish street  lamps  does  not  render  a  gas  company  subject  to  tax  if  their 
presence  in  and  about  the  gas  factory  premises  is  not  required  or  per- 
mitted. 

s  This  ruling  refers  to  the  employment  of  boys  to  accompany  delivery 
wagons  and  carry  ice  into  houses. 

^  The  employment  of  children  in  the  distribution  of  papers  outside  and 
away  from  the  manufacturing  establishment  does  not  come  within  the 
purview  of  the  statute. 

1"  Letters  from  treasury  department  dated  May  28,  1919;  May  21,  1919; 
April  12,  1919;  May  5,  1919;  and  May  27,  1919,  respectively. 

It  Letters  from  treasury  department  dated  May  2,  1919;  May  1,  1919; 
May  15,  1919;  May  2,  1919;  June  14,  1919;  June  21,  1919;  April  1,  1919; 
May  31,  1919;  May  7,  1919;  May  8,  1919;  June  20,  1919;  May  21,  1919. 
The  presence  of  child  employees  of  the  company,  however,  in  or  about  a 
sawmill  premises  contrary  to  the  standards  laid  down  by  the  statute 
would  subject  the  person  operating  the  mill  to  the  tax. 


1252  FEDERAL  INCOME  TAX 

the  manufacturing  business  is  conducted,  including  the  buildings 
and  grounds.  The  terms  in  their  ordinary  sense  include  what- 
ever is  necessary  to  carry  on  the  mechanical  operation  or  proc- 
ess. Any  part  essential  to  the  conduct  of  a  manufacturing 
business  is  as  much  a  part  of  a  manufacturing  establishment  as 
the  buildings  in  which  the  machinery  is  housed,  or  the  ground 
occupied  by  the  buildings.  A  factory  office,  therefore,  is  a  part 
of  the  establishment  and  no  distinction  can  be  made  in  employ- 
ment in  different  departments.  The  duties  of  office  employees 
frequently  take  them  into  and  often  require  their  presence  in  the 
plant  or  manufacturing  part  of  such  establishments  when  they 
are  accessible.  Actual  employment  in  the  manufacturing  or 
production  part  of  a  plant  is  not  necessary,  and  it  is  not  possible 
to  exempt  from  the  application  of  the  law  any  occupation  or 
class  of  employment  connected  with  the  operation  of  the  estab- 
lishment specified.  The  law  applies  if  children  are  employed  in 
or  about  the  establishment.  An  office  which  occupies  the  top 
floor  of  a  factory  building  of  a  manufacturing  and  selling  com- 
pany would  come  within  the  application  of  the  law,  and  if  chil- 
dren under  14  years  are  employed,  or  if  children  between  14 
and  16  years  are  permitted  to  work  more  than  eight  hours  in  any 
day  or  more  than  six  days  in  any  week,  or  before  6  a.  m.,  or  after 
7  p.  m.,  the  person  operating  the  establishment  would  be  subject 
to  the  imposition  of  the  tax.  Office  employees  as  a  class  and 
apart  from  the  operation  of  the  establishments  specified  are  not 
believed  to  be  within  the  taxation  intent  of  the  Child  Labor  Tax, 
and  the  provisions  of  this  act  do  not  apply  to  the  employment  of 
children  in  a  general  office,  a  main  office,  or  district  office  estab- 
lished purely  for  office  purposes,  in  no  way  a  part  of  the  manu- 
facturing establishment  as  defined,  but  conducted  solely  as  a  city 
office  whose  employees  under  the  age  of  16  years  are  never  re- 
quired or  permitted  or  suffered  to  be  in  or  about  the  manu- 
facturing establishment.i- 

Agricultural  and  Forestry  Operations.  The  statute  does 
not  apply  to  the  agricultural  industry,  even  though  it  may  be 
part  of  a  complete  industrial  cycle,  or  to  forestry  operations.  A 
sugar  mill  and  sugar-cane  plantation  may  be  operated  as  a  unit, 
but  the  law  does  not  apply  to  the  labor  employed  in  the  produc- 
tion of  the  cane.  The  employment  of  children  contrary  to  the 
terms  of  the  law  in  or  about  the  mills  would  subject  the  person 
operating  the  mill  to  the  imposition  of  the  tax,  but  employment 

12  Letters  from  treasury  department  dated  May  31,  1919;  May  2,  1919; 
and  June  26,  1919. 


TAX    ON   EMPLOYMENT   OF   CHILD   LABOR  1253 

or  permission  to  work  of  children  in  the  fields  in  purely  farming 
or  agricultural  operations  does  not  come  within  the  taxation 
intent  of  the  law.^"'  But  the  snipping  of  beans  or  husking  of 
corn  for  canning,  even  though  carried  on  at  some  distance  from 
the  cannery  proper,  is  an  essential  part  of  the  business.  Beans 
are  snipped  and  corn  husked  as  a  necessary  part  of  a  canning 
operation  and  not  a  necessary  part  of  an  agricultural  operation. 
Farming  or  agricultural  work  may  cease  and  be  complete  with 
the  production  arid  picking  or  gathering  of  beans  and  corn,  but 
when  these  vegetables  are  prepared  and  broken,  snipped  or 
husked,  with  a  view  to  their  immediate  use  in  canning  or  pre- 
serving, for  public  sale,  the  snipping  and  husking,  wherever 
carried  on — in  the  fields,  in  sheds  or  shelters  on  the  farm,  in 
farm  houses,  or  in  sheds  and  shelters  near  the  canneries — are  a 
part  of  a  cannery  operation  and  the  children  employed  on  such 
work  are  employed  in  a  cannery  within  the  meaning  of  the  law.^"* 
The  employment  of  children  in  carrying  on  forestry  operations 
in  turpentine  woods — such  as  distributing  the  "cups"  or  recep- 
tacles to  catch  the  crude  gum,  or  collecting  the  cups  or  recep- 
tacles, or  dipping  or  removing  the  crude  gum  from  the  collecting 
receptacles  and  .transferring  it  to  buckets  and  thence  to  barrels, 
or  raking  dead  leaves  and  rubbish  away  from  the  pine  trees,  or 
serving  as  water  boys — occupations  which  are  physically  sep- 
arate and  wholly  apart  from  the  still  or  manufacturing  estab- 
lishment and  from  the  character  of  the  work  would  not  permit 
the  children  to  be  in  or  about  the  still  or  manufacturing  estab- 
lishment, does  not  subject  the  employer  to  the  tax.^''  The  em- 
ployment of  children  in  the  woods,  as  chain  carriers  for  land 
surveyor  and  timber  estimator,  the  nature  of  their  employment 
never  requiring  or  permitting  their  presence  in  or  about  the 
mechanical  operations  essential  to  the  sawmill  industry,  does  not 
come  within  the  taxation  intent  of  the  law,  and  would  not  sub- 
ject the  person  operating  the  sawmill  to  the  tax.^'"' 

Vacation  Period.  There  is  no  exemption  under  the  Child 
Labor  Tax  Law  for  the  vacation  period.^' 

Children  in  Company  of  Mothers.  The  presence  of  any 
child  in  or  about  any  of  the  establishments  specified  in  the  law 

13  Letters  from  treasury  department  dated  April  12,  1919,  and  May  2, 
1919. 

14  Letter  from  treasury  department  dated  June  26,  1919. 
i-")  Letter  from  treasury  department  dated  July  7,  1919. 
1''  Letter  from  treasury  department  dated  May  22,  1919. 
1"  Letter  from  treasury  department  dated  May  27,  1919. 


1254  FEDERAL   INCOME  TAX 

will  be  taken  as  prima  facie  evidence  of  its  employment  therein. 
It  is  immaterial  that  the  children  are  in  or  about  the  establish- 
ments with  their  mothers  and  are  entirely  too  young  to  work  or 
be  of  service  there.^^ 

Son  of  Proprietor.  A  tax  is  imposed  on  every  person  operat- 
ing a  mill,  cannery,  workshop,  factory,  or  manufacturing  estab- 
lishment in  which  children  under  the  age  of  14  years  are  em- 
ployed or  permitted  to  work.  No  distinction  can  be  made  under 
the  law  in  the  matter  of  the  owner's  children. i" 

Janitor  Service  in  Office  of  Manufacturing  Plant.  No 
distinction  can  be  made  in  the  kind  of  occupation  or  employment 
in  any  of  the  establishments  specified  in  the  Child  Labor  Tax 
Law.  A  factory  office  is  a  part  of  the  factory,  and  where  chil- 
dren under  14  years  of  age  are  employed  to  do  sweeping  and 
cleaning  in  the  office  of  a  manufacturing  plant  during  any  por- 
tion of  the  year,  the  person  operating  such  establishment  is  sub- 
ject to  the  tax  imposed.^o 

Mine  or  Quarry.  In  the  case  of  a  mine  or  quarry,  the  tax  ap- 
plies if  any  child  under  the  age  of  16  years  has  been  employed  or 
permitted  to  work  therein. ^^ 

In  or  About  Mines.  The  term  mining  premises  as  applied 
to  the  Child  Labor  Tax  Law  is  held  to  mean  any  property  used 
in  mining  operations — that  is,  the  mining  lands  in  which  the 
deposits  of  minerals  are  worked  by  ordinary  mining  processes — 
and  is  limited  to  the  grounds  and  buildings  used  in  the  operation 
of  the  mine.  The  different  departments  of  the  mining  premises, 
such  as  work  on  tipples,  breakers,  tracks,  in  mine  office,  carrying 
messages  from  department  to  department,  hauling  materials  to 
and  from  the  mines,  or  any  other  operation  connected  with  the 
whole  mode  of  obtaining  metals  or  minerals  for  commercial  pur- 
poses, come  within  the  purview  of  the  law.  Stores  and  other  en- 
terprises outside  and  away  from  the  mining  operations,  though 
owned  and  controlled  by  the  mining  company,  are  not  considered 
necessary  to  carry  on  the  mechanical  operation  or  process  of  the 
mine  and  the  provisions  of  Section  1200  relating  to  mines  do  not 
apply  to  the  employment  of  children  in  such  places,  the  character 
of  the  work  never  requiring  or  permitting  their  presence  in  or 

18  Letter  from  treasury  department  dated  June  4,  1919. 
1!>  Letter  from  treasury  department  dated  May  31,  1919. 

20  Letter  from  treasury  department  dated  May  16,  1919. 

21  Revenue  Act  of  1921,  §1200;  Revenue  Act  of  1918,  §1200;  Reg.  46, 
Art  3.  The  term  "under  the  age  of  sixteen  years"  is  meant  to  include  all 
children  w^ho  have  not  yet  reached  their  sixteenth  year.     (Reg.  46,  Art.  1.) 


TAX    ON    EMPLOYMENT    OF   CHILD    LABOR  1255 

about  the  mines.  Making  of  mine  props  and  cutting  of  ties  or 
the  manufacture  of  other  material  purchased  for  use  in  a  mine  is 
not  part  of  the  mining  process  and  the  law  relating  to  employ- 
ment of  children  in  mines  would  not  apply.  If,  however,  such 
work  is  done  in  connection  with  the  operation  of  a  sawmill  or 
lumber  mill,  or  other  manufacturing  establishment,  the  law  per- 
taining to  mills  and  manufacturing  establishments  would  apply. 
If  the  grading  of  a  road  takes  a  child  employee  under  16  years  in 
or  about  a  mine,  the  person  operating  the  mine  will  be  liable  to 
the  tax.  If  the  work  of  grading  a  road  does  not  require  the  child 
to  be  in  or  about  the  mine,  his  employment  will  not  subject  the 
mine  operator  to  the  tax.  The  tax  is  not  imposed  on  the  employ- 
ment of  children  at  road  grading,  nor  is  it  imposed  on  a  mining 
company  for  employment  of  children  under  16  everywhere,  but 
it  is  imposed  upon  the  mine  operator  if  children  under  16  years 
are  employed  in  or  about  the  mines.^- 

COKE  Ovens.  A  coke  plant  is  not  considered  a  part  of  a  min- 
ing industry  but  is  held  to  be  a  manufacturing  establishment 
within  the  meaning  of  the  law.-"' 

Time  (Sun  or  Clock).  The  Act  of  Congress  approved  March 
19,  1918,  entitled  "An  act  to  save  daylight  and  to  provide  stand- 
ard time  for  the  United  States,"  provides  that  ''In  all  statutes 
'^'-  *  *  relating  to  time  *  *  *  within  which  any  act 
shall  or  shall  not  be  performed  by  any  person  subject  to  the 
jurisdiction  of  the  United  States,  it  shall  be  understood  and  in- 
tended that  the  time  shall  be  the  United  States  standard  time 
of  the  zone  within  which  the  act  is  to  be  performed."  The  stand- 
ard of  hours  relating  to  the  employment  of  children  must  be 
determined  in  accordance  with  the  provisions  of  the  law  on  this 
point,  and  the  United  States  standard  time  of 'the  zone  in  which 
a  mine,  quarry,  mill,  cannery,  workshop,  factory,  or  manufac- 
turing establishment  is  located  will  govern  in  the  enforcement 
of  the  Child  Labor  Tax  law.^-^ 

Duration  of  Employment.  Liability  for  the  tax  is  established 
by  the  employment  of  any  child  laborer.  The  product  of  the 
child's  labor  is  not  the  basis  for  the  imposition  of  the  tax.  The 
tax  is  applied  to  the  entire  net  income  of  the  taxable  establish- 
ment.-''   Employment  contrary  to  the  provisions  of  the  act  for  a 

22  Letter  from  treasury  department  dated  August  2,  1919. 

23  Letter  from  treasury  department  dated  June  21,  1919. 

24  Letter  from  treasury  department  dated  May  2,  1919. 

25  Reg.  4(5,  Art.  3. 


1256  FEDERAL  INCOME  TAX 

single  day  is  sufficient  to  impose  the  tax  on  the  net  profits  for  the 
whole  taxable  year.-" 

Certificate  of  Age.  Any  person  subject  to  the  provision  of  the 
law  who  in  good  faith  obtains  a  certificate  at  the  time  of  employ- 
ment showing  the  child  to  be  of  such  age  as  not  to  come  within 
the  purview  of  the  law,  and  keeps  such  certificate  on  file,  may 
rely  in  good  faith  on  such  certificate  to  relieve  him  from  the 
tax.  Such  certificate  is  to  be  issued  in  such  form,  under  such 
conditions,  and  by  such  persons  as  may  be  prescribed  by  a  board 
composed  of  the  Secretary  of  the  Treasury,  the  Commissioner  of 
Internal  Revenue  and  the  Secretary  of  Labor.  The  board  may 
also  authorize  the  use  of  employment  certificates  or  other  similar 
papers  as  to  the  age  of  the  child  issued  under  the  laws  of  any 
state  designated  by  the  board.-'^  This  board  has  prescribed  the 
following  regulations :  Certificates  of  age,  in  order  to  free  from 
liability  to  taxation  persons  operating  the  business  specified, 
shall  be  either:  (a)  Federal  age  certificates  for  children  between 
14  and  16  years  of  age  when  employed  or  permitted  to  work  in 
any  mill,  cannery,  workshop,  factory,  or  manufacturing  estab- 
lishment, and  for  children  between  16  and  17  years  of  age  when 
employed  or  permitted  to  work  in  or  about  any  mine  or  quarry. 
Such  certificates  shall  bear  (1)  the  child's  name;  (2)  birthplace; 
(3)  month,  day,  and  year  of  birth ;  (4)  color;  (5)  sex;  (6)  kind 
of  evidence  of  age  accepted  and  age  when  physical  age  is  ac- 
cepted; (7)  signature  of  the  child;  (8)  name  and  address  of 
child's  parents,  guardian,  or  custodian;  (9)  name  and  address 
of  employer;  (10)  signature,  address,  and  official  designation  of 
agent  issuing  the  certificate;  (11)  date  and  place  certificate  was 
issued,  (b)  An  age  certificate,  working  or  employment  certifi- 
cate or  permit,  or  other  similar  paper  as  to  the  age  of  the  child, 
issued  in  accordance  with  the  laws  of  the  state  in  such  states 
as  are  designated  by  the  board.-'^ 

Proof  of  Age.  Age-certificate  inspectors  authorized  to  issue 
federal  certificates  of  age  shall  do  so  only  after  securing,  exam- 
ining, and  approving  proof  of  age  as  follows:  The  child  shall 
make  application  to  the  age-certificate  inspectors  in  person,  ac- 
companied by  parent,  guardian  or  custodian,  with  documentary 
evidence  of  age,  showing  that  he  is  14  years  of  age  or  over  if  the 
employment  is  to  be  in  a  mill,  cannery,  workshop,  factory,  or 

26  See  Revenue  Act  of  1921,  §§1200  and  1207;  Revenue  Act  of  1918, 
§§  1200  and  1207. 

27  Revenue  Act  of  1921,  §  1203  (a);  Revenue  Act  of  1918,  §  1203  (a). 

28  Reg.  46,  Art.  8. 


TAX    ON    EMPLOYMENT    OF   CHILD    LABOR  1257 

manufacturing  establishment,  or  that  he  is  between  16  and  17 
years  of  age  if  employment  is  sought  in  or  about  a  mine  or 
quarry.  Documentary  evidence  of  proof  of  age,  required  in  the 
order  following,  shall  be:  (a)  A  birth  certificate  or  duly  attested 
transcript  thereof  issued  by  the  registrar  of  vital  statistics  or 
other  officer  charged  with  the  duty  of  recording  births,  (b)  A 
baptismal  certificate  or  transcript  of  the  record  of  baptism,  duly 
certified,  showing  the  date  of  birth  and  place  of  baptism  of  child, 
(c)  A  bona  fide  contemporary  record  of  the  date  of  the  child's 
birth,  comprising  a  part  of  the  family  record  of  births  in  the 
Bible,  or  other  documentary  evidence  satisfactory  to  the  board, 
such  as  a  certificate  of  arrival  in  the  United  States  issued  by  the 
United  States  immigration  officers  and  showing  the  age  of  the 
child,  a  passport  showing  the  age  of  the  child,  or  a  life  insurance 
policy:  Provided,  that  such  other  satisfactory  documentary 
evidence  has  been  in  existence  at  least  one  year,  and  in  the  case 
of  a  life  insurance  policy  at  least  four  years;  And  provided 
further,  that  a  school  record  or  a  parent's,  guardian's,  or  cus- 
todian's affidavit  or  other  written  statement  of  age  shall  not 
be  accepted  except  as  specified  in  paragraph  (d).  (d)  A  certifi- 
cate signed  by  a  public-health  physician  or  a  public-school  phy- 
sician, stating,  in  his  opinion,  the  physical  age  of  the  child.  Such 
certificate  shall  show  the  height  and  weight  of  the  child  and 
other  evidence  of  physical  age  revealed  by  the  physician's  exam- 
ination or  upon  which  the  opinion  of  the  physician  is  based.  A 
parent's,  guardian's,  or  custodian's  signed  statement  as  to  the 
age  of  the  child,  and  a  record  of  age  as  given  on  the  register  of 
the  school  first  attended  by  the  child,  or  in  any  school  census,  if 
obtainable,  shall  be  submitted  with  the  physician's  certificate 
shovv^ing  physical  age.  No  certificate  shall  be  issued  if  the  phy- 
sician's certificate  of  physical  age  or  the  parent's  statement  or 
the  register  of  the  school  first  attended  or  the  school  census 
shows  the  child  to  be  under  the  age  of  14  if  employment  in  a 
mill,  cannery,  workshop,  factory,  or  manufacturing  establish- 
ment is  contemplated,  or  under  the  age  of  16  if  employment  in  a 
mine  or  quarry  is  contemplated.  The  agent  issuing  the  age 
certificate  for  a  child  shall  require  the  evidence  of  age  stated  in 
paragraph  (a)  in  preference  to  that  specified  in  any  subse- 
quent paragraph,  and  shall  not  accept  evidence  of  age  permitted 
by  any  later  paragraph  unless  he  shall  receive  and  file  evidence 
that  the  proof  of  age  required  by  the  preceding  paragraph  or 
paragraphs  can  not  be  obtained.-" 


29 


Reg.  46,  Art.  9. 


1258  FEDERAL  INCOME  TAX 

Acceptance  of  State  Certificates.  States  in  which  age  certifi- 
cates, or  working  or  employment  certificates,  permits  or  other 
similar  papers  as  to  the  age  of  the  child  are  issued  under  state 
authority,  substantially  in  accord  with  the  requirements  of  this 
act  and  these  regulations  may  be  designated  as  states  in  which 
such  certificates  have  the  same  force  and  effect  as  federal  age 
certificates,  except  as  the  acceptance  for  the  purposes  of  the 
statute  of  individual  certificates  may  be  suspended  or  revoked. 
Certificates,  permits,  or  other  similar  papers  in  states  so  desig- 
nated shall  have  the  same  efi'ect  as  federal  age  certificates  so 
long  as  they  shall  remain  in  force,  the  Commissioner  or  such  per- 
son as  he  may  designate  possessing  the  right  to  suspend  or  re- 
voke the  acceptance  for  the  purposes  of  this  act  of  individual 
certificates  at  any  time.  Certificates  imposing  restrictions  or 
conditions  in  addition  to  the  requirements  of  the  federal  law  or 
of  the  regulations  shall  not  be  held  inconsistent  with  the  law,^" 

Mistakes  as  to  Age  of  Child.  If  a  child  has  been  employed  or 
permitted  to  work  under  a  mistake  of  fact  as  to  the  age  of  such 
child,  and  without  intention  to  evade  the  tax,  such  employment 
will  not  cause  the  tax  to  be  imposed,-'^ 

Inspection  of  Establishment.  The  Commissioner,  or  any  per- 
son authorized  by  him,  may  enter  and  inspect  at  any  time  any 
mine,  quarry,  mill,  cannery,  workshop,  factory  or  manufactur- 
ing establishment.  The  Secretary  of  Labor,  or  any  person  duly 
authorized  by  him,  has  like  authority  to  make  inspections  for  the 
purpose  of  complying  with  a  request  of  the  Commissioner.s- 

Basis  and  Rate  of  Tax.  The  statute  imposes  an  excise  tax 
which  is  in  addition  to  all  other  taxes  imposed  by  law  at  the  rate 
of  10 'v  on  the  entire  net  profits  received  or  accrued  during  any 
taxable  year  in  which  child  labor  is  employed  for  any  period  of 
time,  as  indicated  in  the  law.  The  net  profits  are  computed  by 
deducting  from  the  gross  amount  received  or  accrued  during  the 
taxable  year  from  the  sale  or  disposition  of  such  products  manu- 
factured within  the  United  States  (a)  the  cost  of  raw  materials 
entering  into  the  production;  (b)  running  expenses,  including 
rentals,  repairs,  maintenance,  heat,  power,  insurance,  manage- 
ment and  a  reasonable  allowance  for  salaries  and  depreciation ; 
(c)  interest  on  money  borrowed  and  used  to  meet  the  needs  of  the 
business;  (d)  taxes  of  all  kinds  paid  during  the  taxable  year 
with  respect  to  the  business  or  property  relating  to  the  produc- 

•!0  Reg.  46,  Art.  10. 

31  Revenue  Act  of  1921,  §  1203  (b);  Revenue  Act  of  1918,  §  1203  (b). 

32  Revenue  Act  of  1921,  §  1206;  Revenue  Act  of  1918,  §  1206. 


TAX    ON    EMPLOYMENT    OF   CHILD    LABOR  1259 

tion  and  (e)  losses  actually  sustained  within  the  taxable  year  in 
connection  with  the  business  of  producing  such  products,  includ- 
ing losses  from  fire,  flood,  storm  or  other  casualties,  not  com- 
pensated for  by  insurance  or  otherwise.  If  the  product  is  sold 
at  less  than  the  fair  market  price  in  such  manner  as  to  directly 
or  indirectly  benefit  any  person  directly  or  indirectly  interested 
in  the  business  or  with  intent  to  cause  such  benefit,  the  tax  is  im- 
posed on  the  gross  amount  received  or  accrued  from  the  sale  or 
disposition  during  the  period  that  any  such  sales  took  place."''' 

Returns  to  Be  Filed.  Every  person  subject  to  the  provisions  of 
the  law  (which  seems  to  mean  those  who  operate  establishments 
of  the  kind  enumerated  in  the  law)  is  required  to  file  a  return 
annually  showing  the  gross  amount  of  income  received  or  ac- 
crued during  the  year  from  the  sale  or  disposition  of  the  product 
of  any  mine,  quarry,  mill,  cannery,  workshop,  factory  or  manu- 
facturing establishment  in  which  children  have  been  employed 
subjecting  him  to  the  tax  and  the  amounts  allowed  by  the  law 
to  be  deducted  therefrom,  and  other  particulars,  in  such  form  as 
the  Commissioner  may  require.  Such  returns  are  to  be  filed  on 
or  before  the  first  day  of  the  third  month  following  the  close  of 
each  taxable  year,  with  the  local  collector.  Extension  of  time  to 
file  returns  may  be  granted  by  the  collector  in  case  of  sickness 
or  absence.''^ 

Tax  Due.  The  collector  transmits  forthwith  all  returns  to  the 
Commissioner,  "who  shall,  as  soon  as  practicable,  assess  the  tax 
found  due  and  notify  the  person  making  such  returns  of  the 
amount  of  tax  for  which  such  person  is  liable,  and  such  person 
shall  pay  the  tax  to  the  collector  on  or  before  30  days  from  the 
date  of  such  notice."^''"' 

Time  Record.  A  time  record  should  be  kept  daily  by  persons 
operating  any  mill,  cannery,  workshop,  factory,  or  manufactur- 
ing establishment,  showing  the  hours  of  employment  for  each 
and  every  child  who  has  completed  the  fourteenth  year  but  has 
not  yet  completed  the  sixteenth  year  of  its  age,  whether  em- 
ployed on  a  time  or  a  piece  rate  basis.  Certificates  of  age  for 
children  employed  in  any  mill,  cannery,  workshop,  factory,  or 
manufacturing  establishment  may  be  suspended  or  revoked  for 

33  Revenue  Act  of  1921,  §§1200,  1201  and  1202;  Revenue  Act  of  1918, 
§§  1200,  1201  and  1202;  Reg.  46,  Art.  3. 

34  Revenue  Act  of  1921,  §  1204;  Revenue  Act  of  1918,  §  1204;  R.  S.,  §  3176, 
as  amended;  Reg.  46,  Art.  4. 

35  Revenue  Act  of  1921,  §1205;  Revenue  Act  of  1918,  §1205;  Reg.  46, 
Art.  6. 


1260  FEDERAL  INCOME  TAX 

failure  on  the  part  of  the  person  operating  the  same  to  keep  time 
records  as  required  by  this  regulation  or  for  false  or  fraudulent 
entries  made  therein."'*' 

Penalties.  The  general  penalties  apply  for  failure  to  file  re- 
turns, or  pay  the  tax,  or  for  filing  false  or  fraudulent  returns.^^ 
Refusal  to  permit  entry  or  inspection  of  any  establishment  is 
punished  by  fine  of  not  more  than  $1,000  or  imprisonment  for 
not  more  than  one  year,  or  both  fine  and  imprisonment.^'^  Any 
person  who  knowingly  makes  a  false  statement  or  presents  false 
evidence  in  or  in  relation  to  any  certificate  of  age  or  application 
therefor  will  be  subject  to  a  fine  .of  not  less  than  $100  nor  more 
than  $1,000,  or  to  imprisonment  for  not  more  than  three 
months,  or  to  both  such  fine  and  imprisonment.-"--^  Actions  to 
enforce  these  penalties  will  be  brought  in  the  federal  courts  by 
the  United  States  district  attorney  of  the  federal  judicial  district 
in  which  the  offense  occurs."*" 

Constitutionality  of  Child  Labor  Tax.  The  Supreme  Court  of 
the  United  States  has  declared  unconstitutional  the  so-called 
Child  Labor  Law,  which  prohibited  the  transmission  in  inter- 
state commerce  of  products  of  child  labor.-^i  The  present  excise 
tax  equivalent  to  10' r  of  the  net  profits  received  from  the  sale 
of  products  of  establishments  employing  child  labor  is  intended 
to  accomplish  the  same  object  which  the  former  law  was  unable 
to  reach.42 

36  Reg.  46,  Art.  11. 

37  See  Revenue  Act  of  1918,  §§  1308  and  1317,  containing  R.  S.,  §  3176,  as 
amended  and  re-enacted  without  change  by  Revenue  Act  of  1921,  §  1311. 

38  Revenue  Act  of  1921,  §  1206;  Revenue  Act  of  1918,  §  1206. 

39  Revenue  Act  of  1921,  §  1203;  Revenue  Act  of  1918,  §  1203. 

40  Reg.  46,  Art.  7. 

41  Hammer  v.  Dagenhart,  247  U.  S.  251.  The  Supreme  Court  was  con- 
siderably divided  in  this  decision.  Mr.  Justice  Day  delivered  the  majority 
opinion  which  was  concurred  in  by  Mr.  Justice  Van  Devanter,  Mr.  Justice 
Pitney,  Mr.  Justice  McReynolds  and  Chief  Justice  White.  Mr.  Justice  Holmes 
delivered  a  dissenting  opinion  which  was  concurred  in  by  Mr.  Justice  Mc- 
Kenna,  Mr.  Justice  Brandeis  and  Mr.  Justice  Clarke. 

42  It  has  been  decided  by  a  federal  district  court  (Atherton  Mills  v.  John- 
ston) that  the  child  labor  title  of  the  Revenue  Act  of  1918  is  also  unconsti- 
tutional and  this  case  is  now  No.  16  on  the  docket  of  the  United  States 
Supreme  Court.  Another  case,  Bailey  v.  Drexel  Furniture  Co.,  is  also  before 
the  Supreme  Court  for  decision  on  this  point. 


CHAPTER  47 

CONSTRUCTION  OF  TAXING  STATUTES 

It  is  beyond  the  scope  of  this  chapter  to  discuss  at  great  length 
the  numerous  rules  of  statutory  construction.  The  following 
paragraphs  will  indicate  briefly  rules  especially  applicable  to 
revenue  statutes  which  may  be  of  assistance  in  the  interpreta- 
tion of  such  ambiguities  as  are  encountered  in  our  present  sys- 
tem of  income,  excess-profits  and  other  tax  laws.  Wherever  pos- 
sible the  citation  of  authorities  has  been  confined  to  cases  arising 
under  various  revenue  laws  of  the  United  States. 

Although  a  statute  may  be  construed  contrary  to  its  literal 
meaning  when  a  literal  construction  would  result  in  an  absurd- 
ity, inconsistency,  or  in  glaring  inequality,  and  palpable  injustice, 
where  its  language  is  susceptible  of  more  reasonable,  though 
perhaps  less  natural,  construction  which  carries  out  its  spirit 
rather  than  letter,^  it  is  a  well-settled  general  rule  that  a  legisla- 
tive act  must  be  interpreted  according  to  the  intention  of  the 
legislature  apparent  upon  its  face.-  Construction  and  interpreta- 
tion have  no  place  where  the  language  of  a  statute  is  unambigu- 
ous and  its  meaning  evident.^  Arguments  as  to  the  expediency 
of  a  tax  law  or  the  possible  economic  mistake  or  wrong  involved 
in  the  tax  imposed  thereby  ^  or  the  inequality  thereof,''  are  be- 
yond judicial  cognizance."  To  ascertain  the  intention  of  the  legis- 
lature the  first  resort  is  to  the  grammatical  sense  and  the  natural, 

1  Stratton's  Independence  v.  Howbert,  231  U.  S.  399;  Knowlton  v.  Moore, 
178  U.  S.  41,  77;  Treat  v.  White,  181  U.  S.  264;  Sesnon  Co.  v.  U.  S.,  182  Fed. 
573,  writ  of  certiorari  denied  220  U.  S.  609. 

^Wilkinson  v.  Leland,  2  Pet.  627;  U.  S.  v.  Union  Pacific  R.  R.  Co.,  91 
U.  S.  72;  Sol.  Op.  83,  T.  B.  3-21-1402. 

S  U.  S.  V.  Ninety-Nine  Diamonds,  139  Fed.  961,  writ  of  certiorari  denied 
201  U.  S.  645. 

4Brushaber  v.  Union  Pacific  R.  R.  Co.,  240  U.  S.  1;  Blunt  v.  U.  S.,  255 
Fed.  332. 

5LaBelIe  Iron  Works  v.  U.  S.,  41  Sup.  Ct.  Rep.  528;  65  L.  ed.  604;  Bill- 
ings V.  U.  S.,  232  U.  S.  261,  255  Fed.  332. 

« In  income  tax  cases,  148  Wis.  456,  134  N.  W.  673,  135  N.  W.  164,  the 
court  said :  "With  the  political  or  economic  policy  or  expediency  of  the  law 
we  have  nothing  to  do.  If  it  be  within  constitutional  lines,  it  represents  and 
embodies  public  policy,  because  it  is  enacted  by  that  branch  of  the  govern- 
ment which  determines  public  policy."  See  State  ex  rel.  Wisconsin  Trust 
Company  v.  Widule,  164  Wis.  56. 

1261 


1262  FEDERAL   INCOME   TAX 

ordinary  and  familiar  meaning  of  the  words  employed,"  and  it  is 
particularly  true  that  terms  used  in  statutes  describing  objects  of 
taxation  should  be  construed  according  to  the  popular  acceptation 
of  the  terms  they  employ  rather  than  by  refined  or  strained  anal- 
ogies.^ The  presumption  is  that  language  has  been  employed 
with  sufficient  precision  to  disclose  the  intention  of  the  legislature 
and  unless  this  presumption  is  overthrown,  nothing  remains  but 
to  enforce  the  statute  as  written.'*  If,  however,  it  is  apparent  on 
the  face  of  the  statute,  or  from  its  context,  that  a  term  of  common 
use  and  meaning  is  intended  to  bear  some  other  signification,  it 
may  be  interpreted  accordingly.^"  For  instance,  it  is  the  duty 
of  those  construing  a  statute  to  give  effect  to  the  clear  intention 
of  those  passing  it,  and  to  do  this  it  is  common  practice  to  read 
the  words  "and"  and  "or"  convertibly.^^  The  word  "false"  may 
be  construed  to  mean  either  incorrect  but  in  good  faith  i-  or  in- 
correct with  fraudulent  intent.^-^  Words  having  a  fixed  legal 
meaning  are  presumed  to  have  been  used  in  such  sense. i^  Com- 
mercial and  trade  terms,  which  belong  exclusively  to  the  vocabu- 
lary of  merchants  and  traders  or  which  are  shown  to  have  a  cer- 
tain, uniform  and  general  meaning  in  commerce  and  trade  differ- 
ent from  their  ordinary  meaning,  will  be  interpreted  according- 
ly.i-5  Generally,  a  descriptive  trade  term  used  in  the  act  will  be 
given  the  special  meaning  attaching  to  it  at  the  time  the  act  was 
passed,  1^  but  in  some  cases  a  later  and  broader  meaning  may  be 
adopted  if  warranted  by  commercial  usage  and  the  general  lan- 

"  Treat  v.  White,  181  U.  S.  264;  Columbia  Water  Co.  v.  Columbia  Co.,  172 
U.  S.  475;  Mallard  v.  Lawrence,  16  How.  251;  Schriefer  v.  Wood,  21  Fed. 
Cas.  No.  12,481;  U.  S.  v.  Isham,  17  Wall.  496;  U.  S.  v.  Chesbrough,  176 
Fed.  778;  Seldon  v.  Equitable  Trust  Co.,  8  Fed.  Cas.  No.  4,508,  affirmed 
94  U.  S.  419. 

8  Nix  V.  Hedden,  39  Fed.  109,  affirmed  149  U.  S.  304;  De  Ganay  v.  Lederer, 
239  Fed.  568. 

9  Mannington  v.  Hocking  Valley  R.  R.  Co.,  183  Fed.  133. 

10  U.  S.  V.  Chesbrough,  176  Fed.  778. 

11  U.  S.  V.  Fisk,  3  Wall.  445.  But  the  word  "and"  is  never  construed  to 
mean  "or"  in  the  absence  of  cogent  reasons  for  so  doing.  (Rice  v.  U.  S., 
53  Fed.  910.) 

12  National  Bank  of  Commerce  v.  Allen,  223  Fed.  472;  Eliot  National 
Bank  v.  Gill,  218  Fed.  600. 

13  U.  S.  V.  Ninety-Nine  Diamonds,  139  Fed.  961. 

14  U.  S.  V.  Fidelity  Trust  Co.,  222  U.  S.  158;  Nat.  Life  &  Accident  Ins.  Co. 
V.  Craig,  251  Fed.  524. 

i5Maddock  v.  Magone,  152  U.  S.  368;  Sonn  v.  Magone,  159  U.  S.  417. 

lODennison  Mfg.  Co.  v.  U.  S.,  72  Fed.  258;  Rossman  v.  Hedden,  145  U.  S. 
561;  Hedden  v.  Richard,  149  U.  S.  346;  Mutual  Benefit  Ins.  Co.  v.  Herold, 
198  Fed.  199,  affirmed  201  Fed.  918. 


CONSTRUCTION  OF  TAXING  STATUTES  1263 

guage  of  the  statute.^'^  General  terms  following  special  terms 
are,  as  a  rule,  limited  in  scope  and  meaning  to  the  same  general 
class  as  the  special  terms ;  in  other  words,  the  particular  words 
are  presumed  to  describe  certain  species  and  the  general  words 
to  be  used  to  include  other  species  of  the  same  genus. i"*  But  this 
is  only  a  rule  of  construction  to  aid  in  arriving  at  the  real  legis- 
lative intent.  It  is  not  a  cast-iron  rule,  overriding  all  other  rules 
of  construction,  and  it  will  never  be  applied  to  defeat  the  real 
purpose  of  the  statute  as  gathered  from  its  entire  context.  While 
the  rule  is  aimed  to  preserve  a  meaning  for  the  particular  words, 
it  should  not  be  permitted  to  render  meaningless  the  general 
words.  Therefore,  where  the  particular  words  exhaust  the  class, 
the  general  words  must  be  construed  as  embracing  something 
outside  of  that  class.  If  the  particular  words  exhaust  the  class, 
there  is  nothing  ejusdem  generis  left,  and  in  such  case  the  gen- 
eral words  must  be  given  the  meaning  outside  of  the  class  indi- 
cated by  the  particular  words,  otherwise  the  meaning  of  the 
general  words  would  be  sacrificed  to  preserve  the  particular 
words  and  the  rule  would  defeat  its  own  purpose. i''  The  general 
rule  of  construction  applicable  to  all  statutes  and  written  instru- 
ments that  words  should  be  given  the  meaning  naturally  attach- 
ing to  them  from  their  context  and  that  a  word  of  obscure  mean- 
ing, taken  by  itself,  may  be  construed  by  reference  to  associated 
words,  is  applicable  to  the  construction  of  revenue  laws.-"  Effect 
should  be  given,  if  possible,  to  the  entire  statute,  and  part  should 
not  be  permitted  to  perish  by  construction.  One  part  should 
not  be  allowed  to  defeat  another  part,  if  by  any  reasonable  con- 
struction the  two  can  stand  together.-^  If  the  context  of  the 
statute  is  ambiguous,  the  title,-'-  preamble,--'  and  punctuation,-^ 
may  be  considered,  but  they  are  seldom  the  subject  of  special  con- 
sideration by  the  legislature  and  are  fallible  and  unreliable  guides 

iTPickhardt  v.  Merritt,  132  U.  S.  252;  Newman  v.  Arthur,  109  U.  S.  132. 

ISU.  S.  V.  1,150^  pounds  of  Celluloid,  82  Fed.  627;  Reiche  v.  Smythe,  13 
Wall.  162;  U.  S.  v.  Weise,  28  Fed.  Gas.  No.  16,659. 

i«  U.  S.  V.  Mescall,  215  U.  S.  26. 

-'>Marsching  v.  U.  S.,  113  Fed.  1006;  U.  S.  v.  Sixty-Five  Terra  Cotta 
Vases,  18  Fed.  508,  510;  Patten  v.  U.  S.,  159  U.  S.  500,  509;  Adams  v.  Ban- 
croft, 1  Fed.  Cas.  No.  44;  Taber  v.  U.  S.,  23  Fed.  Gas.  No.  13,722. 

-I  U.  S.  V.  Ninety-Nine  Diamonds,  139  Fed.  961;  State  ex  rel.  Arpin  v. 
Eberhardt,  158  Wis.  20;  Sol.  Op.  90,  T.  B.  7-21-1432. 

-'2  Knowlton  v.  Moore,  178  U.  S.  41;  Smythe  v.  Fiske,  23  Wall.  374;  Church 
of  Holy  Trinity  v.  U.  S.,  143  U.  S.  457;  Hedden  v.  Collector,  5  Wall.  107; 
Cornell  v.  Coyne,  192  U.  S.  418. 

•-':?  Price  v.  Forrest,  173  U.  S.  410,  427. 

-^  U.  S.  V.  Isham,  17  Wall.  496;  U.  S.  v.  Three  Railroad  Cars,  28  Fed.  Cas. 
No.  16,513;  Ford  v.  Delta  Co.,  164  U.  S.  662. 


1264  FEDERAL  INCOME  TAX 

in  ascertaining  the  intention  of  that  body.-"'  While  the  rule  is 
that  taxing  statutes  should  be  so  construed  as  to  prevent  them 
from  operating  retroactively ^6  that  is  merely  a  principle  of  con- 
struction and  the  courts  will  not  save  a  statute  from  producing 
a  retroactive  effect,  if  the  intent  that  it  should  so  operate  is 
clear.27 

Construction  Which  Will  Be  Constitutional.  It  is  a  well-estab- 
Hshed  rule  that  when  a  statute  admits  of  two  interpretations, 
one  of  which  presses  it  beyond  constitutionality  and  the  other 
of  which  brings  it  within  constitutionality  or  avoids  the  ques- 
tion of  constitutionality,  the  courts  tend  to  adopt  the  latter  in- 
terpretation.-^  The  foundation  of  this  rule,  it  is  to  be  noted,  is 
the  possibility  of  two  constructions,  and  the  existence  of  grave 
doubt  as  to  constitutionality.  Where  the  doubt  is  not  grave  the 
courts  will  give  the  statute  the  most  natural  meaning  resulting 
from  its  text,  as  otherwise  the  mere  assertion  that  a  statute  is 
unconstitutional  would  tend  to  set  aside  the  general  rules  of  con- 
struction.-^ 

Proceedings  in  Congress  as  Aid  to  Construction.  Notwith- 
standing the  well-established  rule  that  the  intent  of  the  lawmak- 
,  ers  is  to  be  found  in  the  statutes  they  pass,  the  courts,  where  the 
language  of  a  statute  is  ambiguous  and  its  meaning  doubtful, 
should  not  shut  their  eyes  to  what  can  be  learned  of  the  history 
of  the  times  and  of  the  law,  of  the  condition  of  the  law  at  a  par- 
ticular time,  the  mischief  or  evil  sought  to  be  remedied,  and 
other  kindred  things  which  would  put  them  in  the  light  that  the 
lawmakers  enjoyed  and  enable  them  to  view  the  situation  as  it 
appeared  to  those  who  passed  the  act.^o  The  legislative  history 
of  a  subsequent  statute  will  not  be  considered  as  an  aid  to  con- 
struction.'^i    For  such  purposes,  in  interpreting  ambiguous  stat- 

25  state  ex  rel.  Arpvin  v.  Eberhardt,  158  Wis.  20. 

26Stockdale  v.  Insurance  Co.,  20  Wall.  323;  Lynch  v.  Turrish,  247  U.  S. 
221. 

27  Billings  V.  U.  S.,  232  U.  S.  261. 

28Stratton's  Independence  v.  Howbert,  231  U.  S.  399;  Singer  Mfg.  Co.  v. 
McCollock,  24  Fed.  667. 

29  U.  S.  V.  Bennett,  232  U.  S.  299. 

30  U.  S.  V.  Standard  Oil  Co.,  221  U.  S.  1;  U.  S.  v.  Trans-Missouri  Freight 
Association,  166  U.  S.  290,  318;  Holy  Trinity  Church  v.  U.  S.,  143  U.  S.  457, 
463;  Jennison  v.  Kirk,  98  U.  S.  453;  Carbon  Steel  Co.  v.  Lewellyn,  258  Fed. 
533;  Northern  Commercial  Co.  v.  U.  S.,  217  Fed.  33;  LaBelle  Iron  Works 
V.  U.  S.,  41  Sup.  Ct.  Rep.  528;  65  L.  ed.  604;  Ho  Ah  Kow  v.  Nunan,  5  Sawy 
552;  Peo.  v.  Charles  Schweinler  Press,  214  N.  Y.  395;  Woollcott  v.  Shubert, 
217  N.  Y.  212,  111  N.  E.  829. 

31  Penn  Mutual  Life  Insurance  Co.  v.  Lederer,  252  U.  S.  523. 


CONSTRUCTION  OF  TAXING  STATUTES  1265 

utes,  the  formal  reports  of  committees  having  in  charge  a  pend- 
ing legislative  bill  including  the  bill  as  introduced,  changes  made 
in  the  frame  of  the  bill  in  the  course  of  its  passage,  and  state- 
ments made  by  the  committee  chairman  in  charge  of  it  may, 
under  proper  qualifications,  be  referred  to  as  bearing  upon  ques- 
tions of  legislative  intent."-'  Courts  take  judicial  notice  of  legis- 
lative journals  and  proceedings  in  congress  so  far  as  they  are 
admissible  in  aid  of  statutory  construction.'"--'  But  individual 
statements  made  in  debate  do  not  necessarily  reflect  the  intent 
and  understanding  of  the  legislative  body  and  are  unreliable  as 
an  aid  to  construction,  as  many  individual  members  may  remain 
silent  and  may  vote  for  a  bill  because  in  their  judgment  it  has 
a  wider  or  narrower  scope  than  its  author  states."-^  Accordingly 
the  courts  may  not,  in  interpreting  a  statute,  recur  to  the  motives 
of  individual  members  of  the  legislative  body  nor  to  what  they 
supposed  the  bill  to  mean.^-^  Such  individual  statements  may, 
however,  be  resorted  to  as  a  means  of  ascertaining  the  environ- 
ment at  the  time  of  enactment  of  a  particular  law,  that  is,  the 
history  of  the  period  when  it  was  adopted.--^' 

:52  U.  S.  V.  St.  Paul  M.  &  M.  R.  Co.,  247  U.  S.  310,  318;  Caminetti  v.  U.  S., 
242  U.  S.  470,  490;  Lapina  v.  Williams,  232  U.  S.  78;  Woodward  v.  De- 
Graffenried,  238  U.  S.  284;  Pennsylvania  R.  Co.  v.  International  Coal  Min. 
Co.,  230  U.  S.  184;  McLean  v.  U.  S.,  226  U.  S.  374;  Shallus  v.  U.  S.,  162 
Fed.  653;  Mosle  v.  Bidwell,  130  Fed.  334;  Matter  of  Hamlin,  226  N.  Y.  407, 
414. 

33  Connole  v.  Norfolk  &  Western  Ry.  Co.,  216  Fed.  823;  Wadsworth  v. 
Boysen,  148  Fed.  771.  In  Atlantic  C.  L.  R.  Co.  v.  Riverside  Mills,  219  U,  S. 
196,  200,  the  court  in  construing  the  Carmack  amendment  quotes  a  speech 
of  Judge  William  Richardson,  a  congressman  from  Alabama,  made  when 
the  amendment  was  reported  by  a  conference  committee.  Judge  Richard- 
son was  speaking  for  the  committee  of  the  matter  which  it  was  sought  to 
remedy. 

:^-tSweetser  v.  Emerson,  236  Fed.  161;  Johnson  v.  U.  S.,  215  Fed.  679; 
U.  S.  v.  Trans-Missouri  Freight  Association,  166  U.  S.  290,  318;  Mitchell  v. 
Great  Works  Milling,  etc.  Co.,  2  Story  653;  McKenzie  v.  Hare,  239  U.  S. 
299. 

:i-^U.  S.  V.  Union  Pacific  R.  R.  Co.,  91  U.  S.  72;  Omaha  &  C.  B.  Street  R. 
Co.  V.  Interstate  Commerce  Commission,  230  U.  S.  324;  Pennsylvania  R.  R. 
Co.  v.  International  Coal  Mining  Co.,  230  U.  S.  184;  Aldridge  v.  Williams, 
3  How.  23. 

3«  Standard  Oil  Co.  v.  U.  S.,  221  U.  S.  1;  Jennison  v.  Kirk,  98  U.  S. 
453,  459;  Central  Building,  Loan  &  Savings  Co.  v.  Bowland,  216  Fed.  526.  It 
is  difficult  to  reconcile  the  authorities  on  the  question  of  the  admissibility  of 
individual  statements  in  debate  in  interpreting  a  statute.  There  are  cases 
such  as  Roberts  v.  Southern  Pacific  Co.,  186  Fed.  934,  affirmed  219  Fed. 
1022,  which  consider  such  statements  for  more  extended  purposes  than  are 
permitted  under  the  Standard  Oil  Co.  and  St.  Paul  M.  &  M.  R.  Co.  cases 


1266  FEDERAL  INCOME   TAX 

Effect    of    Rulings    and    Practice    of    Treasury    Department. 

Great  weight  and  due  deference  and  respect  is  always  given  by 
the  courts  to  the  construction  put  upon  a  revenue  statute  by  the 
treasury  department.-'^  This  rule  also  applies  to  the  construction 
of  state  statutes  by  the  highest  state  authorities  charged  with 
the  duty  of  administration,  when  the  meaning  of  such  state 
statutes  is  at  issue  in  the  federal  courts.'-^  Where  the  language 
of  a  statute  is  dubious  and  open  to  different  interpretations  the 
construction  of  the  treasury  department  is  in  the  highest  degree 
persuasive,  if  not  controlling,  in  its  effect  upon  the  courts,  and 
is  not  to  be  disregarded  without  the  most  cogent  reasons  if  it  has 
been  followed  for  many  years  without  any  attempt  on  the  part 
of  congress  to  change  it  and  where  there  has  been  a  long  acquies- 
cence in  it,  and  especially  if  by  it  the  rights  of  parties  for  many 
years  have  been  determined  and  adjusted/'"  But  the  construction 
of  the  treasury  department  cannot  repeal  a  statute;  it  can  only 
be  resorted  to  in  aid  of  interpretation,  and  is  not  applicable  to 
what  has  no  need  of  interpretation.  It  is  therefore  inadmissible 
and  immaterial  where  the  language  of  the  statute  is  clear  and 
precise  or  where  it  will  not  bear  the  interpretation  put  upon  it 
by  the  department.^" 

Construction  by  Reference  to  Similar  Statutes.  As  a  general 
rule,  where  a  statute  is  of  doubtful  meaning  and  susceptible  on 
its  face  of  two  constructions,^!  the  court  may  look  into  prior  acts 
to  determine  its  proper  construction.^-    This  rule  has  been  repeat- 

and  the  authorities  heretofore  cited,  but  they  seem  contrary  to  the  weight 
of  authority. 

•"'"  U.  S.  V.  Cerecedo  Hermanos  y  Compania,  209  U.  S.  338;  De  Ganay  v. 
Lederer,  239  Fed.  568;  affirmed  250  U.  S.  376;  Smythe  v.  Fiske,  23  Wall. 
374;  Edwards  v.  Wabash  Ry.  Co.,  264  Fed.  610;  La  Belle  Iron  Works  v. 
U.  S.,  decided  June  28,  1920,  Ct.  Cls.  No.  34603;  T.  D.  3051,  T.  B.  34-20-1158; 
41  Sup.  Ct.  Rep.  528;  65  L.  ed.  604. 

8S  Maryland  Casualty  Co.  v.  U.  S.,  251  U.  S.  342;  Insurance  Co.  of  North 
America  v.  McCoach,  218  Fed.  905,  reversed  224  Fed.  657,  661,  writ  of 
certiorari  granted  241  U.  S.  694,  reversed  244  U.  S.  585.  See  opinion  of 
Circuit  Court  of  Appeals.  In  reversing  this  court  the  Supreme  Court  con- 
ceded full  effect  to  the  administrative  or  executive  construction  followed, 
but  held  that  it  did  not  answer  the  decisive  question  involved. 

^^\J.  S.  V.  Johnson,  124  U.  S.  236;  Robertson  v.  Downing,  127  U.  S.  607; 
Van  Dyke  v.  Milwaukee,  (Wis.)  146  N.  W.  812;  see  rehearing  150  N.  W. 
509;  Galm  v.  U.  S.,  39  Ct.  Cls.  55;  L.  O.  1060,  T.  B.  14-21-1554. 

w  Swift  Company  v.  U.  S.,  105  U.  S.  691 ;  Merritt  v.  Cameron,  137  U.  S. 
542;  U.  S.  V.  Graham,  110  U.  S.  219;  U.  S.  v.  Tanner,  147  U.  S.  661;  Cryan 
V.  Warden,  263  Fed.  248. 

^1  Bate  Refrigerator  Co.  v.  Sulzberger,  157  U.  S.  1. 

42  Hamilton  v.  Rathbone,  175  U.  S.  414;  Connecticut  General  Life  Ins.  Co. 
v.  Eaton,  218  Fed.  188. 


CONSTRUCTION  OF  TAXING  STATUTES  1267 

edly  applied  in  the  construction  of  the  Revised  Statutes  of  the 
United  States.^-  It  is  particularly  applicable  to  revenue  legis- 
lation and  absolutely  necessary  in  the  case  of  the  legislation  of 
congress  on  this  subject,  for  without  it  the  revenue  could  not  be 
collected  and  inextricable  embarrassments  and  difficulties  would 
constantly  occur.'*  The  revenue  laws,  though  made  up  of  inde- 
pendent enactments,  are  regarded  as  constituting  practically  one 
system,^''  and  to  ascertain  the  legislative  intent  courts  not  only 
search  all  the  provisions  of  the  particular  revenue  statutes  in 
question,  but  look  beyond  those  to  others  in  pari  materia,  or  of 
a  similar  purport,  which  compose  the  system.^'"'  Any  rule  of 
construction,  separating  from  this  revenue  system,  and  its  com- 
ponent numerous  and  diverse  enactments,  each  new  act  altering 
it,  would  be  unsound  and  unsafe.^^  When  congress  re-enacts 
without  change  a  statute  which  has  previously  received  a  con- 
struction by  the  federal  supreme  court,  it  will  be  deemed  to  have 
adopted  such  construction, '^^  and  an  executive  or  departmental 
construction  of  an  earlier  act  will  also  be  sanctioned  by  subse- 
quent re-enactments,^"  especially  where  the  executive  or  depart- 

43  Hamilton  v.  Rathbone,  175  U.  S.  414;  U.  S.  v.  Hirsch,  100  U.  S.  83; 
U.  S.  V.  Bowen,  100  U.  S.  508;  U.  S.  v.  Sixty-Five  Terra  Cotta  Vases,  18 
Fed.  508. 

44  Stuart  V.  Maxwell,  16  How.  160. 

45  In  re  Southern  Pacific  Co.,  82  Fed.  311,  affirmed  87  Fed.  863. 

46  Smietanka  v.  Zibell,  U.  S.  C.  C.  A.,  7th  Circ.  T.  D.  3000,  T.  B.  15-20-857; 
U.  S.  V.  Collier,  25  Fed.  Cas.  No.  14,833. 

47  Saxonville  Mills  v.  Russell,  116  U.  S.  21. 
4S  Latimer  v.  U.  S.,  223  U.  S.  501. 

49  U.  S.  V.  Cerecedo  Hermanos  y  Compania,  209  U.  S.  338;  U.  S.  v.  Falk  & 
Bro.,  204  U.  S.  143,  152;  Komada  v.  U.  S.,  215  U.  S.  392;  Wabash  Valley  Co. 
V.  Edwards,  264  Fed.  152,  610.  In  the  last  mentioned  case  the  court  said: 
"Irrespective  of  original  considei'ations,  it  is  now  too  late  for  the  department 
to  change  and  by  a  novel  ruling  to  alter  a  long  settled  interpretation  of 
language  taken  from  former  acts  of  congress  and  thus  to  subject  the  issu- 
ance of  stock  under  conversion  privilege  created  prior  to  the  passage  of 
the  present  Act  to  an  unexpected  tax.  All  this  could  have  been  done  by 
congress  if  language  had  been  used  specifically  calling  for  such  a  result,  but 
it  can  not  be  accomplished  by  the  mere  use  of  general  terms  which  because  of 
the  repeated  rulings  of  the  department  do  not  have  the  meaning  to  the  busi- 
ness community  now  sought  to  be  placed  upon  them.  It  is,  of  course,  for  the 
very  purpose  of  making  men's  rights  clearly  understood,  that  the  courts 
have  held  that  long  settled  constructions  of  phrases  by  courts  or  govern- 
mental departments  are  to  be  read  into  statutes  relating  to  kindred  subject- 
matters.  The  present  case  is  one  where  this  doctrine  seems  eminently  rea- 
sonable and  just." 


1268  FEDERAL  INCOME  TAX 

mental  construction  has  been  repeated  and  long  continued  ^^  and 
where  valuable  property  rights  have  been  founded  thereon. •'"^i 

Similar  Statutes  in  Other  Jurisdiction.  When  a  statute  is 
adopted  by  another  state  or  by  congress,  the  construction  pre- 
viously given  to  such  a  statute  by  the  highest  court  of  the  state 
from  which  it  is  adopted  presumably  becomes  an  integral  part  of 
and  is  incorporated  into  the  law  so  adopted.^^  This  is  but  a  nar- 
rower application  of  the  general  principle  that  the  language  of 
an  act  is  used,  and  so  is  to  be  interpreted,  according  to  its  legal 
significance  at  the  time  the  act  is  passed."'"  The  rule  applies  only 
to  the  construction  followed  in  the  state  from  which  the  statute 
is  originally  adopted  and  not  to  that  followed  in  the  state  from 
which  the  statute  is  immediately  taken,-^^  and  applies  also  primar- 
ily to  decisions  in  force  at  the  time  of  adoption.  The  courts  will, 
however,  treat  subsequent  decisions  with  respect.^-^  But  the  rule 
that  the  courts  of  one  state  will  deem  the  interpretative  decisions 
of  another  state  a  part  of  a  statute  adopted  from  that  state  is  not 
an  absolute  one,  to  be  followed  under  all  circumstances.  It  will 
not  be  followed  where  the  construction  urged  to  be  adopted  is 
contrary  to  the  obvious  meaning  of  the  statute  to  be  construed''*' 
or  would  make  the  statute  unconstitutional  in  the  state  of  adop- 
tion.57 

Strict  or  Liberal  Construction.  The  authorities  upon  the  ques- 
tion of  whether  a  taxing  statute  should  be  strictly  or  liberally 
construed,  or  whether  it  should  be  construed  according  to  some 
medium  between  these  two  extremes,  are  in  some  confusion  and 
no  broad  general  rule  can  be  safely  stated.  Excluding  the  con- 
struction of  tax  exemptions,  which  will  be  treated  hereafter, 
three  general  lines  of  authority  can  be  traced.    One  line  of  cases  •'^^ 

sou.  S.  V.  Baruch,  223  U.  S.  191;  Wabash  Railway  Co.  v.  Edwards,  264 
Fed.  610. 

•"'1  Swigart  v.  Baker,  229  U.  S.  187. 

52  Mustard  v.  Elwood,  223  Fed.  225;  Robinson  v.  Belt,  187  U.  S.  41;  Mc- 
Donald V.  Hovey,  110  U.  S.  619;  Interstate  Commerce  Commission  v.  D.  L. 
&  W.  R.  Co.,  220  U.  S.  235. 

r.3  Commercial  Travellers  Ass'n  v.  Rodway,  235  Fed.  370,  374. 

r^i  Coulan  v.  Doull,  133  U.  S.  216. 

5;'>  Cathcart  v.  Robinson,  5  Pet.  264. 

56  Whitney  v.  Fox,  168  U.  S.  637. 

57  In  re.  Swearinger,  23  Fed.  Cas.  No.  13,683. 

58  U.  S.  V.  Wigglesworth,  2  Story  369,  28  Fed.  Cas.  No.  16,690;  U.  S.  v. 
Isham,  17  Wall.  504;  U.  S.  v.  Watts,  28  Fed.  Cas.  No.  16,653;  Equitable 
Trust  Co.  V.  Seldon,  8  Fed.  Cas.  No.  4,507;  Osgood  v.  Tax  Commissioner. 
235  Mass.  88,  126  N.  E.  371.  The  court  said  in  Powers  v.  Barney,  5 
Blatch.  202,  "Duties  are  never  imposed  on  the  citizens  upon  vague  or  doubt- 
ful interpretations."    There  are  early  cases  holding  to  the  contrary  such  as 


CONSTRUCTION  OF  TAXING  STATUTES  1269 

holds  that,  as  stated  by  the  court  in  a  leading  case:"'"  "In  the 
first  place,  it  is,  as  I  conceive,  a  general  rule  in  the  interpretation 
of  all  statutes,  levying  taxes  or  duties  upon  subjects  or  citizens, 
not  to  extend  their  provisions,  by  impHcation,  beyond  the  clear 
import  of  the  language  used,  or  to  enlarge  their  operation  so  as  to 
embrace  matters,  not  specifically  pointed  out,  although  standing 
upon  a  close  analogy.  In  every  case,  therefore,  of  doubt,  such 
statutes  are  construed  most  strongly  against  the  government, 
and  in  favor  of  the  subjects  or  citizens,  because  burdens  are  not 
to  be  imposed,  nor  presumed  to  be  imposed,  beyond  what  the 
statutes  expressly  and  clearly  import.  Revenue  statutes  are  in 
no  just  sense  either  remedial  laws  or  laws  founded  upon  any 
permanent  public  policy,  and,  therefore,  are  not  to  be  liberally 
construed."  Since  this  decision  it  has  been  repeatedly  held  by  the 
United  States  Supreme  Court  and  the  inferior  federal  courts  that 
the  provisions  of  a  tariff  act  should  be  liberally  construed  in  favor 
of  the  importer,  and  that  in  case  of  fair  doubt  as  to  the  construc- 
tion of  a  provision  in  such  acts  the  courts  should  resolve  the  doubt 
in  favor  of  the  importer  and  that  in  such  cases  the  intention  of 
congress  to  impose  a  higher  duty  should  be  expressed  in  clear 
and  unambiguous  language.'"*  And  the  same  rule  has  been  ap- 
plied in  the  construction  of  other  revenue  laws,"'  including  the 

U.  S.  V.  Olney,  27  Fed.  Cas.  No.  15,918,  where  a  statue  imposing  a  license 
fee  for  lottery  dealers  was  being  construed  and  the  court  said :  "A  revenue 
law  is  not  to  be  strictly  construed,  but  rather  the  contrary,  so  as  to  attain 
the  ends  for  which  it  was  enacted."  See  Twenty-Eight  Cases,  2  Ben.  63; 
Rankin  v.  Hoyt,  4  How.  327;  Smythe  v.  Fiske,  23  Wall.  374,  380. 

^■^9  U.  S.  V.  Wigglesworth,  2  Story  369,  28  Fed.  Cas.  No.  16,690. 

coBenzinger  v.  U.  S.  192  U.  S.  38;  American  Net  &  Twine  Co.  v.  Worth- 
ington,  141  U.  S.  468;  Shallus  v.  U.  S.,  162  Fed.  653;  U.  S.  v.  Tiffany,  160 
Fed.  408;  Hayes  v.  U.  S.,  150  Fed.  63;  Hempstead  v.  Thomas,  122  Fed.  538; 
U.  S.  V.  Merck  &  Co.,  91  Fed.  639,  affirmed  97  Fed.  989;  Rice  v.  U.  S.,  53 
Fed.  910.  It  has  been  said  that  the  rule  which  gives  the  importer  the  benefit 
of  a  doubt  is  limited  to  cases  where  it  relieves  all  importers  of  all  articles 
whatsoever  of  the  class  concerned;  that  it  probably  has  no  practical  use  ex- 
cept in  cases  of  extraordinary  doubt;  that  it  has  a  more  appropriate  appli- 
cation when  the  question  is  one  of  any  tax  at  all;  and  that  the  federal  re- 
ports are  full  of  suits  where  the  courts  have  not  hesitated  to  perform  the 
duty  of  determining  mere  questions  of  classification  where  it  was  admitted 
some  duty  was  to  be  imposed,  in  favor  of  a  higher  rate,  under  circumstances 
of  great  difficulty.     (U.  S.  v.  Wetherell,  65  Fed.  987.) 

<"'i  Eidman  v.  Martinez,  184  U.  S.  578;  Treat  v.  White,  181  U.  S.  264;  Gill 
v.  Bartlett,  224  Fed.  927;  Rockefeller  v.  O'Brien,  224  Fed.  541,  affirmed  239 
Fed.  127;  Disston  v.  McClain,  147  Fed.  114;  Wright  v.  Michigan  Central  R. 
Co.,  130  Fed.  843;  McNally  v.  Field,  119  Fed.  445;  Treat  v.  Tolman,  113 
Fed.  892. 


1270  FEDERAL  INCOME  TAX 

1909  Law,62  the  1913  Law,  the  1916  Law,  and  the  1917  Stamp  Tax 
Act,63  and  the  1916  Federal  Estate  Tax,  as  amended.''-^  In  a  com- 
paratively late  case  construing  the  war  revenue  act  of  June  13, 
1898,  imposing  a  special  excise  tax  on  sugar  the  Supreme  Court, 
adopting  the  language  of  the  dissenting  opinion  in  the  court  below, 
held  that  where  the  construction  of  a  tax  law  is  doubtful,  the 
doubt  is  to  be  resolved  in  favor  of  those  upon  whom  the  tax  is 
sought  to  be  laid.*^^  And  in  a  very  recent  case  •'"  arising  under  the 
1913  Law  in  the  Supreme  Court,  the  rule  quoted  above  was  re- 
stated as  an  established  rule  of  construction.  Three  recent  cases 
in  the  lower  federal  courts  have  also  stated  generally  with  par- 
ticular reference  to  the  1909  Corporation  Excise  Tax  Law  that 
revenue  laws  should  be  strictly  construed  against  the  govern- 
ment,^^  and  it  has  been  held  that  this  rule  applies  especially  where 
they  impose  burdens  of  a  special  or  unusual  character.*^*^  A  sec- 
ond line  of  cases  holds  that  revenue  laws  are  not  to  be  strictly 
construed  in  favor  of  the  subject  and  against  the  state,  but  still 
with  reasonable  fairness  to  the  citizen.  It  is  stated  in  U.  S.  v. 
Distilled  Spirits:  *^'''  "In  construing  a  severe  statute,  declaring  a 
heavy  forfeiture,  (and,  according  to  one  construction  claimed,  for 
small  offenses,)  it  is  just  to  say,  that  those  who  are  called  upon 
to  conduct  their  business  affairs  in  view  of  all  its  provisions, 
ought  to  be  fairly  apprised  of  its  requirements,  and  of  its  pen- 
alties, of  whatever  kind.  They  are  bound  to  know  the  law,  but 
lawmakers  owe  to  them  the  duty  to  make  the  law  intelligible ;  and 

62  Parkview  Building  &  Loan  Ass'n  v.  Herold,  203  Fed.  876,  affirmed  210 
Fed.  577. 

63  Haiku  Sugar  Co.  v.  Johnstone,  249  Fed.  103;  U.  S.  v.  Coulby,  251  Fed. 
982,  affirmed  258  Fed.  27;  First  Trust  &  Savings  Bank  v.  Smietanka,  268 
Fed.  230;  Scott  v.  Western  Pac.  Ry.  Co.,  246  Fed.  545;  see  Miller  v.  Gearin, 
258  Fed.  225  as  to  the  1916  Law;  see  Wabash  Railway  Co.  v.  Edwards,  264 
Fed.  610  as  to  the  Stamp  Tax  Act,  (all  decided  since  the  Gould  case,  cited 
hereafter)  ;  see  also  New  York  Trust  Co.  v.  Eisner,  U.  S.  Dist.  Ct.,  So.  Dist., 
N.  Y.,  N.  Y.  Law  Journal,  March  4,  1920. 

•i^U.  S.  V.  Field,  decided  by  U.  S.  Supreme  Court,  February  28,  1921; 
W.  T.  D.  1921,  11362^ 

65  Spreckels  Sugar  Ref.  Co.  v.  McClain,  192  U.  S.  397. 

66  Gould  V.  Gould,  245  U.  S.  151.  It  is  to  be  noted  that  in  this  case  the 
court  used  almost  identically  the  language  of  Judge  Story  in  the  old  Wig- 
glesworth  case;  also  that  Mr.  Justice  McReynolds  makes  no  reference  to 
the  Stowell  case  (cited  hereafter).     See  Crocker  v.  Malley,  249  U.  S.  223. 

67  Mutual  Benefit  Ins.  Co.  v.  Herold,  198  Fed.  199,  affirmed  201  Fed.  918; 
Anderson  v.  Morris  &  E.  R.  Co.,  216  Fed.  83;  Penn.  Steel  Co.  v.  N.  Y,  City 
Co.,  198  Fed.  774,  affirmed  231  U.  S.  144. 

68  Lynch  v.  Union  Trust  Co.,  164  Fed.  161. 

60  U.  S.  V.  Distilled  Spirits,  27  Fed.  Cas.  No.  15,960;  10  Blatch.  428. 


CONSTRUCTION  OF  TAXING  STATUTES  1271 

those  whose  business  it  is  to  construe  or  expound  a  law  which  is 
of  doubtful  or  double  meaning,  should  not  incline  to  the  harshest 
possible  meaning,  when  it  is  obvious  that  those  to  whom  it  is  to 
be  applied  may  well  have  been  led  to  trust  in  another  which  is  less 
severe,  but  equally  satisfying  in  its  terms.  This  is  not  saying 
that  laws  of  the  kind  in  question  are  to  be  strictly  construed  in 
favor  of  the  subject  and  against  the  state  but,  only,  that  they 
should  be  construed  with  reasonable  fairness  to  the  citizen."  ^"  A 
third  line  of  cases  announces  a  rule  much  more  favorable  to  the 
government.  As  stated  in  the  early  cases,  penalties  annexed  to 
violations  of  the  general  revenue  laws  do  not  make  them  penal 
in  the  sense  which  requires  them  to  be  construed  strictly."^  This 
statement  was  amplified  and  further  explained  in  the  leading 
case  of  U.  S.  v.  Stowell,^-  which  was  an  information  on  forfeiture 
of  distilling  machinery,  on  the  theory  that  statutes  to  prevent 
frauds  on  the  revenue  are  considered  as  enacted  for  the  public 
good  and  to  suppress  a  public  wrong,  and  therefore,  although 
they  impose  penalties  or  forfeitures,  are  not  to  be  construed,  like 
penal  laws  generally,  strictly  in  favor  of  the  defendant ;  but  they 

""  The  U.  S.  V.  Distilled  Spirits  case  was  a  penalty  case  arising  under  the 
Internal  Revenue  Laws  and  the  rule  announced  in  it  seems  to  have  been 
modified  by  the  Stowell  case  (cited  hereafter). 

n  U.  S.  V.  Barrels  of  Spirits,  2  Abb.  (U.  S.)  305,  314;  U.  S.  v.  Cases  of 
Cloth,  Crabbe  356;  Taylor  v.  U.  S.,  3  How.  197;  Cliquot's  Champagne,  3 
Wall.  114,  145;  U.  S.  v.  Hodson,  10  Wall.  395,  406. 

~-  U.  S.  v.  Stowell,  133  U.  S.  1.  It  is  to  be  doubted  whether  in  this  case  or 
the  case  of  U.  S.  v.  Hodson,  10  Wall.  395,  406,  the  Supreme  Court  meant  to 
overrule  Judge  Story  in  the  Wigglesworth  case.  In  both  cases  the  court 
refers  as  authority  to  the  case  of  Taylor  v.  U.  S.,  3  How.  197,  210,  which 
was  decided  by  Judge  Story  without  mentioning  his  immediately  previous 
opinion  in  the  Wisglesworth  case.  It  seems  highly  improbable  Judge  Story 
meant  to  overrule  himself  in  the  Taylor  case  but  rather  that  he  had  a  dis- 
tinction in  mind  between  i-evenue  laws  generally  and  statutes  to  prevent 
fraud  upon  the  revenue.  At  the  time  of  the  Wiggle.sworth  decision  Judge 
Story  had  also  decided  the  case  of  U.  S.  v.  Breed,  24  Fed.  Cas.  No.  14,638 
in  which  he  said  in  part:  "Revenue  and  duty  acts  are  not  in  the  sense  of 
the  law  penal  acts;  and  are  not  therefore  to  be  construed  strictly.  Nor  are 
they,  on  the  other  hand,  acts  in  furtherance  of  private  rights  and  liberty, 
or  remedial;  and  therefore  to  be  construed  with  extraordinary  liberality. 
They  are  to  be  construed  according  to  the  true  import  and  meaning  of  their 
terms;  and  when  the  legislative  intention  is  ascertained,  that,  and  that 
only,  is  to  be  our  guide  in  interpreting  them.  We  are  not  to  strain  them 
to  reach  cases  not  within  their  terms,  even  if  we  might  conjecture  that 
public  policy  might  have  reached  those  cases;  nor,  on  the  other  hand,  are 
we  to  restrain  their  terms,  so  as  to  exclude  cases  clearly  within  them,  simply 
because  public  policy  might  possibly  dictate  such  an  exclusion."  See  also 
Rankin  v.  Hoyt,  4  How.  332;  Smythe  v.  Fiske,  23  Wall,  374,  380.  In  the 
last  mentioned  case  the  question  was  the  amount  of  duty  on  silk  ties. 


1272  FEDERAL  INCOME  TAX 

are  to  be  fairly  and  reasonably  construed,  so  as  to  carry  out  the 
intention  of  the  legislature.  This  case  has  been  cited  and  fol- 
lowed constantly  "^^  notably  in  a  recent  case^^  in  the  Supreme 
Court  construing  certain  forfeiture  provisions  of  the  internal 
revenue  laws,  and  its  authority  has  never  been  expressly  ques- 
tioned or  restricted.  The  latest  statement  of  the  United  States 
Supreme  Court  referred  to  above""'  makes  it  clear  that  revenue 
laws,  as  to  the  persons  and  things  to  be  taxed  will  be  strictly 
construed  in  the  sense  that  their  provisions  will  not  be  extended 
beyond  the  clear  import  of  the  language  used  or  their  operations 
enlarged  so  as  to  embrace  matters  not  specifically  pointed  out, 
and  that  doubt  as  to  such  matters  will  be  resolved  more  strongly 
against  the  government  and  in  favor  of  the  citizen.  In  respect 
to  their  penal  provisions,  however,  both  those  working  forfeit- 
ures and  those  imposing  penalties  or  imprisonment,  rather  than 
in  respect  to  the  question  of  whom  and  what  the  statute  taxes, 
it  may  still  be  that  revenue  laws  will  be  considered  as  remedial 
in  their  character  and  so  liberally  construed  so  as  to  carry  out 
the  purpose  of  their  enactment.'"' 

73  In  the  following  cases  involving  the  construction  of  revenue  laws  with 
particular  reference  to  penal  forfeitures  and  criminal  provisions  for  viola- 
tions: U.  S.  V.  Two  Barrels  of  Whisky,  96  Fed.  479;  U.  S.  v.  246 J.  Pounds 
of  Tobacco,  103  Fed.  791;  581  Diamonds  v.  U.  S.,  119  Fed.  556,  561;  U.  S. 
V.  Cole,  134  Fed.  697;  U.  S.  v.  Gallant,  177  Fed.  281;  U.  S.  v.  Thompson,  189 
Fed.  838.  In  the  following  cases  with  particular  reference  to  bonds  to  pro- 
tect the  government  against  violations:  U.  S.  v.  Nat.  Surety  Co.,  122  Fed. 
904,  909;  U.  S.  v.  Zemel,  137  Fed.  989;  U.  S.  v.  U.  S.  Fidelity  &  G.  Co.,  144 
Fed.  866.  In  the  following  cases  as  authority  for  the  liberal  construction 
of  miscellaneous  laws ;  Roberts  v.  Pacific  Nav.  Co.,  104  Fed.  577 ;  U.  S.  v.  St. 
Louis  S.  W.  Ry.,  189  Fed.  954,  962;  U.  S.  v.  Ramsey,  197  Fed.  144,  147;  U.  S. 
v.  Brown,  224  Fed.  135;  Johnson  v.  Southern  Pacific  Co.,  196  U.  S.  1.  See 
also  Sesnon  Co.  v.  U.  S.,  182  Fed.  573,  writ  of  certiorari  denied  220  U.  S. 
609.  Before  the  Stowell  decision  there  were  cases  adopting  a  strict  construc- 
tion even  of  statutes  to  pi-event  frauds  on  the  revenue.  See  U.  S.  v.  84  Boxes 
of  Sugar,  7  Pet.  453  (expressly  disapproved  in  the  Stowell  case)  ;  Sixty  Pipes 
Brandy,  10  Wheat.  424;  U.  S.  v.  A  Lot  of  Silk  Umbrellas,  12  Fed.  412  (citing 
U.  S.  V.  84  Boxes  Sugar)  ;  U.  S.  v.  Ten  Cases  Shawls,  28  Fed.  Cas.  No. 
16,448.  One  case  adopting  a  strict  construction  of  the  statute  to  prevent 
frauds  on  the  revenue  since  the  Stowell  case  is  U.  S.  v.  1,150J  Pounds  Cel- 
luloid, 82  Fed.  634  (citing  U.  S.  v.  84  Boxes  of  Sugar,  supra,  and  not  citing 
the  Stowell  case). 

"-1  U.  S.  v.  Graft  Distilling  Co.,  208  U.  S.  198. 

"5  See  Gould  v.  Gould,  245  U.  S.  151. 

"•*  This  distinction  will  not  reconcile  all  the  cases.  For  instance,  the  early 
cases  of  Smythe  v.  Fiske  (See  Note  72)  and  Rankin  v.  Hoyt,  (See  Note  72), 
the  latter  cases  of  Hunter  v.  Corning  &  Co.,  86  Fed.  913;  Lowe  v.  Farb- 
werke-Hoechst  Co.,  240  Fed.  671;  De  Ganay  v.  Lederer,  239  Fed.  568  (af- 
firmed 250  U.  S.  376),  clearly  contemplate  the  application  of  the  liberal  con- 


CONSTRUCTION  OF  TAXING  STATUTES  1273 

Exemption  from  Taxation.  This  paragraph  deals  only  with 
the  construction  of  the  language  of  a  tax  law  which  exempts. 
The  rules  of  construction  applicable  to  language  which  lays  the 
tax  have  already  been  discussed,"*'  The  distinction  between  the 
rules  of  construction  applicable  to  language  laying  the  tax  and 
language  exempting  from  tax  is  important,  for,  as  has  been 
observed,  in  respect  to  the  former,  doubts  will  be  resolved  most 
strongly  against  the  government  and  in  favor  of  the  citizen, 
while  in  respect  to  the  latter,  as  will  appear,  a  most  strict  con- 
struction in  favor  of  the  government  is  called  for."^  The  taxing 
power  is  of  vital  importance  and  is  essential  to  the  existence  of 
government;  the  whole  community  is  interested  in  maintaining 
it  undiminished,'^''  Exemptions  from  taxation  are  regarded  as 
in  derogation  of  sovereignty  '^"  and  it  is  abundantly  established 
that  the  taxing  power  should  never  be  presumed  to  be  relin- 
quished unless  the  intention  to  do  so  be  declared  in  clear  and 
unambiguous  terms,'^^  which  will  admit  of  no  other  construc- 
tion ^-  and  which  are  too  plain  to  be  mistaken,^''  The  existence 
of  a  well  founded  or  rational  doubt  is  equivalent  to  a  denial  of 
a  claim  to  exemption.''^  No  claim  can  be  sustained  unless  within 
the  express  letter  or  the  necessary  scope  of  the  exempting 
clause,*^-^  construed  stictissimi  juris ;^^  an  exemption  will  not  be 
inserted  in  a  statute  by  construction."^'''  But  this  salutary  rule 
requiring  a  strict  construction  of  exemptions  must  not  be  mis- 
understood. It  is  not  a  substitute  for  all  other  rules  and  does 
not  mean  that  whenever  a  controversy  is  or  can  be  raised  as  to 
the  meaning  of  a  taxing  statute,  such  ambiguity  occurs  as  im- 

struction  with  respect  to  subjects  and  objects  of  taxation.  On  the  other 
hand,  the  case  of  U.  S.  v.  Distilled  Sprits  (See  Note  69),  contemplates  the 
application  of  the  rule  of  liberal  construction  as  announced  in  the  Stowell 
case  in  a  modified  form;  that  is,  neither  liberally  nor  strictly  but  "with  rea- 
sonable fairness  to  the  citizen." 

77  See  paragraph  headed  "Strict  or  Liberal  Construction." 

78  Herold  v.  Parkview  Building  &  Loan  Ass'n,  210  Fed.  577. 

''S  Providence  Bank  v.  Billings,  4  Pet.  514;  Christ  Church  v.  Philadelphia 
County,  24  How.  300. 

^0  Yazoo  &  Miss.  Valley  R.  Co.  v.  Thomas,  132  U.  S.  174. 

81  Tennessee  v.  Whitworth,  117  U.  S.  139;  Keokuk  &  W.  R.  Co.  v.  Mis- 
souri, 152  U.  S.  301. 

82  Southwestern  R.  R.  Co.  v.  Wright,  116  U.  S.  231. 

83  Chicago,  etc.,  R.  R.  Co.  v.  Missouri,  120  U.  S.  569. 

84  Phoenix  Fire  Ins.  Co.  v.  Tennessee,  161  U.  S.  174;  Wright  v.  Georgia 
R.,  etc.,  Co.,  216  U.  S.  420. 

85  Ford  V.  Delta  &  Pine  Land  Co.,  164  U.  S.  662. 
86Vicksburg  S.  &  P.  R.  Co.  v.  Dennis,  116  U.  S.  665. 

87  Providence  Bank  v.  Billings,  4  Pet.  514;  U.  S.  v.  Coulby,  251  Fed.  982. 


1274  FEDERAL   INCOME  TAX 

mediately  and  inevitably  to  determine  its  interpretation.  The 
proper  office  of  the  rule  is  to  help  solve  ambiguities,  not  to  com- 
pel an  immediate  surrender  to  them — to  be  an  element  in  de- 
cision, and  effective,  perhaps,  when  all  other  tests  of  meaning 
have  been  employed  which  experience  has  afforded  and  which 
it  is  the  duty  of  courts  to  consider.'^'^  And  so  courts,  in  con- 
struing the  exempting  clauses  of  taxing  statutes,  are  not  required 
to  hunt  for  an  escape  from  an  exemption,  but  will,  where  the 
intent  to  exempt  clearly  appears,  give  effect  to  such  intent  with- 
out evasion.s^ 

Rule  of  Construction  Followed  by  the  Treasury  Department. 
As  a  general  rule  the  construction  by  the  treasury  department 
is  such  as  is  most  favorable  to  the  enforcement  of  the  revenue 
laws  and  no  liberal  interpretation  in  favor  of  the  individual  is 
indulged  in.'-'o  In  announcing  this  rule  the  attorney-general 
cited  the  cases  of  Taylor  v.  U.  S. ;  '-^^  Cliquot's  Champagne,'*-  U.  S. 
V.  Hodson,'*^  and  Smythe  v.  Fiske,'-^^  and  which,  as  has  been  stated, 
construed  both  statutes  to  prevent  frauds  on  the  revenue  and 
the  provisions  of  taxing  statutes,  laying  the  tax.  The  attorney- 
general  does  not  appear  to  have  taken  account  of  the  distinction 
which  has  been  pointed  out  between  these  two  kinds  of  pro- 
visions, so  far  as  their  construction  is  concerned.  As  a  matter  of 
practice  the  treasury  department  cannot,  of  course,  assume  the 
balanced  judicial  attitude  of  the  courts  in  interpretation  of  doubt- 
ful points,  as  its  function  is  to  administer  the  law  and  its  duty, 
primarily,  to  collect  revenue.  However,  in  some  cases  the  depart- 
ment has  gone  to  great  length  in  making  a  liberal  interpretation 
favorable  to  the  taxpayer.""' 

ss  Citizens  Bank  v.  Parker,  192  U.  S.  73. 

«»  Buchanan  v.  Knoxville  &  O.  R.  Co.,  71  Fed.  324. 

90  18  Op.  Atty.  Gen.  246. 

91  3  How.  197,  210. 

92  3  Wall.  114. 

93  10  Wall.  395. 

94  23  Wall.  374. 

9t  Compare,  for  instance,  the  Excess-Profits  Tax  Law  of  1917  (Ax;t  of 
October  3,  1917),  with  the  Regulations  No.  41,  especially  §210  of  that  law 
with  Reg.  41,  Art.  52. 


APPENDIX 

REVENUE  ACT  OF  1918^ 

AN  ACT  TO  PROVIDE  REVENUE.  AND  FOR  OTHER  PURPOSES 

(Act  of  Feb.  24,  1919,  Public  No.  254) 

TITLE   1— GENERAL  DEFINITIONS 

Section  1.  That  when  used  in  this  Act— 

The  term   •'person"   includes   partnerships   and   corporations,   as   well    as 

'"Thl'^trrm  "corporation"  includes  associations,  joint-stock  companies,  and 

insurance  companies;  ^         u- 

The  term  "domestic"  when  applied  to  a  corporation  or  partnership  means 

created  or  organized  in  the  United  States; 

The  term  "foreign"  when  applied  to  a  corporation  or  partnership  means 
created  or  organized  outside  the  United  States; 

The  term  "United  States"  when  used  in  a  geographical  sense  includes  only 
the  states,  the  territories  of  Alaska  and  Hawaii,  and  the  District  of  Colum- 
bia; J.   ^U       i 

The  term  "secretary"  means  the  secretary  of  the  treasury; 

The  term  "commissioner"  means  the  commissioner  of  internal  revenue; 

The  term   "collector"  means  collector  of  internal   revenue; 

The  term  "Revenue  Act  of  1916"  means  the  Act  entitled  "An  Act  to  in- 
crease the  revenue,  and  for  other  purposes,"  approved  September  8,   191b; 

The  term  "Revenue  Act  of  1917"  means  the  Act  entitled  "An  Act  to  pro- 
vide revenue  to  defray  war  expenses,  and  for  other  purposes,"  approved 

October  3,  1917;  ^  ^         u-     .  *     ^ 

The  term  "taxpayer"  includes  any  person,  trust  or  estate  subject  to  a 

tax  imposed  by  this  Act;  ,        •.,    ^u^ 

The  term  "government  contract"  means  (a)  a  contract  made  with  the 
United  States,  or  with  any  department,  bureau,  officer,  commission,  board,  or 
agency  under  the  United  States  and  acting  in  its  behalf,  or  with  any  agency 
controlled  by  any  of  the  above  if  the  contract  is  for  the  benefit  of  the  United 
States  or  (b)  a  subcontract  made  with  a  contractor  performing  such  a  con- 
tract jf  the  products  or  services  to  be  furnished  under  the  subcontract  are 
for  the  benefit  of  the  United  States.  The  term  "government  contract  or 
contracts  made  between  April  6,  1917,  and  November  11,  1918,  both  dates 
inclusive"  when  applied  to  a  contract  of  the  kind  referred  to  in  clause  (a)  of 
this  paragraph,  includes  all  such  contracts  which,  although  entered  into 
during  such  period,  were  originally  not  enforceable,  but  which  have  been 
or  may  become  enforceable  by  reason  of  subsequent  validation  in  pursuance 

of  law;  ^  „   •     ,    J       xu 

The  term  "military  or  naval  forces  of  the  United   States     includes  the 
Marine  Corps,  the  Coast  Guard,  the  Army  Nurse  Corps,  Female,  and  the 


1  Onl.v  IlK.s..  i.arls  of  the  Act  which  appl.v  t..  the  taxes  treate.l  In  this  hook  arc   re- 
printed   liere. 

1275 


1276  APPENDIX 

Navy  Nurse  Corps,  Female,  but  this  shall  not  be  deemed  to  exclude  other 
units  otherwise  included  within  such  term; 

The  term  "present  war"  means  the  war  in  which  the  United  States  is  now 
engaged  against  the  German  government. 

For  the  purposes  of  this  Act  the  date  of  the  termination  of  the  present  war 
shall  be  fixed  by  proclamation  of  the  President. 

TITLE  II— INCOME  TAX 
Part  I — General  Provisions 

DEFINITIONS 

Sec.  200.    That  when  used  in  this  title — 

The  term  "taxable  year"  means  the  calendar  year,  or  the  fiscal  year  end- 
ing during  such  calendar  year,  upon  the  basis  of  which  the  net  income  is 
computed  under  §  212  or  §  232.  The  term  "fiscal  year"  means  an  accounting 
period  of  twelve  months  ending  on  the  last  day  of  any  month  other  than 
December.  The  first  taxable  year,  to  be  called  the  taxable  year  1918,  shall 
be  the  calendar  year  1918  or  any  fiscal  year  ending  during  the  calendar  year 
1918; 

The  term  "fiduciary"  means  a  guardian,  trustee,  executor,  administrator, 
receiver,  conservator,  or  any  person  acting  in  any  fiduciary  capacity  for  any 
person,  trust  or  estate; 

The  term  "withholding  agent"  means  any  person  required  to  deduct  and 
withhold  any  tax  under  the  provisions  of  §  221  or  §  237; 

The  term  "personal  service  corporation"  means  a  corporation  whose  in- 
come is  to  be  ascribed  primarily  to  the  activities  of  the  principal  owners 
or  stockholders  who  are  themselves  regularly  engaged  in  the  active  conduct 
of  the  affairs  of  the  corporation  and  in  which  capital  (whether  invested  or 
borrowed)  is  not  a  material  income-producing  factor;  but  does  not  include 
any  foreign  corporation,  nor  any  corporation  50  per  centum  or  more  of 
whose  gross  income  consists  either  (1)  of  gains,  profits  or  income  derived 
from  trading  as  a  principal,  or  (2)  of  gains,  profits,  commissions,  or  other 
income,  derived  from  a  government  contract  or  contracts  made  between 
April  6,  1917,  and  November  11,  1918,  both  dates  inclusive; 

The  term  "paid,"  for  the  purposes  of  the  deductions  and  credits  under  this 
title,  means  "paid  or  accrued"  or  "paid  or  incurred,"  and  the  terms  "paid 
or  incurred"  and  "paid  or  accrued"  shall  be  construed  according  to  the 
method  of  accounting  upon  the  basis  of  which  the  net  income  is  computed 
under  §  212. 

DIVIDENDS 

Sec.  201.  (a)  That  the  term  "dividend"  when  used  in  this  title  (except  in 
paragraph  (10)  of  subdivision  (a)  of  §  234)  means  (1)  any  distribution 
made  by  a  corporation,  other  than  a  personal  service  corporation,  to  its 
shareholders  or  members,  whether  in  cash  or  in  other  property  or  in  stock 
of  the  corporation,  out  of  its  earnings  or  profits  accumulated  since  February 
28,  1913,  or  (2)  any  such  distribution  made  by  a  personal  service  corporation 
out  of  its  earnings  or  profits  accumulated  since  February  28,  1913,  and 
prior  to  January  1,  1918. 

(b)  Any  distribution  shall  be  deemed  to  have  been  made  from  earnings  or 
profits  unless  all  earnings  and  profits  have  first  been  distributed.  Any  dis- 
tribution made  in  the  year  1918  or  any  year  thereafter  shall  be  deemed  to 
have  been  made  from  earnings  or  profits  accumulated  since  February  28, 


REVENUE  ACT  OF   1918  1277 

1913,  or,  in  the  case  of  a  personal  service  corporation,  from  the  most 
recently  accumulated  earnings  or  profits;  but  any  earnings  or  profits  accu- 
mulated prior  to  March  1,  1913,  may  be  distributed  in  stock  dividends  or 
otherwise,  exempt  from  the  tax,  after  the  earnings  and  profits  accumulated 
since  February  28,   1913,  have  been  distributed. 

(c)  A  dividend  paid  in  stock  of  the  corporation  shall  be  considered  income 
to  the  amount  of  the  earnings  or  profits  distributed.  Amounts  distributed 
in  the  liquidation  of  a  corporation  shall  be  treated  as  payments  in  exchange 
for  stock  or  shares,  and  any  gain  or  profit  realized  thereby  shall  be  taxed 
to  the  distributee  as  other  gains  or  profits. 

(d)  If  any  stock  dividend  (1)  is  received  by  a  taxpayer  between  Jan- 
uary 1  and  November  1,  1918,  both  dates  inclusive,  or  (2)  is  during  such 
period  bona  fide  authorized  or  declared,  and  entered  on  the  books  of  the 
corporation,  and  is  received  by  a  taxpayer  after  November  1,  1918,  and  be- 
fore the  expiration  of  thirty  days  after  passage  of  this  Act,  then  such 
dividend  shall,  in  the  manner  provided  in  §  206,  be  taxed  to  the  recipient 
at  the  rates  prescribed  by  law  for  the  years  in  which  the  corporation  ac- 
cumulated the  earnings  or  profits  from  which  such  dividend  was  paid,  but 
the  dividend  shall  be  deemed  to  have  been  paid  from  the  most  recently 
accumulated  earnings  or  profits. 

(e)  Any  distribution  made  during  the  first  sixty  days  of  any  taxable  year 
shall  be  deemed  to  have  been  made  from  earnings  or  profits  accumulated 
during  preceding  taxable  years;  but  any  distribution  made  during  the  re- 
mainder of  the  taxable  year  shall  be  deemed  to  have  been  made  from 
earnings  or  profits  accumulated  between  the  close  of  the  preceding  taxable 
year  and  the  date  of  distribution,  to  the  extent  of  such  earnings  or  profits, 
and  if  the  books  of  the  corporation  do  not  show  the  amount  of  such  earnings 
or  profits,  the  earnings  or  profits  for  the  accounting  period  within  which  the 
distribution  was  made  shall  be  deemed  to  have  been  accumulated  ratably 
during  such  period. 

BASIS  FOR  DETERMINING  GAIN  OR  LOSS 

Sec.  202.  (a)  That  for  the  pui'pose  of  ascertaining  the  gain  derived  or  loss 
sustained  from  the  sale  or  other  disposition  of  property,  real,  personal,  or 
mixed,  the  basis  shall  be — 

(1)  In  the  case  of  property  acquired  before  i\Iarch  1,  1913,  the  fair  market 
price  or  value  of  such  property  as  of  that  date;  and 

(2)  In  the  case  of  property  acquired  on  or  after  that  date,  the  cost  there- 
of; or  the  inventory  value  if  the  inventory  is  made  in  accordance  with  §  203. 

(b)  When  pi'operty  is  exchanged  for  other  property,  the  property  received 
in  exchange  shall  for  the  purpose  of  determining  gain  or  loss  be  treated  as 
the  equivalent  of  cash  to  the  amount  of  its  fair  market  value,  if  any;  but 
when  in  connection  with  the  reorganization,  merger,  or  consolidation  of  a 
corporation  a  person  receives  in  place  of  stock  or  securities  owned  by  him 
new  stock  or  securities  of  no  greater  aggregate  par  or  face  value,  no  gain 
or  loss  shall  be  deemed  to  occur  from  the  exchange,  and  the  new  stock  or 
securities  received  shall  be  treated  as  taking  the  place  of  the  stock,  secu- 
rities, or  property  exchanged. 

When  in  the  case  of  any  such  reorganization,  merger  or  consolidation  the 
aggregate  par  or  face  value  of  the  new  stock  or  securities  received  is  in 
excess  of  the  aggregate  par  or  face  value  of  the  stock  or  securities  ex- 
changed, a  like  amount  in  par  or  face  value  of  the  new  stock  or  securities 
received   shall  be   treated   as   taking   the   place   of   the   stock   or   securities 


1278  APPENDIX 

exchanged,  and  the  amount  of  the  excess  in  par  or  face  value  shall  be 
treated  as  a  gain  to  the  extent  that  the  fair  market  value  of  the  new  stock 
or  securities  is  greater  than  the  cost  (or  if  acquired  prior  to  March  1,  1913, 
the  fair  market  value  as  of  that  date)  of  the  stock  or  securities  exchanged. 

INVENTORIES 

Sec.  203.  That  whenever  in  the  opinion  of  the  commissioner  the  use  of  in- 
ventories is  necessary  in  order  clearly  to  determine  the  income  of  any  tax- 
payer, inventories  shall  be  taxen  by  such  taxpayer  upon  such  basis  as  the 
commissioner,  with  the  approval  of  the  secretary,  may  prescribe  as  con- 
forming as  nearly  as  may  be  to  the  best  accounting  practice  in  the  trade 
or  business  and  as  most  clearly  reflecting  the  income. 

NET   LOSSES 

Sec,  204.  (a)  That  as  used  in  this  section  the  term  ''net  loss"  refers  only 
to  net  losses  resulting  from  either  (1)  the  operation  of  any  business  regular- 
ly carried  on  by  the  taxpayer,  or  (2)  the  bona  fide  sale  by  the  taxpayer  of 
plant,  buildings,  machinery,  equipment  or  other  facilities,  constructed,  in- 
stalled or  acquired  by  the  taxpayer  on  or  after  April  6,  1917,  for  the  pro- 
duction of  articles  contributing  to  the  prosecution  of  the  present  war;  and 
when  so  resulting  means  the  excess  of  the  deductions  allowed  by  law  (ex- 
cluding in  the  case  of  corporations  amounts  allowed  as  a  deduction  under 
^  (6)  of  subdivision  (a)  of  §  234)  over  the  sum  of  the  gross  income  plus 
any  interest  received  free  from  taxation  both  under  this  title  and  under 
Title  III. 

(b)  If  for  any  taxable  year  beginning  after  October  31,  1918,  and  ending 
prior  to  January  1,  1920,  it  appears  upon  the  production  of  evidence  satisfac- 
tory to  the  commissioner  that  any  taxpayer  has  sustained  a  net  loss,  the 
amount  of  such  net  loss  shall  under  regulations  prescribed  by  the  commis- 
sioner with  the  approval  of  the  secretary  be  deducted  from  the  net  income 
of  the  taxpayer  for  the  preceding  taxable  year;  and  the  taxes  imposed  by 
this  title  and  by  Title  III  for  such  preceding  taxable  year  shall  be  rede- 
termined accordingly.  Any  amount  found  to  be  due  to  the  taxpayer  upon 
the  basis  of  such  redetermination  shall  be  credited  or  refunded  to  the  tax- 
payer in  accordance  with  the  provisions  of  §  252.  If  such  net  loss  is  in 
excess  of  the  net  income  for  such  preceding  taxable  year,  the  amount  of 
such  excess  shall  under  regulations  prescribed  by  the  commissioner  with 
the  approval  of  the  secretary  be  allowed  as  a  deduction  in  computing  the 
net  income  for  the  succeeding  taxable  year. 

(c)  The  benefit  of  this  section  shall  be  allowed  to  the  members  of  a 
partnership  and  the  beneficiaries  of  an  estate  or  trust  under  regulations 
prescribed  by  the  commissioner  with  the  approval  of  the  secretary. 

FISCAL   YEAR   WITH    DIFFERENT    RATES 

Sec.  205.  (a)  That  if  a  taxpayer  makes  return  for  a  fiscal  year  beginning 
in  1917  and  ending  in  1918,  his  tax  under  this  title  for  the  first  taxable  year 
shall  be  the  sum  of:  (1)  the  same  proportion  of  a  tax  for  the  entire  period 
computed  under  Title  I  of  the  Revenue  Act  of  1916  as  amended  by  the 
Revenue  Act  of  1917  and  under  Title  I  of  the  Revenue  Act  of  1917,  which 
the  portion  of  such  period  falling  within  the  calendar  year  1917  is  of  the 
entire  period,  and  (2)  the  same  proportion  of  a  tax  for  the  entire  period 
computed  under  this  title  at  the  rates  for  the  calendar  year  1918  which 
the  portion  of  such  period  falling  within  the  calendar  year  1918  is  of  the 


REVENUE  ACT  OF   1918  1279 

entire  period:  Provided,  That  in  the  case  of  a  personal  service  corporation 
the  amount  to  be  paid  shall  be  only  that  specified  in  clause   (1). 

Any  amount  heretofore  or  hereafter  paid  on  account  of  the  tax  imposed 
for  such  fiscal  year  by  Title  I  of  the  Revenue  Act  of  191(5  as  amended  by 
the  Revenue  Act  of  1917,  and  by  Title  I  of  the  Revenue  Act  of  1917,  shall 
be  credited  towards  the  payment  of  the  tax  imposed  for  such  fiscal  year  by 
this  act,  and  if  the  amount  so  paid  exceeds  the  amount  of  such  tax  imposed 
by  this  act,  or,  in  the  case  of  a  pei'sonal  service  corporation,  the  amount 
specified  in  clause  (1),  the  excess  shall  be  credited  or  refunded  in  accordance 
with  the  provisions  of  §  252. 

(b)  If  a  taxpayer  makes  a  return  for  a  fiscal  year  beginning  in  1918 
and  ending  in  1919,  the  tax  under  this  title  for  such  fiscal  year  shall  be 
the  sum  of:  (1)  the  same  proportion  of  a  tax  for  the  entire  period  com- 
puted under  this  title  at  the  rates  specified  for  the  calendar  year  1918 
which  the  portion  of  such  period  falling  within  the  calendar  year  1918  is 
of  the  entire  period,  and  (2)  the  same  proportion  of  a  tax  for  the  entire 
period  computed  under  this  title  at  the  rates  specified  for  the  calendar 
year  1919  which  portion  of  such  period  falling  within  the  calendar  year 
1919  is  of  the  entire  period. 

(c)  If  a  fiscal  year  of  a  partnership  begins  in  1917  and  ends  in  1918  or 
begins  in  1918  and  ends  in  1919,  then  notwithstanding  the  provisions  of 
subdivision  (b)  of  §  218,  (1)  the  rates  for  the  calendar  year  during  which 
such  fiscal  year  begins  shall  apply  to  an  amount  of  each  partner's  share 
of  such  partnership  net  income  (determined  under  the  law  applicable  to  such 
year)  equal  to  the  proportion  which  the  part  of  such  fiscal  year  falling 
within  such  calendar  year  bears  to  the  full  fiscal  year,  and  (2)  the  rates 
for  the  calendar  year  during  which  such  fiscal  year  ends  shall  apply  to  an 
amount  of  each  partner's  share  of  such  partnership  net  income  (deter- 
mined under  the  law  applicable  to  such  calendar  year)  equal  to  the  propor- 
tion which  the  part  of  such  fiscal  year  falling  within  such  calendar  year 
bears  to  the  full  fiscal  year:  Provided,  That  in  the  case  of  a  personal  serv- 
ice corporation  with  respect  to  a  fiscal  year  beginning  in  1917  and  ending 
in  1918.  the  amount  specified  in  clause  (1)  shall  not  be  subject  to  normal  tax. 

PARTS  OF  INCOME  SUBJECT  TO  RATES  FOR  DIFFERENT  YEARS 

Sec.  206.  That  whenever  parts  of  a  taxpayer's  income  are  subject  to 
rates  for  different  calendar  years,  the  part  subject  to  the  rates  for  the  most 
recent  calendar  year  shall  be  placed  in  the  lower  brackets  of  the  rate 
schedule  provided  in  this  title,  the  part  subject  to  the  rates  for  the  next 
preceding  calendar  year  shall  be  placed  in  the  next  higher  brackets  of  the 
rate  schedule  applicable  to  that  year,  and  so  on  until  the  entire  net  income 
has  been  accounted  for.  In  determining  the  income,  any  deductions,  exemp- 
tions or  credits  of  a  kind  not  plainly  and  properly  chargeable  against  the 
income  taxable  at  rates  for  a  preceding  year  shall  first  be  applied  against 
the  income  subject  to  rates  for  the  most  recent  calendar  year;  but  any 
balance  thereof  shall  be  applied  against  the  income  subject  to  the  rates  of 
the  next  preceding  year  or  years  until  fully  allowed. 

Part  II — Individuals 

NORMAL  TAX 

Sec.  210.  That,  in  lieu  of  the  taxes  imposed  by  subdivision  (a)  of  §  1  of 
the  Revenue  Act  of  1916  and  by  §  1  of  the  Revenue  Act  of  1917,  there  shall 


1280  APPENDIX 

be  levied,  collected,  and  paid   for  each  taxable   year  upon  the  net 'income 
of  every  individual  a  normal  tax  at  the  following  rates : 

(a)  For  the  calendar  year  1918,  12  per  centum  of  the  amount  of  the  net 
income  in  excess  of  the  credits  provided  in  §  216:  Provided,  That  in  the 
case  of  a  citizen  or  resident  of  the  United  States  the  rate  upon  the  first 
$4,000  of  such  excess  amount  shall  be  6  per  centum; 

(b)  For  each  calendar  year  thereafter,  8  per  centum  of  the  amount  of 
the  net  income  in  excess  of  the  credits  provided  in  §  216:  Provided,  That  in 
the  case  of  a  citizen  or  resident  of  the  United  States  the  rate  upon  the 
first  $4,000  of  such  excess  amount  shall  be  4  per  centum. 

SURTAX 

Sec.  211.  (a)  That,  in  lieu  of  the  taxes  imposed  by  subdivision  (b)  of 
§  1  of  the  Revenue  Act  of  1916  and  by  §  2  of  the  Revenue  Act  of  1917,  but 
in  addition  to  the  normal  tax  imposed  by  §  210  of  this  Act,  there  shall  be 
levied,  collected,  and  paid  for  each  taxable  year  upon  the  net  income  of 
every  individual,  a  surtax  equal  to  the  sum  of  the  following: 

1  per  centum  of  the  amount  by  which  the  net  income  exceeds  $5,000  and 
does  not  exceed  $6,000; 

2  per  centum  of  the  amount  by  which  the  net  income  exceeds  $6,000  and 
does  not  exceed  $8,000; 

3  per  centum  of  the  amount  by  which  the  net  income  exceeds  $8,000  and 
does  not  exceed  $10,000; 

4  per  centum  of  the  amount  by  which  the  net  income  exceeds  $10,000  and 
does  not  exceed  $12,000; 

5  per  centum  of  the  amount  by  which  the  net  incom.e  exceeds  $12,000  and 
does  not  exceed  $14,000; 

6  per  centum  of  the  amount  by  which  the  net  income  exceeds  $14,000  and 
does  not  exceed  $16,000; 

7  per  centum  of  the  amount  by  which  the  net  income  exceeds  $16,000  and 
does  not  exceed  $18,000; 

8  per  centum  of  the  amount  by  which  the  net  income  exceeds  $18,000  and 
does  not  exceed  $20,000; 

9  per  centum  of  the  amount  by  which  the  net  income  exceeds  $20,000  and 
does  not  exceed  $22,000; 

10  per  centum  of  the  amount  by  which  the  net  income  exceeds  $22,000  and 
does  not  exceed  $24,000; 

11  per  centum  of  the  amount  by  which  the  net  income  exceeds  $24,000  and 
does  not  exceed  $26,000; 

12  per  centum  of  the  amount  by  which  the  net  income  exceeds  $26,000  and 
does  not  exceed  $28,000; 

13  per  centum  of  the  amount  by  which  the  net  income  exceeds  $28,000  and 
does  not  exceed  $30,000; 

14  per  centum  of  the  amount  by  which  the  net  income  exceeds  $30,000  and 
does  not  exceed  $32,000; 

15  per  centum  of  the  amount  by  which  the  net  income  exceeds  $32,000  and 
does  not  exceed  $34,000; 

16  per  centum  of  the  amount  by  which  the  net  income  exceeds  $34,000  and 
does  not  exceed  $36,000; 

17  per  centum  of  the  amount  by  which  the  net  income  exceeds  $36,000  and 
does  not  exceed  $38,000; 

18  per  centum  of  the  amount  by  which  the  net  income  exceeds  $38,000  and 
does  not  exceed  $40,000; 


REVENUE   ACT  OF    1918  1281 

19  per  centum  of  the  amount  by  wliich  tlie  net  income  exceeds  $40,000  and 
does  not  exceed  $42,000; 

20  per  centum  of  the  amount  by  which  the  net  income  exceeas  $42,000  and 
does  not  exceed  $44,000; 

21  per  centum  of  the  amount  by  which  the  net  income  exceeas  $44,000  and 
does  not  exceed  $46,000; 

22  per  centum  of  the  amount  by  which  tl>e  net  income  exceeds  $46,000  and 
does  not  exceed  $48,000; 

23  per  centum  of  the  amount  by  which  the  net  income  exceeds  $48,000  and 
does  not  exceed  $50,000; 

24  per  centum  of  the  amount  by  whicli  the  net  income  exceeds  $50,000  and 
does  not  exceed  $52,000; 

25  per  centum  of  the  amount  by  which  the  net  income  exceeds  $52,000  and 
does  not  exceed  $54,000; 

26  per  centum  of  the  amount  by  which  the  net  income  exceeds  $54,000  and 
does  not  exceed  $56,000; 

27  per  centum  of  the  amount  by  which  the  net  income  exceeds  $56,000  and 
does  not  exceed  $58,000; 

28  per  centum  of  the  amount  by  which  the  net  income  exceeds  $58,000  and 
does  not  exceed  $60,000; 

29  per  centum  of  the  amount  by  which  the  net  income  exceeds  $60,000  and 
does  not  exceed  $62,000; 

30  per  centum  of  the  amount  by  which  the  net  income  exceeds  $62,000  and 
does  not  exceed  $64,000; 

31  per  centum  of  the  amount  by  which  the  net  income  exceeds  $64,000  and 
does  not  exceed  $66,000; 

32  per  centum  of  the  amount  by  which  the  net  income  exceeds  $66,000  and 
does  not  exceed  $68,000; 

33  per  centum  of  the  amount  by  which  the  net  income  exceeds  $68,000  and 
does  not  exceed  $70,000; 

34  per  centum  of  the  amount  by  which  the  net  income  exceeds  $70,000  and 
does  not  exceed  $72,000; 

35  per  centum  of  the  amount  by  which  the  net  income  exceeds  $72,000  and 
does  not  exceed  $74,000; 

36  per  centum  of  the  amount  by  which  the  net  income  exceeds  $74,000  and 
does  not  exceed  $76,000; 

37  per  centum  of  the  amount  by  which  the  net  income  exceeds  $76,000  and 
does  not  exceed  $78,000; 

38  per  centum  of  the  amount  by  which  the  net  income  exceeds  $78,000  and 
does  not  exceed  $80,000; 

39  per  centum  of  the  amount  by  which  tlie  net  income  exceeds  $80,000  and 
does  not  exceed  $82,000; 

40  per  centum  of  tlie  amount  by  which  the  net  income  exceeds  $82,000  and 
does  not  exceed  $84,000; 

41  per  centum  of  the  amount  by  which  the  net  income  exceeds  $84,000  and 
does  not  exceed  $80,000; 

42  per  centum  of  the  amount  by  which  the  net  income  exceeds  $86,000  and 
does  not  exceed  $88,000 ; 

43  per  centum  of  the  amount  by  which  the  net  income  exceeds  $88,000  and 
does  not  exceed  $90,000; 

44  per  centum  of  the  amount  by  which  the  net  income  exceeds  $90,000  and 
does  not  exceed  $92,000; 


1282  APPENDIX 

45  per,  centum  of  the  amount  by  which  the  net  income  exceeds  $92,000  and 
does  not  exceed  $94,000; 

46  per  centum  of  the  amount  by  which  the  net  income  exceeds  $94,000  and 
does  not  exceed  $96,000; 

47  per  centum  of  the  amount  by  which  the  net  income  exceeds  $96,000  and 
does  not  exceed  $98,000; 

48  per  centum  of  the  amount  by  which  the  net  income  exceeds  $98,000  and 
does  not  exceed  $100,000; 

52  per  centum  of  the  amount  by  which  the  net  income  exceeds  $100,000 
and  does  not  exceed  $150,000; 

56  per  centum  of  the  amount  by  which  the  net  income  exceeds  $150,000 
and  does  not  exceed  $200,000; 

60  per  centum  of  the  amount  by  which  the  net  income  exceeds  $200,000 
and  does  not  exceed  $300,000; 

63  per  centum  of  the  amount  by  which  the  net  income  exceeds  $300,000 
and  does  not  exceed  $500,000; 

64  per  centum  of  the  amount  by  which  the  net  income  exceeds  $500,000 
and  does  not  exceed  $1,000,000; 

65  per  centum  of  the  amount  by  which  the  net  income  exceeds  $1,000,000. 

(b)In  the  case  of  a  bona  fide  sale  of  mines,  oil  or  gas  wells,  (or  any  in- 
terest therein),  where  the  principal  value  of  the  property  has  been  demon- 
strated by  prospecting  or  exploration  and  discovery  work  done  by  the  tax- 
payer, the  portion  of  the  tax  imposed  by  this  section  attributable  to  such 
sale  shall  not  exceed  20  per  centum  of  the  selling  price  of  such  property  or 
interest, 

NET   INCOME   DEFINED 

Sec.  212.  (a)  That  in  the  case  of  an  individual  the  term  "net  income" 
means  the  gross  income  as  defined  in  §  213,  less  the  deductions  allowed  by 
§214. 

(b)  The  net  income  shall  be  computed  upon  the  basis  of  the  taxpayer's 
annual  accounting  period  (fiscal  year  or  calendar  year,  as  the  case  may  be) 
in  accordance  with  the  method  of  accounting  regularly  employed  in  keeping 
the  books  of  such  taxpayer;  but  if  no  such  method  of  accounting  has  been  so 
employed,  or  if  the  method  employed  does  not  clearly  reflect  the  income,  the 
computation  shall  be  made  upon  such  basis  and  in  such  manner  as  in  the 
opinion  of  the  commissioner  does  clearly  reflect  the  income.  If  the  tax- 
payer's annual  accounting  period  is  other  than  a  fiscal  year  as  defined  in 
§  200  or  if  the  taxpayer  has  no  annual  accounting  period  or  does  not  keep 
books,  the  net  income  shall  be  computed  on  the  basis  of  the  calendar  year. 

If  a  taxpayer  changes  his  accounting  period  from  fiscal  year  to  calendar 
year,  from  calendar  year  to  fiscal  year,  or  from  one  fiscal  year  to  another, 
the  net  income  shall,  with  the  approval  of  the  commissioner,  be  computed 
on  the  basis  of  such  new  accounting  period,  subject  to  the  provisions  of 
§  226. 

GROSS    INCOME    DEFINED 

Sec.  213.  That  for  the  purposes  of  this  title  (except  as  otherwise  provided 
in  §  233)  the  term  "gross  income" — 

(a)  Includes  gains,  profits,  and  income  derived  from  salaries,  wages,  or 
compensation  for  personal  service  (including  in  the  case  of  the  President 
of  the  United  States,  the  judges  of  the  supreme  and  inferior  courts  of  the 
United  States,  and  all  other  oflftcers  and  employes,  whether  elected  or  ap- 
pointed, of  the  United  States,  Alaska,  Hawaii,  or  any  political  subdivision 


REVENUE  ACT  OF   1918  1283 

thereof,  or  the  District  of  Columbia,  the  compensation  received  as  such), 
of  whatever  kind  and  in  whatever  form  paid,  or  from  professions,  vocations, 
trades,  businesses,  commerce,  or  sales,  or  dealings  in  property,  whether  real 
or  personal,  growing  out  of  the  ownership  or  use  of  or  interest  m  such 
property;  also  from  interest,  rent,  dividends,  securities,  or  the  transaction 
of  any  business  carried  on  for  gain  or  profit,  or  gains  or  profits  and  income 
derived  from  any  source  whatever.  The  amount  of  all  such  items  shall  be 
included  in  the  gross  income  for  the  taxable  year  in  which  received  by  the 
taxpayer,  unless,  under  methods  of  accounting  permitted  under  subdivision 

(b)  of  §  212,  any  such  amounts  are  to  be  properly  accounted  for  as  of  a  dif- 
ferent period;   but 

(b)  Does  not  include  the  following  items,  which  shall  be  exempt  from 
taxation  under  this  title: 

(1)  The  proceeds  of  life  insurance  policies  paid  upon  the  death  of  the 
insured  to  individual  beneficiaries  or  to  the  estate  of  the  insured; 

(2)  The  amount  received  by  the  insured  as  a  return  of  premium  or  pre- 
miums paid  by  him  under  life  insurance,  endowment,  or  annuity  contracts, 
either  during' the  term  or  at  the  maturity  of  the  term  mentioned  in  the 
contract  or  upon  surrender  of  the  contract; 

(3)  The  value  of  property  acquired  by  gift,  bequest,  devise,  or  descent 
(but  the  income  from  such  property  shall  be  included  in  gross  income)  ; 

(4)  Interest  upon  (a)  the  obligations  of  a  state,  territory,  or  any  political 
subdivision  thereof,  or  the  District  of  Columbia;  or  (b)  securities  issued 
under  the  provisions  of  the  Federal  Farm  Loan  Act  of  July  17,  1916;  or 

(c)  the  obligations  of  the  United  States  or  its  possessions;  or  (d)  bonds 
issued  by  the  War  Finance  Corporation;  Provided,  That  every  person  own- 
ing any  of  the  obligations,  securities  or  bonds  enumerated  in  clauses  (a), 
(b),  (c)  and  (d)  shall,  in  return  required  by  this  title,  submit  a  statement 
showing  the  number  and  amount  of  such  obligations,  securities  and  bonds 
owned  by  him  and  the  income  received  therefrom,  in  such  form  and  with 
such  information  as  the  commissioner  may  require.  In  the  case  of  obliga- 
tions of  the  United  States  issued  after  September  1,  1917,  and  in  the  case 
of  bonds  issued  by  the  War  Finance  Corporation,  the  interest  shall  be 
exempt  only  if  and  to  the  extent  provided  in  the  respective  Acts  authorizing 
the  issue  thereof  as  amended  and  supplemented,  and  shall  be  excluded  from 
gross  income  only  if  and  to  the  extent  it  is  wholly  exempt  from  taxation 
to  the  taxpayer  both  under  this  title  and  under  Title  III; 

(5)  The  income  of  foreign  governments  received  from  investments  in 
the  United  States  in  stocks,  bonds,  or  other  domestic  securities,  owned  by 
such  foreign  governments,  or  from  interest  on  deposits  in  banks  in  the 
United  States  of  moneys  belonging  to  such  foreign  governments,  or  from  any 
other  source  within  the  United  States; 

(6)  Amounts  received,  through  accident  or  health  insurance  or  under 
workmen's  compensation  acts,  as  compensation  for  personal  injuries  or 
sickness,  plus  the  amount  of  any  damages  received  whether  by  suit  or  agree- 
ment on  account  of  such  injuries  or  sickness; 

(7)  Income  derived  from  any  public  utility  or  the  exercise  of  any  essen- 
tial governmental  function  and  accruing  to  any  state,  territory,  or  the 
District  of  Columbia,  or  any  political  subdivision  of  a  state  or  territory,  or 
income  accruing  to  the  government  of  any  possession  of  the  United  States, 
or  any  political  subdivision  thereof. 

Whenever  any  state,  territory,  or  the  District  of  Columbia,  or  any  politi- 
cal subdivision  of  a  state  or  territory,  prior  to  September  8,  1916,  entered 


L 


1284  APPENDIX 

in  good  faith  into  a  contract  with  any  person,  the  object  and  purpose  of 
which  is  to  acquire,  construct,  operate,  or  maintain  a  public  utility,  no  tax 
shall  be  levied  under  the  provisions  of  this  title  upon  the  income  derived 
from  the  operation  of  such  public  utility,  so  far  as  the  payment  thereof  will 
impose  a  loss  or  burden  upon  such  state,  or  territory,  District  of  Columbia, 
or  political  subdivision;  but  this  provision  is  not  intended  to  confer  upon 
such  person  any  financial  gain  or  exemption  or  to  relieve  such  person  from 
the  payment  of  a  tax  as  provided  for  in  this  title  upon  the  part  or  portion  of 
such  income  to  which  such  person  is  entitled  under  such  contract; 

(8)  So  much  of  the  amount  received  during  the  present  war  by  a  person 
in  the  military  or  naval  forces  of  the  United  States  as  salary  or  compen- 
sation in  any  form  from  the  United  States  for  active  services  in  such  forces, 
as  does  not  exceed  $3,500. 

(c)  In  the  case  of  nonresident  alien  individuals,  gross  income  includes  only 
the  gross  income  from  sources  within  the  United  States,  including  interest 
on  bonds,  notes,  or  other  interest-bearing  obligations  of  residents,  corpo- 
rate or  otherwise,  dividends  from  resident  corporations,  and  including  all 
amounts  received  (although  paid  under  a  contract  for  the  sale  of  goods  or 
otherwise)  representing  profits  on  the  manufacture  and  disposition  of  goods 
within  the  United  States. 

DEDUCTIONS  ALLOWED 

Sec.  214.  (a)  That  in  computing  net  income  there  shall  be  allowed  as 
deductions : 

(1)  All  the  ordinary  and  necessary  expenses  paid  or  incurred  during  the 
taxable  year  in  carrying  on  any  trade  or  business,  including  a  reasonable 
allowance  for  salaries  or  other  compensation  for  personal  services  actually 
rendered,  and  including  rentals  or  other  payments  required  to  be  made  as  a 
condition  to  the  continued  use  or  possession,  for  purposes  of  the  trade  or 
business,  of  property  to  which  the  taxpayer  has  not  taken  or  is  not  taking 
title  or  in  which  he  has  no  equity; 

(2)  All  interest  paid  or  accrued  within  the  taxable  year  on  indebtedness, 
except  on  indebtedness  incurred  or  continued  to  purchase  or  carry  obligations 
or  securities  (other  than  obligations  of  the  United  States  issued  after  Sep- 
tember 24,  1917),  the  interest  upon  which  is  wholly  exempt  from  taxation 
under  this  title  as  income  to  the  taxpayer,  or,  in  the  case  of  a  nonresident 
alien  individual,  the  proportion  of  such  interest  which  the  amount  of  his 
gross  income  from  sources  within  the  United  States  bears  to  the  amount  of 
his  gross  income  from  all  sources  within  and  without  the  United  States; 

(3)  Taxes  paid  or  accrued  within  the  taxable  year  imposed  (a)  by  the 
authority  of  the  United  States,  except  income,  war-profits  and  excess-profits 
taxes;  or  (b)  by  the  authority  of  any  of  its  possessions,  except  the  amount 
of  income,  war-profits  and  excess-profits  taxes  allowed  as  a  credit  under 
§  222;  or  (c)  by  the  authority  of  any  state  or  territory,  or  any  county, 
school  district,  municipality,  or  other  taxing  subdivision  of  any  state  or  terri- 
tory, not  including  those  assessed  against  local  benefits  of  a  kind  tending  to 
increase  the  value  of  the  property  assessed;  or  (d)  in  the  case  of  a  citizen 
or  resident  of  the  United  States,  by  the  authority  of  any  foreign  country, 
except  the  amount  of  income,  war-profits  and  excess-profits  taxes  allowed 
as  a  credit  under  §  222;  or  (e)  in  the  case  of  a  nonresident  alien  individual, 
by  the  authority  of  any  foreign  country    (except  income,  war-profits  and 


REVENUE   ACT  OF    1918  128'» 

excess-profits  taxes,  and  taxes  assessed  against  local  benefits  of  a  kind 
tending  to  increase  the  value  of  the  property  assessed),  upon  property  or 
business; 

(4)  Losses  sustained  during  the  taxable  year  and  not  compensated  for 
by  insurance  or  otherwise,  if  incurred  in  trade  or  business. 

(5)  Losses  sustained  during  the  taxable  year  and  not  compensated  for 
by  insurance  or  otherwise,  if  incurred  in  any  transaction  entered  into  for 
profit,  though  not  connected  with  the  trade  or  business;  but  in  the  case  of  a 
nonresident  alien  individual  only  as  to  such  transactions  within  the  United 
States; 

(6)  Losses  sustained  during  the  taxable  year  of  property  not  connected 
with  the  trade  or  business  (but  in  the  case  of  a  nonresident  alien  individual 
only  property  within  the  United  States)  if  arisnig  from  fires,  storms,  ship- 
wreck, or  other  casualty,  or  from  theft,  and  if  not  compensated  for  by  in- 
surance or  otherwise; 

(7)  Debts  ascertained  to  be  worthless  and  charged  off  within  the  taxable 
year; 

(8)  A  reasonable  allowance  for  the  exhaustion,  wear  and  tear  of  property 
used  in  the  trade  or  business,  including  a  reasonable  allowance  for  obsoles- 
cence ; 

(9)  In  the  case  of  buildings,  machinery,  equipment,  or  other  facilities, 
constructed,  erected,  installed,  or  acquired,  on  or  after  April  6,  1917,  for  the 
production  of  articles  contributing  to  the  prosecution  of  the  present  war, 
and  in  the  case  of  vessels  constructed  or  acquired  on  or  after  such  date  for 
the  transportation  of  articles  or  men  contributing  to  the  prosecution  of  the 
present  war,  there  shall  be  allowed  a  reasonable  deduction  for  the  amortiza- 
tion of  such  part  of  the  cost  of  such  facilities  or  vessels  as  has  been  borne 
by  the  taxpayer,  but  not  again  including  any  amount  otherwise  allowed 
under  this  title  or  previous  Acts  of  Congress  as  a  deduction  in  computing 
net  income.  At  any  time  within  three  years  after  the  termination  of  the 
present  war,  the  commissioner  may,  and  at  the  request  of  the  taxpayer  shall, 
re-examine  the  return,  and  if  he  then  finds  as  a  result  of  an  appraisal  or 
from  other  evidence  that  the  deduction  originally  allowed  was  incorrect, 
the  taxes  imposed  by  this  title  and  by  Title  III  for  the  year  or  years  affected 
shall  be  redetermined;  and  the  amount  of  tax  due  upon  such  redetermination, 
if  any.  shall  be  paid  upon  notice  and  demand  by  the  collector,  or  the  amount 
of  tax  overpaid,  if  any,  shall  be  credited  or  refunded  to  the  taxpayer  in 
accordance  with  the  provisions  of  §  252; 

(10)  In  the  case  of  mines,  oil  and  gas  wells,  other  natural  deposits,  and 
timber,  a  reasonable  allowance  for  depletion  and  for  depreciation  of  im- 
provements, according  to  the  peculiar  conditions  in  each  case,  based  upon 
cost  including  cost  of  development  not  otherwise  deducted:  Provided,  That 
in  the  case  of  such  properties  acquired  prior  to  March  1,  1913,  the  fair 
market  value  of  the  property  (or  the  taxpayer's  interest  therein)  on  that 
date  shall  be  taken  in  lieu  of  cost  up  to  that  date:  Provided  further.  That 
in  the  case  of  mines,  oil  and  gas  wells,  discovered  by  the  taxpayer,  on  or 
after  March  1,  1913,  and  not  acquired  as  the  result  of  purchase  of  a  proven 
tract  or  lease,  where  the  fair  market  value  of  the  pi'operty  is  materially 
disproportionate  to  the  cost,  the  depletion  allowance  shall  be  based  upon  the 
fair  market  value  of  the  property  at  the  date  of  the  discovery,  or  within 
thirty  days  thereafter;  such  reasonable  allowance  in  all  the  above  cases  to 
be  made  under  rules  and  regulations  to  be  prescribed  by  the  commissioner 


1286  APPENDIX 

with  the  approval  of  the  secretary.  In  the  case  of  leases  the  deductions 
allowed  by  this  paragraph  shall  be  equitably  apportioned  between  the  lessor 
and  the  lessee; 

(11)  Contributions  or  gifts  made  within  the  taxable  year  to  corporations 
organized  and  operated  exclusively  for  religious,  charitable,  scientific,  or 
educational  purposes,  or  for  the  prevention  of  cruelty  to  children  or  ani- 
mals, no  part  of  the  net  earnings  of  which  inures  to  the  benefit  of  any  private 
stockholder  or  individual,  or  to  the  special  fund  for  vocational  rehabilita- 
tion authorized  by  §  7  of  the  Vocational  Rehabilitation  Act,  to  an  amount  not 
in  excess  of  15  per  centum  of  the  taxpayer's  net  income  as  computed  with- 
out the  benefit  of  this  paragraph.  Such  contributions  or  gifts  shall  be  al- 
lowable as  deductions  only  if  verified  under  rules  and  regulations  prescribed 
by  the  commissioner,  with  the  approval  of  the  secretary.  In  the  case  of  a 
nonresident  alien  individual  this  deduction  shall  be  allowed  only  as  to  con- 
tributions or  gifts  made  to  domestic  corporations,  or  to  such  vocational  re- 
habilitation fund; 

(12)  (a)  At  the  time  of  filing  return  for  the  taxable  year  1918  a  taxpayer 
may  file  a  claim  in  abatement  based  on  the  fact  that  he  has  sustained  a  sub- 
stantial loss  (whether  or  not  actually  realized  by  sale  or  other  disposition) 
resulting  from  any  material  reduction  (not  due  to  temporary  fluctuation) 
of  the  value  of  the  inventory  for  such  taxable  year,  or  from  the  actual 
payment  after  the  close  of  such  taxable  year  of  rebates  in  pursuance  of 
contracts  entered  into  during  such  year  upon  sales  made  during  such  year. 
In  such  case  payment  of  the  amount  of  the  tax  covered  by  such  claim  shall 
not  be  required  until  the  claim  in  decided,  but  the  taxpayer  shall  accompany 
his  claim  with  a  bond  in  double  the  amount  of  the  tax  covered  by  the  claim, 
with  sureties  satisfactory  to  the  commissioner,  conditioned  for  the  payment 
of  any  part  of  such  tax  found  to  be  due,  with  interest.  If  any  part  of  such 
claim  is  disallowed  then  the  remainder  of  the  tax  due  shall  on  notice  and 
demand  by  the  collector  be  paid  by  the  taxpayer  with  interest  at  the  rate 
of  1  per  centum  per  month  from  the  time  the  tax  would  have  been  due  had 
no  such  claim  been  filed.  If  it  is  shown  to  the  satisfaction  of  the  commis- 
sioner that  such  substantial  loss  has  been  sustained,  then  in  computing  the 
tax  imposed  by  this  title  the  amount  of  such  loss  shall  be  deducted  from  the 
net  income,  (b)  If  no  such  claim  is  filed,  but  it  is  shown  to  the  satisfaction 
of  the  commissioner  that  during  the  taxable  year  1919  the  taxpayer  has 
sustained  a  substantial  loss  of  the  character  above  described  then  the  amount 
of  such  loss  shall  be  deducted  from  the  net  income  for  the  taxable  year  1918 
and  the  tax  imposed  by  this  title  for  such  year  shall  be  redetermined  ac- 
cordingly. Any  amount  found  to  be  due  to  the  taxpayer  upon  the  basis  of 
such  redetermination  shall  be  credited  or  refunded  to  the  taxpayer  in  ac- 
cordance with  the  provisions  of  §  252. 

(b)  In  the  case  of  a  nonresident  alien  individual  the  deductions  allowed 
in  n  (1),  (4),  (7),  (8),  (9),  (10)  and  (12) ,  and  clause  (e)  of  H  (3),  of 
subdivision  (a)  shall  be  allowed  only  if  and  to  the  extent  that  they  are 
connected  with  income  arising  from  a  source  within  the  United  States;  and 
the  proper  apportionment  and  allocation  of  the  deductions  with  respect  to 
sources  of  income  within  and  without  the  United  States  shall  be  determined 
under  rules  and  regulations  prescribed  by  the  commissioner  with  the  ap- 
proval of  the  secretary. 


REVENUE   ACT  OF    1918  1287 


ITEMS    NOT    DEDUCTIBLE 

Sec.  215.  That  in  computing  net  income  no  deduction  shall  in  any  case  be 
allowed  in  respect  of — 

(a)  Personal,  livinp:,  or  family  expenses; 

(b)  Any  amount  paid  out  for  new  buildings  or  for  permanent  improve- 
ments or  betterments  made  to  increase  the  value  of  any  property  or  estate; 

(c)  Any  amount  expended  in  restoring  property  or  in  making  good  the 
exhaustion  thereof  for  which  an  allowance  is  or  has  been  made;  or 

(d)  Premiums  paid  on  any  life  insurance  policy  covering  the  life  of  any 
officer  or  employee,  or  of  any  person  financially  interested  in  any  trade  or 
business  carried  on  by  the  taxpayer,  when  the  taxpayer  is  directly  or  in- 
directly  a   beneficiary   under   such   policy. 

CREDITS  AXLOWED 

Sec.  216.  That  for  the  purpose  of  the  normal  tax  only  there  shall  be 
allowed  the  following  credits: 

(a)  The  amount  received  as  dividends  from  a  corporation  which  is  tax- 
able under  this  title  upon  its  net  income,  and  amounts  received  as  dividends 
from  a  per.sonal  service  corpoi'ation  out  of  earnings  or  profits  upon  which 
income  tax  has  been  imposed  by  Act  of  Congress; 

(b)  The  amount  received  as  interest  upon  obligations  of  the  United 
States  and  bonds  issued  by  the  War  Finance  Corporation,  which  is  inclutled 
in  gross  income  under  §  213; 

(c)  In  the  case  of  a  single  person,  a  personal  exemption  of  $1,000,  or  in 
the  case  of  the  head  of  a  family  or  a  married  person  living  with  husband  or 
wife,  a  personal  exemption  of  $2,000.  A  husband  and  wife  living  together 
shall  receive  but  one  personal  exemption  of  $2,000  against  their  aggregate 
net  income;  and  in  case  they  make  separate  returns,  the  personal  exemption 
of  $2,000  may  be  taken  by  either  or  divided  between  them; 

(d)  $200  for  each  person  (other  than  husband  or  wife)  dependent  upon 
and  receiving  his  chief  support  from  the  taxpayer,  if  such  dependent  person 
is  under  eighteen  years  of  age  or  is  incapable  of  self-support  because 
mentally  or  physically  defective. 

(e)  In  the  case  of  a  nonresident  alien  individual  who  is  a  citizen  or 
subject  of  a  country  which  imposes  an  income  tax,  the  credits  allowed  in 
subdivisions  (c)  and  (d)  shall  be  allowed  only  if  such  country  allows  a 
similar  credit  to  citizens  of  the  United  States  not  residing  in  such  country. 

NON-RESIDENT  ALIENS — ALLOWANCE  OF   DEDUCTIONS   AND   CREDITS 

Sec.  217.  That  a  nonresident  alien  individual  shall  receive  the  benefit  of 
the  deductions  and  credits  allowed  in  this  title  only  by  filing  or  causing  to  be 
filed  with  the  collector  a  true  and  accurate  return  of  his  total 
income  received  from  all  sources  corporate  or  otherwise  in  the  .  United 
States,  in  the  manner  prescribed  by  this  title,  including  therein  all  the  in- 
formation which  the  commissioner  may  deem  necessary  for  the  calculation 
of  such  deductions  and  credits:  Provided,  That  the  benefit  of  the  credits 
allowed  in  subdivisions  (c)  and  (d)  of  §  216  may,  in  the  discretion  of  the 
commissioner,  and  except  as  otherwise  provided  in  subdivision  (e)  of  that 
section,  be  received  by  filing  a  claim  therefor  with  the  withholding  agent. 
In  case  of  failure  to  file  a  return,  the  collector  shall  collect  the  tax  on  such 
income,  and  all  property  belonging  to  such  nonresident  alien  individual 
shall  be  liable  to  distraint  for  the  tax. 


1288  APPENDIX 

PARTNERSHIPS   AND    PERSONAL    SERVICE    CORPORATIONS 

Sec.  218.  (a)  That  individuals  carrying  on  business  in  partnership  shall 
be  liable  for  income  tax  only  in  their  individual  capacity.  There  shall  be 
included  in  computing  the  net  income  of  each  partner  his  distributive  share, 
vv'hether  distributed  or  not,  of  the  net  income  of  the  partnership  for  the 
taxable  year,  or,  if  his  net  income  for  such  taxable  year  is  computed  upon 
the  basis  of  a  period  different  from  that  upon  the  basis  of  which  the  net 
income  of  the  partnership  is  computed,  then  his  distributive  share  of  the 
net  income  of  the  partnership  for  any  accounting  period  of  the  partnership 
ending  w^ithin  the  fiscal  or  calendar  year  upon  the  basis  of  which  the  part- 
ner's net  income  is  computed. 

The  partner  shall,  for  the  purpose  of  the  normal  tax,  be  allowed  as  credits, 
in  addition  to  the  credits  allowed  to  him  under  §  216,  his  proportionate 
share  of  such  amounts  specified  in  subdivisions  (a)  and  (b)  of  §  216  as 
are  received  by  the  partnership. 

(b)  If  a  fiscal  year  of  a  partnership  ends  during  a  calendar  year  for 
which  the  rates  of  tax  differ  from  those  for  the  preceding  calendar  year, 
then  (1)  the  rates  for  such  preceding  calendar  year  shall  apply  to  an 
amount  of  each  partner's  share  of  such  partnership  net  income  equal  to 
the  proportion  which  the  part  of  such  fiscal  year  falling  within  such  calendar 
year  bears  to  the  full  fiscal  year,  and  (2)  the  rates  for  the  calendar  year 
during  which  such  fiscal  year  ends  shall  apply  to  the  remainder. 

(c)  In  the  case  of  an  individual  member  of  a  partnership  which  makes 
return  for  a  fiscal  year  beginning  in  1917  and  ending  in  1918,  his  propor- 
tionate share  of  any  excess-profits  tax  imposed  upon  the  partnership  under 
the  Revenue  Act  of  1917  with  respect  to  that  part  of  such  fiscal  year  falling 
in  1917,  shall,  for  the  purpose  of  determining  the  tax  imposed  by  this  title, 
be  credited  against  that  portion  of  the  net  income  embraced  in  his  personal 
return  for  the  taxable  year  1918  to  which  the  rates  for  1917  apply. 

(d)  The  net  income  of  the  partnership  shall  be  computed  in  the  same 
manner  and  on  the  same  basis  as  provided  in  §  212  except  that  the  deduc- 
tion provided  in  T[  (11)  of  subdivision  (a)   of  §  214  shall  not  be  allowed. 

(e)  Personal  service  corporations  shall  not  be  subject  to  taxation  under 
this  title,  but  the  individual  stockholders  thereof  shall  be  taxed  in  the  same 
manner  as  the  members  of  partnerships.  All  the  provisions  of  this  title 
relating  to  partnerships  and  the  members  thereof  shall  so  far  as  practicable 
apply  to  personal  service  corporations  and  the  stockholders  thereof:  Pro- 
vided, That  for  the  purpose  of  this  subdivision  amounts  distributed  by  a 
personal  service  corporation  during  its  taxable  year  shall  be  accounted  for 
by  the  distributees;  and  any  portion  of  the  net  income  remaining  undis- 
tributed at  the  close  of  its  taxable  year  shall  be  accounted  for  by  the  stock- 
holders of  such  corporation  at  the  close  of  its  taxable  year  in  proportion 
to  their  respective  shares. 

ESTATES  AND  TRUSTS 

Sec.  219.  (a)  That  the  tax  imposed  by  §§  210  and  211  shall  apply  to  the 
income  of  estates  or  of  any  kind  of  property  held  in  trust,  including — 

(1)  Income  received  by  estates  of  deceased  persons  during  the  period  of 
administration  or  settlement  of  the  estate; 

(2)  Income  accumulated  in  trust  for  the  benefit  of  ynborn  or  unascer- 
tained persons  or  persons  with  contingent  interests;  • 

(3)  Income  held  for  future  distribution  under  the  terms  of  the  will  or 
trust;  and 


REVENUE  ACT  OF  ,1918  1289 

(4)  Income  which  is  to  be  distributed  to  the  beneficiaries  periodically, 
whether  or  not  at  regular  intervals,  and  the  income  collected  by  a  guardian 
of  an  infant  to  be  held  or  distributed  as  the  court  may  direct. 

(b)  The  fiduciary  shall  be  responsible  for  making  the  return  of  income  for 
the  estate  or  trust  for  which  he  acts.  The  net  income  of  the  estate  or  trust 
shall  be  computed  in  the  same  manner  and  on  the  same  basis  as  provided  in 
§  212,  except  that  there  shall  also  be  allowed  as  a  deduction  (in  lieu  of  the 
deduction  authorized  by  ^  (11)  of  subdivision  (a)  of  §  214)  any  part  of 
the  gross  income  which,  pursuant  to  the  terms  of  the  will  or  deed  creating 
the  trust,  is  during  the  taxable  year  paid  to  or  permanently  set  aside  for  the 
United  States,  any  state,  territory,  or  any  political  subdivision  thereof,  or 
the  District  of  Columbia,  or  any  corporation  organized  and  operated  exclu- 
sively for  religious,  charitable,  scientific,  or  educational  purposes,  or  for 
the  prevention  of  cruelty  to  children  or  animals,  no  part  of  the  net  earnings 
of  which  inures  to  the  benefit  of  any  private  stockholder  or  individual;  and 
in  cases  under  ^  (4)  of  subdivision  (a)  of  this  section  the  fiduciary  shall 
include  in  the  return  a  statement  of  each  beneficiary's  distributive  share  of 
such  net  income,  whether  or  not  distributed  before  the  close  of  the  taxable 
year  for  which  the  return  is  made. 

(c)  In  cases  under  ^  (1),  (2),  or  (3)  of  subdivision  (a)  the  tax  shall 
be  imposed  upon  the  net  income  of  the  estate  or  trust  and  shall  be  paid 
by  the  fiduciary,  except  that  in  determining  the  net  income  of  the  estate  of 
any  deceased  person  during  the  period  of  administration  or  settlement  there 
may  be  deducted  the  amount  of  any  income  properly  paid  or  credited  to 
any  legatee,  heir  or  other  beneficiary.  In  such  cases  the  estate  or  trust  shall, 
for  the  purpose  of  the  normal  tax,  be  allowed  the  same  credits  as  are  allowed 
to  single  persons  under  §  216. 

(d)  In  cases  under  ^  (4)  of  subdivision  (a),  and  in  the  case  of  any 
income  of  an  estate  during  the  period  of  administration  or  settlement  per- 
mitted by  subdivision  (c)  to  be  deducted  from  the  net  income  upon  which 
tax  is  to  be  paid  by  the  fiduciary,  the  tax  shall  not  be  paid  by  the  fiduciary, 
but  there  shall  be  included  in  computing  the  net  income  of  each  beneficiary 
his  distributive  share,  whether  distributed  or  not,  of  the  net  income  of  the 
estate  or  trust  for  the  taxable  year,  or,  if  his  net  income  for  such  taxable 
year  is  computed  upon  the  basis  of  a  period  different  from  that  upon  the 
basis  of  which  the  net  income  of  the  estate  or  trust  is  computed,  then  his 
distributive  share  of  the  net  income  of  the  estate  or  trust  for  any  account- 
ing period  of  such  estate  or  trust  ending  within  the  fiscal  or  calendar  year 
upon  the  basis  of  which  such  beneficiary's  net  income  is  computed.  In  such 
cases  the  beneficiary  shall,  for  the  purpose  of  the  normal  tax,  be  allowed  as 
credits  in  addition  to  the  credits  allowed  to  him  under  §  216,  his  propor- 
tionate share  of  such  amounts  specified  in  subdivisions  (a)  and  (b)  of 
§  216  as  are  received  by  the  estate  or  trust. 

PROFITS   OF   CORPORATIONS   fAXABLE  TO    STOCKHOLDERS 

Sec.  220.  That  if  any  corporation,  however  created  or  oreanized.  is 
formed  or  availed  of  for  the  purpose  of  preventing  the  imposition  of  the 
surtax  upon  its  stockholders  or  members  through  the  medium  of  permitting 
its  gains  and  profits  to  accumulate  instead  of  being  divided  or  distributed, 
such  corporation  shall  not  be  subject  to  the  tax  imposed  by  §  230,  but  the 
stockholders  or  members  thereof  shall  be  subject  to  taxation  under  this  title 
in  the  same  manner  as  provided  in  subdivision  (e)  of  §  218  in  the  case  of 
stockholders  of  a  personal  service  corporation,  except  that  the  tax  imposed 


]290  APPENDIX 

by  Title  III  shall  be  deducted  from  the  net  income  of  the  corporation  before 
the  computation  of  the  proportionate  share  of  each  stockholder  or  member. 
The  fact  that  any  corporation  is  a  mere  holding  company,  or  that  the  gains 
and  profits  are  permitted  to  accumulate  beyond  the  reasonable  needs  of  the 
business,  shall  be  prima  facie  evidence  of  a  purpose  to  escape  the  surtax; 
but  the  fact  that  the  gains  and  profits  are  in  any  case  permitted  to  accumu- 
late and  become  surplus  shall  not  be  construed  as  evidence  of  a  purpose  to 
escape  the  tax  in  such  case  unless  the  commissioner  certifies  that  in  his 
opinion  such  accumulation  is  unreasonable  for  the  purposes  of  the  business. 
When  requested  by  the  commissioner,  or  any  collector,  every  corporation 
shall  forward  to  him  a  correct  statement  of  such  gains  and  profits  and  the 
names  and  addresses  of  the  individuals  or  shareholders  who  would  be  en- 
titled to  the  same  if  divided  or  distributed,  and  of  the  amounts  that  .would 
be  payable  to  each. 

PAYMENT  OF  TAX  AT  SOURCE 

Sec.  221.  (a)  That  all  individuals,  corporations  and  partnerships,  in 
whatever  capacity  acting,  including  lessees  or  mortgagors  of  real  or  per- 
sonal property,  fiduciaries,  employers,  and  all  officers  and  employees  of  the 
United  States,  having  the  control,  receipt,  custody,  disposal,  or  payment, 
of  interest,  rent,  salaries,  wages,  premiums,  annuities,  compensations,  re- 
munerations, emoluments,  or  other  fixed  or  determinable  annual  or  periodi- 
cal gains,  profits,  and  income,  of  any  nonresident  alien  individual  (other 
than  income  received  as  dividends  from  a  corporation  which  is  taxable  under 
this  title  upon  its  net  income)  shall  (except  in  the  cases  provided  for  in 
subdivision  (b)  and  except  as  otherwise  provided  in  regulations  prescribed 
by  the  commissioner  under  §  217)  deduct  and  withhold  from  such  annual 
or  periodical  gains,  profits,  and  income  a  tax  equal  to  8  per  centum  thereof: 
Provided,  That  the  commissioner  may  authorize  such  tax  to  be  deducted  and 
withheld  from  the  interest  upon  any  securities  the  owners  of  which  are  not 
known  to  the  withholding  agent. 

(b)  In  any  case  where  bonds,  mortgages,  or  deeds  of  trust,  or  other 
similar  obligations  of  a  corporation  contain  a  contract  or  provision  by  which 
the  obligor  agrees  to  pay  any  portion  of  the  tax  imposed  by  this  title  upon 
the  obligee,  or  to  reimburse  the  obligee  for  any  portion  of  the  tax,  or  to  pay 
the  interest  without  deduction  for  any  tax  which  the  obligor  may  be  required 
or  permitted  to  pay  thereon  or  to  retain  therefrom  under  any  law  of  the 
United  States,  the  obligor  shall  deduct  and  withhold  a  tax  equal  to  2  per 
centum  of  the  interest  upon  such  bonds,  mortgages,  deeds  of  trust,  or  other 
obligations,  whether  such  interest  is  payable  annually  or  at  shorter  or  longer 
periods  and  whether  payable  to  a  nonresident  alien  individually  or  to  an 
individual  citizen  or  resident  of  the  United  States  or  to  a  partnership: 
Provided,  That  the  commissioner  may  authorize  such  tax  to  be  deducted 
and  withheld  in  the  case  of  interest  upon  any  such  bonds,  mortgages,  deeds 
of  trust  or  other  obligations,  the  owners  of  which  are  not  known  to  the 
withholding  agent.  Such  deduction  and  withholding  shall  not  be  required 
in  the  case  of  a  citizen  or  resident  entitled  to  receive  such  interest,  if  he 
files  with  the  withholding  agent  on  or  before  February  1,  a  signed  notice 
in  writing  claiming  the  benefit  of  the  credits  provided  in  subdivisions  (c) 
and  (d)  of  §  216;  nor  in  the  case  of  a  nonresident  alien  individual  if  so 
provided  for  in  regulations  prescribed  by  the  commissioner  under  §  217. 

(c)  Every  individual,  corporation,  or  partnership  required  to  deduct  and 
withhold  any  tax  under  this  section  shall  make  return  thereof  on  or  before 


REVENUE   ACT  OF    1918  1291 

March  first  of  each  year  and  shall  on  or  before  June  fifteenth  pay  the  tax 
to  the  official  of  the  United  States  government  authorized  to  receive  it. 
Every  such  individual,  corporation,  or  partnership  is  hereby  made  liable 
for  such  tax  and  is  hereby  indemnified  ag:ainst  the  claims  and  demands  of 
any  individual,  corporation,  or  partnership  for  the  amount  of  any  payments 
made  in  accordance  with  the  provisions  of  this  section. 

(d)  Income  upon  which  any  tax  is  required  to  be  withheld  at  the  source 
under  this  section  shall  be  included  in  the  return  of  the  recipient  of  such 
income,  but  any  amount  of  tax  so  withheld  shall  be  credited  ag^ainst  the 
amount  of  income  tax  as  computed  in  such  return. 

(e)  If  any  tax  requii*ed  under  this  section  to  be  deducted  and  withheld 
is  paid  by  the  recipient  of  the  income,  it  shall  not  be  re-collected  from  the 
withholding  agent;  nor  in  cases  in  which  the  tax  is  so  paid  shall  any  penalty 
be  imposed  upon  or  collected  from  the  recipient  of  the  income  or  the  with- 
holding agent  for  failure  to  return  or  pay  the  same,  unless  such  failure  was 
fraudulent  and  for  the  purpose  of  evading  payment. 

CREDIT   FOR   TAXES 

Sec.  222.  (a)  That  the  tax  computed  under  Part  II  of  this  title  shall  be 
credited  with : 

(1)  In  the  case  of  a  citizen  of  the  United  States,  the  amount  of  any 
income,  war-profits  and  excess-profits  taxes  paid  during  the  taxable  year 
to  any  foreign  country,  upon  income  derived  from  sources  therein,  or  to  any 
possession  of  the  United  States;  and 

(2)  In  the  case  of  a  resident  of  the  United  States,  the  amount  of  any 
such  taxes  paid  during  the  taxable  year  to  any  possession  of  the  United 
States;  and 

(3)  In  the  case  of  an  alien  resident  of  the  United  States  who  is  a  citizen 
or  subject  of  a  foreign  country,  the  amount  of  any  such  taxes  paid  during 
the  taxable  year  to  such  country,  upon  income  derived  from  sources  therein, 
if  such  country,  in  imposing  such  taxes,  allows  a  similar  credit  to  citizens 
of  the  United  States  residing  in  such  country;  and 

(4)  In  the  case  of  any  such  individual  who  is  a  member  of  a  partnership 
or  a  beneficiary  of  an  estate  or  trust,  his  proportionate  share  of  such  taxes 
of  the  partnership  or  the  estate  or  trust  paid  during  the  taxable  year  to  a 
foreign  country  or  to  any  possession  of  the  United  States,  as  the  case 
may  be. 

(b)  If  accrued  taxes  when  paid  differ  from  the  amounts  claimed  as 
credits  by  the  taxpayer,  or  if  any  tax  paid  is  refunded  in  whole  or  in  part, 
the  taxpayer  shall  notify  the  commissioner  who  shall  redetermine  the  amount 
of  the  tax  due  under  Part  II  of  this  title  for  the  year  or  years  affected, 
and  the  amount  of  tax  due  upon  such  redetermination,  if  any,  shall  be  paid 
by  the  taxpayer  upon  notice  and  demand  by  the  collector,  or  the  amount  of 
tax  overpaid,  if  any,  shall  be  credited  or  refunded  to  the  taxpayer  in 
accordance  with  the  provisions  of  §  252.  In  the  case  of  such  a  tax  accrued 
but  not  paid,  the  commissioner  as  a  condition  precedent  to  the  allowance  of 
this  credit  may  require  the  taxpayer  to  give  a  bond  with  sureties  satisfac- 
tory to  and  to  be  approved  by  the  commissioner  in  such  penal  sum  as  the 
commissioner  may  require,  conditioned  for  the  payment  by  the  taxpayer  of 
any  amount  of  tax  found  due  upon  any  such  redetermination;  and  the  bond 
herein  prescribed  shall  contain  such  further  conditions  as  the  commissioner 
may  require. 


1292  APPENDIX 

(c)  These  credits  shall  be  allowed  only  if  the  taxpayer  furnishes  evidence 
satisfactory  to  the  commissioner  showing  the  amount  of  income  derived  from 
sources  within  such  foreign  country  or  such  possession  of  the  United  States, 
and  all  other  information  necessary  for  the  computation  of  such  credits. 

INDIVIDUAL  RETURNS 

Sec.  223.  That  every  individual  having  a  net  income  for  the  taxable  year 
of  $1,000  or  over  if  single  or  if  married  and  not  living  with  husband  or 
wife,  or  of  $2,000  or  over  if  married  and  living  with  husband  or  wife,  shall 
make  under  oath  a  return  stating  specifically  the  items  of  his  gross  income 
and  the  deductions  and  credits  allowed  by  this  title.  If  a  husband  and  wife 
living  together  have  an  aggregate  net  income  of  $2,000  or  over,  each  shall 
make  such  a  return  unless  the  income  of  each  is  included  in  a  single  joint 
return. 

If  the  taxpayer  is  unable  to  make  his  own  return,  the  return  shall  be 
made  by  a  duly  authorized  agent  or  by  the  guardian  or  other  person  charged 
with  the  care  of  the  person  or  property  of  such  taxpayer. 

PARTNERSHIP  RETURNS 

Sec.  224.  That  every  partnership  shall  make  a  return  for  each  taxable 
year,  stating  specifically  the  items  of  its  gross  income  and  the  deductions 
allowed  by  this  title,  and  shall  include  in  the  return  the  names  and  addresses 
of  the  individuals  who  would  be  entitled  to  share  in  the  net  income  if  dis- 
tributed and  the  amount  of  the  distributive  share  of  each  individual.  The 
return  shall  be  sworn  to  by  any  one  of  the  partners. 

FIDUCIARY   RETURNS 

Sec.  225.  That  every  fiduciary  (except  receivers  appointed  by  authority 
of  law  in  possession  of  part  only  of  the  property  of  an  individual)  shall 
make  under  oath  a  return  for  the  individual,  estate  or  trust  for  which  he 
acts  (1)  if  the  net  income  of  such  individual  is  $1,000  or  over  if  single  or 
if  married  and  not  living  with  husband  or  wife,  or  $2,000  or  over  if  married 
and  living  with  husband  or  wife,  or  (2)  if  the  net  income  of  such  estate 
or  trust  is  $1,000  or  over  or  if  any  beneficiary  of  such  estate  or  trust  is  a 
nonresident  alien,  stating  specifically  the  items  of  the  gross  income  and 
the  deductions  and  credits  allowed  by  this  title.  Under  such  regulations 
as  the  commissioner  with  the  approval  of  the  secretary  may  prescribe,  a 
return  made  by  one  of  two  or  more  joint  fiduciaries  and  filed  in  the  office 
of  the  collector  of  the  district  where  such  fiduciary  resides  shall  be  a  sufficient 
compliance  with  the  above  requirement.  The  fiduciary  shall  make  oath  that 
he  has  sufficient  knowledge  of  the  affairs  of  such  individual,  estate  or  trust 
to  enable  him  to  make  the  return,  and  that  the  same  is,  to  the  best  of  his 
knowledge  and  belief,  true  and  correct. 

Fiduciaries  required  to  make  returns  under  this  act  shall  be  subject  to 
all  the  provisions  of  this  act  which  apply  to  individuals. 

RETURNS   WHEN   ACCOUNTING   PERIOD   CHANGED 

Sec.  226.  That  if  a  taxpayer,  with  the  approval  of  the  commissioner, 
changes  the  basis  of  computing  net  income  from  fiscal  year  to  calendar 
year  a  separate  return  shall  be  made  for  the  period  between  the  close  of 
the  last  fiscal  year  for  which  return  was  made  and  the  following  December 
thirty-first.  If  the  change  is  from-  calendar  year  to  fiscal  year,  a  separate 
return  shall  be  made  for  the  period  between  the  close  of  the  last  calendar 


REVENUE   ACT  OF    1918  1293 

year  for  which  return  was  made  and  the  date  designated  as  the  close  of  the 
fiscal  year.  If  the  change  is  from  one  fiscal  year  to  another  fiscal  year  a 
separate  return  shall  be  made  for  the  period  between  the  close  of  the  former 
fiscal  year  and  the  ilate  designated  as  the  close  of  the  new  fiscal  year.  If 
a  taxpayer  making  his  first  return  for  income  tax  keeps  his  accounts  on 
the  basis  of  a  fiscal  year  he  shall  make  a  separate  return  for  the  period 
between  the  beginning  of  the  calendar  year  in  which  such  fiscal  year  ends 
and  the  end  of  such  fiscal  year. 

In  all  of  the  above  cases  the  net  income  shall  be  computed  on  the  basis 
of  such  period  for  which  separate  return  is  made,  and  the  tax  shall  be  paid 
thereon  at  the  rate  for  the  calendar  year  in  which  such  period  is  included; 
and  the  credits  provided  in  subdivisions  (c)  and  (d)  of  §  216  shall  be 
reduced  respectively  to  amounts  which  bear  the  same  ratio  to  the  full 
credits  provided  in  such  subdivisions  as  the  number  of  months  in  such  period 
bears  to  twelve  months. 

TIME  AND   PLACE   FOR   FILING   RETURNS 

Sec.  227.  (a)  That  returns  shall  be  made  on  or  before  the  fifteenth  day 
of  the  third  month  following  the  close  of  the  fiscal  year,  or,  if  the  return 
is  made  on  the  basis  of  the  calendar  year,  then  the  i-eturn  shall  be  made  on 
or  before  the  fifteenth  day  of  March.  The  commissioner  may  grant  a 
reasonable  extension  of  time  for  filing  returns  whenever  in  his  judgment 
good  cause  exists  and  shall  keep  a  record  of  every  such  extension  and  the 
reason  therefor.  Except  in  the  case  of  taxpayers  who  are  abroad,  no  such 
extension  shall  be  for  more  than  six  months. 

(b)  Returns  shall  be  made  to  the  collector  for  the  district  in  which  is 
located  the  legal  residence  or  principal  place  of  business  of  the  person 
making  the  return,  or,  if  he  has  no  legal  residence  or  principal  place  of 
business  in  the  United  States,  then  to  the  collector  at  Baltimore,  Maryland. 

UNDERSTATEMENT  IN  RETURNS 

Sec.  228.  That  if  the  collector  or  deputy  collector  has  reason  to  believe 
that  the  amount  of  any  income  returned  is  understated,  he  shall  give  due 
notice  to  the  taxpayer  making  the  return  to  show  cause  why  the  amount 
of  the  return  should  not  be  increased,  and  upon  proof  of  the  amount  under- 
stated, may  increase  the  same  accordingly.  Such  taxpayer  may  furnish 
sworn  testimony  to  prove  any  relevant  facts  and  if  dissatisfied  with  the 
decision  of  the  collector  may  appeal  to  the  commissioner  for  his  decision, 
under  such  rules  of  procedure  as  may  be  prescribed  by  the  commissioner 
with  the  approval  of  the  secretary. 

Part  III — Corporations 

TAX   ON   CORPORATIONS 

Sec.  230.  (a)  That,  in  lieu  of  the  taxes  imposed  by  §  10  of  the  Revenue 
Act  of  1916,  as  amended  by  the  Revenue  Act  of  1917,  and  by  §  4  of  the 
Revenue  Act  of  1917,  there  shall  be  levied,  collected,  and  paid  for  each 
taxable  year  upon  the  net  income  of  every  corporation  a  tax  at  the  following 
rates : 

(1)  For  the  calendar  year  1918.  12  per  centum  of  the  amount  of  the  net 
income  in  excess  of  the  credits  provided  in  §  236;  and 

(2)  For  each  calendar  year  thereafter,  10  per  centum  of  such  excess 
amount. 


1294  APPENDIX 

(b)  For  the  purposes  of  the  act  approved  March  21,  1918,  entitled  "An 
act  to  provide  for  the  operation  of  transpoi'tation  systems  while  under 
federal  control,  for  the  just  compensation  of  their  owners,  and  for  other 
purposes,"  five-sixths  of  the  tax  imposed  by  11  (1)  of  subdivision  (a)  and 
four-fifths  of  the  tax  imposed  by  ^  (2)  of  subdivision  (a)  shall  be  treated 
as  levied  by  an  act  in  amendment  of  Title  I  of  the  Revenue  Act  of  1917. 

CONDITIONAL    AND    OTHER    EXEMPTIONS 

Sec.  231.  That  the  following  organizations  shall  be  exempt  from  taxation 
under  this  title — 

(1)  Labor,  agricultural,  or  horticultural  organizations; 

(2)  Mutual  savings  banks  not  having  a  capital  stock  represented  by 
shares ; 

(3)  Fraternal  beneficiary  societies,  orders,  or  associations,  (a)  operating 
under  the  lodge  system  or  for  the  exclusive  benefit  of  the  members  of  a  fra- 
ternity itself  operating  under  the  lodge  system,  and  (b)  providing  for  the 
payment  of  life,  sick,  accident,  or  other  benefits  to  the  members  of  such  so- 
ciety, order,  or  association  or  their  dependents; 

(4)  Domestic  building  and  loan  associations  and  co-operative  banks  with- 
out capital  stock  organized  and  operated  for  mutual  purposes  and  without 
profit; 

(5)  Cemetery  companies  owned  and  operated  exclusively  for  the  benefit 
of  their  members; 

(6)  Corporations  organized  and  operated  exclusively  for  religious,  chari- 
table, scientific,  or  educational  purposes,  or  for  the  prevention  of  cruelty  to 
children  or  animals,  no  part  of  the  net  earnings  of  which  inures  to  the  bene- 
fit of  any  private  stockholder  or  individual; 

(7)  Business  leagues,  chambers  of  commerce,  or  boards  of  trade,  not  or- 
ganized for  profit  and  no  part  of  the  net  earnings  of  which  inures  to  the 
benefit  of  any  private  stockholder  or  individual; 

(8)  Civic  leagues  or  organizations  not  organized  for  profit  but  operated 
exclusively  for  the  promotion  of  social  welfare; 

(9)  Clubs  organized  and  operated  exclusively  for  pleasure,  recreation, 
and  other  nonprofitable  purposes,  no  part  of  the  net  earnings  of  which  inures 
to  the  benefit  of  any  private  stockholder  or  member; 

(10)  Farmers'  or  other  mutual  hail,  cyclone,  or  fire  insurance  companies, 
mutual  ditch  or  irrigation  companies,  mutual  or  co-operative  telephone  com- 
panies, or  like  organizations  of  a  purely  local  character,  the  income  of  which 
consists  solely  of  assessments,  dues,  and  fees  collected  from  members  for  the 
sole  purpose  of  meeting  expenses; 

(11)  Farmers',  fruit  growers',  or  like  associations,  organized  and  oper- 
ated as  sales  agents  for  the  purpose  of  marketing  the  products  of  members 
and  turning  back  to  them  the  proceeds  of  sales,  less  the  necessary  selling 
expenses,  on  the  basis  of  the  quantity  of  produce  furnished  by  them ; 

(12)  Corporations  organized  for  the  exclusive  purpose  of  holding  title  to 
property,  collecting  income  therefrom,  and  turning  over  the.  entire  amount 
thereof,  less  expenses,  to  an  organization  which  itself  is  exempt  from  the 
tax  imposed  by  this  title; 

(13)  Federal  land  banks  and  national  farm-loan  associations  as  provided 
in  §  26  of  the  act  approved  July  17,  1916,  entitled  "An  act  to  provide  capital 
for  agricultural  development,  to  create  standard  forms  of  investment  based 


REVENUE   ACT  OF   1918  1295 

upon  farm  mortgage,  to  equalize  rates  of  interest  upon  farm  loans,  to  fur- 
nish a  market  for  United  States  bonds,  to  create  government  depositaries 
and  financial  agents  for  the  United  States,  and  for  other  purposes;" 
(14)    Personal  service  corporations. 

NET  INCOME  DEFINED 

Sec.  232.  That  in  the  case  of  a  corporation  subject  to  the  tax  imposed  by 
§  230  the  term  "net  income"  means  the  gross  income  as  defined  in  §  233  less 
the  deductions  allowed  by  §  234,  and  the  net  income  shall  be  computed 
on  the  same  basis  as  is  provided  in  subdivision  (b)  of  §  212  or  in  §  226. 

GROSS    INCOME   DEFINED 

Sec.  233.  (a)  That  in  the  case  of  a  corporation  subject  to  the  tax  imposed 
by  §  230  the  term  "gross  income"  means  the  gross  income  as  defined  in  §  213, 
except  that : 

(1)  In  the  case  of  life  insurance  companies  there  shall  not  be  included  in 
gross  income  such  portion  of  any  actual  premium  received  from  any  individ- 
ual policyholder  as  is  paid  back  or  credited  to  or  treated  as  an  abatement  of 
premium  of  such  policyholder  within  the  taxable  year. 

(2)  Mutual  marine  insurance  companies  shall  include  in  gross  income  the 
gross  premiums  collected  and  received  by  them  less  amounts  paid  for  rein- 
surance. 

(b)  In  the  case  of  a  foreign  corporation  gross  income  includes  only  the 
gross  income  from  sources  within  the  United  States,  including  the  interest 
on  bonds,  notes,  or  other  interest-bearing  obligations  of  residents,  corporate 
or  otherwise,  dividends  from  resident  corporations,  and  including  all  amounts 
received  (although  paid  under  a  contract  for  the  sale  of  goods  or  otherwise) 
representing  profits  on  the  manufacture  and  disposition  of  goods  within  the 
United  States. 

DEDUCTIONS  ALLOWED 

Sec.  234.  (a)  That  in  computing  the  net  income  of  a  corporation  subject 
to  the  tax  imposed  by  §  230  there  shall  be  allowed  as  deductions: 

(1)  All  the  ordinary  and  necessary  expenses  paid  or  incurred  during  the 
taxable  year  in  carrying  on  any  trade  or  business,  including  a  reasonable 
allowance  for  salaries  or  other  compensation  for  personal  services  actually 
rendered,  and  including  rentals  or  other  payments  required  to  be  made  as 
a  condition  to  the  continued  use  or  possession  of  property  to  which  the  cor- 
poration has  not  taken  or  is  not  taking  title,  or  in  which  it  has  no  equity; 

(2)  All  interest  paid  or  accrued  within  the  taxable  year  on  its  indebted- 
ness, except  on  indebtedness  incurred  or  continued  to  purchase  or  carry 
obligations  or  securities  (other  than  obligations  of  the  United  States  issued 
after  September  24.  1917)  the  interest  upon  which  is  wholly  exempt  from 
taxation  under  this  title  as  income  to  the  taxpayer,  or,  in  the  case  of  a 
foreign  corporation,  the  proportion  of  such  interest  which  the  amount  of  its 
gross  income  from  sources  within  the  United  States  bears  to  the  amount  of 
its  gross  income  from  all  sources  within  and  without  the  United  States; 

(3)  Taxes  paid  or  accrued  within  the  taxable  year  imposed  (a)  by  the 
authority  of  the  United  States,  except  income,  war-profits  and  excess-profits 
taxes;  or  (b)  by  the  authority  of  any  of  its  possessions,  except  the  amount 
of  income,  war-profits  and  excess-profits  taxes  allowed  as  a  credit  under 
§  238;  or  (c)  by  the  authority  of  any  state  or  territory,  or  any  county, 
school  district,  municipality,  or  other  taxing  subdivision   of  any  state  or 


1296  APPENDIX 

territory,  not  including  those  assessed  against  local  benefits  of  a  kind  tending 
to  increase  the  value  of  the  property  assessed;  or  (d)  in  the  case  of  a  domes- 
tic corporation,  by  the  authority  of  any  foreign  country,  except  the  amount 
of  income,  war-profits  and  excess-profits  taxes  allowed  as  a  credit  under 
§  238;  or  (e)  in  the  case  of  a  foreign  corporation,  by  the  authority  of  any 
foreign  country  (except  income,  war-profits  and  excess-profits  taxes,  and 
taxes  assessed  against  local  benefits  of  a  kind  tending  to  increase  the  value 
of  the  property  assessed),  upon  the  property  or  business:  Provided,  That  in 
the  case  of  obligors  specified  in  subdivision  (b)  of  §  221  no  deduction  for 
the  payment  of  the  tax  imposed  by  this  title  or  any  other,  tax  paid  pursuant 
to  the  contract  or  provision  referred  to  in  that  subdivision,  shall  be  allowed; 

(4)  Losses  sustained  during  the  taxable  year  and  not  compensated  for  by 
insurance  or  otherwise; 

(5)  Debts  ascertained  to  be  worthless  and  charged  off  within  the  taxable 
year ; 

(6)  Amounts  received  as  dividends  from  a  corporation  which  is  taxable 
under  this  title  upon  its  net  income,  and  amounts  received  as  dividends  from 
a  personal  service  corporation  out  of  earnings  or  profits  upon  which  income 
tax  has  been  imposed  by  Act  of  Congress ; 

(7)  A  reasonable  allowance  for  the  exhaustion,  wear  and  tear  of  property 
used  in  the  trade  or  business,  including  a  reasonable  allowance  for  obso- 
lescence; 

(8)  In  the  case  of  buildings,  machinery,  equipment,  or  other  facilities,  con- 
structed, erected,  installed,  or  acquired,  on  or  after  April  6,  1917,  for  the 
production  of  articles  contributing  to  the  prosecution  of  the  present  war,  and 
in  the  case  of  vessels  constructed  or  acquired  on  or  after  such  date  for  the 
transportation  of  articles  or  men  contributing  to  the  prosecution  of  the  pres- 
ent war,  there  shall  be  allowed  a  reasonable  deduction  for  the  amortiza- 
tion of  such  part  of  the  cost  of  such  facilities  or  vessels  as  has  been  borne  by 
the  taxpayer,  but  not  again  including  any  amount  otherwise  allowed  under 
this  title  or  previous  Acts  of  Congress  as  a  deduction  in  computing  net  in- 
come. At  any  time  within  three  years  after  the  termination  of  the  present 
war,  the  commissioner  may,  and  at  the  request  of  the  taxpayer  shall,  re- 
examine the  return,  and  if  he  then  finds  as  a  result  of  an  appraisal  or  from 
other  evidence  that  the  deduction  originally  allowed  was  incorrect,  the  taxes 
imposed  by  this  title  and  by  Title  III  for  the  year  or  years  affected  shall  be 
redetermined  and  the  amount  of  tax  due  upon  such  redetermination,  if  any, 
shall  be  paid  upon  notice  and  demand  by  the  collector,  or  the  amount  of  tax 
overpaid,  if  any,  shall  be  credited  or  refunded  to  the  taxpayer  in  accordance 
with  the  provisions  of  §  252; 

(9)  In  the  case  of  mines,  oil  and  gas  wells,  other  natural  deposits,  and 
timber,  a  reasonable  allowance  for  depletion  and  for  depreciation  of  im- 
provements, according  to  the  peculiar  conditions  in  each  case,  based  upon 
cost  including  cost  of  development  not  otherwise  deducted:  Provided,  That 
in  the  case  of  such  properties  acquired  prior  to  March  1,  1913,  the  fair  mar- 
ket value  of  the  property  (or  the  taxpayer's  interest  therein)  on  that  date 
shall  be  taken  in  lieu  of  cost  up  to  that  date :  Provided  further.  That  in  the 
case  of  mines,  oil  and  gas  wells,  discovered  by  the  taxpayer,  on  or  after 
March  1,  1913,  and  not  acquired  as  the  result  of  purchase  of  a  proven  tract 
or  lease,  where  the  fair  market  value  of  the  property  is  materially  dispropor- 
tionate to  the  cost,  the  depletion  allowance  shall  be  based  upon  the  fair  mar- 
ket value  of  the  property  at  the  date  of  the  discovery,  or  within  thirty  days 
thereafter;  such  reascr.able  a.lowancc  in  all  the  above  cases  to  be  made 


REVENUE  ACT  OF    1918  1297 

under  rules  and  regulations  to  be  prescribed  by  the  commissioner  with  the 
approval  of  the  secretary.  In  the  case  of  leases  the  deductions  allowed  by 
this  paragraph  shall  be  equitably  apportioned  between  the  lessor  and  lessee; 

(10)  In  the  case  of  insurance  companies,  in  addition  to  the  above:  (a) 
The  net  addition  required  by  law  to  be  made  within  the  taxable  year  to  re- 
serve funds  (including  in  the  case  of  assessment  insurance  companies  the 
actual  deposit  of  sums  with  state  or  territorial  officers  pursuant  to  law  as 
additions  to  guarantee  or  reserve  funds)  ;  and  (b)  the  sums  other  than  divi- 
dends paid  within  the  taxable  year  on  policy  and  annuity  contracts; 

(11)  In  the  case  of  corporations  issuing  policies  covering  life,  health,  and 
accident  insurance  combined  in  one  policy  issued  on  the  weekly  premium  pay- 
ment plan  continuing  for  life  and  not  subject  to  cancellation,  in  addition  to 
the  above,  such  portion  of  the  net  addition  (not  required  by  law)  made  with- 
in the  taxable  year  to  reserve  funds  as  the  commissioner  finds  to  be  required 
for  the  protection  of  the  holders  of  such  policies  only; 

(12)  In  the  case  of  mutual  marine  insurance  companies,  there  shall  bo 
allowed,  in  addition  to  the  deductions  allowed  in  H  (D  to  (10),  inclusive, 
amounts  repaid  to  policyholders  on  account  of  premiums  previously  paid  by 
them,  and  interest  paid  upon  such  amounts  between  the  ascertainment  and 
the  payment  thereof; 

(13)  In  the  case  of  mutual  insurance  companies  (other  than  mutual  life 
or  mutual  marine  insurance  companies)  requiring  their  members  to  make 
premium  deposits  to  provide  for  losses  and  expenses,  there  shall  be  allowed, 
in  addition  to  the  deduction  allowed  in  ^^  (1)  to  (10),  inclusive,  (unless 
otherwise  allowed  under  such  paragraphs)  the  amount  of  premium  deposits 
returned  to  their  policyholders  and  the  amount  of  premium  deposits  retained 
for  the  payment  of  losses,  expenses,  and  reinsurance  reserves; 

(14)  (a)  At  the  time  of  filing  return  for  the  taxable  year  1918  a  tax- 
payer may  file  a  claim  in  abatement  based  on  the  fact  that  he  has  sustained 
a  substantial  loss  (whether  or  not  actually  realized  by  sale  or  other  disposi- 
tion) resulting  from  any  material  reduction  (not  due  to  temporary  fluctua- 
tion) of  the  value  of  the  inventory  for  such  taxable  year,  or  from  the 
actual  payment  after  the  close  of  such  taxable  year  of  rebates  in  pursuance 
of  contracts  entered  into  during  such  year  upon  sales  made  during  such 
year.  In  such  case  payment  of  the  amount  of  the  tax  covered  by  such  claim 
shall  not  be  required  until  the  claim  is  decided,  but  the  taxpayer  shall  accom- 
pany his  claim  with  a  bond  in  double  the  amount  of  the  tax  covered  by  the 
claim,  with  sureties  satisfactory  to  the  commissioner,  conditioned  for  the 
payment  of  any  part  of  such  tax  found  to  be  due,  with  interest.  If  any  part 
of  such  claim  is  disallowed  then  the  remainder  of  the  tax  due  shall  on  notice 
and  demand  by  the  collector  be  paid  by  the  taxpayer  with  interest  at  the 
rate  of  1  per  centum  per  month  from  the  time  the  tax  would  have  been  due 
had  no  such  claim  been  filed.  If  it  is  shown  to  the  satisfaction  of  the  com- 
missioner that  such  substantial  loss  has  been  sustained,  then  in  computing 
the  taxes  imposed  by  this  title  and  by  Title  III  the  amount  of  such  loss  shall 
be  deducted  from  the  net  income,  (b)  If  no  such  claim  is  filed,  but  it  is 
shown  to  the  satisfaction  of  the  commissioner  that  during  the  taxable  year 
1919  the  taxpayer  has  sustained  a  substantial  loss  of  the  character  above  de- 
scribed then  the  amount  of  such  loss  shall  be  deducted  from  the  net  income 
for  the  taxable  year  1918  and  the  taxes  imposed  by  this  title  and  by  Title  III 
for  such  year  shall  be  redetermined  accordingly.  Any  amount  found  to  be  due 
to  the  taxpayer  upon  the  basis  of  such  redetermination  shall  be  credited  or 
refunded  to  the  taxpayer  in  accordance  with  the  provisions  of  §  252. 


1298  APPENDIX 

(b)  In  the  case  of  a  foreign  corporation  the  deductions  allowed  in  sub- 
division (a),  except  those  allowed  in  ^  (2)  and  in  clauses  (a),  (b),  and  (c) 
of  ^  (3),  shall  be  allowed  only  if  and  to  the  extent  that  they  are  connected 
with  income  arising  from  a  source  within  the  United  States ;  and  the  proper 
apportionment  and  allocation  of  the  deductions  with  respect  to  sources  of 
income  within  and  without  the  United  States  shall  be  determined  under  rules 
and  regulations  prescribed  by  the  commissioner  with  the  approval  of  the 
secretary. 

ITEMS    NOT    DEDUCTIBLE 

Sec.  235.  That  in  computing  net  income  no  deduction  shall  in  any  case  be 
allowed  in  respect  of  any  of  the  items  specified  in  §215. 

CREDITS  ALLOWED 

Sec.  236.  That  for  the  purpose  only  of  the  tax  imposed  by  §  230  there  shall 
be  allowed  the  following  credits : 

(a)  The  amount  received  as  interest  upon  obligations  of  the  United  States 
and  bonds  issued  by  the  War  Finance  Corporation,  which  is  included  in 
gross  income  under  §  233 ; 

(b)  The  amount  of  any  taxes  imposed  by  Title  III  for  the  same  taxable 
year:  Provided,  That  in  the  case  of  a  corporation  which  makes  return  for 
a  fiscal  year  beginning  in  1917  and  ending  in  1918,  in  computing  the  tax  as 
provided  in  subdivision  (a)  of  §  205,  the  tax  computed  for  the  entire  period 
under  Title  II  of  the  Revenue  Act  of  1917  shall  be  credited  against  the  net 
income  computed  for  the  entire  period  under  Title  I  of  the  Revenue  Act  of 
1916  as  amended  by  the  Revenue  Act  of  1917  and  under  Title  I  of  the  Rev- 
enue Act  of  1917,  and  the  tax  computed  for  the  entire  period  under  Title  III 
of  this  Act  at  the  rates  prescribed  for  the  calendar  year  1918  shall  be 
credited  against  the  net  income  computed  for  the  entire  period  under  this 
title;  and 

(c)  In  the  case  of  a  domestic  corporation,  $2,000. 

PAYMENT   OF  TAX  AT   SOURCE 

Sec.  237.  That  in  the  case  of  foreign  corporations  subject  to  taxation 
under  this  title  not  engaged  in  trade  or  business  within  the  United  States 
and  not  having  any  office  or  place  of  business  therein,  there  shall  be  deducted 
and  withheld  at  the  source  in  the  same  manner  and  upon  the  same  items  of 
income  as  is  provided  in  §  221  a  tax  equal  to  10  per  centum  thereof,  and 
such  tax  shall  be  returned  and  paid  in  the  same  manner  and  subject  to  the 
same  conditions  as  provided  in  that  section :  Provided,  That  in  the  case  of 
interest  described  in  subdivision  (b)  of  that  section  the  deduction  and  with- 
holding shall  be  at  the  rate  of  2  per  centum. 

CREDIT  FOR  TAXES 

Sec.  238.  (a)  That  in  the  case  of  a  domestic  corporation  the  total  taxes 
imposed  for  the  taxable  year  by  this  title  and  by  Title  III  shall  be  credited 
with  the  amount  of  any  income,  war-profits  and  excess-profits  taxes  paid  dur- 
ing the  taxable  year  to  any  foreign  country,  upon  income  derived  from 
sources  therein,  or  to  any  possession  of  the  United  States. 

If  accrued  taxes  when  paid  differ  from  the  amounts  claimed  as  credits  by 
the  corporation,  or  if  any  tax  paid  is  refunded  in  whole  or  in  part,  the  cor- 
poration shall  at  once  notify  the  commissioner  who  shall  redetermine  the 
amount  of  the  taxes  due  under  this  title  and  under  Title  III  for  the  year  or 


REVENUE   ACT  OF   1918  1299 

years  affected,  and  the  amount  of  taxes  due  upon  such  redetermination,  if 
any,  shall  be  paid  by  the  corporation  upon  notice  and  demand  by  the  collector, 
or  the  amount  of  taxes  overpaid,  if  any,  shall  be  credited  or  refunded  to  the 
corporation  in  accordance  with  the  provisions  of  §  252.  In  the  case  of  such  a 
tax  accrued  but  not  paid,  the  commissioner  as  a  condition  precedent  to  the 
allowance  of  this  credit  may  require  the  corporation  to  give  bond  with 
sureties  satisfactory  to  and  to  be  approved  by  him  in  such  penal  sum  as  he 
may  require,  conditioned  for  the  payment  by  the  taxpayer  of  any  amount  of 
taxes  found  due  upon  any  such  redetermination;  and  the  bond  herein  pre- 
scribed shall  contain  such  further  conditions  as  the  commissioner  may  re- 
quire. 

(b)  This  credit  shall  be  allowed  only  if  the  taxpayer  furnishes  evidence 
satisfactory  to  the  commissioner  showing  the  amount  of  income  derived  from 
sources  within  such  foreign  country  or  such  possession  of  the  United  States, 
as  the  case  may  be,  and  all  other  information  necessary  for  the  computation 
of  such  credit. 

(c)  If  a  domestic  corporation  makes  a  return  for  a  fiscal  year  beginning 
in  1917  and  ending  in  1918,  only  that  proportion  of  this  credit  shall  be  al- 
lowed which  the  part  of  such  period  within  the  calendar  year  1918  bears  to 
the  entire  period. 

CORPORATION  RETURNS 

Sec.  239.  That  every  corporation  subject  to  taxation  under  this  title  and 
every  personal  service  corporation  shall  make  a  return,  stating  specifically 
the  items  of  its  gross  income  and  the  deductions  and  credits  allowed  by  this 
title.  The  return  shall  be  swom  to  by  the  president,  vice  president,  or  other 
principal  officer  and  by  the  treasurer  or  assistant  treasurer.  If  any  foreign 
corporation  has  no  office  or  place  of  business  in  the  United  States  but  has 
an  agent  in  the  United  States,  the  return  shall  be  made  by  the  agent.  In 
cases  where  receivers,  trustees  in  bankruptcy,  or  assignees  are  operating  the 
property  or  business  of  corporations,  such  receivers,  trustees,  or  assignees 
shall  make  returns  for  such  corporations  in  the  same  manner  and  form  as 
corporations  are  required  to  make  returns.  Any  tax  due  on  the  basis  of  such 
returns  made  by  receivers,  trustees,  or  assignees  shall  be  collected  in  the 
same  manner  as  if  collected  from  the  corporation  of  whose  business  or 
property  they  have  custody  and  control. 

Returns  made  under  this  section  shall  be  subject  to  the  provisions  of 
§§  226  and  228.  When  return  is  made  under  §  226  the  credit  provided  in 
subdivision  (c)  of  §  236  shall  be  reduced  to  an  amount  which  bears  the  same 
ratio  to  the  full  credit  therein  provided  as  the  number  of  months  in  the 
period  for  which  such  return  is  made  bears  to  twelve  months. 

CONSOLIDATED   RETURNS 

Sec.  240.  (a)  That  corporations  which  are  affiliated  within  the  meaning 
of  this  section  shall,  under  regulations  to  be  prescribed  by  the  commissioner 
with  the  approval  of  the  secretary,  make  a  consolidated  return  of  net  in- 
come and  invested  capital  for  the  purposes  of  this  title  and  Title  III,  and  the 
taxes  thereunder  shall  be  computed  and  determined  upon  the  basis  of  such 
return:  Provided,  That  there  shall  be  taken  out  of  such  consolidated  net 
income  and  invested  capital,  the  net  income  and  invested  capital  of  any  such 
affiliated  corporation  organized  after  August  1,  1914,  and  not  successor  to  a 
then  existing  business,  50  per  centum  or  more  of  whose  gross  income  consists 
of  gains,  profits,  commissions,  or  other  income,  derived  from  a  government 


1300  APPENDIX 

contract  or  contracts  made  between  April  6,  1917,  and  November  11,  1918, 
both  dates  inclusive.  In  such  case  the  corporation  so  taken  out  shall  be  sep- 
arately assessed  on  the  basis  of  its  own  invested  capital  and  net  income 
and  the  remainder  of  such  affiliated  group  shall  be  assessed  on  the  basis  of 
the  remaining  consolidated  invested  capital  and  net  income. 

In  any  case  in  which  a  tax  is  assessed  upon  the  basis  of  a  consolidated  re- 
turn, the  total  tax  shall  be  computed  in  the  first  instance  as  a  unit  and  shall 
then  be  assessed  upon  the  respective  affiliated  corporations  in  such  propor- 
tions as  may  be  agreed  upon  among  them,  or,  in  the  absence  of  any  such 
agreement,  then  on  the  basis  of  the  net  income  properly  assignable  to  eac'i. 
There  shall  be  allowed  in  computing  the  income  tax  only  one  specific  credit 
of  $2,000  (as  provided  in  §  236)  ;  in  computing  the  war-profits  credit  (as 
provided  in  §  311)  only  one  specific  exemption  of  $3,000;  and  in  computing 
the  excess-profits  credits  (as  provided  in  §  312)  only  one  specific  exemption 
of  $3,000. 

(b)  For  the  purpose  of  this  section  two  or  more  domestic  corporations 
shall  be  deemed  to  be  affiliated  (1)  if  one  corporation  owns  directly  or  con- 
trols through  closely  affiliated  interests  or  by  a  nominee  or  nominees  sub- 
stantially all  the  stock  of  the  other  or  others,  or  (2)  if  substantially  all  the 
stock  of  two  or  more  corporations  is  ovimed  or  controlled  by  the  same  in- 
terests. 

(c)  For  the  purposes  of  §  238  a  domestic  corporation  which  owns  a  major- 
ity of  the  voting  stock  of  a  foreign  corporation  shall  be  deemed  to  have  paid 
the  same  proportion  of  any  income,  war-profits  and  excess-profits  taxes  paid 
(but  not  including  taxes  accrued)  by  such  foreign  corporation  during  the 
taxable  year  to  any  foreign  country  or  to  any  possession  of  the  United 
States  upon  income  derived  from  sources  without  the  United  States,  which 
the  amount  of  any  dividends  (not  deductible  under  §  234)  received  by  such 
domestic  corporation  from  such  foreign  corporation  during  the  taxable  year 
bears  to  the  total  taxable  income  of  such  foreign  corporation  upon  or  with 
respect  to  which  such  taxes  were  paid :  Provided,  That  in  no  such  case  shall 
the  amount  of  the  credit  for  such  taxes  exceed  the  amount  of  such  dividends 

(not  deductible  under  §  234)  received  by  such  domestic  corporation  during 
the  taxable  year. 

TIME  AND   PLACE  FOR  FILING  RETURNS 

Sec.  241.  (a)  That  returns  of  corporations  shall  be  made  at  the  same  time 
as  is  provided  in  subdivision  (a)  of  §  227. 

(b)  Returns  shall  be  made  to  the  collector  of  the  district  in  which  is 
located  the  principal  place  of  business  or  principal  office  or  agency  of  the 
corporation,  or,  if  it  has  no  principal  place  of  business  or  principal  office  or 
agency  in  the  United  States,  then  to  the  collector  at  Baltimore,  Maryland. 

Part  IV — Administrative  Provisions 

PAYMENT  OF  TAXES 

Sec.  250.  (a)  That  except  as  otherwise  provided  in  this  section  and  §§  221 
and  237  the  tax  shall  be  paid  in  four  installments,  each  consisting  of  one- 
fourth  of  the  total  amount  of  the  tax.  The  first  installment  shall  be  paid  at 
the  time  fixed  by  law  for  filing  the  return,  and  the  second  installment  shall 
be  paid  on  the  fifteenth  day  of  the  third  month,  the  third  installment  on  the 
fifteenth  day  of  the  sixth  month,  and  the  fourth  installment  on  the  fifteenth 
day  of  the  ninth  month,  after  the  time  fixed  by  law  for  filing  the  return. 
Where  an  extension  of  time  for  filing  a  return  is  granted  the  time  for  pay- 


REVENUE   ACT   OF   1918  1301 

ment  of  the  first  installment  shall  be  postponed  until  the  date  of  the  expira- 
tion of  the  period  of  the  extension,  but  the  time  for  payment  of  the  other 
installments  shall  not  be  postponed  unless  the  commissioner  so  provides  in 
granting  the  extension.  In  any  case  in  which  the  time  for  the  payment  of 
any  installment  is  at  the  request  of  the  taxpayer  thus  postponed  there  shall 
be  added  as  part  of  such  installment  interest  thereon  at  the  rate  of  /^  of  1 
per  centum  per  month  from  the  time  it  would  have  been  due  if  no  extension 
had  been  granted  until  paid.  If  any  installment  is  not  paid  when  due,  the 
whole  amount  of  the  tax  unpaid  shall  become  due  and  payable  upon  notice 
and  demand  by  the  collector,  .  .      ,  . 

The  tax  may  at  the  option  of  the  taxpayer  be  paid  in  a  single  payment 
instead  of  in  installments,  in  which  case  the  total  amount  shall  be  paid  on  or 
before  the  time  fixed  by  law  for  filing  the  return,  or,  where  an  extension  of 
time  for  filing  the  return  has  been  granted,  on  or  before  the  expiration  ol 
the  period  of  such  extension.  _     . 

(b)  As  soon  as  practicable  after  the  return  is  filed,  the  commissioner  shall 
examine  it.  If  it  then  appears  that  the  correct  amount  of  the  tax  is  greater 
or  less  than  that  shown  in  the  return,  the  installments  shall  be  recomputed. 
If  the  amount  already  paid  exceeds  that  which  should  have  been  paid  on  the 
basis  of  the  installments  as  recomputed,  the  excess  so  paid  shall  be  credited 
against  the  subsequent  installments;  and  if  the  amount  already  paid  exceeds 
the  correct  amount  of  the  tax,  the  excess  shall  be  credited  or  refunded  to  the 
taxpayer  in  accordance  with  the  provisions  of  §  252. 

If  the  amount  already  paid  is  less  than  that  which  should  have  been  paid, 
the  difference  shall,  to  the  extent  not  covered  by  any  credits  then  due  to  the 
taxpayer  under  §  252,  be  paid  upon  notice  and  demand  by  the  collector.  In 
such  case  if  the  return  is  made  in  good  faith  and  the  understatement  of 
the  amount  in  the  return  is  not  due  to  any  fault  of  the  taxpayer,  there  shall 
be  no  penalty  because  of  such  understatement.  If  the  understatement  is  due 
to  negligence  on  the  part  of  the  taxpayer,  but  without  intent  to  defraud, 
there  shall  be  added  as  part  of  the  tax  5  per  centum  of  the  total  amount  ot 
the  deficiency,  plus  interest  at  the  rate  of  1  per  centum  per  month  on  the 
amount  of  the  deficiency  of  each  installment  from  the  time  the  installment 

was  due.  j    ^u     j. 

If  the  understatement  is  false  or  fraudulent  with  intent  to  evade  the  tax, 
then  in  lieu  of  the  penalty  provided  by  §  3176  of  the  Revised  Statutes,  as 
amended,  for  false  or  fraudulent  returns  willfully  made,  but  in  addition  to 
other  penalties  provided  by  law  for  false  or  fraudulent  returns,  there  shall 
be  added  as  part  of  the  tax  50  per  centum  of  the  amount  of  the  deficiency. 

(c)  If  the  return  is  made  pursuant  to  §  3176  of  the  Revised  Statutes  as 
amended,  the  amount  of  tax  determined  to  be  due  under  such  return  shall  be 
paid  upon  notice  and  demand  by  the  collector, 

(d)  Except  in  the  case  of  false  or  fraudulent  returns  with  intent  to  evade 
the  tax  the  amount  of  tax  due  under  any  return  shall  be  determined  and 
assessed  by  the  commissioner  within  five  years  after  the  return  was  due  or 
was  made,  and  no  suit  or  proceeding  for  the  collection  of  any  tax  shall  be 
begun  after  the  expiration  of  five  years  after  the  date  when  the  return  was 
due  or  was  made.  In  the  case  of  such  false  or  fraudulent  returns,  the  amount 
of  tax  due  may  be  determined  at  any  time  after  the  return  is  filed,  and  the 
tax  may  be  collected  at  any  time  after  it  becomes  due. 

(e)  If  any  tax  remains  unpaid  after  the  date  when  it  is  due,  and  for  ten 
days  after  notice  and  demand  by  the  collector,  then,  except  in  the  case  of 
estates  of  insane,  deceased,  or  insolvent  persons,  there  shall  be  added  as  part 


1302  APPENDIX 

of  the  tax  the  sum  of  5  per  centum  on  the  amount  due  but  unpaid,  plus  in- 
terest at  the  rate  of  1  per  centum  per  month  upon  such  amount  from  the 
time  it  became  due :  Provided,  That  as  to  any  such  amount  which  is  the  sub- 
ject of  a  bona  fide  claim  for  abatement  such  sum  of  5  per  centum  shall  not 
be  added  and  the  interest  from  the  time  the  amount  was  due  until  the  claim 
is  decided  shall  be  at  the  rate  of  V2  of  1  per  centum  per  month. 

In  the  case  of  the  first  installment  provided  for  in  subdivision  (a)  the  in- 
structions printed  on  the  return  shall  be  deemed  sufficient  notice  of  the  date 
when  the  tax  is  due  and  sufficient  demand,  and  the  taxpayer's  computation 
of  the  tax  on  the  return  shall  be  deemed  sufficient  notice  of  the  amount  due. 

(f )  In  any  case  in  which  in  order  to  enforce  payment  of  a  tax  it  is  neces- 
sary for  a  collector  to  cause  a  warrant  of  distraint  to  be  served,  there  shall 
also  be  added  as  part  of  the  tax  the  sum  of  $5. 

(g)  If  the  commissioner  finds  that  a  taxpayer  designs  quickly  to  depart 
from  the  United  States  or  to  remove  his  property  therefrom,  or  to  conceal 
himself  or  his  property  therein,  or  to  do  any  other  act  tending  to  prejudice 
or  to  render  wholly  or  partly  ineffectual  proceedings  to  collect  the  tax  for 
the  taxable  year  then  last  past  or  the  taxable  year  then  current  unless  such 
proceeding  be  brought  without  delay,  the  commissioner  shall  declare  the  tax- 
able period  for  such  taxpayer  terminated  at  the  end  of  the  calendar  month 
then  last  past  and  shall  cause  notice  of  such  finding  and  declaration  to  be 
given  the  taxpayer,  together  with  a  demand  for  immediate  payment  of  the 
tax  for  the  taxable  period  so  declared  terminated  and  of  the  tax  for  the  pre- 
ceding taxable  year  or  so  much  of  said  tax  as  is  unpaid,  whether  or  not  the 
time  otherwise  allowed  by  law  for  filing  return  and  paying  the  tax  has  ex- 
pired ;  and  such  taxes  shall  thereupon  become  immediately  due  and  payable. 
In  any  action  or  suit  brought  to  enforce  payment  of  taxes  made  due  and 
payable  by  virtue  of  the  provisions  of  this  subdivision  the  finding  of  the 
commissioner,  made  as  herein  provided,  whether  made  after  notice  to  the 
taxpayer  or  not,  shall  be  for  all  purposes  presumptive  evidence  of  the  tax- 
payer's design.  A  taxpayer  who  is  not  in  default  in  making  any  return  or 
paying  income,  war-profits,  or  excess-profits  tax  under  any  Act  of  Congress 
may  furnish  to  the  United  States,  under  regulations  to  be  prescribed  by  the 
commissioner  with  the  approval  of  the  secretary,  security  approved  by  the 
commissioner  that  he  will  duly  make  the  return  next  thereafter  required  to 
be  filed  and  pay  the  tax  next  thereafter  required  to  be  paid.  The  commis- 
sioner m.ay  approve  and  accept  in  like  manner  security  for  return  and  pay- 
ment of  taxes  made  due  and  payable  by  virtue  of  the  provisions  of  this  sub- 
division, provided  the  taxpayer  has  paid  in  full  all  other  income,  war-profits, 
or  excess-profits  taxes  due  from  him  under  any  Act  of  Congress.  If  security 
is  approved  and  accepted  pursuant  to  the  provisions  of  this  subdivision  and 
such  further  or  other  security  with  respect  to  the  tax  or  taxes  covered  there- 
by is  given  as  the  commissioner  shall  from  time  to  time  find  necessary  and 
require,  payment  of  such  taxes  shall  not  be  enforced  by  any  proceedings 
under  the  provisions  of  this  subdivision  prior  to  the  expiration  of  the  time 
otherwise  allowed  for  paying  such  respective  taxes. 

RECEIPTS  FOR  TAXES 

Sec.  251.  That  every  collector  to  whom  any  payment  of  any  tax  is  made 
under  the  provisions  of  this  title  shall  upon  request  give  to  the  person  mak- 
ing such  payment  a  full  written  or  printed  receipt,  stating  the  amount  paid 
and  the  particular  account  for  which  such  payment  was  made;  and  when- 
ever any  debtor  pays  taxes  on  account  of  payments  made  or  to  be  made  by 


REVENUE   ACT  OF   1918  1303 

him  to  separate  creditors  the  collector  shall,  if  requested  by  such  debtor,  give 
a  separate  receipt  for  the  tax  paid  on  account  of  each  creditor  in  such  form 
that  the  debtor  can  conveniently  produce  such  receipts  separately  to  his 
several  creditors  in  satisfaction  of  their  respective  demands  up  to  the 
amounts  stated  in  the  receipts;  and  such  receipt  shall  be  sufficient  evidence 
in  favor  of  such  debtor  to  justify  him  in  withholding  from  his  next  payment 
to  his  creditor  the  amount  therein  stated ;  but  the  creditor  may,  upon  giving 
to  his  debtor  a  full  written  receipt  acknowledging  the  payment  to  him  of  any 
sum  actually  paid  and  accepting  the  amount  of  tax  paid  as  aforesaid  (speci- 
fying the  same)  as  a  further  satisfaction  of  the  debt  to  that  amount,  re- 
quire the  surrender  to  him  of  such  collector's  receipt. 

REFUNDS 

Sec  252  That  if,  upon  examination  of  any  return  of  income  made  pur- 
suant" to  this  Act,  the  Act  of  August  5,  1909,  entitled  "An  Act  to  provide 
revenue,  equalize  duties,  and  encourage  the  industries  of  the  United  States, 
and  for  other  purposes,"  the  Act  of  October  3,  1913,  entitled  "An  Act  to  re- 
duce tariff  duties  and  to  provide  revenue  for  the  government,  and  for  other 
purposes,"  the  Revenue  Act  of  1916,  as  amended,  or  the  Revenue  Act  of 
1917,  it  appears  that  an  amount  of  income,  war-profits  or  excess-profits  tax 
has  been  paid  in  excess  of  that  properly  due,  then,  notwithstanding  the  pro-  . 
visions  of  §  3228  of  the  Revised  Statutes,  the  amount  of  the  excess  shall  be 
credited  against  any  income,  war-profits  or  excess-profits  taxes,  or  install- 
ment thereof,  then  due  from  the  taxpayer  under  any  other  return,  and  any 
balance  of  such  excess  shall  be  immediately  refunded  to  the  taxpayer:  Pro- 
vided, That  no  such  credit  or  refund  shall  be  allowed  or  made  after  five 
years  from  the  date  when  the  return  was  due,  unless  before  the  expiration  of 
such  five  years  a  claim  therefor  is  filed  by  the  taxpayer. 

PENALTIES 

Sec.  253.  That  any  individual,  corporation,  or  partnership  required 
under  this  title  to  pay  or  collect  any  tax,  to  make  a  return  or  to  supply  in- 
formation, who  fails  to  pay  or  collect  such  tax,  to  make  such  return,  or  to 
supply  such  information  at  the  time  or  times  required  under  this  title,  shall 
be  liable  to  a  penalty  of  not  more  than  $1,000.  Any  individual,  corporation, 
or  partnership,  or  any  officer  or  employee  of  any  corporation  or  member  or 
employee  of  a  partnership,  who  willfully  refuses  to  pay  or  collect  such  tax, 
to  make  such  return,  or  to  supply  such  information  at  the  time  or  times  re- 
quired under  this  title,  or  who  willfully  attempts  in  any  manner  to  defeat  or 
evade  the  tax  imposed  by  this  title,  shall  be  guilty  of  a  misdemeanor  and 
shall  be  fined  not  more  than  $10,000  or  imprisoned  for  not  more  than  one 
year,  or  both,  together  with  the  costs  of  prosecution. 

RETURNS  OF  PAYMENTS  OF  DIVIDENDS 

Sec.  254.  That  every  corporation  subject  to  the  tax  imposed  by  this  title 
and  every  personal  service  corporation  shall,  when  required  by  the  commis- 
sioner, render  a  correct  return  duly  verified  under  oath,  of  its  payments  of 
dividends,  stating  the  name  and  address  of  each  stockholder,  the  number  of 
shares  owned  by  him,  and  the  amount  of  dividends  paid  to  him. 

RETURNS    OF    BROKERS 

Sec.  255.  That  every  individual,  corporation,  or  partnership  doing  business 
as  a  broker  shall,  when  required  by  the  commissioner,  render  a  correct  re- 


1304  APPENDIX 

turn  duly  verified  under  oath,  under  such  rules  and  regulations  as  the  com- 
missioner, with  the  approval  of  the  secretary,  may  prescribe,  showing  the 
names  of  customers  for  whom  such  individual,  corporation,  or  partnership 
has  transacted  any  business,  with  such  details  as  to  the  profits,  losses,  or 
other  information  which  the  commissioner  may  require,  as  to  each  of  such 
customers,  as  will  enable  the  commissioner  to  determine  whether  all  income 
tax  due  on  profits  or  gains  of  such  cutomers  has  been  paid. 

INFORMATION  AT  SOURCE 

Sec.  256.  That  all  individuals,  corporations,  and  partnerships,  in  what- 
ever capacity  acting,  including  lessees  or  mortgagors  of  real  or  personal 
property,  fiduciaries,  and  employers,  making  payment  to  another  individual, 
corporation,  or  partnership,  of  interest,  rent,  salaries,  wages,  premiums,  an- 
nuities, compensations,  remunerations,  emoluments,  or  other  fixed  or  deter- 
minable gains,  profits,  and  income  (other  than  payments  described  in  §§  254 
and  255),  of  $1,000  or  more  in  any  taxable  year,  or,  in  the  case  of  such  pay- 
ments made  by  the  United  States,  the  oflJicers  or  employees  of  the  United 
States  having  information  as  to  such  payments  and  required  to  make  returns 
in  regard  thereto  by  the  regulations  hereinafter  provided  for,  shall  render 
a  true  and  accurate  return  to  the  commissioner,  under  such  regulations  and 
in  such  form  and  manner  and  to  such  extent  as  may  be  prescribed  by  him 
with  the  approval  of  the  secretary,  setting  forth  the  amount  of  such  gains, 
profits,  and  income,  and  the  name  and  address  of  the  recipient  of  such  pay- 
ment. 

Such  returns  may  be  required,  regardless  of  amounts,  (1)  in  the  case  of 
payments  of  interest  upon  bonds,  mortgages,  deeds  of  trust,  or  other  similar 
obligations  of  corporations,  and  (2)  in  the  case  of  collections  of  items  (not 
payable  in  the  United  States)  of  interest  upon  the  bonds  of  foreign  countries 
and  interest  upon  the  bonds  of  and  dividends  from  foreign  corporations  by 
individuals,  corporations,  or  partnerships,  undertaking  as  a  matter  of  busi- 
ness or  for  profit  the  collection  of  foreign  payments  of  such  interests  or  div- 
idends by  means  of  coupons,  checks,  or  bills  of  exchange. 

When  necessary  to  make  effective  the  provisions  of  this  section  the  name 
and  address  of  the  recipient  of  income  shall  be  furnished  upon  demand  of 
the  individual,  corporation,  or  partnership  paying  the  income. 

The  provisions  of  this  section  shall  apply  to  the  calendar  year  1918  and 
each  calendar  year  thereafter,  but  shall  not  apply  to  the  payment  of  interest 
on  obligations  of  the  United  States. 

RETURNS  TO  BE  PUBLIC  RECORDS 

Sec.  257.  That  returns  upon  which  the  tax  has  been  determined  by  the 
commissioner  shall  constitute  public  records;  but  they  shall  be  open  to  in- 
spection only  upon  order  of  the  President  and  under  rules  and  regulations 
prescribed  by  the  secretary  and  approved  by  the  President :  Provided,  That 
the  proper  officers  of  any  state  imposing  an  income  tax  may,  upon  the  re- 
quest of  the  governor  thereof,  have  access  to  the  returns  of  any  corporation, 
or  to  an  abstract  thereof  showing  the  name  and  income  of  the  corporation, 
at  such  times  and  in  such  manner  as  the  secretary  may  prescribe :  Provided 
further,  That  all  bona  fide  stockholders  of  record  owning  1  per  centum  or 
more  of  the  outstanding  stock  of  any  corporation  shall,  upon  making  request 
of  the  commissioner,  be  allowed  to  examine  the  annual  income  returns  of 
such  corporation  and  of  its  subsidiaries.  Any  stockholder  who  pursuant  to 
the  provisions  of  this  section  is  allowed  to  examine  the  return  of  any  cor- 


REVENUE   ACT   OF   1918  1305 

poration.  and  who  makes  known  in  any  manner  whatever  not  provided  by 
Lw  the  amount  or  source  of  income,  profits,  losses,  expenditures    or  an 
particular  thereof,  set  forth  or  disclosed  in  any  such  -turn  shall  be  .u  Ity 
of  a  misdemeanor  and  be  punished  by  a  fine  not  exceedmg  $1,000,  or  by  im 
nrisonment  not  exceeding  one  year,  or  both. 

'  ThHommissioner  shall  as  soon  as  practicable  in  each  year  cause  to  be 
prepared  and  made  available  to  public  inspection  in  such  manner  as  he  may 
Slterm  ne,  in  the  office  of  the  collector  in  each  internal-revenue  d'^tr.ct  and 
?n  such  otker  places  as  he  may  determine,  lists  containmg  the  names  and  the 
post  office  adcLsses  of  all  individuals  making  income-tax  returns  m  such 

district. 

PUBLICATION  OF  STATISTICS 

Sec  258  That  the  commissioner,  with  the  approval  of  the  secretary,  shall 
prepa're  and  publish  annually  statistics  reasonably  available  with  respect  o 
the  operation  of  the  income,  war-profits  and  excess-profits  tax  aws  inlud 
ing  classifications  of  taxpayers  and  of  income,  the  amounts  allowed  as  de- 
ductions, exemptions,  and  credits,  and  any  other  facts  deemed  pertinent  and 
valuable. 

COLLECTION    OF    FOREIGN    ITEMS 

Sec  259  That  all  individuals,  corporations,  or  partnerships  undertaking 
as  a  matter  of  business  or  for  profit  the  collection  of  foreign  payments  of  in- 
teresror  dividends  by  means  of  coupons,  checks,  or  bills  of  exchange  shall 
obtain  a  license  from  the  commissioner  and  shall  be  subject  to  -ch  regu^- 
tions  enabling  the  government  to  obtain  the  information  required  under  this 

itle  as  the  commissioner,  with  the  approval  of  the  secretary,  shall  prescribe; 
and  wh  ever  knowingly  undertakes  to  collect  such  payments  without  having 

btained  a  license  therefor,  or  without  complying  with  -^^^V^S  'oOo";i  im 
be  guilty  of  a  misdemeanor  and  shall  be  fined  not  more  than  $5,000,  oi  im- 
prisoned for  not  more  than  one  year,  or  both. 

CITIZENS  OF  UNITED  STATES  POSSESSIONS 

Sec  260  That  any  individual  who  is  a  citizen  of  any  possession  of  the 
United  States  (but  not  otherwise  a  citizen  of  the  United  States)  and  who 
Tno  a  res  den  of  the  United  States,  shall  be  subject  to  taxation  u«der  this 
t^e  onl^as  to  income  derived  from  sources  within  the  United  States  and 
n  such  case  the  tax  shall  be  computed  and  paid  in  the  same  manner  and  sub 
Sect  to  the  same  conditions  as  in  the  case  of  other  persons  who  are  taxable 
only  as  to  income  derived  from  such  sources. 

PORTO  RICO  AND  PHILIPPINE  ISLANDS 

Sec  261  That  in  Porto  Rico  and  the  Philippine  Islands  the  income  tax 
shall  be  levied,  assessed,  collected,  and  paid  in  accordance  with  the  provi- 
sions  of  the  Revenue  Act  of  1916  as  amended.  ^.  ,     t     *        i    A.t 

Zurns  shall  be  made  and  taxes  shall  be  paid  under  Ti  le  Ijf  such  Act 
in  Porto  Rico  or  the  Philippine  Islands,  as  the  case  "^^y ^^'^^ ^^\2ll 
ndividual  who  is  a  citizen  or  resident  of  Porto  Rico  or  the  Philippine  Islands 
or  derives  income  from  sources  therein,  and  (2)  every  corporation  created 
or  organized  in  Porto  Rico  or  the  Philippine  Islands  or  deriving  income  from 
sourc?.  therein.  An  individual  who  is  neither  a  citizen  nor  a  resident  of 
Porto  Rico  or  the  Philippine  Islands  but  derives  income  from  sources  there- 
in hall  be  taxed  in  Porto  Rico  or  the  Philippine  Islands  as  a  nonresident 
a";en  individual,  and  a  corporation  created  or  organized  outside  Porto  Rico  or 


1306  APPENDIX 

the  Philippine  Islands  and  deriving  income  from  sources  therein  shall  be 
taxed  in  Porto  Rico  or  the  Philippine  Islands  as  a  foreign  corporation.  For 
the  purposes  of  §  216  and  of  Tj  (6)  of  subdivision  (a)  of  §  234  a  tax  imposed 
in  Porto  Rico  or  the  Philippine  Islands  upon  the  net  income  of  a  corporation 
shall  not  be  deemed  to  be  a  tax  under  this  title. 

The  Porto  Rican  or  Philippine  Legislature  shall  have  power  by  due  enact- 
ment to  amend,  alter,  modify,  or  repeal  the  income  tax  laws  in  force  in 
Porto  Rico  or  the  Philippine  Islands,  respectively. 

TITLE  III— WAR-PROFITS  AND  EXCESS-PROFITS  TAX 
Part  I — General  Definitions 

Sec.  300.  That  when  used  in  this  title  the  terms  "taxable  year,"  "fiscal 
year,"  "personal  service  corporation,"  "paid  or  accrued,"  and  "dividends" 
shall  have  the  same  meaning  as  provided  for  the  purposes  of  income  tax  in 
§§  200  and  20L  The  first  taxable  year  for  the  purposes  of  this  title  shall 
be  the  same  as  the  first  taxable  year  for  the  purposes  of  the  income  tax 
under  Title  II. 

Part  II — Imposition  of  Tax 

Sec.  301.  (a)  That  in  lieu  of  the  tax  imposed  by  Title  II  of  the  Revenue 
Act  of  1917,  but  in  addition  to  the  other  taxes  imposed  by  this  act,  there 
shall  be  levied,  collected,  and  paid  for  the  taxable  year  1918  upon  the  net 
income  of  every  corporation  a  tax  equal  to  the  sum  of  the  following: 

first  bracket 

Thirty  per  centum  of  the  amount  of  the  net  income  in  excess  of  the  excess- 
profits  credit  (determined  under  §  312)  and  not  in  excess  of  20  per  centum 
of  the  invested  capital; 

SECOND   bracket 

Sixty-five  per  centum  of  the  amount  of  the  net  income  in  excess  of  20  per 
centum  of  the  invested  capital; 

third  bracket 
The  sum,  if  any,  by  which  80  per  centum  of  the  amount  of  the  net  income 
in  excess  of  the  war-profits  credit   (determined  under  §  311)    exceeds  the 
amount  of  the  tax  computed  under  the  first  and  second  brackets. 

(b)  For  the  taxable  year  1919  and  each  taxable  year  thereafter  there 
shall  be  levied,  collected,  and  paid  upon  the  net  income  of  every  corporation 
(except  corporations  taxable  under  subdivision  (c)  of  this  section)  a  tax 
equal  to  the  sum  of  the  following: 

FIRST  bracket 

Twenty  per  centum  of  the  amount  of  the  net  income  in  excess  of  the 
excess-profits  credit  (determined  under  §  312)  and  not  in  excess  of  20  per 
centum  of  the  invested  capital ; 

SECOND  bracket 

Forty  per  centum  of  the  amount  of  the  net  income  in  excess  of  20  per 
centum  of  the  invested  capital. 

(c)  For  the  taxable  year  1919  and  each  taxable  year  thereafter  there 
shall  be  levied,  collected,  and  paid  upon  the  net  income  of  every  corporation 
which  derives  in  such  a  year  a  net  income  of  more  than  $10,000  from  any 
government  contract  or  contracts  made  between  April  6,  1917,  and  Novem- 


REVENUE  ACT  OF   1918  1307 

ber  11,  1918,  both  dates  inclusive,  a  tax  equal  to  the  sum  of  the  followinj?: 

(1)  Such  a  portion  of  a  tax  computed  at  the  rates  specified  in  subdivision 

(a)  as  the  part  of  the  net  income  attributable  to  such  provernment  contract 
or  contracts  bears  to  the  entire  net  income.  In  computing  such  tax  the 
excess-profits  credit  and  the  war-profits  credit  applicable  to  the  taxable  year 
shall  be  used; 

(2)  Such  a  portion  of  a  tax  computed  at  the  rates  specified  in  subdivision 

(b)  as  the  part  of  the  net  income  not  attributable  to  such  government 
contract  or  contracts  bears  to  the  entire  net  income. 

For  the  purpose  of  determininj?  the  part  of  the  net  income  attributable 
to  such  government  contract  or  contracts,  the  proper  apportionment  and 
allocation  of  the  deductions  with  respect  to  gross  income  derived  from  such 
government  contract  or  contracts  and  from  other  sources,  respectively,  shall 
be  determined  under  rules  and  regulations  prescribed  by  the  commissioner 
with  the  approval  of  the  secretary. 

(d)  In  any  case  where  the  full  amount  of  the  excess  profit  credit  is  not 
allowed  under  the  first  bracket  of  subdivision  (a)  or  (b),  by  reason  of  the 
fact  that  such  credit  is  in  excess  of  20  per  centum  of  the  invested  capital, 
the  part  not  so  allowed  shall  be  deducted  from  the  amount  in  the  second 
bracket. 

(e)  For  the  purposes  of  the  act  approved  March  21,  1918,  entitled  "An 
act  to  provide  for  the  operation  of  transportation  systems  while  under 
federal  conti'ol,  for  the  just  compensation  of  their  owners,  and  for  other 
purposes,"  the  tax  imposed  by  this  title  shall  be  treated  as  levied  by  an 
act  in  amendment  of  Title  II  of  the  Revenue  Act  of  1917. 

Sec.  302.  That  the  tax  imposed  by  subdivision  (a)  of  §  301  shall  in  no 
case  be  more  than  30  per  centum  of  the  amount  of  the  net  income  in  excess 
of  $3,000  and  not  in  excess  of  $20,000,  plus  80  per  centum  of  the  amount 
of  the  net  income  in  excess  of  $20,000;  the  tax  imposed  by  subdi\nsion  (b) 
of  §  301  shall  in  no  case  be  more  than  20  per  centum  of  the  amount  of 
the  net  income  in  excess  of  $3,000  and  not  in  excess  of  $20,000,  plus  40  per 
centum  of  the  amount  of  the  net  income  in  excess  of  $20,000;  and  the  above 
limitations  shall  apply  to  the  taxes  computed  under  subdivisions  (a)  and  (b) 
of  §  301,  respectively,  when  used  in  subdivision  (c)  of  that  section.  Nothing 
in  this  section  shall  be  construed  in  such  manner  as  to  increase  the  tax 
imposed  by  §  301. 

Sec.  303.  That  if  part  of  the  net  income  of  a  corporation  is  derived  (1) 
from  a  trade  or  business  (or  a  branch  of  a  trade  or  business)  in  which  the 
employment  of  capital  is  necessary,  and  (2)  a  part  (constituting  not  less 
than  30  per  centum  of  its  total  net  income)  is  derived  from  a  separate  trade 
or  business  (or  a  distinctly  separate  branch  of  the  trade  or  business)  which 
if  constituting  the  sole  trade  or  business  would  bring  it  within  the  class  of 
"personal  service  corporations,"  then  (under  regulations  prescribed  by  the 
commissioner  with  the  approval  of  the  secretary)  the  tax  upon  the  first  part 
of  such  net  income  shall  be  separately  computed  (allowing  in  such  computa- 
tion only  the  same  proportionate  part  of  the  credits  authorized  in  §§  311 
and  312),  and  the  tax  upon  the  second  part  shall  be  the  same  percentage 
thereof  as  the  tax  so  computed  upon  the  first  part  is  of  such  first  part: 
Provided,  That  the  tax  upon  such  second  part  shall  in  no  case  be  less  than 
20  per  centum  thereof,  unless  the  tax  upon  the  entire  net  income,  if  com- 
puted without  benefit  of  this  section,  would  constitute  less  than  20  per 
centum  of  such  entire  net  income,  in  which  event  the  tax  shall  be  determined 


1308  APPENDIX 

upon  the  entire  net  income,  without  reference  to  this  section,  as  other  taxes 
are  determined  under  this  title.  The  total  tax  computed  under  this  section 
shall  be  subject  to  the  limitations  provided  in  §  302. 

Sec.  304.  (a)  That  the  corporations  enumerated  in  §  231  shall,  to  the 
extent  that  they  are  exempt  from  income  tax  under  Title  II,  be  exempt 
from  taxation  under  this  title. 

(b)  Any  corporation  whose  net  income  for  the  taxable  year  is  less  than 
$3,000  shall  be  exempt  from  taxation  under  this  title. 

(c)  In  the  case  of  any  corporation  engaged  in  the  mining  of  gold,  the 
portion  of  the  net  income  derived  from  the  mining  of  gold  shall  be  exempt 
from  the  tax  imposed  by  this  title,  and  the  tax  on  the  remaining  portion 
of  the  net  income  shall  be  the  proportion  of  a  tax  computed  without  the 
benefit  of  this  subdivision  which  such  remaining  portion  of  the  net  income 
bears  to  the  entire  net  income. 

Sec.  305.  That  if  a  tax  is  computed  under  this  title  for  a  period  of  less 
than  twelve  months,  the  specific  exemption  of  $3,000,  wherever  referred  to 
in  this  title,  shall  be  reduced  to  an  amount  which  is  the  same  proportion 
of  $3,000  as  the  number  of  months  in  the  period  is  of  twelve  months. 

Part  III — Credits 

Sec.  310.  That  as  used  in  this  title  the  term  "prewar  period"  means  the 
calendar  years  1911,  1912,  and  1913,  or,  if  a  corporation  was  not  in  existence 
during  the  whole  of  such  period,  then  as  many  of  such  years  during  the 
whole  of  which  the  corporation  was  in  existence. 

Sec.  311.      (a)    That  the  war-profits  credit  shall  consist  of  the  sum  of: 

(1)  A  specific  exemption  of  $3,000;  and 

(2)  An  amount  equal  to  the  average  net  income  of  the  corporation  for 
the  prewar  period,  plus  or  minus,  as  the  case  may  be,  10  per  centum  of  the 
difference  between  the  average  invested  capital  for  the  prewar  period  and 
the  invested  capital  for  the  taxable  year.  If  the  tax  is  computed  for  a 
period  of  less  than  twelve  months  such  amount  shall  be  reduced  to  the  same 
proportion  thereof  as  the  number  of  months  in  the  period  is  of  twelve 
months. 

(b)  If  the  corporation  had  no  net  income  for  the  prewar  period,  or  if  the 
amount  computed  under  ^  (2)  of  subdivision  (a)  is  less  than  10  per  centum 
of  its  invested  capital  for  the  taxable  year,  then  the  war-profits  credit  shall 
be  the  sum  of: 

(1)  A  specific  exemption  of  $3,000;  and 

(2)  An  amount  equal  to  10  per  centum  of  the  invested  capital  for  the 
taxable  year. 

(c)  If  the  corporation  was  not  in  existence  during  the  whole  of  at  least 
one  calendar  year  during  the  prewar  period,  then,  except  as  provided  in 
subdivision  (d),  the  war-profits  credit  shall  be  the  sum  of: 

(1)  A  specific  exemption  of  $3,000;  and 

(2)  An  amount  equal  to  the  same  percentage  of  the  invested  capital  of 
the  taxpayer  for  the  taxable  year  as  the  average  percentage  of  net  income 
to  invested  capital,  for  the  prewar  period,  of  corporations  engaged  in  a 
trade  or  business  of  the  same  general  class  as  that  conducted  by  the  tax- 
payer; but  such  amount  shall  in  no  case  be  less  than  10  per  centum  of  the 
invested  capital  of  the  taxpayer  for  the  taxable  year.  Such  average  per- 
centage shall  be  determined  by  the  commissioner  on  the  basis  of  data  con- 
tained in  returns  made  under  Title  II  of  the  Revenue  Act  of  1917,  and  the 


REVENUE   ACT  OF   1918  1309 

avei'apre  known  as  the  median  shall  be  used.  If  such  averajre  percentage 
has  not  been  determined  and  published  at  least  30  days  prior  to  the  time 
when  the  return  of  the  taxpayer  is  due,  then  for  purposes  of  such  return 
10  per  centum  shall' be  used  in  lieu  thereof;  but  such  average  percentage 
when  determined  shall  be  used  for  the  purposes  of  §  250  in  determining  the 
correct  amount  of  the  tax. 

(d)  The  war-profits  credit  shall  be  determined  in  the  manner  provided 
in  subdivision  (b)  instead  of  in  the  manner  provided  in  subdivision  (c),  in 
the  case  of  any  corporation  which  was  not  in  existence  during  the  whole 
of  at  least  one  calendar  year  during  the  prewar  period,  if  (1)  a  majority 
of  its  stock  at  any  time  during  the  taxable  year  is  owned  or  controlled, 
directly  or  indirectly,  by  a  corporation  which  was  in  existence  during  the 
whole  of  at  least  one  calendar  year  during  the  prewar  period,  or  if  (2)  50 
per  centum  or  more  of  its  gross  income  (as  computed  under  §  233  for 
income  tax  purposes)  consists  of  gains,  profits,  commissions,  or  other  in- 
come, derived  from  a  government  contract  or  contracts  made  between  April 
6,  1917,  and  November  11,  1918,  both  dates  inclusive. 

(e)  A  foreign  corporation  shall  not  be  entitled  to  a  specific  exemption 
of  $3,000. 

Sec,  312.  That  the  excess-profits  credit  shall  consist  of  a  specific  exemp- 
tion of  $3,000  plus  an  amount  equal  to  8  per  centum  of  the  invested  capital 
for  the  taxable  year. 

A  foreign  corporation  shall  not  be  entitled  to  the  specific  exemption  of 
$3,000. 

Part  IV — Net  Income 

Sec.  320.  (a)  That  for  the  purpose  of  this  title  the  net  income  of  a 
corporation  shall  be  ascertained  and  returned — 

(1)  For  the  calendar  years  1911  and  1912  upon  the  same  basis  and  in 
the  same  manner  as  provided  in  §  38  of  the  act  entitled  "An  act  to  provide 
revenue,  equalize  duties,  and  encourage  the  industries  of  the  United  States, 
and  for  other  purposes,"  approved  August  5,  1909,  except  that  taxes  im- 
posed by  such  section  and  paid  by  the  corporation  within  the  year  shall 
be  included; 

(2)  For  the  calendar  year  1913  upon  the  same  basis  and  in  the  same 
manner  as  provided  in  §  II  of  the  act  entitled  "An  act  to  reduce  tariff 
duties  and  to  provide  revenue  for  the  government,  and  for  other  purposes," 
approved  October  3,  1913,  except  that  taxes  imposed  by  §  38  of  such  act 
of  August  5,  1909,  and  paid  by  the  corporation  within  the  year  shall  be 
included,  and  except  that  the  amounts  received  by  it  as  dividends  upon  the 
stock  or  from  the  net  earnings  of  other  corporations  subject  to  the  tax 
imposed  by  §  II  of  such  act  of  October  3,  1913,  shall  be  deducted;  and 

(3)  For  the  taxable  year  upon  the  same  basis  and  in  the  same  manner 
as  provided  for  income  tax  purposes  in  Title  II  of  this  act. 

(b)  The  average  net  income  for  the  prewar  period  shall  be  determined 
by  dividing  the  number  of  years  within  that  period  during  the  whole  of 
which  the  corporation  was  in  existence  into  the  sum  of  the  net  income  for 
such  years,  even  though  there  may  have  been  no  net  income  for  one  or  more 
of  such  years. 

Part  V — Invested  Capital 

Sec.  325.     (a)  That  as  used  in  this  title— 

The  term  "intangible  property"  means  patents,  copyrights,  secret  proc- 


2310  APPENDIX 

esses  and  formulae,  good  will,  trade-marks,  trade-brands,  franchises,  and 
other  like  property; 

The  term  "tangible  property"  means  stocks,  bonds,  notes,  and  other  evi- 
dences of  indebtedness,  bills  and  accounts  receivable,  leaseholds,  and  other 
property  other  than  intangible  property; 

The  term  "borrowed  capital"  means  money  or  other  property  borrowed, 
whether  represented  by  bonds,  notes,  open  accounts,  or  otherwise; 

The  term  "inadmissible  assets"  means  stocks,  bonds,  and  other  obligations 
(other  than  obligations  of  the  United  States),  the  dividends  or  interest 
from  which  is  not  included  in  computing  net  income,  but  where  the  income 
derived  from  such  assets  consists  in  part  of  gain  or  profit  derived  from  the 
sale  or  other  disposition  thereof,  or  where  all  or  part  of  the  interest  derived 
from  such  assets  is  in  effect  included  in  the  net  income  because  of  the  limita- 
tion on  the  deduction  of  interest  under  ^  (2)  of  subdivision  (a)  of  §  234, 
a  corresponding  part  of  the  capital  invested  in  such  assets  shall  not  be 
deemed  to  be  inadmissible  assets; 

The  term  "admissible  assets"  means  all  assets  other  than  inadmissible 
assets,  valued  in  accordance  with  the  provisions  of  subdivision  (a)  of  §  326, 
§  330,  and  §  331. 

(b)  For  the  purposes  of  this  title,  the  par  value  of  stock  or  shares  shall, 
in  the  case  of  stock  or  shares  issued  at  a  nominal  value  or  having  no  par 
value,  be  deemed  to  be  the  fair  market  value  as  of  the  date  or  dates  of  issue 
of  such  stock  or  shares. 

Sec.  326.  (a)  That  as  used  in  this  title  the  term  "invested  capital"  for 
any  year  means  (except  as  provided  in  subdivisions  (b)  and  (c)  of  this 
section)  : 

(1)  Actual  cash  bona  fide  paid  in  for  stock  or  shares; 

(2)  Actual  cash  value  of  tangible  property,  other  than  cash,  bona  fide 
paid  in  for  stock  or  shares,  at  the  time  of  such  payment,  but  in  no  case  to 
exceed  the  par  value  of  the  original  stock  or  shares  specifically  issued 
therefor,  unless  the  actual  cash  value  of  such  tangible  property  at  the  time 
paid  in  is  shown  to  the  satisfaction  of  the  commissioner  to  have  been  clearly 
and  substantially  in  excess  of  such  par  value,  in  which  case  such  excess 
shall  be  treated  as  paid-in  surplus :  Provided,  That  the  commissioner  shall 
keep  a  record  of  all  cases  in  which  tangible  property  is  included  in  invested 
capital  at  a  value  in  excess  of  the  stock  or  shares  issued  therefor,  containing 
the  name  and  address  of  each  taxpayer,  the  business  in  which  engaged,  the 
amount  of  invested  capital  and  net  income  shown  by  the  return,  the  value 
of  the  tangible  property  at  the  time  paid  in,  the  par  value  of  the  stock  or 
shares  specifically  issued  therefor,  and  the  amount  included  under  this  para- 
graph as  paid-in  surplus.  The  commissioner  shall  furnish  a  copy  of  such 
record  and  other  detailed  information  with  respect  to  such  cases  when 
required  by  resolution  of  either  House  of  Congress,  without  regard  to  the 
restrictions  contained  in  §  257; 

(3)  Paid-in  or  earned  surplus  and  undivided  profits;  not  including  sur- 
plus and  undivided  profits  earned  during  the  year; 

(4)  Intangible  property  bona  fide  paid  in  for  stock  or  shares  prior  to 
March  3,  1917,  in  an  amount  not  exceeding  (a)  the  actual  cash  value  of 
such  property  at  the  time  paid  in,  (b)  the  par  value  of  the  stock  or  shares 
issued  therefor,  or  (c)  in  the  aggregate  25  per  centum  of  the  par  value  of 
the  total  stock  or  shares  of  the  corporation  outstanding  on  March  3,  1917, 
whichever  is  lowest; 


REVENUE   ACT  OF   1918  1311 

• 

(5)     Intangible  property  bona  fide  paid  in  for  stock  or  shares  on  or  after 

March  3    1917    in  an  amount  not  exceeding   (a)    the  actual  cash  value  of 

fuch  property  at  the  time  paid  in,  (b)  the  par  value  of  the  stock  or  shares 

ssued  therefor,  or  (c)   in  the  aggregate  25  per  centum  of  the  par  value  of 

he    otil  stock  or  shares  of  the  corporation  outstanding  at  the  beg.nmng  of 

he  taxable  year,  whichever  is  lowest:     Provided,  That  in  no  case  shall  the 

otal  amount  included  under  n    (4)    and    (5)    exceed   m  t^e   aggregate  25 

per  centum  of  the  par  value  of  the  total  stock  or  shares  of  the  corporation 

outstanding  at  the  beginning  of  the  taxable  year;  but  ,   .     ,    , 

(b)      Abused  in  this  title  the  term  "invested   capital"  does  not  include 

'7;;^4rrflhall  be  deducted  from  invested  capital  as  above  defined  a 
percentage  thereof  equal  to  the  percentage  which  the  amount  of  inadm.s- 
!ible  assets  is  of  the  amount  of  admissible  and  inadmissible  assets  held 
during  the  taxable  year.  •         ^    j 

(d)  The  invested  capital  for  any  period  shall  be  the  average  invested 
capital  for  such  period,  but  in  the  case  of  a  corporation  making  a  return 
for  a  fractional  part  of  a  year,  it  shall  (except  for  the  purpose  of  H  (2)  of 
subdivision   (a)   of  §  311)   be  the  same  fractional  part  of  such  average  in- 

""^The  aveSe  invested  capital  for  the  prewar  period  shall  be  determined 
by  dividing  the  number  of  years  within  that  period  during  the  whole  of 
which  the  corporation  was  in  existence  into  the  sum  of  the  average  invested 

capital  for  such  years.  ,    „   ,       ,4.        -^^a   oe 

Sec.  327.     That  in  the  following  cases  the  tax  shall  be   determined  as 

provided  in  §  328:  .  .     , 

(a)  Where  the  commissioner  is  unable  to  determine  the  invested  capital 

as  provided  in  §  326; 

(b)  In  the  case  of  a  foreign  corporation; 

c)  Where  a  mixed  aggregate  of  tangible  property  and  intangible  prop- 
erty has  been  paid  in  for  stock  or  for  stock  and  bonds  and  the  conrimissioner 
is  unable  satisfactorily  to  determine  the  respective  values  of  the  several 
classes  of  property  at  the  time  of  payment,  or  to  distinguish  the  classes  of 
property  paid  in  for  stock  and  for  bonds,  respectively; 

(d)  Where  upon  application  by  the  corporation  the  commissioner  finds 
and  so  declares  of  record  that  the  tax  if  determined  without  benefit  of  this 
section  would,  owing  to  abnormal  conditions  affecting  the  capital  or  income 
of  the  corporation,  work  upon  the  corporation  an  exceptional  hardship  evi- 
dence.! bv  gross  disproportion  between  the  tax  computed  without  benefit  of 
this  section  and  the  tax  computed  by  reference  to  the  representative  corpo- 
rations specified  in  §  328.  This  subdivision  shall  not  apply  to  any  case 
(1)  in  which  the  tax  (computed  without  benefit  of  this  section)  is  high 
merely  because  the  corporation  earned  within  the  taxable  year  a  high  rate 
of  profit  upon  a  normal  invested  capital,  nor  (2)  in  which  50  per  centum  or 
more  of  the  gross  income  of  the  corporation  for  the  taxable  year  (com- 
puted under  §  233  of  Title  II)  consists  of  gains,  profits,  commissions,  or 
other  income,  derived  on  a  cost-plus  basis  from  a  government  contract  or 
contracts  made  between  April  6,  1917,  and  November  11.  1918,  both  dates 

inclusive 

Sec  328  (a)  In  the  cases  specified  in  §  327  the  tax  shall  be  the  amount 
which  bears  the  same  ratio  to  the  net  income  of  the  taxpayer  (in  excess  of 
the  specific  exemption  of  $3,000)  for  the  taxable  year,  as  the  average  tax  of 
representative  corporations  engaged  in  a  like  or  similar  trade  or  business. 


1312  APPENDIX 

bears  to  their  average  net  income  (in  excess  of  the  specific  exemption  of 
$3,000)  for  such  year.  In  the  case  of  a  foreign  corporation  the  tax  shall  be 
computed  without  deducting  the  specific  exemption  of  $3,000  either  for  the 
taxpayer  or  the  representative  corporations. 

In  computing  the  tax  under  this  section  the  commissioner  shall  compare 
the  taxpayer  only  with  representative  corporations  whose  invested  capital 
can  be  satisfactorily  determined  under  §  326  and  which  are,  as  nearly  as 
may  be,  similarly  circumstanced  with  respect  to  gross  income,  net  income, 
profits  per  unit  of  business  transacted  and  capital  employed,  the  amount 
and  rate  of  war  profits  or  excess  profits,  and  all  other  relevant  facts  and 
circumstances. 

(b)  For  the  purposes  of  subdivision  (a)  the  ratios  between  the  average 
tax  and  the  average  net  income  of  representative  corporations  shall  be 
determined  by  the  commissioner  in  accordance  with  regulations  prescribed 
by  him  with  the  approval  of  the  secretary. 

In  cases  in  which  the  tax  is  to  be  computed  under  this  section,  if  the  tax 
as  computed  without  the  benefit  of  this  section  is  less  than  50  per  centum 
of  the  net  income  of  the  taxpayer,  the  installments  shall  in  the  first  in- 
stance be  computed  upon  the  basis  of  such  tax;  but  if  the  tax  so  computed 
is  50  per  centum  or  more  of  the  net  income,  the  installments  shall  in  the 
first  instance  be  computed  upon  the  basis  of  a  tax  equal  to  50  per  centum 
of  the  net  income.  In  any  case,  the  actual  ratio  when  ascertained  shall  be 
used  in  determining  the  correct  amount  of  the  tax.  If  the  correct  amount 
of  the  tax  when  determined  exceeds  50  per  centum  of  the  net  income,  any 
excess  of  the  correct  installments  over  the  amounts  actually  paid  shall  on 
notice  and  demand  be  paid  together  with  interest  at  the  rate  of  one-half  of 
1  per  centum  per  month  on  such  excess  from  the  time  the  installment 
was  due. 

(c)  The  commissioner  shall  keep  a  record  of  all  cases  in  which  the  tax 
is  determined  in  the  manner  prescribed  in  subdivision  (a),  containing  the 
name  and  address  of  each  taxpayer,  the  business  in  which  engaged,  the 
amount  of  invested  capital  and  net  income  shown  by  the  return,  and  the 
amount  of  invested  capital  as  determined  under  such  subdivision.  The 
commissioner  shall  furnish  a  copy  of  such  record  and  other  detailed  infor- 
mation with  respect  to  such  cases  when  required  by  resolution  of  either 
House  of  Congress,  without  regard  to  the  restrictions  contained  in  §  257. 

Part  VI — Reorganization 

Sec.  330.  That  in  the  case  of  the  reorganization,  consolidation,  or  change 
of  ownership  after  January  1,  1911,  of  a  trade  or  business  now  carried  on 
by  a  corporation,  the  corporation  shall  for  the  purposes  of  this  title  be 
deemed  to  have  been  in  existence  prior  to  that  date,  and  the  net  income  and 
invested  capital  of  such  predecessor  trade  or  business  for  all  or  any  part 
of  the  prewar  period  prior  to  the  organization  of  the  corporation  now 
carrying  on  such  trade  or  business  shall  be  deemed  to  have  been  the  net 
income  and  invested  capital  of  such  corporation. 

If  such  predecessor  trade  or  business  was  carried  on  by  a  partnership  or 
individual  the  net  income  for  the  prewar  period  shall,  under  regulations 
prescribed  by  the  commissioner  with  the  approval  of  the  secretary,  be 
ascertained  and  returned  as  nearly  as  may  be  upon  the  same  basis  and  in 
the  same  manner  as  provided  for  corporations  in  Title  II,  including  a 
reasonable  deduction  for  salary  or  compensation  to  each  partner  or  the 
individual  for  personal  services  actually  rendered. 


REVENUE   ACT  OF    1918  1313 

In  the  case  of  the  organization  as  a  corporation  before  July  1,  1919,  of 
any  trade  or  business  in  which  capital  is  a  material  income-producing  factor 
and  which  was  previously  owned  by  a  partnership  or  individual,  the  net 
income  of  such  trade  or  business  from  January  1,  1918,  to  the  date  of  such 
reorganization  may  at  the  option  of  the  individual  or  partnership  be  taxed 
as  the  net  income  of  a  corporation  is  taxed  under  Titles  II  and  III;  in 
which  event  the  net  income  and  invested  capital  of  such  trade  or  business 
shall  be  computed  as  if  such  corporation  had  been  in  existence  on  and  after 
January  1,  1918,  and  the  undistributed  profits  or  earnings  of  such  trade 
or  business  shall  not  be  subject  to  the  surtax  imposed  in  §  211,  but  amounts 
distributed  on  or  after  January  1,  1918,  from  the  earnings  of  such  trade 
or  business  shall  be  taxed  to  the  recipients  as  dividends,  and  all  the  provi- 
sions of  Titles  II  and  III  relating  to  coi-porations  shall  so  far  as  practicable 
apply  to  such  trade  or  business:  Provided,  That  this  paragraph  shall  not 
apply  to  any  trade  or  business  the  net  income  of  which  for  the  taxable 
year  1918  was  less  than  20  per  centum  of  its  invested  capital  for  such  year: 
Provided  further,  That  any  taxpayer  who  takes  advantage  of  this  para- 
graph shall  pay  the  tax  imposed  by  §  1000  of  this  act  and  by  the  first 
subdivision  of  §  407  of  the  Revenue  Act  of  1916,  as  if  such  taxpayer  had 
been  a  corporation  on  and  after  January  1,  1918,  with  a  capital  stock 
having  no  par  value. 

If  any  asset  of  the  trade  or  business  in  existence  both  during  the  taxable 
year  and  any  prewar  year  is  included  in  the  invested  capital  for  the  taxable 
year  but  is  not  included  in  the  invested  capital  for  such  prewar  year,  or  is 
valued  on  a  different  basis  in  computing  the  invested  capital  for  the  taxable 
year  and  such  prewar  year,  respectively,  then  under  rules  and  regulations 
to  be  prescribed  by  the  commissioner  with  the  approval  of  the  secretary 
such  readjustments  shall  be  made  as  are  necessary  to  place  the  computation 
of  the  invested  capital  for  such  prewar  year  on  the  basis  employed  in  deter- 
mining the  invested  capital  for  the  taxable  year. 

Sec.  331.  In  the  case  of  the  reorganization,  consolidation,  or  change  of 
ownership  of  a  trade  or  business,  or  change  of  ownership  of  property,  after 
March  3,  1917,  if  an  interest  or  control  in  such  trade  or  business  or  prop- 
erty of  50  per  centum  or  more  remains  in  the  same  persons,  or  any  of  them, 
then  no  asset  transferred  or  received  from  the  previous  owner  shall,  for  the 
purpose  of  determining  invested  capital,  be  allowed  a  greater  value  than 
would  have  been  allowed  under  this  title  in  computing  the  invested  capital 
of  such  previous  owner  if  such  asset  had  not  been  so  transferred  or  received: 
Provided,  That  if  such  previous  owner  was  not  a  corporation,  then  the 
value  of  any  asset  so  transferred  or  received  shall  be  taken  at  its  cost  of 
acquisition  (at  the  date  when  acquired  by  such  previous  owner)  with  proper 
allowance  for  depreciation,  impairment,  betterment  or  development,  but  no 
addition  to  the  original  cost  shall  be  made  for  any  charge  or  expenditure 
deducted  as  expense  or  otherwise  on  or  after  March  1,  1913,  in  computing 
the  net  income  of  such  previous  owner  for  purposes  of  taxation. 

Part  VII — Miscellaneous 

Sec.  335.  (a)  That  if  a  corporation  (other  than  a  personal  service  cor- 
poration) makes  return  for  a  fiscal  year  beginning  in  1917  and  ending  in 
1918,  the  tax  for  the  first  taxable  year  under  this  title  shall  be  the  sum 
of:  (1)  The  same  proportion  of  a  tax  for  the  entire  period  computed  under 
Title  II  of  the  Revenue  Act  of  1917  which  the  portion  of  such  period  fall- 
ing within  the  calendar  year  1917  is  of  the  entire  period,  and  (2)  the  same 


1314  APPENDIX 

proportion  of  a  tax  for  the  entire  period  computed  under  this  title  at  the 
rates  specified  in  subdivision  (a)  of  §  301  which  the  portion  of  such  period 
falling  within  the  calendar  year  1918  is  of  the  entire  period.  Any  amount 
heretofore  or  hereafter  paid  on  account  of  the  tax  imposed  for  such  fiscal 
year  by  Title  II  of  the  Revenue  Act  of  1917  shall  be  credited  toward  the 
payment  of  the  tax  imposed  for  such  fiscal  year  by  this  title,  and  if  the 
amount  so  paid  exceeds  the  amount  of  the  tax  imposed  by  this  title,  the 
excess  shall  be  credited  or  refunded  to  the  corporation  in  accordance  with 
the  provisions  of  §  252. 

(b)  If  a  corporation  makes  return  for  a  fiscal  year  beginning  in  1918 
and  ending  in  1919,  the  tax  for  such  fiscal  year  under  this  title  shall  be 
the  sum  of:  (1)  The  same  proportion  of  a  tax  for  the  entire  period  com- 
puted under  subdivision  (a)  of  §  301  which  the  portion  of  such  period 
falling  within  the  calendar  year  1918  is  of  the  entire  period,  and  (2)  the 
same  proportion  of  a  tax  for  the  entire  period  computed  under  subdivisions 
(b)  or  (c)  of  §  301  which  the  portion  of  such  period  falling  within  the 
calendar  year  1919  is  of  the  entire  period. 

(c)  If  a  partnership  or  a  personal  service  coi'poration  makes  return  for 
a  fiscal  year  beginning  in  1917  and  ending  in  1918,  it  shall  pay  the  same 
proportion  of  a  tax  for  the  entire  period  computed  under  Title  II  of  the 
Revenue  Act  of  1917  which  the  portion  of  such  period  falling  within  the 
calendar  year  1917  is  of  the  entire  period. 

Any  tax  paid  by  a  partnership  or  personal  service  corporation  for  any 
period  beginning  on  or  after  January  1,  1918,  shall  be  immediately  refunded 
to  the  partnership  or  corporation  as  a  tax  erroneously  or  illegally  collected. 

Sec.  336.  That  every  corporation,  not  exempt  under  §  304,  shall  make 
a  return  for  the  purposes  of  this  title.  Such  returns  shall  be  made,  and 
the  taxes  imposed  by  this  title  shall  be  paid,  at  the  same  times  and  places, 
in  the  same  manner,  and  subject  to  the  same  conditions,  as  is  provided  in 
the  case  of  returns  and  payment  of  income  tax  by  corporations  for  the 
purposes  of  Title  II,  and  all  the  provisions  of  that  title  not  inapplicable, 
including  penalties,  are  hereby  made  applicable  to  the  taxes  imposed  by 
this  title. 

Sec.  337.  That  in  the  case  of  a  bona  fide  sale  of  mines,  oil  or  gas  wells, 
or  any  interest  therein,  where  the  principal  value  of  the  property  has  been 
demonstrated  by  prospecting  or  exploration  and  discovery  work  done  by  the 
taxpayer,  the  portion  of  the  tax  imposed  by  this  title  attributable  to  such 
sale  shall  not  exceed  20  per  centum  of  the  selling  price  of  such  property 
or  interest. 

TITLE  X— SPECIAL  TAXES 

[Capital  Stock  Tax] 

Sec.  1000.  (a)  That  on  and  after  July  1,  1918,  in  lieu  of  the  tax  imposed 
by  the  first  subdivision  of  section  407  of  the  Revenue  Act  of  1916 — 

(1)  Every  domestic  corporation  shall  pay  annually  a  special  excise  tax 
with  respect  to  carrying  on  or  doing  business,  equivalent  to  $1  for  each 
$1,000  of  so  much  of  the  fair  average  value  of  its  capital  stock  for  the 
preceding  year  ending  June  30  as  is  in  excess  of  $5,000.  In  estimating  the 
value  of  capital  stock  the  surplus  and  undivided  profits  shall  be  included; 

(2)  Every  foreign  corporation  shall  pay  annually  a  special  excise  tax  with 
respect  to  carrying  on  or  doing  business  in  the  United  States,  equivalent  to 


REVENUE  ACT  OF   1918  1315 

$1  for  each  $1,000  of  the  average  amount  of  capital  employed  in  the  trans- 
action of  its  business  in  the  United  States  during  the  preceding  year  ending 
June  thirtieth. 

(b)  In  computing  the  tax  in  the  case  of  insurance  companies  such  deposits 
and  reserve  funds  as  they  are  required  by  law  or  contract  to  maintain  or 
hold  for  the  protection  of  or  payment  to  or  apportionment  among  policy- 
holders shall  not  be  included. 

(c)  The  taxes  imposed  by  this  section  shall  not  apply  in  any  year  to  any 
corporation  which  was  not  engaged  in  business  (or  in  the  case  of  a  foreign 
corporation  not  engaged  in  business  in  the  United  States)  during  the  pre- 
ceding year  ending  June  30,  nor  to  any  corporation  enumerated  in  section 
231.  The  taxes  imposed  by  this  section  shall  apply  to  mutual  insurance  com- 
panies, and  in  the  case  of  every  such  domestic  company  the  tax  shall  be 
equivalent  to  $1  for  each  $1,000  of  the  excess  over  $5,000  of  the  sum  of  its 
surplus  or  contingent  reserves  maintained  for  the  general  use  of  the  busi- 
ness and  any  reserves  the  net  additions  to  which  are  included  in  net  income 
under  the  provisions  of  Title  II,  as  of  the  close  of  the  preceding  accounting 
period  used  by  such  company  for  purposes  of  making  its  income  tax  return: 
Provided,  That  in  the  case  of  a  foreign  mutual  insurance  company  the  tax 
shall  be  equivalent  to  $1  for  each  $1,000  of  the  same  proportion  of  the  sum 
of  such  surplus  and  reserves,  which  the  reserve  fund  upon  business  trans- 
acted within  the  United  States  is  of  the  total  reserve  upon  all  business 
transacted,  as  of  the  close  of  the  preceding  accounting  period  used  by  such 
company  for  purposes  of  making  its  income  tax  return. 

(d)  Section  257  shall  apply  to  all  returns  filed  with  the  Commissioner  for 
purposes  of  the  tax  imposed  by  this  section. 


TITLE  XI— STAMP  TAXES 

Sec.  1100.  That  on  and  after  April  1,  1919,  there  shall  be  levied,  collected, 
and  paid,  for  and  in  respect  of  the  several  bonds,  debentures,  or  certificates 
of  stock  and  of  indebtedness,  and  other  documents,  instruments,  matters,  and 
things  mentioned  and  described  in  Schedule  A  of  this  title,  or  for  or  in  re- 
spect of  the  vellum,  parchment,  or  paper  upon  which  such  instruments, 
matters,  or  things,  or  any  of  them,  are  written  or  printed,  by  any  person 
who  makes,  signs,  issues,  sells,  removes,  consigns,  or  ships  the  same,  or  for 
whose  use  or  benefit  the  same  are  made,  signed,  issued,  sold,  removed,  con- 
signed, or  shipped,  the  several  taxes  specified  in  such  schedule.  The  taxes 
imposed  by  this  section  shall,  in  the  case  of  any  article  upon  which  a  corre- 
sponding stamp  tax  is  now  imposed  by  law,  be  in  lieu  of  such  tax. 

Sec.  1101.  That  there  shall  not  be  taxed  under  this  title  any  bond,  note, 
or  other  instrument,  issued  by  the  United  States,  or  by  any  foreign  Govern- 
ment, or  by  any  State,  Territory,  or  the  District  of  Columbia,  or  local  sub- 
division thereof,  or  municipal  or  other  corporation  exercising  the  taxing 
power;  or  any  bond  of  indemnity  required  to  be  filed  by  any  person  to  secure 
payment  of  any  pension,  allowance,  allotment,  relief,  or  insurance  by  the 
United  States;  or  stocks  and  bonds  issued  by  co-operative  building  and  loan 
associations  which  are  organized  and  operated  exclusively  for  the  benefit  of 
their  members  and  make  loans  only  to  their  shareholders,  or  by  mutual  ditch 
or  irrigating  companies. 

Sec.  1102.  That  whoever — 


1316  APPENDIX 

(a)  Makes,  signs,  issues,  or  accepts,  or  causes  to  be  made,  signed,  issued, 
or  accepted,  any  instrument,  document,  or  paper  of  any  kind  or  description 
whatsoever  without  the  full  amount  of  tax  thereon  being  duly  paid: 

(b)  Consigns  or  ships,  or  causes  to  be  consigned  or  shipped,  by  parcel 
post  any  parcel,  package,  or  article  without  the  full  amount  of  tax  being 
duly  paid; 

(c)  Manufactures  or  imports  and  sells,  or  offers  for  sale,  or  causes  to  be 
manufactured  or  imported  and  sold,  or  offered  for  sale,  any  playing  cards, 
package,  or  other  article  without  the  full  amount  of  tax  being  duly  paid; 

(d)  Makes  use  of  any  adhesive  stamp  to  denote  any  tax  imposed  by  this 
title  without  canceling  or  obliterating  such  stamp  as  prescribed  in  section 
1104; 

Is  guilty  of  a  misdemeanor  and  upon  conviction  thereof  shall  pay  a  fine  of 
not  more  than  $100  for  each  offense. 
Sec.  1103.    That  whoever— 

(a)  Fraudulently  cuts,  tears,  or  removes  from  any  vellum,  parchment, 
paper,  instrument,  writing,  package,  or  article,  upon  which  any  tax  is  im- 
posed by  this  title,  any  adhesive  stamp  or  the  impression  of  any  stamp,  die, 
plate,  or  other  article  provided,  made,  or  used  in  pursuance  of  this  title; 

(b)  Fraudulently  uses,  joins,  fixes,  or  places  to,  with,  or  upon  any  vellum, 
parchment,  paper,  instrument,  writing,  package,  or  article,  upon  which  any 
tax  is  imposed  by  this  title,  (1)  any  adhesive  stamp,  or  the  impression  of 
any  stamp,  die,  plate,  or  other  ai'ticle,  which  has  been  cut,  torn,  or  removed 
from  any  other  vellum,  parchment,  paper,  instrument,  writing,  package,  or 
article,  upon  which  any  tax  is  imposed  by  this  title;  or  (2)  any  adhesive 
stamp  or  the  impression  of  any  stamp,  die,  plate,  or  other  article  of  insuffi- 
cient value;  or  (3)  any  forged  or  counterfeit  stamp,  or  the  impression  of  any 
forged  or  counterfeit  stamp,  die,  plate,  or  other  article; 

(c)  Willfully  removes,  or  alters  the  cancellation,  or  defacing  marks  of, 
or  otherwise  prepares,  any  adhesive  stamp,  with  intent  to  use,  or  cause  the 
same  to  be  used,  after  it  has  been  already  used,  or  knowingly  or  willfully 
buys,  sells,  offers  for  sale,  or  gives  away,  any  such  washed  or  restored 
stamp  to  any  person  for  use,  or  knowingly  uses  the  same; 

(d)  Knowingly  and  without  lawful  excuse  (the  burden  of  proof  of  such 
excuse  being  on  the  accused)  has  in  possession  any  washed,  restored,  or 
altered  stamp,  which  has  been  removed  from  any  vellum,  parchment,  paper, 
instrument,  writing,  package,  or  article; 

Is  guilty  of  a  misdemeanor,  and  upon  conviction  shall  be  punished  by  a 
fine  of  not  more  than  $1,000,  or  by  imprisonment  for  not  more  than  fivg 
years  or  both,  and  any  such  reused,  canceled,  or  counterfeit  stamp  and  the 
vellum,  parchment,  document,  paper,  package,  or  article  upon  which  it  is 
placed  or  impressed  shall  be  forfeited  to  the  United  States. 

Sec.  1104.  That  whenever  an  adhesive  stamp  is  used  for  denoting  any  tax 
imposed  by  this  title,  except  as  hereinafter  provided,  the  person  using  or 
affixing  the  same  shall  write  or  stamp  or  cause  to  be  written  or  stamped 
thereupon  the  initials  of  his  or  its  name  and  the  date  upon  which  the  same 
is  attached  or  used,  so  that  the  same  may  not  again  be  used:  Provided, 
That  the  Commissioner  may  prescribe  such  other  method  for  the  cancella- 
tion of  such  stamps  as  he  may  deem  expedient. 

Sec.  1105.  (a)  That  the  Commissioner  shall  cause  to  be  prepared  and  dis- 
tributed for  the  payment  of  the  taxes  prescribed  in  this  title  suitable  stamps 
denoting  the  tax  on  the  document,  articles,  or  thing  to  which  the  same  may 
be  affixed,  and  shall  prescribe  such  method  for  the  affixing  of  said  stamps  in 


REVENUE   ACT  OF    1918  1317 

substitution  for  or  in  addition  to  tlie  method  provided  in  this  title,  as  he  may 
deem  expedient. 

(b)  The  Commissioner,  with  the  approval  of  the  Secretary,  is  authorized 
to  procure  any  of  the  stamps  provided  for  in  this  title  by  contract  whenever 
such  stamps  can  not  be  speedily  prepared  by  the  Bureau  of  Engraving  and 
Printing;  but  this  authority  shall  expire  on  January  1,  1920,  except  as  to 
imprinted  stamps  furnished  under  contract,  authorized  by  the  Commissioner. 

(c)  All  internal-revenue  laws  relating  to  the  assessment  and  collection  of 
taxes  are  hereby  extended  to  and  made  a  part  of  this  title,  so  far  as  ap- 
plicable, for  the  purpose  of  collecting  stamp  taxes  omitted  through  mistake 
or  fraud  from  any  instrument,  document,  paper,  writing,  parcel,  package, 
or  article  named  herein. 

Sec.  1106.  That  the  Commissioner  shall  furnish  to  the  Postmaster-General 
without  prepayment  a  suitable  quantity  of  adhesive  stamps  to  be  distributed 
to  and  kept  on  sale  by  the  various  postmasters  in  the  United  States.  The 
Postmaster-General  may  require  each  such  postmaster  to  give  additional  or 
increased  bond  as  postmaster  for  the  value  of  the  stamps  so  furnished,  and 
each  such  postmaster  shall  deposit  the  receipts  from  the  sale  of  such  stamps 
to  the  credit  of  and  render  accounts  to  the  Postmaster-General  at  such  times 
and  in  such  form  as  he  may  by  regulations  prescribe.  The  Postmaster- 
General  shall  at  least  once  monthly  transfer  all  collections  from  this  source 
to   the   Treasury   as   internal-revenue   collections. 

Sec.  1107.  That  the  collectors  of  the  several  districts  shall  furnish  withou*^ 
prepayment  to  any  assistant  treasurer  or  designated  depositary  of  the 
United  States  located  in  their  respective  collection  districts  a  suitable  quan- 
tity of  adhesive  stamps  for  sale.  In  such  cases  the  collector  may  require 
a  bond,  with  sufficient  sureties,  to  an  amount  equal  to  the  value  of  the 
adhesive  stamps  so  furnished,  conditioned  for  the  faithful  return,  whenever 
so  required,  of  all  quantities  or  amounts  undisposed  of,  and  for  the  payment 
monthly  of  all  quantities  or  amounts  sold  or  not  remaining  on  hand.  The 
Secretary  may  from  time  to  time  make  such  regulations  as  he  may  find 
necessary  to  insure  the  safekeeping  or  prevent  the  illegal  use  of  all  such 
adhesive  stamps. 

Schedule  A — Stamp  Taxes 

1.  Bonds  of  indebtedness:  On  all  bonds,  debentures,  or  certificates  of 
indebtedness  issued  by  any  person,  and  all  instruments,  however  termed, 
issued  by  any  corporation  with  interest  coupons  or  in  registered  form, 
known  generally  as  corporate  securities,  on  each  $100  of  face  value  or  frac- 
tion thereof,  5  cents:  Provided,  That  every  renewal  of  the  foregoing  shall 
be  taxed  as  a  new  issue:  Provided  further,  That  when  a  bond  conditioned 
for  the  repayment  or  payment  of  money  is  given  in  a  penal  sum  greater 
than  the  debt  secured,  the  tax  shall  be  based  upon  the  amount  secured. 

2.  Bonds,  indemnity  and  surety:  On  all  bonds  executed  for  indemnifying 
any  person  who  shall  have  become  bound  or  engaged  as  surety,  and  on  all 
bonds  executed  for  the  due  execution  or  performance  of  any  contract,  ob- 
ligation, or  requirement,  or  the  duties  of  any  office  or  position,  and  to  ac- 
count for  money  received  by  virtue  thereof,  and  on  all  policies  of  guaranty 
and  fidelity  insurance,  including  policies  guaranteeing  titles  to  real  estate 
and  mortgage  guarantee  policies,  and  on  all  other  bonds  of  any  description, 
made,  issued,  or  executed,  not  otherwise  provided  for  in  this  schedule,  ex- 
cept such  as  may  be  required  in  legal  proceedings.  50  cents:  Provided,  That 
where  a  premium  is  charged  for  the  issuance,  execution,  renewal  or  co'n- 


1318  APPENDIX 

tinuance  of  such  bond  the  tax  shall  be  1  cent  on  each  dollar  or  fractional 
part  thereof  the  premium  charged:  Provided  further.  That  policies  of  re- 
insurance shall  be  exempt  from  the  tax  imposed  by  this  subdivision. 

3.  Capital  stock,  issued:  On  each  original  issue,  whether  on  organization 
or  reorganization,  of  certificates  of  stock,  or  of  profits,  or  of  interest  in 
property  or  accumulations,  by  any  corporation,  on  each  $100  of  face  value 
or  fraction  thereof,  5  cents:  Provided,  That  where  a  certificate  is  issued 
without  face  value,  the  tax  shall  be  5  cents  per  share,  unless  the  actual  value 
is  in  excess  of  $100  per  share,  in  which  case  the  tax  shall  be  5  cents  on  each 
$100  of  actual  value  or  fraction  thereof. 

The  stamps  representing  the  tax  imposed  by  this  subdivision  shall  be  at- 
tached to  the  stock  books  and  not  to  the  certificates  issued. 

4.  Capital  stock,  sales  or  transfers :  On  all  sales,  or  agreements  to  sell, 
or  memoranda  of  sales  or  deliveries  of,  or  transfers  of  legal  title  to  shares 
or  certificates  of  stock  or  of  profits  or  of  interest  in  property  or  accumula- 
tions in  any  corporation,  or  to  rights  to  subscribe  for  or  to  receive  such 
shares  or  certificates,  whether  made  upon  or  shown  by  the  books  of  the 
corporation,  or  by  any  assignment  in  blank,  or  by  any  delivery,  or  by  any 
paper  or  agreement  or  memorandum  or  other  evidence  of  transfer  or 
sale,  whether  entitling  the  holder  in  any  manner  to  the  benefit  of  such  stock, 
interest,  or  rights,  or  not,  on  each  $100  of  face  value  or  fraction  thereof, 
2  cents,  and  where  such  shares  are  without  par  or  face  value,  the  tax 
shall  be  2  cents  on  the  transfer  or  sale  or  agreement  to  sell  on  each  share, 
unless  the  actual  value  thereof  is  in  excess  of  $100  per  share,  in  which  case 
the  tax  shall  be  2  cents  on  each  $100  of  actual  value  or  fraction  thereof: 
Provided,  That  it  is  not  intended  by  this  title  to  impose  a  tax  upon  an 
agreement  evidencing  a  deposit  of  certificates  as  collateral  security  for 
money  loaned  thereon,  which  certificates  are  not  actually  sold,  nor  upon 
the  delivery  or  transfer  for  such  purpose  of  certificates  so  deposited: 
Provided  further.  That  the  tax  shall  not  be  imposed  upon  deliveries  or  trans- 
fers to  a  broker  for  sale,  nor  upon  deliveries  or  transfers  by  a  broker  to  a 
customer  for  whom  and  upon  whose  order  he  has  purchased  same,  but  such 
deliveries  or  transfers  shall  be  accompanied  by  a  certificate  setting  forth 
the  facts:  Provided  further.  That  in  case  of  sale  where  the  evidence  of 
transfer  is  shown  only  by  the  books  of  the  corporation  the  stamp  shall  be 
placed  upon  such  books;  and  where  the  change  of  ownership  is  by  transfer 
of  the  certificate  the  stamp  shall  be  placed  upon  the  certificate ;  and  in  cases 
of  an  agreement  to  sell  or  where  the  transfer  is  by  delivery  of  the  certifi- 
cate assigned  in  blank  there  shall  be  made  and  delivered  by  the  seller  to  the 
buyer  a  bill  or  memorandum  of  such  sale,  to  which  the  stamp  shall  be 
affixed;  and  every  bill  or  memorandum  of  sale  or  agreement  to  sell  before 
mentioned  shall  show  the  date  thereof,  the  name  of  the  seller,  the  amount 
of  the  sale  and  the  matter  or  thing  to  which  it  refers.  Any  person  liable 
to  pay  the  tax  as  herein  provided,  or  anyone  who  acts  in  the  matter  as  agent 
or  broker  for  such  person,  who  makes  any  such  sale,  or  who  in  pursuance 
of  any  such  sale  delivers  any  certificate  or  evidence  of  the  sale  of  any 
stock,  interest  or  right,  or  bill  or  memorandum  thereof,  as  herein  required, 
without  having  the  proper  stamps  affixed  thereto  with  intent  to  evade  the 
foregoing  provisions,  shall  be  deemed  guilty  of  a  misdemeanor,  and  upon 
conviction  thereof  shall  pay  a  fine  of  not  exceeding  $1,000,  or  be  im- 
prisoned not  more  than  six  months,  or  both. 

5.  Produce,  sales  of,  on  exchange:  Upon  each  sale,  agreement  of  sale, 
or  agreement  to  sell  (not  including  so-called  transferred  or  scratch  sales). 


REVENUE   ACT  OF   1918  1319 

any  products  or  merchandise  at,  or  under  the  rules  or  usages  of,  any  ex- 
change, or  board  of  trade,  or  other  similar  place,  for  future  delivery,  for 
each  $100  in  value  of  the  merchandise  covered  by  said  sale  or  agreement 
of  sale  or  agreement  to  sell,  2  cents,  and  for  each  additional  $100  or  frac- 
tional part  thereof  in  excess  of  $100,  2  cents:  Provided,  That  on  every 
sale  or  agreement  of  sale  or  agreement  to  sell  as  aforesaid  there  shall  be 
made  and  delivered  by  the  seller  to  the  buyer  a  bill,  memorandum,  agree- 
ment, or  other  evidence  of  such  sale,  agreement  of  sale,  or  agreement  to 
sell,  to  which  there  shall  be  affixed  a  lawful  stamp  or  stamps  in  value 
equal  to  the  amount  of  the  tax  on  such  sale:  Provided  further,  That  sellers 
of  commodities  described  herein,  having  paid  the  tax  provided  by  this 
subdivision,  may  transfer  such  contracts  to  a  clearing-house  corporation  or 
association,  and  such  transfer  shall  not  be  deemed  to  be  a  sale,  or  agree- 
ment of  sale,  or  an  agreement  to  sell  within  the  provisions  of  this  Act, 
provided  that  such  transfer  shall  not  vest  any  beneficial  interest  in  such 
clearing-house  association  but  shall  be  made  for  the  sole  purpose  of  en- 
abling such  clearing-house  association  to  adjust  and  balance  the  accounts 
of  the  members  of  such  clearing-house  association  on  their  several  con- 
tracts. Every  such  bill,  memorandum,  or  other  evidence  of  sale  or  agree- 
ment to  sell  shall  show  the  date  thereof,  the  name  of  the  seller,  the  amount 
of  the  sale,  and  the  matter  or  thing  to  which  it  refers;  and  any  person 
liable  to  pay  the  tax  as  herein  provided  or  anyone  who  acts  in  the  matter  as 
agent  or  broker  for  such  person,  who  makes  any  such  sale  or  agreement  of 
sale,  or  agreement  to  sell,  or  who,  in  pursuance  of  any  such  sale,  agree- 
ment of  sale,  or  agreement  to  sell,  delivers  any  such  products  or  merchandise 
without  a  bill,  memorandum,  or  other  evidence  thereof  as  herein  required, 
or  who  delivers  such  bill,  memorandum,  or  other  evidence  of  sale,  or  agree- 
ment to  sell,  without  having  the  proper  stamps  affixed  thereto,  with  intent 
to  evade  the  foregoing  provisions,  shall  be  deemed  guilty  of  a  misdemeanor, 
and  upon  conviction  thereof  shall  pay  a  fine  of  not  exceeding  $1,000  or  be 
imprisoned  not  more  than  six  months,  or  both. 

No  bill,  memorandum,  agreement,  or  other  evidence  of  such  sale,  or  agree- 
ment of  sale,  or  agreement  to  sell,  in  case  of  cash  sales  of  products  or  mer- 
chandise for  immediate  or  prompt  delivery  which  in  good  faith  are  ac- 
tually intended  to  be  delivered  shall  be  subject  to  this  tax. 

6.  Drafts  or  checks  (payable  otherwise  than  at  sight  or  on  demand)  upon 
their  acceptance  or  delivery  within  the  United  States  whichever  is  prior, 
promissory  notes,  except  bank  notes  issued  for  circulation,  and  for  each 
renewal  of  the  same,  for  a  sum  not  exceeding  $100,  2  cents;  and  for  each 
additional  $100,  or  fractional  part  thereof,  2  cents. 

This  subdivision  shall  not  apply  to  a  promissory  note  secured  by  the 
pledge  of  bonds  or  obligations  of  the  United  States  issued  after  April  24, 
1917,  or  secured  by  the  pledge  of  a  promissory  note  which  itself  is  secured 
by  the  pledge  of  such  bonds  or  obligations:  Provided,  That  in  either  case 
the  par  value  of  such  bonds  or  obligations  shall  be  not  less  than  the  amount 
of  such  note. 

7.  Conveyances:  Deed,  instrument,  or  writing,  whereby  any  lands, 
tenements,  or  other  realty  sold  shall  be  granted,  assigned,  transferred,  or 
otherwise  conveyed  to,  or  vested  in,  the  purchaser  or  purchasers,  or  any 
other  person  or  persons,  by  his,  her,  or  their  direction,  when  the  considera- 
tion or  value  of  the  interest  or  property  conveyed,  exclusive  of  the  value 
of  any  lien  or  encumbrance  remaining  thereon  at  the  time  of  sale,  exceeds 


1320  APPENDIX 

$100  and  does  not  exceed  $500,  50  cents;  and  for  each  additional  $500  or 
fractional  part  thereof,  50  cents.  This  subdivision  shall  not  apply  to  any 
instrument  or  writing  given  to  secure  a  debt. 

8.  Entry  of  any  goods,  wares,  or  merchandise  at  any  customhouse,  either 
for  consumption  or  warehousing,  not  exceeding  $100  in  value,  25  cents; 
exceeding  $100  and  not  exceeding  $500  in  value,  50  cents;  exceeding  $500  in 
value,  $1. 

9.  Entry  for  the  withdrawal  of  any  goods  or  merchandise  from  cus- 
toms bonded  warehouse,  50  cents. 

10.  Passage  ticket,  one  way  or  round  trip,  for  each  passenger,  sold  or 
issued  in  the  United  States  for  passage  by  any  vessel  to  a  port  or  place 
not  in  the  United  States,  Canada,  or  Mexico,  if  costing  not  exceeding 
$30,  $1 ;  costing  more  than  $30  and  not  exceeding  $60,  $3 ;  costing  more  than 
$60,  $5.  This  subdivision  shall  not  apply  to  passage  tickets  costing  $10 
or  less. 

11.  Proxy  for  voting  at  any  election  for  officers,  or  meeting  for  the 
transaction  of  business,  of  any  corporation,  except  religious,  educational, 
charitable,  fraternal,  or  literary  societies,  or  public  cemeteries,  10  cents. 

12.  Power  of  attorney  granting  authority  to  do  or  perform  some  act  for 
or  in  behalf  of  the  grantor,  which  authority  is  not  otherwise  vested  in  the 
grantee,  25  cents.  This  subdivision  shall  not  apply  to  any  papers  necessary 
to  be  used  for  the  collection  of  claims  from  the  United  States  or  from  any 
state  for  pensions,  back  pay,  bounty,  or  for  property  lost  in  the  military 
or  naval  service,  or  to  powers  of  attorney  required  in  bankruptcy  cases. 

13.  Playing  cards:  Upon  every  pack  of  playing  cards  containing  not 
more  than  fifty-four  cards,  manufactured  or  imported,  and  sold,  or  re- 
moved for  consumption  or  sale,  a  tax  of  8  cents  per  pack. 

14.  Parcel-post  packages:  Upon  every  parcel  or  package  transported 
from  one  point  in  the  United  States  to  another  by  parcel  post  on  which 
the  postage  amounts  to  25  cents  or  more,  a  tax  of  1  cent  for  each  25  cents 
or  fractional  part  thereof  charged  for  such  transportation,  to  be  paid  by 
the  consignor. 

No  such  parcel  or  package  shall  be  transported  until  a  stamp  or  stamps 
representing  the  tax  due  shall  have  been  affixed  thereto. 

15.  On  each  policy  of  insurance,  or  certificate,  binder,  covering  note, 
memorandum,  cablegram,  letter,  or  other  instrument  by  whatever  name 
called  whereby  insurance  is  made  or  renewed  upon  property  within  the 
United  States  (including  rents  and  profits)  against  peril  by  sea  or  on  in- 
land waters  or  in  transit  on  land  (including  transshipments  and  storage  at 
termini  or  way  points)  or  by  fire,  lightning,  toronado,  windstorm,  bombard- 
ment, invasion,  insurrection  or  riot,  issued  to  or  for  or  in  the  name  of  a  do- 
mestic corporation  or  partnership  or  an  individual  resident  of  the  United 
States  by  any  foreign  corporation  or  partnership  or  any  individual  not  a 
resident  of  the  United  States,  when  such  policy  or  other  instrument  is  not 
signed  or  countersigned  by  an  officer  or  agent  of  the  insurer  in  a  State, 
Territory,  or  district  of  the  United  States  within  which  such  insurer  is 
authorized  to  do  business,  a  tax  of  3  cents  on  each  dollar,  or  fractional  part 
thereof  of  the  premium  charged :  Provided,  That  policies  of  re-insurance 
shall  be  exempt  from  the  tax  imposed  by  this  subdivision. 

Any  person  to  or  for  whom  or  in  whose  name  any  such  policy  or  other 
instrument  is  issued,  or  any  solicitor  or  broker  acting  for  or  on  behalf  of 
such  person  in  the  procurement  of  any  such  policy  or  other  instrument, 
shall  affix  the  proper  stamps  to  such  policy  or  other  instrument,  and  for  fail- 


REVENUE  ACT  OF    1918  1321 

urc  to  affix  such  stamps  with  intent  to  evade  the  tax  shall,  in  addition  to 
other  penalties  provided  therefor,  pay  a  fine  of  double  the  amount  of  the 
tax. 

TITLE   XII— TAX   ON   EMPLOYMENT   OF   CHILD    LABOR 

Sec.  1200.  That  every  person  (other  than  a  bona  fide  boys'  or  girls'  can- 
ning club  recognized  by  the  Agricultural  Department  of  a  State  and  of  the 
United  States)  operating  (a)  any  mine  or  quarry  situated  in  the  United 
States  in  which  children  under  the  age  of  sixteen  years  have  been  employed 
or  permitted  to  work  during  any  portion  of  the  taxable  year;  or  (b)  any 
mill,  cannery,  workshop,  factory,  or  manufacturing  establishment  situated 
in  the  United  States  in  which  children  under  the  age  of  fourteen  years 
have  been  employed  or  permitted  to  work,  or  children  between  the  ages  of 
fourteen  and  sixteen  have  been  employed  or  permitted  to  work  more  than 
eight  hours  in  any  day  or  more  than  six  days  in  any  week,  or  after  the 
hour  of  seven  o'clock  post  meridian,  or  before  the  hour  of  six  o'clock  ante 
m.eridian,  during  any  portion  of  the  taxable  year,  shall  pay  for  each  tax- 
able year,  in  addition  to  all  other  taxes  imposed  by  law,  an  excise  tax  equiva- 
leflt  to  10  per  centum  of  the  entire  net  profits  received  or  accrued  for  such 
year  from  the  sale  or  disposition  of  the  product  of  such  mine,  quarry,  mill, 
cannery,  workshop,  factory,  or  manufacturing  establishment. 

Sec.  1201.  That  in  computing  net  profits  under  the  provisions  of  this  title. 
for  the  purpose  of  the  tax  there  shall  be  allowed  as  deductions  from  the 
gross  amount  received  or  accrued  for  the  taxable  year  from  the  sale  or  dis- 
position of  such  products  manufactured  within  the  United  States  the  fol- 
lowing items: 

(a)  The  cost  of  raw  materials  entering  into  the  production; 

(b)  Running  expenses,  including  rentals,  cost  of  repairs,  and  main- 
tenance, heat,  power,  insurance,  management,  and  a  reasonable  allowance 
for  salaries  or  other  compensations  for  personal  services  actually  rendered, 
and  for  depreciation; 

(c)  Interest  paid  within  the  taxable  year  on  debts  or  loans  contracted 
to  meet  the  needs  of  the  business,  and  the  proceeds  of  which  have  been 
actually  used  to  meet  such  needs; 

(d)  Taxes  of  all  kinds  paid  during  the  taxable  year  with  respect  to  the 
business  or  property  relating  to  the  production;   and 

(e)  Losses  actually  sustained  within  the  taxable  year  in  connection  with 
the  business  of  producing  such  products,  including  losses  from  fire,  flood, 
storm,  or  other  casualties,  and  not  compensated  for  by  insurance  or  other- 
wise. 

Pec.  1202.  That  if  any  such  person  during  any  taxable  year  or  part 
thereof,  whether  under  any  agreement,  arrangement,  or  understanding  or 
otherwise,  sells  or  disposes  of  any  product  of  such  mine,  quarry,  mill,  can- 
nery, workshop,  factory,  or  manufacturing  establishment  at  less  than  the 
fair  n^arket  price  obtainable  therefor  either  (a)  in  such  manner  as  directly 
or  indirectly  to  benefit  such  person  or  any  person  directly  or  indirectly  in- 
terested in  the  business  of  such  person;  or  (b)  with  intent  to  cause  such 
benefit:  the  gross  amount  received  or  accrued  for  such  year  or  part  thereof 
from  the  sale  or  disposition  of  such  product  shall  be  taken  to  be  the  amount 
which  would  have  been  received  or  accrued  from  the  sale  or  disposition  of 
such  product  if  sold  at  the  fair  market  price. 


1322  APPENDIX 

Sec.  1203.  (a)  That  no  person  subject  to  the  provisions  of  this  title  shall 
be  liable  for  the  tax  herein  imposed  if  the  only  employment  or  permis- 
sion to  work  which  but  for  this  section  would  subject  him  to  the  tax,  has 
been  of  a  child  as  to  whom  such  person  has  in  good  faith  procured  at  the 
time  of  employing  such  child  or  permitting  him  to  work,  and  has  since  in 
good  faith  relied  upon  and  kept  on  file  a  certificate,  issued  in  such  form, 
under  such  conditions  and  by  such  persons  as  may  be  prescribed  by  a  board 
consisting  of  the  Secretary,  the  Commissioner,  and  the  Secretary  of  Labor, 
showing  the  child  to  be  of  such  age  as  not. to  subject  such  person  to  the  tax 
imposed  by  this  title.  Any  person  who  knowingly  makes  a  false  statement 
or  presents  false  evidence  in  or  in  relation  to  any  such  certificate  or  ap- 
plication therefor  shall  be  punished  by  a  fine  of  not  less  than  $100,  nor  more 
than  $1,000,  or  by  imprisonment  for  not  more  than  three  months,  or  by 
both  such  fine  and  imprisonment,  in  the  discretion  of  the  court. 

In  any  state  designated  by  such  board  an  employment  certificate  or 
other  similar  paper  as  to  the  age  of  the  child,  issued  under  the  laws  of  that 
state,  and  not  inconsistent  with  the  provisions  of  this  title,  shall  have  the 
same  force  and  effect  as  a  certificate  herein  provided  for. 

(b)  The  tax  imposed  by  this  title  shall  not  be  imposed  in  the  case  of  ai^y 
person  who  proves  to  the  satisfaction  of  the  Secretary  that  the  only  em- 
ployment or  permission  to  work  which  but  for  this  section  would  subject  him 
to  the  tax,  has  been  of  a  child  employed  or  permitted  to  work  under  a  mis- 
take of  fact  as  to  the  age  of  such  child,  and  without  intention  to  evade  the 
tax. 

Sec.  1204.  That  on  or  before  the  first  day  of  the  third  month  following 
the  close  of  each  taxable  year,  a  true  and  accurate  return  under  oath  shall 
be  made  by  each  person  subject  to  the  provisions  of  this  title  to  the  collector 
for  the  district  in  which  such  person  has  his  principal  office  or  place  of  busi- 
ness, in  such  form  as  the  Commissioner,  with  the  approval  of  the  Secretary, 
shall  prescribe,  setting  forth  specifically  the  gross  amount  of  income  re- 
ceived or  accrued  during  such  year  from  the  sale  or  disposition  of  the  prod- 
uct of  any  mine,  quarry,  mill,  cannery,  workshop,  factory,  or  manufacturing 
establishment,  in  which  children  have  been  employed  subjecting  him  to  the 
tax  imposed  by  this  title,  and  from  the  total  thereof  deducting  the  aggre- 
gate items  of  allowance  authorized  by  this  title,  and  such  other  particulars 
as  to  the  gross  receipts  and  items  of  allowance  as  the  Commissioner,  with 
the  approval  of  the  Secretary  may  require. 

Sec.  1205.  That  all  such  returns  shall  be  transmitted  forthwith  by  the 
collector  to  the  Commissioner,  who  shall,  as  soon'  as  practicable,  assess  the 
tax  found  due  and  notify  the  person  making  such  return  of  the  amount  of 
tax  for  which  such  person  is  liable,  and  such  person  shall  pay  the  tax  to 
the  collector  on  or  before  thirty  days  from  the  date  of  such  notice. 

Sec.  1206.  That  for  the  purposes  of  this  Act  the  Commissioner,  or  any 
other  person  duly  authorized  by  him,  shall  have  authority  to  enter  and  in- 
spect at  any  time  any  mine,  quarry,  mill,  cannery,  workshop,  factory  or 
manufacturing  establishment.  The  Secretary  of  Labor,  or  any  person  duly 
authorized  by  him,  shall,  for  the  purpose  of  complying  with  a  request  of 
the  Commissioner  to  make  such  an  inspection,  have  like  authority,  and  shall 
make  report  to  the  Commissioner  of  inspections  made  under  such  authority 
in  such  form  as  may  be  prescribed  by  the  Commissioner  with  the  approval 
of  the  Secretary  of  the  Treasury. 


REVENUE  ACT  OF   1918  1323 

Any  person  who  refuses  or  obstructs  entry  or  inspection  authorized  by 
this  section  shall  be  punished  by  a  fine  of  not  more  than  $1,000,  or  by  im- 
prisonment for  not  more  than  one  year,  or  both  such  fine  and  imprisonment. 

Sec.  1207.  That  as  used  in  this  title  the  term  "taxable  year"  shall  have 
the  same  meaning  as  provided  for  the  purposes  of  income  tax  in  section  200. 
The  first  taxable  year  for  the  purposes  of  this  title  shall  be  the  period  be- 
tween sixty  days  after  the  passage  of  this  Act  and  December  31,  1919,  both 
inclusive,  or  such  portion  of  such  period  as  is  included  within  the  fiscal  year 
(as  defined  in  section  200)   of  the  taxpayer. 

TITLE  XIII— GENERAL  ADMINISTRATIVE  PROVISIONS^ 

Section  1301.  (d)  (1)  There  is  hereby  created  a  board  to  be  known  as 
the  "Advisory  Tax  Board,"  hereinafter  called  the  Board,  and  to  be  com- 
posed of  not  to  exceed  six  members  to  be  appointed  by  the  Commissioner 
with  the  approval  of  the  Secretary.  The  Board  shall  cease  to  exist  at  the 
expiration  of  two  years  after  the  passage  of  this  Act,  or  at  such  earlier  time 
as  the  Commissioner  with  the  approval  of  the  Secretary  may  designate. 

Vacancies  in  the  membership  of  the  Board  shall  be  filled  in  the  same  man- 
ner as  an  original  appointment.  Any  member  shall  be  subject  to  removal 
by  the  Commissioner  with  the  approval  of  the  Secretary.  The  Commissioner 
with  the  approval  of  the  Secretary  shall  designate  the  chairman  of  the 
Board.  Each  member  shall  receive  an  annual  salary  of  $9,000,  payable 
monthly,  together  with  actual  necessary  expenses  when  absent  from  the 
District  of  Columbia  on  official  business. 

(2)  The  Commissioner  may,  and  on  the  request  of  any  taxpayer  directly 
interested  shall,  submit  to  the  Board  any  question  relating  to  the  interpreta- 
tion or  administration  of  the  income,  war-profits  or  excess-profits  tax  laws, 
and  the  Board  shall  report  its  findings  and  recommendations  to  the  Com- 
missioner. 

(3)  The  Board  shall  have  its  office  in  the  Bureau  of  Internal  Revenue  in 
the  District  of  Columbia.  The  expenses  and  salaries  of  members  of  the 
Board  shall  be  audited,  allowed,  and  paid  out  of  appropriations  for  collect- 
ing internal  revenue,  in  the  same  manner  as  expenses  and  salaries  of  em- 
ployees of  the  Bureau  of  Internal  Revenue  are  audited,  allowed,  and  paid. 

(4)  The  Board  shall  have  the  power  to  summon  witnesses,  take  testimony, 
administer  oaths,  and  to  require  any  person  to  produce  books,  papers,  docu- 
ments, or  other  data  relating  to  any  matter  under  investigation  by  the 
Board.  Any  member  of  the  Board  may  sign  subpoenas  and  members  and 
employees  of  the  Bureau  of  Internal  Revenue  designated  to  assist  the  Board, 
when  authorized  by  the  Board,  may  administer  oaths,  examine  witnesses, 
take  testimony  and  receive  evidence. 

Sec.  1305.  That  all  administrative,  special,  or  stamp  provisions  of  law, 
including  the  law  relating  to  the  assessment  of  taxes,  so  far  as  applicable, 
are  hereby  extended  to  and  made  a  part  of  this  Act,  and  every  person  liable 
to  any  tax  imposed  by  this  Act,  or  for  the  collection  thereof,  shall  keep 
such  records  and  render,  under  oath,  such  statements  and  returns,  and  shall 
comply  with  such  regulations  as  the  Commissioner,  with  the  approval  of  the 
Secretary,  may  from  time  to  time  prescribe. 

Whenever  in  the  judgment  of  the  Commissioner  necessary  he  may  require 
any  person,  by  notice  served  upon  him,  to  make  a  return  or  such  statements 
as  he  deems  sufficient  to  show  whether  or  not  such  person  is  liable  to  tax. 


'  Parts  of  this  title  are  omitted,  being  general    provisions  of   no    direct  application 
to  the  taxes  treated  in  this  book. 


1324  APPENDIX 

The  Commissioner,  for  the  purpose  of  ascertaining  the  correctness  of  any 
return  or  for  the  purpose  of  making  a  return  where  none  has  been  made, 
is  hereby  authorized,  by  any  revenue  agent  or  inspector  designated  by  him 
for  that  purpose,  to  examine  any  books,  papers,  records  or  memoranda 
bearing  upon  the  matters  required  to  be  included  in  the  return,  and  may 
require  the  attendance  of  the  person  rendering  the  return  or  of  any  oflRcer 
or  employee  of  such  person,  or  the  attendance  of  any  other  person  having 
knowledge  in  the  premises,  and  may  take  his  testimony  with  reference  to 
the  matter  required  by  law  to  be  included  in  such  return,  with  power  to 
administer  oaths  to  such  person  or  persons. 

Sec.  1307.  That  in  all  cases  where  the  method  of  collecting  the  tax  im- 
posed by  this  Act  is  not  specifically  provided  in  this  Act,  the  tax  shall  be 
collected  in  such  manner  as  the  Commissioner,  with  the  approval  of  the 
Secretary,  may  prescribe.  All  administrative  and  penalty  provisions  of 
Title  XI  of  this  Act,  in  so  far  as  applicable,  shall  apply  to  the  collection  of 
any  tax  which  the  Commissioner  determines  or  prescribes  shall  be  paid  by 
stamp. 

Sec.  1308.  (a)  That  any  person  required  under  Titles  V,  VI,  VII,  VIII. 
IX,  X,  or  XII,  to  pay,  or  to  collect,  account  for  and  pay  over  any  tax,  or 
required  by  law  or  regulations  made  under  authority  thereof  to  make  a 
return  or  supply  any  information  for  the  purposes  of  the  computation, 
assessment  or  collection  of  any  such  tax,  who  fails  to  pay,  collect,  or  truly 
account  for  and  pay  over  any  such  tax,  make  any  such  return  or  supply 
any  such  information  at  the  time  or  times  required  by  law  or  regulation 
shall  in  addition  to  other  penalties  provided  by  law  be  subject  to  a  penalty 
of  not  more  than  $1,000. 

(b)  Any  person  who  willfully  refuses  to  pay,  collect,  or  truly  account  for 
and  pay  over  any  such  tax,  make  such  return  or  supply  such  information 
at  the  time  or  times  required  by  law  or  regulation,  or  who  willfully  attempts 
in  any  manner  to  evade  such  tax  shall  be  guilty  of  a  misdemeanor  and  in 
addition  to  other  penalties  provided  by  law  shall  be  fined  not  more  than 
$10,000  or  imprisoned  for  not  more  than  one  year,  or  both,  together  with 
the  costs  of  prosecution. 

(c)  Any  person  who  willfully  refuses  to  pay,  collect,  or  truly  account  for 
and  pay  over  any  such  tax  shall  in  addition  to  other  penalties  provided  by 
law  be  liable  to  a  penalty  of  the  amount  of  the  tax  evaded,  or  not  paid, 
collected,  or  accounted  for  and  paid  over,  to  be  assessed  and  collected  in 
the  same  manner  as  taxes  are  assessed  and  collected:  Provided,  hotvever. 
That  no  penalty  shall  be  assessed  under  this  subdivision  for  any  off^ense 
for  which  a  penalty  may  be  assessed  under  authority  of  section  3176  of  the 
Revised  Statutes,  as  amended,  or  of  section  605  or  620  of  this  Act,  or  for 
any  offense  for  which  a  penalty  has  been  recovered  under  section  3256  of 
the  Revised  Statutes. 

(d)  The  term  "person"  as  used  in  this  section  includes  an  officer  or  em- 
ployee of  a  corporation  or  a  member  or  employee  of  a  partnership,  who  as 
such  officer,  employee,  or  member  is  under  a  duty  to  perform  the  act  in 
respect  of  which  the  violation  occurs. 

Sec.  1309.  That  the  Commissioner,  with  the  approval  of  the  Secretary, 
is  hereby  authorized  to  make  all  needful  rules  and  regulations  for  the  en- 
forcement of  the  provisions  of  this  Act. 

The  Commissioner  with  such  approval  may  by  regulation  provide  that 
any  return  required  by  Titles  V,  VI,  VII,  VIII,  IX,  or  X  to  be  under  oath 


REVENUE  ACT  OF    1918  1325 

may,  if  the  amount  of  the  tax  covered  thereby  is  not  in  excess  of  $10,  be 
signed  or  acknowledged  before  two  witnesses  instead  of  under  oath. 

Sec.  i;n3.  That  in  the  payment  of  any  tax  under  this  Act  not  payable 
by  stamp  a  fractional  part  of  a  cent  shall  be  disregarded  unless  it  amounts 
to  one-half  cent  or  more,  in   which  case   it   shall  be  increased   to   1   cent. 

Sec.  1314.  That  collectors  may  receive,  at  par  with  an  adjustment  for 
accrued  interest,  certificates  of  indebtedness  issued  by  the  United  States 
and  uncertified  checks  in  payment  of  income,  war-profits  and  excess-profits 
taxes  and  any  other  taxes  payable  other  than  by  stamp,  during  such  time 
and  under  such  regulations  as  the  Commissioner,  with  the  approval  of  the 
Secretary,  shall  prescribe;  but  if  a  check  so  received  is  not  paid  by  the 
bank  on  which  it  is  drawn  the  person  by  whom  such  check  has  been  tendered 
shall  remain  liable  for  the  payment  of  the  tax  and  for  all  legal  penalties 
and  additions  the  same  as  if  such  check  had   not  been  tendered. 

Sec.  1316.  (a)  That  section  3220  of  the  Revised  Statutes  is  hereby 
amended  to   read   as  follows: 

"Sec.  3220.  The  Commissioner  of  Internal  Revenue,  subject  to  regula- 
tions prescribed  by  the  Secretary  of  the  Treasury,  is  authorized  to  remit, 
refund,  and  pay  back  all  taxes  erroneously  or  illegally  assessed  or  collected, 
all  penalties  collected  without  authority,  and  all  ta.xes  that  appear  to  be 
unjustly  assessed  or  excessive  in  amount,  or  in  any  manner  wrongfully 
collected ;  also  to  repay  to  any  collector  or  deputy  collector  the  full  amount 
of  such  sums  of  money  as  may  be  recovered  against  him  in  any  court,  for 
any  internal  revenue  taxes  collected  by  him,  with  the  cost  and  expenses  of 
suit;  also  all  damages  and  costs  recovered  against  any  assessor,  assistant 
assessor,  collector,  deputy  collector,  agent,  or  inspector,  in  any  suit  brought 
against  him  by  reason  of  anything  done  in  the  due  performance  of  his  official 
duty,  and  shall  make  report  to  Congress  at  the  beginning  of  each  regular 
session  of  Congress  of  all  transactions  under  this  section." 

(b)  Section  3225  of  the  Revised  Statutes  of  the  United  States  is  hereby 
amended  to  read  as  follows: 

"Sec.  3225.  When  a  second  assessment  is  made  in  case  of  any  list,  state- 
ment, or  return,  which  in  the  opinion  of  the  collector  or  deputy  collector  was 
false  or  fraudulent,  or  contained  any  understatement  or  undervalua- 
tion, such  assessment  shall  not  be  remitted,  nor  shall  taxes  collected  under 
such  assessment  be  refunded,  or  paid  back,  or  recovered  by  any  suit,  unless 
it  is  proved  that  such  list,  statement,  or  return  was  not  willfully  false  or 
fraudulent  and  did  not  contain  any  willful  understatement  or  undervalua- 
tion." 

(c)  That  the  paragraph  of  section  3(589  of  the  Revised  Statutes,  as 
amended,  reading  as  follows:  "Refunding  taxes  illegally  collected  (internal 
revenue)  :  To  refund  and  pay  back  duties  erroneously  or  illegally  assessed 
or  collected  under  the  internal-revenue  laws,"  is  repealed  from  and  after 
June  30,  1920;  and  the  Secretary  of  the  Treasury  shall  submit  for  the 
fiscal  year  1921,  and  annually  thereafter,  an  estimate  of  appropriations  to 
refund  and  pay  back  duties  or  taxes  erroneously  or  illegally  assessed  or 
collected  under  the  internal-revenue  laws,  and  to  pay  judgments,  including 
interest  and  costs,  rendered  for  taxes  or  penalties  erroneously  or  illegally 
assessed  or  collected  under  the  internal-revenue  laws. 

Sec.  1317.  That  sections  3164.  3165.  3167.  3172,  3173,  and  3176  of  the 
Revised  Statutes  as  amended  are  hereby  amended  to  read  as  follows: 

"Sec.  3164.  It  shall  be  the  duty  of  every  collector  of  internal  revenue 
having  knowledge  of  any  willful  violation  of  any  law  of  the  United  States 


1326  APPENDIX 

relating  to  the  revenue,  within  thirty  days  after  coming  into  possession  of 
such  knowledge,  to  file  with  the  district  attorney  of  the  district  in  which 
any  fine,  penalty,  or  forfeiture  may  be  incurred,  a  statement  of  all  the 
facts  and  circumstances  of  the  case  within  his  knowledge,  together  with 
the  names  of  the  witnesses,  setting  forth  the  provisions  of  law  believed  to 
be  so  violated  on  which  reliance  may  be  had  for  condemnation  or  con- 
viction. 

"Sec.  3165.  Every  collector,  deputy  collector,  internal-revenue  agent,  and 
internal-revenue  officer  assigned  to  duty  under  an  internal-revenue  agent, 
is  authorized  to  administer  oaths  and  to  take  evidence  touching  any  part 
of  the  administration  of  the  internal-revenue  laws  with  which  he  is  charged, 
or  where  such  oaths  and  evidence  are  authorized  by  law  or  regulation 
authorized  by  law  to  be  taken. 

"Sec.  3167.  It  shall  be  unlawful  for  any  collector,  deputy  collector,  agent, 
clerk,  or  other  officer  or  employee  of  the  United  States  to  divulge  or  to  make 
known  in  any  manner  whatever  not  provided  by  law  to  any  person  the 
operation,  style  of  work,  or  apparatus  of  any  manufacturer  or  producer 
visited  by  him  in  the  discharge  of  his  official  duties,  or  the  amount  or  source 
of  income,  profits,  losses,  expenditures,  or  any  particular  thereof  set  forth 
or  disclosed  in  any  income  return,  or  to  permit  any  income  return  or  copy 
thereof  or  any  book  containing  any  abstract  or  particulars  thereof  to  be 
seen  or  examined  by  any  person  except  as  provided  by  law;  and  it  shall 
be  unlawful  for  any  person  to  print  or  publish  in  any  manner  whatever 
not  provided  by  law  any  income  return,  or  any  part  thereof  or  source  of 
income,  profits,  losses,  or  expenditures  appearing  in  any  income  return;  and 
any  offense  against  the  foregoing  provision  shall  be  a  misdemeanor  and  be 
punished  by  a  fine  not  exceeding  $1,000  or  by  imprisonment  not  exceeding 
one  year,  or  both,  at  the  discretion  of  the  court;  and  if  the  offender  be  an 
officer  or  employee  of  the  United  States  he  shall  be  dismissed  from  office  or 
discharged  from  employment. 

"Sec.  3172.  Every  collector  shall,  from  time  to  time,  cause  his  deputies  to 
proceed  through  every  part  of  his  district  and  inquire  after  and  concern- 
ing all  persons  therein  who  are  liable  to  pay  any  internal-revenue  tax,  and 
all  persons  owning  or  having  the  care  and  management  of  any  objects 
liable  to  pay  any  tax,  and  to  make  a  list  of  such  persons  and  enumerate 
said  objects. 

"Sec.  3173.  It  shall  be  the  duty  of  any  person,  partnership,  firm,  associa- 
tion, or  corporation,  made  liable  to  any  duty,  special  tax,  or  other  tax  im- 
posed by  law,  when  not  otherwise  provided  for,  (1)  in  case  of  a  special 
tax,  on  or  before  the  thirty-first  day  of  July  in  each  year,  and  (2)  in  other 
cases  before  the  day  on  which  the  taxes  accrue,  to  make  a  list  or  return, 
verified  by  oath,  to  the  collector  or  a  deputy  collector  of  the  district  where 
located,  of  the  articles  or  objects,  including  the  quantity  of  goods,  wares, 
and  merchandise,  made  or  sold  and  charged  with  a  tax,  the  several  rates 
and  aggregate  amount,  according  to  the  forms  and  regulations  to  be  pre- 
scribed by  the  Commissioner  of  Internal  Revenue,  with  the  approval  of 
the  Secretary  of  the  Treasury,  for  which  such  person,  partnership,  firm, 
association,  or  corporation  is  liable:  Provided,  That  if  any  person  liable  to 
pay  any  duty  or  tax,  or  owning,  possessing,  or  having  the  care  or  manage- 
ment of  property,  goods,  wares,  and  merchandise,  article  or  objects  liable 
to  pay  any  duty,  tax,  or  license,  shall  fail  to  make  and  exhibit  a  list  or 
return  required  by  law,  but  shall  consent  to  disclose  the  particulars  of  any 
and  all  the  property,  goods,  wares,  and  merchandise,  articles,  and  objects 


REVENUE   ACT  OF   1918  1327 

liable  to  pay  any  duty  or  tax,  or  any  business  or  occupation  liable  to  pay 
any  tax  as  aforesaid,  then,  and  in  that  case,  it  shall  be  the  duty  of  the 
collector  or  deputy  collector  to  make  such  list  or  return,  which,  being  dis- 
tinctly read,  consented  to,  and  signed  and  verified  by  oath  by  the  person  so 
owning,  possessing,  or  having  the  care  and  management  as  aforesaid,  may 
be  received  as  the  list  of  such  person:  Provided  further.  That  in  case  no 
annual  list  or  return  has  been  rendered  by  such  person  to  the  collector  or 
deputy  collector  as  required  by  law,  and  the  person  shall  be  absent  from  his 
or  her  residence  or  place  of  business  at  the  time  the  collector  or  deputy 
collector  shall  call  for  the  annual  list  or  return,  it  shall  be  the  duty  of  such 
collector  or  deputy  collector  to  leave  at  such  place  of  residence  or  business, 
with  some  one  of  suitable  age  and  discretion,  if  such  be  present,  otherwise  to 
deposit  in  the  nearest  post-office,  a  note  or  memorandum  addressed  to  such 
person,  requiring  him  or  her  to  render  to  such  collector  or  deputy  collector 
the  list  or  return  required  by  law  within  ten  days  from  the  date  of  such 
note  or  memorandum,  verified  by  oath.  And  if  any  person,  on  being  notified 
or  required  as  aforesaid,  shall  refuse  or  neglect  to  render  such  list  or  return 
within  the  time  required  as  aforesaid,  or  whenever  any  person  who  is  re- 
quired to  deliver  a  monthly  or  other  return  of  objects  subject  to  tax  fails  to 
do  so  at  the  time  required,  or  delivers  any  returpi  which,  in  the  opinion  of  the 
collector,  is  erroneous,  false,  or  fraudulent,  or  contains  any  undervaluation 
or  understatement,  or  refuses  to  allow  any  regularly  authorized  government 
officer  to  examine  the  books  of  such  person,  firm,  or  corporation,  it  shall  be 
lawful  for  the  collector  to  summon  such  person,  or  any  other  person  having 
possession,  custody,  or  care  of  books  of  account  containing  entries  relating 
to  the  business  of  such  person  or  any  other  person  he  may  deem  proper, 
to  appear  before  him  and  produce  such  books  at  a  time  and  place  named 
in  the  summons,  and  to  give  testimony  or  answer  interrogatories,  under 
oath,  respecting  any  objects  or  income  liable  to  tax  or  the  returns  thereof. 
The  collector  may  summon  any  person  residing  or  found  within  the  State 
or  Territory  in  which  his  district  lies;  and  when  the  persoVi  intended  to  be 
summoned  does  not  reside  and  can  not  be  found  within  such  State  or  Ter- 
ritory, he  may  enter  any  collection  district  where  such  person  may  be 
found  and  there  make  the  examination  herein  authorized.  And  to  this  end 
he  may  there  exercise  all  the  authority  which  he  might  lawfully  exercise  in 
the  district  for  which  he  was  commissioned:  Provided,  That  'person'  as 
used  in  this  section,  shall  be  construed  to  include  any  corporation,  joint- 
stock  company  or  association,  or  insurance  company  when  such  construction 
is  necessary  to  carry  out  its  provisions. 

"Sec.  31 7G.  If  any  person,  corporation,  company,  or  association  fails  to 
make  and  file  a  return  or  list  at  the  time  prescribed  by  law  or  by  regulation 
made  under  authority  of  law,  or  makes,  willfully  or  otherwise,  a  false  or 
fraudulent  return  or  list,  the  collector  or  deputy  collector  shall  make  the  re- 
turn or  list  from  his  own  knowledge  and  from  such  information  as  he  can 
obtain  through  testimony  or  otherwise.  In  any  such  case  the  Commissioner 
may,  from  his  own  knowledge  and  from  such  information  as  he  can  obtain 
through  testimony  or  otherwise,  make  a  return  or  amend  any  return  made 
by  a  collector  or  deputy  collector.  Any  return  or  list  so  made  and  subscribed 
by  the  Commissioner,  or  by  a  collector  or  deputy  collector  and  approved  by  the 
Commissioner,  shall  be  prima  facie  good  and  sufficient  for  all  legal  purposes. 

"If  the  failure  to  file  a  return  list  is  due  to  sickness  or  absence,  the  col- 
lector may  allow  such  further  time,  not  exceeding  thirty  days,  for  making 
and  filing  the  return  or  list  as  he  deems  proper. 


1328  APPENDIX 

"The  Commissioner  of  Internal  Revenue  shall  determine  and  assess  all 
taxes,  other  than  stamp  taxes,  as  to  which  returns  or  lists  are  so  made 
under  the  provisions  of  this  section.  In  case  of  any  failure  to  make  and  file 
a  return  or  list  within  the  time  prescribed  by  law,  or  prescribed  by  the  Com- 
missioner of  Internal  Revenue  or  the  collector  in  pursuance  of  law,  the 
Commissioner  of  Internal  Revenue  shall  add  to  the  tax  25  per  centum  of  its 
amount,  except  that  when  a  return  is  filed  after  such  time  and  it  is  shown 
that  the  failure  to  file  it  was  due  to  a  reasonable  cause  and  not  to  willful 
neglect,  no  such  addition  shall  be  made  to  the  tax.  In  case  a  false  or 
fraudulent  return  or  list  is  willfully  made,  the  Commissioner  of  Internal 
Revenue  shall  add  to  the  tax  50  per  centum  of  its  amount. 

"The  amount  so  added  to  any  tax  shall  be  collected  at  the  same  time  and  in 
the  same  manner  and  as  part  of  the  tax  unless  the  tax  has  been  paid  before 
the  discovery  of  the  neglect,  falsity,  or  fraud,  in  which  case  the  amount  so 
added  shall  be  collected  in  the  same  manner  as  the  tax." 

Sec.  1318.  That  if  any  person  is  summoned  under  this  Act  to  appear,  to 
testify,  or  to  produce  books,  papers  or  other  data,  the  district  court  of  the 
United  States  for  the  district  in  which  such  person  resides  shall  have  juris- 
diction by  appropriate  process  to  compel  such  attendance,  testimony,  or  pro- 
duction of  books,  papers,  or  other  data. 

The  district  courts  of  the  United  States  at  the  instance  of  the  United 
States  are  hereby  invested  with  such  jurisdiction  to  make  and  issue,  both 
in  actions  at  law  and  suits  in  equity,  writs  and  orders  of  injunction,  and  of 
ne  exeat  republica,  orders  appointing  receivers,  and  such  other  orders  and 
process,  and  to  render  such  judgments  and  decrees,  granting  in  proper 
cases  both  legal  and  equitable  relief  together,  as  may  be  necessary  or 
appropriate  for  the  enforcement  of  the  provisions  of  this  Act.  The  rem- 
edies hereby  provided  are  in  addition  to  and  not  exclusive  of  any  and  all 
other  remedies  of  the  United  States  in  such  courts  or  otherwise  to  enforce 
such  provisions^ 

Sec.  1319.  That  whoever  in  connection  with  the  sale  or  lease,  or  offer  for 
sale  or  lease,  of  any  article,  or  for  the  purpose  of  making  such  sale  or 
lease,  makes  any  statement,  written  or  oral,  (1)  intended  or  calculated  to 
lead  any  person  to  believe  that  any  part  of  the  price  at  which  such  article 
is  sold  or  leased,  or  offered  for  sale  or  lease,  consists  of  a  tax  imposed  under 
the  authority  of  the  United  States,  or  (2)  ascribing  a  particular  part  of 
such  price  to  a  tax  imposed  under  the  authority  of  the  United  States, 
knowing  that  such  statement  is  false  or  that  the  tax  is  not  so  great  as  the 
portion  of  such  price  ascribed  to  such  tax,  shall  be  guilty  of  a  misdemeanor 
and  upon  conviction  thereof  shall  be  punished  by  a  fine  of  not  more  than 
$1,000  or  by  imprisonment  not  exceeding  one  year,  or  both. 

Sec.  1320.  That  wherever  by  the  laws  of  the  United  States  or  regula- 
tions made  pursuant  thereto,  any  person  is  required  to  furnish  any  recog- 
nizance, stipulation,  bond,  guaranty,  or  undertaking  hereinafter  called 
"penal  bond,"  with  surety  or  sureties,  such  person  may,  in  lieu  of  such 
surety  or  sureties,  deposit  as  security  with  the  official  having  authority 
to  approve  such  penal  bond,  United  States  Liberty  bonds  or  other  bonds 
of  the  United  States  in  a  sum  equal  at  their  par  value  to  the  amount  of 
such  penal  bond  required  to  be  furnished,  together  with  an  agreement 
authorizing  such  official  to  collect  or  sell  such  bonds  so  deposited  in  case  of 
any  default  in  the  performance  of  any  of  the  conditions  or  stipulations  of 
such  penal  bond.  The  acceptance  of  such  United  States  bonds  in  lieu  of 
surety  or  sureties  required  by  law  shall  have  the  same  force  and  effect  as 


REVENUE  ACT  OK    I'JIS  1329 

individual  or  corporate  sureties,  or  certified  checks    bank  ''-f^^'  P-^-^^ 
m.nev  orders,  or  cash,  for  the  penalty  or  amount  of  such  penal  bond.     The 
bonds"  deposited  hereunder,  and  such  other  United  States  bonds  as  may  be 
substitute.1  therefor  from  time  to  time  as  such  security,  may  be  deposited 
with   the   Treasurer,   or   an    Assistant    Treasurer   of  the    United    States     a 
Government  depositary,  Federal  Reserve  bank,  or  "^7^^':  ^^"^' ^'^^'^^^^f  "j 
issue    receipt    therefor,   describing   such    bonds    so   deposited.      As    soon    as 
security  for  the  performance  of  such  penal  bond  is  no  lonjfer  necessary,  such 
bonds  so  deposited,  shall  be  returned  to  the  depositor:  />,onW.c/.  That  ,n  case 
a  person  o.   persons  supplying  a  contractor  with  ^f/^^  ^  ^^^'ij^^^^^?;;- 
vided  by  the  Act  of  Confess,  approved  February  24,  1905   (33  Stat..  811) 
entitled  "An  Act  to  amend  an  Act  approved   August   thirteenth    eighteen 
Tundi^d    and   ninety-four,   entitled   'An    Act   ^^   the   protection^  o^  persons 
furnishing  materials  and  labor  for  the  construction  of  public  Nso.ks.       shall 
file  with  fhe  obligee,  at  any  time  after  a  default  in  the  performance  of  any 
contract  subject  to  said  Acts,  the  application  and  affidavit  therein  provided, 
the  obligee  shall  not  deliver  to  the  obligor  the  deposited  bonds  "o.''  «">;  «^;;- 
plus  proceeds  thereof  until  the  expiration  of  the  time  limited  by  said  Acts    or 
the  institution  of  suit  by  such  person  or  persons,  and.  m  case  suit    hall  be  in- 
stituted within  such  time,  shall  hold  said  bonds  or  proceeds  subject  to  the  or- 
der of  the  court  having  juris.liction  thereof:    Pro.icle.lfnrn.er,  That  -t'.!"^ 
herein  contained  shall  atfect  or  impair  the  priority  of  the  claim  of  the  Un  ted 
States  against  the  bonds  deposited  or  any  right  or  remedy  granted  by    aid 
Acts  or  by  this  section  to  the  United  States  for  default  upon  any  obligation 
of  said  p;nal  bond:  Provided  further.  That  all  laws  inconsistent  wi  h  this 
section  are  hereby  so  modified  as  to  conform  to  the  provisions  hereof:  Avd 
noZd  further    T^^^t  nothing  contained  herein  shall  affect  the  authority 
of  courts  over   the  security,  where   such   bonds   are   taken   ««   security   in 
judicial  proceedings,  or  the  authority  of  any  administrative  officer  of  the 
United    States   to   receive   United    States   bonds   for   security   in   c^ses   au- 
thorized by  existing  laws.     The  Secretary  may  prescribe  rules  and  regula- 
tions necessary  and  proper  for  carrying  this  section  into  effect. 
TITLE   XIV— GENERAL  PROVISIONS 
Sec.    1400.    (a)    That    the   following  parts   of    Acts   arc   hereby    repealed, 
subject  to  the  limitations  provided  in  subdivision   (b)  : 

(1)  The  following  titles  of  the  Revenue  Act  of  11)10: 
Title  I    (called  "Income  Tax")  ; 

Title  II  (called  "Estate  Tax")  ; 

Title  III    (called  "Munitions  Manufacturers'  Tax"),  as  amended; 

Title  IV   (called  "Miscellaneous  Taxes"). 

(2)  The  following  parts  of  the  Act  entitled  "An  Act  to  provide  increased 
revenue  to  defray  the  expenses  of  the  increased  appropriations  for  the 
Army  and  Navy 'and  the  extensions  of  fortifications,  and  for  other  pur- 
poses," approved  March  3,  1917: 

Title  III    (called  "Estate  Tax")  ; 

Section   402    (called  "Returns  of   Dividends")  ; 

(3)  The  followin!4  titles  of  the  Revenue  Act  of  1917: 
Title  1    (called  "War  Income  Tax"); 

Title  II    (called  "War  Excess-Profits  Tax")  ; 
Title  III  (called  "War  Tax  on  Beverages")  ; 

Title  IV  (called  "War  Tax  on  Cigars,  Tobacco,  and  Manufactures  There- 
of") ; 


1330  APPENDIX 

Title  V  (called  "War  Tax  on  Facilities  Furnished  by  Public  Utilities, 
and  Insurance")  ; 

Title  VI  (called  "War  Excise  Taxes")  ; 

Title  VII  (called  "War  Tax  on  Admissions  and  Dues") ; 

Title  VIII  (called  "War  Stamp  Taxes")  ; 

Title  IX   (called  "War  Estate  Tax")  ; 

Title  X   (called  "Administrative  Provisions")  ; 

Title  XII   (called  "Income  Tax  Amendments"). 

(b)  Such  parts  of  Acts  shall  remain  in  force  for  the  assessment  and  col- 
lection of  all  taxes  w^hich  have  accrued  thereunder  and  for  the  imposition 
and  collection  of  all  penalties  or  forfeitures  which  have  accrued  and  may  ac- 
crue in  relation  to  any  such  taxes,  and  except  that  the  unexpended  bal- 
ance of  any  appropriation  heretofore  made  and  now  available  for  the  ad- 
ministration of  any  such  part  of  an  Act  shall  be  available  for  the  ad- 
ministration of  this  Act  or  the  corresponding  provision  thereof:  Provided, 
That  except  as  otherwise  provided  in  this  Act,  no  taxes  shall  be  collected 
under  Title  I  of  the  Revenue  Act  of  1916  as  amended  by  the  Revenue  Act 
of  1917,  or  Title  I  or  II  of  the  Revenue  Act  of  1917,  in  respect  to  any 
period  after  December  31,  1917:  Provided  further.  That  the  assessment  and 
collection  of  all  estate  taxes,  and  the  imposition  and  collection  of  all  pen- 
alties or  forfeitures,  which  have  accrued  under  Title  II  of  the  Revenue 
Act  of  1916  as  amended  by  the  Act  entitled  "An  Act  to  provide  increased 
revenue  to  defray  the  expenses  of  the  increased  appropriations  for  the 
Army  and  Navy  and  the  extensions  of  fortifications,  and  for  other  pur- 
poses," approved  March  3,  1917,  or  Title  IX  of  the  Revenue  Act  of  1917, 
shall  be  according  to  the  provisions  of  Title  IV  of  this  Act.  In  the  case  of 
any  tax  imposed  by  any  part  of  an  Act  herein  repealed,  if  there  is  a  tax 
imposed  by  this  Act  in  lieu  thereof,  the  provision  imposing  such  tax  shall 
remain  in  force  until  the  corresponding  tax  under  this  Act  takes  effect 
under  the  provisions  of  this  Act. 

Title  I  of  the  Revenue  Act  of  1916  as  amended  by  the  Revenue  Act  of 
1917  shall  remain  in  force  for  the  assessment  and  collection  of  the  income 
tax  in  Porto  Rico  and  the  Philippine  Islands,  except  as  may  be  otheirwise 
provided  by  their  respective  legislatures. 

Sec.  1401.  That  section  1100  of  the  Revenue  Act  of  1917  is  hereby 
repealed,  to  take  effect  on  July  1,  1919,  and  thereafter  the  rate  of  postage 
on  all  mail  matter  of  the  first  class  shall  be  the  same  as  the  rate  in  force 
on  October  2,  1917:  Provided,  That  letters  written  and  mailed  by  soldiers, 
sailors,  and  marines  assigned  to  duty  in  a  foreign  country  engaged  in  the 
present  war  may  be  mailed  free  of  postage,  subject  to  such  rules  and  regu- 
lations as  may  be  prescribed  by  the  Postmaster-General. 

Section  1107  of  such  Act  is  hereby  repealed,  to  take  effect  July  11,  1919. 

Sec.  1402.  That  if  any  clause,  sentence,  paragraph,  or  part  of  this  Act 
shall  for  any  reason  be  adjudged  by  any  court  of  competent  jurisdiction  to 
be  invalid,  such  judgment  shall  not  affect,  impair,  or  invalidate  the  re- 
mainder of  this  Act,  but  shall  be  confined  in  its  operation  to  the  clause,  sen- 
tence, paragraph,  or  part  thereof  directly  involved  in  the  controversy  in 
which  such  judgment  has  been  rendered. 

Sec.  1403.  That  the  Revenue  Act  of  1916  is  hereby  amended  by  adding  at 
the  end  thereof  a  section  to  read  as  follows: 

"Sec.  903.    That  this  Act  may  be  cited  as  the  'Revenue  Act  of  1916.'  " 

Sec.  1404.  That  the  Revenue  Act  of  1917  is  hereby  amended  by  adding  at 
the  end  thereof  a  section  to  read  as  follows: 


REVENUE  ACT  OF   1918  1331 

"Sec.  1303.  That  this  Act  may  be  cited  as  the  'Revenue  Act  of  1917.'  " 
Sec.  1405.  That  this  Act  may  be  cited  as  the  "Revenue  Act  of  1918." 
Sec.  1408.  That  every  person  who  on  or  after  April  6,  1917,  has  entered 
into  any  contract,  undertakinj?,  or  agreement,  with  the  United  States,  or 
with  any  department,  bureau,  officer,  commission,  board,  or  agency  under 
the  United  States  or  acting  in  its  behalf,  or  with  any  other  person  having 
contract  relations  with  the  United  States,  for  the  performance  of  any  work 
or  the  supplying  of  any  materials  or  property  for  the  use  of  or  for  the  ac- 
count of  the  United  States  shall,  within  thirty  days  after  a  request  of  the 
Commissioner  therefor,  file  with  the  Commissioner  a  true  and  correct  copy  of 
every  such  contract,  undertaking,  or  agreement. 

Whoever  fails  to  comply  with  such  request  of  the  Commissioner  shall  be 
guilty  of  a  misdemeanor  and  shall  be  punished  by  a  fine  of  not  more  than 
$1,000,  or  by  imprisonment  for  npt  more  than  one  year  or  both. 

The  Commissioner  shall  (when  not  violative  of  the  technical  military  or 
naval  secrets  of  the  Government)  have  access  to  all  information  and  data 
relating  to  any  such  contract,  undertaking,  or  agreement,  in  the  possession, 
control  or  custody  of  any  department,  bureau,  board,  agency,  officer,  or 
commission  of  the  United  States,  and  may  call  upon  any  such  departments, 
bureau,  board,  agency,  officer  or  commission  for  a  full  statement  and  de- 
scription of  any  allowance  for  amortization,  obsolescence,  depreciation  or 
loss,  or  of  any  valuation,  appraisal,  adjustment  or  final  settlement,  made  in 
pursuance  of  any  such  contract,  undertaking,  or  agreement. 

Sec.  1409.  That  unless  otherwise  herein  specially  provided,  this  Act  shall 
take  effect  on  the  day  following  its  passage. 

ACT  OF  JUNE  13,   1898   (30   STAT.  454),  AS   AMENDED  BY    ACT  OF 
MARCH  2,  1901   (31  STAT.  940).i 

Sec.  13.  That  any  person  or  persons  who  shall  register,  issue,  sell,  or 
transfer,  or  who  shall  cause  to  be  issued,  registered,  sold,  or  transferred, 
any  instrument,  document,  or  paper  of  any  kind  or  description  whatsoever 
mentioned  in  Schedule  A  of  this  Act,  without  the  same  being  duly  stamped, 
or  having  thereupon  an  adhesive  stamp  for  denoting  the  tax  chargeable 
thereon,  and  canceled  in  the  manner  required  by  law  with  intent  to  evade 
the  provisions  of  this  Act,  shall  be  deemed  guilty  of  a  misdemeanor,  and 
upon  conviction  thereof  shall  be  punished  by  a  fine  not  exceeding  fifty  dol- 
lars, or  by  imprisonment  not  exceeding  six  months,  or  both,  in  the  dis- 
cretion of  the  court;  and  such  instrument,  document,  or  paper,  not  being 
stamped  according  to  law,  shall  be  deemed  invalid  and  of  no  effect:  Provided, 
That  hereafter,  in  all  cases  where  the  party  has  not  affixed  to  any  instru- 
ment the  stamp  required  by  law  thereon  at  the  time  of  issuing,  selling,  or 
transferring  the  said  bonds,  debentures,  or  certificates  of  stock  or  of  in- 
debtedness, or  any  instrument,  document  or  paper  of  any  kind  or  descrip- 
tion whatsoever  mentioned  in  Schedule  A  of  this  Act,  and  he  or  they,  or  any 
party  having  an  interest  therein,  shall  be  subsequently  desirous  of  affixing 
such  stamp  to  said  instrument,  or,  if  said  instrument  be  lost,  to  a  copy 
thereof,  he  or  they  shall  appear  before  the  collector  of  internal  revenue 
of  the  proper  district,  who  shall,  upon  the  payment  of  the  price  of  the 
proper  stamp  required  by  law,  and  of  a  penalty  of  ten  dollars,  and  where 
the  whole  amount  of  the  tax  denoted  by  the  stamp  required  shall  exceed  the 
sum  of  fifty  dollars,  on  payment  also  of  interest,  at  the  rate  of  six  per 


'These  provisions  are  refern'd  to  In  Chapter  4.j  on  the  Stamp  Tax. 


1332  APPENDIX 

centum,  on  said  tax  from  the  day  on  which  such  stamp  ought  to  have  been 
affixed,  affix  the  proper  stamp  to  such  bond,  debenture,  certificate  of  stock 
or  of  indebtedness  or  copy,  or  instrument,  document,  or  paper  of  any  kind  or 
description  whatsoever  mentioned  in  Schedule  A  of  this  Act,  and  note  upon 
the  margin  thereof  the  date  of  his  so  doing,  and  the  fact  that  such  penalty 
has  been  paid;  and  the  same  shall  thereupon  be  deemed  and  held  to  be  as 
valid,  to  all  intents  and  purposes,  as  if  stamped  when  made  or  issued:  And 
provided  further,  That  where  it  shall  appear  to  said  collector,  upon  oath  or 
otherwise,  to  his  satisfaction,  that  any  such  instrument  has  not  been  duly 
stamped,  at  the  time  of  making  or  issuing  the  same,  by  reason  of  accident, 
mistake,  inadvertence,  or  urgent  necessity,  and  without  any  willfull  design 
to  defraud  the  United  States  of  the  stamp,  or  to  evade  or  delay  the  pay- 
ment thereof,  then  and  in  such  case,  if  such  instrument,  or,  if  the  original 
be  lost,  a  copy  thereof,  duly  certified  by  the  officer  having  charge  of  any 
records  in  which  such  original  is  required  to  be  recorded  or  otherwise  duly 
proven  to  the  satisfaction  of  the  collector,  shall,  within  twelve  calendar 
months  after  the  making  or  issuing  thereof,  be  brought  to  the  said  collector 
of  internal  revenue  to  be  stamped,  and  the  stamp  tax  chargeable  thereon 
shall  be  paid,  it  shall  be  lawful  for  the  said  collector  to  remit  the  penalty 
aforesaid  and  to  cause  such  instrument  to  be  duly  stamped.  And  when  the 
original  instrument,  or  a  certified,  or  duly  proven  copy  thereof,  as  afore- 
said, duly  stamped  so  as  to  entitle  the  same  to  be  recorded,  shall  be  pre- 
sented to  the  clerk,  register,  recorder,  or  other  officer  having  charge  of  the 
original  record  it  shall  be  lawful  for  such  officer,  upon  the  payment  of  the 
fee  legally  chargeable  for  the  recording  thereof,  to  make  a  new  record 
thereof,  or  to  note  upon  the  original  record  the  fact  that  the  error  or 
omission  in  the  stamping  of  said  original  instrument  has  been  corrected 
pursuant  to  law;  and  the  original  instrument  or  such  certified  copy,  or  the 
record  thei*eof,  may  be  used  in  all  courts  and  places  in  the  same  manner 
and  with  like  effect  as  if  the  instrument  had  been  originally  stamped:  And 
provided  further,  That  in  all  cases  where  the  party  has  not  affixed  the 
stamp  required  by  law  upon  any  such  instrument  issued,  registered,  sold,  or 
transferred  at  a  time  when  and  at  a  place  where  no  collection  district  was 
established,  it  shall  be  lawful  for  him  or  them,  or  any  party  having  an  in- 
terest therein,  to  affix  the  proper  stamp  thereto,  or,  if  the  original  be  lost, 
to  a  copy  thereof.  But  no  right  acquired  in  good  faith  before  the  stamping 
of  such  instrument,  or  copy  thereof,  as  herein  provided,  if  such  record  be 
required  by  law,  shall  in  any  manner  be  affected  by  such  stamping  as  afore- 
said. 

Sec.  14.  That  hereafter  no  instrument,  paper  or  document  required  by 
law  to  be  stamped,  which  has  been  signed  or  issued  without  being  duly 
stamped,  or  with  a  deficient  stamp,  nor  any  copy  thereof,  shall  be  recorded 
or  admitted,  or  used  as  evidence  in  any  court  until  a  legal  stamp  or  stamps, 
denoting  the  amount  of  tax,  shall  have  been  affixed  thereto,  as  prescribed  by 
law ;       *      *      * 

Sec.  15.  That  it  shall  not  be  lawful  to  record  or  register  any  instrument, 
paper,  or  document  required  by  law  to  be  stamped  unless  a  stamp  or  stamps 
of  the  proper  amount  shall  have  been  affixed  and  cancelled  in  the  manner 
prescribed  by  law;  and  the  record,  registry,  or  transfer  of  any  such  instru- 
ments upon  which  the  proper  stamp  or  stamps  aforesaid  shall  not  have 
been  affixed  and  cancelled  as  aforesaid  shall  not  be  used  in  evidence. 


REVENUE  ACT  OF  1921  i 

Public  No.  98 — 67th  Congress 

AN  ACT  TO  REDUCE  AND  EQUALIZE  TAXATION,  TO  PROVIDE 
REVENUE,  AND  FOR  OTHER  PURPOSES 

Be  it  enacted  by  the  Senate  anxl  House  of  Representatives  of  the  United 
States  of  America  in  Congress  assembled, 

TITLE  I— GENERAL  DEFINITIONS 

Section  1.    That  this  Act  may  be  cited  as  the  "Revenue  Act  of  1921." 
Sec.  2.    That  when  used  in  this  Act — 

(1)  The  term  "person"  includes  partnerships  and  corporations,  as  well  as 
individuals; 

(2)  The  term  "corporation"  includes  associations,  joint-stock  companies, 
and  insurance  companies; 

(3)  The  term  "domestic"  when  applied  to  a  corporation  or  partnership 
means  created  or  organized  in  the  United  States; 

(4)  The  term  "foreign"  when  applied  to  a  corporation  or  partnership 
means  created  or  organized  outside  the  United  States; 

(5)  The  term  "United  States"  when  used  in  a  geographical  sense  includes 
only  the  States,  the  Territories  of  Alaska  and  Hawaii,  and  the  District  of 
Columbia; 

(6)  The  term  "Secretary"  means  the  Secretary  of  the  Treasury; 

(7)  The  term  "Commissioner"  means  the  Commissioner  of  Internal 
Revenue; 

(8)  The  term  "collector"  means  collector  of  internal  revenue; 

(9)  The  term  "taxpayer"  includes  any  person,  trust  or  estate  subject  to  a 
tax  imposed  by  this  Act; 

(10)  The  term  "military  or  naval  forces  of  the  United  States"  includes 
the  Marine  Corps,  the  Coast  Guard,  the  Army  Nurse  Corps,  Female,  and  the 
Navy  Nurse  Corps,  Female,  but  this  shall  not  be  deemed  to  exclude  other 
units  otherwise  included  within  such  terms;  and 

(11)  The  term  "Government  contract"  means  (a)  a  contract  made  with 
the  United  States,  or  with  any  department,  bureau,  officer,  commission, 
board,  or  agency,  under  the  United  States  and  acting  in  its  behalf,  or  with 
any  agency  controlled  by  any  of  the  above  if  the  contract  is  for  the  benefit 
of  the  United  States,  or  (b)  a  subcontract  made  with  a  contractor  perform- 
ing such  a  contract  if  the  products  or  services  to  be  furnished  under  the  sub- 
contract are  for  the  benefit  of  the  United  States.  The  term  "Government 
contract  or  contracts  made  between  April  (i,  1917,  and  November  11,  1918, 
both  dates  inclusive"  when  applied  to  a  contract  of  the  kind  referred  to  in 
clause  (a)  of  this  subdivision,  includes  all  such  contracts  which,  although 
entered  into  during  such  period,  were  originally  not  enforceable,  but  which 
have  been  or  may  become  enforceable  by  reason  of  subsequent  validation  in 
pursuance  of  law. 

'Only    lliosc    i)iirts   of   tlic    .Vi'l    wliirli    iippl.v    to    the    Imxcs    Ircntrd    In    ilils    Imok    ari' 
rt'prln((>i1   Iut*". 

1333 


1334  APPENDIX 

TITLE  II— INCOME  TAX 
Part  I — General  Provisions 

DEFINITIONS 

Sec.  200.  That  when  used  in  this  title — 

(1)  The  term  "taxable  year"  means  the  calendar  year,  or  the  fiscal  year 
ending  during  such  calendar  year,  upon  the  basis  of  which  the  net  income 
is  computed  under  section  212  or  section  232.  The  term  "fiscal  year"  means 
an  accounting  period  of  twelve  months  ending  on  the  last  day  of  any  month 
other  than  December.  The  first  taxable  year,  to  be  called  the  taxable  year 
1921,  shall  be  the  calendar  year  1921  or  any  fiscal  year  ending  during  the 
calendar  year  1921 ; 

(2)  The  term  "fiduciary"  means  a  guardian,  trustee,  executor,  adminis- 
trator, receiver,  conservator,  or  any  person  acting  in  any  fiduciary  capacity 
for  any  person,  trust  or  estate; 

(3)  The  term  "withholding  agent"  means  any  person  required  to  deduct 
and  withhold  any  tax  under  the  provisions  of  section  221  or  section  237; 

(4)  The  term  "paid,"  for  the  purposes  of  the  deductions  and  credits  under 
this  title,  means  "paid  or  accrued"  or  "paid  or  incurred,"  and  the  terms 
"paid  or  incurred"  and  "paid  or  accrued"  shall  be  construed  according  to 
the  method  of  accounting  upon  the  basis  of  which  the  net  income  is  com- 
puted under  section  212;  and 

(5)  The  term  "personal  service  corporation"  means  a  corporation  whose 
income  is  to  be  ascribed  primarily  to  the  activities  of  the  principal  owners 
or  stockholders  who  are  themselves  regularly  engaged  in  the  active  conduct 
of  the  aflFairs  of  the  corporation  and  in  which  capital  (whether  invested  or 
borrowed)  is  not  a  material  income-producing  factor;  but  does  not  include 
any  foreign  corporation,  nor  any  corporation  50  per  centum  or  more  of 
whose  gross  income  consists  either  (1)  of  gains,  profits,  or  income  derived 
from  trading  as  a  principal,  or  (2)  of  gains,  profits,  commissions,  or  other 
income,  derived  from  a  Government  contract  or  contracts  made  between 
April  6,  1917,  and  November  11,  1918,  both  dates  inclusive. 

DIVIDENDS 

Sec.  201.  (a)  That  the  term  "dividend"  when  used  in  this  title  (except  in 
paragraph  (10)  of  subdivision  (a)  of  section  234  and  paragraph  (4)  of  sub- 
division (a)  of  section  245)  means  any  distribution  made  by  a  corporation 
to  its  shareholders  or  members,  whether  in  cash  or  in  other  property,  out  of 
its  earnings  or  profits  accumulated  since  February  28,  1913,  except  a  distri- 
bution made  by  a  personal  service  corporation  out  of  earnings  or  profits 
accumulated  since  December  31,  1917,  and  prior  to  January  1,  1922. 

(b)  For  the  purposes  of  this  Act  every  distribution  is  made  out  of  earn- 
ings or  profits,  and  from  the  most  recently  accumulated  earnings  or  profits, 
to  the  extent  of  such  earnings  or  profits  accumulated  since  February  28, 
1913;  but  any  earnings  or  profits  accumulated  or  increase  in  value  of  prop- 
erty accrued  prior  to  March  1,  1913,  may  be  distributed  exempt  from  the 
tax,  after  the  earnings  and  profits  accumulated  since  February  28,  1913, 
have  been  distributed.  If  any  such  tax-free  distribution  has  been  made  the 
distributee  shall  not  be  allowed  as  a  deduction  from  gross  income  any  loss 
sustained  from  the  sale  or  other  disposition  of  his  stock  or  shares  unless,  and 
then  only-  to  the  extent  that,  the  basis  provided  in  section  202  exceeds  the 
sum  of   (1)   the  amount  realized  from  the  sale  or  other  disposition  of  such 


REVENUE    ACT    OF    1921  1335 

stock  or  shares,  and  (2)  the  ap:Kregate  amount  of  such  distributions  received 
by  him  thereon. 

(c)  Any  distribution  (whether  in  cash  or  other  property)  made  by  a. cor- 
poration to  its  shareholders  or  members  otherwise  than  out  of  (1)  earnings 
or  profits  accumulated  since  February  28,  1913,  or  (2)  earnings  or  profits 
accumulated  or  increase  in  value  of  property  accrued  prior  to  March  1,  1913, 
shall  be  applied  against  and  reduce  the  basis  provided  in  section  202  for  the 
purpose  of  ascertaining  the  k'ain  derived  or  the  loss  sustained  from  the  sale 
or  other  disposition  of  the  stock  or  shares  by  the  distributee. 

(d)  A  stock  dividend  shall  not  be  subject  to  tax  but  if  after  the  distribu- 
tion of  any  such  dividend  the  corporation  proceeds  to  cancel  or  redeem  its 
stock  at  such  time  and  in  such  manner  as  to  make  the  distribution  and  can- 
cellation or  redemption  essentially  equivalent  to  the  distribution  of  a  taxable 
dividend,  the  amount  received  in  redemption  or  cancellation  of  the  stock  shall 
be  treated  as  a  taxable  dividend  to  the  extent  of  the  earnings  or  profits  accu- 
mulated by  such  corporation  after  February  28,  1913. 

(e)  For  the  purposes  of  this  Act,  a  taxable  distribution  made  by  a  cor- 
poration to  its  shareholders  or  members  shall  be  included  in  the  gross  income 
of  the  distributees  as  of  the  date  when  the  cash  or  other  property  is  unquali- 
fiedly made  subject  to  their  demands. 

(f)  Any  distribution  made  during  the  first  sixty  days  of  any  taxable 
year  shall  be  deemed  to  have  been  made  from  earnings  or  profits  accumu- 
lated during  preceding  taxable  years;  but  any  distribution  made  during  the 
remainder  of  the  taxable  year  shall  be  deemed  to  have  been  made  from 
earnings  or  profits  accumulated  between  the  close  of  the  preceding  taxable 
year  and  the  date  of  distribution,  to  the  extent  of  such  earnings  or  profits, 
and  if  the  books  of  the  corporation  do  not  show  the  amount  of  such  earnings 
or  profits,  the  earnings  or  profits  for  the  accounting  period  within  which  the 
distribution  was  made  shall  be  deemed  to  have  been  accumulated  ratably 
during  such  period.  This  subdivision  shall  not  be  in  effect  after  December 
31,  1921. 

BASIS   FOR  DETERMINING  GAIN   OR  LOSS 

Sec.  202.  (a)  That  the  basis  for  ascertaining  the  gain  derived  or  loss 
sustained  from  a  sale  or  other  disposition  of  property,  real,  personal,  or 
mixed,  acquired  after  February  28,  1913,  shall  be  the  cost  of  such  property; 
except  that — 

(1)  In  the  case  of  such  property,  which  should  be  included  in  the  inven- 
tory, the  basis  shall  be  the  last  inventory  value  thereof; 

(2)  In  the  case  of  such  property,  acquired  by  gift  after  December  31. 
1920,  the  basis  shall  be  the  same  as  that  which  it  would  have  in  the  hands  of 
the  donor  or  the  last  preceding  owner  by  whom  it  was  not  acquired  by  gift. 
If  the  facts  necessary  to  determine  such  basis  are  unknown  to  the  donee,  the 
Commissioner  shall,  if  possible,  obtain  such  facts  from  such  donor  or  last 
preceding  owner,  or  any  other  person  cognizant  thereof.  If  the  Commis- 
sioner finds  it  impossible  to  obtain  such  facts,  the  basis  shall  be  the  value 
of  such  property  as  found  by  the  Commissioner  as  of  the  date  or  approxi- 
mate date  at  which,  according  to  the  best  information  the  Commissioner  is 
able  to  obtain,  such  property  was  acquired  by  such  doiior  or  last  preceding 
owner.  In  the  case  of  such  property  acquired  by  gift  on  or  before  December 
31,  1920,  the  basis  for  ascertaining  gain  or  loss  from  a  sale  or  other  dis- 
position thereof  shall  be  the  fair  market  price  or  value  of  such  property  at 
the  time  of  such  acquisition ; 


1336  APPENDIX 

(3)  In  the  case  of  such  property,  acquired  by  bequest,  devise,  or  inherit- 
ance, the  basis  shall  be  the  fair  market  price  or  value  of  such  property  at 
the  -time  of  such  acquisition.  The  provisions  of  this  paragraph  shall  apply 
to  the  acquisition  of  such  property  interests  as  are  specified  in  subdivision 
(c)  or  (e)  of  section  402. 

(b)  The  basis  for  ascertaining  the  gain  derived  or  loss  sustained  from  the 
sale  or  other  disposition  of  property,  real,  personal,  or  mixed,  acquired  be- 
fore March  1,  1913,  shall  be  the  same  as  that  provided  by  subdivision  (a) ; 
but— 

(1)  If  its  fair  market  price  or  value  as  of  March  1,  1913,  is  in  excess  of 
such  basis,  the  gain  to  be  included  in  the  gross  income  shall  be  the  excess  of 
the  amount  realized  therefor  over  such  fair  market  price  or  value; 

(2)  If  its  fair  market  price  or  value  as  of  March  1,  1913,  is  lower  than 
such  basis,  the  deductible  loss  is  the  excess  of  the  fair  market  price  or  value 
as  of  March  1,  1913,  over  the  amount  realized  therefor;  and 

(3)  If  the  amount  realized  therefor  is  more  than  such  basis  but  not  more 
than  its  fair  market  price  or  value  as  of  March  1,  1913,  or  less  than  such 
basis  but  not  less  than  such  fair  market  price  or  value,  no  gain  shall  be  in- 
cluded in  and  no  loss  deducted  from  the  gross  income. 

(c)  For  the  purposes  of  this  title,  on  an  exchange  of  property,  real,  per- 
sonal or  mixed,  for  any  other  such  property,  no  gain  or  loss  shall  be  recog- 
nized unless  the  property  received  in  exchange  has  a  readily  realizable 
market  value;  but  even  if  the  property  received  in  exchange  has  a  readily 
realizable  market  value,  no  gain  or  loss  shall  be  recognized — 

(1)  When  any  such  property  held  for  investment,  or  for  productive  use 
in  trade  or  business  (not  including  stock-in-trade  or  other  property  held 
primarily  for  sale),  is  exchanged  for  property  of  a  like  kind  or  use; 

(2)  When  in  the  reorganization  of  one  or  more  corporations  a  person 
receives  in  place  of  any  stock  or  securities  owned  by  him.  stock  or  securities 
in  a  corporation  a  party  to  or  resulting  from  such  reorganization.  The 
word  "reorganization,"  as  used  in  this  paragraph,  includes  a  merger  or 
consolidation  (including  the  acquisition  by  one  corporation  of  at  least  a 
majority  of  the  voting  stock  and  at  least  a  majority  of  the  total  number  of 
shares  of  all  other  classes  of  stock  of  another  corporation,  or  of  substantially 
all  the  properties  of  another  corporation),  recapitalization,  or  mere  change 
in  identity,  form,  or  place  of  organization  of  a  corporation,  (however 
effected)  ;  or 

(3)  When  (A)  a  person  transfers  any  property,  real,  personal  or  mixed, 
to  a  corporation,  and  immediately  after  the  transfer  is  in  control  of  such 
corporation,  or  (B)  two  or  more  persons  transfer  any  such  property  to  a 
corporation,  and  immediately  after  the  transfer  are  in  control  of  such  cor- 
poration, and  the  amounts  of  stock,  securities,  or  both,  received  by  such  per- 
sons are  in  substantially  the  same  proportion  as  their  interests  in  the  prop- 
erty before  such  transfer.  For  the  purposes  of  this  paragraph,  a  person  is, 
or  two  or  more  persons  are,  "in  control"  of  a  corporation  when  owning  at 
least  80  per  centum  of  the  voting  stock  and  at  least  80  per  centum  of  the 
total  number  of  shares  of  all  other  classes  of  stock  of  the  corporation. 

(d)  (1)  Where  property  is  exchanged  for  other  property  and  no  gain  or 
loss  is  recognized  under  the  provisions  of  subdivision  (c),  the  property  re- 
ceived shall,  for  the  purposes  of  this  section,  be  treated  as  taking  the  place 
of  the  property  exchanged  therefor,  except  as  provided  in  subdivision  (e) ; 

(2)  Where  property  is  compulsorily  or  involuntarily  converted  into  cash 
or  its  equivalent  in  the  manner  described  in  paragraph   (12)  of  subdivision 


REVENUE    ACT    OF    1921  1337 

(a)  of  section  214  and  paragraph  (14)  of  subdivision  (a)  of  section  234,  and 
the  taxpayer  proceeds  in  good  faith  to  expend  or  set  aside  the  proceeds  of 
such  conversion  in  the  form  and  in  the  manner  therein  provided,  the  prop- 
erty acquired  shall,  for  the  purpose  of  this  section,  be  treated  as  taking  the 
place  of  a  like  proportion  of  the  property  converted. 

(3)  Where  no  deduction  is  allowed  for  a  loss  or  a  part  thereof  under  the 
provisions  of  paragraph  (5)  of  subdivision  (a)  of  section  214  and  paragraph 
(4)  of  subdivision  (a)  of  section  234,  that  part  of  the  property  acquired 
with  relation  to  which  such  loss  is  disallowed  shall  for  the  purposes  of  this 
section  be  treated  as  taking  the  place  of  the  property  sold  or  disposed  of. 

(e)  Where  property  is  exchanged  for  other  property  which  has  no  readily 
realizable  market  value,  together  with  money  or  other  property  which  h^s  a 
readily  realizable  market  value,  then  the  money  or  the  fair  market  value 
of  the  property  having  such  readily  realizable  market  value 
received  in  exchange  shall  be  applied  against  and  reduce  the  basis,  provided 
in  this  section,  of  the  property  exchanged,  and  if  in  excess  of  such  basis, 
shall  be  taxable  to  the  extent  of  the  excess;  but  when  property  is  exchanged 
for  property  specified  in  paragraphs  (1),  (2),  and  (3)  of  subdivision  (c) 
as  received  in  exchange,  together  with  money  or  other  property  of  a  rdadily 
realizable  market  value  other  than  that  specified  in  such  paragraphs,  the 
money  or  the  fair  market  value  of  such  other  property  received  in  exchange 
shall  be  applied  against  and  reduce  the  basis,  provided  in  this  section,  of 
the  property  exchanged,  and  if  in  excess  of  such  basis,  shall  be  taxable  to 
the  extent  of  the  excess. 

(f)  Nothing  in  this  section  shall  be  construed  to  prevent  (in  the  case  of 
property  sold  under  contract  providing  for  payment  in  installments)  the 
taxation  of  that  portion  of  any  installment  payment  representing  gain  or 
profit  in  the  year  in  which  such  payment  is  received. 

INVENTORIES 

Sec.  203.  That  whenever  in  the  opinion  of  the  Commissioner  the  use  of 
inventories  is  necessary  in  order  clearly  to  determine  the  income  of  any 
taxpayer,  inventories  shall  be  taken  by  such  taxpayer  upon  such  basis  as  the 
Commissioner,  with  the  approval  of  the  Secretary,  may  prescribe  as  con- 
forming as  nearly  as  may  be  to  the  best  accounting  practice  in  the  trade  or 
business  and  as  most  clearly  reflecting  the  income. 

NET   LOSSES 

Sec.  204.  (a)  That  as  used  in  this  section  the  term  "net  loss"  means  only 
net  losses  resulting  from  the  operation  of  any  trade  or  business  regularly 
carried  on  by  the  taxpayer  (including  losses  sustained  from  the  sale  or  other 
disposition  of  real  estate,  machinery,  and  other  capital  assets,  used  in  the 
conduct  of  such  trade  or  business)  ;  and  when  so  resulting  means  the  excess 
of  the  deductions  allowed  by  section  214  or  234,  as  the  case  may  be,  over  the 
sum  of  the  following:  (1)  the  gross  income  of  the  taxpayer  for  the  taxable 
year,  (2)  the  amount  by  which  the  interest  received  free  from  taxation 
under  this  title  exceeds  so  much  of  the  interest  paid  or  accrued  within  the 
taxable  year  on  indebtedness  as  is  not  permitted  to  be  deducted  by  paragraph 
(2)  of  subdivision  (a)  of  section  214  or  by  paragraph  (2)  of  subdivision  (a) 
of  section  234,  (3)  the  amount  by  which  the  deductible  losses  not  sustained 
in  such  trade  or  business  exceed  the  taxable  gains  or  profits  not  derived  from 
such  trade  or  business,  (4)  amounts  received  as  dividends  and  allowed  as  a 


1338  APPENDIX 

deduction  under  paragraph  (6)  of  subdivision  (a)  of  section  234,  and  (5) 
so  much  of  the  depletion  deduction  allowed  with  respect  to  any  mine,  oil  or 
gas  well  as  is  based  upon  discovery  value  in  lieu  of  cost. 

(b)  If  for  any  taxable  year  beginning  after  December  31,  1920,  it  appears 
upon  the  production  of  evidence  satisfactory  to  the  Commissioner  that  any 
taxpayer  has  sustained  a  net  loss,  the  amount  thereof  shall  be  deducted  from 
the  net  income  of  the  taxpayer  for  the  succeeding  taxable  year;  and  if  such 
net  loss  is  in  excess  of  the  net  income  for  such  succeeding  taxable  year,  the 
amount  of  such  excess  shall  be  allowed  as  a  deduction  in  computing  the  net 
income  for  the  next  succeeding  taxable  year;  the  deduction  in  all  cases  to 
be  made  under  regulations  prescribed  by  the  Commissioner  with  the  approval 
of  the  Secretary. 

(c)  The  benefit  of  this  section  shall  be  allowed  to  the  members  of  a  part- 
nership and  the  beneficiaries  of  an  estate  or  trust,  and  to  insurance  com- 
panies subject  to  the  tax  imposed  by  section  243  or  246,  under  regulations 
prescribed  by  the  Commissioner  with  the  approval  of  the  Secretary. 

(d)  If  it  appears,  upon  the  production  of  evidence  satisfactory  to  the 
Commissioner,  that  a  taxpayer  having  a  fiscal  year  beginning  in  1920  and 
ending  in  1921  has  sustained  a  net  loss  during  such  fiscal  year,  such  taxpayer 
shall  be  entitled  to  the  benefits  of  this  section  in  respect  to  the  same  pro- 
portion of  such  net  loss  which  the  portion  of  such  fiscal  year  falling  within 
the  calendar  year  1921  is  of  the  entire  fiscal  year. 

FISCAL  YEARS  1920-1921  AND  1921-1922 

Sec.  205.  (a)  That  if  a  taxpayer  makes  return  for  a  fiscal  year  beginning 
in  1920  and  ending  in  1921,  his  tax  under  this  title  for  the  taxable  year  1921 
shall  be  the  sum  of:  (1)  the  same  proportion  of  a  tax  for  the  entire  period 
computed  under  Title  II  of  the  Revenue  Act  of  1918  at  the  rates  for  the  cal- 
endar year  1920  which  the  portion  of  such  period  falling  within  the  calendar 
year  1920  is  of  the  entire  period,  and  (2)  the  same  proportion  of  a  tax  for 
the  entire  period  computed  under  this  title  at  the  rates  for  the  calendar  year 
1921,  which  the  portion  of  such  period  falling  within  the  calendar  year  1921 
is  of  the  entire  period. 

Any  amount  paid  before  or  after  the  passage  of  this  Act  on  account  of  the' 
tax  imposed  for  such  fiscal  year  by  Title  II  of  the  Revenue  Act  of  1918  shall 
be  credited  toward  the  payment  of  the  tax  imposed  for  such  fiscal  year  by 
this  Act,  and  if  the  amount  so  paid  exceeds  the  amount  of  such  tax  imposed 
by  this  Act,  the  excess  shall  be  credited  or  refunded  in  accordance  with  the 
provisions  of  section  252. 

(b)  If  a  taxpayer  makes  return  for  a  fiscal  year  beginning  in  1921  and 
ending  in  1922,  his  tax  under  this  title  for  the  taxable  year  1922  shall  be  the 
sum  of:  (1)  the  same  proportion  of  a  tax  for  the  entire  period  computed 
under  this  title  (as  in  force  on  December  31,  1921)  at  the  rates  for  the  cal- 
endar year  1921  which  the  portion  of  such  period  falling  within  the  calendar 
year  1921  is  of  the  entire  period,  and  (2)  the  same  proportion  of  a  tax  for 
the  entire  period  computed  under  this  title  (as  in  force  on  January  1,  1922) 
at  the  rates  for  the  calendar  year  1922  which  the  portion  of  such  period  fall- 
ing within  the  calendar  year  1922  is  of  the  entire  period:  Provided,  That  in 
the  case  of  a  personal  service  corporation  the  amount  to  be  paid  shall  be 
only  that  specified  in  clause  (2). 

(c)  If  a  fiscal  year  of  a  partnership  begins  in  1920  and  ends  in  1921,  or 
begins  in  1921  and  ends  in  1922,  then  (1)  the  rates  for  the  calendar  year 
during  which  such  fiscal  year  begins  shall  apply  to  an  amount  of  each  part- 


REVENUE    ACT    OF    1921  1339 

ner's  share  of  such  partnership  net  income  (determined  under  the  law 
applicable  to  such  year)  equal  to  the  proportion  which  the  part  of  such  fiscal 
year  falling  within  such  calendar  year  bears  to  the  full  fiscal  year,  and  (2) 
the  rates  for  the  calendar  year  during  which  such  fiscal  year  ends  shall 
apply  to  an  amount  of  each  partner's  share  of  such  partnership  net  income 
(determined  under  the  law  applicable  to  such  calendar  year)  equal  to  the 
proportion  which  the  part  of  such  fiscal  year  falling  within  such  calendar 
year  bears  to  the  full  fiscal  year. 

CAPITAL  GAIN 

Sec.  206.    (a)    That  for  the  purpose  of  this  title: 

(1)  The  term  "capital  gain"  means  taxable  gain  from  the  sale  or  ex- 
change of  capital  assets  consummated  after  December  31,  1921 ; 

(2)  The  term  "capital  loss"  means  deductible  loss  resulting  from  the  sale 
or  exchange  of  capital  assets  consummated  after  December  31,  1921; 

(3)  The  term  "capital  deductions"  means  such  deductions  as  are  allowed 
under  this  title  for  the  purpose  of  computing  net  income  and  are  properly 
allocable  to  or  chargeable  against  items  of  capital  gain  as  defined  in  this 
section ; 

(4)  The  term  "capital  net  gain"  means  the  excess  of  the  total  amount  of 
capital  gain  over  the  sum  of  the  capital  deductions  and  capital  losses; 

(5)  The  term  "ordinary  net  income"  means  the  net  income,  computed  in 
accordance  with  the  provisions  of  this  title,  after  excluding  all  items  of 
capital  gain,  capital  loss,  and  capital  deductions;  and 

(6)  The  term  "capital  assets"  as  used  in  this  section  means  property 
acquired  and  held  by  the  taxpayer  for  profit  or  investment  for  more  than 
two  years  (whether  or  not  connected  with  his  trade  or  business),  but  does 
not  include  property  held  for  the  personal  use  or  consumption  of  the  tax- 
payer or  his  family,  or  stock  in  trade  of  the  taxpayer  or  other  property  of  a 
kind  which  would  properly  be  included  in  the  inventory  of  the  taxpayer  if 
on  hand  at  the  close  of  the  taxable  year. 

(b)  In  the  case  of  any  taxpayer  (other  than  a  corporation)  who  for  any 
taxable  year  derives  a  capital  net  gain,  there  shall  (at  the  election  of  the 
taxpayer)  be  levied,  collected  and  paid,  in  lieu  of  the  taxes  imposed  by 
sections  210  and  211  of  this  title,  a  tax  determined  as  follows: 

A  partial  tax  shall  first  be  computed  upon  the  basis  of  the  ordinary  net 
income  at  the  rates  and  in  the  manner  provided  in  sections  210  and  211,  and 
the  total  tax  shall  be  this  amount  plus  12i  per  centum  of  the  capital  net 
gain;  but  if  the  taxpayer  elects  to  be  taxed  under  this  section  the  total  tax 
shall  in  no  such  case  be  less  than  121  per  centum  of  the  total  net  income. 
The  total  tax  thus  determined  shall  be  computed,  collected  and  paid  in  the 
same  manner,  at  the  same  time  and  subject  to  the  same  provisions  of  law, 
including  penalties,  as  other  taxes  under  this  title. 

(c)  In  the  case  of  a  partnership  or  of  an  estate  or  trust,  the  proper  part 
of  each  share  of  the  net  income  which  consists,  respectively,  of  ordinary  net 
income  and  capital  net  gain,  shall  be  determined  under  rules  and  regulations 
to  be  prescribed  by  the  Commissioner  with  the  approval  of  the  Secretary, 
and  shall  be  separately  shown  in  the  return  of  the  partnership  or  estate  or 
trust,  and  shall  be  taxed  to  the  member  or  beneficiary  or  to  the  estate  or 
trust  as  provided  in  sections  218  and  219,  but  at  the  rates  and  in  the  manner 
provided  in  subdivision  (b)  of  this  section. 


1340  APPENDIX 

Part  II — Individuals 

NORMAL  TAX 

Sec.  210.  That,  in  lieu  of  the  tax  imposed  by  section  210  of  the  Revenue 
Act  of  1918,  there  sh^ll  be  levied,  collected,  and  paid  for  each  taxable  year 
upon  the  net  income  of  every  individual  a  normal  tax  of  8  per  centum  of  the 
amount  of  the  net  income  in  excess  of  the  credits  provided  in  section  216: 
Provided,  That  in  the  case  of  a  citizen  or  resident  of  the  United  States  the 
rate  upon  the  first  $4,000  of  such  excess  amount  shall  be  4  per  centum. 

SURTAX 

Sec.  211.  (a)  That,  in  lieu  of  the  tax  imposed  by  section  211  of  the  Reve- 
nue Act  of  1918,  but  in  addition  to  the  normal  tax  imposed  by  section  210 
of  this  act,  there  shall  be  levied,  collected,  and  paid  for  each  taxable  year 
upon  the  net  income  of  every  individual — 

(1)  For  the  calendar  year  1921,  a  surtax  equal  to  the  sum  of  the  following: 

1  per  centum  of  the  amount  by  which  the  net  income  exceeds  $5,000  and 
does  not  exceed  $6,000; 

2  per  centum  of  the  amount  by  which  the  net  income  exceeds  $6,000  and 
does  not  exceed  $8,000; 

3  per  centum  of  the  amount  by  which  the  net  income  exceeds  $8,000  and 
does  not  exceed  $10,000; 

4  per  centum  of  the  amount  by  which  the  net  income  exceeds  $10,000  and 
does  not  exceed  $12,000; 

5  per  centum  of  the  amount  by  which  the  net  income  exceeds  $12,000  and 
does  not  exceed  $14,000; 

6  per  centum  of  the  amount  by  which  the  net  income  exceeds  $14,000  and 
does  not  exceed  $16,000; 

7  per  centum  of  the  amount  by  which  the  net  income  exceeds  $16,000  and 
does  not  exceed  $18,000; 

8  per  centum  of  the  amount  by  which  the  net  income  exceeds  $18,000  and 
does  not  exceed  $20,000; 

9  per  centum  of  the  amount  by  which  the  net  income  exceeds  $20,000  and 
does  not  exceed  $22,000; 

10  per  centum  of  the  amount  by  which  the  net  income  exceeds  $22,000  and 
does  not  exceed  $24,000; 

11  per  centum  of  the  amount  by  which  the  net  income  exceeds  $24,000  and 
does  not  exceed  $26,000; 

12  per  centum  of  the  amount  by  which  the  net  income  exceeds  $26,000  and 
does  not  exceed  $28,000; 

13  per  centum  of  the  amount  by  which  the  net  income  exceeds  $28,000  and 
does  not  exceed  $30,000; 

14  per  centum  of  the  amount  by  which  the  net  income  exceeds  $30,000  and 
does  not  exceed  $32,000; 

15  per  centum  of  the  amount  by  which  the  net  income  exceeds  $32,000  and 
does  not  exceed  $34,000; 

16  per  centum  of  the  amount  by  which  the  net  income  exceeds  $34,000  and 
does  not  exceed  $36,000; 

17  per  centum  of  the  amount  by  which  the  net  income  exceeds  $36,000  and 
does  not  exceed  $38,000; 

18  per  centum  of  the  amount  by  which  the  net  income  exceeds  $38,000  and 
does  not  exceed  $40,000; 


REVENUE    ACT    OF    1921  1341 

19  per  centum  of  the  amount  by  which  the  net  income  exceeds  $40,000  and 
does  not  exceed  $42,000; 

20  per  centum  of  the  amount  by  which  the  net  income  exceeds  $42,000  and 
does  not  exceed  $44,000; 

21  per  centum  of  the  amount  by  which  the  net  income  exceeds  $44,000  and 
does  not  exceed  $46,000; 

22  per  centum  of  the  amount  by  which  the  net  income  exceeds  $46,000  and 
does  not  exceed  $48,000; 

23  per  centum  of  the  amount  by  which  the  net  income  exceeds  $48,000  and 
does  not  exceed  $50,000; 

24  per  centum  of  the  amount  by  which  the  net  income  exceeds  $50,000  and 
does  not  exceed  $52,000; 

25  per  centum  of  the  amount  by  which  the  net  income  exceeds  $52,000  and 
does  not  exceed  $54,000; 

26  per  centum  of  the  amount  by  which  the  net  income  exceeds  $54,000  and 
does  not  exceed  $56,000; 

27  per  centum  of  the  amount  by  which  the  net  income  exceeds  $56,000  and 
does  not  exceed  $58,000; 

28  per  centum  of  the  amount  by  which  the  net  income  exceeds  $58,000  and 
does  not  exceed  $60,000; 

29  per  centum  of  the  amount  by  which  the  net  income  exceeds  $60,000  and 
does  not  exceed  $62,000; 

30  per  centum  of  the  amount  by  which  the  net  income  exceeds  $62,000  and 
does  not  exceed  $64,000; 

31  per  centum  of  the  amount  by  which  the  net  income  exceeds  $64,000  and 
does  not  exceed  $66,000; 

32  per  centum  of  the  amount  by  which  the  net  income  exceeds  $66,000  and 
does  not  exceed  $68,000; 

33  per  centum  of  the  amount  by  which  the  net  income  exceeds  $68,000  and 
does  not  exceed  $70,000; 

34  per  centum  of  the  amount  by  which  the  net  income  exceeds  $70,000  and 
does  not  exceed  $72,000; 

35  per  centum  of  the  amount  by  which  the  net  income  exceeds  $72,000  and 
does  not  exceed  $74,000; 

36  per  centum  of  the  amount  by  which  the  net  income  exceeds  $74,000  and 
does  not  exceed  $76,000; 

37  per  centum  of  the  amount  by  which  the  net  income  exceeds  $76,000  and 
does  not  exceed  $78,000; 

38  per  centum  of  the  amount  by  which  the  net  income  exceeds  $78,000  and 
does  not  exceed  $80,000; 

39  per  centum  of  the  amount  by  which  the  net  income  exceeds  $80,000  and 
does  not  exceed  $82,000; 

40  per  centum  of  the  amount  by  which  the  net  income  exceeds  $82,000  and 
does  not  exceed  $84,000; 

41  per  centum  of  the  amount  by  which  the  net  income  exceeds  $84,000  and 
does  not  exceed  $86,000; 

42  per  centum  of  the  amount  by  which  the  net  income  exceeds  $86,000  and 
does  not  exceed  $88,000; 

43  per  centum  of  the  amount  by  which  the  net  income  exceeds  $88,000  and 
does  not  exceed  $90,000; 

44  per  centum  of  the  amount  by  which  the  net  income  exceeds  $90,000  and 
does  not  exceed  $92,000; 


amount  by  which  the  net  income  exceeds  $96,000  and 


1342  APPENDIX 

45  per  centum  of  the  amount  by  which  the  net  income  exceeds  $92,000  and 
does  not  exceed  $94,000; 

46  per  centum  of  the  amount  by  which  the  net  income  exceeds  $94,000  and 
does  not  exceed  $96,000 

47  per  centum  of  the 
does  not  exceed  $98,000 

48  per  centum  of  the  amount  by  which  the  net  income  exceeds  $98,000  and 
does  not  exceed  $100,000; 

52  per  centum  of  the  amount  by  which  the  net  income  exceeds  $100,000 
and  does  not  exceed  $150,000; 

56  per  centum  of  the  amount  by  which  the  net  income  exceeds  $150,000 
and  does  not  exceed  $200,000; 

60  per  centum  of  the  amount  by  which  the  net  income  exceeds  $200,000 
and  does  not  exceed  $300,000; 

63  per  centum  of  the  amount  by  which  the  net  income  exceeds  $300,000 
and  does  not  exceed  $500,000; 

64  per  centum  of  the  amount  by  which  the  net  income  exceeds  $500,000 
and  does  not  exceed  $1,000,000; 

65  per  centum  of  the  amount  by  which  the  net  income  exceeds  $1,000,000; 
(2)  For  the  calendar  year  1922  and  each  calendar  year  thereafter,  a  sur- 
tax equal  to  the  sum  of  the  following: 

1  per  centum  of  the  amount  by  which  the  net  income  exceeds  $6,000  and 
does  not  exceed  $10,000; 

2  per  centum  of  the  amount  by  which  the  net  income  exceeds  $10,000  and 
does  not  exceed  $12,000; 

3  per  centum  of  the  amount  by  which  the  net  income  exceeds  $12,000  and 
does  not  exceed  $14,000; 

4  per  centum  of  the  amount  by  which  the  net  income  exceeds  $14,000  and 
does  not  exceed  $16,000; 

5  per  centum  of  the  amount  by  which  the  net  income  exceeds  $16,000  and 
does  not  exceed  $18,000; 

6  per  centum  of  the  amount  by  which  the  net  income  exceeds  $18,000  and 
does  not  exceed  $20,000; 

8  per  centum  of  the  amount  by  which  the  net  income  exceeds  $20,000  and 
does  not  exceed  $22,000; 

9  per  centum  of  the  amount  by  which  the  net  income  exceeds  $22,000  and 
does  not  exceed  $24,000; 

10  per  centum  of  the  amount  by  which  the  net  income  exceeds  $24,000  and 
does  not  exceed  $26,000; 

11  per  centum  of  the  amount  by  which  the  net  income  exceeds  $26,000  and 
does  not  exceed  $28,000; 

12  per  centum  of  the  amount  by  which  the  net  income  exceeds  $28,000  and 
does  not  exceed  $30,000; 

13  per  centum  of  the  amount  by  which  the  net  income  exceeds  $30,000  and 
does  not  exceed  $32,000; 

15  per  centum  of  the  amount  by  which  the  net  income  exceeds  $32,000  and 
does  not  exceed  $36,000; 

16  per  centum  of  the  amount  by  which  the  net  income  exceeds  $36,000  and 
does  not  exceed  $38,000; 

17  per  centum  of  the  amount  by  which  the  net  income  exceeds  $38,000  and 
does  not  exceed  $40,000; 

18  per  centum  of  the  amount  by  which  the  net  income  exceeds  $40,000  and 
does  not  exceed  $42,000; 


REVENUE    ACT    OF    1921 

19  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $44,000; 

20  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $4G,000; 

21  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $48,000; 

22  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $50,000; 

23  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $52,000; 

24  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $54,000; 

25  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $56,000; 

26  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $58,000; 

27  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $60,000; 

28  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $62,000; 

29  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $64,000; 

30  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $66,000; 

31  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $68,000; 

32  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $70,000; 

33  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $72,000; 

34  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $74,000; 

35  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $76,000; 

36  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $78,000; 

37  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $80,000; 

38  per  .centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $82,000; 

39  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $84,000; 

40  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $86,000; 

41  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $88,000; 

42  per  centum  of  the  amount  by  which  the  net  incc 
does  not  exceed  $90,000; 

43  per  centum  of  the  amount  by  which  the  net  inco 
does  not  exceed  $92,000; 

44  per  centum  of  the  amount  by  which  the  net  incc 
does  not  exceed  $94,000; 


1343 

exceeds  $42,000  and 
exceeds  $44,000  and 
exceeds  $46,000  and 
exceeds  $48,000  and 
exceeds  $50,000  and 
exceeds  $52,000  and 
exceeds  $54,000  and 
exceeds  $56,000  and 
exceeds  $58,000  and 
exceeds  $60,000  and 
exceeds  $62,000  and 
exceeds  $64,000  and 
exceeds  $66,000  and 
exceeds  $68,000  and 
exceeds  $70,000  and 
exceeds  $72,000  and 
exceeds  $74,000  and 
exceeds  $76,000  and 
exceeds  $78,000  and 
exceeds  $80,000  and 
exceeds  $82,000  and 
exceeds  $84,000  and 
exceeds  $86,000  and 
exceeds  $88,000  and 
exceeds  $90,000  and 
exceeds  $92,000  and 


1344  APPENDIX 

45  per  centum  of  the  amount  by  which  the  net  income  exceeds  $94,000  and 
does  not  exceed  $96,000; 

46  per  centum  of  the  amount  by  which  the  net  income  exceeds  $96,000  and 
does  not  exceed  $98,000; 

47  per  centum  of  the  amount  by  which  the  net  income  exceeds  $98,000  and 
does  not  exceed  $100,000; 

48  per  centum  of  the  amount  by  which  the  net  income  exceeds  $100,000 
and  does  not  exceed  $150,000; 

49  per  centum  of  the  amount  by  which  the  net  income  exceeds  $150,000 
and  does  not  exceed  $200,000; 

50  per  centum  of  the  amount  by  which  the  net  income  exceeds  $200,000. 

(b)  In  the  case  of  a  bona  fide  sale  of  mines,  oil  or  gas  wells,  or  any  inter- 
est therein,  where  the  principal  value  of  the  property  has  been  demonstrated 
by  prospecting  or  exploration  and  discovery  work  done  by  the  taxpayer,  the 
portion  of  the  tax  imposed  by  this  section  attributable  to  such  sale  shall  not 
exceed,  for  the  calendar  year  1921,  20  per  centum,  and  for  each  calendar 
year  thereafter  16  per  centum,  of  the  selling  price  of  such  property  or 
interest. 

NET  INCOME  OF  INDIVIDUALS  DEFINED 

Sec.  212.  (a)  That  in  the  case  of  an  individuetl  the  term  "net  income" 
means  the  gross  income  as  defined  in  section  213,  less  the  deductions  allowed 
by  section  214. 

(b)  The  net  income  shall  be  computed  upon  the  basis  of  the  taxpayer's 
annual  accounting  period  (fiscal  year  or  calendar  year,  as  the  case  may  be) 
in  accordance  with  the  method  of  accounting  regularly  employed  in  keeping 
the  books  of  such  taxpayer;  but  if  no  such  method  of  accounting  has  been  so 
employed,  or  if  the  method  employed  does  not  clearly  reflect  the  income,  the 
computation  shall  be  made  upon  such  basis  and  in  such  manner  as  in  the 
opinion  of  the  Commissioner  does  clearly  reflect  the  income.  If  the  tax- 
payer's annual  accounting  period  is  other  than  a  fiscal  year  as  defined  in 
section  200  or  if  the  taxpayer  has  no  annual  accounting  period  or  does  not 
keep  books,  the  net  income  shall  be  computed  on  the  basis  of  the  calendar 
year. 

(c)  If  a  taxpayer  changes  his  accounting  period  from  fiscal  year  to  cal- 
endar year,  from  calendar  year  to  fiscal  year,  or  from  one  fiscal  year  to 
another,  the  net  income  shall,  with  the  approval  of  the  Commissioner,  be 
computed  on  the  basis  of  such  new  accounting  period,  subject  to  the  pro- 
visions of  section  226. 

GROSS  INCOME  DEFINED 

Sec.  213.  That  for  the  purposes  of  this  title  (except  as  otherwise  provided 
in  section  233)  the  term  "gross  income" — 

(a)  Includes  gains,  profits,  and  income  derived  from  salaries,  wages,  or 
compensation  for  personal  service  (including  in  the  case  of  the  President  of 
the  United  States,  the  judges  of  the  Supreme  and  inferior  courts  of  the 
United  States,  and  all  other  officers  and  employees,  whether  elected  or  ap- 
pointed, of  the  United  States,  Alaska,  Hawaii,  or  any  political  subdivision 
thereof,  or  the  District  of  Columbia,  the  compensation  received  as  such),  of 
whatever  kind  and  in  whatever  form  paid,  or  from  professions,  vocations, 
trades,  businesses,  commerce,  or  sales,  or  dealings  in  property,  whether  real 
or  personal,  growing  out  of  the  ownership  or  use  of  or  interest  in  such  prop- 
erty; also  from  interest,  rent,  dividends,  securities,  or  the  transaction  of  any 


REVENUE    ACT   OF    1921  1345 

business  carried  on  for  gain  or  profit,  or  gains  or  profits  and  incomp  derived 
from  any  source  whatever.  The  amount  of  all  such  items  (except  as  pro- 
vided in  subdivision  (e)  of  section  201)  shall  be  included  in  the  gross  income 
for  the  taxable  year  in  which  received  by  the  taxpayer,  unless,  under  meth- 
ods of  accounting  permitted  under  subdivision  (b)  of  section  212,  any  such 
amounts  are  to  be  properly  accounted  for  as  of  a  different  period;  but 

(b)  Does  not  include  the  following  items,  which  shall  be  exempt  from 
taxation  under  this  title: 

(1)  The  proceeds  of  life  insurance  policies  paid  upon  the  death  of  the 
insured; 

(2)  The  amount  received  by  the  insured  as  a  return  of  premium  or  pre- 
miums paid  by  him  under  life  insurance,  endowment,  or  annuity  contracts, 
either  during  the  term  or  at  the  maturity  of  the  term  mentioned  in  the  con- 
♦^ract  or  upon  surrender  of  the  contract; 

(3)  The  value  of  property  acquired  by  gift,  bequest,  devise,  or  descent 
(but  the  income  from  such  property  shall  be  included  in  gross  income)  ; 

(4)  Interest  upon  (a)  the  obligations  of  a  State,  Territory,  or  any  politi- 
cal subdivision  thereof,  or  the  District  of  Columbia;  or  (b)  securities  issued 
under  the  provisions  of  the  Federal  Farm  Loan  Act  of  July  17,  1916;  or  (c) 
the  obligations  of  the  United  States  or  its  possessions;  or  (d)  bonds  issued 
by  the  War  Finance  Corporation.  In  the  case  of  obligations  of  the  United 
States  issued  after  September  1,  1917  (other  than  postal  savings  certificates 
of  deposit),  and  in  the  case  of  bonds  issued  by  the  War  Finance  Corporation, 
the  interest  shall  be  exempt  only  if  and  to  the  extent  provided  in  the  re- 
spective Acts  authorizing  the  issue  thereof  as  amended  and  supplemented, 
and  shall  be  excluded  from  gross  income  only  if  and  to  the  extent  it  is  wholly 
exempt  to  the  ta.xpayer  from  income,  war-profits  and  excess-profits  taxes; 

(5)  The  income  of  foreign  governments  received  from  investments  in  the 
United  States  in  stocks,  bonds,  or  other  domestic  securities,  owned  by  such 
foreign  governments,  or  from  interest  on  deposits  in  banks  in  the  United 
States  of  moneys  belonging  to  such  foreign  governments,  or  from  any  other 
source  within  the  United  States; 

(6)  Amounts  received,  through  accident  or  health  insurance  or  under 
workmen's  compensation  acts,  as  compensation  for  personal  injuries  or  sick- 
ness, plus  the  amount  of  any  damages  received  whether  by  suit  or  agree- 
ment on  account  of  such  injuries  or  sickness; 

(7)  Income  derived  from  any  public  utility  or  the  exercise  of  any  essential 
governmental  function  and  accruing  to  any  State,  Territory,  or  the  District 
of  Columbia,  or  any  political  subdivision  of  a  State  or  Territory,  or  income 
accruing  to  the  government  of  any  possession  of  the  United  States,  or  any 
political  subdivision  thereof. 

Whenever  any  State,  Territory,  or  the  District  of  Columbia,  or  any  politi- 
cal subdivision  of  a  State  or  Territory,  prior  to  September  8,  1916.  entered 
in  good  faith  into  a  contract  with  any  person,  the  object  and  purpose  of 
which  is  to  acquire,  construct,  operate,  or  maintain  a  public  utility,  no  tax 
shall  be  levied  under  the  provisions  of  this  title  upon  the  income  derived 
from  the  operation  of  such  public  utility,  so  far  as  the  payment  thereof  will 
impose  a  loss  or  burden  upon  such  State,  Territory,  District  of  Columbia,  or 
political  subdivision;  but  this  provision  is  not  intended  and  shall  not  be 
construed  to  confer  upon  such  person  any  financial  gain  or  exemption  or  to 
relieve  such  person  from  the  payment  of  a  tax  as  provided  for  in  this  title 
upon  the  part  or  portion  of  such  income  to  which  such  person  is  entitled 
under  such  contract;  , 


1346  APPENDIX 

(8)  The  income  of  a  nonresident  alien  or  foreign  corporation  which  con- 
sists exclusively  of  earnings  derived  from  the  operation  of  a  ship  or  ships 
documented  under  the  laws  of  a  foreign  country  which  grants  an  equivalent 
exemption  to  citizens  of  the  United  States  and  to  corporations  organized 
in  the  United  States; 

(9)  Amounts  received  as  compensation,  family  allotments  and  allowances 
under  the  provisions  of  the  War  Risk  Insurance  and  the  Vocational  Rehabili- 
tation Acts,  or  as  pensions  from  the  United  States  for  service  of  the  bene- 
ficiary or  another  in  the  military  or  naval  forces  of  the  United  States  in 
time  of  war; 

(10)  So  much  of  the  amount  received  by  an  individual  after  December  31, 
1921,  and  before  January  1,  1927,  as  dividends  or  interest  from  domestic 
building  and  loan  associations,  operated  exclusively  for  the  purpose  of 
making  loans  to  members,  as  does  not  exceed  $300; 

(11)  The  rental  value  of  a  dwelling  house  and  appurtenances  thereof 
furnished  to  a  minister  of  the  gospel  as  part  of  his  compensation; 

(12)  The  receipts  of  shipowners'  mutual  protection  and  indemnity  as- 
sociations, not  organized  for  profit,  and  no  part  of  the  net  earnings  of 
which  inures  to  the  benefit  of  any  private  stockholder  or  member  but  such 
corporations  shall  be  subject  as  other  persons  to  the  tax  upon  their  net  in- 
come from  interest,  dividends,  and  rents. 

(c)  In  the  case  of  a  nonresident  alien  individual,  gross  income  means 
only  the  gross  income  from  sources  within  the  United  States,  determined 
under  the  provisions  of  section  217. 

DEDUCTIONS   ALLOWED    INDIVIDUALS 

Sec.  214.  (a)  That  in  computing  net  income  there  shall  be  allowed  as 
deductions: 

(1)  All  the  ordinary  and  necessary  expenses  paid  or  incurred  during  the 
taxable  year  in  carrying  on  any  trade  or  business,  including  a  reasonable 
allowance  for  salaries  or  other  compensation  for  personal  services  actually 
rendered;  traveling  expenses  (including  the  entire  amount  expended  for 
meals  and  lodging)  while  away  from  home  in  the  pursuit  of  a  trade  or  bus- 
iness; and  rentals  or  other  payments  required  to  be  made  as  a  condition 
to  the  continued  use  or  possession,  for  purposes  of  the  trade  or  business, 
of  property  to  which  the  taxpayer  has  not  taken  or  is  not  taking  title  or  in 
which  he  has  no  equity; 

(2)  All  interest  paid  or  accrued  within  the  taxable  year  on  indebtedness, 
except  on  indebtedness  incurred  or  continued  to  purchase  or  carry  obliga- 
tions or  securities  (other  than  obligations  of  the  United  States  issued  after 
September  24,  1917,  and  originally  subscribed  for  by  the  taxpayer)  the 
interest  upon  which  is  wholly  exempt  from  taxation  under  this  title; 

(3)  Taxes  paid  or  accrued  within  the  taxable  year  except  (a)  income, 
war-profits,  and  excess-profits  taxes  imposed  by  the  authority  of  the  United 
States,  (b)  so  much  of  the  income,  war-profits  and  excess-profits  taxes, 
imposed  by  the  authority  of  any  foreign  country  or  possession  of  the 
United  States,  as  is  allowed  as  a  credit  under  section  222,  (c)  taxes  assessed 
against  local  benefits  of  a  kind  tending  to  increase  the  value  of  the  prop- 
erty assessed,  and  (d)  taxes  imposed  upon  the  taxpayer  upon  his  interest 
as  shareholder  or  member  of  a  corporation,  which  are  paid  by  the  cor- 
poration without  reimbursement  from   the  taxpayer.     For  the  purpose   of 


REVENUE    ACT    OF    lt»21  1347 

this  paranraph  estate,  inheritance,  letracy,  and  succession  taxes  accrue  on 
the  due  date  thereof  except  as  otherwise  proviiled  by  the  law  of  the  juris- 
diction imposing  such  taxes; 

(4)  Losses  sustained  durinjr  the  taxable  year  and  not  compensated  for 
by  insurance  or  otherwise,  if  incurred  in  trade  or  business; 

(5)  Losses  sustained  durinjr  the  taxable  year  and  not  compensated  for 
by  insurance  or  otherwise,  if  incurred  in  any  transaction  entered  into  for 
profit,  thouph  not  connected  with  the  trade  or  business;  but  in  the  case  of 
a  nonresident  alien  individual  only  if  and  to  the  extent  that  the  profit,  if 
such  transaction  had  resulted  in  a  profit,  would  be  taxable  under  this  title. 
No  deduction  shall  be  allowed  under  this  paraprraph  for  any  loss  claimed  to 
have  been  sustained  in  any  sale  or  other  disposition  of  shares  of  stock  or 
securities  made  after  the  passage  of  this  Act  where  it  appears  that  within 
thirty  days  before  or  after  the  date  of  such  sale  or  other  disposition  the 
taxpayer  has  acquired  (otherwise  than  by  bequest  or  inheritance)  sub- 
stantially identical  property,  and  the  property  so  acquired  is  held  by  the 
taxpayer  for  any  period  after  such  sale  or  other  disposition.  If  such  ac- 
quisition is  to  the  extent  of  part  only  of  substantially  identical  property, 
then  only  a  proportionate  part  of  the  loss  shall  be  disallowed; 

(6)  Losses  sustained  during  the  taxable  year  of  property  not  connected 
with  the  trade  or  business  (but  in  the  case  of  a  nonresident  alien  individual 
only  property  within  the  United  States)  if  arising  from  fires,  storms,  ship- 
wreck, or  other  casualty,  or  from  theft,  and  if  not  compensated  for  by  in- 
surance or  otherwise.  Losses  allowed  under  paragraphs  (4),  (5),  and  (6) 
of  this  subdivision  shall  be  deducted  as  of  the  taxable  year  in  which  sus- 
tained unless,  in  order  to  clearly  reflect  the  income,  the  loss  should,  in  the 
opinion  of  the  Commissioner,  be  accounted  for  as  of  a  different  period. 
In  case  of  losses  arising  from  destruction  of  or  damage  to  property,  where 
the  property  so  destroyed  or  damaged  was  acquired  before  March  1,  1913, 
the  deduction  shall  be  computed  upon  the  basis  of  its  fair  market  price  or 
value  as  of  March  1,  1913; 

(7)  Debts  ascertained  to  be  worthless  and  charged  off  within  the  taxable 
year  (or,  in  the  discretion  of  the  Commissioner,  a  reasonable  addition  to 
a  reserve  for  bad  debts);  and  when  satisfied  that  a  debt  is  recoverable  only 
in  part,  the  Commissioner  may  allow  such  debt  to  be  charged  off  in  part; 

(8)  A  reasonable  allowance  for  the  exhaustion,  wear  and  tear  of  prop- 
erty used  in  the  trade  or  business,  including  a  reasonable  allowance  for 
obsolescence.  In  the  case  of  such  property  acquired  before  March  1,  1013. 
this  deduction  shall  be  computed  upon  the  basis  of  its  fair  market  price  or 
value  as  of  March  1,  1913; 

(9)  In  the  case  of  buildings,  machinery,  equipment,  or  other  facilities, 
constructed,  erected,  installed,  or  acquired,  on  or  after  April  6,  1917,  for 
the  production  of  articles  contributing  to  the  prosecution  of  the  war 
against  the  German  government,  ami  in  the  case  of  vessels  constructed 
or  acquired  on  or  after  such  date  for  the  transportation  of  articles  or  men 
contributing  to  the  prosecution  of  such  war.  there  shall  be  allowed,  for  any 
taxable  year  ending  before  March  3,  1924  (if  claim  therefor  was  made  at 
the  time  of  filing  return  for  the  taxable  year  1918,  1919.  1920,  or  1921)  a 
reasonable  deduction  for  the  amortization  of  such  part  of  the  cost  of  such 
facilities  or  vessels  as  has  been  borne  by  the  taxpayer,  but  not  again  in- 
cluding any  amount  otherwise  allowed  under  this  title  or  previous  Act  of 
Congress  as  a  deduction  in  computing  net  income.  At  any  time  before 
March  3,  1924,  the  Commissioner  may.  and  at  the  request  of  the  taxpayer 


^ 


1348  APPENDIX 

shall,  re-examine  the  return,  and  if  he  then  finds  as  a  result  of  an  appraisal 
or  from  other  evidence  that  the  deduction  originally  allowed  was  incorrect, 
the  income,  war-profits,  and  excess-profits  taxes  for  the  year  or  years 
affected  shall  be  redetermined;  and  the  amount  of  tax  due  upon  such  re- 
determination, if  any,  shall  be  paid  upon  notice  and  demand  by  the  collector, 
or  the  amount  of  tax  overpaid,  if  any,  shall  be  credited  or  refunded  to  the 
taxpayer  in  accordance  with  the  provisions  of  section  252; 

(10)  In  the  case  of  mines,  oil  and  gas  wells,  other  natural  deposits,  and 
timber,  a  reasonable  allowance  for  depletion  and  for  depreciation  of  im- 
provements, according  to  the  peculiar  conditions  in  each  case,  based 
upon  cost  including  cost  of  development  not  otherwise  deducted:  Provided, 
That  in  the  case  of  such  properties  acquired  prior  to  March  1,  1913, 
the  fair  market  value  of  the  property  (or  the  taxpayer's  interest 
therein)  on  that  date  shall  be  taken  in  lieu  of  cost  up  to  that  date:  Provided 
further,  That  in  the  case  of  mines,  oil  and  gas  wells,  discovered  by  the  tax- 
payer, on  or  after  March  1,  1913,  and  not  acquired  as  the  result  of  purchase 
of  a  proven  tract  or  lease,  where  the  fair  market  value  of  the  property  is 
materially  disproportionate  to  the  cost,  the  depletion  allowance  shall  be 
based  upon  the  fair  market  value  of  the  property  at  the  date  of  the  dis- 
covery, or  within  thirty  days  thereafter:  And  provided  further,  That 
such  depletion  allowance  based  on  discovery  value  shall  not  exceed  the  net 
income,  computed  without  allowance  for  depletion,  from  the  property  upon 
which  the  discovery  is  made,  except  where  such  net  income  so  computed 
is  less  than  the  depletion  allowance  based  on  cost  or  fair  market  value 
as  of  March  1,  1913;  such  reasonable  allowance  in  all  the  above  cases  to 
be  made  under  rules  and  regulations  to  be  prescribed  by  the  Commissioner, 
with  the  approval  of  the  secretary.  In  the  case  of  leases  the  deductions 
allowed  by  this  paragraph  shall  be  equitably  apportioned  between  the 
lessor  and  lessee; 

(11)  Contributions  or  gifts  made  within  the  taxable  year  to  or  for  the 
use  of:  (A)The  United  States,  any  state,  territory,  or  any  political  sub- 
division thereof,  or  the  District  of  Columbia,  for  exclusively  public  pur- 
poses; (B)  any  corporation,  or  community  chest,  fund,  or  foundation,  or- 
ganized and  operated  exclusively  for  religious,  charitable,  scientific,  literary, 
or  educational  purposes,  including  posts  of  the  American  Legion  or  the 
women's  auxiliary  units  thereof,  or  for  the  prevention  of  cruelty  to  children 
or  animals,  no  part  of  the  net  earnings  of  which  inures  to  the  benefit  of 
any  private  stockholder  or  individual;  or  (C)  the  special  fund  for  vocational 
rehabilitation  authorized  by  section  7  of  the  Vocational  Rehabilitation  Act; 
to  an  amount  which  in  all  the  above  cases  combined  does  not  exceed  15 
per  centum  of  the  taxpayer's  net  income  as  computed  without  the  benefit 
of  this  paragraph.  In  the  case  of  a  nonresident  alien  individual  this  de- 
duction shall  be  allowed  only  as  to  contributions  or  gifts  made  to  domestic 
corporations,  or  to  community  chests,  funds,  or  foundations,  created  in  the 
United  States,  or  to  such  vocational  rehabilitation  fund.  Such  contributions 
or  gifts  shall  be  allowable  as  deductions  only  if  verified  under  rules  and 
regulations  prescribed  by  the  Commissioner,  with  the  approval  of  the  secre- 
tary; 

(12)  If  property  is  compulsorily  or  involuntarily  converted  into  cash  or 
its  equivalent  as  a  result  of  (A)  its  destruction  in  whole  or  in  part,  (B) 
theft  or  seizure,  or  (C)  an  exercise  of  the  power  of  requisition  or  condem- 
nation, or  the  threat  or  imminence  thereof;  and  if  the  taxpayer  proceeds 
forthwith  in  good  faith,  under  regulations  prescribed  by  the  Commissioner 


REVENUE    ACT    OF    1921  1349 

with  the  approval  of  the  Secretary,  to  expend  the  proceeds  of  such  con- 
version in  the  acquisition  of  other  property  of  a  character  similar  or  re- 
lated in  service  or  use  to  the  property  so  converted,  or  in  the  acquisition 
of  80  per  centum  or  more  of  the  stock  or  shares  of  a  corporation  owning: 
such  other  property,  or  in  the  establishment  of  a  replacement  fund,  then 
there  shall  be  allowed  as  a  deduction  such  portion  of  the  prain  derived  as 
the  portion  of  the  proceeds  so  expended  bears  to  the  entire  proceeds.  The 
provisions  of  this  paragraph  prescribin>r  the  conditions  under  which  a  de- 
duction may  be  taken  in  respect  of  the  proceeds  or  ^ains  derived  from  the 
compulsory  or  involuntary  conversion  of  property  into  cash  or  Its  equiv- 
alent, shall  apply  so  far  as  may  be  practicable  to  the  exemption  or  exclusion 
of  such  proceeds  or  gains  fi-om  gross  income  under  prior  income,  war-profits 
and  excess-profits  tax  acts. 

(b)  In  the  case  of  a  nonresident  alien  individual,  the  deductions  allowed 
in  subdivision  (a),  except  those  allowed  in  paragraphs  (5),  (G),  and  (11), 
shall  be  allowed  only  if  and  to  the  extent  that  they  are  connected  with  in- 
come from  sources  within  the  United  States;  and  the  proper  apportion- 
ment and  allocation  of  the  deductions  with  respect  to  sources  of  income 
within  and  without  the  United  States  shall  be  determined  as  provided  in 
section  217  under  rules  and  regulations  prescribed  by  the  Commissioner 
with  the  approval  of  the  Secretary.  In  the  case  of  a  citizen  entitled  to 
the  benefits  of  section  262  the  deductions  shall  be  the  same  and  shall  be 
determined  in  the  same  manner  as  in  the  case  of  a  nonresident  alien  in- 
dividual. 

ITEMS   NOT  DEDUCTIBLE 

Sec.  215.  (a)  That  in  computing  net  income  no  deduction  shall  in  any 
case  be  allowed  in  respect  of — 

(1)  Personal,  living,  or  family  expenses; 

(2)  Any  amount  paid  out  for  new  buildings  or  for  permanent  improve- 
ments or  betterments  made  to  increase  the  value  of  any  pi-operty  or  estate; 

(3)  Any  amount  expended  in  restoring  pi-operty  or  in  making  good  the 
exhaustion  thereof  for  which  an  allowance  is  or  has  been  made;  or 

(4)  Premiums  paid  on  any  life  insurance  policy  covering  the  life  of  any 
officer  or  employee,  or  of  any  person  financially  interested  in  any  trade  or 
business  carried  on  by  the  taxpayer,  when  the  taxpayer  is  directly  or  in- 
directly a  beneficiary  under  such  policy. 

(b)  Amounts  paid  under  the  laws  of  any  State,  Territory,  District  of 
Columbia,  possession  of  the  United  States,  or  foreign  country  as  income  to 
the  holder  of  a  life  or  terminable  interest  accjuiretl  by  gift,  bequest,  or 
inheritance  shall  not  be  reduced  or  diminished  by  any  deduction  for  shrink- 
age (by  whatever  name  called)  in  the  value  of  such  interest  due  to  the 
lapse  of  time,  nor  by  any  deduction  allowed  by  this  Act  for  the  purpose  of 
computing  the  net  income  of  an  estate  or  trust  but  not  allowed  under  the 
laws  of  such  State,  Territory,  District  of  Columbia,  possession  of  the 
United  States,  or  foreign  country  for  the  purpose  of  computing  the  income 
to  which  such  holder  is  entitled. 

CRFDITS   ALLOWED    INDIVIDUALS 

Sec.  216.  That  for  the  purpose  of  the  normal  tax  only  there  shall  be 
allowed  the  following  credits: 

(a)  The  amount  received  as  dividends  (1)  from  a  domestic  corporation 
other  than  a  corporation  entitled  to  the  benefits  of  section  262,  or  (2)  from 


Vy 


1350  APPENDIX 

a  foreign  corporation  when  it  is  shown  to  the  satisfaction  of  the  Com- 
missioner that  more  than  50  per  centum  of  the  gross  income  of  such  foreign 
corporation  for  the  three-year  period  ending  with  the  close  of  its  taxable 
year  preceding  the  declaration  of  such  dividends  (or  for  such  part  of  such 
period  as  the  corporation  has  been  in  existence)  was  derived  from  sources 
within  the  United  States  as  determined  under  the  provisions  of  section  217; 

(b)  The  amount  received  as  interest  upon  obligations  of  the  United 
States  and  bonds  issued  by  the  "War  Finance  Corporation,  which  is  in- 
cluded in  gross  income  under  section  213; 

(c)  In  the  case  of  a  single  person,  a  personal  exemption  of  $1,000;  or 
in  the  case  of  the  head  of  a  family  or  a  married  person  living  with  husband 
or  wife,  a  personal  exemption  of  $2,500,  unless  the  net  income  is  in  excess 
of  $5,000,  in  which  case  the  personal  exemption  shall  be  $2,000.  A  husband 
and  wife  living  together  shall  receive  but  one  personal  exemption.  The 
amount  of  such  personal  exemption  shall  be  $2,500,  unless  the  aggregate 
net  income  of  such  husband  and  wife  is  in  excess  of  $5,000,  in  which  case 
the  amount  of  such  personal  exemption  shall  be  $2,000.  If  such  husband 
and  wife  make  separate  returns,  the  personal  exemption  may  be  taken  by 
either  or  divided  between  them.  In  no  case  shall  the  reduction  of  the  per- 
sonal exemption  from  $2,500  to  $2,000  operate  to  increase  the  tax,  which 
would  be  payable  if  the  exemption  were  $2,500,  by  more  than  the  amount 
of  the  net  income  in  excess  of  $5,000; 

(d)  $400  for  each  person  (other  than  husband  or  wife)  dependent  upon 
and  receiving  his  chief  support  from  the  taxpayer  if  such  dependent  person 
is  under  eighteen  years  of  age  or  is  incapable  of  self-support  because 
mentally  or  physically  defective; 

(e)  In  the  case  of  a  nonresident  alien  individual  or  of  a  citizen  entitled 
to  the  benefits  of  section  262,  the  personal  exemption  shall  be  only  $1,000, 
and  he  shall  not  be  entitled  to  the  credit  provided  in  subdivision  (d); 

(f)  The  credits  allowed  by  subdivisions  (c),  (d),  and  (e)  of  this  section 
shall  be  determined  by  the  status  of  the  taxpayer  on  the  last  day  of  the 
period  for  which  the  return  of  income  is  made;  but  in  the  case  of  an  in- 
dividual who  dies  during  the  taxable  year,  such  credits  shall  be  determined 
by  his  status  at  the  time  of  his  death,  and  in  such  case  full  credits  shall  be 
allowed  to  the  surviving  spouse,  if  any,  according  to  his  or  her  status  at 
the  close  of  the  period  for  which  such  survivor  makes  return  of  income. 

NET    INCOME    OF    NONRESIDENT    ALIEN    INDIVIDUALS 

Sec.  217.  (a)  That  in  the  case  of  a  nonresident  alien  individual  or  of  a 
citizen  entitled  to  the  benefits  of  section  262,  the  following  items  of  gross 
income  shall  be  treated  as  income  from  sources  within  the  United  States: 

(1)  Interest  on  bonds,  notes,  or  other  interest-bearing  obligations  of 
residents,  corporate  or  otherwise,  not  including  (A)  interest  on  deposits 
with  persons  carrying  on  the  banking  business  paid  to  persons  not  en- 
gaged in  business  within  the  United  States  and  not  having  an  oflice  or  place 
of  business  therein,  or  (B)  interest  received  from  a  resident  alien  individual 
or  a  resident  foreign  corporation  when  it  is  shown  to  the  satisfaction  of 
the  Commissioner  that  less  than  20  per  centum  of  the  gross  income  of 
such  resident  payor  has  been  derived  from  sources  within  the  United  States, 
as  determined  under  the  provisions  of  this  section,  for  the  three-year  period 
ending  with  the  close  of  the  taxable  year  of  such  payor,  or  for  such  part 
of  such  period  immediately  preceding  the  close  of  such  taxable  year  as  may 
be  applicable; 


RFA'KNUE    ACT    OF    ll»2l  1351 

(2)  The  amount  received  as  dividends  (A)  from  a  domestic  corporation 
other  than  a  corporation  entitled  to  the  benefits  of  section  262,  or  (B) 
from  a  foreign  corporation  unless  less  than  50  per  centum  of  the  gross 
income  of  such  foreign  corporation  for  the  three-year  period  ending  with 
the  close  of  its  taxable  year  preceding  the  declaration  of  such  dividends 
(or  for  such  part  of  such  period  as  the  corporation  has  been  in  existence) 
was  derived  from  sources  within  the  United  States  as  determined  under  the 
provisions  of  this  section; 

(3)  Compensation  for  labor  or  personal  services  performed  in  the  United 
States; 

(4)  Rentals  or  royalties  from  property  located  in  the  United  States  or 
from  any  interest  in  such  property,  including  rentals  or  royalties  for  the 
use  of  or  for  the  privilege  of  using  in  the  United  States,  patents,  copy- 
rights, secret  processes  and  foi-mulas,  good  will,  trade-marks,  trade  brands, 
franchises,  and  other  like  property;  and 

(5)  Gains,  profits,  and  income  from  the  sale  of  real  property  located  in 
the  United  States. 

(b)  From  the  items  of  gross  income  specified  in  subdivision  (a)  there 
shall  be  deducted  the  expenses,  losses,  and  other  deductions  properly  ap- 
portioned or  allocated  thereto  and  a  ratable  part  of  any  expenses,  losses, 
or  other  deductions  which  can  not  definitely  be  allocated  to  some  item  or 
class  of  gross  income.  The  remainder,  if  any.  shall  be  included  in  full  as 
net  income  from  sources  within  the  United  States. 

(c)  The  following  items  of  gross  income  shall  be  treated  as  income  from 
sources  without  the  United  States: 

(1)  Interest  other  than  that  derived  from  sources  within  the  United 
States  as  provided  in  paragraph  (1)  of  subdivision  (a); 

(2)  Dividends  other  than  those  derived  from  sources  within  the  United 
States  as  provided  in  paragraph  (2)  of  subdivision  (a); 

(3)  Compensation  for  labor  or  personal  service  performed  without  the 
United  States; 

(4)  Rentals  or  royalties  from  property  located  without  the  United 
States  or  from  any  interest  in  such  property,  including  rentals  or  royalties 
for  the  use  of  or  for  the  privilege  of  using  without  the  United  States, 
patents,  copyrights,  secret  processes  and  formulas,  good  will,  trade-marks, 
trade  brands,  franchises,  and  other  like  property;  and 

(5)  Gains,  profits,  and  income  from  the  sale  of  real  property  located 
without  the  United  States; 

(d)  From  the  items  of  gross  income  specified  in  subdivision  (c)  there 
shall  be  deducted  the  expenses,  losses,  and  other  deductions  properly  ap- 
portioned or  allocated  thereto,  and  a  ratable  part  of  any  expenses,  los.ses. 
or  other  deductions  which  can  not  definitely  be  allocated  to  some  item  or 
class  of  gross  income.  The  remainder,  if  any,  shall  be  treated  in  full  as 
net  income  from  sources  without  the   United   States. 

(e)  Items  of  gross  income,  expenses,  losses  and  tleductions,  other  than 
those  specified  in  subdivisions  (a)  and  (c),  shall  be  allocated  or  apportioned 
to  sources  within  or  without  the  United  States  under  rules  and  regulations 
prescribed  by  the  Commissioner  with  the  approval  of  the  Secretary.  Where 
items  of  gross  income  are  separately  allocated  to  sources  within  the  United 
States,  there  shall  be  deducted  (for  the  purpose  of  computing  the  net  in- 
come therefrom)  the  expenses,  losses  and  other  deductions  properly  ap- 
portioned or  allocated  thereto  and  a  ratable  part  of  other  expenses,  losses 
or  other  deductions  which  can  not  definitely  be  allocated  to  some  item  or 


1352  APPENDIX 

class  of  gross  income.  The  remainder,  if  any,  shall  be  included  in  full  as 
net  income  from  sources  within  the  United  States.  In  the  case  of  gross 
income  derived  from  sources  partly  within  and  partly  without  the  United 
States,  the  net  income  may  first  be  computed  by  deducting  the  expenses, 
losses  or  other  deductions  apportioned  or  allocated  thereto  and  a  ratable 
part  of  any  expenses,  losses  or  other  deductions  which  can  not  definitely  be 
allocated  to  some  item  or  class  of  gross  income;  and  the  portion  of  such 
net  income  attributable  to  sources  within  the  United  States  may  be  de- 
termined by  processes  or  formulas  of  general  apportionment  prescribed 
by  the  Commissioner  with  the  approval  of  the  Secretary.  Gains,  profits 
and  income  from  (1)  transportation  or  other  services  rendered  partly 
within  and  partly  without  the  United  States,  or  (2)  from  the  sale  of  per- 
sonal property  produced  (in  whole  or  in  part)  by  the  taxpayer  within  and 
sold  without  the  United  States,  or  produced  (in  whole  or  in  part)  by  the 
taxpayer  without  and  sold  within  the  United  States,  shall  be  treated  as 
derived  partly  from  sources  within  and  partly  from  sources  without  the 
United  States.  Gains,  profits  and  income  derived  from  the  purchase  of 
personal  property  within  and  its  sale  without  the  United  States  or  from  the 
purchase  of  personal  property  without  and  its  sale  within  the  United  States, 
shall  be  treated  as  derived  entirely  from  the  country  in  which  sold. 

(f )  As  used  in  this  section  the  words  "sale"  or  "sold"  include  "exchange" 
or  "exchanged";  and  the  word  "produced"  includes  "created,"  "fabricated," 
"manufactured,"  "extracted,"  "processed,"  "cui'ed,"  or  "aged." 

(g)  A  nonresident  alien  individual  or  citizen  entitled  to  the  benefits  of 
section  262  shall  receive  the  benefit  of  the  deductions  and  credits  allowed 
in  this  title  only  by  filing  or  causing  to  be  filed  with  the  collector  a  true 
and  accurate  return  of  his  total  income  received  from  all  sources  corporate 
or  otherwise  in  the  United  States,  in  the  manner  prescribed  in  this  title; 
including  therein  all  the  information  which  the  Commissioner  may  deem 
necessary  for  the  calculation  of  such  deductions  and  credits:  Provided,  That 
the  benefit  of  the  credit  allowed  in  subdivision  (e)  of  section  216  may,  in 
the  discretion  of  the  Commissioner,  be  received  by  filing  a  claim  therefor 
with  the  withholding  agent.  In  case  of  failure  to  file  a  return,  the  col- 
lector shall  collect  the  tax  on  such  income,  and  all  property  belonging  to 
such  nonresident  alien  individual  or  foreign  trader  shall  be  liable  to  dis- 
traint for  the  tax. 

PARTNERSHIPS  AND  PERSONAL  SERVICE  CORPORATIONS 

Sec.  218.  (a)  That  individuals  carrying  on  business  in  partnership 
shall  be  liable  for  income  tax  only  in  their  individual  capacity.  There 
shall  be  included  in  computing  the  net  income  of  each  partner  his  distrib- 
utive share,  whether  distributed  or  not,  of  the  net  income  of  the  partner- 
ship for  the  taxable  year,  or,  if  his  net  income  for  such  taxable  year  is 
computed  upon  the  basis  of  a  period  different  from  that  upon  the  basis  of 
which  the  net  income  of  the  partnership  is  computed,  then  his  distributive- 
share  of  the  net  income  of  the  partnership  for  any  accounting  period  of  the 
partnership  ending  within  the  fiscal  or  calendar  year  upon  the  basis  of 
which  the  partner's  net  income  is  computed. 

(b)  The  partner  shall,  for  the  purpose  of  the  normal  tax,  be  allowed  as 
credits,  in  addition  to  the  credits  allowed  to  him  under  section  216,  his 
proportionate  share  of  such  amounts  specified  in  subdivisions  (a)  and  (b) 
of  section  216  as  are  received  by  the  partnership. 


REVENUE    ACT    OF    1921  1353 

(c)  The  net  income  of  the  partnership  shall  be  computed  in  the  same 
manner  and  on  the  same  basis  as  provided  in  section  212  except  that  the 
deduction  provided  in  paragraph  (11)  of  subdivision  (a)  of  section  214 
shall  not  be  allowed. 

(d)  Personal  service  corporations  shall  not  be  subject  to  taxation  under 
this  title,  but  the  individual  stockholders  thereof  shall  be  taxed  in  the  same 
manner  as  the  members  of  partnerships.  All  the  provisions  of  this  title 
relating  to  partnerships  and  the  members  thereof  shall  so  far  as  practicable 
apply  to  personal  service  corporations  and  the  stockholders  thereof: 
Provided,  That  for  the  purpose  of  this  subdivision  amounts  distributed  by  a 
personal' service  corporation  during  its  taxable  year  shall  be  accounted 
for  by  the  distributees;  and  any  portion  of  the  net  income  remaining  un- 
distributed at  the  close  of  its  taxable  year  shall  be  accounted  for  by  the 
stockholders  of  such  corporation  at  the  close  of  its  taxable  year  in  pro- 
portion to  their  respective  shares. 

This  subdivision  .shall  not  be  in  effect  after  December  31.  1921.  In  the 
case  of  a  personal  service  corporation  having  a  fiscal  year  beginning  in 
1921  and  ending  in  1922,  amounts  distributed  prior  to  January  1,  1922,  to 
its  stockholders  out  of  earnings  or  profits  accumulated  after  December  31, 
1920,  shall  be  taxed  to  the  distributees;  and  the  stockholders  of  record  on 
December  31,  1921,  shall  be  taxed  upon  their  distributive  shares  of  the 
difference  (if  any)  between  such  distributive  profits  and  the  portion  of 
the  corporation's  net  income  assignable  to  the  calendar  year  1921,  de- 
termined in  the  manner  provided  in  clause  (1)  of  subdivision  (c)  of  sec- 
tion 20.5  of  this  Act. 

ESTATES   AND   TRUSTS 

Sec.  219.  (a)  That  the  tax  imposed  by  sections  210  and  211  shall  apply 
to  the  income  of  estates  or  of  any  kind  of  property  held  in  trust,  including— 

(1)  Income  received  by  estates  of  deceased  persons  during  the  period 
of  administration  or  settlement  of  the  estate; 

(2)  Income  accumulated  in  trust  for  the  benefit  of  unborn  or  un- 
ascertained person  or  persons  with  contingent  interests; 

(3)  Income  held  for  future  distribution  under  the  terms  of  the   will   or 

trust;  and 

(4)  Income  which  is  to  be  distributed  to  the  beneficiaries  periodically, 
whether  or  not  at  regular  intervals,  and  the  income  collected  by  a  guardian 
of  an  infant  to  be  held  or  distributed  as  the  court  may  direct. 

(b)  The  fiduciary  shall  be  responsible  for  making  the  return  of  income 
for  the  estate  or  trust  for  which  he  acts.  The  net  income  of  the  estate  or 
trust  shall  be  computed  in  the  same  manner  and  on  the  same  basis  as  pro- 
vided in  section  212,  except  that  (in  lieu  of  the  deduction  authorized  by 
paragraph  (11)  of  subdivision  (a)  of  section  214)  there  shall  also  be 
allowed  as  a  deduction,  without  limitation,  any  part  of  the  gross  income 
which,  pursuant  to  the  terms  of  the  will  or  deed  creating  the  trust,  is 
during  the  taxable  year  paid  or  permanently  set  aside  for  the  purposes 
and  in  the  manner  .specified  in  paragraph  (11)  of  subdivision  (a)  of  sec- 
tion 214.  In  cases  in  which  there  is  any  income  of  the  class  described  in 
paragraph  (4)  of  subdivision  (a)  of  this  section  the  fiduciary  shall  include 
in  the  return  a  statement  of  the  income  of  the  estate  or  trust  which,  pur- 
suant to  the  instrument  or  order  governing  the  distribution,  is  distributable 
to  each  beneficiary,  whether  or  not  distributed  before  the  close  of  the 
taxable  year  for  which  the  return  is  made. 


1354  APPENDIX 

(c)  In  cases  under  paragraphs  (1),  (2),  or  (3)  of  subdivision  (a)  or  in 
any  other  case  within  subdivision  (a)  of  this  section  except  paragraph  (4) 
thereof  the  tax  shall  be  imposed  upon  the  net  income  of  the  estate  or  trust 
and  shall  be  paid  by  the  fiduciary,  except  that  in  determining  the  net  in- 
come of  the  estate  of  any  deceased  person  during  the  period  of  administra- 
tion or  settlement  there  may  be  deducted  the  amount  of  any  income  properly 
paid  or  credited  to  any  legatee,  heir,  or  other  beneficiary.  In  such  cases 
the  estate  or  trust  shall,  for  the  purpose  of  the  normal  tax,  be  allowed  the 
same  credits  as  are  allowed  to  single  persons  under  section  216. 

(d)  In  cases  under  paragraph  (4)  of  subdivision  (a),  and  in  the  case  of 
any  income  of  an  estate  during  the  period  of  administration  or  settlement 
permitted  by  subdivision  (c)  to  be  deducted  from  the  net  income  upon  which 
tax  is  to  be  paid  by  the  fiduciary,  the  tax  shall  not  be  paid  by  the  fiduciary, 
but  there  shall  be  included  in  computing  the  net  income  of  each  beneficiary 
that  part  of  the  income  of  the  estate  or  trust  for  its  taxable  year  which, 
pursuant  to  the  instrument  or  order  governing  the  distribution,  is  dis- 
tributable to  such  beneficiary,  whether  distributed  or  not,  or,  if  his  tax- 
able year  is  diff^erent  from  that  of  the  estate  or  trust,  then  there  shall  be 
included  in  computing  his  net  income  his  distributive  share  of  the  income 
of  the  estate  or  trust  for  its  taxable  year  ending  within  the  taxable  year 
of  the  beneficiary.  In  such  cases  the  beneficiary  shall,  for  the  purpose  of 
the  normal  tax,  be  allowed  as  credits,  in  addition  to  the  credits  allowed  to 
him  under  section  216,  his  proportionate  share  of  such  amounts  specified 
in  subdivisions  (a)  and  (b)  of  section  216  as  are  received  by  the  estate  or 
trust. 

(e)  In  the  case  of  an  estate  or  trust  the  income  of  which  consists  both 
of  income  of  the  class  described  in  paragraph  (4)  of  subdivision  (a)  of 
this  section  and  other  income,  the  net  income  of  the  estate  or  trust  shall 
be  computed  and  a  return  thereof  made  by  the  fiduciary  in  accordance  with 
subdivision  (b)  and  the  tax  shall  be  imposed,  and  shall  be  paid  by  the 
fiduciary  in  accordance  with  subdivision  (c),  except  that  there  shall  be 
allawed  as  an  additional  deduction  in  computing  the  net  income  of  the  estate 
or  trust  that  part  of  its  income  of  the  class  described  in  paragraph  (4)  of 
subdivision  (a)  which,  pursuant  to  the  instrument  or  order  governing  the 
distribution,  is  distributable  during  its  taxable  year  to  the  beneficiaries. 
In  cases  under  this  subdivision  there  shall  be  included,  as  provided  in  sub- 
division (d)  of  this  section,  in  computing  the  net  income  of  each  beneficiary, 
that  part  of  the  income  of  the  estate  or  trust  which,  pursuant  to  the  instru- 
ment or  order  governing  the  distribution,  is  distributable  during'  the  taxable 
year  to  such  beneficiary. 

(f)  A  trust  created  by  an  employer  as  a  part  of  a  stock  bonus  or  profit- 
sharing  plan  for  the  exclusive  benefit  of  some  or  all  of  his  employees,  to 
which  contributions  are  made  by  such  employer,  or  employees,  or  both, 
for  the  purpose  of  distributing  to  such  employees  the  earnings  and  prin- 
cipal of  the  fund  accumulated  by  the  trust  in  accordance  with  such  plan, 
shall  not  be  taxable  under  this  section,  but  the  amount  actually  distributed 
or  made  available  to  any  distributee  shall  be  taxable  to  him  in  the  year 
in  which  so  distributed  or  made  available  to  the  extent  that  it  exceeds  the 
amounts  paid  in  by  him.  Such  distributees  shall  for  the  purpose  of  the 
normal  tax  be  allowed  as  credits  that  part  of  the  amount  so  distributed  or 
made  available  as  represents  the  items  specified  in  subdivisions  (a)  and 
(b)   of  section  216. 


REVENUE    ACT    OF    1921  1355 

EVASION  OK  SI  RTAXKS  BY  INCORPORATION 

Sec.  220.  That  if  any  corporation,  however  created  or  orfranized,  is 
formed  or  availed  of  for  the  purpose  of  prevent injr  the  imposition  of  the 
surtax  upon  its  stockholders  or  members  through  the  medium  of  permitting 
its  Rains  and  profits  to  accumulate  instead  of  beinj-:  divided  or  distributed, 
there  shall  be  levied,  collected,  and  paid  for  each  taxable  year  upon  the 
net  income  of  such  corporation  a  tax  equal  to  25  per  centum  of  the  amount 
thereof,  which  shall  be  in  addition  to  the  tax  imposed  by  section  2.S0  of 
this  title  and  shall  be  computed,  collected,  and  paid  upon  the  same  basis 
and  in  the  same  manner  and  subject  to  the  same  provisions  of  law,  including; 
penalties,  as  that  tax:  Provided,  That  if  all  the  stockholders  or  members 
of  such  corporation  agree  thereto,  the  Commissioner  may,  in  lieu  of  all 
income,  war-profits  and  excess-profits  taxes  imposed  upon  the  corporation 
for  the  taxable  year,  tax  the  stockholders  or  members  of  such  corporation 
upon  their  distributive  shares  in  the  net  income  of  the  corporation  for  the 
taxable  year  in  the  same  manner  as  provided  in  subdivision  (a)  of  section 
218  in  the  case  of  members  of  a  partnership.  The  fact  that  any  corporation 
is  a  mere  holding  company,  or  that  the  gains  and  profits  are  permitted  to 
accumulate  beyond  the  reasonable  needs  of  the  business,  shall  be  prima 
facie  evidence  of  a  purpose  to  escape  the  surtax;  but  the  fact  that  the  gains 
and  profits  are  in  any  case  permitted  to  accumulate  and  become  surplus 
shall  not  be  construed  as  evidence  of  a  purpose  to  escape  the  tax  in  such 
case  unless  the  Commissioner  certifies  that  in  his  opinion  such  accumulation 
is  unreasonable  for  the  purposes  of  the  business.  When  requested  by  the 
Coiumissioner,  or  any  collector,  every  corporation  shall  forward  to  him  a 
correct  statement  of  such  gains  and  profits  and  the  names  and  addresses 
of  the  individuals  or  shareholders  who  would  be  entitled  to  the  same  if 
divided  or  distributed,  and  of  the  amounts  that  would  be  payable  to  each. 

PAY.MENT    OF    INDIVIDUAL'S    TAX    AT    SOURCE 

Sec.  221.  (a)  That  all  individuals,  corporations,  and  partnerships,  in 
whatever  capacity  acting,  including  lessees  or  mortgagors  of  real  or  per- 
sonal property,  fiduciaries,  employers,  and  all  officers  and  employees  of 
the  United  States  having  the  control,  receipt,  custody,  disposal,  or  payment 
of  interest  (except  interest  on  deposits  with  persons  carrying  on  the  bank- 
ing business  paid  to  persons  not  engaged  in  business  in  the  United  States 
and  not  having  an  office  or  place  of  bu.siness  therein),  rent,  salaries,  wages, 
premiums,  annuities,  compensations,  remunerations,  emoluments,  or  other 
fixed  or  determinable  annual  or  periodical  gains,  profits,  and  income,  of 
any  nonresident  alien  individual  or  partnership  composed  in  whole  or  in 
part  of  nonresident  aliens  (other  than  income  received  as  dividends  of  the 
class  allowed  as  a  credit  by  subdivision  (a)  of  section  21G)  shall  (except 
in  the  cases  provided  for  in  subdivision  (b)  and  except  as  otherwise  pro- 
vided in  regulations  prescribed  by  the  Commissioner  under  section  217) 
deduct  and  withhold  from  such  annual  or  periodical  gains,  profits,  and  in- 
come a  tax  equal  to  8  per  centum  thereof:  Provided,  That  the  Commissioner 
may  authorize  such  tax  to  be  deducted  and  withheld  from  the  interest 
upon  any  securities  the  owners  of  which  arc  not  known  to  the  withholding 

agent. 

(b)  In  any  case  where  bonds,  mortgages,  or  deeds  of  trust,  or  other  sim- 
ilar obligations  of  a  corporation  contain  a  contract  or  provision  by  which 
the  obligor  agrees  to  pay  any  portion  of  the  tax  imposed  by  this  title  upon 
the  obligee,  or  to  reimburse  the  obligee  for  any  portion  of  the  tax,  or  to 


1356  APPENDIX 

pay  the  interest  without  deduction  for  any  tax  which  the  obligor  may  be 
required  or  permitted  to  pay  thereon,  or  to  retain  therefrom  under  any  law 
of  the  United  States,  the  obligor  shall  deduct  and  withhold  a  tax  equal  to 
2  per  centum  of  the  interest  upon  such  bonds,  mortgages,  deeds  of  trust, 
or  other  obligations,  whether  such  interest  is  payable  annually  or  at  shorter 
or  longer  periods  and  whether  payable  to  a  nonresident  alien  individual  or 
to  an  individual  citizen  or  resident  of  the  United  States  or  to  a  partnership: 
Provided,  That  the  Commissioner  may  authorize  such  tax  to  be  deducted 
and  withheld  in  the  case  of  interest  upon  any  such  bonds,  mortgages,  deeds 
of  trust,  or  other  obligations,  the  owners  of  which  are  not  known  to  the 
withholding  agent.  Such  deduction  and  withholding  shall  not  be  required 
in  the  case  of  a  citizen  or  resident  entitled  to  receive  such  interest,  if  he 
files  with  the  withholding  agent  on  or  before  February  1  a  signed  notice 
in  writing  claiming  the  benefit  of  the  credits  provided  in  subdivisions  (c) 
and  (d)  of  section  216;  nor  in  the  case  of  a  nonresident  alien  individual 
if  so  provided  for  in  regulations  prescribed  by  the  Commissioner  under 
subdivision  (g)  of  section  217. 

(c)  Every  individual,  corporation,  or  partnership  required  to  deduct  and 
withhold  any  tax  under  this  section  shall  make  return  thereof  on  or  before 
March  1  of  each  year  and  shall  on  or  before  June  15  pay  the  tax  to  the 
official  of  the  United  States  government  authorized  to  receive  it.  Every 
such  individual,  corporation,  or  partnership  is  hereby  made  liable  for  such 
tax  and  is  hereby  indemnified  against  the  claims  and  demands  of  any  in- 
dividual, corporation,  or  partnership  for  the  amount  of  any  payments  made 
in  accordance  with  the  provisions  of  this  section. 

(d)  Income  upon  which  any  tax  is  required  to  be  withheld  at  the  source 
under  this  section  shall  be  included  in  the  return  of  the  recipient  of  such 
income,  but  any  amount  of  tax  so  withheld  shall  be  credited  against  the 
amount  of  income  tax  as  computed  in  such  return. 

(e)  If  any  tax  required  under  this  section  to  be  deducted  and  withheld 
is  paid  by  the  recipient  of  the  income,  it  shall  not  be  re-collected  from  the 
withholding  agent;  nor  in  the  cases  in  which  the  tax  is  so  paid  shall  any 
penalty  be  imposed  upon  or  collected  from  the  recipient  of  the  income  or 
the  withholding  agent  for  failure  to  return  or  pay  the  same,  unless  such 
failure"  was  fraudulent  and  for  the  purpose  of  evading  payment. 

CREDIT  FOR  TAXES  IN  CASE  OF  INDIVIDUALS 

Sec.  222.  (a)  That  the  tax  computed  under  Part  II  of  this  title  shall 
be  credited  with: 

(1)  In  the  case  of  a  citizen  of  the  United  States  the  amount  of  any  in- 
come, war-profits  and  excess-profits  taxes  paid  during  the  taxable  year  to 
any  foreign  country  or  to  any  possession  of  the  United  States;  and 

(2)  In  the  case  of  a  resident  of  the  United  States,  the  amount  of  any 
such  taxes  paid  during  the  taxable  year  to  any  possession  of  the  United 
States;  and 

(3)  In  the  case  of  an  alien  resident  of  the  United  States,  the  amount  of 
any  such  taxes  paid  during  the  taxable  year  to  any  foreign  country,  if  the 
foreign  country  of  which  such  alien  resident  is  a  citizen  or  subject,  in  im- 
posing such  taxes,  allows  a  similar  credit  to  citizens  of  the  United  States 
residing  in  such  country;  and 

(4)  In  the  case  of  any  such  individual  who  is  a  member  of  a  partnership 
or  a  beneficiary  of  an  estate  or  trust,  his  proportionate  share  of  such  taxes 


REVENUE    ACT    OF    1921  1357 

of  the  partnership  or  the  estate  or  trust  paid  during  the  taxable  year  to  a 
foreign   country    or   to   any    possession    of   the    United    States,   as    the   case 

may  be.  ,    , 

(5)  The  above  credits  shall  not  be  allowed  in  the  case  of  a  citizen  entitled 
to  the  benefits  of  section  262;  and  in  no  other  case  shall  the  amount  of  credit 
taken  under  this  subdivision  exceed  the  same  proportion  of  the  tax,  against 
which  such  credit  is  taken,  which  the  taxpayer's  net  income  (computed 
without  deduction  for  any  income,  war-profits  and  excess-profits  taxes  im- 
posed by  any  foreign  country  or  possession  of  the  United  States)  from 
sources  without  the  United  States  bears  to  his  entire  net  income  (computed 
without  such  deduction)   for  the  same  taxable  year. 

(b)  If  accrued  taxes  when  paid  differ  from  the  amounts  claimed  as 
credits  by  the  taxpayer,  or  if  any  tax  paid  is  refunded  in  whole  or  in  part, 
the  taxpayer  shall  notify  the  Commissioner,  who  shall  redetermine  the 
amount  of  the  tax  due  under  Part  II  of  this  title  for  the  year  or  years 
affected,  and  the  amount  of  tax  due  upon  such  redetermination,  if  any,  shall 
be  paid  by  the  taxpayer  upon  notice  and  demand  by  the  Collector,  or  the 
amount  of  tax  overpaid,  if  any,  shall  be  credited  or  refunded  to  the  taxpayer 
in  accordance  with  the  provisions  of  section  2.52.  In  the  case  of  such  a  tax 
accrued  but  not  paid,  the  Commissioner  as  a  condition  precedent  to  the 
allowance  of  this  credit  may  require  the  taxpayer  to  give  a  bond  with  sure- 
ties satisfactory  to  and  to  be  approved  by  the  Commissioner  in  such  penal 
sum  as  the  Commissioner  may  require,  conditioned  for  the  payment  by  the 
taxpayer  of  any  amount  of  tax  found  due  upon  any  such  redetermination; 
and  the  bond  herein  prescribed  shall  contain  such  further  conditions  as  the 
Commissioner  may  require. 

(c)  These  credits  shall  be  allowed  only  if  the  taxpayer  furnishes  evidence 
satisfactory  to  the  Commissioner  showing  the  amount  of  income  derived 
from  sources  without  the  United  States,  and  all  other  information  neces- 
sary for  the  verification  and  computation  of  such  credits. 

(d)  If  the  taxpayer  makes  a  return  for  a  fiscal  year  beginning  in  1920 
and  ending  in  1921,  the  credit  for  the  entire  fiscal  year  shall,  notwithstand- 
ing any  provision  of  this  Act,  be  determined  under  the  provisions  of  this 
section;  and  the  Commissioner  is  authorized  to  disallow,  in  whole  or  part, 
any  such  credit  which  he  finds  has  already  been  taken  by  the  taxpayer. 

INDIVIDUAL    RETURNS 

Sec.  223.  (a)  That  the  following  individuals  shall  each  make  under  oath 
a  return  stating  specifically  the  items  of  his  gross  income  and  the  deductions 
and  credits  allowed  under  this  title — 

(1)  Every  individual  having  a  net  income  for  the  taxable  year  of  $1,000 
or  over,  if  single,  or  if  married  and  not  living  with  husband  or  wife; 

(2)  Every  individual  having  a  net  income  for  the  taxable  year  of  $2,000 
or  over,  if  married  and  living  with  husband  or  wfe;  and 

(3)  Every  individual  having  a  gross  income  for  the  taxable  year  of  $5,000 
or  over,  regardless  of  the  amount  of  his  net  income. 

(b)  if  a  husband  and  wife  living  together  have  an  aggregate  net  income 
for  the  taxable  year  of  $2,000  or  over,  or  an  aggregate  gross  income  for  such 
year  of  $5,000  or  over— 

(1)  Each  shall  make  such  a  return,  or 

(2)  The  income  of  each  shall  be  included  in  a  single  joint  return,  in 
which  case  the  tax  shall  be  computed  on  the  aggregate  income. 


y 


1358  APPENDIX 

(c)  If  the  taxpayer  is  unable  to  make  his  own  return,  the  return  shall 
be  made  by  a  duly  authorized  agent  or  by  the  guardian  or  other  person 
charged  with  the  care  of  the  person  or  property  of  such  taxpayer. 

PARTNERSHIP  RETURNS 

Sec.  224.  That  every  partnership  shall  make  a  return  for  each  taxable 
year,  stating  specifically  the  items  of  its  gross  income  and  the  deductions 
allowed  by  this  title,  and  shall  include  in  the  return  the  names  and  addresses 
of  the  individuals  who  would  be  entitled  to  share  in  the  net  income  if  dis- 
tributed and  the  amount  of  the  distributive  share  of  each  individual.  The 
return  shall  be  sworn  to  by  any  one  of  the  partners. 

FIDUCIARY    RETURNS 

Sec.  225.  (a)  That  every  fiduciary  (except  a  receiver  appointed  by 
authority  of  law  in  possession  of  part  only  of  the  property  of  an  individual) 
shall  make  under  oath  a  return  for  any  of  the  following  individuals,  estates, 
or  trusts  for  which  he  acts,  stating  specifically  the  items  of  gross  income 
thereof  and  the  deductions  and  credits  allowed  under  this  title — 

(1)  Every  individual  having  a  net  income  for  the  taxable  year  of  $1,000 
or  over,  if  single,  or  if  married  and  not  living  with  husband  or  wife; 

(2)  Every  individual  having  a  net  income  for  the  taxable  year  of  $2,000 
or  over,  if  married  and  living  with  husband  or  wife; 

(3)  Every  individual  having  a  gross  income  for  the  taxable  year  of  $5,000 
or  over,  regardless  of  the  amount  of  his  net  income; 

(4)  Every  estate  or  trust  the  net  income  of  which  for  the  taxable  year 
is  $1,000  or  over;  and 

(5)  Every  estate  or  trust  of  which  any  beneficiary  is  a  nonresident  alien, 
(b)  Under  such  regulations  as  the  Commissioner  with  the  approval  of  the 

Secretary  may  prescribe  a  return  made  by  one  of  two  or  more  joint 
fiduciaries  and  filed  in  the  office  of  the  collector  of  the  district  where  such 
fiduciary  resides  shall  be  sufficient  compliance  with  the  above  requirement. 
Such  fiduciary  shall  make  oath  (1)  that  he  has  sufficient  knowledge  of  the 
affairs  of  the  individual,  estate  or  trust  for  which  the  return  is  made,  to 
enable  him  to  make  the  return,  and  (2)  that  the  return  is,  to  the  best  of  his 
knowledge  and  belief,  true  and  correct.  Any  fiduciary  required  to  make  a 
return  under  this  Act  shall  be  subject  to  all  the  provisions  of  this  Act  which 
apply  to  individuals. 

RETURNS    FOR    A    PERIOD    OP    LESS    THAN    TWELVE    MONTHS 

Sec.  226.  (a)  That  if  a  taxpayer,  with  the  approval  of  the  Commissioner, 
changes  the  basis  of  computing  net  income  from  fiscal  year  to  calendar  year 
a  separate  return  shall  be  made  for  the  period  between  the  close  of  the 
last  fiscal  year  for  which  return  was  made  and  the  following  December  31. 
If  the  change  is  from  calendar  year  to  fiscal  year,  a  separate  return  shall 
be  made  for  the  period  between  the  close  of  the  last  calendar  year  for  which 
return  was  made  and  the  date  designated  as  the  close  of  the  fiscal  year. 
If  the  change  is  from  one  fiscal  year  to  another  fiscal  year  a  separate  re- 
turn shall  be  made  for  the  period  between  the  close  of  the  former  fiscal  year 
and  the  date  designated  as  the  close  of  the  new  fiscal  year. 

(b)  In  all  cases  where  a  separate  return  is  made  for  a  part  of  a  taxable 
year  the  net  income  shall  be  computed  on  the  basis  of  such  period  for 
which  separate  return  is  made,  and  the  tax  shall  be  paid  thereon  at  the  rate 
for  the  calendar  year  in  which  such  period  is  included. 


REVENUE    ACT    OF    1921  1359 

(c)  In  the  case  of  a  return  for  a  period  of  less  than  one  year  the  net 
income  shall  be  placed  on  an  annual  basis  by  multiplying  the  amount  thereof 
by  twelve  and  dividing  by  the  number  of  months  included  in  such  period; 
and  the  tax  shall  be  such  part  of  a  tax  computed  on  such  annual  basis  as 
the  number  of  months  in  such  period  is  of  twelve  months. 

TIME    AND    PLACE    FOR    FILING    INDIVIDUAL,    PARTNERSHIP,    AND 
FIDUCIARY    RETURNS 

Sec.  227.  (a)  That  returns  (except  in  the  case  of  nonresident  aliens) 
shall  be  made  on  or  before  the  fifteenth  day  of  the  third  month  following 
the  close  of  the  fiscal  year,  or,  if  the  return  is  made  on  the  basis  of  the 
calendar  year,  then  the  return  shall  be  made  on  or  before  the  15th  day 
of  March.  In  the  case  of  a  nonresident  alien  individual  returns  shall  be 
made  on  or  before  the  fifteenth  day  of  the  sixth  month  following  the  close 
of  the  fiscal  year,  or,  if  the  return  is  made  on  the  basis  of  the  calendar  year, 
then  the  return  shall  be  made  on  or  before  the  15th  day  of  June.  The  Com- 
missioner may  grant  a  reasonable  extension  of  time  for  filing  returns  when- 
ever in  his  judgment  good  cause  exists  and  shall  keep  a  record  of  every 
such  extension  and  the  reason  therefor.  Except  in  the  case  of  taxpayers 
who  are  abroad,  no  such  extension  shall  be  for  more  than  six  months. 

(b)  Returns  shall  be  made  to  the  collector  for  the  district  in  which  is 
located  the  legal  residence  or  principal  place  of  business  of  the  person 
making  the  return,  or,  if  he  has  no  legal  residence  or  principal  place  of 
business  in  the  United  States,  then  to  the  collector  at  Baltimore,  Maryland. 

UNDERSTATEMENT    IN     RETURNS 

Sec.  228.  That  if  the  collector  or  deputy  collector  has  reason  to  believe 
that  the  amount  of  any  income  returned  is  understated,  he  shall  give  due 
notice  to  the  taxpayer  making  the  return  to  show  cause  why  the  amount  of 
the  return  should  not  be  increased,  and  upon  proof  of  the  amount  under- 
stated, may  increase  the  same  accordingly.  Such  taxpayer  may  furnish 
sworn  testimony  to  prove  any  relevant  facts  and  if  dissatisfied  with  the 
decision  of  the  collector  may  appeal  to  the  Commissioner  for  his  decision, 
under  such  rules  of  procedure  as  may  be  prescribed  by  the  Commissioner 
with  the  approval  of  the  Secretary. 

INCORPORATION    OF    INDIVIDUAL    OR    PARTNERSHIP    BUSINESS 

Sec.  229.  That  in  the  case  of  the  organization  as  a  corporation  within 
four  months  after  the  passage  of  this  act  of  any  trade  or  business  in  which 
capital  is  a  material  income-producing  factor,  and  which  was  previously 
owned  by  a  partnership  or  individual,  the  net  income  of  such  trade  or 
business  from  January  1,  1921,  to  the  date  of  such  organization  may  at  the 
option  of  the  individual  or  partnership  be  taxed  as  the  net  income  of  a  cor- 
poration is  taxed  under  Titles  II  and  III;  in  which  event  the  net  income  and 
invested  capital  of  such  trade  or  business  shall  be  computed  as  if  such 
corporation  had  been  in  existence  on  and  after  January  1,  1921,  and  the 
undistributed  profits  or  earnings  of  such  trade  or  business  shall  not  be  sub- 
ject to  the  surtaxes  imposed  in  section  211,  but  amounts  distributed  on  and 
after  January  1,  1921,  from  the  earnings  or  profits  of  such  trade  or  business 
accumulated  after  December  31.  1920.  shall  be  taxed  to  the  recipients  as 
diviilends;  and  all  the  provisions  of  Titles  II  and  III  relating  to  corpora- 
tions shall  so  far  as  practicable  apply  to  such  trade  or  business:  Provided, 
That  this  section  shall  not  apply  to  any  trade  or  business,  the  net  income 


1360  APPENDIX 

of  which  for  the  taxable  year  1921  was  less  than  20  per  centum  of  its 
invested  capital  for  such  year:  Provided  further,  That  any  taxpayer  who 
takes  advantage  of  this  section  shall  pay  the  tax  imposed  by  section  1000 
of  the  Revenue  Act  of  1918  as  if  such  taxpayer  had  been  a  corporation  on 
and  after  January  1,  1921. 

Part  III. — Corporations 

TAX  ON   CORPORATIONS 

Sec.  230.  That,  in  lieu  of  the  tax  imposed  by  section  230  of  the  Revenue 
Act  of  1918,  there  shall  be  levied,  collected,  and  paid  for  each  taxable  year 
upon  the  net  income  of  every  corporation  a  tax  at  the  following  rates: 

(a)  For  the  calendar  year  1921,  10  per  centum  of  the  amount  of  the  net 
income  in  excess  of  the  credits  provided  in  section  236 ;   and 

(b)  For  each  calendar  year  thereafter,  12a  per  centum  of  such  excess 
amount. 

CONDITIONAL  AND  OTHER  EXEMPTIONS   OF   CORPORATIONS 

Sec.  231.  That  the  following  organizations  shall  be  exempt  from  taxation 
under  this  title — 

(1)  Labor,  agricultural,  or  horticultural   organizations; 

(2)  Mutual  savings  banks  not  having  a  capital  stock  represented  by 
shares; 

(3)  Fraternal  beneficiary  societies,  orders  or  associations,  (a)  operating 
under  the  lodge  system  or  for  the  exclusive  benefit  of  the  members  of  a 
fraternity  itself  operating  under  the  lodge  system;  and  (b)  providing  for 
the  payment  of  life,  sick,  accident,  or  other  benefits  to  the  members  of  such 
society,  order,  or  association  or  their  dependents; 

(4)  Domestic  building  and  loan  associations  substantially  all  the  business 
of  which  is  confined  to  making  loans  to  members;  and  co-operative  banks 
without  capital  stock  organized  and  operated  for  mutual  purposes  and 
without  profit; 

(5)  Cemetery  companies  owned  and  operated  exclusively  for  the  benefit 
of  their  members  or  which  are  not  operated  for  profit;  and  any  corpora- 
tion chartered  solely  for  burial  purposes  as  a  cemetery  corporation  and 
not  permitted  by  its  charter  to  engage  in  any  business  not  necessarily  in- 
cident to  that  purpose,  no  part  of  the  net  earnings  of  which  inures  to  the 
benefit  of  any  private  stockholder  or  individual; 

(6)  Corporations,  and  any  community  chest,  fund,  or  foundation,  or- 
ganized and  operated  exclusively  for  religious,  charitable,  scientific,  liter- 
ary, or  educational  purposes,  or  for  the  prevention  of  cruelty  to  children 
or  animals,  no  part  of  the  net  earnings  of  which  inures  to  the  benefit  of  any 
private  stockholder  or  individual; 

(7)  Business  leagues,  chambers  of  commerce,  or  boards  of  trade,  not  or- 
ganized for  profit  and  no  part  of  the  net  earnings  of  which  inures  to  the 
benefit  of  any  private  stockholder  or  individual; 

(8)  Civic  leagues  or  organizations  not  organized  for  profit  but  operated 
exclusively  for  the  promotion  of  social  welfare; 

(9)  Clubs  organized  and  operated  exclusively  for  pleasure,  recreation, 
and  other  nonprofitable  purposes,  no  part  of  the  net  earnings  of  which 
inures  to  the  benefit  of  any  private  stockholder  or  member; 

(10)  Farmers'  or  other  mutual  hail,  cyclone,  or  fire  insurance  companies, 
mutual  ditch  or  irrigation  companies,  mutual  or  co-operative  telephone  com- 


REVENUE    ACT    OF    1921  1361 

panies,  or  like  organizations  of  a  purely  local  character,  the  income  of 
which  consists  solely  of  assessments,  dues,  and  fees  collected  from  members 
for  the  sole  purpose  of  meeting  expenses; 

(11)  Farmers',  fruit  growers',  or  like  associations,  organized  and  operated 
as  sales  agents  for  the  purpose  of  marketing  the  products  of  members 
and  turning  back  to  them  the  proceeds  of  sales,  less  the  necessary  selling 
expenses,  on  the  basis  of  the  quantity  of  produce  furnished  by  them;  or 
organized  and  operated  as  purchasing  agents  for  the  purpose  of  purchasing 
supplies  and  equipment  for  the  use  of  members  and  turning  over  such 
supplies  and  equipment  to  such  members  at  actual  cost,  plus  necessary  ex- 
penses; 

(12)  Corporations  organized  for  the  exclusive  purpose  of  holding  title 
to  property,  collecting  income  therefrom,  and  turning  over  the  entire 
amount  thereof,  less  expenses,  to  an  organization  which  itself  is  exempt 
from  the  tax  imposed  by  this  title; 

(13)  Federal  land  banks  and  national  farm-loan  associations  as  pro- 
vided in  section  2(>  of  the  Act  approved  July  17,  1916,  entitled  "An  Act  to 
provide  capital  for  agricultural  development,  to  create  standard  forms  of 
investment  based  upon  farm  mortgage,  to  equalize  rates  of  interest  upon 
farm  loans,  to  furnish  a  market  for  United  States  bonds,  to  create  gov- 
ernment depositaries  and  financial  agents  for  the  United  States,  and  for 
other  purposes"; 

(14)  Personal  service  corporations.  This  subdivision  shall  not  be  in 
effect  after  December  31,  1921. 

NET    INCU.ME   OF   CORPORATIONS   DEFINED 

Sec.  232.  That  in  the  case  of  a  corporation  subject  to  the  tax  imposed 
by  section  230  the  term  "net  income"  means  the  gross  income  as  de- 
fined in  section  233  less  the  deductions  allowed  by  section  234,  and  the  net 
income  shall  be  computed  on  the  same  basis  as  is  provided  in  subdivision 
(b)  of  section  212  or  in  section  22(5.  In  the  case  of  a  foreign  corporation 
or  of  a  corporation  entitled  to  the  benefits  of  section  262  the  computation 
shall  also  be  made  in  the  manner  provided  in  section  217. 

GROSS    INCO.ME   OF   CORPORATIO.NS    DEFINED 

Sec.  233.  (a)  That  in  the  case  of  a  corporation  subject  to  the  tax  im- 
posed by  section  230  the  term  "gross  income"  means  the  gross  income  as  de- 
fined in  sections  213  and  217,  except  that  mutual  marine  insurance  com- 
panies shall  include  in  gross  income  the  gross  premiums  collected  and  re- 
ceived by  them  less  amounts   paid    for   reinsurance. 

(b)  In  the  case  of  a  foreign  corporation,  gross  income  means  only  gross 
mcome  from  sources  within  the  United  States,  determined  (except  in  the 
case  of  insurance  companies  subject  to  the  tax  imposed  by  sections  243  or 
246)    in  the  manner  provided  in  section  217. 

DEDICTIONS    ALLOWED    CORPORATIONS 

Sec.  234.  (a)  That  in  computing  the  net  income  of  a  corporation  subject 
to  the  tax   imposed   by  section   230   there   shall   be   allowed   as   deductions: 

(1)  All  the  ordinary  and  necessary  expenses  paid  or  incurred  during  the 
taxable  year  in  carrying  on  any  trade  or  business,  including  a  reasonable 
allowance  for  salaries  or  other  compensation  for  personal  services  actually 
rendered,   and    including   rentals   or   other   payments   required   to  be   made 


1362  APPENDIX 

as  a  condition  to  the  continued  use  or  possession  of  property  to  which 
the  corporation  has  not  taken  or  is  not  taking  title,  or  in  which  it  has  no 
equity ; 

(2)  All  interest  paid  or  accrued  within  the  taxable  year  on  its  indebted- 
ness, except  on  indebtedness  incurred  or  continued  to  purchase  or  carry 
obligations  or  securities  (other  than  obligations  of  the  United  States  issued 
after  September  24,  1917,  and  originally  subscribed  for  by  the  taxpayer) 
the  interest  upon  which  is  wholly  exempt  from  taxation  under  this  title; 

(3)  Taxes  paid  or  accrued  within  the  taxable  year  except  (a)  income,  war- 
profits,  and  excess-profits  taxes  imposed  by  the  authority  of  the  United 
States,  (b)  so  much  of  the  income,  war-profits  and  excess-profits  taxes  im- 
posed by  the  authority  of  any  foreign  country  or  possession  of  the  United 
States  as  is  allowed  as  a  credit  under  section  238,  and  (c)  taxes  assessed 
against  local  benefits  of  a  kind  tending  to  increase  the  value  of  the  prop- 
erty assessed.  In  the  case  of  obligors  specified  in  subdivision  (b)  of  sec- 
tion 221  no  deduction  for  the  payment  of  the  tax  imposed  by  this  title,  or 
any  other  tax  paid  pursuant  to  the  contract  or  provision  referred  to  in  that 
subdivision,  shall  be  allowed  nor  shall  such  tax  be  included  in  the  gross 
income  of  the  obligee.  The  deduction  allowed  by  this  paragraph  shall  be 
allowed  in  the  case  of  taxes  imposed  upon  a  shareholder  or  member  of  a 
corporation  upon  his  interest  as  shareholder  or  member,  which  are  paid  by 
the  corporation  without  reimbursement  from  the  shareholder  or  member,  but 
in  such  cases  no  deduction  shall  be  allowed  the  shareholder  or  member  for 
the  amount  of  such  taxes.  For  the  purpose  of  this  paragraph,  estate,  in- 
heritance, legacy,  and  succession  taxes  accrue  on  the  due  date  thereof  ex- 
cept as  otherwise  provided  by  the  law  of  the  jurisdiction  imposing  such 
taxes ; 

(4)  Losses  sustained  during  the  taxable  year  and  not  compensated  for 
by  insurance  or  otherwise;  unless,  in  order  to  clearly  reflect  the  income, 
the  loss  should  in  the  opinion  of  the  Commissioner  be  accounted  for  as  of 
a  diff"erent  period.  No  deduction  shall  be  allowed  for  any  loss  claimed  to 
have  been  sustained  in  any  sale  or  other  disposition  of  shares  of  stock  or 
securities  made  after  the  passage  of  this  Act  where  it  appears  that  within 
thirty  days  before  or  after  the  date  of  such  sale  or  other  disposition  the 
taxpayer  has  acquired  (otherwise  than  by  bequest  or  inheritance)  substan- 
tially identical  property,  and  the  property  so  acquired  is  held  by  the  tax- 
payer for  any  period  after  such  sale  or  other  disposition,  unless  such  claim 
is  made  by  a  dealer  in  stock  or  securities  and  with  respect  to  a  transac- 
tion made  in  the  ordinary  course  of  its  business.  If  such  acquisition  is 
to  the  extent  of  part  only  of  substantially  identical  property,  then  only  a 
proportionate  part  of  the  loss  shall  be  disallowed.  In  case  of  losses  arising 
from  destruction  of  or  damage  to  property,  where  the  property  so  destroyed 
or  damaged  was  acquired  before  March  1,  1913,  the  deduction  shall  be  com- 
puted upon  the  basis  of  its  fair  market  price  or  value  as  of  March  1,  1913; 

(5)  Debts  ascertained  to  be  worthless  and  charged  off  within  the  taxable 
year  (or  in  the  discretion  of  the  Commissioner,  a  reasonable  addition  to  a 
reserve  for  bad  debts)  ;  and  when  satisfied  that  a  debt  is  recoverable  only 
in  part,  the  Commissioner  may  allow  such  debt  to  be  charged  off  in  part; 

(6)  The  amount  received  as  dividends  (A)  from  a  domestic  corporation 
other  than  a  corporation  entitled  to  the  benefits  of  section  262,  or  (B)  from 
any  foreign  corporation  when  it  is  shovra  to  the  satisfaction  of  the  Com- 
missioner that  more  than  50  per  centum  of  the  gross  income  of  such  for- 
eign corporation  for  the  three-year  period  ending  with  the  close  of  its  tax- 


REVENUE    ACT    OF    1921  1363 

able  year  preceding  the  declaration  of  such  dividends  (or  for  such  part  of 
such  period  as  the  foreign  corporation  has  been  in  existence)  was  derived 
from  sources   within   the    United   States   as  determined   under  section   217; 

(7)  A  reasonable  allowance  for  the  exhaustion,  wear  and  tear  of  prop- 
erty used  in  the  trade  or  business,  including  a  reasonable  allowance  for 
obsolescence.  In  the  case  of  such  property  acquired  before  March  1,  1913, 
this  deduction  shall  be  computed  upon  the  basis  of  its  fair  market  price 
or  value  as  of  March  1,  1913; 

(8)  In  the  case  of  buildings,  machinery,  equipment,  or  other  facilities, 
constructed,  erected,  installed,  or  acquired,  on  or  after  April  ti,  1917,  for  the 
production  of  articles  contributing  to  the  prosecution  of  the  war  against 
the  German  government,  and  in  the  case  of  vessels  constructed  or  ac- 
quired on  or  after  such  date  for  the  transportation  of  articles  or  men  con- 
tributing to  the  prosecution  of  such  war,  there  shall  be  allowed,  for  any 
taxable  year  ending  before  March  3,  1924  (if  claim  therefor  was  made^at 
the  time  of  filing  return  for  the  _taxable_year  1918,  1919,  1920,. or  Jil2i)_a_ 
reasonable  deduction  for  the  amortization  of  such  part  of  the  cost  of  such 
facilities  or  vessels  as  has  been  borne  by  the  taxpayer,  but  not  again  in- 
cluding any  amount  otherwise  allowed  under  this  title  or  previous  Acts  of 
Con^'ress  as  a  deduction  in  computing  net  income.  At  any  time  before 
March  3,  1924,  the  Commissioner  may,  and  at  the  request  of  the  taxpayer 
shall  re-examine  the  return,  and  if  he  then  finds  as  a  result  of  an  appraisal 
or  from  other  evidence  that  the  deduction  originally  allowed  was  incorrect, 
the  income,  war-profits,  and  excess-profits  taxes  for  the  year  or  years 
affected  shall  be  redetermined  and  the  amount  of  tax  due  upon  such  re- 
determination, if  any,  shall  be  paid  upon  notice  and  demand  by  the  collector, 
or  the  amount  of  tax  overpaid,  if  any,  shall  be  credited  or  refunded  to  the 
taxpayer  in  accordance  with  the  provisions  of  section  252; 

(9)  In  the  case  of  mines,  oil  and  gas  wells,  other  natural  deposits,  and 
timber,  a  reasonable  allowance  for  depletion  and  for  depreciation  of  im- 
provements, according  to  the  peculiar  conditions  in  each  case,  based  upon 
cost  including  cost  of  development  not  otherwise  deducted:  Provided,  That 
in  the  case  of  such  properties  acquired  prior  to  March  1,  1913,  the  fair  mar- 
ket value  of  the  property  (or  the  taxpayer's  interest  therein)  on  that  date 
shall  be  taken  in  lieu  of  cost  up  to  that  date:  Protnded  further.  That  in  the 
case  of  mines,  oil  and  gas  wells,  discovered  by  the  taxpayer,  on  or  after 
March  1,  1913,  and  not  acquired  as  the  result  of  purchase  of  a  proven  tract 
or  lease,  where  the  fair  market  value  of  the  property  is  materially  dispropor- 
tionate to  the  cost,  the  depletion  allowance  shall  be  based  upon  the  fair  mar- 
ket value  of  the  property  at  the  date  of  the  discovery,  or  within  thirty  days 
thereafter:  And  provided  further.  That  such  depletion  allowance  based 
on  discovery  value  shall  not  exceed  the  net  income,  computed  without  al- 
lowance for  depletion,  from  the  property  upon  which  the  discovery  is  made, 
except  where  such  net  income  so  computed  is  less  than  the  depletion  allow- 
ance based  on  cost  or  fair  market  value  as  of  March  1,  1913;  such  reason- 
able allowance  in  all  the  above  cases  to  be  made  under  rules  and  regula- 
tions to  be  prescribed  by  the  Commissioner  with  the  approval  of  the 
Secretary.  In  the  case  of  leases  the  deductions  allowed  by  this  paragraph 
shall  be  equitably  apportioned  between  the  lessor  and  lessee; 

(10)  In  case  of  insurance  companies  (other  than  life  insurance  com- 
panies), in  addition  to  the  above  (unless  otherwise  allowed):  (A)  The 
net  addition  required  by  law  to  be  made  within  the  taxable  year  to  re- 
serve funds   (including  in  the  case  of  assessment  insurance  companies  the 


^y 


1364  APPENDIX 

actual  deposit  of  sums  with  state  or  territorial  officers  pursuant  to  law  as 
additions  to  guarantee  or  reserve  funds)  ;  and  (B)  the  sums  other  than 
dividends  paid  within  the  taxable  year  on  policy  and  annuity  contracts. 
After  December  31,  1921,  this  subdivision  shall  apply  only  to  mutual  in- 
surance companies  other  than  life  insurance  companies; 

(11)  In  the  case  of  corporations  (except  those  taxed  under  section  243) 
issuing  policies  covering  life,  health,  and  accident  insurance  combined  in 
one  policy  issued  on  the  weekly  premium  payment  plan  continuing  for  life 
and  not  subject  to  cancellation,  in  addition  to  the  above,  such  portion  of  the 
net  addition  (not  required  by  law)  made  within  the  taxable  year  to  re- 
serve funds  as  the  Commissioner  finds  to  be  required  for  the  protection 
of  the  holders  of  such  policies  only.  This  subdivision  shall  not  be  in  effect 
after  December  31,  1921; 

(12)  In  the  case  of  mutual  marine  insurance  companies,  there  shall  be 
allowed,  in  addition  to  the  deductions  allowed  in  paragraphs  (1)  to  (10), 
inclusive,  and  paragraph  (14),  unless  otherwise  allowed,  amounts  repaid 
to  policyholders  on  account  of  premiums  previously  paid  by  them,  and  in- 
terest paid  upon  such  amounts  between  the  ascertainment  and  the  pay- 
ment thereof; 

(13)  In  the  case  of  mutual  insurance  companies  (including  interinsurers 
and  reciprocal  underwriters,  but  not  including  mutual  life  or  mutual 
marine  insurance  companies)  requiring  their  members  to  make  premium 
deposits  to  provide  for  losses  and  expenses,  there  shall  be  allowed,  in  addi- 
tion to  the  deductions  allowed  in  paragraphs  (1)  to  (10),  inclusive,  and 
paragraph  (14),  unless  otherwise  allowed,  the  amount  of  premium  de- 
posits returned  to  their  policyholders  and  the  amount  of  premium  deposits 
retained  for  the  payment  of  losses,  expenses,  and  reinsurance  reserves; 

(14)  If  property  is  compulsorily  or  involuntarily  converted  into  cash  or 
its  equivalent  as  a  result  of  (A)  its  destruction  in  whole  or  in  part,  (B) 
theft  or  seizure,  or  (C)  an  exercise  of  the  power  of  requisition  or  con- 
demnation, or  the  threat  or  imminence  thereof;  and  if  the  taxpayer  proceeds 
forthwith  in  good  faith,  under  regulations  prescribed  by  the  Commissioner 
with  the  approval  of  the  Secretary,  to  expend  the  proceeds  of  such  conver- 
sion in  the  acquisition  of  other  property  of  a  character  similar  or  related  in 
service  or  use  to  the  property  so  converted,  or  in  the  acquisition  of  80  per 
centum  or  more  of  the  stock  or  shares  of  a  corporation  owning  such  other 
property,  or  in  the  establishment  of  a  replacement  fund,  then  there  shall  be 
allowed  as  a  deduction  such  portion  of  the  gain  derived  as  the  portion  of 
the  proceeds  so  expended  bears  to  the  entire  proceeds.  The  provisions  of 
this  paragraph  prescribing  the  conditions  under  which  a  deduction  may  be 
taken  in  respect  of  the  proceeds  or  gains  derived  from  the  compulsory  or 
involuntary  conversion  of  property  into  cash  or  its  equivalent,  shall  apply 
so  far  as  may  be  practicable  to  the  exemption  or  exclusion  of  such  proceeds 
or  gains  from  gross  income  under  prior  income,  war-profits  and  excess- 
profits  tax  Acts. 

(b)  In  the  case  of  a  foreign  corporation  or  of  a  corporation  entitled  to  the 
benefits  of  section  262  the  deductions  allowed  in  subdivision  (a)  shall  be 
allowed  only  if  and  to  the  extent  that  they  are  connected  with  income  from 
sources  within  the  United  States;  and  the  proper  apportionment  and  alloca- 
tion of  the  deductions  with  respect  to  sources  within  and  without  the  United 
States  shall  be  determined  as  provided  in  section  217  under  rules  and  regula- 
tions prescribed  by  the  Commissioner  with  the  approval  of  the  Secretary. 


REVENUE    ACT    OF    1921  1365 


ITEMS  NOT   DKDUCTIBLK  BY   CORPORATIDNS 

Sec.  235.  That  in  computing  net  income  no  deduction  shall  in  any  case 
be  allowed  in  respect  of  any  of  the  items  specified  in  section  215. 

CREDITS    AU^)WEI)    CORPORATIONS 

Sec.  236.  That  for  the  purpose  only  of  the  ta.x  imposed  by  section  230 
there  shall  be  allowed  the  following  credits: 

(a)  The  amount  received  as  interest  upon  obligations  of  the  United 
States  and  bonds  issued  by  the  War  P^inance  Corporation,  which  is  in- 
cluded in  iiross  income  under  section  233; 

(b)  In  the  case  of  a  domestic  corporation  the  net  income  of  which  is 
$25,000  or  less,  a  specific  credit  of  $2,000;  but  if  the  net  income  is  more  than 
$25,000  the  tax  imposed  by  section  230  shall  not  exceed  the  tax  which 
would  be  payable  if  the  $2,000  credit  were  allowed,  plus  the  amoUnt  of  the 
net  income  in  excess  of  $25,000;  and 

(c)  The  amount  of  any  war-profits  and  excess-profits  taxes  iniposed  by 
Act  of  Congress  for  the  same  taxable  year.  The  credit  allowed  by  this 
subdivision  shall  be  determined  as  follows: 

(1)  In  the  case  of  a  corporation  which  makes  return  for  a  fiscal  year 
beginning  in  1920  and  ending  in  1921,  in  computing  the  income  tax  as  pro- 
vided in  subdivision  (a)  of  section  205,  the  portion  of  the  war-profits  and 
excess-profits  tax  computed  for  the  entire  period  under  clause  (1)  of  sub- 
division (a)  of  section  335  shall  be  credited  against  the  net  income  computed 
for  the  entire  period  as  provided  in  clause  (1)  of  subdivision  (a)  of  section 
205,  and  the  portion  of  the  war-profits  and  excess-profits  tax  computed  for 
the  entire  period  under  clause  (2)  of  subdivision  (a)  of  section  335  shall  be 
credited  against  the  net  income  computed  for  the  entire  period  as  provided 
in  clause    (2)    of  subdivision    (a)    of  section  205. 

(2)  In  the  case  of  a  corporation  which  makes  return  for  a  fiscal  year 
beginning  in  1921  and  ending  in  1922,  in  computing  the  income  tax  as  pro- 
vided in  subdivi.^ion  (b)  of  section  205,  the  war-profits  and  excess-profits 
tax  computed  under  subdivision  (b)  of  section  335  shall  be  credited  against 
the  net  income  computed  for  the  entire  period  as  provided  in  clause  (1)  of 
subdivision  (b)  of  section  205. 

PAYMENT   OF    CORPORATION    INtOME   TAX    AT   SOURCE 

Sec.  237.  That  in  the  case  of  foreign  corporations  subject  to  taxation 
under  this  title  not  engaged  in  trade  or  business  within  the  United  States 
and  not  having  any  office  or  place  of  business  therein,  there  shall  be  de- 
ducted and  withheld  at  the  source  in  the  same  manner  and  upon  the  same 
items  of  income  as  is  provided  in  section  221  a  tax  equal  to  12>.  per  centum 
thereof  (but  during  the  calendar  year  1921  only  10  per  centum),  and  such 
tax  shall  be  returned  and  paid  in  the  same  manner  and  subject  to  the  same 
conditions  as  provided  in  that  section:  Provided,  That  in  the  case  of  interest 
described  in  subdivision  (b)  of  that  section  the  deduction  and  withholding 
shall  be  at  the  rate  of  2  per  centum. 

CREDIT  FOR  TAXES  IN  CASE  OF  CORPORATIONS 

Sec.  238.  (a)  That  in  the  case  of  a  domestic  corporation  the  tax  imposed 
by  this  title,  plus  the  war-profits  and  excess-profits  taxes,  if  any,  shall  be 
credited  with  the  amount  of  any  income,  war-profits,  and  excess-profits 
taxes  paid  during  the  same  taxable  year  to  any  foreign  country,  or  to  ar.v 


1366  APPENDIX 

possession  of  the  United  States :  P^-ovided,  That  the  amount  of  credit  taken 
under  this  subdivision  shall  in  no  case  exceed  the  same  proportion  of  the 
taxes,  against  which  such  credit  it  taken,  which  the  taxpayer's  net  income 
(computed  without  deduction  for  any  income,  war-profits,  and  excess-profits 
taxes  imposed  by  any  foreign  country  or  possession  of  the  United  States) 
from  sources  without  the  United  States  bears  to  its  entire  net  income  (com- 
puted without  such  deduction)  for  the  same  taxable  year.  In  the  case  of 
domestic  insurance  companies  subject  to  the  tax  imposed  by  section  243 
or  246,  the  term  "net  income,"  as  used  in  this  subdivision  means  net  income 
as  defined  in  sections  245  and  246,  respectively. 

(b)  If  accrued  taxes  when  paid  differ  from  the  amounts  claimed  as  credits 
by  the  corporation,  or  if  any  tax  paid  is  refunded  in  whole  or  in  part,  the 
corporation  shall  at  once  notify  the  Commissioner,  who  shall  redetermine  the 
amount  of  the  income,  war-profits  and  excess-profits  taxes  for  the  year  or 
years  aflTected,  and  the  amount  of  taxes  due  upon  such  redetermination, 
if  any,  shall  be  paid  by  the  corporation  upon  notice  and  demand  by  the  col- 
lector, or  the  amount  of  taxes  overpaid,  if  any,  shall  be  credited  or  re- 
funded to  the  corporation  in  accordance  with  the  provisions  of  section  252. 
In  the  case  of  such  a  tax  accrued  but  not  paid,  the  Commissioner  as  a  condi- 
tion precedent  to  the  allowance  of  this  credit  may  require  the  corporation  to 
give  a  bond  with  sureties  satisfactory  to  and  to  be  approved  by  him  in  such 
penal  sum  as  he  may  require,  conditioned  for  the  payment  by  the  tax- 
payer of  any  amount  of  taxes  found  due  upon  any  such  redetermination; 
and  the  bond  herein  prescribed  shall  contain  such  further  conditions  as  the 
Commissioner  may  require. 

(c)  These  credits  shall  be  allowed  only  if  the  taxpayer  furnishes  evidence 
satisfactory  to  the  Commissioner  showing  the  amount  of  income  derived 
from  sources  without  the  United  States,  and  all  other  information  neces- 
sary for  the  verification  and  computation  of  such  credit. 

(d)  If  a  domestic  corporation  makes  a  return  for  a  fiscal  year  begin- 
ning in  1920  and  ending  in  1921,  the  credit  for  the  entire  fiscal  year  shall, 
notwithstanding  any  provision  of  this  Act,  be  determined  under  the  pro- 
visions of  this  section;  and  the  Commissioner  is  authorized  to  disallow,  in 
whole  or  in  part,  any  such  credit  which  he  finds  has  already  been  taken 
by  the  taxpayer. 

(e)  For  the  purposes  of  this  section  a  domestic  corporation  which  owns 
a  majority  of  the  voting  stock  of  a  foreign  corporation  from  which  it  re- 
ceives dividends  (not  deductible  under  section  234)  in  any  taxable  year  shall 
be  deemed  to  have  paid  the  same  proportion  of  any  income,  war-profits,  or 
excess-profits  taxes  paid  by  such  foreign  corporation  to  any  foreign  country 
or  to  any  possession  of  the  United  States,  upon  or  with  respect  to  the  ac- 
cumulated profits  of  such  foreign  corporation  from  which  such  dividends 
were  paid,  which  the  amount  of  such  dividends  bears  to  the  amount  of  such 
accumulated  profits:  Provided,  That  the  credit  allowed  to  any  domestic 
corporation  under  this  subdivision  shall  in  no  case  exceed  the  same  pro- 
portion of  the  taxes  against  which  it  is  credited,  which  the  amount  of 
such  dividends  bears  to  the  amount  of  the  entire  net  income  of  the  domestic 
corporation  in  which  such  dividends  are  included.  The  term  "accumulated 
profits"  when  used  in  this  subdivision  in  reference  to  a  foreign  corporation, 
means  the  amount  of  its  gains,  profits,  or  income  in  excess  of  the  income, 
war-profits,  and  excess-profits  taxes  imposed  upon  or  with  respect  to  such 
profits  or  income;  and  the  Commissioner  with  the  approval  of  the  Secretary 
shall  have  full  power  to  determine  from  the  accumulated  profits  of  what 


REVENUE    ACT    OF    1921  1367 

year  or  years  such  dividends  were  paid;  treating  dividends  paid  in  the  first 
sixty  days  of  any  year  as  having  been  paid  from  the  accumulated  profits 
of  the  preceding  year  or  years  (unless  to  his  satisfaction  shown  otherwise), 
and  in  other  respects  treating  dividends  as  having  been  paid  from  the  most 
recently  accumulated  gains,  profits,  or  earnings.  In  the  case  of  a  foreign 
corporation,  the  income,  war-profits,  and  excess-profits  taxes  of  which  are 
determined  on  the  basis  of  an  accounting  period  of  less  than  one  year,  the 
word  "year"  as  used  in  this  subdivision  shall  be  construed  to  mean  such 
accounting  period. 

(f)  F'or  the  purposes  of  this  section  a  corporation  entitled  to  the  benefits 
of  section  202  shall  be  treated  as  a  foreign  corporation. 

CORPORATION   RETURNS 

Sec.  239.  (a)  That  every  corporation  subject  to  taxation  under  this  title 
and  every  personal  service  corporation  shall  make  a  return,  stating  specifi- 
cally the  items  of  its  gross  income  and  the  deductions  and  credits  allowed 
by  this  title.  The  return  shall  be  sworn  to  by  the  president,  vice  president, 
or  other  principal  officer  and  by  the  treasurer  or  assistant  treasurer.  If  any 
foreign  corporation  has  no  office  or  place  of  business  in  the  United  States 
but  has  an  agent  in  the  United  States,  the  return  shall  be  made  by  the  agent. 
In  cases  where  receivers,  trustees  in  bankruptcy,  or  assignees  are  operating 
the  property  or  business  of  corporations,  such  receivers,  trustees,  or 
assignees  shall  make  returns  for  such  corporations  in  the  same  manner  and 
form  as  corporations  are  required  to  make  returns.  Any  tax  due  on  the 
basis  of  such  returns  made  by  receivers,  trustees,  or  assignees  shall  be  col- 
lected in  the  same  manner  as  if  collected  from  the  corporations  of  whose 
business  or  property  they  have  custody  and  control. 

(b)  Returns  made  under  this  section  shall  be  subject  to  the  provisions 
of  sections  226  and  228.  When  return  is  made  under  section  226  the  credit 
provided  in  subdivision  (b)  of  section  236  shall  be  reduced  to  an  amount 
which  bears  the  same  ratio  to  the  full  credit  therein  provided  as  the  number 
of  months  in  the  period  for  which  such  return  is  made  bears  to  twelve 
months. 

(c)  There  shall  be  included  in  the  return  or  appended  thereto  a  state- 
ment of  such  facts  as  will  enable  the  Commissioner  to  determine  the  por- 
tion of  the  earnings  or  profits  of  the  corporation  (including  gains,  profits 
and  income  not  taxed)  accumulated  during  the  taxable  year  for  which  the 
return  is  made,  which  have  been  distributed  or  ordered  to  be  distributed,  re- 
spectively, to  its  stockholders  or  members  during  such  year. 

CONSOLIDATED   RETURNS  OF  CORPORATIONS 

Sec.  240.  (a)  That  corporations  which  are  affiliated  within  the  meaning 
of  this  section  may,  for  any  taxable  year  beginning  on  or  after  January  1, 
1922,  make  separate  returns  or,  under  regulations  prescribed  by  the  Com- 
missioner with  the  approval  of  the  Secretary,  make  a  consolidated  return 
of  net  income  for  the  purpose  of  this  title,  in  which  case  the  taxes  there- 
under shall  be  computed  and  deteimined  upon  the  basis  of  such  return.  If 
return  is  made  on  either  of  such  bases,  all  returns  thereafter  made  shall  be 
upon  the  same  basis  unless  permission  to  change  the  basis  is  granted  by  the 
Commissioner. 

(b)  In  any  case  in  which  a  tax  is  assessed  upon  the  basis  of  a  con- 
solidated return,  the  total  tax  shall  be  computed  in  the  first  instance  as  a 
unit  and  shall  then  be  assessed  upon  the  respective  affiliated  corporations  in 


1368  APPENDIX 

such  proportions  as  may  be  agreed  upon  among  them,  or,  in  the  absence  of 
any  such  agreement,  then  on  the  basis  of  the  net  income  properly  assign- 
able to  each.  There  shall  be  allowed  in  computing  the  income  tax  only  one 
specific  credit  computed  as  provided  in  subdivision  (b)  of  section  236. 

(c)  For  the  purpose  of  this  section  two  or  more  domestic  corporations 
shall  be  deemed  to  be  affiliated  (1)  if  one  corporation  owns  directly  or  con- 
trols through  closely  affiliated  interests  or  by  a  nominee  or  nominees  sub- 
stantially all  of  the  stock  of  the  other  or  others,  or  (2)  if  substantially  all 
of  the  stock  of  two  or  more  corporations  is  owned  or  controlled  by  the  same 
interests. 

(d)  For  the  purposes  of  this  section  a  corporation  entitled  to  the  benefits 
of  section  262  shall  be  treated  as  a  foreign  corporation:  Provided,  That  in 
any  case  of  two  or  more  related  trades  or  businesses  (whether  unincor- 
porated or  incorporated  and  whether  organized  in  the  United  States  or  not) 
owned  or  controlled  directly  or  indirectly  by  the  same  interests  the  Com- 
missioner may  consolidate  the  accounts  of  such  related  trades  and  businesses, 
in  any  proper  case,  for  the  purpose  of  making  an  accurate  distribution  or 
apportionment  of  gains,  profits,  income,  deductions,  or  capital  between  or 
among  such  related  trades  or  businesses. 

(e)  Corporations  which  are  affiliated  within  the  meaning  of  this  section 
shall  make  consolidated  returns  for  any  taxable  year  beginning  prior  to 
January  1,  1922,  in  the  same  manner  and  subject  to  the  same  conditions  as 
provided  by  the  Revenue  Act  of  1918. 

TIME  AND  PLACE  FOR  FILING  CORPORATE  RETURNS 

Sec.  241.  (a)  That  returns  of  corporations  shall  be  made  at  the  same 
time  as  is  provided  in  subdivision  (a)  of  section  227,  except  that  in  the  case 
of  foreign  corporations  not  having  any  oflfice  or  place  of  business  in  the 
United  States  returns  shall  be  made  at  the  same  time  as  provided  in  section 
227  in  the  case  of  a  nonresident  alien  individual. 

(b)  Returns  shall  be  made  to  the  collector  of  the  district  in  which  is 
located  the  principal  place  of  business  or  principal  office  or  agency  of  the 
corporation,  or,  if  it  has  no  principal  place  of  business  or  principal  office  or 
agency  in  the  United  States,  then  to  the  collector  at  Baltimore,  Maryland. 

TAXES   ON    INSURANCE   COMPANIES 

Sec.  242.  That  when  used  in  this  title  the  term  "life  insurance  com- 
pany" means  an  insurance  company  engaged  in  the  business  of  issuing  life 
insurance  and  annuity  contracts  (including  contracts  of  combined  life,  health, 
and  accident  insurance),  the  reserve  funds  of  which  held  for  the  fulfillment 
of  such  contracts  comprise  more  than  50  per  centum  of  its  total  reserve 
funds. 

Sec.  243.  That  in  lieu  of  the  taxes  imposed  by  sections  230  and  1000  and 
by  Title  III,  there  shall  be  levied,  collected,  and  paid  for  the  calendar  year 
1921  and  for  each  taxable  year  thereafter  upon  the  net  income  of  every  life 
insurance  company  a  tax  as  follows : 

(1)  In  the  case  of  a  domestic  life  insurance  company,  the  same  per- 
centage of  its  net  income  as  is  imposed  upon  other  corporations  by  section 
230; 

(2)  In  the  case  of  a  foreign  life  insurance  company,  the  same  percentage 
of  its  net  income  from  sources  within  the  United  States  as  is  imposed  upon 
the  net  income  of  other  corporations  by  section  230. 


REVENUE    ACT    OF    1921  1369 


Sec    '44      (a,    That  in  the  case  of  a  life  insurance  ^.'^l'^';;'  ''[',^',^7. 
"gvoss  rncon,e''  means  the  gross  amount  of  income  rece,ve.l  ,lu„ng  .he  tax 

"''rbrTL'Te™"r::;rfunr%:u?re7h;-  ,»»■•  incudes,  in  the  case  of 

asi^L?:t  fn™.  ance.  sums  -^^f-^:::^x'Z'r^zr::'^ 
:-trrLr;rnrt':;:e=^^^^^ 

-^:rul  ^;r,   TtarintfcLe  ora°rin::;a„ce  compan.  the  term 

""%'■,  a"  amount  equal  to  the  excess,  if  any.  over  the  deduction  specified 
in  oaratraph  (1)  ot  this  subdivision,  of  4  per  centum  of  the  mean  of  he 
in  paidgrapn   \^.,   yj>-  beuinnine:  and   end  of  the 

rem  anv  oreign  corporation  when  it  is  shown  to  the  satisfaction  of  the 
CoLl"  ioner  that  n.ore  than  50  per  centum  of  the  .ross  -om-f  uch 
foreign  corporation  for  the  three-year  period  ending  with  the  c»os«  «*  ^^^ 
taxable  year  preceding  the  declaration  of  such  dividends  (or  for  such  part 
of  su  h  pei'od  as  the  foreign  corporation  has  been  in  existence,  was  de- 
;[ved  from  sources  within  the  United  States  as  determined  under  section 

^^^(4)  An  amount  equal  to  2  per  centum  of  any  sums  held  at  the  end  of  the 
taxable  veai  as  a  reserve  for  dividends  (other  than  dividends  payable  during 
the  yeai  following  the  taxable  year)   the  payment  of  which  is  deferred  fo 
a  pe'rod  of  not  L  than  five  years  from  the  date  of  the  PoUcy  contrac 

(5)  Investment  expenses  paid  during  the  taxable  year:  Prorided,  That  if 
ant  UeraHLpenses  are  in  part  assigned  to  or  included  in  the  investment 
expen  es  the  total  deduction  under  this  paragraph  shall  not  exceed  one- 
fourth  of  1  per  centum  of  the  book  value  of  the  mean  of  the  invested  assets 
held  at  the  beginning  and  end  of  the  taxable  year; 

6)  Taxes  and  other  expenses  paid  during  the  taxable  year  exclusivdy 
upon  or  with  respect  to  the  real  estate  owned  by  the  company,  not  nclud ing 
taxes  assessed  against  local  benefits  of  a  kind  tending  to  increase  the  value 
7theTroptrty  assessed,  and  not  including  any  amount  paid  out  for  new 
bui  dings  or  for  permanent  improvements  or  betterments  made  to  increase 
the  value  of  any  property.  The  deduction  allowed  by  this  paragraph  shal 
be  alfowed  n  the  case  of  taxes  imposed  upon  a  shareholder  or  member  of 
a  company  upon  his  interest  as  shareholder  or  member,  which  are  paid  by 


1370  APPENDIX 

the  company  without  reimbursement  from  the  shareholder  or  member,  but 
in  such  cases  no  deduction  shall  be  allowed  the  shareholder  or  member  for 
the  amount  of  such  taxes; 

(7)  A  reasonable  allowance  for  the  exhaustion,  wear  and  tear  of  prop- 
erty, including  a  reasonable  allowance  for  obsolescence.  In  the  case  of  prop- 
erty acquired  before  March  1,  1913,  this  deduction  shall  be  computed  upon 
the  basis  of  its  fair  market  price  or  value  as  of  March  1,  1913; 

(8)  All  interest  paid  or  accrued  within  the  taxable  year  on  its  indebted- 
ness, except  on  indebtedness  incurred  or  continued  to  purchase  or  carry 
obligations  or  securities  (other  than  obligations  of  the  United  States  issued 
after  September  24,  1917,  and  originally  subscribed  for  by  the  taxpayer) 
the  interest  upon  which  is  wholly  exempt  from  taxation  under  this  title; 

(9)  In  the  case  of  a  domestic  life  insurance  company,  the  net  income  of 
which  (computed  without  the  benefit  of  this  paragraph)  is  $25,000  or  less, 
the  sum  of  $2,000;  but  if  the  net  income  is  more  than  $25,000  the  tax  im- 
posed by  section  243  shall  not  exceed  the  tax  which  would  be  payable  if  the 
$2,000  credit  were  allowed,  plus  the  amount  of  the  net  income  in  excess  of 
$25,000. 

(b)  No  deduction  shall  be  made  under  paragraphs  (6)  and  (7)  of  sub- 
division (a)  on  account  of  any  real  estate  owned  and  occupied  in  whole  or 
in  part  by  a  life  insurance  company  unless  there  is  included  in  the  return 
of  gross  income  the  rental  value  of  the  space  so  occupied.  Such  rental 
value  shall  be  not  less  than  a  sum  which  in  addition  to  any  rents  received 
from  other  tenants  shall  provide  a  net  income  (after  deducting  taxes,  de- 
preciation, and  all  other  expenses)  at  the  rate  of  4  per  centum  per  annum 
of  the  book  value  at  the  end  of  the  taxable  year  of  the  real  estate  so  owned 
or  occupied. 

(c)  In  the  case  of  a  foreign  life  insurance  company  the  amount  of  its  net 
income  for  any  taxable  year  from  sources  within  the  United  States  shall  be 
the  same  proportion  of  its  net  income  for  the  taxable  year  from  sources 
within  and  without  the  United  States,  which  the  reserve  funds  required  by 
law  and  held  by  it  at  the  end  of  the  taxable  year  upon  business  transacted 
within  the  United  States  is  of  the  reserve  funds  held  by  it  at  the  end  of 
the  taxable  year  upon  all  business  transacted. 

Sec.  246.  (a)  That,  in  lieu  of  the  taxes  imposed  by  sections  230  and  1000, 
there  shall  be  levied,  collected  and  paid  for  the  calendar  year  1922,  and  for 
each  taxable  year  thereafter,  upon  the  net  income  of  every  insurance  com- 
pany (other  than  a  life  or  mutual  insurance  company)  a  tax  as  follows: 

(1)  In  the  case  of  such  a  domestic  insurance  company  the  same  percentage 
of  its  net  income  as  is  imposed  upon  other  corporations  by  section  230; 

(2)  In  the  case  of  such  a  foreign  insurance  company  the  same  percentage 
of  its  net  income  from  sources  within  the  United  States  as  is  imposed  upon 
the  net  income  of  other  corporations  by  section  230. 

(b)  In  the  case  of  an  insurance  company  subject  to  the  tax  imposed  by 
this  section — 

(1)  The  term  "gross  income"  means  the.  combined  gross  amount  earned 
during  the  taxable  year,  from  investment  income  and  from  underwriting 
income  as  provided  in  this  subdivision,  computed  on  the  basis  of  the  under- 
writing and  investment  exhibit  of  the  annual  statement  approved  by  the 
National  Convention  of  Insurance  Commissioners; 

(2)  The  term  "net  income"  means  the  gross  income  as  defined  in  para- 
graph  (1)   of  this  subdivision  less  the  deductions  allowed  by  section  247; 


REVENUE    ACT'  OF    1921  1371 

(3)  The  term  "investment  income"  means  the  pross  amount  of  income 
earned  during  the  taxable  year  from  interest,  dividends  and  rents,  computed 
as  follows: 

To  all  interest,  dividends  and  rents  received  during  the  taxable  year, 
add  interest,  dividends  and  rents  due  and  accrued  at  the  end  of  the  taxable 
year,  and  deduct  all  interest,  dividends  and  rents  due  and  accrued  at  the 
end  of  the  preceding  taxable  year; 

(4)  The  term  "underwriting  income"  means  the  premiums  earned  on  in- 
surance contracts  during  the  taxable  year  less  losses  incurred  and  expenses 
incurred; 

(5)  The  term  "premiums  earned  on  insurance  contracts  during  the  tax- 
able year"  means  an  amount  computed  as  follows: 

From  the  amount  of  gross  premiums  written  on  insurance  contracts  dur- 
ing the  taxable  year,  deduct  return  premiums  and  premiums  paid  for  rein- 
surance. To  the  result  so  obtained  add  unearned  premiums  on  outstanding 
business  at  the  end  of  the  preceding  taxable  year  and  deduct  unearned  pre- 
miums on  outstanding  business  at  the  end  of  the  taxable  year; 

(6) The  term  "losses  incurred"  means  losses  incurred  during  the  taxable 
year  on  insurance  contracts,  computed  as  follows: 

To  losses  paid  during  the  taxable  year,  add  salvage  and  reinsurance  recov- 
erable outstanding  at  the  end  of  the  preceding  taxable  year,  and  deduct 
salvage  and  reinsurance  recoverable  outstanding  at  the  end  of  the  taxable 
year.  To  the  result  so  obtained  add  all  unpaid  losses  outstanding  at  the  end 
of  the  taxable  year  and  deduct  unpaid  losses  outstanding  at  the  end  of  the 
preceding  taxable  year; 

(7)  The  term  "expenses  incurred"  means  all  expenses  shown  on  the 
annual  statement  approved  by  the  National  Convention  of  Insurance  Com- 
missioners, and  shall  be  computed  as  follows: 

To  all  expenses  paid  during  the  taxable  year  add  expenses  unpaid  at  the 
end  of  the  taxable  year  and  deduct  expenses  unpaid  at  the  end  of  the  pre- 
ceding taxable  year.  For  the  purpose  of  computing  the  net  income  subject 
to  the  tax  imposed  by  this  section  there  shall  be  deducted  from  expenses 
incurred  as  defined  in  this  paragraph  all  expenses  incurred  which  are  not 
allowed  as  deductions  by  section  247. 

Sec.  247.  (a)  That  in  computing  the  net  income  of  an  insurance  company 
subject  to  the  tax  imposed  by  section  24(>  there  shall  be  allowed  as  deduc- 
tions: 

(1)  All  ordinary  and  necessary  expenses  incurred,  as  provided  in  par- 
agraph (1)  of  subdivision  (a)  of  section  234; 

(2)  All  interest  as  provided  in  paragraph  (2)  of  subdivision  (a)  of 
section  234 ; 

(3)  Taxes  as  provided  in  paragraph  (3)  of  subdivision  (a>  of  section  234; 

(4)  Losses  incurred ; 

(5)  Bad  debts  in  the  nature  of  agency  balances  and  bills  receivable 
ascertained  to  be  worthless  and  charged  off  within  the  taxable  year; 

(6)  The  amount  received  as  dividends  from  corporations  as  provided  in 
paragraph  (6)  of  subdivision  (a)  of  section  234; 

(7)  The  amount  of  interest  earned  during  the  taxable  year  which  under 
paragraph  (4)  of  subdivision  (b)  of  section  213  is  exempt  from  taxation 
under  this  title,  and  the  amount  of  interest  allowed  as  a  credit  under  sub- 
division  (a)  of  section  23(5; 

(8)  A  reasonable  allowance,  for  the  exhaustion,  wear  and  tear  of  prop- 
erty, as  provided  in  paragraph  (7)  of  subdivision  (a)  of  section  234; 


1372  APPENDIX 

(9)  In  the  case  of  such  a  domestic  insurance  company,  the  net  income 
of  which  (computed  without  the  benefit  of  this  paragraph)  is  $25,000  or 
less,  the  sum  of  $2,000;  but  if  the  net  income  is  more  than  $25,000  the  tax 
imposed  by  section  246  shall  not  exceed  the  tax  which  would  be  payable 
if  the  $2,000  credit  were  allowed,  plus  the  amount  of  the  net  income  in 
excess  of  $25,000. 

(b)  In  the  case  of  a  foreign  corporation  the  deductions  allowed  in  this 
section  shall  be  allowed  to  the  extent  provided  in  subdivision  (b)  of  sec- 
tion 234.  • 

(c)  Nothing  in  this  section  or  in  section  246  shall  be  construed  to  permit 
the  same  item  to  be  twice  deducted. 

Part  IV — Administrative  Provisions 

PAYMENT  OF  TAXES 

Sec.  250.  (a)  That  except  as  otherwise  provided  in  this  section  and 
sections  221  and  237  the  tax  shall  be  paid  in  four  installments,  each  con- 
sisting of  one-fourth  of  the  total  amount  of  the  tax.  The  first  installment 
shall  be  paid  at  the  time  fixed  by  law  for  filing  the  return,  and  the  second 
installment  shall  be  paid  on  the  fifteenth  day  of  the  third  month,  the  third 
installment  on  the  fifteenth  day  of  the  sixth  month,  and  the  fourth  install- 
ment on  the  fifteenth  day  of  the  ninth  month,  after  the  time  fixed  by  law 
for  filing  the  return.  Where  an  extension  of  time  for  filing  a  return  is 
granted  the  time  for  payment  of  the  first  installment  shall  be  postponed 
until  the  date  of  the  expiration  of  the  period  of  the  extension,  but  the  time 
for  payment  of  the  other  installments  shall  not  be  postponed  unless  the 
Commissioner  so  provides  in  granting  the  extension.  In  any  case  in  which 
the  time  for  the  payment  of  any  installment  is  at  the  request  of  the 
taxpayer  thus  postponed,  there  shall  be  added  as  a  part  of  such  installment 
interest  thereon  at  the  rate  of  one-half  of  1  per  centum  per  month  from 
the  time  it  would  have  been  due  if  no  extension  had  been  granted,  until 
paid.  If  any  installment  is  not  paid  when  due,  the  whole  amount  of  the 
tax  unpaid  shall  become  due  and  payable  upon  notice  and  demand  by  the 
collector. 

The  tax  may  at  the  option  of  the  taxpayer  be  paid  in  a  single  payment 
instead  of  installments,  in  which  case  the  total  amount  shall  be  paid  on 
or  before  the  time  fixed  by  law  for  filing  the  return,  or,  where  an  extension 
of  time  for  filing  the  return  has  been  granted,  on  or  before  the  expiration 
of  the  period  of  such  extension. 

(b)  As  soon  as  practicable  after  the  return  is  filed,  the  Commissioner 
shall  examine  it.  If  it  then  appears  that  the  correct  amount  of  the  tax  is 
greater  or  less  than  that  shown  in  the  return,  the  installments  shall  be 
recomputed.  If  the  amount  already  paid  exceeds  that  which  should  have 
been  paid  on  the  basis  of  the  installments  as  recomputed,  the  excess  so 
paid  shall  be  credited  against  the  subsequent  installments;  and  if  the 
amount  already  paid  exceeds  the  correct  amount  of  the  tax,  the  excess  shall 
be  credited  or  refunded  to  the  taxpayer  in  accordance  with  the  provisions 
of  section  252. 

If  the  amount  already  paid  is  less  than  that  which  should  have  been 
paid,  the  difference,  to  the  extent  not  covered  by  any  credits  due  to  the 
taxpayer  under  section  252  (hereinafter  called  "deficiency"),  together  with 
interest  thereon  at  the  rate  of  one-half  of  1  per  centum  per  month  from 
the  time  the  tax  was  due    (or,  if  paid   on  the   installment   basis,  on  the 


REVENUE    ACT    OF    1921  1373 

deficiency  of  each  installment  from  the  time  the  installment  was  due), 
shall  be  paid  upon  notice  and  demand  hy  the  collector.  If  any  part  of  the 
lieficiency  is  due  to  ne^rliprence  or  intentional  disregard  of  authorized  rules 
and  regulations  with  knowledge  thereof,  but  without  intent  to  defraud, 
there  shall  be  added  as  part  of  the  tax  5  per  centum  of  the  total  amount 
of  the  deficiency  in  the  tax,  and  interest  in  such  a  case  shall  be  collected  at 
the  rate  of  1  per  centum  per  month  on  the  amount  of  such  deficiency  in 
the  tax  from  the  time  it  was  due  (or,  if  paid  on  the  installment  basis,  on 
the  amount  of  the  deficiency  in  each  installment  from  the  time  the  install- 
ment was  due),  which  penalty  and  interest  shall  become  due  and  payable 
upon  notice  and  demand  by  the  collector.  If  any  part  of  the  deficiency  is 
due  to  fraud  with  intent  to  evade  tax.  then,  in  lieu  of  the  penalty  provided 
by  section  3176  of  the  Revised  Statutes,  as  amended,  for  false  or  fraud- 
ulent returns  wilfully  made,  but  in  addition  to  other  penalties  provided  by 
law  for  false  or  fraudulent  returns,  there  shall  be  added  as  part  of  the 
tax  50  per  centum  of  the  total  amount  of  the  deficiency  in  the  tax.  In 
such  case  the  whole  amount  of  the  tax  unpaid,  including  the  penalty  so 
added,  shall  become  due  and  payable  upon  notice  and  demand  by  the  col- 
lector. 

(c)  If  the  return  is  made  pursuant  to  section  3176  of  the  Revised 
Statutes  as  amended,  the  amount  of  tax  determined  to  b^?  due  under  such 
return  shall  be  paid  upon  notice  and  demand  by  the  collector. 

(d)  The  amount  of  income,  excess-profits,  or  war-profits  taxes  due  under 
any  return  made  under  this  Act  for  the  taxable  year  1921  or  succeeding 
taxable  years  shall  be  determined  and  assessed  by  the  Commissioner 
within  four  years  after  the  retui'n  was  filed,  and  the  amount  of  any  such 
taxes  due  under  any  return  made  under  this  Act  for  prior  taxable  years 
or  under  prior  income,  excess-profits,  or  war-profits  tax  Acts,  or  under 
section  38  of  the  Act  entitled  "An  Act  to  provide  revenue,  equalize  duties, 
and  encourage  the  industries  of  the  United  States,  and  for  other  pur- 
poses," approved  August  5,  1909,  shall  be  determined  and  assessed  within 
five  years  after  the  return  was  filed,  unless  both  the  Commissioner  and  the 
taxpayer  consent  in  writing  to  a  later  determination,  assessment,  and 
collection  of  the  tax;  and  no  suit  or  proceeding  for  the  collection  of  any 
such  taxes  due  under  this  Act  or  under  prior  income,  excess-profits,  or 
war-profits  tax  Acts,  or  of  any  taxes  due  under  section  38  of  such  Act  of 
August  5,  1909,  shall  be  begun,  after  the  expiration  of  five  yeai's  after 
the  date  when  such  return  was  filed,  but  this  shall  not  affect  suits  or  pro- 
ceedings begun  at  the  time  of  the  passage  of  this  Act:  Provided,  That  in 
the  case  of  income  received  during  the  lifetime  of  a  decedent,  all  taxes 
due  thereon  shall  be  determined  and  assessed  by  the  Commissioner  within 
one  year  after  written  request  therefor  by  the  executor,  administrator,  or 
other  fiduciary  representing  the  estate  of  such  decedent:  Provided  further. 
That  in  the  case  of  a  false  or  fraudulent  return  with  intent  to  evade  tax, 
or  of  a  failure  to  file  a  required  return,  the  amount  of  tax  due  may  be 
determined,  assessed,  and  collected,  and  a  suit  or  proceeding  for  the 
collection  of  such  amount  may  be  begun,  at  any  time  after  it  becomes 
due:  Provided  further,  That  in  cases  coming  within  the  scope  of  para- 
graph (9)  of  subdivision  (a)  of  section  214,  or  of  paragraph  (8)  of  sub- 
division (a)  of  section  234,  or  in  cases  of  final  settlement  of  losses  and 
other  deductions  tentatively  allowed  by  the  Commissioner  pending  a  de- 
termination of  the  exact  amount  deductible,  the  amount  of  tax  or  de- 
ficiency in  tax  due  may  be  determined,  assessed,  and  collected  at  any  time; 


1374  APPENDIX 

hut  prior  to  the  assessment  thereof  the  taxpayer  shall  be  notified  and  given 
a  period  of  not  less  than  thirty  days  in  which  to  file  an  appeal  and  be 
heard  as  hereinafter  provided  in  this  subdivision. 

If  upon  examination  of  a  return  made  under  the  Revenue  Act  of  1916, 
the  Revenue  Act  of  1917,  the  Revenue  Act  of  1918,  or  this  Act,  a  tax  or  a 
deficiency  in  tax  is  discovered,  the  taxpayer  shall  be  notified  thereof  and 
given  a  period  of  not  less  than  thirty  days  after  such  notice  is  sent  by 
registered  mail  in  w^hich  to  file  an  appeal  and  show  cause  or  reason  why 
the  tax  or  deficiency  should  not  be  paid.  Opportunity  for  hearing  shall 
be  granted  and  a  final  decision  thereon  shall  be  made  as  quickly  as  prac- 
ticable. Any  tax  or  deficiency  in  tax  then  determined  to  be  due  shall  be 
assessed  and  paid,  together  with  the  penalty  and  interest,  if  any,  applicable 
thereto,  within  ten  days  after  notice  and  demand  by  the  collector  as  here- 
inafter provided,  and  in  such  cases  no  claim  in  abatement  of  the  amount 
so  assessed  shall  be  entertained:  Provided,  That  in  cases  where  the 
Commissioner  believes  that  the  collection  of  the  amount  due  will  be 
jeopardized  by  such  delay  he  may  make  the  assessment  without  giving 
such  notice  or  awaiting  the  conclusion  of  such  hearing. 

(e)  If  any  tax  remains  unpaid  after  the  date  when  it  is  due,  and  for 
ten  days  after  notice  and  demand  by  the  collector,  then,  except  in  the 
case  of  estates  of  insane,  deceased,  or  insolvent  persons,  there  shall  be 
added  as  part  of  the  tax  the  sum  of  5  per  centum  on  the  amount  due  but 
unpaid,  plus  interest  at  the  rate  of  1  per  centum  per  month  upon  such 
amount  from  the  time  it  became  due :  Provided,  That  as  to  any  such 
amount  which  is  the  subject  of  a  bona  fide  claim  for  abatement  filed  within 
ten  days  after  notice  and  demand  by  the  collector,  where  the  taxpayer  has 
not  had  the  benefit  of  the  provisions  of  subdivision  (d),  such  sum  of  5  per 
centum  shall  not  be  added  and  the  interest  from  the  time  the  amount  was 
due  until  the  claim  is  decided  shall  be  at  the  rate  of  one-half  of  1  per 
centum  per  month  on  that  part  of  the  claim  rejected. 

In  the  case  of  the  first  installment  provided  for  in  subdivision  (a)  the 
instructions  printed  on  the  return  shall  be  sufficient  notice  of  the  date  when 
the  tax  is  due  and  sufficient  demand,  and  the  taxpayer's  computation  of  the 
tax  on  the  return  shall  be  suflRcient  notice  of  the  amount  due.  In  the  case 
of  each  subsequent  installment  the  collector  may,  within  thirty  days  and 
not  later  than  ten  days  before  the  installment  becomes  due,  mail  to  the 
taxpayer  notice  of  the  amount  of  the  installment  and  the  date  on  which 
it  is  due  for  payment.  Such  notice  of  the  collector  shall  be  sufficient  notice 
and  sufficient  demand  under  this  section. 

(f)  In  the  case  of  any  deficiency  (except  where  the  deficiency  is  due  to 
negligence  or  to  fraud  with  intent  to  evade  tax)  where  it  is  shown  to  the 
satisfaction  of  the  Commissioner  that  the  payment  of  such  deficiency 
would  result  in  undue  hardship  to  the  taxpayer,  the  Commissioner  may, 
with  the  approval  of  the  Secretary,  extend  the  time  for  the  payment  of 
such  deficiency  or  any  part  thereof  for  such  period  not  in  excess  of 
eighteen  months  from  the  passage  of  this  Act  as  the  Commissioner  may 
determine.  In  such  case  the  Commissioner  may  require  the  taxpayer  to 
furnish  a  bond  with  sufficient  sureties  conditioned  upon  the  payment  of 
the  deficiency  in  accordance  with  the  terms  of  the  extension  granted. 
There  shall  be  added  in  lieu  of  other  interest  provided  by  law,  as  a  part  of 
such  deficiency,  interest  thereon  at  the  rate  of  two-thirds  of  1  per  centum 
per  month  from  the  time  such  extension  is  granted;  except  where  such 
other  interest  provided  by  law  is  in  excess  of  interest  at  the  rate  of  two- 


REVENUE    ACT    OF    1921  1375 

thirds  of  1  PCT  centum  per  month.     If  the  deficiency  or  any  part  thereof  is 
o    paid  in    Hcurdance  lith  the  terms  of  the  extension  granted    there  shal 
b^add    1  «;  pa  t  of  the  deticiency.  in  lieu  of  other  interest  and  penalt.e 
p  ot-^ed  by  L.  the  sum  of  5  per  centum  of  the  ^ef-ncy   and  ,nt    e 
on  the  deficiency  at  the  rate  of  1  per  centum  per  '"""^h  fiom  the 
becomes  payable  in  accordance  with  the  terms  of  such  extens  on^ 

(e)   If  the  Commissioner  finds  that  a  taxpayer  designs  quickly  to  depar 
from  the  United  States  or  to  remove  his  property  therefrom,  or  to  conceal 
Iff  or  h-s  property  therein,  or  to  do  any  other  -ttenain^  to  Prejudice 
or  to  render  wholly  or  partly  ineffectual  proceedings  to  collect  the  tax  tor 
tL  taxable   year  then   last   past  or  the   Uxable   year  then   current   unless 
u  h  ;     c     d  ngs  be  brought'without  delay,  the  Commissioner  shall     eclare 
h      taxable    period    for   such    taxpayer   immediately    terminated    and    .hall 
cause  notice  of  such  finding  and  declaration  to  be  given  the  taxpayer,  to- 
gcther'ith  a  demand  for  immediate  payment  of  the  tax  for  the     axable 
neriod   To   declared   terminated   and   of   t^e   tax   for  the   preceding  taxable 
y  ar  or  so  n^ch  of  said  tax  as  is  unpaid,  whether  or  not  the  t>me  other^ 
Itl  aHowed  by  law  for  filing  return  and  paying  the  tax  has  expired;  and 
Zl  taxes  shall  thereupon  become  immediately  due  and  payable      In  any 
ac  ion  or  suit  brought  to  enforce  payment  of  taxes  made  due  and  payable 
Tv^rtue  of  the  provisions  of  this  subdivision  the  finding  of  the  Commis- 
sioner   made  a     herein   provided,   whether   made  after   notice   to  the  tax- 
payer or  not.  shall  be  for  all  purposes  presumptive  evidence  of  the  tax^ 
payer's  design.     A  taxpayer  who  is  not  in  default  in  making  any  re  urn 
or   pajing   fncome.   war-profits,    or   excess-profits    tax    under    any    Act    of 
Congre  s  may  furnish  to  the  United  States,  under  regulations  to  be  pre- 
scribed by  the  Commissioner  with  the  approval  of  the  Secretary    security 
approved  bv   the   Commissioner   that   he   will   duly   make   the   return   next 
hTafter  required  to  be  filed  and    pay  the   tax  next   thereafe^   required 
to  be  paid      The  Commissioner  may   approve  and   accept   in  like   manner 
ecu  ity    or  return  and  payment  of  taxes  made  due  and  payable  by  virtue 
of  the  provisions  of  this  subdivision,  provided  the  taxpayer  has  paid  in  full 
aU  other  incol.  war-profits,  or  excess-profits  taxes  due  from  him  under  any 
Act  of  Cong"    s.     If  security  is  approved   and  accepted  pursuant   to   the 
provisions   of   this    subdivision    and    such    further   or   other   security   with 
resp    t  to  the  tax  or  taxes  covered  thereby  is  given  as  the  Commission 
shall  from  time  to  time  find  necessary  and  require,  payment  of  such  taxes 
1m   not  be   enforced   by   any   proceedings   under   the    provisions    of   this 
Sdiv;::^^  r^f  r^e  e:;pira5;ic^  of  the  time  othenv^^l-d^  l^aying 
such  respective  taxes.     In  the  case  of  a  citizen  of  the  United  States  about 
o  Ipirt  from  the  United  States  the  Commissioner  may.  at  his  discretion, 
wah^  any  or  all  of  the  requirements  placed  on  the  taxpayer  by  this  sub 
Tvison      No   alien   shall   depart   from   the   United   States   unless   he   first 
slues  from  the  collector  or  agent  in  charge  a  certificate  that  he  has  com- 
nl  ed  witHll  the  obligations  imposed  upon  him  by  the  income,  war-profits, 
phed  with  all  the  om.g  .     taxpayer  violates  or  attempts  to  violate 

::;  luX^::'  h"  ^,  u'^lLol  l  an  other  penalties,  be  adcled  as 
trt  of  the'ax  2.  per  centum  of  the  total  amount  of  the  tax  or  deficiency 
In  the  tlx!  together  with  interest  at  the  rate  of  1  per  centum  per  month 
fmni  the  time  the  tax  became  due. 

(h,Th  provisions  of  sulxlivision.  (e).  (f)  and  (>r)  of  this  seCon  shall 
app';  to  the  assessment  and  collection  of  .a.es  which  ha-  -rue.l  ,n-  ,n  • 
al-m.e  under  the  Revenue  Act  of  1917,  the  Revenue  Act  of  11118  or  th,»  Act. 


\ 


^\|k 


1376  APPENDIX 

RECEIPTS  FOR  TAXES 

Sec.  251.  That  every  collector  to  whom  any  payment  of  any  tax  is 
made  under  the  provisions  of  this  title  shall  upon  request  'give  to  the 
person  making  such  payment  a  full  written  or  printed  receipt,  stating  the 
amount  paid  and  the  particular  account  for  which  such  payment  was 
made;  and  whenever  any  debtor  pays  taxes  on  account  of  payments  made 
or  to  be  made  by  him  to  separate  creditors  the  collector  shall,  if  requested 
by  such  debtor,  give  a  separate  receipt  for  the  tax  paid  on  account  of 
each  creditor  in  such  form  that  the  debtor  can  conveniently  produce  such 
receipts  separately  to  his  several  creditors  in  satisfaction  of  their  respec- 
tive demands  up  to  the  amounts  stated  in  the  receipts;  and  such  receipt 
shall  be  sufficient  evidence  in  favor  of  such  debtor  to  justify  him  in  with- 
holding from  his  next  payment  to  his  creditor  the  amount  therein  stated; 
but  the  creditor  may,  upon  giving  to  his  debtor  a  full  written  receipt 
acknowledging  the  payment  to  hiip  of  any  sum  actually  paid  and  accepting 
the  amount  of  tax  paid  as  aforesaid  (specifying  the  same)  as  a  further 
satisfaction  of  the  debt  to  that  amount,  require  the  surrender  to  him  of 
such  collector's  receipt. 

REFUNDS 

Sec.  252.  That  if,  upon  examination  of  any  return  of  income  made 
pursuant  to  this  Act,  the  Act  of  August  5,  1909,  entitled  "An  Act  to  provide 
revenue,  equalize  duties,  and  encourage  the  industries  of  the  United  States, 
and  for  other  purposes,"  the  Act  of  October  3,  1913,  entitled  "An  Act  to 
reduce  tariff  duties  and  to  provide  revenue  for  the  Government,  and  for 
other  purposes,"  the  Eevenue  Act  of  1916,  as  amended,  the  Revenue  Act 
of  1917,  or  the  Revenue  Act  of  1918,  it  appears  that  an  amount  of  income, 
war-profits  or  excess-profits  tax  has  been  paid  in  excess  of  that  properly 
due,  then,  notwithstanding  the  provisions  of  section  3228  of  the  Revised 
.  Statutes,  the  amoui^t  of  the  excess  shall  be  credited  against  any  income, 

V  war-profits  or  excess-profits  taxes,  or  installment  thereof,  then  due  from 

the  taxpayer  under  any  other  return,  and  any  balance  of  such  excess  shall 
be  immediately  refunded  to  the  taxpayer:  Provid'sd,  That  no  such  credit  or 
refund  shall  be  allowed  or  made  after  five  years  from  the  date  when  the 
return  was  due,  unless  before  the  expiration  of  such  five  years  a  claim 
therefor  is  filed  by  the  taxpayer:  Provided JtirtJier^hat  if  upon  elcamina- 
tion  of  any^etufh  of  income  made  pursuant  to  the  Revenue  Act  of  1917, 
the  Revenue  Act  of  1918,  or  this  Act,  the  invested  capital  of  a  taxpayer  is 
decreased  by  the  Commissioner,  and  such  decrease  is  due  to  the  fact  that 
the  taxpayer  failed  to  take  adequate  deductions  in  previous  years,  with 
the  result  that  an  amount  of  income  tax  in  excess  of  that  properly  due  was 
paid  in  any  previous  year  or  years,  then,  notwithstanding  any  other 
provision  of  law  and  regardless  of  the  expiration  of  such  five-year  period, 
the  amount  of  such  excess  shall,  without  the  filing  of  any  claim  therefor, 
be  credited  or  refunded  as  provided  in  this  section:  And  lyrovided  fiirther. 
That  nothing  in  this  section  shall  be  construed  to  bar  from  allowance 
claims  for  refund  filed  prior  to  the  passage  of  the  Revenue  Act  of  1918 
under  subdivision  (a)  of  section  14  of  the  Revenue  Act  of  1916,  or  filed 
prior  to  the  passage  of  this  Act  under  section  252  of  the  Revenue  Act 
of  1918. 


REVENUE    ACT    OF    1921  1377 


PENALTIES 

Sec.  253.  That  any  individual,  corporation,  or  partnership  required  under 
this  title  to  pay  or  collect  any  tax.  to  make  a  return  or  to  supply  informa- 
tion, who  fails  to  pay  or  collect  such  tax,  to  make  such  return,  or  to  supply 
such  information  at  the  time  or  times  required  under  this  title,  shall  be 
liable  to  a  penalty  of  not  more  than  $1,000.  Any  individual,  corporation,  or 
partnership,  or  any  officer  or  employee  of  any  corporation  or  member  or 
employee  of  a  partnership,  who  willfully  refuses  to  pay  or  collect  such 
tax,  to  make  such  return,  or  to  supply  such  information  at  the  time  or 
times  required  under  this  title,  or  who  willfully  attempts  in  any  manner 
to  defeat  or  evade  the  tax  imposed  by  this  title,  shall  be  guilty  of  a 
misdemeanor  and  shall  be  fined  not  more  than  $10,000  or  imprisoned  for 
not  more  than  one  year,  or  both,  together  with  the  costs  of  prosecution. 

RETURNS  OF  PAYMENTS  OF  DIVIDENDS 
Sec.  2.54.  That  every  corporation  subject  to  the  tax  imposed  by  this 
title  and  every  personal  service  corporation  shall,  when  required  by  the 
Commissioner,  render  a  correct  return,  duly  verified  under  oath,  of  its. 
payments  of  dividends,  stating  the  name  and  address  of  each  stockholder, 
the  number  of  shares  owned  by  him,  and  the  amount  of  dividends  paid 
to  him. 

RETURNS  OF  BROKERS 

Sec.  255.  That  every  individual,  corpoi-ation,  or  partnership  doing 
business  as  a  broker  shall,  when  required  by  the  Commissioner,  render 
a  correct  return  duly  verified  under  oath,  under  such  rules  and  regulations 
as  the  Commissioner,  with  the  approval  of  the  Secretary,  may  prescribe, 
showing  the  names  of  customers  for  whom  such  individual,  corporation,  or 
partnership  has  transacted  any  business,  with  such  details  as  to  the  profits, 
losses,  or  other  information  which  the  Commissioner  may  require,  as  to 
each  of  such  customers,  as  will  enable  the  Commissioner  to  determine 
whether  all  income  tax  due  on  profits  or  gains  of  such  customers  has 
been  paid. 

INFORMATION   AT  SOURCE 

Sec.  250.  That  all  individuals,  corporations,  and  partnerships,  in  what- 
ever capacity  acting,  including  lessees  or  mortgagors  of  real  or  personal 
property,  fiduciaries,  and  employers,  making  payment  to  another  individ- 
ual, corporation,  or  partnership,  of  interest,  rent,  salaries,  wages,  premiums, 
annuities,  compensations,  remunerations,  emoluments,  or  other  fixed  or 
determinable  gains,  profits,  and  income  (other  than  payments  described  in 
sections  2'A  and  255),  of  $1,000  or  more  in  any  taxable  year,  or,  in  the 
case  of  such  payments  made  by  the  United  States,  the  officers  or  employees 
of  the  United  States  having  information  as  to  such  payments  and  required 
to  make  returns  in  regard  thereto  by  the  regulations  hereinafter  provided 
for,  shall  render  a  true  and  accurate  return  to  the  Commissioner,  under 
such  regulations  and  in  such  form  and  manner  and  to  such  extent  as  may 
be  prescribed  by  him  with  the  approval  of  the  Secretary,  setting  forth 
the  amount  of  such  gains,  profits,  and  income,  and  the  name  and  address 
of  the  recipient  of  such  payment. 

Such  returns  may  be  required,  regardless  of  amounts.  (1)  in  the  case  of 
payments  of  interest  upon  bonds,  mortgages,  deeds  of  trust,  or  other 
similar  obligations   of  corporations,  and    (2)    in   the  case   of  collections  of 


1378  APPENDIX 

items  (not  payable  in  the  United  States)  of  interest  upon  the  bonds  of 
foreign  countries  and  interest  upon  the  bonds  of  and  dividends  from 
foreign  corporations  by  individuals,  corporations,  or  partnerships,  under- 
taking as  a  matter  of  business  or  for  profit  the  collection  of  foreign  pay- 
ments of  such  interest  or  dividends  by  means  of  coupons,  checks,  or  bills 
of  exchange. 

When  necessary  to  make  effective  the  provisions  of  this  section  the 
name  and  address  of  the  recipient  of  income  shall  be  furnished  upon 
demand  of  the  individual,  corporation,  or  partnership  paying  the  income. 

The  provisions  of  this  section  shall  apply  to  the  calendar  year  1921  and 
each  calendar  year  thereafter,  but  shall  not  apply  to  the  payment  of 
interest  on  obligations  of  the  United  States. 

RETURNS  TO  BE  PUBLIC  RECORDS 

Sec.  257.  That  returns  upon  which  the  tax  has  been  determined  by  the 
Commissioner  shall  constitute  public  records;  but  they  shall  be  open  to 
inspection  only  upon  order  of  the  President  and  under  rules  and  regula- 
tions prescribed  by  the  Secretary  and  approved  by  the  President:  Provided, 
That  the  proper  officers  of  any  state  imposing  an  income  tax  may,  upon 
the  request  of  the  governor  thereof,  have  access  to  the  returns  of  any 
corporation,  or  to  an  abstract  thereof  showing  the  name  and  income  of  the 
corporation,  at  such  times  and  in  such  manner  as  the  Secretary  may  pre- 
scribe: Provided  further,  That  all  bona  fide  stockholders  of  record  owning 
1  per  centum  or  more  of  the  outstanding  stock  of  any  corporation  shall, 
upon  making  request  of  the  Commissioner,  be  allowed  to  examine  the 
annual  income  returns  of  such  corporation  and  of  its  subsidiaries.  Any 
stockholder  who  pursuant  to  the  provisions  of  this  section  is  allowed  to 
examine  the  return  of  any  corporation,  and  who  makes  known  in  any  man- 
ner whatever  not  provided  by  law  the  amount  or  source  of  income,  profits, 
losses,  expenditures,  or  any  particular  thereof,  set  forth  or  disclosed  in 
any  such  return,  shall  be  guilty  of  a  misdemeanor  and  be  punished  by  a 
fine  not  exceeding  $1,000,  or  by  imprisonment  not  exceeding  one  year, 
or  both. 

The  Commissioner  shall  as  soon  as  practicable  in  each  year  cause  to  be 
prepared  and  made  available  to  public  inspection  in  such  manner  as  he 
may  determine,  in  the  office  of  the  collector  in  each  internal-revenue 
district  and  in  such  other  places  as  he  may  determine,  lists  containing  the 
names  and  the  post-office  addresses  of  all  individuals  making  income-tax 
returns  in  such  district. 

PUBLICATION    OF   STATISTICS 

Sec.  258.  That  the  Commissioner,  with  the  approval  of  the  Secretary, 
shall  prepare  and  publish  annually  statistics  reasonably  available  with 
respect  to  the  operation  of  the  income,  war-profits  and  excess-profits  tax 
laws,  including  classifications  of  taxpayers  and  of  income,  the  amounts 
allowed  as  deductions,  exemptions,  and  credits,  and  any  other  facts  deemed 
pertinent  and  valuable. 

COLLECTION   OF   FOREIGN   ITEMS 

Sec.  259.  That  all  individuals,  corporations,  or  partnerships  undertaking 
as  a  matter  of  business  or  for  profit  the  collection  of  foreign  payments 
of  interest  or  dividends  by  ineans  of  coupons,  checks,  or  bills  of  exchange 
shall  obtain  a  license  from  the  Commissioner  and  shall  be  subject  to  such 


REVENUE    ACT    OF    1921  1379 

regulations  enabling  the  Government  to  obtain  the  information  required 
under  this  title  as  the  Commissioner,  with  the  approval  of  the  Secretary, 
shall  prescribe;  and  whoever  knowingly  undertakes  to  collect  such  pay- 
ments without  having  obtained  a  license  therefor,  or  without  complying 
with  such  regulations,  shall  be  guilty  of  a  misdemeanor  and  shall  be  fined 
not  more  than  $5,000,  or  imprisoned  for  not  more  than  one  year,  or  both. 

CITIZENS   OF    POSSESSIONS   OK   THE   UNITED   STATES 

Sec.  260.  That  any  individual  who  is  a  citizen  of  any  possession  of 
the  United  States  (but  not  otherwise  a  citizen  of  the  United  States)  and 
who  is  not  a  resident  of  the  United  States,  shall  be  subject  to  taxation 
under  this  title  only  as  to  income  derived  from  sources  within  the  United 
States,  and  in  such  case  the  tax  shall  be  computed  and  paid  in  the  same 
manner  and  subject  to  the  same  conditions  as  in  the  case  of  other  persons 
who  are  taxable  only  as  to  income  derived  from  such  sources. 

Nothing  in  this  section  shall  be  construed  to  alter  or  amend  the  pro- 
visions of  the  Act  entitled  "An  Act  making  appropriations  for  the  naval 
service  for  the  fiscal  year  ending  June  30,  1922,  and  for  other  purposes." 
approved  July  12,  1921,  relating  to  the  imposition  of  income  taxes  in  the 
Virgin  Islands  of  the  United  States. 

PORTO  RICO   AND   PHILIPPINE   ISLANDS 

Sec.  201.  That  in  Porto  Rico  and  the  Philippine  Islands  the  income  tax 
shall  be  levied,  assessed,  collected,  and  paid  as  provided  by  law  prior  to 
the  passage  of  this  Act. 

The  Porto  Rican  or  Philippine  Legislature  shall  have  power  by  due  en- 
actment to  amend,  alter,  modify,  or  repeal  the  income  tax  laws  in  force  in 
Porto  Rico  or  the  Philippine  Islands,  respectively. 

INCOME   FROM    SOURCES   WITHIN    THE   POSSESSIONS   OF   THE   UNITED   STATES 

Sec.  262.  (a)  That  in  the  case  of  citizens  of  the  United  States  or  domestic 
corporations,  satisfying  the  following  conditions,  gross  income  means  only 
gross  income  from  sources  within  the  United  States— 

(1)  If  80  per  centum  or  more  of  the  gross  income  of  such  citizen  or  do- 
mestic corporation  (computed  without  the  benefit  of  this  section)  for  the 
three-year  period  immediately  preceding  the  close  of  the  taxable  year  (or 
for  such  part  of  such  period  immediately  preceding  the  close  of  such  tax- 
able year  as  may  be  applicable)  was  derived  from  sources  within  a  pos- 
session of  the  United  States;  and 

(2)  If,  in  the  case  of  such  corporation.  50  per  centum  or  more  of  its 
gross  income  (computed  without  the  benefit  of  this  section)  for  such  period 
or  such  part  thereof  was  derived  from  the  active  conduct  of  a  trade  or 
business  within  a  possession  of  the  United  States;  or 

(3)  If,  in  the  case  of  such  citizen,  50  per  centum  or  more  of  his  gross 
income  (computed  without  the  benefit  of  this  section)  for  such  period  or 
such  part  thereof  was  derived  fi-om  the  active  conduct  of  a  trade  or  busi- 
ness within  a  possession  of  the  United  States  either  on  his  own  account  or 
as  an   employee  or   agent  of  another, 

(b)  Notwithstanding  the  provisions  of  subdivision  (a)  there  shall  be 
included  in  gross  income  all  amounts  I'eceived  by  such  citizens  or  corpora- 
tions within  the  United  States,  whether  derived  from  sources  within  or 
without  the  United  States. 

(c)  As  used  in  this  section  the  term  "possession  of  the  United  States" 
does  not  include  the  Virgin  Islands  of  the  United  States. 


1380  APPENDIX 

EFFECTIVE  DATE  OF  TITLE 

Sec.  263.     That  this  title  shall  take  effect  as  of  January  1,  1921. 
TITLE  III— WAR-PROFITS  AND  EXCESS-PROFITS  TAX  FOR  1921 
Part  I — General  Definitions 
Sec.    300.      That   when    used    in    this    title    the    terms    "taxable    year," 
"fiscal  year,"  "personal  service  corporation,"  "paid  or  accrued,"  and  "div- 
idends" shall  have  the  same  meaning  as  provided  for  the  purposes  of  income 
tax  in  sections  200  and  201. 

Part  II — Imposition  of  Tax 

Sec.  301.  (a)  That  in  lieu  of  the  tax  imposed  by  Title  III  of  the  Rev- 
enue Act  of  1918,  but  in  addition  to  the  other  taxes  imposed  by  this  Act, 
there  shall  be  levied,  collected  and  paid  for  the  calendar  year  1921  upon 
the  net  income  of  every  corporation  (except  corporations  taxable  under 
subdivision  (b)  of  this  section)  a  tax  equal  to  the  sum  of  the  following: 

first  bracket 

20  per  centum  of  the  amount  of  the  net  income  in  excess  of  the  excess- 
profits  credit  (determined  under  section  312)  and  not  in  excess  of  20  per 
centum  of  the  invested  capital; 

second  bracket 
40  per  centum  of  the  amount  of  the  net  income  in  excess  of  20  per  centum 
of  the  invested  capital. 

(b)  For  the  calendar  year  1921  there  shall  be  levied,  collected,  and  paid 
upon  the  net  income  of  every  corporation  which  derives  in  such  year  a 
net  income  of  more  than  $10,000  from  any  government  contract  or  con- 
tracts made  between  April  6,  1917,  and  November  11,  1918,  both  dates  in- 
clusive, a  tax  equal  to  the  sum  of  the  following: 

(1)  Such  a  portion  of  a  tax  computed  at  the  rates  specified  in  subdivision 
(a)  of  section  301  of  the  Revenue  Act  of  1918,  as  the  part  of  the  net  in- 
come attributable  to  such  government  contract  or  contracts  bears  to  the 
entire  net  income.  In  computing  such  tax  the  excess-profits  credit  and 
the  war-profits  credit  which  would  be  applicable  to  such  calendar  year  under 
the  Revenue  Act  of  1918  if  it  had  been  continued  in  force,  shall  be  used; 

(2)  Such  a  portion  of  a  tax  computed  at  the  rates  specified  in  subdivision 
(a)  of  this  section  as  the  part  of  the  net  income  not  attributable  to  such 
government  contract  or  contracts  bears  to  the  entire  net  income. 

For  the  purpose  of  determining  the  part  of  the  net  income  attributable 
to  such  government  contract  or  contracts,  the  proper  apportionment  and 
allocation  of  the  deductions  with  respect  to  gross  income  derived  from 
such  government  contract  or  contracts  and  from  other  sources,  respectively, 
shall  be  determined  under  rules  and  regulations  prescribed  by  the  Commis- 
sioner with  the  approval  of  the  Secretary. 

(c)  In  any  case  where  the  full  amount  of  the  excess-profits  credit  is  not 
allowed  under  the  first  bracket  of  subdivision  (a),  by  reason  of  the  fact 
that  such  credit  is  in  excess  of  20  per  centum  of  the  invested  capital,  the 
part  not  so  allowed  shall  be  deducted  from  the  amount  in  the  second  bracket. 

Sec.  302.  That  the  tax  imposed  by  subdivision  (a)  of  section  301  shall 
in  no  case  be  more  than  20  per  centum  of  the  amount  of  the  net  income  in 
excess  of  $3,000  and  not  in  excess  of  $20,000,  plus  40  per  centum  of  the 
amount  of  the  net  income  in  excess  of  $20,000;  and  the  limitations  imposed 


REVENUE    ACT    OF    11)21  1381 

by  section  302  of  the  Revenue  Act  of  1918  (upon  taxes  computed  under 
subdivision  (c)  of  section  301  of  that  Act)  are  hereby  made  applicable  to 
taxes  computed  under  subdivision  (b)  of  section  301  of  this  Act.  Nothing 
in  this  section  shall  be  construed  in  such  manner  as  to  increase  the  tax 
imposed  by  section  301  of  this  Act. 

Sec.  303.  That  if  part  of  the  net  income  of  a  corporation  is  derived  (1) 
from  a  trade  or  business  (or  a  branch  of  a  trade  or  business)  in  which  the 
employment  of  capital  is  necessary,  and  (2)  a  part  (constituting  not  less 
than  30  per  centum  of  its  total  net  income)  is  derived  from  a  separate 
trade  or  business  (or  a  distinctly  separate  branch  of  the  trade  or  business) 
which  if  constituting:  the  sole  trade  or  business  would  bring  it  within  the 
cla.ss  of  "personal  service  corporations,"  then  (under  regulations  pre- 
scribed by  the  Commissioner  with  the  approval  of  the  Secretary)  the  tax 
upon  the  first  part  of  such  net  income  shall  be  separately  computed  (allow- 
ing in  such  computation  only  the  same  proportionate  part  of  the  credits 
authorized  in  section  312),  and  the  tax  upon  the  second  part  shall  be 
the  same  percentage  thereof  as  the  tax  so  computed  upon  the  first  part 
is  of  such  first  part:  Provided,  That  the  tax  upon  such  second  part  shall 
in  no  case  be  less  than  20  per  centum  thereof,  unless  the  tax  upon  the 
entire  net  income,  if  computed  without  benefit  of  this  section,  would  con- 
stitute less  than  20  per  centum  of  such  entire  net  income,  in  which  event 
the  tax  shall  be  determined  upon  the  entire  net  income,  without  reference 
to  this  section,  as  other  taxes  are  determined  under  this  title.  The  total 
tax  computed  under  this  section  shall  be  subject  to  the  limitations  pro- 
vided in  section  302. 

Sec.  304.  (a)  That  the  corporations  enumerated  in  section  231  shall, 
to  the  extent  that  they  are  exempt  from  income  tax  under  Title  II,  be 
exempt  from  taxation  under  this  title. 

(b)  Any  corporation  whose  net  income  for  the  taxable  year  is  less  than 
$3,000  shall  be  exempt  from  taxation  under  this  title. 

(c)  In  the  case  of  any  corporation  engaged  in  the  mining  of  gold,  the 
portion  of  the  net  income  derived  from  the  mining  of  gold  shall  be  exempt 
from  the  tax  imposed  by  this  title  or  any  tax  imposed  by  Title  II  of  the 
Revenue  Act  of  1917,  and  the  tax  on  the  remaining  portion  of  the  net 
income  shall  be  the  same  proportion  of  a  tax  computed  without  the  benefit 
of  this  subdivision  which  such  remaining  portion  of  the  net  income  bears 
to  the  entire  net  income. 

Sec.  305.  That  if  a  tax  is  computed  under  this  title  for  a  period  of  less 
than  twelve  months,  the  specific  exemption  of  $3,000,  wherever  referred 
to  in  this  title,  shall  be  reduced  to  an  amount  which  is  the  same  proportion 
of  $3,000  as  the  number  of  months  in  the  period  is  of  twelve  months. 

Part  III — Excess-Profits  Credit 

Sec.  312.  That  the  excess-profits  credit  shall  consist  of  a  specific  exemp- 
tion of  $3,000  plus  an  amount  equal  to  8  per  centum  of  the  invested  capital 
for  the  taxable  year. 

A  foreign  corporation  or  a  corporation  entitled  to  the  benefits  of  sec- 
tion 2(52  shall   not  be  entitled  to  the  specific  exemption  of  $3,000. 

Part  IV — Net  Income 
Sec.  320.  That  for  the  purpose  of  this  title  the  net  income  of  a  corporation 
shall    be   ascertained   and    returned    for   the   taxable   year   upon    the   same 
basis  and    in   the   same   manner   as   provided   for   income   tax   purposes   in 
Title  II  of  this  Act. 


1382  APPENDIX 

Part  V — Invested  Capital 

Sec.  325.    (a)    That  as  used  in  this  title — 

The  term  "intangible  property"  means  patents,  copyrights,  secret  pro- 
cesses and  formulae,  good  will,  trade-marks,  trade  brands,  franchises,  and 
other  like  property; 

The  term  "tangible  property"  means  stocks,  bonds,  notes,  and  other 
evidences  of  indebtedness,  bills  and  accounts  receivable,  leaseholds,  and 
other  property  other  than  intangible  property; 

The  term  "borrowed  capital"  means  money  or  other  property  borrowed, 
whether  represented  by  bonds,  notes,  open  accounts,  or  otherwise; 

The  term  "inadmissible  assets"  means  stocks,  bonds,  and  other  obligations 
(other  than  obligations  of  the  United  States),  the  dividends  or  interest 
from  which  is  not  included  in  computing  net  income,  but  where  the  incomfj 
derived  from  such  assets  consists  in  part  of  gain  or  profit  derived  from  the 
sale  or  other  disposition  thereof,  or  where  all  or  part  of  the  interest  derived 
from  such  assets  is  in  effect  included  in  the  net  income  because  of  the  limi- 
tation on  the  deduction  of  interest  under  paragraph  (2)  of  subdivision  (a) 
of  section  234,  a  corresponding  part  of  the  capital  invested  in  such  assets 
shall  not  be  deemed  to  be  inadmissible  assets; 

The  term  "admissible  assets"  means  all  assets  other  than  inadmissible 
assets,  valued  in  accordance  with  the  provisions  of  subdivision  (a)  of  section 
326  and  section  331. 

(b)  For  the  purposes  of  this  title  the  par  value  of  stock  or  shares  shall, 
in  the  case  of  stock  or  shares  issued  at  a  nominal  value  or  having  no  par 
value,  be  deemed  to  be  the  fair  market  value  as  of  the  date  or  dates  of 
issue  of  such  stock  or  shares. 

Sec.  326.  (a)  That  as  used  in  this  title  the  term  "invested  capital"  for 
any  year  means  (except  as  provided  in  subdivision  (b)  and  (c)  of  this 
section)  : 

(1)  Actual  cash  bona  fide  paid  in  for  stock  or  shares; 

(2)  Actual  cash  value  of  tangible  property,  other  than  cash,  bona  fide 
paid  in  for  stock  or  shares,  at  the  time  of  such  payment,  but  in  no  case 
to  exceed  the  par  value  of  the  original  stock  or  shares  specifically  issued 
therefor,  unless  the  actual  cash  value  of  such  tangible  property  at  the  time 
paid  in  is  shown  to  the  satisfaction  of  the  Commissioner  to  have  been 
clearly  and  substantially  in  excess  of  such  par  value,  in  which  case  such 
excess  shall  be  treated  as  paid-in  surplus :  Provided,  That  the  Commissioner 
shall  keep  a  record  of  all  cases  in  which  tangible  property  is  included  in 
invested  capital  at  a  value  in  excess  of  the  stock  or  shares  issued  therefor, 
containing  the  name  and  address  of  each  taxpayer,  the  business  in  which 
engaged,  the  amount  of  invested  capital  and  the  net  income  shown  by  the 
return,  the  value  of  the  tangible  property  at  the  time  paid  in,  the  par  val- 
ue of  the  stock  or  shares  specifically  issued  therefor,  and  the  amount  in- 
cluded under  this  paragraph  as  paid-in  surplus.  The  Commissioner  shall 
furnish  a  copy  of  such  record  and  other  detailed  information  with  respect 
to  such  cases  when  required  by  resolution  of  either  House  of  Congress, 
without  regard  to  the  restrictions  contained  in  section  257; 

(3)  Paid-in  or  earned  surplus  and  undivided  profits;  not  including  sur- 
plus and  undivided  profits  earned  during  the  year; 

(4)  Intangible  property  bona  fide  paid  in  for  stock  or  shares  prior  to 
March  3,  1917,  in  an  amount  not  exceeding  (a)  the  actual  cash  value  of 
such  property  at  the  time  paid  in,   (b)  the  par  value  of  the  stock  or  shares 


REVENUE    ACT    OF    1921  1383 

issued  therefor,  or  (c)  in  the  aRgregate  25  per  centum  of  the  par  valui- 
of  the  total  stock  or  shares  of  the  corporation  outstanding  on  March  3, 
1917,  whichever  is  lowest; 

(5)  Intangible  property  bona  fide  paid  in  for  stock  or  shares  on  or  after 
March  3,  1917,  in  an  amount  not  exceeding  (a)  the  actual  cash  value  of 
such  property  at  the  time  paid  in,  (b)  the  par  value  of  the  stock  or  shares 
issued  therefor,  or  (c)  in  the  aggregate  25  per  centum  of  the  par  value 
of  the  total  stock  or  shares  of  the  corporation  outstanding  at  the  beginning 
of  the  taxable  year,  whichever  is  lowest:  I'rorided,  That  in  no  case  shall 
the  total  amount  included  under  paragraphs  (4)  and  (5)  exceed  in  the 
aggregate  25  per  centum  of  the  par  value  of  the  total  stock  or  shares  of 
the  corporation  outstanding  at  the  beginning  of  the  taxable   year;   but 

(b)  As  used  in  this  title  the  term  "invested  capital"  does  not  include 
borrowed  capital. 

(c)  There  shall  be  deducted  from  invested  capital  as  above  defined  a 
percentage  thereof  equal  to  the  percentage  which  the  amount  of  inadmissible 
assets  is  of  the  amount  of  admissible  and  inadmissible  assets  held  during 
the  taxable  year. 

(d)  The  invested  capital  for  any  period  shall  be  the  average  invested 
capital  for  such  period,  but  in  the  case  of  a  corporation  making  a  return 
for  a  fractional  part  of  a  year,  it  shall  be  the  same  fractional  part  of 
such  average  invested  capital. 

Sec.  327.  That  in  the  following  cases  the  tax  shall  be  determined  as 
provided  in  section  328: 

(a)  Where  the  Commissioner  is  unable  to  determine  the  invested  capital 
as  provided  in  section  326 ; 

(b)  In  the  case  of  a  foreign  corporation  or  of  a  corporation  entitled  to 
the  benefits  of  section  262; 

(c)  Where  a  mixed  aggregate  of  tangible  property  and  intangible  prop- 
erty has  been  paid  in  for  stock  or  for  stock  and  bonds  and  the  Commissioner 
is  unable  satisfactorily  to  determine  the  respective  values  of  the  several 
classes  of  property  at  the  time  of  payment,  or  to  distinguish  the  classes 
of  property  paid  in  for  stock  and  for  bonds,  respectively; 

(d)  Where  upon  application  by  the  corporation  the  Commissioner  finds 
and  so  declares  of  record  that  the  tax  if  determined  without  benefit  of  this 
section  would,  owing  to  abnormal  conditions  affecting  the  capital  or  income 
of  the  corporation,  work  upon  the  corporation  an  exceptional  hardship 
evidenced  by  gross  disproportion  between  the  tax  computed  without  benefit 
of  this  section  and  the  tax  computed  by  reference  to  the  representative 
corporations  specified  in  section  328.  This  subdivision  shall  not  apply  to 
any  case  (1)  in  which  the  tax  (computed  without  benefit  of  this  section) 
is  high  merely  because  the  corporation  earned  within  the  taxable  year  a 
high  rate  of  profit  upon  a  normal  invested  capital,  nor  (2)  in  which  50 
per  centum  or  more  of  the  gross  income  of  the  corporation  for  the  taxable 
year  (computed  under  section  233  of  Title  II)  consists  of  gains,  profits, 
commissions,  or  other  income,  derived  on  a  cost-plus  basis  from  a  govern- 
ment contract  or  contracts  made  between  April  6,  1917,  and  November  11, 
1918,  both  dates  inclusive. 

Sec.  328.  (a)  That  in  the  cases  specified  in  section  327  the  tax  shall 
be  the  amount  which  bears  the  same  ratio  to  the  net  income  of  the  tax- 
payer (in  excess  of  the  specific  exemption  of  $3,000)  for  the  taxable  year, 
as  the  average  tax  of  representative  corporations  engaged  in  a  like  or 
similar  trade  or  business,  bears  to  their  average  net  income    (in  excess  of 


]384  APPENDIX 

the  specific  exemption  of  $3,000)  for  such  year.  In  the  case  of  a  foreign 
corporation  or  of  a  corporation  entitled  to  the  benefits  of  section  262  the 
tax  shall  be  computed  without  deducting  the  specific  exemption  of  $3,000 
either  for  the  taxpayer  or  the  representative  corporations. 

In  computing  the  tax  under  this  section  the  Commissioner  shall  compare 
the  taxpayer  only  with  representative  corporations  whose  invested  capital 
can  be  satisfactorily  determined  under  section  326  and  which  are,  as  nearly 
as  may  be,  similarly  circumstanced  with  respect  to  gross  income,  net  in- 
come, profits  per  unit  of  business  transacted  and  capital  employed,  the 
amount  and  rate  of  war  profits  or  excess  profits,  and  all  other  relevant 
facts  and  circumstances. 

(b)  For  the  purposes  of  subdivision  (a)  the  ratios  between  the  average 
tax  and  the  average  net  income  of  representative  corporations  shall  be  de- 
termined by  the  Commissioner  in  accordance  with  regulations  prescribed 
by  him  with  the  approval  of  the  Secretary. 

(c)  The  Commissioner  shall  keep  a  record  of  all  cases  in  which  the  tax 
is  determined  in  the  manner  prescribed  in  subdivision  (a),  containing  the 
name  and  address  of  each  taxpayer,  the  business  in  which  engaged,  the 
amount  of  invested  capital  and  the  net  income  shown  by  the  return,  and 
the  amount  of  invested  capital  as  determined  under  such  subdivision.  The 
Commissioner  shall  furnish  a  copy  of  such  record  and  other  detailed  in- 
formation with  respect  to  such  cases  when  required  by  resolution  of  either 
House  of  Congress,  without  regard  to  the  restrictions  contained  in  section 
257. 

Part  VI — Reorganizations 

Sec.  331.  That  in  the  case  of  the  reorganization,  consolidation,  or  change 
of  ownership  of  a  trade  or  business,  or  change  of  ownership  of  property, 
after  March  3,  1917,  if  an  interest  or  control  in  such  trade  or  business  or 
property  of  50  per  centum  or  more  remains  in  the  same  persons,  or  any 
of  them,  then  no  asset  transferred  or  received  from  the  previous  owner 
shall,  for  the  purpose  of  determining  invested  capital,  be  allowed  a  greater 
value  than  would  have  been  allowed  under  this  title  in  computing  the  in- 
vested capital  of  such  previous  owner  if  such  asset  had  not  been  so  trans- 
ferred or  received :  Provided,  That  if  such  previous  owner  was  not  a  cor- 
poration, then  the  value  of  any  asset  so  transferred  or  received  shall  be 
taken  at  its  cost  of  acquisition  (at  the  date  when  acquired  by  such  previous 
owner)  with  proper  allowance  for  depreciation,  impairment,  betterment 
or  development,  but  no  addition  to  the  original  cost  shall  be  made  for  any 
charge  or  expenditure  deducted  as  expense  or  otherwise  on  or  after  March 
1,  1913,  in  computing  the  net  income  of  such  previous  owner  for  purposes 
of  taxation. 

Part  VII — Miscellaneous 

Sec.  335.  (a)  That  if  a  corporation  (other  than  a  personal  service  cor- 
poration) makes  return  for  a  fiscal  year  beginning  in  1920  and  ending  in 
1921,  the  war-profits  and  excess-profits  tax  for  the  taxable  year  1921  shall 
be  the  sum  of:  (1)  the  same  proportion  of  a  tax  for  the  entire  period 
computed  under  the  Revenue  Act  of  1918,  which  the  portion  of  such  period 
falling  within  the  calendar  year  1920  is  of  the  entire  period,  and  (2)  the 
same  proportion  of  a  tax  for  the  entire  period  computed  under  this  title, 
which  the  portion  of  such  period  falling  within  the  calendar  year  1921  is 
of  the  entire  period.     Any  amount  heretofore  or  hereafter  paid  on  account 


RKVENUE    ACT    OF    1«J21  1385 

of  the  tax  imposed  for  such  taxable  year  by  the  Revenue  Act  of  1918  shall 
le  credited  towards  the  payment  of  the  tax  as  above  computpd,  and  if 
the  amount  so  paid  exceeds  the  amount  of  such  tax,  the  excess  shall  be 
cretlited  or  refunded  to  the  corporation  in  accordance  with  the  provisions 
of  section  2r)2  of  this  Act. 

(b)  If  a  corporation  (other  than  a  personal  service  corporation)  makes 
a  return  for  a  fiscal  year  beginning  in  1921  and  ending  in  1922,  the  war- 
profits  and  excess-profits  tax  for  the  portion  of  the  year  falling  within 
the  calendar  year  1921  shall  be  an  amount  equivalent  to  the  same  pro- 
|)()rtion  of  a  tax  for  the  entire  period  computed  under  this  title,  which  the 
portion  of  such  period  falling  within  the  calendar  year  1921  is  of  the  entire 
period. 

Sec.  33<i.  That  every  corporation,  not  exempt  under  section  304,  shall 
make  a  return  for  the  purposes  of  this  title.  Such  returns  shall  be  made, 
and  the  taxes  imposed  by  this  title  shall  be  paid,  at  the  same  times  and 
places,  in  the  same  manner,  and  subject  to  the  same  conditions,  as  is  pro- 
vided in  the  case  of  returns  and  payment  of  income  tax  by  corporations 
for  the  purposes  of  Title  II,  and  all  the  provisions  of  that  title  not  in- 
applicable, including  penalties,  are  hereby  made  applicable  to  the  taxes 
imposed  1^(/  this  title. 

Sec.  337.  That  in  the  case  of  a  bona  fide  sale  of  mines,  oil  or  gas  wells, 
or  any  interest  therein,  where  the  principal  value  of  the  property  has  been 
demonstrated  by  prospecting  or  exploration  and  discovery  work  done  by 
the  taxpayer,  the  portion  of  the  tax  imposed  by  this  title  attributable  to 
such  sale  shall  not  exceed  20  per  centum  of  the  selling  price  of  such  prop- 
erty or  interest. 

EFFECTIVE    DATE   OF    TITLE 

Sec.  338.  That  this  title  shall  take  effect  as  of  January  1,  1921. 
TITLE  X— SPECIAL  TAXES 

CAPITAL    STOCK    TAX 

Sec.  1000.  (a)  That  on  and  after  July  1.  1922."  in  lieu  of  the  tax  im- 
posed by  section   1000  of  the  Revenue  Act  of  1918  — 

(1)  Every  domestic  corporation  shall  pay  annually  a  special  excise  tax 
with  respect  to  carrying  on  or  doing  business,  equivalent  to  $1  for  each 
$1,000  of  so  much  of  the  fair  average  value  of  its  capital  stock  for  the 
preceding  year  ending  June  30  as  is  in  excess  of  $5,000.  In  estimating 
the  value  of  capital  stock  the  surplus  and  undivided  profits  shall  be  in- 
cluded; 

(2)  Every  foreign  corporation  shall  pay  annually  a  special  excise  tax 
with  respect  to  carrying  on  or  doing  business  in  the  United  States,  equiva- 
lent to  $1  for  each  $1,000  of  the  average  amount  of  capital  employed  in 
the  transaction  of  its  business  in  the  United  States  during  the  jirecediiig 
year  ending  June  30. 

(b)  The  taxes  imposed  by  this  section  shall  not  apply  in  any  year  to  any 
corporation  which  was  not  engaged  in  business  (or,  in  the  case  of  a  foreign 
corporation,  not  engaged  in  business  in  the  United  States)  during  the  pre- 
ceding year  ending  June  30,  nor  to  any  corporation  enumerated  in  section 
231,  nor  to  any  insurance  companv  subjeit  t'>  the  tax  imposed  by  section 
243  or  246. 

(c)  Section  257  shall  apply  to  all  returns  filed  with  the  C'oniniissioncr 
for  purposes  of  the  tax   imposed  by  this  section. 


1386  APPENDIX 

TITLE  XI— STAMP  TAXES 

Sec.  1100.  That  on  and  after  January  1,  1922,  there  shall  be  levied,  col- 
lected, and  paid,  for  and  in  respect  of  the  several  bonds,  debentures,  or 
certificates  of  stock  and  of  indebtedness,  and  other  documents,  instruments, 
matters,  and  things  mentioned  and  described  in  schedule  A  of  this  title,  or 
for  or  in  respect  of  the  vellum,  parchment,  or  paper  upon  which  such  in- 
struments, matters,  or  things,  or  any  of  them,  are  written  or  printf^d,  by 
any  person  who  makes,  signs,  issues,  sells,  removes,  consigns,  or  ships  the 
same,  or  for  whose  use  or  benefit  the  same  are  made,  signed,  issued,  sold, 
removed,  consigned,  or  shipped,  the  several  taxes  specified  in  such  schedule. 
The  taxes  imposed  by  this  section  shall,  in  the  case  of  any  article  upon 
which  a  corresponding  stamp  tax  is  now  imposed  by  law,  be  in  lieu  of  such 
tax. 

Sec.  1101.  That  there  shall  not  be  taxed  under  this  title  any  bond,  note, 
or  other  instrument,  issued  by  the  United  States,  or  by  any  foreign  gov- 
ernment, or  by  any  state,  territory,  or  the  District  of  Columbia,  or  local 
subdivision  thereof,  or  municipal  or  other  corporation  exercising  the  tax- 
ing power;  or  any  bond  of  indemnity  required  to  be  filed  by  any  person  to 
secure  payment  of  any  pension,  allowance,  allotment,  relief,  or  insurance 
by  the  United  States,  or  to  secure  a  duplicate  for,  or  the  payment  of,  any 
bond,  note,  certificate  of  indebtedness,  war-savings  certificate,  warrant  or 
check,  issued  by  the  United  States;  or  stocks  and  bonds  issued  by  co-op- 
erative building  and  loan  associations  which  are  organized  and  operated 
exclusively  for  the  benefit  of  their  members  and  make  loans  only  to  their 
shareholders,  of  by  mutual  ditch  or  irrigation  companies. 

Sec.  1102.    That  whoever— 

(a)  Makes,  signs,  issues,  or  accepts,  or  causes  to  be  made,  signed,  issued, 
or  accepted^  any  instrument,  document,  or  paper  of  any  kind  or  description 
whatsoever  without  the  full  amount  of  tax  thereon  being  duly  paid; 

(b)  Manufactures  or  imports  and  sells,  or  offers  for  sale,  or  causes  to  be 
manufactured  or  imported  and  sold,  or  off'ered  for  sale,  any  playing  cards, 
package,  or  other  article 'without  the  full  amount  of  tax  being  duly  paid; 

(c)  Makes  use  of  any  adhesive  stamp  to  denote  any  tax  imposed  by  this 
title  without  canceling  or  obliterating  such  stamp  as  prescribed  in  section 
1104; 

Is  guilty  of  a  misdemeanor  and  upon  conviction  thereof  shall  pay  a  fine 
of  not  more  than  $100  for  each  offense. 
Sec.  1103.    That  whoever— 

(a)  Fraudulently  cuts,  tears,  or  removes  from  any  vellum,  parchment, 
paper,  instrument,  writing,  package,  or  article,  upon  which  any  tax  is  im- 
posed by  this  title,  any  adhesive  stamp  or  the  impression  of  any  stamp,  die, 
plate,  or  other  article  provided,  made,  or  used  in  pursuance  of  this  title; 

(b)  Fraudulently  uses,  joins,  fixes,  or  places  to,  with,  or  upon  any  vellum, 
parchment,  paper,  instrument,  writing,  package,  or  article,  upon  which 
any  tax  is  imposed  by  this  title,  (1)  any  adhesive  stamp,  or  the  impression 
of  any  stamp,  die,  plate,  or  other  article,  which  has  been  cut,  torn,  or  re- 
moved from  any  other  vellum,  parchment,  paper,  instrument,  writing, 
package,  or  article,  upon  which  any  tax  is  imposed  by  this  title;  or  (2)  any 
adhesive  stamp  or  the  impression  of  any  stamp,  die,  plate,  or  other  article 
of  insufficient  value;  or  (3)  any  forged  or  counterfeited  stamp,  or  the  im- 
pression of  any  forged  or  counterfeited  stamp,  die,  plate,  or  other  article; 


REVENUE    ACT    OF    1U21  1387 

(f)  Willfully  removes,  or  alters  the  cancellation,  or  defacinK  marks  of. 
or  otherwise  prepares,  any  adhesive  stamp,  with  intent  to  use,  or  cause  the 
same  to  be  used,  after  it  has  been  already  used,  or  knowingly  or  willfully 
buys,  sells,  offers  for  sale,  or  gives  away,  any  such  washed  or  restored 
stamp  to  any  person  for  use,  or  knowingly  uses  the  same; 

(d)  Knowingly  and  without  lawful  excuse  (the  burden  of  proof  of  such 
excuse  being  on  the  accused)  has  in  possession  any  washed,  restored,  or 
altered  stamp,  which  has  been  removed  from  any  vellum,  parchment,  paper, 
instrument,   writing,  package,  or  article; 

Is  guilty  of  a  misdemeanor,  and  upon  conviction  shall  be  punished  by  a 
fine  of  not  more  than  $1,000,  or  by  imprisonment  for  not  more  than  five 
years,  or  both,  and  any  such  reused,  canceled,  or  counterfeited  stamp  and 
the  vellum,  parchment,  document,  paper,  package,  or  article  upon  which 
it  is  placed  or  impressed  shall  be  forfeited  to  the  United  States. 

Sec.  1104.  That  whenever  an  adhesive  stamp  is  used  for  denoting  any 
tax  imposed  by  this  title,  except  as  hereinafter  provided,  the  person  using 
or  affixing  the  same  shall  write  or  stamp  or  cause  to  be  written  or  stamped 
thereupon  the  initials  of  his  or  its  name  and  the  date  upon  which  the  same 
is  attached  or  used,  so  that  the  same  may  not  again  be  used:  Provided 
That  the  Commissioner  may  prescribe  such  other  method  for  the  cancella- 
tion of  such  stamps  as  he  may  deem  expedient. 

Sec.  1105.  (a)  That  the  Commissioner  shall  cause  to  be  prepared  and  dis- 
tributed for  the  payment  of  the  taxes  prescribed  in  this  title  suitable  stamps 
denoting  the  tax  on  the  document,  articles,  or  thing  to  which  the  same  may 
he  affixed,  and  shall  prescribe  such  method  for  the  affixing  of  said  stamps  in 
substitution  for  or  in  addition  to  the  method  provided  in  this  title,  as 
he  may  deem  expedient. 

(b)  All  internal  revenue  laws  relating  to  the  assessment  and  collection 
of  taxes  are  hereby  extended  to  and  made  a  part  of  this  title,  so  far  as  ap- 
plicable, for  the  purpose  of  collecting  stamp  taxes  omitted  through  mistake 
or  fraud  from  any  instrument,  document,  paper,  writing,  parcel,  package,  or 
article  named  herein. 

Sec.  not;.  That  the  Commissioner  shall  furnish  to  the  Postmaster  Gen- 
eral without  prepayment  a  suitable  quantity  of  adhesive  stamps  to  be  dis- 
tributed to  and  kept  on  sale  by  the  various  postmasters  in  the  United 
States.  The  Postmaster  General  may  require  each  such  postmaster  to  give 
additional  or  increased  bond  as  postmaster  for  the  value  of  the  stamps 
so  furnished,  and  each  such  postmaster  shall  deposit  the  receipts  from 
the  sale  of  such  stamps  to  the  credit  of  and  render  accounts  to  the  Post- 
master General  at  such  times  and  in  such  form  as  he  may  by  regulations 
l)rescribe.  The  Postmaster  General  shall  at  least  once  monthly  transfer 
all  collections  from  this  source  to  the  treasury  as  internal-revenue  col- 
lections. 

Sec.  1107.  (a)  That  each  collector  shall  furnish,  without  prepayment, 
to  any  assistant  treasurer  or  designated  depositary  of  the  United  States, 
located  in  the  district  of  such  collector,  a  suitable  quantity  of  adhesive 
stamps  to  be  kept  on  sale  by  such  assistant  treasurer  or  designated  de- 
positary. 

(b)  Each  collector  shall  furnish,  without  prepayment,  to  any  person 
who  is  (1)  located  in  the  district  of  such  collector,  (2)  duly  appointed  and 
acting  as  agent  of  any  state  for  the  sale  of  stock  transfer  stamps  of  such 


1388  APPENDIX 

state,  and  (3)  designated  by  the  Commissioner  for  the  purpose,  a  suitable 
quantity  of  such  adhesive  stamps  as  are  required  by  subdivisions  2,  3,  and 
4  of  schedule  A  of  this  title,  to  be  kept  on  sale  by  such  person. 

(c)  In  such  cases  the  collector  may  require  a  bond,  with  sufficient  sure- 
ties, in  a  sum  to  be  fixed  by  the  Commissioner,  conditioned  for  the  faithful 
return,  whenever  so  required,  of  all  quantities  or  amounts  undisposed  of, 
and  for  the  payment  monthly  of  all  quantities  or  amounts  sold  or  not  re- 
maining on  hand.  The  Secretary  may  from  time  to  time  make  such  regula- 
tions as  he  may  find  necessary  to  insure  the  safe-keeping  or  prevent  the 
illegal  use  of  all  such  adhesive  stamps. 

Schedule  A. — Stamp   Taxes 

1.  Bonds  of  indebtedness:  On  all  bonds,  debentures,  or  certificates  of 
indebtedness  issued  by  any  person,  and  all  instruments,  however  termed, 
issued  by  any  corporation  with  interest  coupons  or  in  registered  form, 
known  generally  as  corporate  securities,  on  each  $100  or  face  value  or 
fraction  thereof,  5  cents:  Provided,  That  every  renewal  of  the  foregoing 
shall  be  taxed  as  a  new  issue:  Provided  further.  That  when  a  bond  con- 
ditioned for  the  repayment  or. payment  of  money  is  given  in  a  penal  sum 
greater  than  the  debt  secured,  the  tax  shall  be  based  upon  the  amount 
secured. 

2.  Capital  stock,  issued:  On  each  original  issue,  whether  on  organ- 
ization or  reorganization,  of  certificates  of  stock,  or  of  profits,  or  of 
interest  in  property  or  accumulations,  by  any  corporation,  on  each 
$100  of  face  value  or  fraction  thereof,  5  cents:  Provided,  That  where  a 
certificate  is  issued  without  face  value,  the  tax  shall  be  5  cents  per  share, 
unless  the  actual  value  is  in  excess  of  $100  per  share,  in  which  case  the 
tax  shall  be  5  cents  on  each  $100  of  actual  value  or  fraction  thereof,  or 
unless  the  actual  value  is  less  than  $100  per  share,  in  which  case  the  tax 
shall  be  1  cent  on  each  $20  of  actual  value,  or  fraction  thereof. 

The  stamps  representing  the  tax  imposed  by  this  subdivision  shall  be 
attached  to  the  stock  books  and  not  to  the  certificates  issued. 

3.  Capital  stock,  sales  or  transfers:  On  all  sales,  or  agreements  to  sell, 
or  memoranda  of  sales  or  deliveries  of,  or  transfers  of  legal  title  to  shares 
or  certificates  of  stock  or  of  profits  or  of  interest  in  property  or  accumula- 
tions in  any  corporation,  or  to  rights  to  subscribe  for  or  to  receive  such 
shares  or  certificates,  whether  made  upon  or  shown  by  the  books  of  the 
corporation,  or  by  any  assignment  in  blank,  or  by  any  delivery,  or  by  any 
paper  or  agreement  or  memorandum  or  other  evidence  of  transfer  or  sale, 
whether  entitling  the  holder  in  any  manner  to  the  benefit  of  such  stock, 
interest,  or  rights,  or  not,  on  each  $100  of  face  value  or  fraction  thereof, 

^  cents,  and  where  such  shares  are  without  par  or  face  value,  the  tax 
shall  be  2  cents  on  the  transfer  or  sale  or  agreement  to  sell  on  each  share: 
Provided,  That  it  is  not  intended  by  this  title  to  impose  a  tax  upon  an 
agreement  evidencing  a  deposit  of  certificates  as  collateral  security  for 
money  loaned  thereon,  which  certificates  are  not  actually  sold,  nor  upon 
the  delivery  or  transfer  for  such  purpose  of  certificates  so  deposited,  nor 
upon  mere  loans  of  stock  nor  upon  the  return  of  stock  so  loaned:  Provided 
fia-ther.  That  the  tax  shall  not  be  imposed  upon  deliveries  or  transfers  to 
a  broker  for  sale,  nor  upon  deliveries  or  transfers  by  a  broken  to  a  customer 
for  whom  and  upon  whose  order  he  has  purchased  same,  but  such  deliveries 
or  transfers  shall  be  accompanied  by  a  certificate  setting  forth  the  facts : 
Provided  further.  That  in  case  of  sale  where  the  evidence  of  transfer  is 


REVENUE    ACT    OF    1921  1389 

shown  only  by  the  books  of  the  corporation  the  stamp  shall  be  placed  upon 
such  books;  and  where  the  change  of  ownership  is  by  transfer  of  the  cer- 
tificate the  stamp  shall  be  placed  upon  the  certificate;  and  in  cases  of  an 
agreement  to  sell  or  where   the   transfer   is  by  delivery  of   the  certificate 
assigned  in   blank  there  shall   be  made  and  delivered  by  the  seller  to  the 
buyer  a  bill  or  memorandum  of  such   sale,  to  which   the   stamp   shall   be 
affixed;  and  every  bill  or  memorandum  of  sale  or  agreement  to  sell  before 
mentioned  shall  show  the  date  thereof,  the  name  of  the  seller,  the  amount 
of  the  sale,  and  the  matter  or  thing  to  which  it  refers.     Any  person  liable 
to  pay  the  tax   as  herein   provided,  or  anyone  who  acts  in  the   matter  as 
agent  or  broker  for  such  person,  who  makes  any  such  sale,  or  who  in  pursu- 
ance of  any   such   sale  delivers  any  certificate  or  evidence  of  the   sale  of 
any  stock,  interest  or  right,  or  bill  or  memorandum  thereof,  as  herein  re- 
quired,  without  having   the   proper   stamps   affixed   thereto   with    intent   to 
evade  the  foregoing  provisions,  shall  be  deemed  guilty  of  a  misdemeanor, 
and  upon  conviction  thereof  shall  pay  a  fine  of  not  exceeding  $1,000,  or  be 
imprisoned  not  more  than  six  months,  or  both. 

4.    Produce,  sales  of,  on  exchange:    Upon  each  sale,  agreement  of  sale, 
or  agreement  to  sell  (not  including  so-called  transferred  or  scratch  sales), 
any  products  or  merchandise  at.  or  under  the  rules  or  usages  of,  any  ex- 
change, or  board  of  trade,  or  other  similar  place,  for  future  delivery,  for 
each  $100  in  value  of  the  merchandise  covered  by  said  sale  or  agreement 
of  sale  or  agreement  to  sell.  2  cents,  and  for  each  additional  $100  or  frac- 
tional  part  thereof   in   excess   of  $100,   2   cents:   Provided,   That   on   every 
sale  or  agreement  of  sale  or  agreement  to  sell  as  aforesaid  there  shall  be 
made  and  delivered  by  the  seller  to  the  buyer  a  bill,  memorandum,  agree- 
ment, or  other  evidence  of  such  sale,  agreement  of  sale,  or  agreement  to 
sell,  to   which  there  shall  be  affixed   a   lawful   stamp  or  stamps   in  value 
equal  to  the  amount  of  the  tax  on  such  sale:  Provided  further.  That  sellers 
of  commodities  described  herein,  having  paid  the  tax  provided  by  this  sub- 
division,  may   transfer  such   contracts   to    a   clearing-house   corporation   or 
association,  and  such  transfer  shall  not  be  deemed  to  be  a  sale,  or  agree- 
ment of  sale,  or  an  agreement  to  sell   within  the  provisions  of  this    Act, 
provided  that  such  transfer  shall  not  vest  any  beneficial   interest   in  such 
clearing-house  association  but  shall  be  made  for  the   sole  purpose  of  en- 
abling such  clearing-house  association  to  adjust  and  balance  the  accounts 
of  the  members  of  such  clearing-house  association  on  their  several  contracts. 
Every  such  bill,  memorandum,  or  other  evidence  of  sale  or  agreement  to  sell 
shall   show   the  date   thereof,  the   name   of  the   seller,  the   amount   of   the 
sale,  and  the  matter  or  thing  to  which  it  refers;  and  any  person  liable  to 
pay  the  tax  as  herein  provided,  or  anyone  who  acts  in  the  matter  as  agent 
or  broker   for   such    person,   who   makes   any   such    sale   or   agreement   of 
sale,  or  agreement  to  sell,  or  who,  in  pursuance  of  any  such  sale,  agreement 
ol  sale,  or  agreement  to  sell,  delivers  any  such  products  or  merchandise  with- 
out a  bill,  memorandum,  or  other  evidence  thereof  as  herein  required,  or 
who  delivers  such  bill,  memorandum,  or  other  evidence  of  sale,  or  agree- 
ment to  sell,  without  having  the  proper  stamps  affixed  thereto,  with  intent 
to  evade  the  foregoing  provisions,  shall  be  deemed  guilty  of  a  misdemeanor, 
and  upon  conviction  thereof  shall  pay  a  fine  of  not  exceeding  $1,000  or  be 
imprisoned  not  more  than  six  months,  or  both. 

No   bill,   memorandum,   agreement,   or  other   evidence   of   such    sale,   or 
agreement  of  sale,  or  agreement  to  sell,  in  case  of  cash  sales  of  products 


1390  APPENDIX 

or  merchandise  for  immediate  or  prompt  delivery  which  in  good  faith  are 
actually  intended  to  be  delivered  shall  be  subject  to  this  tax. 

This  subdivision  shall  not  affect  but  shall  be  in  addition  to  the  provisions 
of  the  "United  States  Cotton  Futures  Act,"  approved  August  11,  1916,  as 
amended,  and  "The  Future  Trading  Act,"  approved  August  24,  1921. 

5.  Drafts  or  checks  (payable  othervi^ise  than  at  sight  or  on  demand)  upon 
their  acceptance  or  delivery  within  the  United  States  whichever  is  prior, 
promissory  notes,  except  bank  notes  issued  for  circulation,  and  for  each  re- 
newal of  the  same,  for  a  sum  not  exceeding  $100,  2  cents;  and  for  each 
additional  $100,  or  fractional  part  thereof,  2  cents. 

This  subdivision  shall  not  apply  to.  a  promissory  note  secured  by  the 
pledge  of  bonds  or  obligations  of  the  United  States  issued  after  April  24, 
1917,  or  secured  by  the  pledge  of  a  promissory  note  which  itself  is  secured 
by  the  pledge  of  such  bonds  or  obligations:  Provided,  That  in  either  case 
the  par  value  of  such  bonds  or  obligations  shall  be  not  less  than  the 
amount  of  such  note. 

6.  Conveyances:  Deed,  instrument,  or  writing,  whereby  any  lands,  tene- 
ments, or  other  realty  sold  shall  be  granted,  assigned,  transferred,  or  other- 
wise conveyed  to,  or  vested  in,  the  purchaser  or  purchasers,  or  any  other 
person  or  persons,  by  his,  her,  or  their  direction,  when  the  consideration  or 
value  of  the  interest  or  property  conveyed,  exclusive  of  the  value  of  any 
lien  or  encumbrance  remaining  thereon  at  the  time  of  sale,  exceeds  $100  and 
does  not  exceed  $500,  50  cents;  and  for  each  additional  $500  or  fractional 
part  thereof,  50  cents.  This  subdivision  shall  not  apply  to  any  instrument 
or  writing  given  to  secure  a  debt. 

7.  Entry  of  any  goods,  wares,  or  merchandise  at  any  customhouse,  either 
for  consumption  or  warehousing,  not  exceeding  $100  in  value,  25  cents;  ex- 
ceeding $100  and  not  exceeding  $500  in  value,  50  cents;  exceeding  $500 
in  value,  $1. 

8.  Entry  for  the  withdrawal  of  any  goods  or  merchandise  from  customs 
bonded  warehouse,  50  cents. 

9.  Passage  ticket,  one  way  or  round  trip,  for  each  passenger,  sold  or 
issued  in  the  United  States  for  passage  by  any  vessel  to  a  port  or  place  not 
in  the  United  States,  Canada,  or  Mexico,  if  costing  not  exceeding  $30,  $1; 
costing  more  than  $30  and  not  exceeding  $60,  $3;  costing  more  than  $60,  $5. 
This  subdivision  shall  not  apply  to  passage  tickets  costing  $10  or  less. 

10.  Proxy  for  voting  at  any  election  for  officers,  or  meeting  for  the  trans- 
action of  business,  of  any  corporation,  except  religious,  educational, 
charitable,  fraternal,  or  literary  societies,  or  public  cemeteries,  10  cents. 

11.  Power  of  attorney  granting  authority  to  do  or  perform  some  act  for 
or  in  behalf  of  the  grantor,  which  authority  is  not  otherwise  vested  in  the 
grantee,  25  cents.  This  subdivision  shall  not  apply  to  any  papers  neces- 
sary to  be  used  for  the  collection  of  claims  from  the  United  States  or 
from  any  state  for  pensions,  back  pay,  bounty,  or  for  property  lost  in  the 
military  or  naval  service,  nor  to  powers  of  attorney  required  in  bankruptcy 
cases  nor  to  powers  of  attorney  contained  in  the  application  of  those  who 
become  members  of  or  policyholders  in  mutual  insurance  companies  doing 
business  on  the  inter-insurance  or  reciprocal  indemnity  plan  through  an 
attorney  in  fact. 

12.  Playing  cards:  Upon  every  pack  of  playing  cards  containing  not 
more  than  fifty-four  cards,  manufactured  or  imported,  and  sold,  or  re- 
moved for  consumption  or  sale,  a  tax  of  8  cents  per  pack. 


REVENUE    ACT    OF    1921  1391 

13.  On  each  polity  of  insurance,  or  certificate,  binder,  covering  note, 
memorandum,  cablegram,  letter,  or  other  instrument  by  whatever  name 
called  whereby  insurance  is  made  or  renewed  upon  property  within  the 
United  States  (including  rents  and  profits)  against  peril  by  sea  or  on  inland 
waters  or  in  transit  on  land  (including  trans-shipments  and  storage  at 
termini  or  way  points)  or  by  fire,  lightning,  tornado,  wind-storm,  bombard- 
ment, invasion,  insurrection  or  riot,  issued  to  or  for  or  in  the  name  of  a  do- 
mestic corporation  or  partnership  or  an  individual  resident  of  the  United 
States  by  any  foreign  corporation  or  partnership  or  any  individual  not  a 
resident  of  the  United  States,  when  such  policy  or  other  instrument  is  not 
signed  or  countersigned  by  an  officer  or  agent  of  the  insurer  in  a  state, 
territory,  or  district  of  the  United  States  within  which  such  insurer  is 
authorized  to  do  business,  a  tax  of  3  cents  on  each  dollar,  or  fractional 
part  thereof  of  the  premium  charged:  Prorided,  That  policies  of  reinsurance 
shall  be  exempt  from  the  tax  imposed  by  this  subdivision. 

Any  person  to  or  for  whom  or  in  whose  name  any  such  policy  or  other 
instrument  is  issued,  or  any  solicitor  or  broker  acting  for  or  on  behalf  of 
such  person  in  the  procurement  of  any  such  policy  or  other  instrument, 
shall  affix  the  proper  stamps  to  such  policy  or  other  instrument,  and  for 
failure  to  affix  such  stamps  with  intent  to  evade  the  tax  shall,  in  addition 
tc  other  penalties  provided  therefor,  pay  a  fine  of  double  the  amount  of  the 
tax. 

TITLE  XII— TAX  ON  EMPLOYMENT  OF  CHILD  LABOR 

Sec.    1200.     That   every   person    (other  than   a   bona   fide   boys'   or   girls' 
canning  club  recognized  by  the  agricultural  department  of  a  state  and  of 
the    United    States)    operating    (a)    any   mine   or    quarry   situated    in    the 
United  States  in  which  children  under  the  age  of  sixteen  years  have  been 
employed  or  permitted  to  work  during  any  portion  of  the  taxable  year;  or 
(b)  any  mill,  cannery,  workshop,  factory,  or  manufacturing  establishment 
situated  in  the  United  States  in  which  children  under  the  age  of  fourteen 
years  have  been  employed  or  permitted  to  work,  or  children  between  the 
ages  of   fourteen   and    sixteen   have   been   employed   or    permitted    to   work 
more  than  eight  hours  in  any  day  or  more  than  six  days   in   any   week, 
or  after  the  hour  of  seven  o'clock  post  meridian,  or  before  the  hour  of  six 
o'clock  ante  meridian,  during  any   portion  of  the  taxable  year,  shall  pay 
for  each  taxable  year,  in  addition  to  all  other  taxes  imposed  by  law  (but  in 
lieu  of  the  tax  imposed  by  section  1200  of  the  Revenue  Act  of  1918),  an  ex- 
cise tax  equivalent  to  10  per  centum  of  the  entire  net  profits  received  or  ac- 
crued for  such  vear  from  the  sale  or  disposition  of  the  product  of  such  mine, 
quarry,  mill,  cannery,  workshop,  factory,  or  manufacturing  establishment. 
Sec.   1201.     That  in  computing  net   profits   under  the   provisions  of  this 
title,   for   the   purpose   of   the   tax   there    shall    be    allowed    as    deductions 
from  the  gross  amount  received  or  accrued  for  the  taxable  year  from  the 
sale  or  disposition  of  such  products  manufactured  within  the  United  SUtes 
the  following  items: 

(a)  The  cost  of  raw  materials  entering  into  the  production; 

(b)  Running  expenses,  including  rentals,  cost  of  repairs,  and  mainte- 
nance, heat,  power,  insurance,  management,  and  a  resonable  allowance  for 
salaries  or  other  compensations  for  personal  services  actually  rendered, 
and  for  depreciation; 


1392  APPENDIX 

(c)  Interest  paid  within  the  taxable  year  on  debts  or  loans  contracted  to 
meet  the  needs  of  the  business,  and  the  proceeds  of  which  have  been  ac- 
tually used  to  meet  such  needs; 

(d)  Taxes  of  all  kinds  paid  during  the  taxable  year  with  respect  to  the 
business  or  property  relating  to  the  production;  and 

(e)  Losses  actually  sustained  within  the  taxable  year  in  connection  with 
the  business  of  producing  such  products,  including  losses  from  fire,  flood, 
storm,  or  other  casualties,  and  not  compensated  for  by  insurance  or  other- 
wise. 

Sec.  1202.  That  if  any  such  person  during  any  taxable  year  or  part 
thereof,  whether  under  any  agreement,  arrangement,  or  understanding  or 
otherwise,  sells  or  disposes  of  any  product  of  such  mine,  quarry,  mill,  can- 
nery, workshop,  factory,  or  manufacturing  establishment  at  less  than  the 
fair  market  price  obtainable  therefor  either  (a)  in  such  manner  as  directly 
or  indirectly  to  benefit  such  person  or  any  person  directly  or  indirectly 
interested  in  the  business  of  such  person;  or  (b)  with  intent  to  cause  such 
benefit;  the  gross  amount  received  or  accrued  for  such  year  or  part  thereof 
from  the  sale  or  disposition  of  such  product  shall  be  taken  to  be  the 
amount  which  would  have  been  received  or  accrued  from  the  sale  or  dis- 
position of  such  product  if  sold  at  the  fair  market  price. 

Sec.  1203.  (a)  That  no  person  subject  to  the  provisions  of  this  title  shall 
be  liable  for  the  tax  herein  imposed  if  the  only  employment  or  permission 
to  work  which  but  for  this  section  would  subject  him  to  the  tax  has  been 
of  a  child  as  to  whom  such  person  has  in  good  faith  procured  at  the  time  of 
employing  such  child  or  permitting  him  to  work,  and  has  since  in  good 
faith  relied  upon  and  kept  on  file  a  certificate,  issued  in  such  form,  under 
such  conditions  and  by  such  persons  as  may  be  prescribed  by  a  board  con- 
sisting of  the  Secretary,  the  Commissioner,  and  the  Secretary  of  Labor, 
showing  the  child  to  be  of  such  age  as  not  to  subject  such  person  to  the 
tax  imposed  by  this  title.  Any  person  who  knowingly  makes  a  false  state- 
ment or  presents  false  evidence  in  or  in  relation  to  any  such  certificate  or 
application  therefor  shall  be  punished  by  a  fine  of  not  less  than  $100,  nor 
more  than  $1,000,  or  by  imprisonment  for  not  more  than  three  months,  or 
by  both  such  fine  and  imprisonment,  in  the  discretion  of  the  court. 

In  any  state  designated  by  such  board  an  employment  certificate  or  other 
similar  paper  as  to  the  age  of  the  child,  issued  under  the  laws  of  that 
state,  and  not  inconsistent  with  the  provisions  of  this  title,  shall  have  the 
same  force  and  effect  as  a  certificate  herein  provided  for. 

(b)  The  tax  imposed  by  this  title  shall  not  be  imposed  in  the  case  of  any 
person  who  proves  to  the  satisfaction  of  the  Secretary  that  the  only  em- 
ployment or  permission  to  work  which  but  for  this  section  would  subject 
him  to  the  tax,  has  been  of  a  child  employed  or  permitted  to  work  under 
a  mistake  of  fact  as  to  the  age  of  such  child,  and  without  intention  to 
evade  the  tax. 

Sec.  1204.  That  on  or  before  the  first  day  of  the  third  month  following 
the  close  of  each  taxable  year,  a  true  and  accurate  return  under  oath  shall 
be  made  by  each  person  subject  to  the  provisions  of  this  title  to  the  col- 
lector for  the  district  in  which  such  person  has  his  principal  office  or 
place  of  business,  in  such  form  as  the  Commissioner,  with  the  approval  of 
the  Secretary,  shall  prescribe,  setting  forth  specifically  the  gross  amount 
of  income  received  or  accrued  during  such  year  from  the  sale  or  dis- 
position of  the  product  of  any  mine,  quarry,  mill,  cannery,  workshop,  fac- 


REVENUE"  ACT    OF    1921  1393 

tory,  or  manufacturing  establishment,  in  which  children  have  been  em- 
ployed subjecting  him  to  the  tax  imposed  by  this  title,  and  from  the  total 
thereof  deductinfr  the  apTKicKate  items  of  allowance  authorized  by  this 
title,  and  such  other  particulars  as  to  the  gross  receipts  and  items  of  allow- 
ance authorized  by  this  title,  and  such  other  particulars  as  to  the  gross 
receipts  and  items  of  allowance  as  the  Commissioner,  with  the  approval  of 
the  Secretary,  may  require. 

Sec.  1205.  That  all  such  returns  shall  be  transmitted  forthwith  by  the 
collector  to  the  Commissioner,  who  shall,  as  soon  as  practicable,  assess  the 
tax  found  due  and  notify  the  person  making  such  I'eturn  of  the  amount  of 
tax  for  which  such  person  is  liable,  and  such  person  shall  pay  the  tax  to  the 
collector  on  or  before  thirty  days  from  the  date  of  such  notice. 

Sec.  1206.  That  for  the  purposes  of  this  Act  the  Commissioner,  or  any 
person  duly  authorized  by  him,  shall  have  authority  to  enter  and  inspect  at 
any  time  any  mine,  c]uarry,  mill,  cannery,  workshop,  factory,  or  manufactur- 
ing establishment.  The  Secretary  of  Labor,  or  any  person  duly  authorized 
by  him,  shall,  for  the  purpose  of  complying  with  a  request  of  the  Commis- 
sioner to  make  such  an  inspection,  have  like  authority,  and  shall  make  re- 
port to  the  Commissioner  of  inspections  made  under  such  authority  in 
such  form  as  may  be  prescribed  by  the  Commissioner  with  the  approval  of 
the  Secretary  of  the  Treasury. 

Any  person  who  refuses  or  obstructs  entry  or  inspection  authorized  by 
this  section  shall  be  punished  by  a  fine  of  not  more  than  $1,000,  or  by  im- 
prisonment for  not  more  than  one  year,  or  both. 

Sec.  1207.  That  as  used  in  this  title  the  term  "taxable  year"  shall  have 
the  same  meaning  as  provided  for  the  pui*poses  of  income  tax  in  section  200. 

TITLE  XIII— GENERAL  ADMINISTRATIVE  PROVISIONS 

LAWS    MADE   APPLICABLE 

Sec.  1300.  That  all  administrative,  special,  or  stamp  provisions  of  law, 
including  the  law  relating  to  the  assessment  of  taxes,  so  far  as  applicable, 
are  hereby  extended  to  and  made  a  part  of  this  Act,  and  every  pei\-^on  liable 
to  any  tax  imposed  by  this  Act,  or  for  the  collection  thereof,  shall  keep 
such  records  and  I'ender,  under  oath,  such  statements  and  returns,  and  shall 
comply  with  such  regulations  as  the  Commissioner,  with  the  approval  of  the 
Secretary,  may  from  time  to  time  prescribe. 

METHOD    OF   COLLECTING    TAX 

Sec.  1301.  That  whether  or  not  the  method  of  collecting  any  tax  im- 
posed by  Titles  V,  VI,  VII,  VIII,  IX,  or  X  of  this  Act  is  specifically  pro- 
vided therein,  any  such  tax  may,  under  regulations  prescribed  by  the  Com- 
missioner with  the  approval  of  the  Secretary,  be  collected  by  stamp,  coupon, 
serial-numbered  ticket,  or  such  other  reasonable  device  or  method  as  may 
be  necessary  or  helpful  in  securing  a  complete  and  prompt  collection  of  the 
tax.  All  administrative  and  penalty  provisions  of  Title  XI,  in  so  far  as 
applicable,  shall  apply  to  the  collection  of  any  tax  which  the  Commis- 
sioner determines  or  prescribes  shall   be  collected  in  such   manner. 

PENALTIES 

Sec.  1302.  (a)  That  any  per.son  ri"(iuirc'<l  under  Titles  V.  VI,  VII.  VIII,  IX, 
X,  or  XII,  to  pay,  or  to  collect,  account  for  and  pay  over  any  tax,  or  re- 
quired by  law  or  regulations  made  under  authority  thereof  to  make  a  re- 


1394  APPENDIX 

turn  or  supply  any  information  for  the  purposes  of  the  computation,  assess- 
ment, or  collection  of  any  such  tax,  who  fails  to  pay,  collect,  or  truly  ac- 
count for  and  pay  over  any  such  tax,  make  any  such  return  or  supply  any 
such  information  at  the  time  or  times  required  by  law  or  regulation  shall 
in  addition  to  other  penalties  provided  by  law  be  subject  to  a  penalty  of 
not  more  than  $1,000. 

(b)  Any  person  who  willfully  refuses  to  pay,  collect,  or  truly  account  for 
and  pay  over  any  such  tax,  make  such  return  or  supply  such  information  at 
the  time  or  times  required  by  law  or  regulation,  or  who  willfully  attempts 
in  any  manner  to  evade  such  tax,  shall  be  guilty  of  a  misdemeanor  and  in 
addition  to  other  penalties  provided  by  law  shall  be  fined  not  more  than 
$10,000  or  imprisoned  for  not  more  than  one  year,  or  both,  together  with  the 
costs  of  prosecution. 

(c)  Any  person  who  willfully  refuses  to  pay,  collect,  or  truly  account 
for  and  pay  over  any  such  tax  shall  in  addition  to  other  penalties  pro- 
vided by  law  be  liable  to  a  penalty  of  the  amount  of  the  tax  evaded,  or  not 
paid,  collected,  or  accounted  for  and  paid  over,  to  be  assessed  and  collected 
in  the  same  manner  as  taxes  are  assessed  and  collected:  Provided,  hoivever, 
That  no  penalty  shall  be  assessed  under  this  subdivision  for  any  offense  for 
which  a  penalty  may  be  assessed  under  authority  of  section  3176  of  the 
Revised  Statutes,  as  amended,  or  for  any  offense  for  which  a  penalty  has 
been  recovered  under  section  3256  of  the  Revised  Statutes. 

(d)  The  term  "person"  as  used  in  this  section  includes  an  officer  or 
employee  of  a  corporation  or  a  member  or  employee  of  a  partnership, 
who  as  such  officer,  employee,  or  member  is  under  a  duty  to  perform  the 
act  in  respect  of  which  the  violation  occurs. 

RULES   AND   REGULATIONS 

Sec.  1303.  That  the  Commissioner,  with  the  approval  of  the  Secretary,  is 
hereby  authorized  to  make  all  needful  rules-  and  regulations  for  the  en- 
forcement of  the  provisions  of  this  Act. 

The  Commissioner,  with  such  approval  may  by  regulation  provide  that 
any  return  required  by  Titles  V,  VI,  VII,  VIII,  IX,  or  X  to  be  under  oath 
may,  if  the  amount  of  the  tax  covered  thereby  is  not  in  excess  of  $10,  be 
signed  or  acknowledged  before  two  witnesses  instead  of  under  oath. 

OVERPAYMENTS   AND    OVERCOLLECTIONS 

Sec.  1304.  That  in  the  case  of  any  overpayment  or  overcollection  of  any 
tax  imposed  by  section  602  or  by  Title  V,  Title  VIII,  or  Title  IX,  the  person 
making  such  overpayment  or  overcollection  may  take  credit  therefor 
against  taxes  due  upon  any  monthly  return,  and  shall  make  refund  of  any 
excessive  amount  collected  by  him  upon  proper  application  by  the  person 
entitled  thereto. 

FRACTIONAL  PARTS   OF   A  CENT 

Sec.  1306.  That  in  the  payment  of  any  tax  under  this  Act  not  payable 
by  stamp  a  fractional  part  of  a  cent  shall  be  disregarded  unless  it  amounts 
to  one-half  cent  or  more,  in  which  case  it  shall  be  increased  to  1  cent. 

RETURNS 

Sec.  1307.  That  whenever  in  the  judgment  of  the  Commissioner  neces- 
sary he  may  require  any  person,  by  notice  served  upon  him,  to  make  a  re- 


REVENUE    ACT    OF    1<J21  1395 

turn  or   such   statements   as    he   deems   sufficient    to   show    whether  or   not 
such  person  is  liable  to  tax. 

EXAMINATH).N    OF   B(M)KS    ANU    WITNESSES 

Sec.  1308.  That  the  Commissioner,  for  the  purpose  of  ascertaining  the 
correctness  of  any  return  or  for  the  purpose  of  making  a  return  where 
none  has  been  made,  is  hereby  authorized,  by  any  revenue  agent  or  in- 
spector designated  by  him  for  that  purpose,  to  examine  any  books,  papers, 
records,  or  memoranda  bearing  upon  the  matters  required  to  be  included 
in  the  return,  and  may  require  the  attendance  of  the  person  rendering  the 
return  or  of  any  officer  or  employee  of  such  person,  or  the  attendance  of 
any  other  person  having  knowledge  in  the  premises,  and  may  take  his  testi- 
mony with  reference  to  the  matter  required  by  law  to  be  included  in  such 
return,  with  power  to  administer  oaths  tp  such  person  or  persons. 

UNNECESSARY     EXAMINATIONS 

Sec.  1309.  That  no  taxpayer  shall  be  subjected  to  unnecessary  examina- 
tions or  investigations,  and  only  one  inspection  of  a  taxpayer's  books  of 
account  shall  be  made  for  each  taxable  year  unless  the  taxpayer  requests 
otherwise  or  unless  the  Commissioner,  after  investigation,  notifies  the  tax- 
payer in  writing  that  an  additional  inspection  is  necessary. 

JURISDICTION    OF   COURTS 

Sec.  1310.  (a)  That  if  any  person  is  summoned  under  this  Act  to  appear, 
to  testify,  or  to  produce  books,  paper.s  or  other  data,  the  district  court  of 
the  United  States  for  the  district  in  which  such  person  resides  shall  have 
jurisdiction  by  appropriate  process  to  compel  such  attendance,  testimony, 
or  production  of  books,  papers,  or  other  data. 

(b)  The  district  courts  of  the  United  States  at  the  instance  of  the  United 
States  are  hereby  invested  with  such  jurisdiction  to  make  and  issue,  both 
in  actions  at  law  and  suits  in  equity,  writs  and  orders  of  injunction,  and  of 
ne  exeat  republica,  orders  appointing  receivers,  and  such  other  orders  and 
process,  and  to  render  such  judgments  and  decrees,  granting  in  proper 
cases  both  legal  and  equitable  relief  together,  as  may  be  necessary  or  ap- 
propriate for  the  enforcement  of  the  provisions  of  this  Act.  The  remedies 
hereby  provided  are  in  addition  to  and  not  exclusive  of  any  and  all  other 
remedies  of  the  United  States  in  such  courts  or  otherwise  to  enforce  such 
provisions.  J 

(c)  Paragraph  twentieth  of  section  24  of  the  Judicial  Code  is  amended 
by  adding  at  the  end  thereof  the  following  new  paragraph: 

"Concurrent  with  the  Court  of  Claims,  of  any  suit  or  proceeding,  com- 
menced after  the  passage  of  the  Revenue  Act  of  1921,  for  the  recovery  of 
any  internal-revenue  tax  alleged  to  have  been  erroneously  or  illegally 
assessed  or  collected,  or  of  any  penalty  claimed  to  have  been  collected  with- 
out authority  or  any  sum  alleged  to  have  been  excessive  or  in  any  manner 
wrongfully  collected,  under  the  internal-revenue  laws,  even  if  the  claim  ex- 
ceeds If  10,000,  if  the  collector  of  internal-revenue  by  whom  such  tax,  penalty, 
or  sum  was  collected  is  dead  at  the  time  such  suit  or  proceeding  is  com- 
menced." 

AMENDMENTS  TO  REVISED  STATUTES 

Sec.  1311.  That  sections  3104,  3165.  3107,  3172.  3173,  and  3176  of  the  Re- 
vised Statutes,  as  amended,  are  re-enacted,  without  change,  as  follows: 


1396  APPENDIX 

"Sec.  3164.  It  shall  be  the  duty  of  every  collector  of  internal  revenue 
having  knowledge  of  any  willful  violation  of  any  law  of  the  United  States 
relating  to  the  revenue,  within  thirty  days  after  coming  into  possession  of 
such  knowledge,  to  file  with  the  district  attorney  of  the  district  in  which 
any  fine,  penalty,  or  forfeiture  may  be  incurred,  a  statement  of  all  the 
facts  and  circumstances  of  the  case  within  his  knowledge,  together  with 
the  names  of  the  witnesses,  setting  forth  the  provisions  of  law  believed  to 
be  so  violated  on  which  reliance  may  be  had  for  condemnation  or  con- 
viction. 

"Sec.  3165.  Every  collector,  deputy  collector,  internal-revenue  agent,  and 
internal-revenue  officer  assigned  to  duty  under  an  internal-revenue  agent, 
is  authorized  to  administer  oaths  and  to  take  evidence  touching  any  part 
of  the  administration  of  the  internal-revenue  laws  with  which  he  is  charged, 
or  where  such  oaths  and  evidence  are  authorized  by  law  or  regulation 
authorized  by  law  to  be  taken. 

"Sec.  3167.  It  shall  be  unlawful  for  any  collector,  deputy  collector,  agent, 
clerk,  or  other  officer  or  employee  of  the  United  States  to  divulge  or  to 
make  known  in  any  manner  whatever  not  provided  by  law  to  any  person  the 
operations,  style  of  work, -or  apparatus  of  any  manufacturer  or  producer 
visited  by  him  in  the  discharge  of  his  official  duties,  or  the  amount  or  source 
of  income,  profits,  losses,  expenditures,  or  any  particular  thereof,  set  forth 
or  disclosed  in  any  income  return,  or  to  permit  any  income  return  or  copy 
thereof  or  any  book  containing  any  abstract  or  particulars  thereof  to  be 
seen  or  examined  by  any  person  except  as  provided  by  law;  and  it  shall  be 
unlawful  for  any  person  to  print  or  publish  in  any  manner  whatever  not 
provided  by  law  any  income  return,  or  any  part  thereof  or  source  of  in- 
come, profits,  losses,  or  expenditures  appearing  in  any  income  return;  and 
any  offense  against  the  foregoing  provision  shall  be  a  misdemeanor  and  be 
punished  by  a  fine  not  exceeding  $1,000  or  by  imprisonment  not  exceeding 
one  year,  or  both,  at  the  discretion  of  the  court;  and  if  the  offender  be  an 
officer  or  employee  of  the  United  States  he  shall  be  dismissed  from  office 
or  discharged  from  employment. 

"Sec.  3172.  Every  collector  shall,  from  time  to  time,  cause  his  deputies 
to  proceed  through  every  part  of  his  district  and  inquire  after  and  con- 
cerning all  persons  therein  who  are  liable  to  pay  any  internal-revenue  tax, 
and  all  persons  owning  or  having  the  care  and  management  of  any  objects 
liable  to  pay  any  tax,  and  to  make  a  list  of  such  persons  and  enumerate 
said  objects. 

"Sec.  3173.  It  shall  be  the  duty  of  any  person,  partnership,  firm,  associa- 
tion, or  corporation,  made  liable  to  any  duty,  special  tax,  or  other  tax  im- 
posed by  law,  when  not  otherwise  provided  for,  (1)  in  case  of  a  special 
tax,  on  or  before  the  thirty-first  day  of  July  in  each  year,  and  (2)  in  other 
cases  before  the  day  on  which  the  taxes  accrue,  to  make  a  list  or  return, 
verified  by  oath,  to  the  collector  or  a  deputy  collector  of  the  district  where 
located,  of  the  articles  or  objects,  including  the  quantity  of  goods,  wares, 
and  merchandise,  made  or  sold  and  charged  with  a  tax,  the  several  rates 
and  aggregate  amount,  according  to  the  forms  and  regulations  to  be  pre- 
scribed by  the  Commissioner  of  Internal  Revenue,  with  the  approval  of  the 
Secretary  of  the  Treasury,  for  which  such  person,  partnership,  firm,  associa- 
tion, or  corporation  is  liable:  Provided,  That  if  any  person  liable  to  pay 
any  duty  or  tax,  or  owning,  possessing,  or  having  the  care  or  management 
of  property,  goods,  wares,  and  merchandise,  article  or  objects  liable  to  pay 
any  duty,  tax,  or  license,  shall  fail  to  make  and  exhibit  a  list  or  return  re- 


REVENUE    ACT    OF    H»2l  1397 

quired  by  law,  but  shall  consent  to  disclose  the  particulars  of  any  and  all 
the  property,  goods,  wares,  and  merchandise,  articles,  and  objects  liable 
to  pay  any  duty  or  tax,  or  any  business  or  occupation  liable  to  pay  any  tax 
as  aforesaid,  then,  and  in  that  case,  it  shall  be  the  duty  of  the  collector 
or  deputy  collector  to  make  such  list  or  return,  which,  beinfr  distinctly 
read,  consented  to,  and  signed  and  verified  by  oath  by  the  person  so  owning, 
possessing,  or  having  the  care  and  management  as  aforesaid,  may  be  re- 
ceived as  the  list  of  such  person:  Provided  further,  That  in  case  no  annual 
list  or  return  has  been  rendered  by  such  person  to  the  collector  or  deputy 
collector  as  required  by  law,  and  the  person  shall  be  absent  from  his  or  her 
residence  or  place  of  business  at  the  time  the  collector  or  a  deputy  collector 
shall  call  for  the  annual  list  or  return,  it  shall  be  the  duty  of  such  collector 
or  deputy  collector  to  leave  at  such  place  of  residence  or  business,  with 
some  one  of  suitable  age  and  discretion,  if  such  be  present,  otherwise  to 
deposit  in  the  nearest  post-office,  a  note  or  memorandum  addressed  to  such 
person,  requiring  him  or  her  to  render  to  such  collector  or  deputy  collector 
the  list  or  return  required  by  law  within  ten  days  from  the  date  of  such 
note  or  memorandum,  verified  by  oath.  And  if  any  person,  on  being  notified 
or  required  as  aforesaid,  shall  refuse  or  neglect  to  render  such  list  or 
return  within  the  time  required  as  aforesaid,  or  whenever  any  person  who 
is  required  to  deliver  a  monthly  or  other  return  of  objects  subject  to  tax 
fails  to  do  so  at  the  time  required,  or  delivers  any  return  which,  in  the 
opinion  of  the  collector,  is  erroneous,  false,  or  fraudulent,  or  contains  any 
undervaluation  or  understatement,  or  refuses  to  allow  any  regularly  author- 
ized government  officer  to  examine  the  books  of  such  person,  firm,  or  cor- 
poration, it  shall  be  lawful  for  the  collector  to  summon  such  person,  or  any 
other  person  having  possession,  custody,  or  care  of  books  of  account  con- 
taining entries  relating  to  the  business  of  such  person  or  any  other  per- 
son he  may  deem  proper,  to  appear  before  him  and  produce  such  books  at 
a  time  and  place  named  in  the  summons,  and  to  give  testimony  or  answer 
interrogatories,  under  oath,  respecting  any  objects  or  income  liable  to  tax 
or  the  returns  thereof.  The  collector  may  summon  any  person  residing  or 
found  within  the  state  or  territory  in  which  his  district  lies;  and  when  the 
person  intended  to  be  summoned  does  not  reside  and  can  not  be  found 
within  such  state  or  territory,  he  may  enter  any  collection  district  where 
such  person  may  be  found  and  there  make  the  examination  herein  author- 
ized. And  to  this  end  he  may  there  exercise  all  the  authority  which  he 
mi^ht  lawfully  exercise  in  the  district  for  which  he  was  commissioned : 
Provided,  That  'person,'  as  used  in  this  section,  shall  be  construed  to  in- 
clude any  corporation,  joint-stock  company  or  association,  or  insurance 
company  when  such  construction  is  necessary  to  carry  out  its  provisions. 
"Sec.  3176.  If  any  person,  corporation,  company,  or  association  fails 
to  make  and  file  a  return  or  list  at  the  time  prescribed  by  law  or  by  regula- 
tion made  under  authority  of  law,  or  makes,  willfully  or  otherwise,  a 
false  or  fraudulent  return  or  list,  the  collector  or  deputy  collector  shall 
make  the  return  or  list  from  his  own  knowledge  and  from  such  information 
as  he  can  obtain  through  testimony  or  otherwise.  In  any  such  case  the 
Commissioner  may,  from  his  own  knowledge  and  from  such  information 
as  he  can  obtain  through  testimony  or  otherwise,  make  a  return  or  amend 
any  return  made  by  a  collector  or  deputy  collector.  Any  return  or  list  so 
made  and  subscribed  by  the  Commissioner,  or  by  a  collector  or  deputy  col- 
lector and  approved  by  the  Commissioner,  shall  be  prima  facie  good  anrl 
sufficient  for  all  legal  purposes. 


1398  APPENDIX 

"If  the  failure  to  file  a  return  or  list  is  -due  to  sickness  or  absence,  the 
collector  may  allow  such  further  time,  not  exceeding  thirty  days,  for  making 
and  filing  the  return  or  list  as  he  deems  proper. 

"The  Commissioner  of  Internal  Revenue  shall  determine  and  assess  all 
taxes,  other  than  stamp  taxes,  as  to  which  returns  or  lists  are  so  made 
under  the  provisions  of  this  section.  In  case  of  any  failure  to  make  and 
file  a  return  or  list  within  the  time  prescribed  by  law,  or  prescribed  by 
the  Commissioner  of  Internal  Revenue  or  the  collector  in  pursuance  of  law, 
the  Commissioner  of  Internal  Revenue  shall  add  to  the  tax  25  per  centum 
of  its  amount,  except  that  when  a  return  is  filed  after  such  time  and  it  is 
shown  that  the  failure  to  file  it  was  due  to  a  reasonable  cause  and  not  to 
willful  neglect,  no  such  addition  shall  be  made  to  the  tax.  In  case  a  false 
or  fraudulent  return  or  list  is  willfully  made,  the  Commissioner  of  Internal 
Revenue  shall  add  to  the  tax  50  per  centum  of  its  amount. 

"The  amount  so  added  to  any  tax  shall  be  collected  at  the  same  time 
and  in  the  same  manner  and  as  a  part  of  the  tax  unless  the  tax  has  been 
paid  before  the  discovery  of  the  neglect,  falsity,  or  fraud,  in  which  case 
the  amount  so  added  shall  be  collected  in  the  same  manner  as  the  tax." 

FINAL  DETERMINATIONS   AND   ASSESSMENTS 

Sec.  1312.  That  if  after  a  determination  and  assessment  in  any  case  the 
taxpayer  has  without  protest  paid  in  whole  any  tax  or  penalty,  or  accepted 
any  abatement,  credit,  or  refund  based  on  such  determination  and  assess- 
ment, and  an  agreement  is  made  in  writing  between  the  taxpayer  and  the 
Commissioner,  with  the  approval  of  the  Secretary,  that  such  determination 
and  assessment  shall  be  final  and  conclusive,  then  (except  upon  a  showing 
of  fraud  or  malfeasance  or  misrepresentation  of  fact  materially  affecting 
the  determination  or  assessment  thus  made)  (1)  the  case  shall  not  be 
reopened  or  the  determination  and  assessment  modified  by  any  officer, 
employee,  or  agent  of  the  United  States,  and  (2)  no  suit,  action,  or  pro- 
ceeding to  annul,  modify,  or  set  aside  such  determination  or  assessment 
shall  be  entertained  by  any  court  of  the  United  States. 

ADMINISTRATIVE   REVIEW 

Sec.  1313.  That  in  the  absence  of  fraud  or  mistake  in  mathematical  cal- 
culation, the  findings  of  facts  in  and  the  decision  of  the  Commissioner 
upon  (or  in  case  the  Secretary  is  authorized  to  approve  the  same,  then 
after  such  approval)  the  merits  of  any  claim  presented  under  or  author 
ized  by  the  internal  revenue  laws  shall  not  be  subject  to  review  by  any 
other  administrative  officer,  employee,  or  agent  of  the  United  States. 

RETROACTIVE  REGULATIONS 

Sec.  1314.  That  in  case  a  regulation  or  treasury  decision  relating  to  the 
internal  revenue  laws  made  by  the  Commissioner  or  the  Secretary,  or  by 
the  Commissioner  with  the  approval  of  the  Secretary,  is  reversed  by  a  sub- 
sequent regulation  or  treasury  decision,  and  such  reversal  is  not  im- 
mediately occasioned  or  required  by  a  decision  of  a  court  of  competent 
jurisdiction,  such  subsequent  regulation  or  treasury  decision  may,  in  the 
discretion  of  the  Commissioner,  with  the  approval  of  the  Secretary,  be 
applied  without  retroactive  effect. 

REFUNDS 
Sec.  1315.  That   section    3220    of   the    Revised    Statutes,    as    amended,    is 
re-enacted  without  change,  as  follows: 


REVENUE    ACT    OF    1921  1399 

"Sec.  3220.  The  Commissioner  of  Internal  Revenue,  subject  to  regula- 
tions prescribed  by  the  Secretary  of  the  Treasury,  is  authorized  to  remit, 
refund,  and  pay  back  all  taxes  erroneously  or  illegally  assessed  or  collected, 
all  penalties  collected  without  authority,  and  all  taxes  that  appear  to  be 
unjustly  assessed  or  excessive  in  amount,  or  in  any  manner  wrongfully 
collected ;  also  to  repay  to  any  collector  or  deputy  collector  the  full  amount 
of  such  sums  of  money  as  may  be  recovered  against  him  in  any  court, 
for  any  internal  revenue  taxes  collected  by  him,  with  the  cost  and  expenses 
of  suit;  also  all  damages  and  costs  recovered  against  any  assessor,  as- 
sistant assessor,  collector,  deputy  collector,  agent,  or  inspector,  in  any  suit 
brought  against  him  by  reason  of  anything  done  in  the  due  performance 
of  his  official  duty,  and  shall  make  report  to  Congress  at  the  beginning  of 
each  regular  session  of  Congress  of  all  transactions  under  this  section." 

Sec.  131(i.  That  section  3228  of  the  Revised  Statutes  is  amended  to  read 
as  follows: 

"Sec.  3228.  All  claims  for  the  refunding  or  crediting  of  any  internal 
revenue  tax  alleged  to  have  been  erroneously  or  illegally  assessed  or  col- 
lected, or  of  any  penalty  alleged  to  have  been  collected  without  authority, 
or  of  any  sum  alleged  to  have  been  excessive  or  in  any  manner  wrong- 
fully collected,  must  be  presented  to  the  Commissioner  of  Internal  Revenue 
within  four  years  next  after  payment  of  such  tax,  penalty,  or  sum." 

This  section,  except  as  modified  by  section  252,  shall  apply  retroactively 
to  claims  for  refund  under  the  Revenue  Act  of  191(i,  the  Revenue  Act  of 
1917,  and  the  Revenue  Act  of  1918. 

Sec.  1317.  That  the  paragraph  of  section  3689  of  the  Revised  Statutes, 
as  amended,  reading  as  follows:  "Refunding  taxes  illegally  collected  (in- 
ternal revenue):  To  refund  and  pay  back  duties  erroneously  or  illegally 
assessed  or  collected  under  the  internal  revenue  laws,"  is  repealed  from 
and  after  June  30,  1920;  and  the  Secretary  of  the  Treasury  shall  submit  for 
the  fiscal  year  1921,  and  annually  thereafter,  an  estimate  of  appropriations 
to  refund  and  pay  back  duties  or  taxes  erroneously  or  illegally  assessed  or 
collected  under  the  internal  revenue  laws,  and  to  pay  judgments,  in- 
cluding interest  and  costs,  i*endered  for  taxes  or  penalties  erroneously  or 
illegally  assessed  or  collected  under  the  internal  revenue  laws. 

LIMITATIONS    UPON    SUITS   AND    PROSECUTIONS 

Sec.  1318.  That  section  3226  of  the  Revised  Statutes  is  amended  to 
read  as  follows: 

"Sec.  3226.  No  suit  or  proceeding  shall  be  maintained  in  any  court 
for  the  recovery  of  any  internal  revenue  tax  alleged  to  have  been  er- 
roneously or  illegally  assessed  or  collected,  or  of  any  penalty  claimed  to 
have  been  collected  without  authority,  or  of  any  sum  alleged  to  have  been 
excessive  or  in  any  maimer  wrongfully  collected,  until  a  claim  for  refund 
or  credit  has  been  duly  filed  with  the  Commissioner  of  Internal  Revenue, 
according  to  the  provisions  of  law  in  that  regard,  and  the  regulations  of 
the  Secretary  of  the  Treasury  established  in  pursuance  thereof.  No  such 
suit  or  proceeding  shall  be  begun  before  the  expiration  of  six  months  from 
the  date  of  filing  such  claim  unless  the  Commissioner  renders  a  decision 
thereon  within  that  time,  nor  after  the  expiration  of  five  years  from  the 
date  of  the  payment  of  such  tax,  penalty,  or  sum." 

This  section  shall  not  affect  any  suit  or  proceeding  instituted  prior  to 
the  passage  of  this   .'Vet.  but   shall   apply  to  all   suits  and   proceedings   in- 


1400  APPENDIX 

stituted  after  the  passage  of  this  Act,  whether  or  not  barred  by  prior  Acts 
of  Congress. 

Sec.  1319.  That  section  3227  of  the  Revised  Statutes  is  hereby  re- 
pealed but  such  repeal  shall  not  affect  any  suit  or  proceeding  instituted 
prior  to  the  passage  of  this  Act. 

Sec.  1320.  That  no  suit  or  proceeding  for  the  collection  of  any  internal 
revenue  tax  shall  be  begun  after  the  expiration  of  five  years  from  the  time 
such  tax  was  due,  except  in  the  case  of  fraud  with  intent  to  evade  tax,  or 
willful  attempt  in  any  manner  to  defeat  or  evade  tax.  This  section  shall 
not  apply  to  suits  or  proceedings  for  the  collection  of  taxes  under  section 
250  of  this  Act,  nor  to  suits  or  proceedings  begun  at  the  time  of  the  pas- 
sage of  this  Act. 

Sec.  1321.  (a)  That  the  Act  entitled  "An  Act  to  limit  the  time  withiji 
which  prosecutions  may  be  instituted  against  persons  charged  with  violat- 
ing internal-revenue  laws,"  approved  July  5,  1884,  is  amended  to  read  as 
follows: 

"That  no  person  shall  be  prosecuted,  tried,  or  punished  for  any  of  the 
various  offenses  arising  under  the  internal-revenue  laws  of  the  United 
States  unless  the  indictment  is  found  or  the  information  instituted  within 
three  years  next  after  the  commission  of  the  offense :  Provided,  That  the  time 
during  which  the  person  committing  the  offense  is  absent  from  the  dis- 
trict wherein  the  same  is  committed  shall  not  be  taken  as  any  part  of  the 
time  limited  by  law  for  the  commencement  of  such  proceedings:  Provided 
further,  That  the  provisions  of  this  Act  shall  not  apply  to  offenses  com- 
mitted prior  to  its  passage:  Provided  further.  That  where  a  complaint  shall 
be  instituted  before  a  commissioner  of  the  United  States  within  the  period 
above  limited,  the  time  shall  be  extended  until  the  discharge  of  the  grand 
jury  at  its  next  session  within  the  district:  And  provided  further,  That 
this  Act  shall  not  apply  to  offenses  committed  by  officers  of  the  United 
States." 

(b)  Any  prosecution  or  proceeding  under  an  indictment  found  or  informa- 
tion instituted  prior  to  the  passage  of  this  Act  shall  not  be  affected  in 
any  manner  by  this  amendment,  but  such  prosecution  or  proceeding  shall 
be  subject  to  the  limitations  imposed  by  law  prior  to  the  passage  of  this 
Act. 

ASSESSMENTS 

Sec.  1322.  That  all  internal  revenue  taxes,  except  as  provided  in  section 
250  of  this  Act,  shall,  notwithstanding  the  provisions  of  section  3182  of 
the  Revised  Statutes  or  any  other  provision  of  law,  be  assessed  within  four 
years  after  such  taxes  became  due,  but  in  the  case  of  fraud  with  intent 
to  evade  tax  or  willful  attempt  in  any  manner  to  defeat  or  evade  tax,  such 
tax  may  be  assessed  at  any  time. 

FRAUDULENT  RETURNS 

Sec.  1323.  That  section  3225  of  the  Revised  Statutes  of  the  United 
States,  as  amended,  is  re-enacted  without  change  as  follows: 

"Sec.  3225.  When  a  second  assessment  is  made  in  case  of  any  list,  state- 
ment, or  return,  which  in  the  opinion  of  the  collector  or  deputy  collector 
was  false  or  fraudulent,  or  contained  any  understatement  or  undervalua- 
tion, such  assessment  shall  not  be  remitted,  nor  shall  taxes  collected  under 
such  assessment  be  refunded,  or  paid  back,  or  recovered  by  any  suit,  un- 


REVENUE    ACT    OF    1921  1401 

less  it  is  proved  that  such  list,  statement,  or  return  was  not  willfully 
false  or  fraudulent  and  did  not  contain  any  willful  understatement  or 
undervaluation." 

INTEREST  ON    REFUNDS  AND  JUDGMENTS 

Sec    1324.   (a)   That  upon  the  allowance  of  a  claim   for   the   refund   of 
or  c  edit  for  internal  revenue  taxes  paid,  interest  shall  be  allowed  and  pa.d 
upon  the  total  amount  of  such  refund  or  credit  at  the  rate  of  one-half  o 
1    per  centum   per   month   to  the  date  of   such   allowance,  as  follows:      1 
f  'such  amount  was   paid   under  a   specific   protest   sett.n.  forth   ,n   deta.l 
he  basis  of  and  reasons  for  such   protest,  from  the  t.me  when   such   tax 
was  pai^.  or   (2)   if  such  amount  was  not  paid  under  protest  but  pursuan 
To  an  additional  assessment,  from  the  time  such  addit.onal  assessment    va 
paid    or   (3)   if  no  protest  was  made  and  the  tax  was  not  Pan>  P--"^""^" 
an  additional  assessment,  from  six  months  after  the  date  of  fihng  of  such 
cl"im  for  refund  or  credit.     The  term  "additional  assessment"  as  used  m 
ihllsecln  means  a  further  assessment  for  a  tax  of  the  same  character 

nreviously  paid  in  part. 

(b)  Section  177  of  the  Judicial  Code  is  amended  to  read  as  follows: 
"Sec  177  No  interest  shall  be  allowed  on  any  claim  up  to  the  time  of 
the  rendition  of  judgment  by  the  Court  of  Claims,  unless  upon  a  contract 
xpressly  stipulaUng  for  the  payment  of  interest,  except  that  -terest  may 
be  allowed  in  any  judgment  of  any  court  rendered  after  ^e  passage  of  the 
Revenue  Act  of  1921  against  the  United  States  for  any  mternal-ievenue  tax 
frroneously  or  illegally  assessed  or  collected,  or  for  any  P-'^^^^  -^-^"^ 
without  authority  or  any  sum  which  was  excessne  or  m  any  manner  w.ong- 
fully  collected,  under  the  internal-revenue  laws." 

PAYMENT  OF  T.OCES  BY  CHECK  OR  UNITED   STATES   SECURITIES 

Sec.  1325.  That  collectors  may  receive,  at  par  with  an  adjustment  for 
accrued  interest,  notes  or  certificates  of  indebtedness  issued  by  the  Umted 
States  and  uncertified  checks  in  payment  of  income,  war-prohts  and  excess- 
profits  taxes  and  any  other  taxes  payable  other  than  by  stamp,  dunng  such 
time  and  under  such  regulations  as  the  Commissioner,  with  the  aPP^^^^^  °^ 
the  Secretary,  shall  prescribe;  but  if  a  check  so  received  >s  not  paid  by  the 
bank  on  which  it  is  drawn  the  person  by  whom  such  check  has  been  endered 
shall  remain  liable  for  the  payment  of  the  tax  and  for  all  legal  penalties  and 
additions  the  same  as  if  such  check  had  not  been  tendered. 

TAX  SIMPLIFICATION   BOARD 

Sec  1327  (a)  That  there  is  hereby  established  in  the  department  of  the 
treasury  a  board  to  be  known  as  the  "Tax  Simplification  Board"  (herein- 
after in  this  section  called  the  "Board"),  to  be  composed  as  follows: 

(1)    Three  members  who  shall  represent  the  public,  to  be  appointed  by  the 

President;  and  ,  ,   ^         10       „,,„ 

(•^)  Three  members  who  shall  represent  the  Bureau  of  Internal  Rexenue 
and%hall  be  officers  or  employees  of  the  United  States  serving  in  such 
bureau,  to  be  appointed  by  the  Secretary. 

(b)  Any  vacancy  in  the  board  shall  be  filled  in  the  same  manner  as  the 
original  appointment.  The  members  representing  the  public  shall  servo 
without  compensation  except  reimbursement  for  traveling,  subsistence,  and 
other  necessary  expenses  incurred  in  the  performance  of  the  duties  vested  in 
them  by  this  section.  The  members  representing  the  Bureau  of  Internal 
Revenue  shall  serve  without  compensation  in  addition  to  that  received  for 
their  service  in  such  bureau. 


1402  APPENDIX 

(c)  The  Secretary  shall  furnish  the  board  with  such  clerical  assistance, 
quarters  and  stationery,  furniture,  office  equipment,  and  other  supplies  as 
may  be  necessary  for  the  performance  of  the  duties  vested  in  them  by  this 
section. 

(d)  It  shall  be  the  duty  of  the  board  to  investigate  the  procedure  of  and 
the  forms  used  by  the  bureau  in  the  administration  of  the  internal  revenue 
law^s,  and  to  make  recommendations  in  respect  to  the  simplification  thereof. 
The  board  shall  make  a  report  to  the  Congress  on  or  before  the  first  Monday 
of  December  in  each  year. 

(e)  The  expenditures  of  the  board  shall  be  paid  upon  vouchers  approved 
by  the  board  and  signed  by  the  chairman  thereof.  For  the  expenditures  of 
the  board  for  the  fiscal  year  ending  June  30,  1922,  there  is  authorized  to  be 
appropriated,  out  of  any  money  in  the  treasury  not  otherwise  appropriated, 
the  sum  of  $10,000. 

(f)  The  board  shall  cease  to  exist  on  December  31,  1924. 

CONSOLIDATION   OF   LIBERTY  BOND  TAX  EXEMPTIONS 

Sec.  1328.  That  the  various  Acts  authorizing  the  issues  of  Liberty  bonds 
are  amended  and  supplemented  as  follows : 

(a)  On  and  after  January  1,  1921,  4  per  centum  and  4^  per  centum  Lib- 
erty bonds  shall  be  exempt  from  graduated  additional  income  taxes,  com- 
monly known  as  surtaxes,  and  excess-profits  and  war-profits  taxes,  now  or 
hereafter  imposed  by  the  United  States  upon  the  income  or  profits  of 
individuals,  partnerships,,  coi-porations,  or  associations,  in  respect  to  the 
interest  on  aggregate  principal  amounts  thereof  as  follows : 

Until  the  expiration  of  two  years  after  the  date  of  the  termination  of  the 
war  between  the  United  States  and  the  German  government,  as  fixed  by 
proclamation  of  the  President,  on  $125,000  aggregate  principal  amount;  and 
for  three  years  more  on  $50,000  aggregate  principal  amount. 

(b)  The  exemptions  provided  in  subdivision  (a)  shall  be  in  addition  to  the 
exemptions  provided  in  section  7  of  the  Second  Liberty  Bond  Act,  and  in 
addition  to  the  exemption  provided  in  subdivision  (3)  of  section  1  of  the 
supplement  to  the  Second  Liberty  Bond  Act  in  respect  to  bonds  issued  upon 
conversion  of  3  a  per  centum  bonds,  but  shall  be  in  lieu  of  the  exemptions 
provided  and  free  from  the  conditions  and  limitations  imposed  in  sub- 
divisions (1)  and  (2)  of  section  1  of  the  supplement  to  Second  Liberty  Bond 
Act  and  in  section  2  of  the  Victory  Liberty  Loan  Act. 

DEPOSIT  OF  UNITED  STATES  BONDS  OR  NOTES  IN  LIEU  OF  SURETY 

Sec.  1329.  That  wherever  by  the  laws  of  the  United  States  or  regula- 
tions made  pursuant  thereto,  any  person  is  required  to  furnish  any 
recognizance,  stipulation,  bond,  guaranty,  or  undertaking,  hereinafter 
called  "penal  bond,"  with  surety  or  sureties,  such  person  may,  in  lieu  of 
such  surety  or  sureties,  deposit  as  security  with  the  official  having  author- 
ity to  approve  such  penal  bond,  United  States  Liberty  bonds  or  other 
bonds  or  notes  of  the  United  States  in  a  sum  equal  at  their  par  value  to 
the  amount  of  such  penal  bond  required  to  be  furnished,  together  with  an 
agreement  authorizing  such  official  to  collect  or  sell  such  bonds  or  notes  so 
deposited  in  case  of  any  default  in  the  performance  of  any  of  the  condi- 
tions or  stipulations  of  such  penal  bond.  The  acceptance  of  such  United 
States  bonds  or  notes  in  lieu  of  surety  or  sureties  required  by  law  shall 
have  the  same  force  and  effect  as  individual  or  corporate  sureties,  or 
certified   cheeks,  bank   drafts,   post-office   money   orders,   or   cash,   for   the 


REVKNUE    ACT    OF    1921  1403 

penalty  or  amount  of  such  penal  bond.  The  bonds  or  notes  deposited  here- 
under and  such  other  United  States  bonds  or  notes  as  may  be  substituted 
therefor  from  time  to  time  as  such  security,  may  be  deposited  with  the 
Treasurer  of  the  United  States,  a  federal  reserve  bank,  or  other  depositary 
duly  designated  for  that  purpose  by  the  Secretary,  which  shall  issue  receipt 
therefor,  describing;  such  bonds  or  notes  so  deposited.  As  soon  as  security 
for  the  performance  of  such  penal  bond  is  no  longer  necessary,  such  bonds 
or  notes  so  deposited,  shall  be  returned  to  the  depositor:  Provided,  That 
in  case  a  person  or  persons  supplyinj?  a  contractor  with  labor  or  material 
as  provided  by  the  Act  of  Congress,  approved  February  24,  1905  (33  Stat. 
811),  entitled  "An  Act  to  amend  an  Act  approved  August  thirteenth,  eigh- 
teen hundred  and  ninety-four,  entitled  'An  act  for  the  protection  of  persons 
furnishing  materials  and  labor  for  the  construction  of  public  works.'  "  shall 
tile  with  the  obligee,  at  any  time  after  a  default  in  the  performance  of 
any  contract  subject  to  said  Acts,  the  application  and  affidavit  therein 
provided,  the  obligee  shall  not  deliver  to  the  obligor  the  deposited  bonds 
or  notes  nor  any  surplus  proceeds  thereof  until  the  expiration  of  the  time 
limited  by  said  Acts  for  the  institution  of  suit  by  such  person  or  persons, 
and,  in  case  suit  shall  be  instituted  within  such  time,  shall  hold  said  bonds 
or  notes  or  proceeds  subject  to  the  order  of  the  court  having  jurisdiction 
thereof:  Prodded  further.  That  nothing  herein  contained  shall  affect  or 
impair  the  priority  of  the  claim  of  the  United  States  against  the  bonds  or 
i.otes  deposited  or  any  right  or  remedy  granted  by  said  Acts  or  by  this  sec- 
lion  to  the  United  States  for  default  upon  any  obligation  of  said  penal  bond : 
Provided  further,  That  all  laws  inconsistent  with  this  section  are  hereby  so 
modified  as  to  conform  to  the  provisions  hereof:  And  provided  further,  That 
nothing  contained  herein  shall  affect  the  authority  of  courts  over  the 
security,  where  such  bonds  are  taken  as  security  in  judicial  proceedings, 
or  the  authority  of  any  administrative  officer  of  the  United  States  to  receive 
United  States  bonds  for  security  in  cases  authorized  by  existing  laws. 
The  Secretary  may  prescribe  rules  and  regulations  necessary  and  proper 
for  carrying  this  section  into  effect. 

CONSOLIDATED  RETURNS   FOR   YEAR    1917 

Sec.  1331.  (a)  That  Title  11  of  the  Revenue  Act  of  1917  shall  be  construed 
to  impose  the  taxes  therein  mentioned  upon  the  basis  of  consolidated  re- 
turns of  net  income  and  invested  capital  in  the  case  of  domestic  corpora- 
tions and  domestic  partnerships  that  were  affiliated  during  the  calendar 
year  1917. 

(b)  For  the  purpose  of  this  section  a  corporation  or  pai'tnership  was 
affiliated  with  one  or  more  corporations  or  partnerships  (1)  when  such 
corporation  or  partnership  owned  directly  or  controlled  through  closely 
affiliated  interests  or  by  a  nominee  or  nominees  all  or  substantially  all  the 
stock  of  the  other  or  others,  or  (2)  when  substantially  all  the  stock  of  two 
or  more  corporations  or  the  business  of  two  or  more  partnerships  was 
owned  by  the  same  interests:  Provided,  That  such  corporations  or  partner- 
ships were  engaged  in  the  same  or  a  closely  related  business,  or  one  cor- 
poration or  partnership  bought  from  or  sold  to  another  corporation  or  part- 
nership products  or  services  at  prices  above  or  below  the  current  market, 
thus  effecting  an  artificial  distribution  of  profits,  or  one  corporation  or 
partnership  in  any  way  so  arranged  its  financial  relationships  with  another 
corporation   or  partnership   as   to   assign   to   it   a   disproportionate   share   of 


1404  APPENDIX 

net  income  or  invested  capital.  For  the  purposes  of  this  section,  public 
service  corporations  which  (1)  were  operated  independently,  (2)  were  not 
physically  connected  or  merged  and  (3)  did  not  receive  special  permission 
to  make  a  consolidated  return,  shall  not  be  construed  to  have  been  affiliated; 
but  a  railroad  or  other  public  utility  which  was  owned  by  an  industrial  cor- 
poration and  was  operated  as  a  plant  facility  or  as  an  integral  part  of  a 
group  organization  of  affiliated  corporations  which  were  required  to  file  a 
consolidated  return,  shall  be  construed  to  have  been  affiliated. 

(c)  The  provisions  of  this  section  are  declaratory  of  the  provisions  of 
Title  II  of  the  Revenue  Act  of  1917. 

ALTERNATIVE   TAX    ON    PERSONAL    SERVICE    CORPORATIONS 

Sec.  1332.  (a)  That  if  either  subdivision  (e)  of  section  218  of  the 
Revenue  Act  of  1918  or  subdivision  (d)  of  section  218  of  this  Act  is  by 
final  adjudication  declared  invalid,  there  shall,  in  addition  to  all  other 
taxes,  be  levied,  collected,  and  paid  on  the  net  income  (as  defined  in  sec- 
tion 232)  received  during  the  calendar  years  1918,  1919,  1920,  and  1921, 
by  every  personal  service  corporation  (as  defined  in  section  200)  included 
within  the  provisions  of  such  subdivisions,  a  tax  equal  to  the  taxes  imposed 
by  Titles  II  and  III  of  the  Revenue  Act  of  1918  and,  in  the  case  of  income 
received  during  the  calendar  year  1921,  by  Titles  II  and  III  of  this  Act. 

(b)  In  such  event  every  such  personal  service  corporation  shall,  on  or 
before  the  fifteenth  day  of  the  sixth  month  following  the  date  of  entry 
of  decree  upon  such  final  adjudication,  make  a  return  of  any  income  re- 
ceived during  each  of  the  calendar  years  1918,  1919,  1920,  and  1921  in  the 
manner  prescribed  by  the  Revenue  Act  of«  1918  (or  in  the  manner  pre- 
scribed by  this  Act,  in  the  case  of  income  received  during  the  calendar 
year  1921).  Such  return  shall  be  made  and  the  net  income  shall  be  com- 
puted on  the  basis  of  the  taxpayer's  annual  accounting  period  (fiscal  year 
or  calendar  year,  as  the  case  may  be)  in  the  manner  provided  for  other 
corporations  under  the  Revenue  Act  of  1918  and  this  Act. 

(c)  If  either  subdivision  (e)  of  section  218  of  the  Revenue  Act  of  1918 
or  subdivision  (d)  of  section  218  of  this  Act  is  so  declared  invalid,  claims 
for  credit  or  refund  of  taxes  paid  under  both  such  sections  shall  be  allowed, 
if  made  within  the  time  provided  in  subdivision  (f)  of  this  section. 

(d)  In  case  the  claims  for  credit  or  refund,  filed  within  six  months  from 
such  date  of  entry  of  decree,  represent  less  than  30  per  centum  of  the 
outstanding  stock  or  shares  in  the  corporation,  the  amount  of  taxes  imposed 
by  this  section  upon  such  corporation  shall  be  reduced  to  that  proportion 
thereof  which  the  number  of  stock  or  shares  owned  by  the  shareholders 
or  members  making  such  claims  bears  to  the  total  number  of  stock  or 
shares  outstanding. 

(e)  The  tax  imposed  by  this  section  shall  be  assessed,  collected,  and  paid 
upon  the  same  basis,  in  the  same  manner,  and  subject  to  the  same  pro- 
visions of  law,  including  penalties,  as  the  taxes  imposed  by  sections  230 
and  301  of  the  Revenue  Act  of  1918  (or  by  sections  230  and  301  of  this 
Act,  in  the  case  of  income  received  during  the  calendar  year  1921),  but  no 
interest  or  penalties  shall  be  due  or  payable  thereon  for  any  period  prior 
to  the  date  upon  which  the  return  is  by  this  section  required  to  be  made 
and  the  first  installment  paid.  The  amount  of  tax  paid  by  any  shareholder 
or  member  of  a  personal  service  corporation  pursuant  to  the  provisions  of 
subdivision  (e)  of  section  218  of  the  Revenue  Act  of  1918  or  subdivision 
(d)  of  section  218  of  this  Act  shall  be  credited  against  the  tax  due  from 


REVENUE    ACT    OF    llfil  1405 

such  corporation  under  this  section  upon  the  joint  written  application  of 
such  corporation  an.l  such  shareholder  or  member  or  his  representatives, 
heirs,  or  assigns,  if  such  application  is  filed  with  the  Commissioner  within 
six  months  from  such  date  of  entry  of  decree. 

(f)  Notwithstanding  any  other  provision  of  law,  no  claim  for  a  credit  or 
refund  of  taxes  paid  under  subdivision  (e)  of  section  218  "^  ^^e J^^^;^^ 
Act  of  1918  or  subdivision  (d)  of  section  218  of  this  Act  may  be  filed  after 
the  expiration  of  six  months  from  such  date  of  entry  of  decree:  frovM 
l„nccrcr.  That  a  personal  service  corporation  of  which  no  f  ^^^^oldei  or 
member  has  filed  such  claim  within  such  period  of  six  months  shall  not  be 
subject  to  the  tax  imposed  by  this  section. 

TITLE  XIV— GENERAL  PROVISIONS 

REPEALS 

Sec  1400.  (a)  That  the  following  parts  of  the  Revenue  Act  of  1918  are 
repealed,  to  take  eflfect  (except  as  otherwise  provided  in  this  Act)  on 
January  1,  1922,  subject  to  the  limitations  provided  in  subdivision  (b). 

Title  II  (called  "Income  Tax")  as  of  January  1,  1921: 

Title  III   (called  "War-Profits  and  Excess-Profits  Tax")    as  of  January 

1,  1921;  r    u-     A  + 

Title  IV   (called  "Estate  Tax")   on  the  passage  of  this  Act; 
Title    V    (called    "Tax    on    Transportation    and    Other    Facilities,   and    on 

Insurance");  ,    ^^;„l-c: 

Sections  628,  629,  and  630  of  Title  VI   (being  the  taxes  on  soft  drinks, 

ice  cream,  and  similar  articles); 

Title  VII  (called  "Tax  on  Cigars,  Tobacco  and  Manufactures  Thereof  ), 

Title  VIII  (called  "Tax  on  Admissions  and  Dues"); 

Title  IX  (called  "Excise  Taxes"); 

Title  X  (called  "Special  Taxes"); 

Title  XI  (called  "Stamp  Taxes"); 

Title  XII   (called  "Tax  on  Employment  of  Child  Labor")   as  of  January 

1,  1921;  and  ^     ,    . 

Sections  1314.  1315,  1316,  1317,  1319,  and  1320  of  Title  XIII  (being  cer- 
tain administrative  provisions)  on  the  passage  of  this  Act. 

(b)  The  parts  of  the  Revenue  Act  of  1918  which  are  repealed  by  this 
Act  shall  (unless  otherwise  specifically  provided  in  this  Act)  remain  in 
force  for  the  assessment  and  collection  of  all  taxes  which  have  accrued 
under  the  Revenue  Act  of  1918  at  the  time  such  parts  cease  to  be  in  effect 
and  for  the  imposition  and  collection  of  all  penalties  or  forfeitures  which 
have  accrued  or  may  accrue  in  relation  to  any  such  taxes.  In  the  case  of 
any  tax  imposed  by  any  part  of  the  Revenue  Act  of  1918  repealed  by  this 
Act  if  there  is  a  tax  imposed  by  this  Act  in  lieu  thereof  the  provision 
imposing  such  tax  shall  remain  in  force  until  the  corresponding  tax  under 
this  Act  takes  effect  under  the  provisions  of  this  Act.  The  unexpended 
balance  of  any  appropriation  heretofore  made  and  novv  ^J^'l^b^e  for  the 
administration  of  any  such  part  of  the  Revenue  Act  of  918  shall  be 
available  for  the  administration  of  this  Act  or  the  corresponding  provision 
thereof. 


1406  APPENDIX 


SAVING   CLAUSE  IN   EVENT   OF   UNCONSTITUTIONALITY 

Sec.  1403.  That  if  any  provision  of  this  Act,  or  the  application  thereof 
to  any  person  or  circumstances,  is  held  invalid,  the  remainder  of  the  Act, 
and  the  application  of  such  provision  to  other  persons  or  circumstances,  shall 
not  be  affected  thereby. 

EFFECTIVE  DATE  OF  ACT 

Sec.  1404.  That  except  as  otherwise  provided,  this  Act  shall  take  effect 
upon  its  passage. 

Approved,  November  23,  1921,  at  3:55  p.  m. 


INDEX 

[References  are  to  pages.] 

A 

ABATEMENT,  CREDIT  AND  REFUND. 

abatement,    effect   of  appeal    from    additional   assessment,   917. 

effect  of  rejection  of  claim   for,  914. 

payment   where   claim   denied,   917. 

procedure    for   claiming,   915. 

procedure  of  collector  on  claims  for,  91fi. 

purpose  of  claims   in,  914. 
claims  for,  893. 
claims  for  credit,  926. 

action   on,  927. 

payment  where  denied,  928. 

procedure  to  be  followed  by  taxpayer,  92(i. 

taxes   erroneously   collected,   926. 
claims    for    abatement    of    uncollectible    taxes,    941. 
claims  for,  after  December  16.  1921,  920. 
claims   for   refund,  923. 

claims  for  refund  of  sums  recovered  by  suit,  938. 
claims  in  case  of  affiliated  corporations,  260. 
claims  of  corporations,  269. 
community  income,  51. 
credit  and   refund,  918. 

authority   for,   918. 
credit   equivalent   to   payment,   932. 
discussed  generally,  19. 
final   determination   and   assessment,  920. 
in  general,  912. 

interest  on    refunds   and   judgments   under   present    law,    939. 
nonresident  aliens,   86. 

claims  for,  87. 
procedure    by    collectors    upon    receipt     of     claims     for     refund     or 

abatement,  924. 
procedure    for    handling    claims,    effective    December    16,    1921,    920. 
refund,  amended   returns  are  not  claims  for,  930! 

authority   of   Commissioner,   923. 

power    of   attorney   sufficient   authority   for    filing,   924. 

procedure    for   claiming,    923. 

statute  of  limitations,  929. 

taxes  collected  on  second  assessment,  928. 

when  allowed,  931. 
reopening  of  cases,  942. 
review  of   Commissioner's   decision.  919. 
suits  after   rejection  of  claim  by  Commissionei',  932. 
when   a  credit  is   made  or  allowed,  931. 
who   may  claim   recovery  of  tax,  913. 

1407 


1408  INDEX 

[References  are  to  pages.] 

ABSTRACTS  OF  TITLE, 

not  subject  to  stamp  tax,  1195. 

ACCIDENT    OR   HEALTH   INSURANCE, 

amounts   received  through,  exempt,  354. 
exemption  of  amounts  received  through,  37. 
exemption  of  income  from,  556. 
payments  under  not  to  be  reported  at  source,  954. 
premiums  paid  by  employers,  367. 

ACCOUNTING, 

accrual  method,  345,  349. 

approved  standard  methods  of,   797. 

changing   basis    for    computation    of    income,    815. 

doctrine  of  election,  as  to  method,  815. 

inconsistent   bases   not  permissible   in   same   return,   798. 

method  of,  in  case  of  installment  sales,  469. 

methods  and  periods  of,  795. 

methods  of,  342,  797. 

on  basis  of  accruals,  796.     . 

on  basis  of  actual  receipt,  795. 

standard  methods   of,  regarded   as   reflecting  income,   349. 

treatment  of  bad  debts  in  case  of  installment  sales,   471. 

treatment  of  discount  by  banks,  387. 

ACCOUNTING   PERIOD, 
changes   in,  817. 

computation   of    income    on    basis   of,   11. 
fiscal  year,  815. 

fiscal   year  ending  in   1919,   819. 
fiscal  years  ending  in   1921  or   1922,  818. 
returns  must  be   made  on  basis   of,   816. 
returns    when   changed,    829. 
taxpayers   changing,   816. 
when   change    in,   permitted,    818. 

ACCRUALS, 

accrued    charges,    797. 

interest  on   obligations   at   time   of   purchase,   493. 

reporting  deductions   on   basis   of,   796. 

reporting  on   basis  of,   349,   796. 

sometimes  taxed  as  income,  344. 

ACCUMULATIONS, 

for   charitable   purposes,   116. 
prior  to  March  1,   1913,  518. 
undistributed   profits   of  corporations,   29 
when  unreasonable,  31,  33. 

ADDITIONS    AND    BETTERMENTS, 

effect  on  depreciation   allowance,   690. 


INDEX  1409 

[References  are  to  pages.] 

ADMINISTRATION, 

capital   stock   tax,  1160. 

collection   of   tax   may    not   be   enjoined,   851. 

income  tax  laws,  5. 

of  war-profits  and   excess-profits   tax   law.   1138. 

powers   of   revenue   officials,   5. 

procedure  before   Committee  on    Appeals  and    Review,  894. 

reopening  of  cases,  942. 

review  of  assessments,  864. 

ADMISSIBLE   ASSETS, 
defined,    1073. 
insurance   policies.    1074. 
school   district   warrants,    1074. 

ADVERTISING   EXPENSES, 
deduction   of,   582. 
in    connection    with    government    contracts,    1031. 

ADVISORY  TAX  BOARD, 

establishment  and  abolition  of,  6. 
function    of,   893. 

AFFILIATED   CORPORATIONS. 

See  Consolidated   Returns. 
capital   stock   tax   return  by,   1159. 
change   in  ownership  during  year,  257. 
claims  for  credit  or  refund,  260. 
consolidated   balance  sheets,  preparation   of,  261. 
consolidated  net  income  of,  259. 

corporation   deriving  chief   income   from   government  contracts,  257. 
different  fiscal   years  of,  259. 
domestic     corporation     affiliated     with     foreign     corporation     under 

1918   Law,  258. 
examples  of,  256. 
inadmissible   assets,   1134. 
intangible  property  paid  in,   1133. 
invested  capital   for  prewar   period,   1135. 
invested   capital   of,   1132. 
Liberty  bond  exemption   in   case  of,  260. 
may  not  file  consolidated   returns  of  information,  963. 
national   bank   stockholders'   trustee   accounts,    1135. 
prewar  net  income  of,   1135. 
related    trades   or   businesses.   258. 
required  to  file  consolidated   returns,  254. 
stock  of  subsidiary  acquired  for  cash,  1134. 
stock  of  subsidiary  acquired    for   stock,   1134. 
when    corporations    are    affiliated,    254. 

AGENTS, 

See  Resident  Agents;  Withholding  Agents. 
are  not  fiduciaries,  103. 
receipt  of  income   by,  considered   receipt  by   principal,  348. 


1410  INDEX 

[References  are  to  pages.'\ 

AGENTS— Continued. 

resident  agents   for  foreign   corporations,  306. 
returns  by,  52,  827. 

for  nonresident   aliens,   85. 
withholding  against,   980. 
withholding   agent   defined,    965. 

AGRICULTURAL  AND  FORESTRY  OPERATIONS, 

not  subject  to  child  labor  tax,  1252. 

AGRICULTURAL   ORGANIZATIONS, 
exemption   of,    315. 

ALIEN   PROPERTY   CUSTODIAN, 

conveyance  by  or  to,  not  subject  to  stamp  tax,  1197. 

corporations  in  hands  of,  249. 

no  stamp  tax  on  sales  or  transfers  of  stock  to   or  by,   1184. 

not  a  fiduciary,  107. 

payment  of  tax  where  property  taken  over  by,  873. 

withholding  on  payments  to,  994. 

ALIENS, 

See    Nonresident    Aliens. 
determination  of  residence  of,  42. 
loss  of  residence,  43. 
proof   of   residence,  42,   57. 
residence  of,  56. 
residing   in    United    States,   taxation    of,    42. 

ALIEN   SEAMEN, 
wages   of,   67. 

ALIMONY, 

is  not  income,  538. 

AMENDED    RETURNS, 

in  case   of  subsequently  discovered   gains,   805. 
where  capital  charges  made  to  income,  251. 
when   necessary,    839. 

AMORTIZATION, 

amortization  period,  710. 

claims   must  be   differentiated    in   return,   706. 
cost  which  may  be   amortized,  708. 
deduction    for,   in   general,   678. 
deduction   for,   under   1918    Law,    705. 
depreciation   of    amortized   property,   707. 
effect  upon   invested  capital,  706. 
information  to  be  furnished  by  taxpayer,  712. 
property  the  cost  of  which  may  be  amortized,  707. 
redetermination   of   allowance,   711. 
sale  of  amortized  property,  711. 
scope  of  provision  for,  706. 

under    Munition     Manufacturers'    Tax,    effect    on    invested    capital, 
1094. 


INDEX  1111 

[References  are  to  pages.] 

ANNUITIES, 

income  from,  556. 

when    not    reported    at   source,    954. 

APARTMENT    HOUSES, 

rate  of  depreciation  allowed,  691. 

APPEALS, 

from   additional    assessments,   863. 

to  Committee  on  Appeals  and  Review,  893. 

APPRECIATION   IN   VALUE   OF   PROPERTY, 
may  be  taxed,  407. 

may   not   be    included    in    invested    capital,    1086. 
penalty   for   including   in    invested    capital,   901. 

ARIZONA, 

community   property,   47. 
ASSESSMENT   OF  TAX, 

See  Notice  and  Demand. 
additional   assessment,   rules   under   present   law,   862. 
additional  assessment   under   pi-ior   laws,  858. 
administrative   review,   864. 
changes  made  by  1921  Law,  857. 
claim  in   abatement  in  case  of  appeal  from.  917. 
computation    of    period    of    limitations,    862. 
discovery  of  deficiency,  855. 

do  not   take  the  place  of  claims  for  credit  or  refund.   930. 
final  determinations  and   assessments,   863. 

five  year  limitation  on   summary  assessment   under  prior  laws,  860. 
limitation   on,   time    in   which   to   make,   860. 
must   be  made  by   Commissioner,  859. 
on   income   received   during   lifetime   of   decedent,    863. 
opportunity   for   hearing,   863. 
procedure  under  1918  Law,  854. 
procedure   under   1921   Law,   855. 

refund   of  taxes  collected  on  second   assessment,  928. 
right  of  taxpayer  to  appeal,  863. 
suits  to  restrain,  not  allowed,  850. 

ASSIGNEE, 

duties    of,   respecting   withholding   at   source,   983. 
income  taxable  in  hands  of,  244. 

ASSOCIATIONS, 

See  Partnerships. 

building    and    loan,    when    exempt,    318. 

distinguished   from   partnership,   1141. 

distinguished    from    trust,    1141. 

dividends   from,   505. 

exemption  of  business  associations,  328. 

exemption  of  national   farm  loan  associations,  337. 

for  marketing  produce  and  purchasing  supplies,  exemption  of,  335. 


1412  INDEX 

[References  are  to  pages."] 
ASSOCIATIONS— Continued. 

subject  to  capital   stock   tax,   1140. 
taxed   as   corporations,   211. 
when  trusts  are  taxed  as,  215. 

AUTOMOBILES, 

depreciation  deduction  for,  when  used  in  business,  680. 
losses  in  connection  with,  622. 
use  of,  by  farmer,  162. 

AUTOMOBILE    LICENSE    FEES, 
deductible  as  taxes,  612. 

B 
BAD  DEBTS, 

See  Worthless  Debts. 
BALANCE    SHEETS, 

exhibits  for  capital  stock  tax,  1144. 

BANKRUPTCY, 

trustee  in,  income  taxable  in  hands  of,  244. 

BANKS, 

carrying    Liberty    bonds,    487. 

deduction  of  amounts  set  apart  for  depositors'  guaranty  fund,  612. 

deposits  in,  not  subject  to  withholding,  969. 

examination  of  books   of  national  banks,   947. 

exemption  of  federal  land  banks,  337. 

inclusion  of  discount  in  invested  capital,  1063. 

interest  on  deposits,  494. 

joint  stock  land   banks  not  exempt,  337. 

Liberty  bonds  held  by,  485. 

national  bank  stockholders'  trustee  accounts,  1135. 

penalty  for  deducting  taxes   paid  for  shareholders,  901. 

private  or  partnership,  170. 

taxes    paid   for   stockholders,   deduction   of,   617. 

treatment  of  discount,  387. 

use   of   substitute   certificates   by,   989. 

when  co-operative  exempt,  318. 

when   mutual   savings  banks   exempt,   316. 

withholding  in  case  of,  970. 

BEQUEST,    DEVISE,    OR    DESCENT, 

exemption   of   property   acquired   by,   37. 

gain  or  loss  from  sale  of  property  acquired  by,  456. 

losses  from  sale  of  property  acquired  by,  625. 

property    acquired    by,    exempt,    354. 

shrinkage   in   value   of   life   or   tei'minable   interest,    575. 

BENEFICIARIES, 

See  Fiduciaries. 
BILLS  OF  SALE, 

conditional  bills  of   sale,   stamp   tax  on,   1190. 


INDEX  1413 

\_Reference8  are  to  pages.} 

BOARDS    OF    TRADE, 

exemption  from  tax,  328. 

BONDS, 

See  Liberty  Bonds;  Tax-Free  Covenant  Bonds. 

business   property   investment   stamp   tax   on,    1167,   1189. 

deduction  when  worthless,  654. 

discount   on   sale  of,  effect  on   invested   capital,    1062. 

given  in  a  penal  sum,  stamp  tax,   1167. 

interest  on    bonds   of   municipality,   491. 

interest  on,  of  exempt  organizations,  493. 

interest    paid    in    scrip,    494. 

issued  at  a  discount,  deduction  of  discount,  238. 

issued  at   a   premium,  income  from,  238. 

issue  of,  stamp  tax  on,  1168. 

loss,  when   purchased   above  par,  636. 

maturing   serially,    treatment    of    discount   and    expenses,    240. 

municipal  bonds  purchased  at  premium  of  discount,  462. 

of   indebtedness,   stamp   tax  on,   1166. 

of  indemnity   and   surety,   not  subject   to   stamp  tax   under   present 

law,   1169. 
of    United    States,    foreign    governments    and    political    subdivisions, 

exempt    from    stamp    tax,    1170. 
purchased   at  a  premium,  interest  on,  495. 
renewal  of,  stamp  tax  on,  1168. 

sale  and   retirement  of  corporate   bonds,   income   from,  238. 
sales  and   dealings  in,  461. 

state   and   municipal,   information   at   source,  955. 
transfer  of,  stamp  tax  on,  1168. 
what   are,    1167. 

when  exempt  from  stamp  tax,  1168. 
when  inadmissible  assets,  1076. 
withholding  at  source   in   case   of  interest  on,  972. 

BONUSES, 

cost  of   stock   received   as,   418. 

deduction  of,  595. 

depletion  when  paid  for  lease,  717. 

paid  in  stock,  366. 

to  be  withheld  at  source,  968. 

treatment  of  for  purposes  of  depletion,  723. 

when    held    to   be   gifts,   365. 

when   subject  to  tax,  365. 

BOOKKEEPING    ENTRIES, 
accrued    charges,    797. 
do  not  constitute  income,  341. 

earnings  or  profits  accumulated  prior  to  March  1,  1913,  523. 
in  case  of  installment  sales,  469. 
not   binding,   342. 

BOOKS, 

See  Examination  of  Books. 


1414  INDEX 

[References  are  to  pages."] 
BOOK   VALUE, 

as   proof   of  market  value,  431. 

BROKERS, 

information  at  source  by,  954. 

interest  received  and   paid   by,   494. 

registration  of,  1188,  1236. 

reports   by,    190. 

reports  by,  when  corporations,  264. 

returns  of  information  at  source  by,  962. 

stamp  tax  on  transfers  of  stock  to  or  by,  1186. 

BUILDING   AND    LOAN    ASSOCIATIONS, 

exemption  of  dividends   from,  355. 

exemption  of  interest  or  dividends  from,  37. 

income   from    shares    in,   551. 

stock  and  bonds  of,  exemption  from   stamp  tax,   1169. 

when   exempt,  318. 

when  payments  by,  not  to  be  reported  at  source,  954. 

BUSINESS, 

See  Trade  or  Business. 
expenses   of,   deductible,   578. 
gross  income  from,  385. 

incorporation   of,   election    as    to    how   taxed,   218. 
what  constitutes,  579. 

BUSINESS    ASSOCIATIONS, 
exemption  of,  328. 

C 

CALIFORNIA, 

community   property,  49. 

CANCELLED   DEBTS, 
income  from,   539. 

CANNERIES, 

subject  to   child   labor  tax,   1250. 

CAPITAL, 

abnormal    conditions    affecting,    1119. 

additions  to  in  case  of  mines,  739. 

distinguished   from  income,   340. 

distributions    of,    526. 

includes  property  held  prior  to  March   1,  1913,  341. 

increments    in   value   of,    341. 

losses  of,  629. 

recoverable  through  depletion,  in  case  of  lessee,  716. 

in   case  of  lessor,   717. 

in  case  of  operating  owner,   71.'>. 

CAPITAL    ASSETS, 
defined,    410. 

penalty  for  omitting  gains  from  sale  of,  901. 
taxation  of  appreciation  in,  407. 


INDEX  It  15 

[References  are   to  pa(fe8.'\ 

CAPITAL    CHARGES, 

amended   returns  where  made   to   income,  251. 

CAPITAL   EXPENDITURES, 
examples  of,  570. 

CAPITAL   GAINS, 
defined,    410. 

limitation    of   tax    on,   22. 
how  tax   computed,  411. 
how    taxed    to   estates   and    trusts,   410. 
how  taxed  to  partnerships,  410. 
taxation  of,  409. 
when  new  provision  for  taxation  of,  is  applicable,  409. 

CAPITAL    LOSS, 
defined,    410. 

CAPITAL  STOCK, 

See  Stock. 
expenses   of   selling,   not    deductible   by   corporations,   231. 
income   from   sale  of,  by   corporation,  227. 
redemption  or  retirement  expenses  not  deductible,  233. 
sales   and   transfers,   affixing  and    cancelling   stamps,    1179. 
sales  and   transfers,  stamp   tax  on,   1177. 

shares  without   par  value,  stamp  tax  on  sales  and   transfers,   1180. 
stamp   tax   on    issue,   1170. 

CAPITAL    STOCK    TAX, 

administration    of   the    law,    IKiO. 
annual  income,   1145. 
applies    to   domestic   corporations,    1140. 
association  distinguished  from  partnership,   1141. 
association  distinguished  from  trust,  1141. 
associations   subject    to,    1140. 
carrying  on  or  doing  business,  1151. 
condensed    balance   sheet,   1144. 

corporations   engaged    in   business   during   preceding    year    and    dur- 
ing taxable  year,   1151. 
corporations  exempt  from,  1140,  1156, 
deduction  of,  610. 
definitions,    1139. 

described    as   a   special    excise   tax,    1139. 
description    of    tax,    1139. 

doing   business    by    foreign    corporations,    1155. 
domestic    mutual    insurance    companies,    1150. 
fair  average  value  of  capital   stock,  1143. 
foreign    mutual    insurance    companies,    1150. 
inactive  corporations,  1151. 
insurance    companies,    1148. 
limited    partnership    as    corporation,    1142. 
limited    partnership    as    partnership,    1141. 
mutual  insurance  companies  under   1918   Law,   1149. 


1416  INDEX 

[Refe7-ences  are  to  pages.'] 

CAPITAL  STOCK  TAX— Continued, 
not    doing   business,    1155. 
on  foreign  corporations,   1147. 
payment  of,   1160. 
penalties,    1160. 

quotations   or  outside   sales   prices,   1145. 
rate   on    domestic    corporations,    1143. 
rate   on   foreign  corporations,  1146. 
returns,    1156. 

by  affiliated   corporation,    1159. 

by      affiliated      corporation      based      upon      consolidated      re- 
port,  1159. 

by   foreign    corporations,    1160. 

corporation  claiming  exemption,   1158. 

extension    of    time,    1157. 

in   what   cases   required,    1157. 

tentative   returns,    1157. 

to   be   public   records,    1157. 
scope   of,    1139. 

stock   insurance    companies    under    1918    Law,    1149. 
when  foreign  corporations  are  subject  to,  1142. 
when  tax  is  due,   1156. 

CAR   TRUST   CERTIFICATES, 

withholding   at   source   in    case   of,   976. 

CASH, 

income    received    in    equivalent    of,    350. 

CASUALTY, 

"other    casualty,"    defined,    637. 

CASUALTY    INSURANCE    ASSOCIATION, 
exemption    of,    334. 

CEMETERY    COMPANIES, 
when   exempt,   322. 

CERTIFICATES, 

generally,  stamp  tax  on,  1190. 

of  age,  for  child  labor  tax,  1256. 

of   deposit,   stamp   tax   on,   1189. 

of    indebtedness,   stamp    tax    on,    1166. 

of  interest  in   property  or  accumulations,   stamp   tax   on,   1174. 

of   profits,   stamp   tax   on,    1174,    1188. 

of  stock,  stamp  tax  on,  1174. 

CERTIFICATES  OF  INDEBTEDNESS, 

issued  by  Director  General  of  Railroads,  not  exempt,  487. 

issued   by   receivers,   stamp   tax   on,    1190. 

stamp   tax  on   scrip   dividend   certificates   or   warrants,    1189. 

subject  to  stamp  tax,   1189. 

taxes   paid   by,   procedure,   with    respect   to,   880. 

tax  may  be  paid  by,  878,  879. 


INDEX  1417 

[References  are   to  payeti.} 

CHAMBERS   OF   COMMERCE, 
exemption   from   tax,   328. 

CHARITABLE    CORPORATIONS, 
exempt    from    tax,    322. 

CHARITABLE    PURPOSES, 

accumulations   for,   116. 
CHARITIES, 

contributions  to,  allowed  as  deduction  to  estates  and  trusts,  120. 

contributions  to,  by   partnerships,   184. 

deduction   of   contributions    to,   561. 
by   corporations,   237. 

examples   of   deductible   contributions,   563. 

examples    of    nondeductible    contributions    to,    564. 

limitation  of  deduction  on  contributions  to,  562. 

CHECKS, 

See   Stamp  Tax. 
stamp    tax    on,    1190. 
taxes   may   be   paid  by,  878. 

CHILD    LABOR    TAX, 

acceptance   of    state    certificates,    1258. 
agricultural   and    forestry   operations,   1252. 
basis  and   rate   of   tax,    1258. 
certificate   of   age,    1256. 
children  in  company  of  mothers,   1253. 
constitutionality   of,    1260. 
duration    of    employment,    1255. 
effective   date  of  act,  1250. 

employment    in    general    and    factory    offices,    1251. 
inspection  of  establishment,   1258. 

janitor   service   in   office   of   manufacturing   plant,   1254. 
manufacturing  establishment  defined,  1251. 

mill,     cannery,     workshop,     factory     or     manufacturing     establish- 
ment,   1250. 
mine   or  quarry,    1254. 

coke    ovens,    1255. 

in    or    about    mines,    1254. 
mistakes  as  to  age  of  child,    1258. 
penalties,  1260. 

persons  to  whom  the  tax  applies,  1250. 
proof  of  age,   1256. 
returns   to   be   filed,   1259. 
son   of   proprietor,    1253. 
tax    due,    1259. 
time    record,    1259. 
time    (sun  or  clock),  1255. 
vacation    period.    1253. 

CITIZENS, 

certain   citizens   treated    as   nonresident   aliens,   57 
credit  of  taxes   allowed  to,  787. 


1418  INDEX 

[References  are  to  pages.} 

CITIZENS— Continued. 

deriving  income  from  United  States  possessions,  41. 

of  possessions,  i-esiding  in  United  States,  credit  for  taxes,  788. 

payment  of  tax  when  leaving  country,  876. 

presumption  of  expatriation,  41. 

residing   abroad,   41. 

residing  in   the   United    States,   41. 

taxation    of,    39. 

who   are,   40. 

withholding   at   source    against,    978. 

CIVIC    ORGANIZATIONS, 

exemption   from   tax,  330. 

CIVIL    WAR    INCOME    TAXES, 
statutes  imposing,  4. 

CLAIMS, 

for    allowance    of   net   loss,   661. 

for  amortization,  must  be  differentiated  in  return,  70G. 

for   credit   of   taxes    erroneously   collected,    926. 

for  inventory  loss   or   loss  from   rebates,   672. 

for  loss  in  inventory  and  from  rebates,  disposition  of,  675. 

in    abatement,    914. 

income    from    payment   of,    546. 

income  from   settlement  of,   113. 

procedure   for   claiming   refund,   923. 

valuation    of,    113. 

CLEARING  HOUSE   ASSOCIATION, 
exemption   from   tax,   329. 

CLEARING   HOUSES, 

See   Stamp   Tax. 
CLERGYMEN, 

exemption  of  rental  value  of  dwelling  house,  38,  355,   368. 

voluntary  offerings  to,  368. 

CLUBS, 

exemption    from    tax,    330. 

COLLECTION    AT    THE    SOURCE, 

See  Withholding  at  Source. 

COLLECTION  OF  TAX, 

addition  of  five  dollars  in  case  of  distraint,  874. 

by  suit  against  former  residents  now  abroad,  870. 

from   taxpayers    contemplating    concealment   of   property,    874. 

lien  for  unpaid  taxes,  870. 

limitation   on   suits  for,  868. 

notice  of  lien,   871. 

priority  of  federal  taxes,  872. 

suits  for,  868. 

suits  to  restrain   not   allowed,   850. 


INDEX  141'.) 

[Rcferoicts  arc   to  paf/ea.l 

COLLECTION  OF  TAX— Continued. 

taxes   collectible    by    distraint,    873. 

taxpayers    leaving   country    or    removing    property,    874,    87(5. 

when    lien   attaches,   872. 

COLORADO, 

mining  partnerships  of,  taxed   as  corporations,  212. 

COMMISSIONS, 

deductible  as  business   expense,  589. 
income  in   form   of,  366. 
in  what  year  to  be  reported,   80L 
withheld   at  source,  967. 

COMMITTEE    FOR    INCOMPETENT, 

certain    amounts    paid    not   deductible,    12-4. 

COMMITTEE    ON    APPEALS    AND    REVIEW, 
establishment   and    functions   of,   6,   893. 
procedure    before,    894. 

COMMUNITY  CHEST, 

deduction  of  contributions  to,  56L 

COMMUNITY  PROPERTY, 

abatement,  credit  and  refund   in  case  of,  51. 

taxation   of   income   from,   45.  1 

COMPENSATION    FOR    LOSS, 
in   {general,  541. 
under    1921    Law,   541. 

COMPENSATION    FOR  SERVICES, 

See  F'EDERAL  Officers  and  Employees;  Officers  am>  Employees  of  State; 

Personal  Services;  Salaries. 

additional    amounts    to   be    paid    at    future    date,    808. 

bonuses    paid    in    stock,    597. 

deduction  of,  590. 

deduction  of  bonuses  and  profit  sharing  payments,  597. 

excessive  payments  by  individuals  or  partnerships,  594. 

extending  over   a   year,   372. 

federal    officers    and    employees,    373. 

living    quarters,    board    or    lodging,    369. 

paid   to  employees  during   absence   at  school,   595. 

promissory  notes  received   as,  371. 

received    in    stock,   371. 

salaries  of  federal  judges,  377. 

soldiers   and   sailors,   374. 

treated   as  dividends,  when  excessive,  506. 

use  of   property   of  employer,  369. 

what   constitutes    reasonable    amount,    591. 

when   to  be  reported,  805. 
COMPROMISES, 

ad   valorem    penalties,    909. 

offers   in   compromise,   909,   910. 


1420  INDEX 

[References  are  to  pages.'] 

COMPROMISES— Continued. 

of  taxes   and  penalties,  907. 

power   of    Commissioner   respecting,   908. 

specific  penalties,   909. 

COMPUTATION    OF    INCOME, 
accrual  basis,  349. 
method   of  accounting,  344. 

COMPUTATION    OF   NET    INCOME, 
method  of,  11. 

COMPUTATION  OF  TAX, 

corporations  with  income  from  government  contracts,  1036. 

illustration   for    1921,   28. 

illustration  for  1922,  29. 

in  case  of  capital  gains,  411. 

in  case  of  husband   and  wife,  824. 

of  corporations  engaged  partly  in  personal  service  business,  1025. 

surtax  tables,  25,  26. 

CONSOLIDATED   RETURNS, 

See  Affiliated  Corporations;  Reorganization. 
change  in  present  law,  251. 
computation  of  tax  under,  252. 
contents    of,    252. 

in  case  of  foreign  corporations,  308. 
necessity   for,    252. 
under    1917   Law,   261. 
under   1918   Law,   252. 

CONSTITUTIONALITY, 

act  of  1894  held  unconstitutional,  4, 

child  labor  tax,   1260. 

construction   of  constitutional   provisions,   1007. 

construction   which  will  be  constitutional,   1264. 

examination    and    production    of   books,    945. 

exempting   certain    corporations   from    tax,    1013. 

of  stamp   taxes,   1245. 

power  of  Congress  to  levy  income  taxes,   1007. 

requiring   disclosure   of   exempt    interest,   1009. 

retroactive  features,   1013. 

sixteenth   amendment,  4. 

statutes  may  be  in  part  unconstitutional,  1006. 

statutes  to  be  held  constitutional  if  possible,  1006. 

taxation  of  salaries  of  President  and  federal  judges,   39. 

taxing  gains  and  profits  from  sale  of  property,  1008. 

tax   on   personal   service   corporations,    207. 

uniformity,    1013. 

want   of   due   process,   1009. 

CONSTRUCTION   OF   TAXING   STATUTES, 
by   reference   to   similar   statutes,    1266. 
construction   which   will  be   constitutional,  1264. 


INDEX  '  1421 

[References  are  to  pages.] 

CONSTRUCTION   OF  TAXING   STATUTES— Continued, 
construing    constitutional    provisions,    1007. 

effect   of   rulings   and    practice   of   treasury   department,    1266. 
exemption    from    taxation,    1273. 
in   general,   12G1. 

proceedings  in  Congress  as  aid  to,  12G4. 
rule   followed   by   treasury   department,    1274. 
similar   statutes  in   other  jurisdiction,   1268. 
strict   or  liberal  construction,   1268. 

CONSTRUCTIVE   RECEIPT   OF   INCOME, 

distinguished   from   accrual,   799. 

dividends,   526. 

examples    of,   346. 

income    from    foreign    countries,    358. 

interest   and   dividends,   347. 

receipt  by  agent,  348. 

rent,   500. 

what    constitutes,    346. 

when   applied,   346. 

CONTRACTS, 

no  stamp  tax   on,   1190. 

CONTRACTORS, 

income    of,   385. 

income  of,  from  state  contract,   546. 

CONVEYANCES, 

See  Stamp  Tax. 
stamp  tax  on,  1190. 
when   not   subject   to   stamp   tax,   1193. 

CO-OPERATIVE    ASSOCIATIONS, 

dividends  from,  508. 

CO-OPERATIVE  BANKS, 
when  exempt,  318. 

CO-OPERATIVE  ORGANIZATIONS  OF  LOCAL  CHARACTER, 
exemption    of,    331. 

COPYRIGHTS, 

may  be  included  in  invested  capital,  1049. 
proof  of  value  of,  433. 
royalties    from,   503. 

CORPORATE   BONDS, 

See  Bonds. 

CORPORATE    ENTITY, 
doctrine    of,    219. 
generally    respected,    224. 
when  disregarded,  222. 

CORPORATION    EXCISE    TAX    ACT, 
imposed    by   1909   Law,   4. 


1422  INDEX 

[References  are  to  pages. 1 

CORPORATIONS, 

See  Affiliated  Corporations;   Bonds;   Consolidated   Returns;    Excess- 
Profits    Tax;    Exempt    Organizations;    Foreign    Corporations; 
Personal  Service  Corporations;    Transportation   Systems. 
amended  returns  where  capital  charges  made  to  income,  251. 
appreciations  in  value  may  not  be  included  in  invested  capital,  1086. 
cannot   enter  into   partnership,   172. 

certain    domestic   corporations    taxed    as    foreign,   225,    308. 
changes  made  by  present  law,  209. 

claims   for   credit   or   refund   of  affiliated   corporations,   260. 
collecting   foreign    items,    269. 
collection    of   tax   from    assets,   266. 
consolidated  returns,  251. 
contributions  by  stockholders,  229. 

corporations    engaged    partly    in    personal    service    business,    1024. 
credit  for  taxes,  789. 

where   domestic   corporation   owns   stock    of   foreign    corpora- 
tion, 789. 
credits    allowed,    240. 

against   tax,   242. 

interest  upon   United   States  obligations,  241. 

specific   exemption,   241. 

war-profits   and   excess-profits   taxes,   241. 
deductions  allowed,  231. 

additional    taxes,    235. 

dividends,  236. 

interest,   234. 

losses,   236. 

ordinary   and   necessary   expenses,    231. 

taxes,  235. 
deductions  not  allowed,  contributions  to  charities,  237. 

expenses    of   retiring   capital    stock,    233. 

expenses  of   selling  stock,  231. 

interest  paid  under  tax-free  covenant  bonds,  235. 

losses  in  ultra  vires  transactions,  236. 

organization  expenses,  231. 
de  facto  corporation  taxed   as,  217. 
defined,   210. 

depreciation  allowed  to,  678. 

deriving   income   from   government   contracts,   1027. 
distribution  in  liquidation   under   1921    Law,  517. 
distributions   which    are   not    dividends,    507. 
dividends  of,  504. 
doctrine  of  corporate  entity,  219. 
domestic,  corporation   defined,  224. 

evasion  of  tax  by  conveyance  of  assets  to  trustees,  455. 
examination   of  books   of,  269,   947. 
exemption  of  cemetery  companies,  322. 

exemption    of    religious,    charitable,    scientific,    literary    and    educa- 
tional  corporations,  322. 
exempt  organizations,  312. 


INDEX  1"*-'' 

[Refere7ices  are  to  payett] 

CORPORATIONS— Continued. 

extent  to  which  dividends  are  taxable,  509. 

fiscal  year,  245. 

fiscal  year  of,  credit  for  taxes,  794. 

formed  during  year,  returns  by,  248. 

formed  to  evade  surtaxes,  207. 

forming    partnership,    174. 

gross  income  of,  226. 

holding   company   financing   subsidiary,   233. 

how    taxed,   209. 

include  joint   stock   companies   and   associations,  210. 

income  of,  from  sinking:  fund,  228. 

interest  on  Liberty  bonds,  230. 
leased  property,  228. 
proceeds  of   insurance,  230. 
sale  of  assets  in  view  of  liquidation,  228. 
sale  of  capital  assets,  228. 
sale  of  capital   stock,  227. 
income  subject  to  tax,  16. 
income  taxable   in   hands   of   assignee,  244. 
income    taxable   in   hands    of   trustee    in   bankruptcy,   244. 
income  tax  on,   16. 
"in  control,"  defined,  634. 

incorporation    of   business,   election    as   to   being   taxed    as   corpora- 
tion, 218. 
information  at  source,  264. 
in   hands  of   alien    property   custodian,   250. 
inspection  of  corporation  returns,  842. 
liability   for   tax   after  dissolution,  265. 

Liberty    bond    exemption    in    case    of    affiliated    corporations,    260. 
liquidating   during   year,   249. 
limited    partnerships   as,   1142. 

losses   in   case  of   amounts   paid  to  make  up   profits,   642. 
loss    in    connection    with    reorganization,    634. 
Massachusetts  trusts  not  taxable  as,  213. 
mining   partnerships   taxed   as,   212. 
notice  of  lien,  267. 

owned   by   exempt   corporations,  exemption   of,   336. 
partial   liquidation   of,   516. 
payment  by  stockholders   of   loss  of,  64(?. 
payment  of  tax,  264. 

pavments   not  to  be   reported   at   source,  953. 
penalties  against  officers  or  employees  of,  901. 
penalties    to    which    liable,    270. 
pooling  of   stock,  212. 

presumption  as  to  source  of  distributions  of,  51/. 
procedure    in    issuing   tax-free   covenant   bonds.   1000 
profit  in  case  of  reorganization,  merger  and  consolidation,  436. 
rate  of  capital  stock  tax  on  domestic   corporations.   1143. 
receivers   for,    duties    of,   242. 
recovery   of  tax  from   stockholders,   267. 
reorganization   of,   entitling   to    revaluation,   1084. 


1424  INDEX 

[References  are  to  pages.'] 

CORPORATIONS— Continued. 

reorganization  prior  to  attachment  of  lien,  267. 
residence    of,   224,   298. 
retirement   of   capital   stock,   515. 
returns    by,    245. 

by  whom   filed,  247.  , 

extension  of  time,  246. 

for   fraction   of   year,   251. 

how   executed,   247. 

liquidating  during  year,  249. 

when    claiming   exemption,  314. 

when    filed,    246. 

when  required,   245. 

where   filed,   247. 
returns  in  case  of  change  of  name  or  domicile,  249. 
returns  of  information  as  to  dividends,  962. 
sale  and  retirement  of  corporate  bonds,  238. 
special  returns  by,  263. 

repoi't  of  dividend  payments,  263. 

report   of   income   payments,   264. 

reports    of    brokers,    264. 
specific   credit   of,   776. 

statement    of    distribution    of    earnings    required,    251. 
subject   to   capital    stock   tax,   1140. 
subject  to  excess-profits  tax,  1026. 
surtax  on  undistributed  profits,  29. 
syndicates  not  taxed  as,  213. 

taxation  of  telephone  companies  taken  over  by  government,  272. 
taxation   of  transportation    systems,   270. 
taxes  paid  for  stockholders,  deduction  of,  617. 

transfer    of    property    to,     loss     not     recognized     when     control     re- 
tained,  634. 
when  copies  of  returns  will  be  furnished,   847. 
when   corporate   entity  disregarded,  222. 
when  lien   attaches,  266. 
when   taxable,   210. 
when   trusts   taxed   as,   215. 
withholding   against,    979. 

withholding   at   source    in    case    of    bonds    containing    tax-free    cove- 
nant,  974. 
withholding  tax   at  source,   269. 
with  more  than   a  nominal  capital,   1022. 

with    no    invested    capital,    not      subject      to      1917      excess-profits 
tax,   1021. 
COST, 

buildings  erected  by  tenant,  586. 

cost  of  reproduction  as  proof  of  market  value,  430. 

of  lease,  418. 

of   manufacturing    products,   what    constitutes,    583. 

of    materials,    584. 

of   mineral    deposits,    718. 


INDEX  1423 

[References  are  to  }>agen.] 

COST— Ccntinued. 

of   oil    and    gas   deposits,    744. 

of  oil   and   Has   wells,   741. 

shares  of  stock  bought  at  different   prices,  432. 

stock  received  as  bonus,  418. 

what    constitutes,    417. 

which  may  be  amortized,  708. 

COSTS, 

in  suits  for  taxes,  941. 

COTTON  EXCHANGE, 
exemption   of,   329. 

COTTON   MERCHANTS, 

use  of  inventories,  392. 

COUPON   SYSTEiM, 

manufacturers  selling  on,  387. 

COVENANTS   TO    PAY   TAXES, 

See  Tax-Free  Covenant  Bonds. 

CREDIT, 

See  Abatement,  Credit  and  Refund. 

CREDIT   FOR  DEPENDENTS, 
nonresident    aliens,    83. 

CREDITS, 

against  income   in  case   of  corporations,   240. 

against  normal  tax,  356,  774. 

allowance  of,  to  nonresident  aliens  under  1918  Law,  784. 

allowed    against   tax   by    corporations,    242. 

allowed   foreign  corporations,  305. 

allowed    stockholders    of    personal    service    corporations,    206. 

allowed  to  estates  and  trusts,  131. 

countries    satisfying    similar    credit    requirement.    782. 

date   determining  exemption,  780. 

dividends  under   1918   Law,   774. 

dividends   under   1921    Law,  775. 

effect    of,    12. 

excess-profits    credit,    1111. 

for    dependents,    779. 

for    taxes,    786. 

allowed    citizens,    787. 

allowed    citizens    of    possessions,    residing    in    United    States. 
788. 

allowed    corporations,    789. 

allowed   members   of  partnerships,   791. 

allowed    nonresident    aliens,    788. 

allowed    resident    aliens,    787. 

conditions   of   allowance,   792. 

countries    satisfying    similar   credit    requirement,    788. 


1426  INDEX 

[References  are  to  pages.'] 

CREDITS— Continued. 

domestic    corporations     owning     stock     of     foreign     corpora- 
tions,  789. 

fiscal  year  in  case  of  individuals,   789. 

fiscal  year  of  corporations,   794. 

redetermination  of  tax  when  credit  proves  incorrect,  794. 

to  beneficiaries  of  estates  and   trusts,   791. 

under    1918    Law,    790. 
interest  on   United   States  obligations  allowed  as  credit  to  corpora- 
tions, 241. 
of  interest,  776. 
personal  exemption,  13. 
specific   credit   to    corporations,   777. 
to  nonresident  aliens  under  1918  Law,  781. 
to  nonresident  individuals  under  1921   Law,  781. 
war-profits   credit,    1108. 
war-profits   and   excess-profits  tax,  241. 

CREDIT   UNIONS, 

exempt  from  tax,   321. 

CUSTOM    HOUSE, 

entry  or  withdrawal  of  goods,  stamp  tax  on,  1198. 

D 

DAMAGES, 

exemption   of,   37. 

for   injuries,   exempt,   354. 

in    personal    actions,   544. 

in   what   year   deductible,   809. 

received   on   account  of   personal   injuries,  37. 

when  railroad   companies   may  deduct   amounts   paid   as,  812. 

DEALERS    IN    SECURITIES, 

inventories   by,   401. 

DEBENTURES, 

stamp   tax   on,    1166,    1198. 

DEBTS, 

See  Worthless  Debts. 

DECEASED   PERSONS, 
returns   for,   53. 

DEDUCTIONS, 

See  Estates  and  Trusts;   Farmers;   Foreign  Corporations;   Insurance 

Companies;  Net  Loss;  Nonresident  Aliens;  Partnerships. 

accrued  charges,  797. 

additional  compensation  paid  in  stock,  597. 

advertising   expenses,   582. 

allocated  to  income  with  which  connected,  807. 

allocation  of,  to  more  than   one  year,  814. 

amortization,   amortization   period,   710. 


INDEX  1427 

[References  are  to  pages."] 

DEDUCTIONS— Continued. 

claims  must  be  differentiated   in   return,   70(3. 

cost   which   may   be   amortized,   708. 

depreciation    of    amortized    property,    707. 

effect   upon    invested   capital,   70(i. 

information    to   be    furnished    by    taxpayer,   712. 

property  the  cost  of  which  may  be   amortized,  707. 

redetermination    of    allowance,    711. 

sale  of  amortized  property,  711. 

scope  of  provision   for,   706. 

under   1918   Law,   705. 
amount   to   secure   cancellation   of  lease,  582. 
automobile   license   fees,   H12. 
buildings   used    for    rental    purposes,    587. 
business   expenses,   576. 

business   expenses  of  leasehold   property,   581. 
capital  stock   tax,   610. 
commissions    paid,    589. 

compensation   paid  in  weekly  installments,  814. 
compensation  to  employees   during  absence   at  school,  595. 
contributions  in  equivalent  of  cash,  562. 
contributions  to  charities,  561. 
cost  of  buildings  erected  by  tenant,  586. 
cost  of  manufacturing  products,  583. 
cost  of  materials,  584. 
definition  of  depletion,  713. 
depletion,  accounts  on  books,  724. 

accounts  on  books  in  case  of  timber,   772. 

accumulated  depletion,  739.  • 

adjustment  of  accounts  based  on  bonus  or  ativanced   royalty, 
723. 

allowable  capital  additions  in  case  of  mines,  739. 

bonuses  paid  for  leases,  717. 

capital    recoverable   by   lessee,    716,    742. 

capital    recoverable    by    lessor,    717,    743. 

capital    recoverable   by    operating   owner,    742. 

capital    recoverable    in    case   of   operating   owner,    715. 

capital   sum,   740.  741. 

charges  to  capital  and  expense  in  case  of  oil  and   gas  wells, 
763. 

computation  of  allowance   in  ca.se  of  gas   wells.   747. 

computation   of    allowance    in    case   of   mines,   735. 

computation   of   allowance   in   case  of  oil   wells,   745. 

computation   of  allowance  in   case  of   timber   for  given   year, 
769. 

computation    of   allowance   where   quantity   of   oil    or    gas   un- 
certain,   756. 

computation   of  deduction,  722. 

cost   of  development   of  oil   and   gas   wells,   741. 

cost  of  oil   and  gas   deposits.   744. 

cost   of  oil    and   gas  wells,  741. 


1428  INDEX 

[References  are  to  pages."] 
DEDUCTIONS— Continued. 

deduction  of  allowance  for  combined  holdings  of  oil  and  gas 

properties,  756. 
determination  of  cost  of  deposits,  718. 
determination  of  fair  market  value  of  timber,  768. 
determination  of  mineral  contents  of  mine,  735. 
determination  of  oil  in  ground,  744. 
determination  of  quantity  of  timber,  769. 
discovery  of  mines,  737. 
discovery  of  oil  and  gas  w^ells,  758,  760. 
fair  market  value  of  mineral  property,  719. 
fair  market  value  of  oil  or  gas  properties,  744. 
in  case  of  mines,  735. 

improvements  in  case  of  mines,  oil  and  gas  virells,  714. 
in  case  of  timber,  767. 

information  to  be  furnished  in  case  of  timber,  773. 
in   general,  713. 

limitation  on,  based  on  discovery  value,  722. 
maps  of  oil  and  gas  properties,  758. 
method  of  estimating  recoverable  reserves,  744. 
mines,  oil  and  gas  vi^ells,  714. 

not  allowed  for  past  years  under  present  law,  734. 
of  oil  and  gas  wells  in  years  before  1916,  765. 
oil  and  gas  wells,  740. 
present  value  method,  720. 
revaluation  of  timber  not  allowed,  770. 
revaluations  not  allowed,  722. 
revised  estimate  of  reserves  of  oil  and  gas,  747. 
rule  as  to  lessees  under  prior  laws,  728. 
rule  as  to  mine  under  1916  Law,  726. 
rule  under  1909  Law,  725. 
rule  under  1913  Law,  725. 

statement  required  where  claimed  for  mineral  property,   736. 
statement  required  where  depletion  of  oil  and  gas  claimed,  756. 
depositors'  guaranty  fund,  612. 
depreciation,  678. 

accounts  on  books,  724. 

accounts  on  books  in  case  of  timber,  772. 

additions  and  betterments,  690. 

allowance  for  patent  or  copyright,  683. 

amortized  property,  707. 

annual  allowances  measured  by  life  of  property,  688. 

annual  allowance  must  be  charged  off  on  books,  692. 

automobile  used  in  business,  680. 

capital  sum  returnable  through  allowances,  685. 

closing  account  as  to  any  items,  694. 

depreciable  property,  679. 

drawings  and  models,  685. 

estimates  of,  in  case  of  oil  and  gas  properties,  765. 

extraordinary  depreciation,  692. 

factories  running  night  shifts,  692. 


INDEX  1429 

[References  are  to  page8.'\ 

DEDUCTIONS— Continued. 

improvements  in  case  of  mines,  oil  and  gas  wells,  714. 

improvements  in  case  of  oil  and  gas  wells,  764. 

incidental  repairs  to  property,  689. 

intangible  property,  682. 

leases,  681. 

loss  in  rental  value  of  buildings,  681. 

method  of  computing  allowance,  687. 

modification  of  method  of  computing  allowance,  687. 

not  allowed  on  inventories  or  stock  in  trade,  682. 

of  oil  and  gas  wells  in  years  before  1916,  765. 

physical  property  in  case  of  oil  and  gas  wells,  764. 

property  acquired  prior  to  March  1,  1913,  685. 

real  estate,  681. 

rate  on  apartment  houses,  691. 

rate  on  steamers,  691. 

rates  of,  690. 

renewals  to  property,  689. 

reserves  for,  694. 

terms  of  patents  and  trade-marks  in  various  countries,  684. 

under  prior  laws,  679. 

wearing  apparel,  682. 
depreciation,  obsolescence  and  amortization,  in  general,  678. 
donations  to  Red  Cross,  not  deductible,  600. 
effect  of,  12. 

entertainment  money,  590. 
examples  of  business  expenses,  580. 
examples  of  deductible  contributions,  563. 
examples  of  items  not  deductible  as  expenses,  581. 
examples  of  nondeductible  contributions,  564. 
excessive  payments  by  individuals  or  partnerships,  594. 
excise  taxes  paid  to  Cuban  government,  611. 
expenditures  for  alterations,  585. 
expenses  relating  to  patents,  583. 
federal  duties  and  excise  taxes,  610. 
federal  estate  taxes,  610. 
fidelity  insurance,  588. 

gifts,  gratuities  or  donations  to  employees,  598. 
in  case  of  public  utilities,  572. 
incurred   or  continued   to  purchase  or   carry   tax   exempt   securities, 

603. 
information  to  be  submitted  regarding  charitable  contributions,  562. 
in  general,  558. 
insurance  on  property,  587. 

insurance  policy  on  life  of  debtor  for  security,  574. 
insurance  reserves  may  not  be  deducted,  588. 
insurance  under  workmen's  compensation  law,  588. 
interest,  in  general,  602. 
interest  on  real'  estate  mortgage,  606. 
interest  on  taxes,  606. 
interest  paid  or  accrued  within  the  year,  604. 


1430  INDEX 

[References  are  to  pages.] 

DEDUCTIONS— Continued. 

in  the  equivalent  of  cash,  560. 
items  not  deductible,  565. 

allowances  to  minor  children,  595. 

assessments  against  local  benefits,  575,  616. 

expense  of  restoring  property,  572. 

ground  rent,  606. 

improvements  and  betterments,  570. 

insurance  on  employees,  572. 

interest  on  capital,  603. 

personal,  living  or  family  expenses,  565. 

propaganda  expenses,  589. 

rent  for  residential  property,  583. 

reserves,  587. 

state  inheritance  taxes,  616. 

taxes  paid  under  tax-free  covenants,  616. 
judgments  against  taxpayer,  809. 
limitation  on  contributions  to  charities,  562. 
losses,  amounts  paid  to  make  up  profits  of  another  corporation,  642. 

arising  from  theft,  638. 

bonds  purchased  above  par,  636. 

connected  with  automobiles,  622. 

connected  with  residential  property,  624. 

cost  of  drawings,  models  and  patterns,  642. 

district  irrigation  bonds,   646. 

dividends  paid  in  property,  636. 

due  to  adverse  judgment,  657. 

embezzlements  recovered,  659. 

exchange  of  stock  under  1918  Law,  634. 

exchanges  of  property,  634. 

from  fires,  storm,  shipwreck  and  other  casualty,  636. 

from   sale   of  property  acquired  by   gift,  bequest,   devises   or 
descent,  625. 

in  connection  with  reorganizations,  634. 

in  general,  621. 

insurance  received  in  subsequent  year,  659. 

in  what  year  deductible,  812. 

measure  of,  630. 

must  be  sustained  during  year,  627. 

not  sustained  in  trade,  623. 

of  capital,  629. 

of  corporation  paid  by  stockholders,  646. 

of  income,  630. 

of  oil  and  gas,  646. 

of  railroad  companies,  812. 

"other  casualty,"  637. 

property  acquired  by  gift,  632. 

recoveries  on,  658. 

rental  value  of  buildings,  681. 

reserves  for,  647. 

reserves  for  cash  discounts,  647. 


INDEX  1-t'^l 

[References  are  to  pageH.I 

DEDUCTIONS— Continued. 

sale  of  capital  stock,  645. 

sale  of  stock  or  securities,  633. 

sales  of  property,  632. 

securities  transferred  to  corporation  formed  for  the  purpose, 

644. 
shrinkage  in  securities  in  stocks,  643. 
.shrinkage  or  deterioration  in  storage,  646. 
sustained  in  trade,  622. 
voluntary  destruction  of  property,  639. 
when  embezzlements  deductible,  628. 
worthless  stock,  645. 
losses  of  useful  value,  640. 
may  not  be  duplicated,  559. 
membership  fees  and  dues,  601. 
money  paid  under  mistake  of  fact,  813. 
munitions  taxes,  609. 
must  be  actual,  559. 

must  be  reported  on  same  basis  as  income,  560. 
New  York  State  franchise  tax,  609. 
obsolescence,  defined,  695. 

distillers  and  dealers  in  liquor,  699. 
intangible  property,  698. 

no  allowance  unless  obsolescence  certain,  696. 
of  vineyards,  703. 
under  1916  Law,  697. 
office  furniture  and  equipment,  585. 
only  those  specified  in  statute  are  allowed.  559. 
ordinary  and  necessary  expenses,  577. 

payments  from  earnings  of  public  utility  paid  to  state,  601. 
procedure  of  banks  improperly  taking  deduction   for  taxes  paid  for 

shareholders  in  1919,  620. 
professional  expenses,  583. 
rent,  581. 

repairs  made  by  tenant,  586. 
repairs  to  property,  584. 
reported  in  year  accrued,  799. 
reported  in  year  paid,  799. 
reporting  upon  accrual  basis,  796. 

salaries  and  compensation  for  personal  services,  590. 
salaries  as  distribution  of  dividends,  593. 
salaries  constituting  part  payment  for  property,  594. 
salaries  constituting  waste  of  assets,  594. 
salaries  paid  to  enlisted  men,  595. 
securities  taxes  deductible,  612. 
state  tax  on  Massachusetts  trust  companies,  612. 
subtraction  for  redemption  of  trading  stamps,  588. 
taxes,  deductible  by  nonresident  aliens  and  foreign  corporations,  607 
imposed  by  authority  of  any  foreign  country,  611. 
in  general,  607. 
not  deductible,  613. 


1432  INDEX 

[References  are  to  pages.l 

DEDUCTIONS— Continued. 

paid  by  corporation  for  stockholders,  617. 

paid  by  tenant,  613. 

paid  by  vendee  for  vendor,  613. 

paid  for  fiscal  year,  609. 

paid  or  accrued  within  the  year,  608. 

paid  to  taxing  subdivisions  of  territories,  612. 
traveling  expenses  under  1921  Law,  567. 
traveling  expenses  under  previous  laws,  567. 
what  constitute  business  expenses,  578. 
what  included  in  deduction  for  loss,  627. 
when  charges  deductible,  560. 
when  deductions  should  be  reported,  798. 
when  donations  deductible,  599. 
when  items  deductible,  additional  compensation,  808. 

amounts  paid  as  damages,  809. 

judgments,  809. 

losses  from  goods  returned,  808. 

reserves  to  meet  liabilities,  810. 

subsequently  discovered  charges,  813. 
when  pensions  deductible,  598. 
worthless  debts,  charging  off  in  part  under  1921  Law,  655. 

classification  of,  648. 

defective  war  conditions,  652. 

endorsement  of  notes,  649. 

existing  prior  to  March  1,  1913,  648. 

foreclosure  of  mortgages,  653. 

must  be  charged  off  on  books,  650. 

reserves  for  under  1921  Law,  655. 

Russian  bank  deposits,  653. 

voluntary  forgiveness  of  debt,  651. 

when  considered  worthless,  650. 

when  deductible  under  1921  Law,  655. 

worthless  securities,  654. 

DEEDS, 

See  Conveyances. 

DEEDS  OF  TRUST, 

irrevocable  trusts,  106. 

when  fiduciary  relationship  created  by,  106. 

DE  FACTO  CORPORATIONS, 
taxed  as  corporation,  217. 

DEFERRED  PAYMENTS, 

sales  of  real  estate  involving,  474. 

sales  of  real  estate  not  on  installment  plan,  475. 

DEFINITIONS, 

admissible  assets,  1073. 

amount  of  taxes  paid  during  taxable  year,  786. 

bond  interest.  966. 


INDEX  1433 


[References  are  to  pages.] 

DEFINITIONS— Continued, 
capital  assets,  410. 
capital  gains,  410. 
capital  loss,  410. 
corporations,  210. 
depletion,  713. 
dividends,  504. 

domestic  and  foreign  partnerships,  166. 
domestic  corporation,  224. 
exchange,  1225. 
fair  market  value,  if  any,  421. 
farmers,  152. 
fiduciaries,  103. 
fiscal  year,  815,  1032. 
foreign  corporations,  297. 
foreign  country,  Gil,  781,  786. 
foreign  fiduciary,  149. 
foreign  items,  956. 
gifts,  459. 

government  contracts,  1028. 
inadmissible  assets,  1074. 
income,  340. 

"in  control"  of  a  corporation,  634. 
insurance  companies,  282. 
intangible  property,  1049. 
invested  capital,  1041. 
manufacturing  establishments.   1251. 
net  income,  356. 
net  loss,  under  1918  Law,  660. 

under  1921  Law,  662. 
nonresident  foreign  corporation,  965,  998. 
obsolescence,  695. 
"other  casualty,"  637. 
personal  service  corporations,  195. 
prewar  period,  1032. 
promissory  notes,  1215. 
relating  to  stamp  tax,  1166. 
reorganization,  441. 
stock  dividend.  532. 
tangible  property,  1048. 
taxable  year,  1032. 

terms  applying  to  insurance  companies,  279. 
terms  in  connection  with  depletion,  714. 
trade  or  business,  625,  1018. 
United  States,  10. 
withholding  agent,  965. 

DEPENDENTS, 

credit  for,  779. 

date  determining,  780. 


1434  INDEX 

[References  are  to  pages.'] 

DEPLETION, 

See  Gas  Wells. 
accounts  on  books,  724. 
accumulated  depletion,  739. 

adjustment  of  accounts  based  on  bonus  or  advanced  royalty,  722. 
aggregating  timber  and  land  for  purpose  of  valuation  and  account- 
ing, 771. 
allowable  capital  additions  in  case  of  mines,  739. 
bonuses  paid  for  leases,  717. 
capital  recoverable  by  lessor,  717,  743. 

by  operating  owner,  742. 

in  case  of  lessee,  716. 

in  case  of  operating  owner,  715. 
capital  sum,  741. 

charges  to  capital  and  expense  in  case  of  oil  and  gas  wells,  763. 
charges  to  capital  and  to  expense  in  case  of  timber,  770. 
computation  of,  722. 

for  combined  holdings  of  oil  and  gas  properties,  756. 

where  quantity  of  oil  or  gas  uncertain,  756. 
computation  of  allowance  for,  in  case  of  gas  wells,  747. 

in  case  of  oil  wells,  745. 

in  case  of  timber  for  given  year,  769. 
cost  of  development  of  oil  and  gas  wells,  741. 
cost  of  oil  and  gas  wells,  741. 
defined,  713. 

definitions  of  terms,  714. 
determination  of  cost  of  deposits,  718. 
determination  of  cost  of  oil  and  gas  deposits,  744. 
determination  of  fair  market  value  of  mineral  property,  719. 
determination  of  fair  market  value  of  timber,  768. 
determination  of  quantity  of  oil  in  ground,  744. 
discovery  of  mines,  737. 
discovery  of  oil  and  gas  wells,  758,  760. 
distributions  from  reserves  for,  525. 
fair  market  value  of  oil  or  gas  properties,  744. 
for  past  years,  not  allowed  under  present  law,  734. 
inadequate  allowance  for,  effect  on  invested  capital,  1089. 
in  case  of  mines,  735. 

information  by  taxpayers  claiming,  in  case  of  timber,  773. 
in  general,  713. 

limitation  on,  based  on  discovery  value,  722. 
maps  to  be  filed,  758. 

method  of  estimating  recoverable  reserves,  744. 
mines,  oil  and  gas  wells,  714. 
of  oil  and  gas  wells,  740. 
of  oil  and  gas  wells  before  1916,  765. 
present  value  method,  720. 
proven  tract  or  lease,  760. 

in  case  of  mines,  738. 
reserves  for,  inclusion  in  invested  capital,  1060. 
revaluations  of  mineral  property  not  allowed,  722. 


INDEX  1435 

[Referenceti  are  to  pages'] 

DEPLETION— Continued. 

revised  estimate  of  reserves  of  oil  and  jcas.  747. 

rule  as  to  mine  under  191G  Law,  72(). 

rules  to  lessees  under  prior  laws,  728. 

rule  under  1909  Law,  725. 

rule  under  1913  Law,  725. 

statement  required  where  claimed  for  mineral  property,  736. 

statement  required  where  depletion  of  oil  or  gas  is  claimed,  75G. 

timber,  767. 

accounts  on  books,  772. 

determination  of  quantity  of  timber,  769. 

revaluation  not  allowed,  770. 
when  fair  market  value  of  mineral  property  required,  "lit. 

DEPOSITORS'  GUARANTY  FUND, 

deduction  of  amount  set  apart  for,  612. 

DEPRECIATION, 

accounts  on  books,  724. 

in  case  of  timber,  772. 
additions  and  betterments  not  deductible  as,  690. 
allowed  on  intangible  property,  682. 
allowed  to  corporations,  678. 
allowed  to  individuals,  678. 

annual  allowances  measured  by  life  of  property,  688. 
annual  allowance  must  be  charged  off  on  books,  ()92. 
automobile  used  in  business,  680. 
capital  sum  returnable  through,  685. 
closing  account  as  to  any  item,  694. 
deduction  for,  in  general,  678. 
deduction  of  by  estates  and  trusts,  127. 

by  farmers,  165. 

by  life  insurance  companies,  277. 
depreciable  property,  679. 
distributions  from  reserves  for,  525. 
drawings  and  models,  685. 

estimates  of,  in  case  of  oil  and  gas  properties,  765. 
extraordinary  depreciation,  692. 
factories  running  night  shifts,  692. 
in  case  of  leases,  681. 

improvements  in  case  of  mines,  oil  and  ;ias  wells.  714. 
improvements  in  case  of  oil  and  gas  wells.  764. 
improvements  on  real  estate,  681. 

in  case  of  property  acquired  prior  to  March  1,  1913,  685. 
inadequate  allowance  for,  effect  on  invested  capital,  1089. 
incidental  repairs  to  property.  689. 
inventories  or  stock  in  trade,  682. 
loss  in  rental  value  of  buildings,  681. 
method  of  computing  allowance,  687. 
modification  of  method  of  computing  allowance,  687. 
of  oil  and  gas  wells  before  1916,  765. 
patents  and  copyrights,  683. 


1436  INDEX 

[References  are  to  pages.'] 
DEPRECIATION— Continued. 

physical  property  in  case  of  oil  and  gas  wells,  764. 
rate  of,  690. 

apartment  houses,  691. 

steamers,  691. 
renewals  to  property,  689. 
reserves  for,  694. 

inclusion  in  invested  capital,  1060. 
under  prior  laws,  679. 

statement  required  where  claimed  for  mineral  property,  736. 
terms  of  patents  in  various  countries,  684. 
wearing  apparel,  682. 

DESTRUCTION  OF  PROPERTY, 

loss  in  case  of  voluntary  destruction,  639. 

DEVISE, 

See  Bequest,  Devise  or  Inheritance. 

DISCOUNT, 

income  from,  496. 

municipal  bonds  purchased  at,  462. 

not  to  be  reported  as  income,  386. 

on  sale  of  bonds,  effect  on  invested  capital,  1062. 

treatment  of  bonds  issued  at,  238. 

treatment  of,  by  banks,  387. 

DISCOVERY  VALUE, 

See  Depletion. 
discovery  of  oil  and  gas  wells,  758. 
in  case  of  mines,  737. 
private  bounding  lines,  761. 
proof  of  discovery  of  oil  and  gas  wells,  762. 
proven  tract  or  lease,  760. 

DISSOLUTION   OF   CORPORATIONS, 
liability  of  tax  after,  265. 
recovery  of  tax  from  stockholders,  267. 

DISTILLERS  AND  DEALERS   IN  LIQUOR, 
obsolescence  in  the  case  of,  699. 

DISTRAINT, 

addition  of  $5  as  part  of  tax,  874. 
collection  of  taxes  by,  873. 

DISTRIBUTIONS, 

See  Dividends. 

DISTRICT  OF  COLUMBIA, 

interest  on  obligations  of,  489. 

DIVIDENDS, 

allowed  as  credit  to  partners,  181. 

changes  in  taxation  of,  made  by  1921  Law,  504. 


INDEX  1437 

[References  are  to  pages.] 

DIVIDENDS— Continued. 

compromise  of  preferred  dividends,  506. 

constructively   received,  347. 

credited  to  stockholders,  eflFect  on   invested  capital,   1071. 

credit  of,  by  nonresident  aliens,  66. 

to  nonresident  aliens,  83. 

under  1918  Law,  774. 

under   1921    Law,  775. 
deductible  loss  when  paid  in  property,  636. 
deduction  of,  by  corporations,  236. 
defined,  504. 

definition  of  stock  dividend,  532. 

distribution  from  depletion  or  depreciation  reserve,  525. 
distribution  in  liquidation  under  1921   Law,  517. 
distributions  from  capital,  526. 

distributions   in    liquidation   under   1918    Law,  511. 
distributions  which  are  not,  507. 
eflFect  of  stock  dividend  on  invested  capital,  1099. 
excessive  compensation,  506. 

exemption   of,  from  domestic  building:  and   loan   associations,  355. 
exemption  of  when  received  from  domestic  building  and  loan  associa- 
tions, 37. 
extent  to  which  taxable,  509. 

paid  by  domestic  corporations,  509. 

paid  by  foreign  corporations,  510. 

paid  by  personal  service  corporations,  510. 
formerly  taxed  at  rates  of  previous  years,  537. 
from   associations,    505. 
from  co-operative  associations,  508. 
from  corporations  with  income  from  possessions,  225. 
from  earnings  or  profits  accumulated  prior  to  March  1.  1913,  518. 

effect  of  book  entries,  523. 

exempt  only  to  stockholders  of  first  corporation.  524. 

received  by  an  estate,  524. 

rulings  under  1916  Law,  522. 

rulings   under   1917   and   1918   Laws,  520. 
from  exempt  income,  524. 

from  federal  land  bank  and  national  farm  loan  association,  508. 
from   federal   reserve   bank,  508. 
from  limited  partnerships,  170. 
from  stock  held  by  employees,  366. 
income  from,  504. 

taxed  to  nonresident  aliens,  64. 
informal  dividends,  eflfect  on  invested  capital,  1071. 
information  at  .'^ource  by  corporations  paying,  95.">. 
in  form  of  royalties,  506. 
legal  and  beneficial  owners  of  stock,  511. 
method  of  determining  available  net  income,   1098. 
of  federal  reserve  banks,  exempt,  356. 
of  personal  service  corporations,  204. 
on  life  insurance  policies,  508,  555. 


1438  INDEX 

{References  are  to  pages.'] 
DIVIDENDS— Continued. 

on  stock  of  employees,  507. 

paid  by  life  insurance  company,  276. 

paid  from  appreciation  of  assets  prior  to  March  1,  1913,  525. 

paid  from  surplus,  effect  on  invested  capital,  1097. 

paid  in  equivalent  of  cash,  527. 

paid  in  Liberty  bonds,  529. 

paid  in  property,  527. 

paid  in  scrip,  530. 

partial  liquidation  of  corporations,  516. 

presumption  as  to  source  of  distribution,  517. 

proceeds  of  liquidation  received  in  installments,  515. 

property  dividend  upon  reorganization,  529. 

report  of  payments   of,  by  corporations,  263. 

representing  accretions  in  value  of  property  acquired  before  March 

1,  1913,  504. 
reserved  for,  by  life  insurance  companies,  276. 
retirement  of  capital  stock,  515. 
returns  of  information  at  source  respecting,  962. 
salaries  constituting  a  distribution  of,  593. 
sale  of  stock  dividend,  534. 

sale  of  stock  dividend  resulting  from  revaluation  of  assets,  536. 
stamp  tax  on  rights  to  receive  stock  dividends,  1224. 
stock  dividends  not  taxable,  531. 
taxable  in  year  received,  526. 
taxable  to  farmers,  160. 

taxes  paid  for  shareholders  treated  as,  506. 
when  not  reported  at  the  source,  953. 
withholding  at  source  in  case  of,  968. 

DOMESTIC   CORPORATIONS, 

See  Corporations. 

DOMESTIC  LIFE  INSURANCE  COMPANIES, 
See  Insurance  Companies. 

DONATIONS, 

not  deductible,  598. 

to  Red  Cross,  not  deductible,  600. 

when  deductible  as  expense,  599. 

DRAFTS, 

See  Stamp  Tax. 

DRAWINGS  AND  MODELS, 
depreciation  of,  685. 
losses  connected  with,  642. 

DRUG  STORES, 

not  subject  to  child  labor  tax,  1251. 

DUE   PROCESS   OF  LAW, 

discussed  in  relation  to  the  income  tax,  1009. 


INDEX  1439 

[References  are  to  pages. '\ 

DURESS, 

a  prerequisite  for  recovery  of  taxes,  88. 

implied  duress,  890. 

necessary  to  maintain  a  suit,  93R. 

necessity  for,   890. 

payment  after  receipt  of  first  notice  and  demand,  892. 

payment  after  receipt  of  Form  1123,  892. 

payment  after  receipt  of  second  notice  and  demand,  893. 

payment  of  stamp  taxes  under,  1247. 

what  constitutes,  888. 

DUTCH  ADMINISTRATION  OFFICES. 

procedure  in  collecting  income  from,  100. 

E 

EARNED  SURPLUS, 

See  Si'RPLL's  AND  Undivided  Pr(»kits. 

EDUCATIONAL  CORPORATIONS, 
exempt  from  tax,  322. 

EMBEZZLED  MONEYS. 

held  not  to  be  income,  545. 
losses  from,  638. 
recovery  of,  659. 
when  deductible,  628. 

EMPLOYEES, 

change  of  status  of  during  year,  982. 
income  of  from  premiums  paid  by  employer.  367. 
of  mining  contractors,  withholding  against.  982. 
residence  of  alien  employees,  981. 

EMPLOYERS, 

duty  of,  to  determine  status  of  alien  employees.  981. 
trusts  created  by.  102. 

ENTERTAINMENT  MONEY, 
deduction  of,  590. 

EQUIPMENT  TRUST  CERTIFICATES, 

withholding  at  source  in  case  of,  971. 

EQUIVALENT  OF  CASH, 
contributions  in.  562. 
deductions  in.  560. 
dividends  paid  in,  527. 
exchanges  of  property.  421. 
income  received  in  kind.  350. 
what  constitutes,  422. 

ESCROW. 

amiHint.'s  placed  in.  when  to  be  reported,  800. 


1440  INDEX 

[References  are  to  pages."] 
ESTATES  AND  TRUSTS, 

See  Fiduciaries;  Foreign  Fiduciaries. 
accumulations  for  charitable  purposes,  116. 

allowance  of  net  loss  to  partnerships  and  estates  and  trusts,  663. 
corpus  of,  111. 

credit  for  taxes  to  beneficiaries  of,  791. 
credits  allowed,  131. 

taxes,  132. 

taxes  paid  at  source.  132. 
decedent's  estate  during  administration,  129. 
deductions  allowed,  120. 

amounts  paid  by  committee,  124. 

contributions  to  charities,  120. 

depreciation,  127. 

executors'  commissions,  125. 

expenses  chargeable  against  corpus,  121. 

expenses  incident  to  administration,  121. 

interest,  125. 

losses,  126. 

ordinary  and  necessary  expenses,  121. 

special  assessments,  124. 

statutory  allowance  to  widow,  125. 

taxes,  126. 

worthless  debts,  127. 
distributable  income,   133. 

distribution  of  several  years,  135. 

not  actually  paid  in  year,  134. 

what  constitutes,  134. 
distribution  of  income,  133. 
dividends  from  earnings  or  profits  accumulated  prior  to     March  1, 

1913,  524. 
exemption  of  Liberty  bonds,  119,  483. 
gross  income  of,  112. 
income  of,  110. 

bequeathed  to  governmental  agency  of  state,  115. 

constructively  received  prior  to  decedent's  death,  114. 

discretion  of  trustee  to  distribute,  136. 

extraordinary  dividends,  112. 

installment  sales  of  real  property,  115. 

investment  of  corpus,  112. 

proceeds  of  life  insurance  policies,  114. 

profit  from  sale  of  corpus,  112. 

settlement  of  claims,  113. 

to  whom  taxed,  110. 
net  income  of,  how  taxed,  128. 
net  losses  of,  126. 

receiver  in  partition  proceedings,  140. 
taxation  of  capital  gains,  410. 
undistributed  income,  133,  136. 

when  free  from  tax  when  distributed,  136. 


INDEX  ^^^^ 

[ReferetictH  arc  to  pagen] 
ESTATES  AND  TRUSTS— Continued. 

whith  cannot  be  treated  as  a  unit,  137. 
t'xamples  of,  138. 
how  taxed,  137. 

EVASION  OF  TAX.  ,     ,       ,  .-r 

sale  of  corporate  assets  by  conveyance  to  trustees.  4.,.,. 

taxpayers  leavinK  country,  874. 

EVIDENCES  OF  INDEBTEDNESS, 
are  tangible  property,  1048. 

EXAMINATION  OF  BOOKS, 

constitutionality  of  provisions  for,  945. 

constitutionality  of,  with  regard  to  corporations,  94  <. 

corporate  records,  269. 

enforcement  of  provisions  respecting,  944. 

general  provisions  respecting,  943. 

in  case  of  special  taxes  and  other  cases,  948. 

inspection  of  government  contracts,  948. 

instructions  to  revenue  agents,  949. 

national  banks,  947. 

records  of  partnerships,  190. 

requiring  attendance  of  witnesses,  943. 

requiring  production  of  books,  944. 

unnecessary  examinations  not  permitted  under  present  law,  943. 

EXCESS  PROFITS  TAX. 

See  GOVERNMENT  Contracts;  Invested  Capital;  Prewar  Period;  Surpli. 
AND  Undivided  Profits,  1056. 

additicms  to  surplus  account,  1064. 

adiustments  which  increase  book  value  of  assets,  1080. 
Adjustments  which  reduce  book  value  of  assets,  amortization  under 
munition  manufactures  Ux.  1094. 

as  to  inadequate  allowance  for  depreciation  or  depletion.  108J. 
as  to  inadmissible  assets,  1095. 
as  to  losses,  1093. 

as  to  value  of  assets  acquired  in  reorganization.  108-. 
as  to  treasury  stock.  1081. 

as  to  values  marked  up  on  books  of  account.  108b. 
as  to  value  of  intangible  assets,  1081. 
administrative  provisions,  1138. 
admissible  assets,  1073. 
defined.   1073. 
insurance  policies,  1074. 
school  district  warrants,  1074. 
affiliated  corporations.  1132. 

allocation  of  net  income  to  particular  source.  103U.  ^ 

amended  contracts,  1029. 
amounts  paid  into  or  left  in  business,  1070. 
applies  to  corporations  only.  1016. 


1442  INDEX 

[References  are  to  pages."] 

EXCESS  PROFITS  TAX— Continued. 

apportionment  of  invested  capital  in  net  income  for  partial  personal 

service  corporations,  1025. 
assessment  by  reference  to  representative  corporations,  1116. 

abnormal  conditions  affecting  capital  or  income,  1119. 

abnormal  conditions  affecting  pre-war  income,  1124. 

abnormal  profits  thrown  into  single  year,  1122. 

Commissioner  to  keep  record,  1130. 

election  of  taxpayer,  1117. 

foreign  corporations,  1118. 

inventions  turned  over  without  consideration,  1118. 

method  of  assessment,  1126. 

payment  of  inadequate  salaries  to  officers,  1124. 

statements  to  be  filed,  1126. 

what  are  representative  corporations,  1127. 

where  Commissioner  unable  to  determine  invested  capital,  1117. 

where    intangible    assets    of    substantial    value    excluded    from 
invested  capital,  1122. 

where  stock  issued  for  mixed  aggregate,  1118. 
average  net  income  for  pre-war  period,  1113. 
balance  sheets  required,  1136. 
borrowed  capital,  1066. 
certain  corporations  exempt,  1026. 
changes  under  1921  Law,  1015. 

computation  of  tax  on  partial  personal  service  corporation,  1025. 
contracts  under  Naval  Appropriation  Acts,  1029. 
corporations  deriving  income  from  government  contracts,  1027. 
corporations  engaged  partly  in  personal  service  business,  1024. 
corporations  subject  to,  1026. 

corporations  with  no  invested  capital  not  subject  to  1917  Law,  1021. 
corporations  with  nominal  capital  not  subject  to  1917  Law,  1021. 
credit  balances  to  stockholders  accounts,  1071. 
determination  of  first  installment  for  1919  in  special  cases,  1129. 
determination  of  installments  in  case  of  foreign  corporation,  1129. 
dividends  credited  to  stockholders,  1071. 
does  not  apply  to  personal  service  corporations,  1017. 
enactment  of  1918  Law,  1016. 

evidences  of  indebtedness  are  tangible  property,  1048. 
examples  of  corporations  with  more  than  a  nominal  capital,  1022. 
examples  of  trade  or  business  under  1917  Law,  1019. 
excess-profits  credit,  1111. 

exemptions  granted  by  Merchant  Marine  Act,  1115. 
fiscal  year,  defined,  1032. 

ending  in  1919,  1035. 

ending  in  1921,  1035. 

ending  in  1922,  1036. 
gold  mining  corporations  exempt,  1030. 
government  contracts  defined,  1028. 
inadmissible  assets,  1074. 

bonds  or  other  obligations,  1076. 

defined,  1074. 


INDEX  1443 

[References  are  to  pages."] 

EXCESS  PROFITS  TAX— Continued. 

may  become  admissible,  1078. 

reduction  of  invested  capital  by,  1079. 

stock  in  Federal  Reserve  Bank,  1075. 

stock  of  domestic  corporations,  1075. 

stock  of  domestic  corporations  with  income  from  possessions, 
1075. 

stock  of  foreign  corporations,  1076. 
incorporation  of  business  of  partnership  or  individual,  1131. 
individuals  not  subject  to,  1018. 
individuals  under  1917  Law,  1018. 
informal  dividends,   1071. 
invested  capital,  adjustments  due  to  changes  in  taxable  year,  1096. 

affiliated  corporations,  1132. 

assessment  without  reference  to,  1116. 

bank  discount,  1063. 

bonus  stock,  1045. 

broker's  commissions,  1044. 

cash  paid  in,  1044. 

computation  of,  1073. 

conversion  of  bonds  into  stock,  1073. 

current  profits,  1063. 

discount  on  sale  of  bonds,  1062. 

distinguished  from  capital  sum,  741. 

dividends  paid  from  surplus,  1097. 

domestic  corporations  with  income  from  possessions,  1107. 

effect  of  additional  assessment,  1102. 

effect  of  amortization  upon,  706. 

effect  of  liquidating  dividend.  1100. 

effect  of  refund,  1103. 

effect  of  stock  dividend,  1099. 

for  fractional  part  of  year,  1103. 

for  pre-war  period,  1104. 

for  1917,  1039. 

for  1918-1921,  1041. 

good  will,  1049. 

in  case  of  reorganization,  1043. 

inclusion  of  reserves,  1059. 

increase  of  capital  stock,  1100. 

individuals  in  1917,  1039. 

intangible  property,  1049. 

intangible  property  acquired  for  tangible  property,  1054. 

intangible   property   paid    in   both   before  and   after  March   3, 
1917,  1052. 

intangible  property  paid  in  on  or  after  March  3,  1917,  1052. 

intangible  property  paid  in  prior  to  March  3,  1917,  1051. 

meaning  of,  1041. 

mixed  aggregate  of  tangible  and  intangible  property,  1054. 

no  paid-in  surplus  as  to  intangible  property,   1053. 

of  foreign  corporations,  1107. 

of  insurance  companies,  1106. 


1444  INDEX 

[References  are  to  pages.'] 

EXCESS  PROFITS  TAX— Continued. 

par  value  of  stock,  1044. 

patents,  1049,  1061. 

payment  of  preceding  years'  tax,  1100. 

presumption  as  to  source  of  distributions  of  dividends,  517. 

property  taken  for  debt,  1062. 

reduction  of,  by  inadmissible  assets,  1079. 

reduction  of  capital  stock,  1100. 

reduction  of  reserves,  1103. 

reserve  for  depreciation  or  depletion,  1060. 

reserves  for  taxes,  1060. 

stock  issued  for  services,  1045. 

stock  or  shares  outstanding  on  March  3,  1917,  1053. 

stock  sold  at  a  discount,  1044. 

surrender  value  of  insurance  policies,  1063. 

tangible  property  paid  in,  1045. 

taxes  withheld  at  source  not  included  in,  1042. 

trade  marks,  1049. 
Liberty  bonds  exemption  of  reorganized  corporation,  1132. 
limitation  of  tax  vv^hen  return  for  part  of  year,  1038. 
limitations  of  additions  to  surplus,  1065. 
maximum  limit  of  tax,  1037. 

method  of  determining  net  income  available  for  dividends,  1098. 
national  bank  stockholders'  trustee  accounts,  1135. 
net  income,  for  purposes  of,  1112. 

for  taxable  year,  1114. 

for  1911  and  1912,  1113. 

for  1913,  1113. 
no  credit  allow^able   on  account  of  estimate   of  excess   payment  till 

special  relief  determined,  1130. 
on  sale  of  mines,  oil  or  gas  wells,  1038. 
paid  in  surplus,  record  to  be  kept  by  Commissioner,  1047. 

tangible  property  paid  in,  1045. 
partnerships  not  taxed  under  present  law,  1020. 
partnerships  taxed  under  1917  Law,  1020. 
partnerships  which  paid  a  tax  on  1918  income,  1021. 
payment  of  1918  tax  by  corporations  applying  for  special  assessments, 

1128. 
penalties,  1138. 

personal  sei'vice  corporation  not  subject  to,  1021. 
personal  service  corporations  under  1917  Law,  1021. 
pre-war  period,  1032. 

property  paid  in  and  subsequently  written  off,  1066. 
rates  for  1917,  1033. 
rates  for  1918,  1017,  1034. 
rates  for  1919,  1920  and  1921,  1017,  1034. 
re-enacted  by  1921  Law,  1015. 
"remains  in  control,"  defined,  1083. 

reorganizations  entitling  corporations  to  revaluation,  1084. 
repealed  as  of  December  31,  1921,  1015. 
repeal  of,  1. 


INDEX 


1445 


[References  are  to  pages] 

EXCESS  PROFITS  TAX— Continued, 
returns  in  special  cases,  1137. 
returns  of,  1136. 
specific  exemption,  1111. 
statement  of  the  tax.  1032. 
sub-contractors,  1030. 
surplus  and  undivided  profits,  10.')5. 
tanRible  property  defined,  1048. 
taxable  year,  defined,  1032. 
taxation  if  corporation  with  income  from  Rovernment  contracts.  10d6. 

the  1917  Act,  1015. 

time  and  manner  of  paying  tax,  1137. 

to  whom  rJ17  Law  applied,  lOlG. 

value  of  property  as  of  January  1,  1914,  1041. 

what  are  government  contracts,  1030. 

when  individuals  not  subject  to  1917  Law,  1018. 

EXCHANGE 

See  Foreign  Exchangk. 

EXCHANGES  OF  PROPERTY. 

See  Market  Value. 
"aggregate  par  value"  of  stock  received,  440. 
basis  of  determining  gain  or  loss  in  case  of,  407. 
change  of  investments  does  not  produce  taxable  income.  412. 
dealings  in  similar  property,  429. 
exchange  of  stock  under  1918  Law,  G34. 
exchanges  for  different  kinds  of  property,  435. 
exchanges  of  stock  under  1921  Law,  635. 
fair  market  value  as  of  March  1,  1913,  428. 
farm  property,  159. 
for  property,  408. 

gain  or  loss  when  acquired  before  March  1,  1913,  415. 
property  acquired  by  bequest,  devise  or  inheritance,  456. 
property  for  stock,  451. 
property  held  for  productive  use,  411. 

stock  exchanged  for  other  stock  of  no  greater  par  value,  441. 
held  for  investment,  408. 

insurance  policies,  462. 

losses  from.  634. 

profit  from  reorganizations,  mergers  and  consolidations,  436. 

property  held  for  investment,  411. 

property  received  must  have  readily  realizable  value,  427. 

reorganizations,  etc..  under  1918  Law,  438. 

selling  price,  419. 

stock  exchanged  for  stock  of  greater  par  value.  446. 

stock  in  trade,  412. 

subsequent  sale,  417.  ,  j    i-n 

subsequent  sale  of  stock  ..f  greater  par  value  than  that  exchanged.  4oO. 

subsequent  sale  of  stock  received  on  exchange.  444. 

what  constitutes  equivalent  of  cash,  422. 

when  gain  arises  from  exchange  of  property  for  stock,  452. 

when  income  realized  from,  under  1918  I^w,  421. 


1446  INDEX 

[References  are  to  pages."] 

EXECUTORS, 

See  Fiduciaries. 
liability  for  tax,  147. 
returns  by  ancillary  executors,  147. 
returns  upon  death  or  termination  of  trust,  146. 

EXEMPT  INCOME, 

accident  or  health  insurance,  37,  355. 

amounts  received  as  compensation  for  personal  injuries,  355. 
amounts  received  as  return  of  premiums,  37,  354. 
amounts    received    under    War    Risk    Insurance   and    Vocational    Re- 
habilitation Acts,  37,  355. 
dividends  from,  524. 

dividends  from  building  and  loan  associations,  355. 
earnings  from  operation  of  ships,  37. 
Federal  Reserve  Banks,  356. 

income  from  operation  of  public  utility,  38,  355. 
income  of  foreign  governments,  354. 
income  of  states  and  political  subdivisions,  357. 
interest,  federal  farm  loan  act  securities,  38. 

obligations    of    District    of    Columbia    or    possession     of    the 
United  States,  38. 

obligations  of  states,  354. 

obligations  of  state,  territory,  or  political  subdivision  thereof, 
38. 

obligations  of  the  United  States,  38,  354. 
interest  or  dividends  from  building  and  loan  associations,  37. 
omitted  from  returns,  39. 
operation  of  foreign  ships,  355. 
pensions,  355. 

pensions  from  United  States,  37. 
proceeds  of  life  insurance  policies,  37,  354. 
property  acquired  by  gift,  bequest,  devise  or  descent,  37,  354. 
receipts  of  shipowners'  mutual  protection  and  indemnity  associations, 

38,  355. 
rental  value  of  clergyman's  dwelling  house,  38,  355,  368. 
returns  of,  493. 

EXEMPT  ORGANIZATIONS, 

associations  for  marketing  produce  and  purchasing  supplies,  335. 

building  and  loan  associations,  318. 

business  associations,  328. 

cemetery  companies,  322. 

civic  organizations,  330. 

clubs,  330. 

constitutionality  of  exempting  certain  corporations,  1013. 

co-operative  banks,  318. 

corporations  owned  by  exempt  corporations,  336. 

credit  unions,  321. 

examples  of  organizations  not  exempt,  313. 

exempt  from  excess-profits  tax,  1026. 


INDEX 


1447 


[References  are  to  pages. ] 

EXEMPT  ORGANIZATIONS— Continued. 

exemption  limited  to  classes  specifically  enumerated,  313. 

federal  land  banks,  337. 

foreign  corporations  may  be,  312. 

fraternal    beneficiary    societies,   317. 

interest  on  bonds  of,  493. 

joint  stock  land  banks  not  exempt  under  1918  or  present  law,  337. 

labor,  agricultural  and  horticultural  organizations,  315. 

mutual  or  co-operative  organizations  of  local  character,  331. 

mutual  savings  banks,  316. 

national  farm  loan  associations,  337. 

personal  service  corporations,  337. 

proof  of  exemption,  313. 

proof  of  exemption  in  case  of  foreign  corporations,  312. 

religious,  charitable,  scientific,  literary  and  educational  corporations, 

322. 
returns  by  those  claiming  to  be,  314. 
right  of  exemption  must  be  proved  on  request,  314. 
where  question  as  to  right  of  exemption  exists,  313. 

EXEMPTIONS, 

See  Exempt  Income;  Exempt  Organizations;  Interest. 
certificates  of  indebtedness  issued  by  Director  General  of  Railroads, 

not  exempt,  487. 
corporations  allowed  specific  exemption,  241. 
corporations  exempt  from  capital  stock  tax,  1156. 

date  determining  in   case  of  personal  exemption   and   credit   for  de- 
pendents, 780. 

exemption  from  withholding,  983. 

exemption  of  Liberty  bonds  under  1918  Law,  480. 

exempt  organizations,  312. 

excess-profits  tax,  specific  exemption,  1111. 

foreign  corporations,  300. 

foreign  steamship  companies,  303. 

from  stamp  tax,  1163. 

income  exempt  to  partners,  184. 

income  of  foreign  ambassadors,  310. 

income  of  foreign  governments,  309. 

interest  exempt  from  tax,  479. 

interest  on  postal  savings  accounts,  488. 

interest  on  War  Finance  Corporation  bonds,  488. 

Liberty  bond,  in  case  of  estates  and  trusts.  119. 

Liberty  bond  interest  in  case  of  partners,  182. 

Liberty  bonds  under  1921   Law,  485. 

pensions  from  the  United  States,  547. 

personal  and  specific,  776. 

proceeds  of  life  insurance,  553. 

specific  exemption  of  domestic  life  insurance  companies.  278. 

to  soldiers  and  sailors  under  1918  Law,  374. 

under  Merchant  Marine  Act,  1115. 


1448  INDEX 

\_References  are  to  pages.'] 

EXPENSES, 

See  Corporations;  Traveling  Expenses. 
allowed  as  deduction  to  partnerships,  177. 
amounts  paid  for  alterations,  585. 
buildings  used  for  rental  purposes,  587. 
business  expenses  of  leasehold  property,  581. 
certain  items  should  be  capitalized,  570. 
commissions  paid,  589. 
deductible  by  corporations,  231, 
deductible  by  railroads,  272, 
deduction  of,  576. 

advertising-  expenses,  582. 

by  estates  and  trusts,  121. 

by  farmers,   161. 

donations,  599. 

entertainment   money,   590. 

membership  fees  and  dues,  601. 

professional   expenses,  583. 
investment  expenses  of  life  insurance  companies,  277. 
items  deductible  as,  580. 
items  not  deductible  as,  581. 
of  insurance  companies  under  1916  Law,  296. 
of  organization,  not  deductible,  231. 
of  propaganda,  not  deductible,  589. 
of  restoring  property,  572. 

ordinary  and  necessary  expenses,  577.  ^ 

personal,  living  or  family,  not  deductible,  565. 
relating  to  patents,  583. 
what  constitute  business  expenses,  578. 
when  deductible,  577. 

EXPORT  BUSINESS, 
income  of,  386. 

EXPRESS  COMPANIES, 

not  subject  to   child   labor  tax,  1251, 

EXTENSION   OF  TIME, 

conditions   under  which  granted  for  payment  of  tax,   865. 

for  payment  of  tax,  865. 

for  payment  of  tax,  when  granted,  866. 

new  provision  of  1921  Law  as  to  payment  of  taxes,  865. 

payment  of  tax,  853. 

taxpayer  may  be  required  to  furnish  bond,  865. 

to  file  returns,  830. 

F 
FACTORIES, 

subject  to  child  labor  tax,  1250. 

FAIR  MARKET  PRICE, 

See  Market  Value. 


INDEX  1-^^^ 

[ReferenvfH  arc   to   i»i(/es.] 

FAIR   MARKET   VALUE, 

See  Market  Vaiak. 

FARMERS, 

accountin^r  on  acciual  basis,  156. 
computing  iiuome  upon  crop  basis,  161. 
deductions  allowed,  161. 
automobile,  162. 
depreciation,  165. 
expense,  161. 

irrigatfon  company  as.sessment.«,  163. 
losses,  163. 
salaries,  162. 
taxes,  163. 
definition,  152. 
Sientlemen  farmers,  152. 

income   of,   dividends   from   co-operative   associations.    160. 
exchange  of  farm  property,  159. 
may  be  in   cash   or  kind.    156. 
miscellaneous  income,  160. 
on  what  basis  reported.  156. 
proceeds  of  insurance,  160. 
products  consumed  by  farmer.  157. 
rents  received  in  kind,  157. 
sale  of  farm  property,  159. 
sale  of  livestock,  157. 
sale  or  exchange  of  annual  produce.  157. 
inventories,  153. 

adjustments  caused  by  use  of,  154.  155. 
change  to  inventory  basis,  153. 
method  of  valuing,   154. 
what  included  in,  153. 
net  losses  of,  164. 

not  keeping  books   and   not  taking  inventories,   156. 
returns  by,  165. 
rulings  relating  to.  152. 
payment  of  tax,  165. 
subject  to  penalties,  165. 
what  constitutes  business   of   farming.   152. 

FARMERS'  MUTUAL  INSURANCE  COMPANIES, 
exemption  from  tax,  333. 

FEDERAL  ESTATE  T.\XES, 
deduction  of,  610. 

FEDERAL  JUDGES, 

exemption  of  salaries  of,  38,  3(7. 

FEDERAL  LAND  BANKS, 
dividends  from,  508. 
exempt  from  tax.  337. 
interest  from,  exempt,  488. 


1450  INDEX 

[References  are  to  pages.l 

FEDERAL  OFFICERS  AND  EMPLOYEES, 

amounts  withheld  to  provide  annuities,  373. 

furnished  heat  and  light,  374. 

income  of,  subject  to  tax,  373. 

living  quarters  of,  373. 

paid  mileage  allowance,  374. 

per  diem  allowances,  374. 

reimbursement  for  actual  expenses,  374. 

FEDERAL  RESERVE  BANK, 

dividends  from,  508, 

income  of,  exempt,  356. 

stock  in,  is  an  inadmissible  asset,  1075. 

FIDUCIARIES, 

See  Estates  and  Trusts;  Foreign  Fiduciaries. 
agents  are  not,  103. 
alien  property  custodian,  107. 
ancillary  administrators  are  not,  105. 
collection  of  tax  from  distributees,  147. 
committee  for  incompetent,  106. 
deeds  of  trust,  106. 
defined,  103. 

duties  of  executors  and  administrators,  109. 
duties  of,  generally,  108. 
duties  of   receivers,   109. 

duties  of,  respecting  decedent's  estate  during  administration,  129. 
guardians  may  be,  104. 

income  received  from,  by  nonresident  aliens,  77. 
income  to  be  reported  by  beneficiary,  144. 
information  at  source,  149. 
irrevocable  trusts,  106. 
liability  of  executors  for  tax,  147. 
mortgage  foreclosure  receivers,  106. 
ownership  certificates  in  case  of,  994. 
penalties  in  case  of,  149. 
power  of  attorney,  104. 
receivers  may  be,  105. 
returns  by,  140. 

for  nonresident  alien  beneficiaries,  143. 

ancillary  executors,  147. 

as  executors  and  administrators,  145. 

by  whom  filed,  141. 

extension  of  time,  142. 

fiduciaries  acting  in  more  than  one  estate,   142. 

for  beneficiaries,  143. 

for  minors  or   insane  persons,   143. 

how  executed,  143. 

revocable  trusts,  141, 

upon  death  or  termination  of  trust,  146. 

when  also  a  beneficiary,  143. 


INDEX  1451 

[References  are  to  pages.] 

FIDUCIARIES— Continued. 

when  filed,  142. 

when  required,  141. 

where  filed,  142. 
returns  of  information  by,  140. 
temporary  receivers  may  be,  105. 
trustees   in   bankruptcy   are,    105. 
trusts  created  by  employers,  102. 
who  are,  103. 
who  are  beneficiaries,  108. 
withholding  against,  978. 
withholding  at  source  against,  148. 
withholding  at  source  by,  148. 

FIRE  INSURANCE  COMPANIES, 

See  Insurance  Companies. 

FIRES,  STORMS,  SHIPWRECK  AND  OTHER   CASUALTY, 
losses  from,  636. 

FISCAL  YEAR, 

See  Accounting  Period. 
affiliated   corporations  with   different   fiscal    years,  259. 
change  in   accounting  period,  817. 
corporations,  245. 

corporations  must  report  on  basis  of,  1032. 
deduction  of  taxes  in  case  of,  609. 
defined,  815,  1032. 
ending  in   1918,  819. 

deductions  and  credits  in  case  of,   820. 

in  case  of  individual,  820. 
ending  in  1919,  821. 

computation  of  excess-profits  tax,  1035. 
ending  in  1921  or  1922,  818. 

ending  in  1921,  computation  of  excess-profits  tax,  1035. 
ending  in   1922,  computation  of  excess-profits  tax,  1036. 
first  returns  on  basis  of,  817. 
in  case  of  capital  stock  tax,  1140. 
in  case  of  corporations  credit  for  taxes,  794. 
of  individuals,  effect  on  credit  for  taxes,  789. 
of   personal   service  corporation,   ending   in    1922,   821. 
partners  and  partnership  with  difTerent,  186. 
partnerships  with,  18(). 
returns  on  basis  of,  816. 
returns  when   changed,  829. 
war-profits  credit  of  corporations  with,    1110. 
when  tax  due  of  computed  on  basis  of.  852. 

FOOD  ADMINISTRATION  GRAIN  CORPORATION  NOTES, 
interest  on,  not  exempt,  488. 

FOREIGN  AMBASSADORS, 
income  exempt  to,  310. 


1452  INDEX 

[References  are  to  pages.] 
FOREIGN  CORPORATIONS, 

See  Nonresident  Aliens. 
assessment  without  reference  to  invested  capital,  1118.  / 

capital  stock  tax  on,  1146. 
capital  stock  tax  returns,  1160. 
certain  domestic  corporations  taxed  as,  225,  308. 
collection  of  foreign  items,  308. 
consolidated  returns  in  case  of,  308. 
credit  for  taxes,  in  case  of,  789. 
ci'edit  of  dividends  from,  775. 
credits  allowed,  305. 
deduction  of  taxes  by,  607. 
deductions  allowed,  79,  304. 
defined,  297. 

determination  of  installments  of  excess-profits  tax,  1129. 
doing  business  for  purposes  of  capital  stock  tax,  1155. 
duty  in  paying  out  income,  308. 
exempt  organizations,  312. 

exemption  of  earnings  from  operation  of  ships,  37. 
income  from  sources  within  the  United  States,  301. 

corporations  having  no  ofiice  or  agent  in  United   States,  col- 
lecting commissions,  302. 

domestic  corporation  owning  stock  of  foreign  corporation,  301. 
income  of  foreign  steamship  companies,  303. 
income  subject  to  tax,  301. 
invested  capital  of,  1107. 
items  not  deductible,  304. 
nonresident  corporations,  298. 

nonresident  foreign  corporation  defined,  965,  998. 
penalties  applicable  to,  308. 

procedure   in   collecting  income   subject  to  withholding,   306. 
proof  of  exemption,  312. 
rate  of  capital  stock  tax,  1146. 
rates  of  tax,  297,  301. 
residence  of,  298. 
resident  agents  for,  88,  306, 
resident  corporations,  298. 
returns  by,  306. 

by  whom  filed,  307. 

how  prepared,  307. 

how  signed  and  sworn  to,  307. 

when  filed,  306. 

where  filed,  307. 
special  returns  by,  308. 
taxation   of  dividends  from,  510. 
taxation  of  dividends  received  by,  66. 

time  of  payment  of  tax  by  nonresident  foreign  corporations,  853. 
when  exempt,  300. 

when  subject  to  capital  stock  tax,  1142. 
when  subject  to  income  tax,  300. 
withholding  at  source,  305. 


INDEX  1453 

[References  are  to  pages.} 

FOREIGN  COUNTRIES. 

defined,  611,  781,  786. 

taxpayers  manufai-turing  or  dealing  in,  361. 

FOREIGN  DEALINGS, 

gain  or  loss  relating  to,  360. 

FOREIGN  EXCHANGE, 

computation  of  income  in  case  of,  358. 
dealers  in,  362. 

gain  or  loss  from  foreign  dealings,  360. 
rates  of,  359.  . 

treatment  of,  in  case  of  manufacturing  or  trading  in  foreign  coun- 
tries, 361. 

FOREIGN   FIDUCIARIES, 

deductions   and   credits  allowed,   149. 
defined,  149. 

extent  to  which  subject  to  law,  149. 
information  at  source,  151. 
returns  by,  150. 

when  filed,  151. 

where  filed,  150. 
trust  estates,  149. 
withholding  at  source  against,  151. 
withholding  at  source  by,  151. 

FOREIGN  GOVERNMENTS, 

income  of  exempt,  309,  354. 
political  subdivisions  of,  310. 

FOREIGN  INCOME, 
how  taxed,  358. 

FOREIGN  INSURANCE  COMPANIES. 

See   Insurance  Co.mpanies. 

FOREIGN   INSURANCE   POLICIES, 
stamp  tax,  1199. 

credits    and    refunds,    1202. 

definitions,  1199. 

effective  date,  1200. 

insurance  on  commodities  exported,  1202. 

insured  to  retain  policy  for  tw<i  years.  1200. 

measure  of  tax,  1202. 

movable  property,  1202. 

penalties.  1202. 

persons  liable  to,  1200. 

returns,  1203. 

sulisequent    instrument    to    indicate    prior   document    stamped, 

1201. 
subsequent    instruments    that    must   be    stamped,    1201. 
unstamped    instruments    and    those    bearing    no    notation    of 

stamping,  1201. 
what  instruments  must  bear  a  stamp,  1200. 


1454  INDEX 

[References  are  to  pages.'] 

FOREIGN   ITEMS, 

collection  of,  by  foreign  corporations,  308. 

corporations  collecting,  269. 

defined,  956. 

license  required,  959. 

ownership  certificates  for,  956. 

presented  for  collection  unaccompanied  by  ownership  certificates,  958. 

return  of  information  as  to,  958. 

source  of  information  as  to,  956. 

FOREIGN   PARTNERSHIPS, 
application  of  tax  to,  190. 
collection  of  tax  at  source,  192. 
duties  in  paying  out  income,  193. 
extent  to  which  taxable,  191. 
nonresident  foreign  partnerships,  191. 
procedure  in  collecting  income,  193. 
resident  foreign  partnerships,  191. 
when  taxed  on  sales,  192. 

FOREIGN    STEAMSHIP    COMPANIES, 
exemption  of,  303. 
income  of,  303. 

FORMS, 

See  Returns. 
of  ownership  certificates,  986. 

FRATERNAL  BENEFICIARY  SOCIETIES, 
when  exempt,  317. 

FUTURES, 

treatment  of  in  inventories,  393. 

G 

GAINS, 

See  Income. 

GAS   COMPANIES, 

subject  to  child  labor  tax,  1251. 

GAS  WELLS, 

apportionment  of  depletion  among  various  sands,  752. 

closed-pressure  method,  749. 

comparison  with  life  history  of  similar  wells,  748. 

computation  of  allowance  for  depletion,  747. 

corrections  and  refinements  of  closed  pressure  method,  750. 

decline  in  open  flow  capacity,  748. 

details  of  production  or  performance  record  of  well  or  property,  748. 

formula  for  computing  depletion  allowance,  754. 

method  of  gauging,  752. 

other  indications  of  depletion,  749. 

pressure  records  to  be  kept,  755. 

season  for  testing  wells  for  closed  pressure,  753. 

size  of  reservoir  and  pressure  of  gas,  or  pore-space  method,  748. 

"unit  cost"  as  applied  to  natural  gas,  750. 


INDEX  1455 

[References  are  to  pages."] 

GIFTS, 

basis  of  determining  loss   from  disposition  of  property  received   as, 

632. 
cancellation  of  debts,  368. 
deduction  of,  when  made  to  charities,  561. 
definition  of,  459. 

exemption  of  property  acquired  as,  37. 
losses  from  sale  of  property  received  as,  625. 
not  deductible,  598. 
profit  or  loss  from  sales  of,  414. 
property  acquired  as,  exempt,  354,  548. 
received  by  clergymen,  368. 
received  in  form  of  bonus,  365. 
sale  of  property  acquired  by,  458. 
shrinkage  in  value  of  life  or  terminal  interest,  575. 
under  1918  Law,  459. 
what  constitutes,  548. 

GOLD-MINING  CORPORATIONS, 

exempt  from  excess-profits  tax,  1030. 

GOOD  WILL, 

inclusion  of,  in  invested  capital,  1049. 

income  from  sale  of,  551. 

obsolescence  in  case  of  distillers  and  dealers  in  liquor,  699. 

obsolescence  of,  698. 

proof  of  value  of,  433. 

GOVERNMENTAL  AGENCY  OF  STATE, 
income  bequeathed  to,  115. 

GOVERNMENT  CONTRACTS, 
advertising  expenses,  1031. 

affiliated  corporation  deriving  chief  income  from,  257. 
allocation  of  net  income  to  particular  source,  1030. 
amended  contracts,  1029. 

corporations  with  income  from,  taxation  of,  1036. 
defined,  1028. 
inspection  of,  948. 

inventories  of  government  contract  material.   1031. 
sub-contractors,  1030. 

taxation  of  corporations  deriving  income  from,  1028. 
under  naval  appropriation  acts,  1029. 

war-profits  credit  of  corporations  with  income  from,  1110. 
what  are,  1030. 

GRAIN  DEALERS, 

use  of  inventories,  392. 

GROCERY  STORES, 

not  subject  to  child  labor  tax,  1251. 


1456  INDEX 

[References  are  to  pages."] 

GROSS  INCOME, 

See  Income. 

certain  items  not  included  in,  353. 

defined,  11. 

from  business,  385. 

not  synonymous  with  gross  receipts,  352. 

what  constitutes,  352. 

GROUND  RENT, 

not  deductible  as  interest,  606. 

GUARDIAN, 

See  Fiduciaries. 

H 
HEAD  OF  FAMILY, 

examples  of,  778. 
who  is,  777. 

HEALTH  INSURANCE, 

See  Accident  or  Health   Insurance. 
exemption  of  income  from,  556. 

HOLDING  COMPANIES, 

See  Consolidated  Returns. 

doctrine  of  corporate  entity,  221. 
financing  subsidiary,  233. 

HOMESTEAD, 

sale  of,  461. 

HORTICULTURAL  ORGANIZATIONS, 
exemption  of,  315. 

HUSBAND  AND  WIFE, 

citizenship  of  married  women,  40. 
community  property,  45. 
computation  of  tax  in  case  of,  824. 
personal  exemption  allowed  to,  779. 
returns  by,  823. 

I 
ICE  FACTORIES, 

subject  to  child  labor  tax,  1251. 

IDAHO, 

community  property,  47. 

mining  partnerships  of,  taxed  as  corporations,  212. 

IMPROVEMENTS   AND  BETTERMENTS, 
not  deductible,  570. 
to  be  added  to  cost,  417. 


INDEX  14^'^ 

[References  are  to  pagex] 

INADMISSIBLE  ASSETS. 

bonds  or  other  obli^rations,  1070. 

defined,  1074. 

in  case  of  affiliated  corporations,  1134. 

may  become  admissible,  1078. 

reduction  of  invested  capital  by,  1079,  1095. 

stock  of  domestic  corporations,  1075. 

stock  of  domestic  corporation  with  income  from  possessions,  10  (o. 

stock  in  Federal  Reserve  Bank,  1075. 

stock  of  foreign  corporations,  1076. 

INCOME,  o  ^o  iv 

See  Bonuses;  Compensation  for  Services;  Constructive  Receipt  of  In- 
come; Corporations;  Estates  and  Trusts;  Exempt  Income;  For- 
eign Corporations;  Insurance  Companies;  Net  Income;  Nonresi- 
dent Aliens;  Partnerships;  Salaries. 
abnormal  conditions  affecting.  1119. 
accrued,  when  taxed,  344. 
accumulated  for  charitable  purposes,  116. 
actually  received,  343. 

additional  compensation  to  be  paid  at  future  date,  808. 
alimony,  538. 

allocation  of,  from  jud^^ments,  806. 

amount  paid  for  option  to  purchase  interest  in  royalties.  538. 
amount  received  by  tenant  for  vacating  premises,  538. 
basis  for  determining  gain  or  loss  from  sales,  413. 
bonuses,  365. 

cancellation  of  debt  becau.'^e  of  services,  368. 
cancelled  debts,  539. 
capitalization  of  as  proof  of,  market  value.  431. 

changing  basis  for  computation  of,  815. 

community  property,  45. 

compensation  by  insurance,  552. 

compensation  for  loss,  540. 
under  1921  Law,  541. 

compensation  of  President  and  certain  judges  exempt.  38. 

computation  of  in  case  of  installment  sales.  464. 

conditionally  received,  801. 

consolidated  net  income  of  affiliated  corporations,  2o9. 

constructive  receipt  distinguished  from  accrual.  799. 

constructive  receipt  of,   114.  346. 

damages  in   personal    actions,  544. 

deductions  allocated  to  income  with  which  connected,  807. 

deductions  from  in  case  of  nonresident  aliens,  78. 

defined,  340. 

distinguished  from  capital.  340. 
distribution  of,  in  case  of  trust  estates.  133. 
dividends  on  life  insurance  policies.  555. 
effect  of  bookkeeping  entries,  341. 
embezzled  moneys  are  not.  545. 
employees'  profit-.sharing  fund,  545. 
examples  of  constructive  receipt,  346,  347. 


1458  INDEX 

[References  are  to  pages."] 

INCOME— Continued. 

excess  of  salvage  value  plus  depreciation  over  cost,  545. 
exchange  of  stock  for  stock  of  greater  par  value,  446. 
exchange  of  stock  for  stock  of  no  greater  par  value,  441. 
exempt  income,  353. 
exemption  based  on  amount  of,  36. 

exemption  based  on  character  of,  or  status  of  recipient,  37. 
exempt  to  foreign  governments,  309. 
farmers,  156. 
'  federal  officers  and  employees,  373,  378. 
fixed  or  determinable,  annual  or  periodical,  966. 

from    accident,    health    or    workmen's    compensation    insurance,    ex- 
empt, 556. 
from  annuities,  556. 
from  business,  385. 
from  commissions,  366. 
from  discount,  496. 
from  dividends,  504. 
from  endowment  policies,  555. 
from  export  business,  386. 
from  foreign  countries,  how  taxed,  358. 
from  foreign  dealings,  360. 
from  legacies,  546. 
from  long  term  contracts,  804. 
from  miscellaneous  sources,  538. 
from  operation  of  ships,  when  exempt,  37. 
from  personal  services,  364. 
from  rent,  497. 

from  reorganizations,  mergers  and  consolidations,  436. 
from  reorganizations,  mergers,  etc.,  under  1918  Law,  438. 
from  rewards,  369. 

from  sale  of  property,  constitutionality  of  taxing,  1008. 
from  services  extending  over  a  year,  372. 
from  tips,  369. 
from  traveling  expenses,  367. 
gross,  of  corporations,  226. 
increment  to  sinking  funds,  546. 
in  form  of  notes,  352. 
in  form  of  royalties,  501. 
in  general,  339. 

interest,  rent  and  royalties,  479. 
involuntary  sales,  539. 
in  what  year  reported,  800. 

allocation  of  income  from  judgments,  806. 

amounts  placed  in  escrow,  801. 

commissions,  801. 

compensation  under  cancelled  contracts,  802. 

dividends  credited  to  employees,  801. 

goods  sold  and  returned  in  succeeding  year,  808. 

income  conditionally  received,  801. 

judgments,  806. 


INDEX  1459 

[References  are  to  pages.] 

INCOME— Continued. 

payments  depending  on  future  developments,  804. 

payments  of  compensation,  805. 

royalties,  800. 

subsequently  discovered  gains,  805. 

where  amount  of  income  is  doubtful,  801. 

where  the  recipient  is  doubtful,  800. 

where  transaction  is  contingent,  803. 
in  what  year  taxed,  345. 
labor  union  benefits,  546. 
losses  of,  not  deductible,  630. 

manufacturing  or  trading  in  foreign  countries,  361.    ■ 
methods  of  accounting,  342,  797. 
money  received  under  mistake  of  fact,  813. 
must  be  reported  on  same  basis  as  deductions,  560. 
net  income  of  estates  and  trusts,  128. 
of  contractors,  385. 

of  independent  contractor  from   state  contract,  546. 
of  states  and  political  subdivisions,  exempt,  357. 
other  than  in  cash,  369. 
payment  of  claims,  546. 
payments  by  tenant  for  landlord,  499. 
payments  received  through  mistake,  547. 
pensions,  547. 

premiums  paid  by  employer,  367. 
procedure  in  paying,  960. 
proceeds  of  life  insurance,  553. 
proceeds  of  tontine  insurance,  554. 
profit  sharing,  364. 
property  acquired  by  gift,  548. 
public  utilities,  572. 
receipt  of,  by  agent,  348. 
receipt  of  rent  in  kind,  499. 
received  in  equivalent  of  cash,  350. 
received  in  kind,  350. 

received  on  an  exchange  of  property,  351. 
received    on    exchange    only    when    property    received    has    readily 

realizable  market  value,  427. 
reflected  by  inventories,  388. 
reported  in  year  accrued,  798. 
reported  in  year  received,  798. 
reported  on  accrual  basis,  349. 
rights  to  subscribe  to  stock,  549. 
salaries,  364. 

salaries  of  federal  judges,  377. 
salaries  of  teachers,  383. 
sale  of  good  will,  551. 
sale  of  homestead,  461. 
sale  of  mines,  oil  or  gas  wells,  464. 

sale  of  property  acquired  by  bequest,  devise  or  inheritance.  456. 
sale  of  real  estate  in  lots,  477. 


1460  INDEX 

[References  are  to  pages!] 

INCOME— Continued. 

sale  of  real  estate  involving  deferred  payments,  474. 

sale  of  stock  received  as  dividend,  534. 

sale  of  war-savings  stamps,  551. 

sales  and  dealings  in  bonds,  461. 

sales  or  dealings  in  property,  407. 

services  rendered  prior  to  March  1,  1913,  371. 

shares  in  building  and  loan  association,  551. 

sources  within  the  United  States,  301. 

sources  within  the  United  States,  defined,  58,  59. 

statistics  of,  published  annually  by  Commissioner,  847. 

subject  to  normal  tax,  14. 

supper  money,  369. 

surrender  value  of  insurance  policies,  555. 

taxable  in  hands  of  assignee,  244. 

taxable  in  hands  of  trustee  in  bankruptcy,  244.  , 

taxed  to  corporations,  16. 

taxes  on  profits  from  sale  of  property  paid  by  vendee,  552. 

tax  paid  by  debtor  on  account  of  tax-free  covenant  bond,  552. 

theory  upon  which  imposed,  35. 

under  1921  excess-profits  tax  law,  1015. 

value  of  improvements  made  by  tenant,  497. 

voluntary  offerings  received  by  clergymen,  368. 

what  constitutes,  339. 

what  income  included  in  statute,  339. 

what  income  subject  to  withholding,  964,  966. 

when  items  should  be  reported,  798. 

when  required  to  be  reported  at  source,  951. 

INCOME  TAX  BULLETIN  SERVICE, 
scope  and  purpose  of,  9. 

INCOME  TAX  LAWS, 

discussion  of  statutes  of  laws  preceding  1921  Law,  3. 

INCOMPETENTS, 

returns  of,  52,  827. 

INDIVIDUALS, 

exemption    from    tax,    based    on    character    of    income    or    status    of 
recipient,  37. 

based  on  amount  of  income,  36. 
invested  capital  of,  for  1917,  1039. 
returns  by,  13. 

returns  for  deceased  persons,  53. 
subject  to  1917  excess-profits  tax,  1018. 
taxation  of,  under  1917  excess-profits  tax,  1018. 
when  not  subject  to  1917  excess-profits  tax,  1018. 

INFORMATION  AT  SOURCE, 

See  Foreign  Items. 
affiliated  corporations  may  not  file  consolidated  returns  of,  963. 
by  corporations,  264. 
by  department  of  municipal  government,  963. 


INDEX  1461 

[References  are  to  pages.'\ 

INFORMATION  AT  SOURCE— Continued, 
discussed  generally,  18. 

dividends  on  stock  of  taxable  corporations,  9o5. 
fixed  or  determinable  income,  O.'il. 
foreign  fiduciaries,  151. 

gains  and  losses  of  customers  of  brokers,  954,  9b2. 
interest  on  obligations  of  domestic  corporations,  955. 
interest  on  obligations  of  the  United  States,  955. 
interest  on  state  and  municipal  bonds,  955. 
miscellaneous  income,  gains  and  profits,  951. 
payments  which  need  not  be  reported,  953. 
penalties  for  failure  to  supply,  902. 
procedure  in  paying  income,  960. 
purpose  of,  951. 
reports  by  broker,  190,  264. 
required  of  exempt  corporations,  963, 
required  of  fiduciaries,  149. 
returns  by  partnerships,  190. 

returns  of,  961. 

as  to  payments  to  nonresident  aliens,  9ob.  ^ 

by  partnerships,  personal  service  corporations  and  fiduciaries, 

961. 

dividends  on  stock  of  taxable  corporations,  962. 

miscellaneous  income,  gains  and  profits,  961. 

payments  of  interest,  963. 
salaries,  wages  or  compensation,  952. 
what  payments  to  be  reported,  951. 

INHERITANCE, 

See  Bequest,  Devise  or  Inheritance. 

INHERITANCE  TAXES, 

state  inheritance  taxes  not  deductible,  610. 

INSPECTION  OF  BOOKS, 

See  Examination  of  Books. 

INSPECTION  OF  RETURNS  BY  PUBLIC, 

See  Returns. 

INSTALLMENT   SALES, 

See  Deferred  Payments. 

change  in  method  of  reporting.  473. 
combination  of  cash,  charge  and  installment  sales,  4|3. 
computation  of  income  from,  of  personal  property.  46  ^ 
illustration  of  computation  of  income  from.  4bS. 

method  of  accounting  to  be  employed,  469. 

of  personal  property,  465. 

scope  of  method  in  case  of  personal  property,  4b7. 

surplus  and  undivided  profits,  1058. 

taxation  of,  464. 

treatment  of  bad  debts,  471. 

when  vendee  defaults,  466. 


1462  INDEX 

[References  are  to  pages.} 

INSURANCE, 

See  Life  Insurance. 

compensation  for  loss,  658. 

deduction  of,  under  Workmen's  Compensation  Law,  588. 
exemption   of  amounts   received   through   accident,   health   or   work- 
men's compensation  insurance,  556. 
fidelity  insurance  as  a  deduction,  588. 
income  from  compensation  by,  552. 
insurance  policies  are  admissible  assets,  1074. 
on  employees,  not  deductible,  572. 
paid  on  property,  deduction  of,  587. 
proceeds  of  in  case  of  farmers,  160. 
receipt  of  annuities,  556. 
received  in  subsequent  year,  659. 
recovery  of,  reduces  losses,  812. 
reserves  for,  not  deductible,  588. 
surrender,  exchange  and  sale  of  policies,  462. 
withholding  at  source,  968. 

INSURANCE  COMPANIES, 

applicability  of  former  rulings,  274. 

capital  stock  tax,  1148. 

comparison  of  1921  and  1918  Laws,  281. 

deduction  of  required  addition  to  reserve  funds,  291. 

deductions  allowed  under  1918  Law,  290. 

definition,  282. 

domestic  life  insurance  companies,  275. 

deductions  allowed,  275. 

depreciation  deductible,  277. 

dividends  received,  276. 

gross  income  of,  275. 

interest  paid,  276. 

interest  upon  state  and  federal  obligations,  275. 

investment  expenses,  277. 

rate  of  tax,  275. 

reserve  for  dividends,  276. 

specific  exemption,  278. 

taxes  deductible,  277. 
expenses  under  1916  Law,  296. 

general  scheme  of  taxation  under  present  law,  274. 
gross  income  of  life  insurance  companies,  285. 
gross  income  of,  under  1918  Law,  283. 
income  of  foreign  companies,  296. 
invested  capital  of,  1106. 
other  than  life  and  mutual  companies,  deductions  allowed,  280. 

definition  of  terms,  279. 

foreign  companies,  280. 

gross  income,  279. 
returns  by,  295. 

special  deductions  allowed  in  case  of  combined  life,  health  and  acci- 
dent policies,  294. 


INDEX  1463 

[References  are  to  pages.] 

INSURANCE  COMPANIES— Continued. 

special  deduction  allowed  mutual  companies,  294. 

special  deductions  allowed  mutual  marine  insurance  companies,  294. 
taxation  of  foreign  life  insurance  companies  under  1921  Law,  278. 
taxation  of  other  than  life  and  mutual  companies  under   1921  Law, 

278. 
under  1918  Law,  281. 

INSURANCE  POLICIES, 

surrender  value  of,  inclusion  in  invested  capital,  1063. 

INTANGIBLE  PROPERTY, 

acquired  for  tangible  property,  1054. 

defined,  1049. 

depreciation  allowed  in  case  of,  682. 

inclusion  of,  in  invested  capital,  1049. 

inclusion  of,  in  invested  capital  for  1917,  1039. 

mixed  aggregates  of  tangible  and,  1054. 

no  paid-in  surplus  as  to,  1053. 

obsolescence  of,  698. 

obsolescence  of  in  case  of  liquor  dealers,  699. 

paid  in  both  before  and  after  March  3,  1917,  1052. 

paid  in,  in  case  of  affiliated  corporations,  1133. 

paid  in,  on  or  after  March  3,  1917,  1052. 

paid  in,  prior  to  March  3,  1917,  1051. 

proof  of  value  of,  483. 

stock  or  shares  outstanding  on  March  3,  1917,  1053. 

what  included  in,  1049. 

INTEREST, 
See  Interest  Upon  United  States  Obligations,  479;  Liberty  Bonds. 
accrued  on  obligations  at  time  of  purchase,  493. 

accruing  prior  to  March  1,  1913,  495. 
allowed  as  credit  to  partners,  181,  183. 
bond  interest,  defined,  966. 
bonds  purchased  at  a  premium,  495. 

constitutionality  of   provision    requiring  disclosure   of  exempt   inter- 
est, 1009. 
constructive  receipt  of,  347. 
credit  of,  776. 

to  nonresident  aliens,  83. 
deductible  by  corporations,  234. 
deduction  of,  602. 

by  estates  and  trusts,  125. 
interest  on  taxes,  606. 
on  real  estate  mortgage,  606. 
deficiency  in  tax,  899. 

exemption  of  when   received   from  domestic  building  and   loan   asso- 
ciations, 37. 
from  federal  land  bank,  488. 
from  National   Farm  Loan   Association,  488. 
income  from,  479. 


1464  INDEX 

IReferences  are  to  pages.'] 

INTEREST— Continued. 

income  from,  in  case  of  nonresident  aliens,  62. 

indebtedness  incurred  or  continued  to  purchase  or  carry  tax  exempi 
securities,  603. 

information  at  source  of  interest  on  obligations  of  domestic  cor- 
porations, 955. 

Liberty  bond  exemption  in  case  of  estates  and  trusts,  119. 

mortgages  assumed  by  state,  493. 

not  paid  on  claims  against  the  United  States  under  prior  laws,  939, 

not  to  be  added  to  cost,  417. 

obligations  of  District  of  Columbia,  489. 

obligations  of  political  subdivision  of  state,  490. 

obligations  of  possessions  of  United  States,  488. 

obligations  of  states,  489. 

obligations  of  territories,  489. 

obligations  of  the  United  States,  64. 

on  amount  of  claim  for  loss  in  inventory  disallowed,  868. 

on  bank  deposits,  494. 

on  bank  deposits,  not  subject  to  withholding,  969. 

on  bonds  of  exempt  organizations,  493. 

on  capital,  not  deductible,  603. 

on  delinquent  taxes,  866. 

on  refunds  and  judgments  under  1921  Law,  939. 

on  taxes  where  time  for  payment  extended,  853. 

on  tax  free  bonds,  not  deductible  by  corporations,  235. 

ownership  certificates  in  case  of  registered  bonds,  992. 

paid  by  life  insurance  company,  276. 

paid  in  scrip,  494. 

paid  in  scrip,  withholding  in  case  of,  977. 

paid  or  accrued  within  the  year,  604. 

received  and  paid  by  brokers,  494. 

received  by  corporations  from  Liberty  bonds,  230. 

received  upon  state  and  federal  obligations  by  domestic  life  insur- 
ance companies,  275. 

recovery  of,  from  collectors,  940. 

returns  of  information  as  to  payments  of,  963. 

to  be  withheld  at  source,  969. 

when  exempt  from  tax,  38,  354,  479. 

when  not  reported  at  the  source,  953. 

withholding  at  source  in  case  of  bond  interest,  972. 

withholding  at  source  when  bonds  contain  a  tax-free  covenant,  974. 

withholding  at  source  when  bonds  do  not  contain  a  tax-free  cove- 
nant, 973. 

INTEREST  UPON  OBLIGATIONS  OF  THE  UNITED  STATES, 

certificates  of  indebtedness   issued  by  director  general   of  railroads 

not  exempt,  487. 
postal  savings  accounts,  exemption  of,  488. 
War  Finance  bonds,  488. 
when  exempt,  479. 


INDEX  1465 

[References  are  to  pages] 

INVENTORIES, 
at  cost,  399. 
at  market,  400. 

base,  stock,  minimum  and  cushion  methods  not  allowed,  398. 
by  cotton  merchants  and  dealers  in  grain,  392. 
by  dealers  in  securities,  401. 
by  lumber  manufacturers,  403. 
by  retail  dry  goods  merchants,  403. 
change  from  cost  or  market  to  cost,  395. 
dealers  in  foreign  exchange,  362. 
farmers,  153. 
farmers  not  taking,  156. 
in  general,  388. 
losses  in,  665. 

claims  for,  672. 
claims  of  partnerships,  674. 
disposition  of  claims,  675. 
effect  of  allowance  of  claim,  666. 
effect  of  claim  in  abatement,  667,  675. 
Liberty  bonds  as  security,  676. 
method  of  computing,  670. 
under  1918  Law,  664. 
what  included,  665. 

where  goods  were  not  sold  in  1919,  670. 
where  goods  were  sold  in  1919,  670. 
need  of,  388. 

of  government  contract  material,  1031. 
on  what  basis  to  be  taken,  388. 
treatment  of  futures,  393. 
valuation  of,  394. 
valuation  on  basis  of  average  cost  or  average  of  market  price?  not 

allowed,  396. 
what   included    in,   389. 
when  use  of  not  permitted.  289. 

INVESTED  CAPITAL, 

See  Affiliated  Corporations;  Admissible  Assets;  Inadmissibij:  Assets; 
Prewar  Period;  Surplus  and  Undivided  Profits. 

additions  to  surplus  account,  1064. 
adjustments  due  to  change  in  taxable  year.  1096. 
adjustments  which  increase  book  value  of  assets,  1080. 
adjustments  which  reduce  book  value  of  assets,  1080. 

amortization  under  Munition   Manufacturers'  Tax,  1094 

as  to  inadequate  allowance  for  depreciation  or  depletion,  1089. 

as  to  inadmissible  assets.  1095. 

as  to  losses,  1093. 

as  to  treasury  stock,  1081. 

as  to  value  of  assets  acquired  in  reorganization.  1082. 

as  to  value  of  intangible  assets,  1081. 

as  to  values  marked  up  on  books  of  account,  1086. 
affiliated  corporations,  1132. 


1466  INDEX 

[References  are  to  pages.} 

INVESTED  CAPITAL— Continued. 

apportionment   of   net   income   and    invested    capital   of   corporations 

engaged  partly  in  personal  service  business,  1025. 
appreciation  may  not  be  included,  in,  1086. 
assessment  when  Commissioner  unable  to  determine,  1117. 
assessment  without  reference  to,  1116. 
bank  discount,  1063. 
bonus  stock,  1045. 
borrowed  capital,  amounts  paid  into  or  left  in  business,  1070. 

bonds,  1069. 

credit  balances  to  stockholders,  accounts,  1071. 

debenture  stock,  1068. 

dividends  credited  to  stockholders,  1071. 

informal  dividends,  1071. 

not  included  in,  1066. 

preferred   stock,   1068. 

what  included  in,  1066. 
brokers'  commissions,  1044. 
cash  paid  in,  1044. 
computation  of,  1073. 
conversion  of  bonds  into  stock,  1073. 

corporations    with    no    invested    capital    not   subject    to    1917    excess- 
profits  tax,  1021. 
current  profits,   1063. 
defined,   1041. 

discount  on  sale  of  bonds,  1062. 
distinguished  from  capital  sum,  741. 
dividends  paid  from  surplus,  1097. 

domestic  corporations  with  income  from  possessions,  1107. 
effect  of  additional  assessment,  1102. 
effect  of  am.ortization  upon,  706. 
effect  of  increase  of  capital  stock,  1100. 
effect  of  liquidating  dividend,  1100. 
effect  of  reduction  of  capital  stoc^,  1100. 
effect  of  refund,  1103. 
effect  of  stock  dividends,  1099. 

evidences  of  indebtedness  are  tangible  property,  1048. 
foreign  corporations,  1107. 
for  fraction  of  year,  1103. 
for  prewar  period,   1104. 
for  1917,  1039. 
for  1918-1921,  1041. 
good  will,  1049. 

in  case  of  reorganization,  1043. 
inclusion  of  reserves,  1059. 
insurance  companies,  1106. 
intangible  property,  1049. 

acquired  for  tangible  property,  1054. 

paid  in  both  before  and  after  March  3,  1917,  1052. 

paid  in  on  or  after  March  3,  1917,  1052. 

paid  in  prior  to  March  3,  1917,  1051. 
limitations  of  additions  to  surplus,   1065. 


INDEX  1467 

[References  arc  to  pages] 

INVESTED  CAPITAI^Continued. 
meaning  of,  1041. 

method  of  determining  income  available  for  dividends,  1098. 
mixed  aggregates  of  tangible  and  intangible  property,  1054. 
no  paid-in  surplus  as  to  intangible  property,   1053. 
of  affiliated  corporations  for  prewar  period,  1135. 
par  value  of  stock,  1044. 
patents,  1049,  10(51. 

payment  of  preceding  year's  excess-profits  tax,  1100. 
penalty  in  case  of  inclusion  of  appreciation  in  value,  901. 
presumption  as  to  source  of  distribution  of  dividends,  517. 
property  paid  in  and  subsequently  written  off,  1066. 
property  taken  for  debt,  1062. 
reduction  of  reserves,   1103. 
reserve  for  depreciation  or  depletion,  1060. 
reserves  for  taxes,  1060. 
stock  issued  for  services,  1045. 

stock  or  shares  outstanding  on  March  3,  1917,  1053. 
stock  sold  at  a  discount,  1044. 
surplus  and  undivided  profits,  1055. 
surrender  value  of  insurance  policies,  1063. 
tangible  property  paid  in,  1045. 
taxes  withheld  at  source,  not  included  in,  1042. 
trade-marks,   1049. 

value  of  property  as  of  January  1,  1914,  1041. 
what  included  in,  1041. 

INVESTIGATIONS, 

See  Examinations  of  Books. 

INVESTMENT, 

exchange  of  property  held  for,  does  not  produce  taxable  income,  412. 
property  held  for,  411. 

INVOLUNTARY  SALE, 

compensation  for  loss,  540. 

compensation  for  loss  under  1921  Law,  541. 

gives  rise  to  income,  539. 

J 
JOINT  STOCK  COMPANIES. 

taxed  as  corporations,  210. 

JOINT  STOCK  LAND  BANKS, 

not  exempt  under   present   law,  337. 
stamp  tax  on  issue  of  stock,  1176. 

JUDGMENTS, 

allocation  of  income  from,  806. 
deduction  of  amounts  paid   under.  809. 
loss  due  to,  657. 

JURISDICTION  OF  COURTS. 

to  hear  internal  revenue  cases,  933. 


1468  INDEX 


LABOR  ORGANIZATIONS, 
exemption  of,  315. 

LABOR  UNIONS, 

income  from  benefits,  546. 

LEASES, 

amounts  received  as  compensation   for  vacating  premises,  538. 

constructive  receipt  of  rent,  500. 

cost  of  buildings  erected  under  terms  of,  586. 

deduction  of  repairs  by  tenant,  586. 

depletion  in  case  of  lessee,  716. 

depletion  under  prior  laws,  728. 

depreciation  in  case  of  leases,  681. 

expenses  in  connection  with,  581. 

not  subject  to  stamp  tax,  1196,  1203. 

payments  by  tenant  for  landlord,  499. 

value  of  improvements,  497. 

what  constitutes  cost  of,  418. 

LEGACIES, 

income  from,  546. 

LIBERTY  BONDS, 

carried  by  banks,  487. 

deduction  of  interest  incurred  for  the  purchase  of,  603. 

deposited  as  security,  676. 

dividends  paid  in,  529. 

exemption  determined  by  bonds  held  at  end  of  year,  484. 

exemption  in  case  of  affiliated  corporations,  260. 

exemption  in  case  of  estates  and  trusts,  119. 

exemption  of  interest  in  case  of  partners,  182. 

exemption  of  reorganized  corporation,  1132. 

exemption  of,  under  1921  Law,  485. 

exemption  to  estates  and  trusts,  483. 

held   by   banks,   485. 

interest  on,  received  by  corporations,  230. 

may  be  deposited  in  lieu  of  surety,  882. 

mortgage  bonds  exchanged  for,  240. 

originally  subscribed  for  and  held  at  date  of  return,  483. 

tax  exemption  of,  under   1918   Law,   480. 

LIENS, 

for  taxes,  in  case  of  corporations,  266. 

for  unpaid  taxes,  870. 

notice  of,  267,  871. 

reorganization  prior  to  attachment  of,  267. 

when  lien  attaches,  266,  872. 

LIFE  INSURANCE, 

amounts  received  as  return  of  premiums  exempt,  354. 

deduction  of  premiums  by  partnership,  178. 

dividends  on  policies  of,  508,  555. 

exemption  of  amounts  received  as  return  of  premiums,  37. 


INDEX  1469 

[References  are  to  pages] 

LIFE  INSURANCE— Continued. 

exemption  of  proceeds  of  policies,  'il. 

income  from  endowment  policies,  555. 

income  from  proceeds  of,  553. 

insurance   policies   on   the   tontine   plan,   554. 

premiums  paid  by  employer  constitute  income  to  employee,  367. 

premiums  paitl  on  insurance  as  security  for  a  loan,  deduction  of,  574. 

proceeds  of,  paid  to  corporations,  230. 

proceeds  of  policies  exempt,  354. 

proceeds  of  policies  paid  to  estate,  114. 

surrender  value  of  policies,  555. 

taken  out  on  employees,  not  deductible,  572. 

LIFE  INSURANCE  COMPANIES, 

See  Insurance  Companies. 
taxation  of,  in  general,  274. 

LIMITATION   OF   TAX, 
capital  gains,  22. 
sales  of  mines,  oil  or  gas  wells,  21. 

LIMITED  PARTNERSHIPS, 

See  Partnerships. 

* 

LIQUIDATION, 

corporations  partially  liquidating,  516. 
distributions  in,  under  1918  Law,  511. 
distribution  in,  under  1921  Law,  517. 
proceeds  of,  received  in  installments,  515. 

LIQUOR  DEALERS  AND  DISTILLERS, 
obsolescence  in  case  of,  699. 

LITERARY  CORPORATIONS, 
exempt  from  tax,  322. 

LIVING  QUARTERS,  BOARD  AND  LODGING, 
income  by  reason  of  furnishing  of,  369. 
of  federal  officers  and  employees,  373. 

LOCAL  BENEFITS, 

assessments  against,  not  deductible,  615. 
special  assessments  against,  not  deductible,  575. 

LOSSES, 

See  Net  Loss;  Wukthllss  Debts. 
amounts  paid  to  make  up  profits  of  another  corporation,  642. 
arising  from  theft,  638. 

basis  for  determining  loss  in  cast-  of  gifts,  632. 
bonds  purchascil  above  par,  636. 
compensation  for,  540. 
compensation  for,  under  1921   Law,  541. 


1470  INDEX 

[References  are  to  pages.'] 

LOSSES— Continued. 

connected  with  residential  property,  624. 
cost  of  drawings,  models  and  patterns,  642. 
deduction   of,  by   corporations,   236. 
by  estates  and  trusts,  126. 
by  farmers,  163. 
by  partnerships,   177. 
in  general,  621. 
district  irrigation  bonds,  646. 
dividends  paid  in  property,  636. 
due  to  adverse  judgment,  657. 
due  to  guaranteeing  bonds,  623. 
effect  of,  on  invested  capital,  1093. 
embezzlements,  628. 
embezzlements  recovered,  659. 
exchange  of  stock  under  1918  Law,  634. 
exchange  of  stock  under  1921  Law,  635. 
from  exchanges  of  property,  634. 

from  fires,  storms,  shipwreck  and  other  casualties,  636. 
from  rebates,  669. 

claims  for,  672. 
claims  of  partnerships,  674. 
disposition   of  claims,   675. 
•  effect  of  claim  in  abatement,  675. 

Liberty  bonds  as  security,  676. 
from  sales  of  property,  632. 
in  case  of  worthless  stock,  645. 

in  inventory  and  from  rebates,  under  1918  Law,  664. 
in  inventory,  claims  for,  672. 

claims  of  partnerships,  674. 
disposition  of  claims,  675. 
effect  of  allowance  of  claim,  666. 
effect  of  claim  in  abatement,  667,  675. 
interest  on  amount  of  claim  disallowed,  868. 
Liberty  bonds  as  security,  676. 
method  of  computing,  670. 
what  included  in,  665. 
where  goods  were  not  sold  in  1919,  670. 
where  goods  were  sold  in  1919,  670. 
in  ultra-vires  transactions,  not  deductible,  236. 
in  what  year  deductible,  811. 
insurance  received  in  subsequent  year,  659. 
measure  of  loss,  630. 
must  be  sustained  during  year,  627. 
new  provisions  as  to  deduction  of,  by  present  law,  622. 
not  recognized,  in  case  of  property  held  for  investment,  634. 

when    property    transferred    to    corporation    and    control    re- 
tained, 634. 
not  sustained  in  trade,  623. 
of  capital,  629. 

of  corporation  paid  by  stockholders,  646. 
of  income,  not  deductible,  630. 


INDEX  1471 

[References  are  to  payes.l 

LOSSES— Continued. 

of  oil   and  gas,  646. 

of   railroad   companies,   when   deductible,   812. 

of  useful  value,  640. 

on  automobiles,  622. 

"other  casualty,"  defined,  637. 

recoveries  on,  658. 

reduced  by  insurance  recovered,  812. 

rental  value  of  buildings,  681. 

replacement  fund  for,  543. 

reserves  for,  647. 

reserves  for,  not  deductible,  811. 

sale  of  capital   stock  by  corporation,  645. 

sale  of  property  acquired  by  gift,  bequest,  devise  or  descent,  G25 

shrinkage   in   securities   and    stocks,   643. 

shrinkage  or  deterioration   in  storage,  646. 

sustained  in  trade  or  business,  622. 

trade  or  business  defined,  625. 

transfer  of  securities   to  corporation   formed   for  purpose,  644. 

voluntary  destruction  of  property,  639. 

w^hat  included  in  deductions  for,  627. 

LOUISIANA, 

community  property,  48. 

LUMBER  MANUFACTURERS, 
inventories   of,   403. 

M 

MANUFACTURE  AND  SALE  OF  PROPERTY, 

income  from  in  case  of  nonresident  aliens,  69. 

MANUFACTURERS, 

selling  on  coupon  system,  387. 

MANUFACTURING  CORPORATIONS, 
gross  income  of,  227. 

MANUFACTURING  ESTABLISHMENT, 

defined,  1251. 

subject  to  child  labor  tax,  1250. 
MARCH  1,  1913, 

determination  of  fair  market  value  of  mineral  property  as  of,  719. 

dividends  from  earnings  or  profits  accumulated  prior  to,  518. 

fair  market  value  as  of,  428. 

gain  or  loss  from  sale  of  property  acquired  prior  to,  415. 

interest  accruing  prior  to,  495. 

value  as  of,  for  depreciation  deduction,  685. 

MARKET  VALUE, 

as  of  March  1,  1913.  how  determined,  428. 
defined  by  Treasury  Department,  422. 
definition  of  fair  market  value,  if  any,  421. 
determination  of,  in  case  of  mineral  property,  719. 
distinguished  from  intrinsic  value,  424. 


1472  ,     INDEX 

[References  are  to  pages ^ 

MARKET  VALUE— Continued. 

exchange  for  different  kinds  of  property,  435,  436. 

exchange  of  property  for  stock,  451, 

fair  market  value,  if  any,  419. 

intangible  property,  proof  of,  433. 

intrinsic  value  used  to  determine,  423. 

must  be  readily  realizable,  419,  427. 

must  be  readily  realizable  to  give  rise  to  gain,  408. 

of  oil  or  gas  properties,  744. 

of  timber,  determination  of,  768. 

present  value  method,  720. 

proof  of,  428,  429. 

appraisals,  430. 

assessment  for  state  tax  purposes,  430. 

book  value,  431. 

capitalization  of  income,  431. 

cost  or  cost  of  reproduction,  430. 

miscellaneous  evidence  of,  432. 

prorating  on  time  basis,  431. 

sales  or  dealings  in  similar  property,  429. 
property  acquired  by  gift  under  1921  Law,  632. 
property  received  on  reorganizations,  436. 
stock,  proof  of,  432. 

use  of  computing  depreciation  allowance,  685. 
when  determination  of,  required,  419. 
when  required  in  cases  of  mineral  property,  719. 

MASSACHUSETTS  TRUSTS, 

credit  for  taxes  in  case  of,  791. 
not  taxable  as  corporations,  213. 

MERCANTILE  ACCOUNTS  CURRENT, 
withholding  at  source,  971. 

MERCHANDISE, 

depreciation  may  not  be  taken  on,  682. 

MERCHANT  MARINE  ACT, 

exemptions  granted  by,  1115. 

MERGER, 

See  Reorganizations. 

METHODS  OF  ACCOUNTING, 

See  Accounting. 
accrual  basis  in  case  of  farmers,  156. 

MILITARY  OR  NAVAL  FORCES, 
defined,  37. 

MILLS, 

subject  to  child  labor  tax,  1250. 


INDEX 
[References  are  to  pageK.'\ 


1473 


MINE  OR  QUARRY, 

child  labor  tax,  1254. 

coke  ovens,  1255. 

in  or  about  mines,  1254. 

MINES, 

accumulated  depletion,  739. 

allowable  capital  additions  in  case  of,  739. 

depletion,  735. 

depletion  under  1916  Law,  726. 

determination   of   mineral   contents  of,  73o. 

discovery  of,  depletion  based  on,  737. 

oil  and  gas  wells,  depreciation  of  improvements,  714. 

proven  tract  or  lease,  738. 

royalties  from,  501. 

sales  of,  464.  .         i   •    ,  i    "'ji; 

statement  required  when  deplotiort  or  depreciation  claimed.  -3b. 

MINES,  OIL  AND  GAS  WELLS, 

See  Mines;  Oil  and  Gas  Wells. 

depletion  allowed,  714. 

excess-profits  in  case  of  sale  of,  1038. 

limitation  of  surtax  on  sales  of,  21. 

MINISTER  OF  GOSPEL, 

See  Clergymen. 

MINORS, 

age  of  majority,  825. 

citizenship  of,  40. 

emancipation  of,  825. 

gifts  to,  826. 

returns  of,  52,  825. 

returns  where  earnings  appropriated  by  parent,  b-b. 

MISTAKE, 

of  fact,  taxes  paid  under,  886. 
of  law,  taxes  paid  under,  886. 
payments  received  through,  547. 

MORATORIUM, 

effect  on  deduction  of  bad  debts.  6o2. 

MORRIS  PLAN  BANKS. 

certificates  of  deposit  of,  not  subject  to  stamp  tax.  1189. 

MORTGAGES,  ,     ,   ,  w     r-? 

foreclosure  of  deduction  for  bad  debts,  bo3. 
interest  on,  when  assumed  by  state.  493. 
not  subject  to  stamp  tax.  1203. 
on  real  estate,  deduction  of,  606. 

MUNICIPALITY, 

See  Political  Subdivision  <»i  Statk. 


1474  INDEX 

[References  are  to  pages. "l 

MUNITION  MANUFACTURERS'  TAX, 

amortization  under,  effect  on  invested  capital,  1094. 
deduction  of,  609. 

MUTUAL  DITCH  AND  IRRIGATING  COMPANIES, 
exemption  from  tax,  334. 
stock  of,  exempt  from  stamp  tax,  1203. 

MUTUAL  INSURANCE  COMPANIES, 

See   Insurance   Companies. 

MUTUAL  LIABILITY  INSURANCE  COMPANY, 

exemption  from  tax,  334. 

MUTUAL  ORGANIZATIONS  OF  LOCAL  CHARACTER, 
exemption  from  tax,  331. 

MUTUAL  SAVINGS  BANKS, 
when  exempt,  316. 


N 


NATIONAL  BANKS, 

examination  of  books,  947. 


NATIONAL  FARM  LOAN  ASSOCIATION, 
dividends  from,  508. 
exempt  from  tax,  337. 
interest  from,  not  exempt,  488. 

NET  INCOME, 

average  for  prewar  period,  1113. 

computation  of,  11. 

defined,  11,  356. 

for  excess-profits  tax  purposes,  1112. 

for  taxable  year  under  excess-profits  tax,  1114. 

for  year  1913,  under  excess-profits  tax,  1113. 

for  years  1911,  1912,  under  excess-profits  tax,  1113. 

of  affiliated  corporations  for  prewar  period,  1135. 

under  1921  excess-profits  tax  law,  1015. 

when  subject  to  normal  tax,  356. 

NET  LOSSES, 

allowance  of,  662. 

allowance  to  partnership  or  beneficiaries  of  estate  or  trust,  663. 

claim  for  allowance  of,  660. 

defined,  under  1918  Law,  660. 

definition  of,  under  1921  Law,  662. 

in  case  of  farmers,  164. 

in  case  of  partnerships,  187. 

limitation  on  deduction  of,  under  1918  Law,  660. 

of  estates  and  trusts,  126. 

under  1918  Law,  660. 

under  1921  Law,  662. 

NEVADA, 

community  property,  47. 


INDEX  1475 

[Refeieticot  are   to   puf/Cfi.] 

NEW  MEXICO, 

community  property,  48. 

NEWSPAPER  PLANTS, 

subject  to  child  labor  tax,  12')!. 

NOMINAL  CAPITAL, 

corporations  with,  not  subject  to  1917  excess-profits  tax,  1()21. 
examples  of  corporations  with  more  than,  1022. 

NOMINAL  STOCKHOLDERS, 

application  of  1918  and  present  law  to,  90. 

certificates  issued  to  bearer,  100.  . 

procedure,  in  case  of  Dutch  administration  officers,  100. 

where  a  nonresident,  and  actual  owner  a  resident,  99. 

where  a  resident,  and  actual  owner  a  nonresident,  98. 

where  a  resident,  and  actual  owner  a  resident.  98. 
who  are,  95. 

NONRESIDENT  ALIENS, 

See  Alien  Seamen. 

abatement  and  refund,  86. 

claims  for,  87. 
allowance  of  credits  to,  under  1918  Law,  784. 
allowance  of  personal  exemption  to  employee,  785. 
beneficiaries  of  trust,  77. 
citizens  who  are  treated  as,  57. 

condition  of  allowance  of  deductions  and  credits,  84. 
credit  for  dependents  not  allowed,  88. 
credit  for  taxes,  in  case  of,  788. 
credit  of  dividends,  06. 
credits  allowed,  conditions  of  allowance,  83. 

dividends,  83. 

interest,  83. 

personal  exemption,  83. 

tax  withheld  at  source,  83. 
credits  to,  under  1918  Law,  781. 
credits  to,  under  1921  Law,  781. 
deduction  of  taxes  by,  607. 
deductions  allowed,  apportionment  of,  79. 

charitable  contributions,  78. 

condition  of  allowance,  82. 

in  general,  78,  79. 

losses,  78. 

net  losses,  79. 
exemption  of  earnings  from  operation  of  ships,  37. 
extent  to  which  taxable,  58. 
income  from,  dividends,  04. 

fiduciaries,  77. 

interest,  generally,  02. 

manufacturing  and  selling  property,  09. 

miscellaneous  sources,  09. 

partnerships.  78. 


1476  INDEX 

[References  are  to  pages.'] 

NONRESIDENT  ALIENS— Continued. 

personal  services,  66. 

rentals  or  royalties,  68. 

sales  and  dealings  in  real  property,  68. 
interest  from  obligations  of  the  United  States,  64. 
payment  of  the  tax,  86. 

by  resident  agents,  94. 

when  leaving  country,  876. 
personal  exemption,  under  1918  Law,  784. 
procedure  of  resident  agents  in  collecting  income  for,  93, 
rates  of  tax,  58. 
resident  agents  for,  88. 
returns  by,  83. 

agents,  53,  85,  94. 

extension  of  time,  86. 

failure  to  file,  86.  , 

when  filed,  86. 

where  filed,  85. 
returns  of  information  as  to  payments  to,  956. 
specially  defined,  58. 

status  of,  determined  on  last  day  of  year,  56. 
taxation  of,  44. 

taxation  of,  under  present  law,  54. 
time  of  payment  of  tax,  853. 

when  entitled  to  personal  exemption  under  1918  Law,  782. 
when  returns  are  filed  by,  828. 
who  are,  54. 

who  are  not  resident  agents  for,  92. 
who  are  resident  agents  for,  91. 
withholding  against,  978. 

NORMAL  TAX, 

comparative  statement  of  rates,  21. 

credits  against,  356,  744. 

imposition  of,  14. 

net  income  subject  to,  356. 

rates  under  1918  Law,  20. 

rates  under  1921  Law,  20. 

NOTES, 

income  from  discount,  496. 
income  in  form  of,  352. 
market  value  of,  352. 
received  for  services,  371. 
withholding  in  case  of,  972. 

NOTICE  AND  DEMAND, 

changes  made  by  1921  Law,  857. 

duress  after  receipt  of  first  notice  and  demand,  892. 

duress  after  receipt  of  second  notice  and  demand,  893. 

failure  of  taxpayer  to  receive,  858. 

for  deficiency,  855. 


INDEX  1477 

[References  are  to  pagea] 

NOTICE  AND  DEMAND— Continued, 
forms  in  use,  856. 

for  tax  remaining  unpaid  after  due  date,  855. 
service  of,  by  mail,  857. 
.service  of,  to  absentees,  858. 

under  return  made  pursuant  to  Revised  Statutes,  855. 
upon  default  in  payment  of  installment,  855. 
with  regard  to  first  installment,  856. 

O 

OBLIGATIONS  OF  STATES, 

constitutionality  of  requiring  disclosure  of  interest  on,  1009. 
exemption  of  interest  on,  489. 

OBLIGATIONS  OF  THE  UNITED  STATES, 
information  at  source  of  interest  on,  955. 

OBSOLESCENCE, 

deduction  for,  in  general,  678. 

defined,  695. 

distillers  and  dealers  in  liquor,  699. 

must  be  certain  to  be  deductible,  696. 

of  good  will,  698. 

of  intangible  property,  698. 

of  vineyards,  703. 

under  1916  Law,  697. 

OFFICERS  AND  EMPLOYEES, 

of  federal  government,  compensation  of,  373. 

OFFICERS  AND  EMPLOYEES  OF  STATE, 
compensation  of,  exempt,  38. 
income  of,  not  taxed,  378. 
pensions  of,  383. 
pilot  fees  not  exempt,  383. 
public  library  employees,  384. 
salaries  of  teachers,  383. 
who  are,  380. 
who  are  not,  381. 

OIL  AND  GAS  WELLS, 

See  Gas  Wells. 

capital  recoverable,  by  lessee,  742. 

by  lessor,  743. 

by  operating  owner,  742. 
charges  to  capital  and  to  expense,  763. 
computation  of  allowance  for  combined  holdings,  756. 
computation  of  depletion  allowance,  745. 

computation  of  depletion  allowance  where  quantity  uncertain,  756. 
depletion,  740. 

capital  sum  to  be  depleted,  740,  741. 
depletion  and  depreciation  in  years  before  1916,  765. 
depreciation  of  improvements,  764. 


1478  INDEX 

[References  are  to  pages.l 

OIL  AND  GAS  WELLS— Continued. 

determination  of  cost  of  deposits,  744. 

determination  of  quantity  of  oil  and  gas  in  ground,  744 

discovery  of,  758. 

estimates  of  depreciation  of  physical  property,  765. 

estimating  recoverable  reserves,  744. 

losses  of  oil  and  gas,  646. 

maps  to  be  filed,  758. 

physical  property,  764. 

private  boundary  line,  761. 

proof  of  discovery,  762. 

proven  tract  or  lease,  760. 

revised  estimate  of  reserves,  745. 

sales  of,  464. 

statement  required  where  depletion  of  oil  or  gas  is  claimed,  756. 

OPTIONS, 

not  subject  to  stamp  tax,  1196. 

to  purchase  interest  in  royalties,  538. 

OWNERSHIP  CERTIFICATES, 

execution  of,  985. 

foreign  items  presented  for  collection  unaccompanied  by,  958. 

for  foreign  items,  956. 

form  of,  where  withholding  required,  988. 

forms  of,  986. 

furnishing  copies  of,  847. 

in  case  of  fiduciaries  and  joint  owners,  994. 

interest  coupons  without,  991. 

interest  on  registered  bonds,  992. 

procedure  with  respect  to  substitute  certificates,  989. 

release  of  excess  tax  withheld,  993. 

return  of  tax  withheld,  993. 

rules  for  use  of  forms,  986. 

table  for  use  of  ownership  and  substitute  certificates,  987. 

use  of  in  connection  with  withholding,  984. 

use  of  information  where  no  actual  withholding,  994. 

use  of  substitute  certificates,  989. 

when  conditions  change  between  interest  dates,  985. 

when  required,  984. 

P 

PAID-IN  SURPLUS, 

no  paid-in  surplus  as  to  intangible  property,  1053. 
record  to  be  kept  by  Commissioner,  1047. 
surplus  and  undivided  profits,  1056. 
tangible  property  paid  in,  1045. 

PARCEL  POST  PACKAGES, 

not  subject  to  stamp  tax  under  present  law,  1203. 

PARTNERSHIP  BUSINESS, 

election  as  to  being  taxed  as  corporation  when  incorporated,  218. 


INDEX  1479 

[Referenci'H  are  to  pages] 
PARTNERSHIPS, 

See  Foreign   Partnerships. 

allowance  of  net  loss  to,  663. 

claims  of,  for  loss  in  inventory  or  from  rebates,  674. 

consisting  of  corporations,  174. 

contributions  to  charities,  184. 

corporations  can  not  generally  enter  into,  172. 

credit  for  ta.xes,  184. 

credit  for  taxes  in  case  of  members  of,  791. 

credit  of  dividends  allowed  partners,  181. 

credit  of  interest  allowed  partners,  181. 

deductions  allowed,  177. 

business  expense,  177. 

insurance  premiums,  178. 

losses,  177. 

profit  sharing,  178. 
distinguished  from  association,  1141. 
distribution  of  profits,  179. 
dividends  from  limited  partnerships,  170. 
domestic  and  foreign,  defined,  166. 
examination  of  partnership  records,  190. 
excessive  payments  of  compensation,  594. 
exemption  of  interest  on  state  bonds,  183. 
fiscal  year  of,  186. 

fiscal  year  of  partnership  and  partners  differing,  186. 
general  or  common  law,  173. 
how  taxed,  166. 

income  exempt  to  partners,  184. 
incorporation  of,  excess-profits  tax  in  case  of,  1131. 
inspection  of  partnership  returns,  842. 
joint  owner  and  joint  adventure,  171. 
limited  partnership  as  corporation,  1142. 
limited  partnerships  as,  1141. 
limited  partnerships,  how  taxed,  167. 

what  are,  168. 
may  e.xist  by  virtue  of  single  transaction,  172. 
net  income  of,  176. 
net  losses  of,  187. 

nonresident  aliens  receiving  income  from,  78. 
not  subject  to  excess-profits  tax,  except  under  11)17  Law,  1020. 
operating  abroad,  175. 
partnership  associations,  how  taxed,  169. 
partner  with  fiscal  period  different  from  partnership,  166. 
penalties  against  members  of,  902. 
penalties  in  case  of,  190. 
private  or  partnership  banks,  170. 
procedure  in  collecting  income,  175. 
profits  earned  prior  to  March  1,  1913,  188. 
profits  to  be  reported  by  partners,  179. 
readjustment  of  partnership  interest,  185. 


1480  INDEX 

[References  are  to  pages. '\ 

PARTNERSHIPS— Continued, 
returns  by,  188. 

contents  of,  189. 

of  information,  190. 

tax  withheld  at  source,  189. 

when  acting  as  brokers,  190. 
returns  of  information  by,  961. 
taxation  of,  17. 

taxation  of  capital  gains,  410. 
what  constitutes,  171. 

when  copies  of  returns  will  be  furnished,  847. 
when  salaries  of  partnerships  withheld,  967. 
which  paid  an  excess-profits  tax  on  1918  income,  1021. 
withholding  against,  979. 
withholding  at  source  against,  175. 
withholding  at  source  by,  176. 

PAR  VALUE, 

effect  of,  on  income  from  exchange  of  stock,  446. 

PASSAGE  TICKETS, 

See  Stamp  Tax. 

PATENTS, 

deduction  of  expenses  relating  to,  583. 

depreciation  allowed,  683. 

inclusion  in  invested  capital,  1061. 

may  be  included  in  invested  capital,  1049. 

proof  of  value  of,  433. 

royalties  from,  503. 

terms  of  in  various  countries,  684. 

PAYMENT  OF  TAX, 

See  Notice  and  Demand;  Protest;  Recovery  of  Taxes. 
appeal  against  deficiency,  840. 
by  certificates  of  indebtedness,  879. 
by  check,  878. 
by  nonresident  aliens,  853. 
by  nonresident  foreign  corporations,  853. 
by  receivers,  851. 
capital  stock  tax,  1160. 
child  labor  tax,  1259. 
citizens  residing  abroad,  41. 

conditions  under  which  extensions  granted,  865. 
corporations,  264. 
"deficiency,"  defined,  849. 
deposit  of  United  States  bonds,  882. 
effect  of  failure  to  pay  installment  when  due,  848,  853. 
excess-profits  tax,  1137. 
extension  of  time,  865. 
extension  of  time  for,  853. 
failure  to  disclose  profits  on  sale  of  capital  assets,  854. 


INDEX  1481 

[References  are  to  pages.] 

PAYMENT  OF  TAX— Continued, 
farmers,  165. 

first  installment,  instructions  on  form  deemed  notice,  848. 
general  requirements  as  to,  18. 
in  case  of  taxpayer's  leaving  country,  874. 
interest  on  delinquent  taxes,  866. 
interest  when  time  extended,  853. 
may  be  by  single  payment,  854. 
medium  of  payment,  878. 

new  provision  of  present  law  as  to  extensions,  865. 
nonresident  aliens,  86. 
notice  and  demand  for,  848. 
notice  of  deficiency,  849. 
not  recoverable  when  paid  voluntarily,  886. 
payable  in  installments,  848. 
payment  of  deficiency,  849,  855. 

payment  of  stamp  taxes  under  protest  and  duress,  1247. 
penalty  for  deficiency,  849. 
penalty  for  failure  to  pay  tax,  904. 
procedure  of  collector  with  respect  to  checks,  878. 
procedure  with  respect  to  certificates  of  indebtedness,  880. 
receipts  for,  881. 

form  of,  881. 

taxes  withheld  at  source,  882. 
recovery  of  taxes  paid,  883. 
remittances  by  mail,  852. 
resident  citizens,  41. 
time  of  payment,  852. 
to  whom  made,  881. 
under  protest,  884. 
when  duress  exists,  892. 
when  extension  granted,  866. 
when  installments  due,  848. 
where  claim  for  credit  denied,  928. 
where  claim  in  abatement  denied,  917. 
where  property  taken  over  by  alien  property  custodian,  873. 

PENALTIES, 

See  Compromises. 
against  officer  of  corporation  or  member  of  partnership,  902. 
applicable  to  partnerships,  190. 

applicable  to  war-profits  and  excess-profits  taxes,  1138. 
attempts  to  evade  the  tax,  903. 
banks  deducting  taxes  paid  for  shareholders,  901. 
capital  stock  tax,  1160. 
child  labor  tax,  1260. 
compromise  of,  907. 

compromise  of  specific  and  ad  valorem.  909. 
corporations  subject  to,  270. 
deficiency  due  to  fraud,  898. 
delay  in  payment  of  tax,  904. 
duty  of  collector  regarding  violations  of  law,  911. 


1482  INDEX 

[References  are  to  pages.] 

PENALTIES- Continued. 

failure  to  file  return,  896. 

failure  to  file  return  when  not  asserted,  897. 

failure  to  pay  installment  on  time,  853. 

failure  to  pay  tax,  904. 

farmers  subject  to,  165. 

for  deficiency,  849. 

for  divulging  information,  905. 

foreign  corporations  subject  to,  308. 

for  failure  to  file  withholding  returns,  903. 

for  failure  to  supply  information  at  source,  902, 

for  false  returns,  898. 

for  fraudulent  returns,  901. 

for  including  appreciation  in  value  in  invested  capital,  901. 

for  omitting  gains  from  sale  of  capital  assets,  901. 

for  understatement,  898. 

for  violating  provisions   relating  to  removal  of  person  or  property 

from  country,  877. 
in  case  of  fiduciaries,  149. 
in  connection  with  stamp  taxes,  1239. 
in  general,  896. 

intentional  neglect  or  refusal  to  make  returns,  898. 
interest  in  case  of  deficiency,  899. 
interest  on  delinquent  taxes,  866. 
negligence  without  intent  to  defraud,  899. 
not  asserted  against  corporation  taking  deduction    for    Red    Cross 

contribution,  900. 
recovery  of  unauthorized  penalties,  934. 
return  made  in  good  faith,  899. 
statute  of  limitations,  905. 
suits  to  enjoin  collection  of,  896. 
what  constitutes  false  return,  899. 
when  ad  valorem  penalties  enforceable,  896. 

PENSIONS, 

exemption  of,  from  the  United  States,  37. 

may  be  income,  547. 

received  by  officers  and  employees  of  state,  383. 

when  deductible,  598. 

when  exempt,  355. 

PERIODS  OF  ACCOUNTING, 

See  Accounting  Period. 

PERSONAL  EXEMPTION, 

See  Head  of  Family. 
allowance  of,  to  nonresident  alien  employee,  785. 
allowed  to  head  of  family,  777. 
amount  of,  776. 

credited  against  normal  tax,  774. 
date  determining,  780. 
of  nonresident  aliens  under  1918  Law,  784. 


INDEX  1483 

[References  are  to  pages.] 

PERSONAL  EXEMPTION— Continued, 
in  case  of  husband  and  wife,  779. 
nonresident  aliens,  88. 
under  present  and  1918  Laws,  13. 
when  nonresident  alien  is  entitled  to,  under  1918  Law,  782. 

PERSONAL  LIVING  OR  FAMILY  EXPENSES, 
may  not  be  deducted,  565. 

PERSONAL  PROPERTY, 

See  Installment  Sales. 

PERSONAL  SERVICE  CORPORATIONS, 

abolition  of,  194. 

acquisition  of  title  to  products  sold,  202. 

activities  of  stockholders,  197. 

change  in  ownership,  199. 
stock  interest  required,  198. 
advancing  funds,  203. 
alternative  retroactive  tax  on,  207. 

apportionment  of  invested  capital  and  net  income,  1025. 
certain  corporations  excluded,  195. 
computation  of  tax  when  only  partially  engaged  in  personal  service 

business,  1025. 
constitutionality  of  tax  on,  207. 
corporations  engaged  in  business  in,  225. 

corporations  engaged  partly  in  personal  service  business,  1024. 
credits  allowed  stockholders,  206. 
definition  of,  161,  195. 
distributive  shares  of  stockholders,  205. 
dividends  of,  204. 
employing  agencies,  203. 
employment  of  capital  by  199. 

inference  from  use  of  capital,  200. 
engaging  in  more  than  one  business,  197. 
examples  of,  201. 

examples  of  corporations  held  not  to  be,  203. 
excess-profits  tax  does  not  apply  to,  1017. 
exempt  from  tax,  337. 
extension  of  credit  by,  203. 
fiscal  year  ending  in  1922,  821. 
formed  to  evade  surtaxes,  207. 
how  taxed.  194,  270. 
income  from,  when  to  be  reported,  805. 
liability  to  consignor  for  selling  price  of  product,  203. 
not  subject  to  excess-profits  tax,  1021. 
ownership  of  property  by,  202. 
personal  services  rendered  by,  196. 
procedure  in  claiming  personal  service  status,  206. 
returns  by,  204. 

contents  of  returns,  204. 
returns  of  information  by,  961. 
taxation  of  dividends  from,  510. 


1484  INDEX 

[References  are  to  pages.l 

PERSONAL  SERVICE  CORPORATIONS— Continued, 
under  1917  excess-profits  tax  law,  1021. 
withholding  against,  979. 
with  nominal  capital  not  subject  to  1917  excess-profits  tax,  1021. 

PERSONAL  SERVICES, 

See  Salaries. 
cancellation  of  debt  because  of,  368. 
income  from,  364. 

in  case  of  nonresident  aliens,  66. 

taxable  in  whatever  form  paid,  364. 
paid  for  in  other  than  cash,  369. 
rendered  by  personal  service  corporations,  196. 
rendered  prior  to  March  1,  1913,  371. 
wages  of  alien  seamen,  67. 
what  constitutes  reasonable  compensation  for,  591. 

PHILIPPINE  ISLANDS, 

income  tax  in,  11,  225. 

taxation  of  individuals  between  United  States  and,  44. 

PILOT  FEES, 

not  exempt  from  tax,  383. 

PLAYING  CARDS, 

penalty  for  selling  without  stamps,  1240. 
stamp  tax  on,  1205. 

POLITICAL  SUBDIVISION, 

of  foreign  governments,  310. 

of  state,  defined,  490. 

of  state,  interest  from  obligations  of,  exempt,  490. 

PORTO  RICO, 

corporations  engaged  in  business  in,  225. 

income  tax  in,  11,  225. 

taxation  of  individuals  between  United  States  and,  44. 

POSSESSIONS  OF  THE  UNITED  STATES, 
interest  on  obligations  of,  488. 
taxation  of  citizens  of,  10,  54. 
withholding  against  citizens  of,  978. 

POSTAL  SAVINGS  ACCOUNTS, 

exemption  of  interest  upon,  488. 

POWER  OF  ATTORNEY, 

See  Stamp  Tax. 
cannot  create  fiduciary  relationship,  104. 
sufficient  authority  for  filing  claim  for  refund,  924. 

PREMIUM, 

interest  on  bonds  purchased  at,  495. 
municipal  bonds  purchased  at,  462. 
treatment  of  bonds  issued  at,  238. 


INDEX  1485 

[ReferenciK  iirf   to  pagen.] 

PRESENT  VALUE  METHOD, 

of  establishinjr  market  value  of  mineral  property,  720. 
salary  of,  38,  378. 

PRE-WAR  PERIOD, 

adjustment  for  assets  differently  valued  in  pre-war  invested  capital, 

1104. 
average  invested  capital  for  pre-war  period,  1106. 
average  net  income  for,  1113. 

corporations  which  had  no  pre-war  period,  1109. 
defined,  1032. 

invested  capital  of  affiliated  corporations,  1135. 
net  income  of  affiliated  corporations,  1135. 
reorganization  after  January  1,  1911,  1105. 

PRIVATE  BANK, 

not  an  association,  217. 

PRODUCTIVE  USE, 

property  held  for,  411. 

PROFESSIONAL  EXPENSES, 
deduction  of,  583.  . 

PROFITS, 

See  Income. 

unreasonable  accumulation  of,  33. 

PROFIT  SHARING, 

by  partnership,  178. 

employees'  fund,  income  from,  545. 

income  from,  365. 

payments  constituting,  to  be  withheld,  968. 

trusts  as  part  of  plan  for,  102. 

when  payments  deductible,  595. 

PROMISSORY  NOTES, 

See  Notes;  Stamp  Tax. 

PROPERTY, 

See  Exchanges  of  Property;  Intangible  Property;   Sales. 
acquired  before  March  1,  1913,  basis  for  determining  gain  or  loss,  415. 
acquired  by  bequest,  devise  or  inheritance,  gain  or  loss  from  sale  of, 

456. 
acquired  by  gift,  basis  for  determining  gain  or  loss  from  sale  of,  414. 
acquired  by  gift,  income  from,  548. 
acquired  by  gift,  sale  of,  458. 

appreciation.s  on,  may  not  be  included  in  invested  capital,  1086. 
basis  for  determining  gain  or  loss  from  sale  of,  414. 
compensation  when  destroyed,  540. 
constitutionality  of  taxing  gains  from  sales  of,  1008. 
cost  of,  417. 

deduction  of  insurance  on,  587. 
dividends  paid   in,  527. 


1486  INDEX 

[References  are  to  pages.'] 

PROPERTY— Continued. 

excess  of  salvage  value  plus  depreciation  over  cost  in  case  of  discarded 

property,  545. 
exchanged  for  different  kin'ds  of,  435,  436. 
exchanged  for  stock,  451. 
fair  market  value  of,  419. 
held  for  investment,  exchange  of,  411. 

no  loss  recognized  from  exchange  of,  634. 
held  for  productive  use,  exchange  of,  411. 
losses  connected  with  residential  property,  624. 
losses  from  exchanges  of,  634. 
losses  from  sales  of,  632. 
loss  from  voluntary  destruction  of,  639. 
loss  when  dividends  paid  in,  636. 
personal  property  sold  on  installment  plan,  465. 
readily  realizable  market  value,  427. 
selling  price  of,  419. 
sold  on  installment  plan,  464. 

subsequent  sale  of,  when  received  in  exchange,  417. 
the  cost  of  which  may  be  amortized,  707. 

value  of,  as  of  January  1,  1914,  for  excess-profits  tax  purposes,  1041. 
when  considered  of  "like  kind",  412. 
when  depreciable,  679. 

PROTEST, 

See   Duress. 
at  time  of  filing  return,  884. 
form  of,  884. 

necessary  in  order  to  maintain  a  suit,  936. 
not  alone  sufficient,  885. 
payment  of  stamp  taxes  under,  1247. 

PROXIES, 

See   Stamp   Tax. 

PUBLIC  LIBRARY  EMPLOYEES, 

taxation  of  compensation  of,  378. 

PUBLIC  UTILITIES, 

deduction  of  payment  from  earnings  of,  601. 

deductions  allowed,  572. 

effect  of  book  entries,  343. 

exemption  of  income  derived  from  operation  of,  38. 

income  from,  exempt,  355. 

income  6f,  572. 

income  of,  exemption  of,  357. 


R 


RACE  TRACK  WINNINGS, 

to  be  withheld  at  source,  971. 


RAILWAYS, 

See  Transportation  Systems. 


INDEX  1487 

[References  are  to  pcujes] 
RATES  OP^  TAX, 

capital  stock  tax,  1143. 

child  labor  tax,  1258. 

comparative  statement  of  normal  rates,  21. 

comparative  statement  of  surtax  rates,  23. 

corporations,  209. 

dividends  taxed  formerly  under  rates  for  previous  years,  537. 

excess-profits  tax,   1017. 

foreign  corporations,  297. 

in  case  of  capital  sains,  409. 

maximum  limit  of  excess-profits  tax,  1037. 

nonresident  aliens,  58. 

normal  tax  under  1918  Law,  20. 

normal  tax  under  1921   Law,  20. 

on  corporations  deriving:  income  from  government  contracts,  1027. 

to  be  withheld  in  case  of  tax-free  covenant  bonds,  999. 

under   1917  excess-profits  tax  law,  1016,  1033. 

under  1918  excess-profits  tax  law,  1034. 

under  1919,  1920  and  1921  excess-profits  tax  law,  1034. 

war-profits  tax,  1017. 

READILY  REALIZABLE  MARKET  VALUE, 

what  constitutes,  427. 

REAL  ESTATE, 

See  Deferred  Payments. 

contracts  to  convey  not  subject  to  stamp  tax,  1195. 

deduction  for  depreciation,  681. 

deduction  of  interest  on  mortgage,  606. 

sale  of,  in  lots,  477. 

sales  of,  involving  deferred  payments,  474. 

REBATES, 

losses  from,  669. 

claims  for,  672. 

claims  of  partnerships,  674. 

disposition  of  claims,  675. 

effect  of  claim  in  abatement,  675. 

Liberty  bonds  as  security,  676. 

under   1918   Law,  664. 

RECEIPTS, 

accounting  on  basis  cf  actual  rtcjipts,  795. 

actual  receipts  taxed,  343. 

by  agent  is  receipt  by  principal,  348. 

for  payment  of  tax,  881. 

for  taxes  withheld  at  source,  882. 

form  of  for  taxes  paid,  881. 

lent   received    in   kind,  499. 


1488  INDEX 

{^References  are  to  pages.'] 

RECEIVERS, 

See  Fiduciaries. 

for  corporations,  duties  of,  242. 

in  charge  of  part  of  property  only,  244. 

payment  of  taxes  by,  851. 

returns  by,  242. 

RECORDS, 

taxpayers  to   keep,   13. 

RECOVERY  OF  TAXES, 

See  Abatement,  Credit  and  Refund. 

by  action  at  law,  883. 

claims  for  refund  of  sums  recovered  by  suit,  938. 

from  Commissioner,  883. 

interest  on  refunds  and  judgments  under  present  law,  939. 

interest  recoverable  against  collectors,  940. 

jurisdiction  of  courts,  933. 

prerequisites  to  suit,  934. 

protest  and  duress  a  prerequisite  for,  885. 

recovery  of  costs,  941. 

recovery  of  interest,  939. 

reopening  of  cases,  942. 

statute  of  limitations  upon  suits,  935. 

suits  against  collectors,  936. 

suits  against  the  United  States,  938. 

suits  when  claim  rejected  by  Commissioner,  932. 

who  may  claim,  913. 

RED  CROSS, 

donations  to,  not  deductible,  238,  600. 

penalties  not  asserted  for  deduction  of  contributions  to,  900. 

REFUND, 

See  Abatement,  Credit  and  Refund. 

REGULATIONS, 

See  Rulings  and  Regulations. 

RELIGIOUS,  CHARITABLE,   SCIENTIFIC   OR   EDUCATIONAL  COR- 
PORATIONS, 

deductions  of  contributions  to,  561. 

RELIGIOUS  CORPORATIONS, 
exempt  from  tax,  322. 

RENT, 

constructively  received,  500. 

deduction  of,  581. 

income  from,  479,  497. 

income  from  in  case  of  nonresident  aliens,  68. 

paid  for  residential  property,  not  deductible,  583. 

received  in  kind,  499. 


INDEX  1489 

[References  are  to  pages.] 

RENT— Continued. 

received  in  kind  by  farmer,  157. 

to  be  withheld  at  source,  972. 

value  of  improvements  made  by,  497. 

when  not  reported  at  source,  954. 

REORGANIZATIONS, 

after  January  1,  1911,  effect  on  prewar  invested  capital,  1106. 

"aggregate  par  value"  of  stock,  440. 

defined,  441. 

entitling  corporations  to  revaluation,  1084. 

exchange  of  stock  for  stock  of  greater  par  value,  446. 

fair  market  value  of  property  sold,  419. 

gain  or  loss  from,  408. 

gain  or  loss  from  subsequent  sale  of  stock  received  on,  444. 

invested  capital  of  new  corporation,  1043. 

losses  in  connection  with,  634. 

losses  under  1921   Law,  635. 

prior  to  attachment  of  lien,  267. 

profit  arising  from,  under  1918  Law,  438. 

profit  from,  436. 

property  dividend  upon,  529. 

value  of  assets  acquired  in,  1082, 

REPAIRS, 

made  by  tenant,  deduction  of,  586. 

to  property  on  which  depreciation  is  claimed,  689. 

when  deductible,  584. 

REPLACEMENT  FUND  FOR  LOSS, 
procedure  for  establishing,  544. 
surplus  and  undivided  profits,  1056. 
use  of,  543. 

REPRESENTATIVE  CORPORATIONS, 

See  Excess-Profits  Tax. 
assessment  by  reference  to,  1116. 

ratio  between  average  tax  and  average   net  income,   1128. 
what  are,  1127. 

RESERVES, 

deduction  of  required  addition  to,  by  insurance  companies,  291. 

distribution  from  depletion  or  depreciation   reserves,  525. 

for  bad  debts  under  1921  Law,  655, 

for  cash  discounts,  not  deductible,  647, 

for  depreciation,  694. 

for  depreciation  or  depletion,  inclusion  in  invested  capital,   1060, 

for  losses,  deduction  of,  647. 

for  taxes,  inclusion   in  invested  capital,   1060, 

inclusion  in  invested  capital,  1059. 

not  deductible,  587. 

of  oil  and  gas,  method  of  estimating.  744. 

reduction  of,  effect  on  invested  capital,  1103, 

to  meet  liabilities,  deduction  of,  810, 


1490  INDEX 

[References  are  to  pages."] 
RESIDENCE, 

loss  of,  by  aliens,  43. 
of  alien  employees,  981. 
of  corporations,  224,  298. 
proof  of,  by  aliens,  42. 

RESIDENT  AGENTS, 

distinguished  from  withholding  agents,  89. 

duties  and  liabilities  of,  88,  93. 

for  nonresident  aliens  and  foreign  corporations,  88. 

lack  of  authority  under  present  law,  88. 

necessity  for,  90. 

payment  of  tax  for  nonresident  principal,  94. 

procedure  in  collecting  income,  93. 

returns  for  nonresident  principal,  94. 

use  of  substitute  certificates  by,  989. 

who  are,  91. 

who  are    not,  92. 

RESIDENTIAL  PROPERTY, 

losses  connected  with,  624. 

RETAIL  DRY  GOODS  MERCHANTS, 
inventories  of,  403. 

RETROACTIVE  TAX, 

on  personal  service  corporations,  207. 

RETURNS, 

See  Corporations;  Fiduciaries;  Nonresident  Aliens;  Penalties. 
assistance  by  collectors,  837. 
by  agents,  827. 
by  clearing  houses,  1230. 
by  Commissioner,  859. 
by  corporations,  245. 

by  corporations   claiming   exemption,   314. 
by  individuals,   823. 

husband  and  wife,  823. 

minors,    825. 

when  required,  823. 
by  persons  making  sales  of  stock,  1228. 
by  receivers,  242. 
by  resident  agents,  89. 
capital   stock   tax,   1156. 
child  labor  tax,  1259. 

consolidated  returns  by  corporations,  251. 
decedent's  estate  during  administration,   129. 

effect  of  failure  to  disclose  income  from  sale  of  capital  assets,  854. 
excess-profits   tax,  1136. 
excess-profits  tax,  in  special  cases,  1137. 
exempt  income,  493. 
extension  of  time,  830. 

by  collector,  830. 

by  Commissioner,  831. 

to  enemies,  833. 

to  persons  abroad,  832. 


INDEX  1491 

[References  are  to  pages] 
RETURNS— Continued, 
farmers,   165. 
fiduciaries,  140. 

fiscal  year  of  corporation,  245. 
foreign   corporations,  306. 
foreign   fiduciaries,   150. 
forms  to  be  used,  834. 
from  whom  required,  822. 
furnishing  copies  of,  846. 
general  requirements  as  to,  12. 
incompetents,  52. 
individuals,    13. 
inspection  of,  840. 

by  government  officers,  843. 

by  state  officers,  844. 

corporation  returns,  842. 

furnishing  copies,  841,  845. 

partnership  returns.  842. 

returns  of  individuals,  841. 
insurance  companies,  295. 
last  due  date,  829. 
made  by  agents,  52. 

made  by  collector  on  failure  of  taxpayer,  837. 
mailing  returns,  829. 
minors,  52. 

must  be  made  on  basis  of  taxpayer's  accounting  period,  816. 
nonresident  aliens,  83. 
notice  of  failure  to  file,  839. 
of  income  from  which  tax  withheld,  995. 
of  incompetents,  827. 
of  information  as  to  foreign  items,  958. 
of  information  at  source,  961.    . 
of  tax  withheld,  993. 

of  withholding  agents,   penalties  connected   with.   903. 
partnerships,  188. 

penalties  for  disclosing  contents  of,  840. 
personal  service  corporations,  204. 
primary  due  date,  828. 

procedure  in  respect  of  erroneous  returns,  838. 
requirements   as  to  first  returns,  817. 
special  returns  of  foreign  corporations,  308. 
tentative  returns,  834. 
understatement  in,  838. 
use  of  amended  returns,  839. 
use   of,   in    litigation,   846. 
use  of  prescribed  forms,  835. 
verification  abroad,  837. 
verification   in   army   and    navy,   837. 
verification  of.  836. 
when   accounting  period   changed,  829. 
when  filed,  828. 
where  filed,  828. 


1492  INDEX 

[References  are  to  jmges.'\ 
REVENUE  ACT  OF  1916, 

administered  with  1917  Law,  3. 

REVENUE  ACT  OF  1918, 

history  of  enactment  of,  3. 
repeal  of,  2. 

REVENUE  ACT  OF  1921, 

changes  in  taxation  of  corporations,  209. 

changes  introduced  by,  1. 

compared  with  1918  Law,  2. 

effective  date  of,  1. 

rates  under,  1. 

remedial  changes  made  by,  1. 

REVENUE  AGENTS  AND  INSPECTORS, 
duties  of,  5. 
instruction   given    to,    949. 

REWARDS, 

constitute  income,  369. 

RIGHTS, 

to  subscribe  to  stock,  income  from,  548. 

ROYALTIES, 

amount  paid  for  option  to  purchase  interest  in,  538. 

dividends  in  form  of,  506. 

from  mines,  501. 

from  mines,  held  income  under  1909  Law,  731. 

from  patents  and  copyrights,  503. 

income  from,  479,  501. 

income  from  in  case  of  nonresident  aliens,  68. 

returned  in  year  received,  800. 

to  be  withheld  at  source,  972. 

RULINGS  AND  REGULATIONS, 

authorization  to  Commissioner  to  make,  7. 

force   and   effect  of,   7. 

informal  rulings,  8. 

publication  of,  bulletin  service,  9. 

retroactive  effect  of,  10. 

RUSSIAN  BANK  DEPOSITS, 

when  considered  worthless,  653. 


SALARIES, 

See  Compensation  for  Services. 

constituting  a  waste  of  assets,  594. 
constituting  distribution  of  dividends,  593. 
constituting  part  payment  for  property,  594. 
constituting  purchase  price  of  property,  365. 
deduction  of,  590. 
deduction  of,  by  farmers,  162. 


INDEX  14:)3 

[References  are  to  pages.'] 
SALARIES— Continued. 

income  of  year  in  which  actually  received,  364. 

information  at  source  respecting,  952. 

may  be  distributions  of  profits,  364. 

of  federal  judges,  377. 

paid  by  exempt  corporations,  364. 

paid  in  other  than  cash,  369. 

paid  to  enlisted  men,  595. 

paid  to  teachers,  when  exempt,  383. 

President  of  the   United   States   and   federal   judges,   exemption   of, 

38,  378. 
representing  appropriation  of  assets,  365. 
taxable  in  whatever  form  paid,  351. 
what  constitutes  reasonable  amount,  591. 
when  withheld  at  source,  967. 

SALES, 

See    Capital    Gains;    Deferred    Payments;    Installment    Sales;    In- 
voluntary Sale. 

annual  produce  sold  by  farmers,  157. 

basis  for  determining  gain  or  loss  from,  413. 

constitutionality  of  taxing  gains  from  sales,  1008. 

corporate  bonds  issued  at  premium  or  discount,  238. 

corpus  of  estate  or  trust,  112. 

dealings  in  bonds,  461. 

defined,  69. 

effect  of,  in  establishing  market  value,  423. 

evasion  of  tax  by  sale  of  corporate  assets  to  trustees,  455. 

fair  market  value  as  of  March  1,  1913,  428. 

farm  property,  159. 

gain  or  loss  from  sale  of  property  acquired  before  March  1.  1913,  415. 

income  from  sale  of  good  will,  551. 

income  from  sale  of  war  savings  stamps,  551. 

installment  sales  of  real  property  by  a  decedent,  115. 

involving  installment  and  deferred  payments,  464. 

live  stock  sold  by  farmers,  157. 

losses  from,  632. 

losses  on  sale  of  residential  property,  624. 

loss  from  sale  of  stock  or  securities,  633. 

made  by  foreign  partnerships,  192. 

mines,  oil  or  gas  wells,  excess-profits  tax  in  case  of,  1038. 

mines,  oil  or  gas  wells,  limitation  of  surtax,  21. 

no  loss  from  sale  of  capital  stock  by  corporation,  645. 

of  amortized  property,  711. 

of  assets  in  view  of  liquidation,  228. 

of  capital  assets  by  corporation,  228. 

of  capital  stock  by  corporation,  227. 

of  homestead,  461. 

of  insurance  policies,  462. 

of  mines,  oil  and  gas  wells,  464. 

of  produce  on  exchange,  stamp  tax  on,  1209. 

of  property  received  on  an  exchange,  417. 


1494  INDEX 

[References  are  to  pages.'\ 

SALES— Continued. 

property  acquired  by  bequest,  devise  or  inheritance,  456. 

property  acquired  by  gift,  458. 

real  estate  involving  deferred  payments,  474. 

real  estate  sold  in  lots,  477. 

real  property  in  case  of  nonresident  aliens,  68. 

sales  or  actual  dealings  in  similar  property,  429. 

stamp  tax  on  sales  and  transfers  of  capital  stock,  1177. 

stock  dividend  resulting  from  revaluation  of  assets,  536. 

stock  received  as  dividend,  534. 

subsequent  sale  of  stock  of  greater  par  value  than  that  exchanged, 

450. 
subsequent  sale  of  stock  received  on  an  exchange,  444. 
taxation  of  capital  gains,  409. 
when  income  from  contingent  transactions  to  be  reported,  803. 

SALES  AND  DEALINGS  IN  PROPERTY, 

See  Exchanges  of  Property;   Sales. 

SCIENTIFIC  CORPORATIONS, 
exempt  from  tax,  322. 

SCRIP, 

bond  interest  paid  in,  494. 

dividends  paid  in,  530. 

withholding  at  source  when  interest  paid  in,  977. 

SELLING  PRICE, 

what  constitutes,  419. 

SERVICES, 

See  Personal  Services. 

SHIP  OWNERS  MUTUAL  PROTECTION  AND  INDEMNITY  ASSOCIA- 
TIONS, 

exemption  of  receipts  from,  38,  355. 

SHIPPING, 

income  of   nonresident   aliens   and   foreign   corporations   from,   when 
exempt,  355. 

SINKING  FUNDS, 

income  from,  228. 

income  from  increment  to,  546. 

SOCIETIES, 

fraternal  beneficiary  society,  when  exempt,  317. 

SOLDIERS  AND  SAILORS, 
compensation  of,  374. 

payments  to,  by  government,  not  to  be  reported  at  source,  954. 
verification  of  returns  by,  837. 

when  compensation  not  within  1918  Law  exemption,  375. 
when  compensation  within  1918  Law  exemption,  376. 
where  returns  are  filed,  828. 


INDEX  1495 

[References  are  to  pages.] 

SOURCES  WITHIN  THE  UNITED  STATES, 
income  from,  59. 

SPECIAL  EXCISE  TAX, 

See  Capital  Stock  Tax. 

STAMP  TAX, 

abstracts  of  title  not  subject  to,  1195. 

acts  imposing,  1162. 

bonds  given  in  a  penal  sum,  1167. 

bonds  of  indebtedness,  1166. 

business  property  investment  bonds,  1167,  1175,  1189. 

cancellation  of  stamps,  1164. 

capital  stock,  sales  and  transfers,  1177. 

certificates  of  deposit,  1189. 

of  deposit  of  Morris-Plan  banks  exempt,  1189. 

of  indebtedness,  1189. 

of  indebtedness,  issued  by  receivers,  1190. 

of  interest  in  property  or  accumulations,  1174. 

of  profits,  1174,  1188. 

of  stock,  1174. 
checks,  1190. 

checks  or  drafts  drawn  otherwise  than  at  sight  or  on  demand,  1217. 
conditional  bills  of  sale,  1190. 
constitutionality  of,  1245. 

contract  to  convey  real  estate  not  subject  to,  1195. 
contract  to  issue  stock,  1170. 
conveyances,  1190. 

abstracts  of  title,  1195. 

by  and  to  United  States  and  political  subdivisions,  1196. 

by  mortgagor  to  mortgagee,  1196. 

by  officers  of  courts,  1197. 

consideration  or  value,  1191. 

contracts  to  convey,  1195. 

incumbrance  on  property  at  time  of  sale,  1195. 

mining  deeds,  1196. 

of  dower,  1195. 

property  in  a  foreign  country,  1197. 

realty  sold,  1191. 

timber  deeds,  1196. 

to  or  by  alien  property  custodian,  1197. 

when  not  subject  to  ti\x,  1193. 

when  tax  accrues,  1191. 

where  stamps  are  affixed,   1191. 

who  affixes  stamps,  1190. 
date  of  incidence,  1162. 
debentures,  1198. 
definitions,  1166. 
drafts.  1198. 

drafts  delivered  in  foreign  countries,  1220. 
drafts  di-awn  against  exports,  1218. 
entry  for  withtlrawal  of  goods  from  customs  bonded  warehouse,  1198. 


1496  INDEX 

[References  are  to  pages.'] 

STAMP  TAX— Continued.  . 

entry  of  goods  at  customhouse,  1198. 

exchange  defined,  1225. 

exempt  bonds,  1168. 

exemption    of    bonds    of    United    States,    foreign    governments    and 

political  subdivisions,   1170. 
exemption  of  stock  and  bonds  of  building  and  loan  associations,  1169. 
exemptions,  1163. 

Federal  Land  Banks,  stock  of,  1176. 
foreign  insurance  policies,  1199. 

credits  and  refunds,  1202. 

definitions,  1199. 

effective  date,  1200. 

insurance  on  commodities  exported,  1202. 

insured  to  retain  policy  for  two  years,  1200. 

measure  of  tax,  1202. 

movable  property,  1202. 

penalties,  1202. 

persons  liable  to  tax,  1200. 

returns,  1203. 

subsequent   instrument  to   indicate   prior  document   to    which 
stamps  affixed,  1201. 

subsequent  instruments  that  must  be  stamped,  1201. 

unstamped   instruments   and   those    bearing    no    notation    of 
stamping,  1201. 

what  instruments  must  bear  a  stamp,  1200. 
fractional  scrip  certificates,  1176. 
general  scope  of  tax,  1162. 
injunctive  relief,  1249. 
issued  by  any  corporation,  1175. 
issue  of  bonds,  1168. 
issue  of  capital  stock,  1170. 
issue  of  stock  of  joint  stock  land  banks,  1176. 
leases,  not  subject  to  tax,  1196,  1203. 
loan  of  certificates  of  stock,  1182. 
measure  of,  on  issue  of  stock,  1176. 
mortgages  not  subject  to,  1203. 
mutual  ditch  and  irrigation  companies,  1203. 
no  tax  on  contracts,  1190. 
of  stock,  records  of,  1225. 
options  not  subject  to,  1196. 
original  issue  of  stock,  1171. 
parcel-post  packages  not  now  subject  to,  1203. 
passage  tickets,  1203. 

issued  to  federal  and  state  officials  and  foreign  representatives, 
1204. 

tickets  not  subject  to  tax,  1204. 

tickets  subject  to  tax,  1204. 
payment  under  protest  and  duress,  1247. 
penalties,  1239. 

excluding  unstamped  documents  in  state  courts,  1242. 


INDEX  1497 

[References  are  to  pages] 

STAMP  TAX— Continued. 

failure  to  cancel  stamps,  1240. 
failure  to  stamp  insurance  policies,  1241. 
fraudulent  removal  or  reuse  of  stamps,  1240. 
issuing  or  accepting  unstamped  instruments,  1239. 
making  sales  of  produce  without  paying  tax,  1240. 
other  penalties,  1241. 

selling  playing  cards  without  paying  tax,  1240. 
transferring  stock  without  paying  tax,  1240. 
playing  cards,  1205. 
powers  of  attorney,  1205. 

assignment  of  insurance  policies,  1207. 

authority  to  transfer  stock,  1208. 

authorizing  deputy  to  have  access  to  safe,  1207. 

authorizing  federal  official  to  sell  United  States  bonds,  1206. 

authorizing  federal  reserve  bank  to  assign  United  States  bonds, 

1206. 
contained  in  assignments,  1207. 
executed  or  accepted  in  foreign  country,  1207. 
formal  powers  of  attorney,  1207. 
from  corporations  to  resident  agents,  1209. 
granted  by  corporation,  1208. 
judgment  notes,  1209. 
power  of  sale,  1208. 
to  pay  poll  taxes,  1208. 

to  sell  or  transfer  government  bonds,  1209. 
to  sell  or  transfer  shares  of  stock,  1209. 
warrant  of  attorney  in  lease,  1206. 
when  tax  accrues,  1209. 
present  law  does  not  tax  bonds  of  indemnity  and  surety,  1169. 
promissory  notes,  1213. 
definition  of,  1215. 
drawn  in  foreign  countries,  1221. 
issued  by  government,  1222. 
renewal  of  notes,  1214. 

secured  by  pledge  of  United  States  securities,  1221. 
transfer  of  notes,  1215. 
who  affixes  stamp,  1214. 
proxies,  1222. 

signed  by  two  or  more  stockholders,  1223. 
when  tax  accrues,  1223. 
who  may  affix  stamps,  1223. 
records  of  intraoffice  borrowing  of  stock,  1227. 
records  required  in  case  of  sales  and  transfers  of  stock,  1224, 
registration  of  brokers,  1236. 

registration  of  brokers,  record  kept  by  collector,  1238. 
renewal  of  bonds,  1168. 
returns,  by  clearing  houses,  1230. 

of  persons  making  sales  of  stock,  1228. 
rights  to  receive  stock  dividends,  1224. 


1498  INDEX 

[References  are  to  pages.] 

STAMP  TAX— Continued. 

rights  to  subscribe  for  stock,  1176,  1224. 

sale  of  stamps,  1238. 

sales  and  transfers  of  stock,  affixing  and  cancellation  of  stamps,  1179. 

brokers  individual  sales,  1184. 

calls,  1187. 

certificate  of  broker,  1187. 

deposit  of  certificates  as  collateral  security,  1186. 

formal  transfers,  no  change  of  title,  1185. 

gifts,  1184. 

inconsistent  by-laws,  rules  or  customs  of  exchange,  1187. 

registration  of  brokers,  1188. 

rights  to  receive  or  subscribe  for  stock,  1181. 

rights  to  receive  stock  dividends,   1182. 

shares  or  certificates  of  stock,  1180. 

shares  without  par  value,  1180. 

stock  of  domestic  corporations,  1180. 

stock  of  foreign  corporations,  1181. 

stock  redeemed  by  issuing  corporation,  1186. 

stockholders'  committee,  1182. 

tax  paid  but  once,  1180. 

to  and  by  fiduciaries,  1183. 

to  or  by  alien  property  custodian,  1184. 

transfer  before  issue  of  certificate,  1181. 

transfer  to  clearing  house,  1187. 

transfers  to  or  by  broker,  1186. 

trusts,  1181. 

voting  trust  certificates,  1182. 

when  change  of  legal  title  only  takes  place,  1184. 

when  tax  accrues,  1180. 

when  title  passed  prior  to  incidence  of  tax,  1180. 
sales  of  produce  on  exchange,  1209. 

clearing  house  as  agent,  1231. 

exchange  or  board  of  trade,  1211. 

future  delivery  stamps,  1236. 

immediate  or  prompt  delivery,   1211. 

inconsistent  by-laws,  rules  or  customs  of  exchange,  1213. 

records,  and  returns  in  case  of,  1231. 

records  to  be  kept  by  buyers  and  sellers,  1232. 

records  to  be  kept  by  clearing  houses,  1234. 

registration  and  records,  1213. 

returns  by  clearing  houses,  1235. 

returns  of  transactions,  1234. 

sale  of  stamps,  1213. 

stamps  may  be  affixed  to  returns,  1235. 

transfers  to  clearing  house,  1212. 

when  tax  accrues,  1211. 
scrip  dividend  certificates  or  warrants,  1189. 
security  agreements  and  applications  for  loans,  1224. 
shares  of  stock  without  par  value,  1177. 
stamps  used,  1163. 


INDEX  1499 

[References  are  to  pages.] 

STAMP  TAX— Continued. 

stock  dividends,  1176. 

stock  issued  for  purchasing  business  or  assets,  1176. 

stock  of  domestic  corporations,  1175. 

stock  of  foreign  corporations,  1175. 

stock  transfer  stamps,  1231. 

suit  for  collection  of  stamp  taxes,  1244. 

time  drafts  covering  shipments  from  Virgin  Islands,  Philippines  and 

Porto  Rico,  1220. 
transfer  of  bonds,  1168. 
voting  trust  certificates,  1176,  1224. 
where  stamps  are  affixed,  1164,  1166. 
where  stamps  are  obtained,  1163. 
who  affixes  stamps,  1164. 

STATES  AND  POLITICAL  SUBDIVISIONS, 
income  of,  exempt,  357. 

STATISTICS  OF  INCOME, 

published  annually  by  Commissioner,  847. 

STATUTE  OF  LIMITATIONS, 

additional  assessments  under  present  law,  862. 

on  assessments  under  prior  laws,  858. 

on  prosecution  for  penalties,  905. 

on  summary  assessments  under  prior  laws,  860. 

refund  of  taxes  by  Commissioner,  929. 

suits  for  collection  of  taxes,  868. 

upon  suits  to  recover  taxes,  935. 

STEAM  LAUNDRIES, 

subject  to  child  labor  tax,  1251. 

STEAMSHIPS, 

rate  of  depreciation  allowed,  691. 

STOCK, 

See  Capital  Stock. 
additional  compensation  paid  in,  597. 

"aggregate  par  value"  of  stock  received  on  exchange,  440. 
cost  of  shares  bought  at  different  prices,  432. 
cost  of,  when  received  as  bonus,  418. 
deduction  for  loss  when  worthless,  645. 
exchanged  for  stock  of  no  greater  par  value,  441. 
exchange  of,  for  stock  of  greater  par  value,  446. 
income  from  rights  to  subscribe  to,  549. 
in  Federal  Reserve  Bank,  is  an  inadmissible  asset,  1075. 
issued  for  services,  inclusion  of,  in  invested  capital,  1045. 
legal  and  beneficial  owners  of,  on  which  dividends  are  paid,  511. 
loss  from  exchange  of,  under  1918  Law,  634. 
loss  from  exchange  of,  under  1921  Law,  635. 
loss  from  sale  of,  633. 
no  loss  from  sale  of,  by  corporation,  645. 


1 500  INDEX 

[References  are  to  pages.] 

STOCK— Continued. 

of  domestic  corporations  is  an  inadmissible  asset,  1275. 

of  foreign  corporations,  when  an  admissible  asset,  1076. 

of  subsidiary  acquired  for  cash,  1134. 

of  subsidiary  acquired  for  stock,  1134. 

par  value  of  for  excess-profits  tax  purposes,  1044. 

proof  of  market  value  of,  432. 

purchased  with  cash  and  patents,  inclusion  in  earned  surplus,  1058. 

received  in  exchange  for  property,  451. 

retirement  of,  515. 

sale  of,  when  received  as  dividend,  534. 

shrinkage  in  value  of,  not  deductible,  643. 

stamp  tax  on  rights  to  subscribe  to,  1224. 

subsequent  sale  of  stock  received  on  exchange,  444. 

transfer  of,  to  corporation  formed  for  the  purpose,  loss  allowed,  644. 

STOCK  DIVIDENDS, 

See  Dividends. 

STOCKHOLDERS, 

contributions  by,  how  treated,  229. 

inspection  of  returns  by,  842. 

paying  loss  of  corporation,  646. 

recovery  of  tax  from,  267. 

taxes  paid  for,  treated  as  dividends,  506. 

STOCKHOLDERS  OF  RECORD, 

See   Nominal  Stockholders. 

STOCK  IN  TRADE, 

exchange  of,  412. 

SUBSIDIARY  COMPANY, 

See  Affiliated  Corporations;   Holding   Company. 
doctrine  of  corporate  entity,  221. 

SUBSTITUTE  CERTIFICATES, 

See  Ownership  Certificates. 
SUITS, 

against  collectors,  936. 

against  former  residents  now  abroad,  870. 

against  the  United  States,  938. 

claims  for  refund  of  sums  recovered  by,  938. 

for  collection  of  stamp  taxes,  1244. 

for  collection  of  taxes,  868. 

for  recovery  of  taxes,  883. 

jurisdiction   of  courts,   933. 

prerequisites   to   suit,   statute    of   limitations,   934. 

protest  and  duress  a  prerequisite,  936. 

recovery  of  costs,  941. 

recovery  of  penalties,  934. 

statute  of  limitations  on  suits,  935. 

to  enjoin  collection  of  penalties,  896. 

to  recover  taxes  on  rejection  of  claim,  932. 

to  restrain  assessment  or  collection  of  tax,  850. 


INDEX  1^^^ 

[References  are  to  paf/es] 

SUMMARY  ASSESSMENT, 

See  Assessment  of  Tax. 

SUPPER  MONEY, 

income  from,  369. 

SURETY,  ^      ,     __„ 

taxpayers  required  to  furnish,  may  deposit  Liberty  bonds,  88Z. 

SURPLUS  AND  UNDIVIDED  PROFITS, 

additions  to  surplus  account,  1064. 

adjustments  which  increase  book  value  of  assets,  1080. 

adjustments  which  reduce  book  value  of  assets,  1080. 

dividends  paid  from,  effect  on  invested  capital,  1097. 

earned  surplus,  1057.  ,     w        maQ 

effect  of  inadequate  allowance  for  depreciation  or  depletion,  10«y. 

installment  sales,  1058. 

limitation  of  additions  to  surplus,  1065. 

may  be  included  in  invested  capital,  1055. 

oil  leases  informally  transferred  to  corporation,  1057. 

paid-in  surplus,  1056. 

purchase  of  stock  with  cash  and  patents,  1058. 

replacement  fund,  1056. 

SURTAX, 

comparative  statement  of  rates,  23. 

imposed  on  net  income,  15. 

income  subject  to,  21. 

limitation  in  case  of  sales  of  mines,  oil  or  gas  wells,  -1. 

net  income  subject  to,  356. 

on  undistributed  profits  of  corporations,  29. 

purpose  to  escape,  31. 

rates  of  under  1918  and  1921  Laws,  15. 

tables  for  1921  and  prior  years,  25. 

tables  for  1922  and  subsequent  years,  26. 

SYNDICATES, 

not  taxed  as  corporations,  213.  » 

T 
TANGIBLE  PROPERTY, 

defined,  1048. 

inclusion  of  in  invested  capital.  1045. 

inclusion  of,  in  invested  capital  for  1917,  1039. 

TAXABLE  YEAR, 

changes  in,  adjustments   in  investe.l  capital,   lOJC 

defined,  1032. 

TAXES 

See  Assessment  of  Taxes;  Payment  of  Taxes. 

abatement,  credit  and  refund,  912. 

additional  taxes  deductible,  235. 

amount  paid  during  taxable  year,  defined,  786. 


1502  INDEX 

[References  are  to  pages.'\ 

TAXES— Continued. 

assessments  against  local  benefits,  not  deductible,  575. 

automobile  license  fees  deductible,  612. 

collection  of  by  distiaint,  873. 

collection  of,  from  distributees,  147. 

compromise    of,    907. 

corporations  may  deduct,  235. 

covenants  to  pay,  examples  of,  1001. 

credit  for,  786. 

allov/ed  corporations,  789. 

allowed  members  of  partnerships,  791. 

allowed  under  1918  Law,  790. 

by  partners,  184. 

conditions    of    allowance,    792. 

domestic  corporation  owning  stock  of  foreign  corporation,  789. 

fiscal  year  in  case  of  corporations,  794. 

fiscal  year  in  case  of  individuals,  789. 

in  case  of  estates,  132. 

redetermination  when  credit  proves  incorrect,  794. 

to  beneficiaries  of  estates  or  trusts,  791. 
credit  of,   allowed    nonresident   aliens,   788. 

citizens  of  possessions,  residing  in   United   States,  788. 

countries  satisfying  similar  credit  requirement,  788. 

to  citizens  of  United  States,  787. 

to  resident  aliens,  787. 
deduction   of,  by  estates   and  trusts,   126. 

by  farmers,  163. 

by  life  insurance  companies,  277. 

excise  taxes  paid  to  Cuban  government,  611. 

in  general,  607. 

New  York  stato.  franchise  tax,  609. 
federal  duties  and  excises,  deduction  of,  610. 
final  determination  and  assessments,  864. 
imposed  by  authority  of  any  foreign  country,  611. 
liens  for  unpaid  taxes,  870. 
raid  at  source,  in  case  of  trust,  132. 
pnid  by  corporation  for  stockholders,  deduction  of,  617. 
paid  by  debtor  on  account  of  tax-free  covenant  bond,  552. 
paid  by  tenant,  deduction  of,  613. 
paid  by  vendee  for  vendor,  deduction  of,  613. 
paid  for  fiscal  year,  deduction  of,  609. 
paid  or  accrued  within  the  year,  608. 
paid  to  taxing  subdivisions  of  territories,  612. 
payable  in  installments,  848. 
penalties  for  attempts  to  evade,  903. 
penalties  for  failure  to  pay,  904. 
priority  of  federal  taxes,  872. 
procedure  in   case  of  banks   improperly   taking  deduction    for   taxes 

paid  for  shareholders  in   1919,   620. 
profits  from  sale  of  property  paid  by  vendee,  552. 
securities  taxes  deductible,  612. 


INDEX  1503 

[References  are  to  pages.^ 

TAXES— Continued. 

state  tax  on  Massachusetts  trust  companies,  612. 
suits  for  collection  of,  808. 
taxes  not  deductible,  G13. 

assessments  against   local  benefits,  (315. 

state  inheritance  taxes,  616. 

taxes   paid   under   tax-free  covenants,   616. 
treated  as  dividends  when  paid  for  shareholders,  506. 

TAX-FREE   COVENANT  BONDS, 

effect  of  covenants,  997. 

examples  of  covenants  to  pay  taxes,  1001. 

how^  exemption  from  withholding  obtained  in  case  of,  983. 

object  of  withholding  provision  in  case  of,  1000. 

procedure  of  corporation  issuing,  1000. 

rate  of  tax  to  be  withheld,  999. 

tax  paid  by  debtor  on  account  of,  552. 

when  covenants  are  within  the  statute,  997. 

when  covenants  operate,  997. 

withholding  at  source  on  interest  of,  974. 

withholding  in  case  of,  998. 

TAX  ON  EMPLOYMENT  OF  CHILD  LABOR, 
See   Child   Labor   Tax. 

TAX  SIMPLIFICATION  BOARD, 

established  by  1921  Law,  duties  of,  7. 

TEACHERS, 

taxability  of  salaries  of,  383. 

TELEGRAPH   OFFICES, 

not  subject  to  child   labor  tax,  1251. 

TELEPHONE  COMPANIES, 

exemption  of  local  organizations,  331. 

not  subject  to  child  labor  tax,  1251. 

taxation  of,  when  taken  over  by  government,  272. 

TENANTS, 

amounts  received  by,  as  compensation  for  vacating  promisos,  538. 

deduction  of  repairs  made  by,  586. 

deduction  of  taxes  paid  by,  613. 

depreciation  allowed  to,  681. 

payments  by,  on  behalf  of  landloril.  499. 

value  of  improvements  made  by,  497. 

TENTATIVE  RETURNS, 

See  Returns. 

TERRITORIES, 

interest  on  obligations  of,  488. 

taxing  subdivisions  of,  deduction   of  taxes   paid   to,  ()12. 


1504  INDEX 

[References  are  to  pages.l 
TEXAS, 

community  propei-ty,  49. 

THEFT, 

losses  arising  from,  638. 

TIMBER, 

aggregating  timber  and  land  for  purposes  of  valuation  and  account- 
ing,  771. 
charges  to  capital  and  to  expense,  770. 
computation  of  depletion  for  given  year,  769. 
;'epl€tion  and  depreciation  accounts  on  books,  772. 
depletion  of,  767. 

determination  of  fair  market  value  of,  768. 
determination  of  quantity  of,  769. 

information  by  taxpayers  claiming  depletion  of,  773. 
revaluation  not  allowed,  770. 

TIPS, 

constitute  income,  369. 

TOBACCO  PLANTATIONS, 

not  subject  to  child  labor  tax,  1251. 

TONTINE  INSURANCE, 
income  from,  553. 

TRADE-MARKS, 

depreciation  allowed  in  case  of,  682. 

may   be   included   in   invested   capital,    1049. 

obsolescence  in  case  of  distillers  and  liquor  dealers,  699. 

proof  of  value  of,  433. 

terms  of  in  various  countries,  684. 

TRADE  OR  BUSINESS, 

conduct  of,  within  possession  of  United  States,  41. 

defined,  625,  1018. 

examples  of,  1019. 

examples  of,  taxed  under  1917  excess-profits  tax  law,  1022. 

losses  not  sustained  in,  623. 

losses  sustained  in,  622. 

when  losses  sustained  in,  626. 

with  no  invested  capital,  1021. 

TRADING  STAMPS, 

subtraction  for  redemption  of,  588. 

TRANSFERS  OF  STOCK, 

See  Stamp  Tax. 

TRANSPORTATION  SYSTEMS, 
expenses  deductible  by,  272. 
standard  return,  272. 
taxation  of,  270. 


INDEX  1505 

[References  are  to  pages.] 

TRAVELING  EXPENSES, 

claims  for  deduction  of,  568. 
deduction  of,  under  1921  Law,  567. 
deduction  of,  under  previous  laws,  567. 
may  constitute  income,  367. 

TRUSTEE   IN  BANKRUPTCY, 

income  taxable  in  hands  of,  244. 

TRUSTEES, 

See   Fiduciaries. 

transfers  of  stock  to  and  by,  stamp  tax  on,  1183. 

TRUSTS, 

See   Fiduciaries. 

distinguished  from  associations,  1141. 

stamp  tax  on  sales  or  transfers  of  stock,  1181. 

when  taxable  as  corporations,  215. 

U 

UNDISTRIBUTED   PROFITS  OF  CORPORATIONS, 
surtax  on  stockholders  in  respect  of,  29. 

UNITED  STATES, 
defined,  10. 
exemption  of  pensions  from,  37. 

UNITED  STATES  POSSESSIONS, 

citizens  deriving  income  from,  41. 

V 

VALUE, 

See  Market  Value. 

VALUE  AS  OF  MARCH  1,  1913, 

use  of,  in  determining  gain  or  loss  from  exchanges,  407. 
use  of,  in  determining  gain  or  loss  from  sales,  413. 

VERIFICATION, 

by  persons  abroad,  837. 

in  army  and  navy,  837. 

of  returns,  836. 

who  may  administer  oaths,  836. 

VICTORY  NOTES, 

See  Liberty  Bonds. 

VINEYARDS, 

obsolescence  in  case  of,  703. 

VOCATIONAL  REHABILITATION  ACT, 
amounts  received  under,  exempt,  355. 
exemption  of  allowances  received  under,  37. 


1506  INDEX 

[Refe7-ences  are  to  pages."] 

VOTING  TRUST  CERTIFICATES, 
no  stamp  tax  on  issue,  1176. 
stamp  tax  on,    1224. 
stamp  tax  on  transfers,  1182. 

W 

WAR  FINANCE  CORPORATION  BONDS, 

exem.ption  of  interest  upon,  488. 

WAR-PROFITS  TAX, 

See  Excess-Profits  Tax. 

applied  to  1918  only,  1017. 

apportionment  of  credit  of  corporations  reporting  for  part  of  year, 

1110. 
corporations  deriving  income   from  government  contracts,   1027. 
corporations  which  had  no  prewar  period,   1109. 
imposed  by  1918  Law,  1017. 
minimum  war-profits  credit,  1109. 
nature  of,  1017. 

omitted  from  present  law,  1015. 
penalties,  1138. 
prewar  period,  1032. 
rates  of  tax,  1017. 

time  and  manner  of  paying  tax,  1137. 
war-profits  credit,  1108. 

of  corporations  with  income  from  government  contracts,  1110. 

of  fiscal  year  corporations,  1110. 

WAR  RISK  INSURANCE  ACT, 

amounts  received  under,  exempt,  37,  355. 

WAR  SAVINGS  STAMPS, 

income  from  sale  of,  551. 

WEARING  APPAREL, 

depreciation  of,  682. 

WITHHOLDING  AGENTS, 
appointment  of,  966. 
defined,  90,  965. 

distinguished  from  resident  agents,  89. 
nominal  stockholders  are  not,  95. 

WITHHOLDING  AT  SOURCE, 

See   Ownership   Certificates;    Resident    Agents. 

against  agents,  980. 

against  citizens  and  residents,  978. 

against  citizens  of  United  States  possessions,  978. 

against  corporations,  979. 

against  employees  of  mining  contractors,  982. 


INDEX  ^^^"^ 

[References  are  to  pages.'\ 

WITHHOLDING  AT  SOURCE— Continued, 
against  fiduciaries,  148,  978. 
against  foreign  fiduciaries,  151. 
against  nonresident  aliens,  978. 
against  partnerships,  175,  979. 
against  personal  service  corporations,  979. 
against  whom  tax  is  withheld,  978. 
appointment  of  withholding  agent,  966. 
bond   interest,  972. 
bonuses,  968. 
by  fiduciaries,  148. 
by  foreign  fiduciaries,  151. 

by  partnerships,  175. 

car-trust  certificates,  976. 

change  of  status  of  employee,  982. 

commissions,  967." 

credit  of  tax  withheld  in  case  of  estates,  132. 

credit  of  tax  withheld,  to  nonresident  aliens,  83. 

discussed  generally,  17. 

dividends,  968. 

duty  of  employee  to  determine  status  of  alien  employees.  981. 

duties  of  assignees,  983. 

equipment  trust  certificates,  971. 

examples  of  covenants  to  pay  taxes,  1001. 

exemption  from,  983. 

fixed  or  determinable,  annual  or  periodical,  966. 

foreign  partnerships,  192. 

in  case  of  corporations,  269. 

in  case  of  enemies,  994. 

in  case  of  foreign  corporations,  305. 

in  case  of  promissory  notes,  972. 

in  case  of  tax-free  covenant  bonds,  997. 

in  case  of  unknown  owners,  976. 

insurance,  968. 

interest,  969. 

interest  on  bonds  containing  tax-free  covenant,  9(4. 

interest  on  bonds  not  containing  tax-free  covenant.  973. 

interest  paid  in  scrip,  977. 

mercantile  accounts  current,  971. 

no  withholding  on  bank  deposits,  969.  ,      ,r,i.r, 

object  of  provision  in  case  of  tax-free  covenant  bonds,  1000. 

on  what  payments  withheld,  964,  966. 

penalties  for  failure  to  file  returns.  903. 

procedure  of  corporation  issuing  tax-free  covenant  bonds.  1000. 

profit  sharings,  968. 

race-track  winnings,  971. 

rate  of  tax  to  be  withheld,  964. 

rate  of  tax  to  be  withheld  in  case  of  tax-free  covenant  bonds,  999. 

receipts  for  taxes,  withheld,  882. 

release  of  excess  tax  withheld,  993. 

rent,  972. 


1508  INDEX 

[Refe7'ences  are  to  pages.} 

WITHHOLDING  AT  SOURCE— Continued. 

return  of  income  from  which  tax  withheld,  995. 

return  of  tax  withheld,  993. 

royalties,  972. 

salaries,  967. 

salaries  of  partnerships,  967. 

tax-free  covenant  bonds,  how  exemption  obtained,  983. 

who  are  required  to  withhold  tax,  980. 

withholding  agent,  defined,  965. 

"WORKMEN'S  COMPENSATION, 

amounts  received,  as,  exempt,  354. 
exemption  of  income  from,  556. 

WORKSHOPS, 

subject  to  child  labor  tax,  1250. 

WORTHLESS  DEBTS, 

See  Losses,  127. 

charging  off  in  part  under  1921  Law,  655. 

deduction  of,  by  estates  and  trusts,  127. 

deduction  of,  in  general,  647. 

effect  of  war  conditions  on  deduction  of,  652. 

endorsement  of  notes,  649. 

existing  prior  to  March  1,  1913,  648. 

foreclosure  of  mortgages,  653. 

must  be  charged  off  on  books,  650. 

reserves  for,  under  1921  Law,  655. 

Russian  bank  deposits,  653. 

treatment  of  in  case  of  installment  sales, 

voluntary  forgiveness  of  debt,  651, 

when  considered  worthless,  650. 

when  deductible,  648. 

when  deductible  under  1921  Law,  655 

worthless  securities,  654. 


.%;- 


1 

D     000  327  209     3 

